No room for complacency

The monetary policy recognises the contextual challenges, particularly banking sector ailments relating to high non-performing loans (NPLs) and limited competitive behaviour, overvalued exchange rate, stock market doldrums, absence of corporate bond markets and still high inflationary expectations. It’s assessment of the global economic outlook is realistic. However, the monetary policy statement (MPS) appears to be somewhat complacent on the domestic growth outlook and the state of liquidity in the money and foreign exchange markets.

The monetary programme can be described as somewhat contractionary with the broad money growth target of 12.5 percent below the projected 14.2 percent growth in nominal GDP. One cannot help but wonder whether the policymakers have become too cautious “not to impair attainment of the targeted inflation containment”, given that most of the surveyed public expect near-term inflation to be over 6 percent and aggregate demand is projected to remain strong.

The target for private sector credit growth in FY20 is reduced to 14.8 percent relative to the 16.5 percent target for FY19.  Perhaps this is an attempt to correct the over 5 percentage points underachievement of the private credit growth target in FY19.

However, the question is whether this would suffice to finance the volume of private investment needed to attain the 8.2 percent GDP growth target. With an incremental capita output ratio of 4.2, achieving 8.2 percent GDP growth will require the investment rate to be 34.4 percent of GDP.  Assuming one quarter of this to come from the public sector, the private investment rate will need to be 25.8 percent of GDP with a nominal volume of Tk 748,100 crore in FY20.  A 14.8 percent growth from the stock credit to the private sector at end-June 2019 means the nominal volume of private credit will be Tk 149,500 crore, constituting just about 20 percent of the required volume of private investment in nominal terms in FY20. 

Historically rapid private sector credit growth has supported Bangladesh’s strong economic performance. The ratio of private credit flow to private investment was 23 percent and 25 percent in FY17 and FY18 respectively. However, the correlation between the change in the private credit to GDP ratio and real activity has diminished and the degree of co-movement of financial and real variables has weakened.  Rapid deterioration of credit quality in recent years in a weakly capitalised banking system perhaps led the Bangladesh Bank to be concerned about the capacity of the financial sector to support a large increase in private demand for credit. If this indeed is what motivated the setting of a conservative target for private credit growth in FY20, one cannot help but wonder where the rest of the needed financing will come from in a year when the government has introduced a 15 percent tax on retained earnings exceeding 50 percent of the paid-up capital, thus discouraging corporate saving.

Indeed, it is in this area of what the BB envisages to do to address the challenge of improving the quality of private sector credit that the MPS has been most short. All it says is that the liquidity stress emerging in one weak bank or another “can best be handled on case-by-case basis as and when needed.” This is neither here nor there. It does not constitute statement of a policy signalling to weak banks that liquidity support will be conditional on a credible corporate plan to improve their balance sheets and compliance with the macro-prudential regulations. Anchored on such a policy stance, a higher private sector credit growth target in the 16-17 percent range could have given the real investors much better comfort.

The exchange rate policy stance is not clear either. There is no indication of any shift towards greater flexibility, notwithstanding the recognition of the failure to correct overvaluation. The MPS seems to draw a lot of comfort from the substantial narrowing of the current account deficit in FY19. It projects further narrowing of the current account deficit in FY20, so much so that the overall balance of payments (before reserve changes) is projected to turn into a surplus. This may have diminished the sense of urgency to change from business as usual on exchange rate management.  The fact is the real effective exchange rate (REER) is still significantly overvalued. According to BB’s own calculations the REER-based exchange rate is 5 percent higher than the currently prevailing interbank average taka-US dollar rate. In a world of intense price competition in export markets, such overvaluation seriously matters. Therefore, there is no room for complacency.  

The author is an economist.