Contradictions in economic policies

The PRS lists a number of key indicators that must be improved upon in order to reduce the impact of poverty. These are: employment, nutrition, quality education, local governance, maternal health, sanitation and safe water, criminal justice and monitoring. A little thought will reveal that no improvement in these indicators is possible without a significant increase in GDP. In the absence of any radical redistribution of income, a reduction in poverty will also require a high economic growth.

The pattern of development of Bangladesh in the recent past has followed the classic textbook case where greater development comes at the expense of greater income inequality. Given the political landscape of the country, there is little prospect of this situation changing substantially in the foreseeable future. This would imply that the only way to reduce poverty quickly would be to accelerate economic growth. The current growth rate of 5-6 per cent would reduce poverty at a painfully slow rate.

It is widely believed that a substantial dent in poverty cannot be made without a growth rate of 7 per cent or higher. The PRS does strategise for such a growth rate beyond fiscal year (FY) 2007. This would require an investment ratio of about 30 per cent, i.e. an increase of 5.6 per cent from the PRS benchmark. (The PRS envisages an increase in investment ratio to only 26 per cent; it is not clear how 1.5 per cent GDP growth can be achieved with an increment in investment ratio of only 1.6 per cent.)

It is a proven fact that the government does not have the capacity to undertake much productive investment except in some infrastructure activities. Thus the bulk of the required investment will have to be done by the private sector, both domestic and foreign. This would require a conducive investment environment. According to a number of studies, investment climate in Bangladesh is not sufficiently business-friendly.

Even before the PRS was launched, some of the other policies of the government negated its fundamentals. Although the PRS clearly suggested a growth target of 6.5 per cent for FY2006 rising to 7 per cent in FY2008 for making a small reduction in poverty possible, the MF decided in early 2005 that economy suffered from an excess demand (inflationary) situation although the growth rate was only 5.5 per cent. It deliberately held back the economy by putting on monetary brakes. The liquidity crunch that followed raised the interest rates by 1-3 per cent. In particular the market lending rate increased by 2-3 per cent. The higher borrowing cost must have reduced investment in the formal sector.

Although we shall not know the rate of investment until later, we can get some feel of the situation from the import data since most of the capital machinery needed for investment is imported. LC opening for import of capital machinery showed a reduction of 7.3 per cent during July-March 2005-06 over the same period in 2004-05 while that for import of intermediate products declined by 4.2 per cent. These figures would suggest a downturn in business investment in the country.

It is known that domestic credit and imports are highly correlated, and so are imports and output. A reduction in credit reduces imports (as has been the case during the first three quarters of FY2006). Falling imports in turn reduces the growth of output. Thus, a tight monetary policy prevents any acceleration of economic growth. We may expect the growth rate this fiscal to be lower than that last year (6.5 per cent), which in any case was one of the lowest in the SAARC region.

It is an unsavoury indictment of our economic policy and management that the country is growing at a slower rate than the civil war ridden countries of the region. The modest growth rate of Bangladesh economy all but eliminates the prospect of reducing poverty significantly as envisaged in the PRS.

Prices of fuel oil increased very markedly in the international market last year and show no sign of declining. The MF seems to have misread the situation; it stubbornly resisted raising domestic prices of fuel oil in line with the import cost. This was ostensibly not to displease the electorate before the election.

However, as the prices of oil climbed, the cost of financing the implicit subsidy mounted. The public commercial banks and Bangladesh Petroleum Corporation were seriously stressed financing the galloping subsidy. When it became apparent that the subsidy was unsustainable, the MF finally raised the prices of fuel oil just a few weeks ago. The damage done to the electoral fortunes of the coalition due to the higher oil prices will obviously be greater now than if the prices were raised last year.

One policy faux pas usually leads to another. The rapidly deteriorating oil deficit lead the MF to consider instructing BPC to borrow a quarter of a billion dollar from a private foreign bank reportedly at an interest rate of LIBOR plus1.75 per cent. If the BPC had borrowed say in April when the LIBOR (US$, 6-months) was about 5.25 per cent, it would have been required to pay back the principal in six months' time with an interest payment of $8.75 million. The government could also have loaned out the money to BPC on the same conditions from the substantial international reserves of Bangladesh Bank, which earned interest of only about 4 per cent. For six months Bangladesh Bank would have had a quarter billion dollar less reserves and thereby foregone $5 million in interest income; but at the end of this period its reserves would have been replenished not only by a quarter billion dollar, but also by $8.75 million in interest income, a net gain of $3.75 million. It was never transparently explained why the MF wanted to hand over $3.75 million net to a foreign bank rather than its own central bank. There was predictably a public outcry from the economists. The MF finally did not execute the deal.

How can such policy dilemmas and mistakes be prevented? If the relevant ministries are manned by well-qualified officers who have the capacity to correctly analyse domestic and international economic trends, and the ministers are wise enough to rise above petty politics and self-interest to take decisions for the general good, such problems need not arise. But this is a tall order even in a highly developed country; it is most unlikely to be realised in Bangladesh.

Noting that the problem arises because the government has a monopoly in oil import, a feasible option is to take away the political element from petroleum pricing by allowing the private sector to participate in petroleum import. Petroleum price would then be determined by market forces. This should also improve the efficiency of the petroleum market just as the privatisation of agricultural input trade in the early 1980s greatly increased the efficiency of the agricultural input market and the floating of the exchange rate in 2003 improved the functioning of the foreign exchange market.

Incorrect economic policies hold back the economy from realising its full potential. Generations of people may be deprived of fruits of economic development and an opportunity to lead a decent life because of the mistakes of the policy makers. There is no dearth of such examples from both within and outside the country. The nation will be spared large social costs if our policy makers learn from past policy gaffes.

The author is a Professor of Economics, University of Dhaka.