Sunday, May 05, 2024
The introduction of a multiple exchange rate regime in September 2022 dis-incentivised remittance and export inflows, leading to a severe forex reserves shortage, which in turn triggered a financial account deficit, fueled external stress, as well as skyrocketing inflation.
This chain of complications weakened consumer sentiment and slowed private investments.
The World Bank, in its twice-year-update, pointed out, “The continued forex crunch has resulted in curtailment of key imports of intermediate goods and capital machinery, depreciation of the Taka against USD, elevated prices of gas, electricity, and petroleum products, compared to lower international commodity prices.”
Making the disclosures in a Media Briefing on the “World Bank’s April 2024 Economic Updates for South Asia and Bangladesh” at its office in the capital on Tuesday, the global lender added, “Urgent monetary reform and a single exchange rate regime will be critical to improving forex reserves and easing inflation.”
The latest Bangladesh Development Update says the exchange rate flexibility is crucial to removing forex market distortions and attracting inflows through formal channels.
“Persistent inflation eroded consumer purchasing power, while investment was dampened by tight liquidity conditions, rising interest rates, import restrictions, and increased input costs stemming from upward revisions in energy prices,” it further adds.
Replying to a question as to why inflation is yet to be tamed despite raising interest rate and implementing contractionary monetary policy, World Bank Country Director for Bangladesh and Bhutan Abdoulaye Seck says, “The public sector credit from banks to deficit financing is increasing, which is hitting inflation.”
Public sector credit growth increased to 34.9 per cent in FY23 from 27.2 per cent in FY22, due to deficit financing from banks including the central bank, while private sector credit growth was 10.6 per cent in FY23, down from 13.7 per cent in the previous year.
Private sector credit slowed in FY24, largely reflecting the decline in imports due to forex shortages.
“Monetary policy transmission remains impaired by a variable cap on bank lending rates. While the policy rate has risen by a cumulative 325 bps, real interest rates remain negative,” mentions the World Bank.
Ongoing challenges, recommendations
The global lender pointed out that persistent inflation, a balance of payments deficit, and financial sector vulnerabilities have dampened the country’s economic growth.
Several policies have been improved, including fuel price reform or adjustments, export subsidy reduction, monetary policy tightening, and the Prompt Corrective Action framework. The new Income Tax Act-2023 will help mobilising domestic resources and reduce fiscal stress.
It recommends removing interest rate caps to further improve monetary transmission, avoiding monetising the deficit in line with contractionary monetary stance to control inflation, reducing tariffs on essential imports to reduce inflationary pressure, strengthening revenue mobilisation, and mostly prioritising income tax and VAT instead of relying on trade-based tax.
For financial sector reforms, the World Bank recommends recognising non-performing loans (NPLs) and expediting bank resolution to reduce vulnerabilities and strengthen transmission.
“Bank mergers need to be carefully managed based on thorough assessment of asset quality, and clear guidelines,” says the global lender.
Economic projection
The World Bank says the real GDP growth is projected to remain relatively subdued at 5.6 per cent in FY24, compared to the average annual growth rate of 6.6 per cent over the decade preceding the Covid-19 pandemic.
Persistent inflation is expected to weigh on private consumption growth, and shortages of energy and imported inputs combined with rising interest rates, and financial sector vulnerabilities are expected to dampen investor sentiment, it says.
Relatively slower growth is projected to persist in FY25 at 5.7 per cent, driven by a modest recovery in private consumption supported by a moderation in inflation. Inflation remained elevated, with contributions from both external and domestic factors.
The World Bank added that the inflation is likely to remain elevated in the near term, and gradually subside if import prices stabilise, international commodity prices become moderate and are passed through to domestic prices, and appropriately contractionary monetary and fiscal policies are maintained over the medium term.
Headline inflation is expected to remain elevated at 9.6 per cent in FY24 before moderating to 8.6 per cent in FY25. However, the inflation trajectory depends crucially on the extent of transmission of the Bangladesh Bank’s contractionary monetary policy and the government’s fiscal policy stance.
The current account moved into surplus in FY24, driven by a substantial contraction in imports. In FY23, the current account deficit moderated to $3.3 billion, down from $18.6 billion recorded in FY22, as intermediate and capital goods drove a 15.8 per cent decline in imports.
Meanwhile, merchandise exports grew by 6.7 per cent, led by a 10.3 per cent increase in RMG exports.
In the first seven months of FY24, the current account moved into a $3.1 billion surplus. Imports contracted 18.2 per cent over this period, significantly higher than the contraction witnessed over the same period of FY23 because of restrictions on letters of credit.
So, the current account balance is projected to be at a surplus of 0.9 per cent of GDP in FY24, and 0.7 per cent in FY25.
