Dr. Mirza Azizul Islam, Professor, BRAC Business School, BRAC University

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In conversation with Asif Tarafdar, Dr. Mirza Azizul Islam, Professor, BRAC Business School shares his opinion about re-thinking our exchange rate policy, the falling stock market and effective ways of containing inflation.

In recent years, while Bangladesh’s major competitors in the global market, such as China, Vietnam, India, and Sri Lanka, have experienced significant depreciation of their currencies against the US dollar, Bangladeshi taka remained quite stable. How important is it to re-think our exchange rate policy to stay competitive in global trade?
The case in point is Bangladesh taka remained stable while the exchange rates of a number of neighboring countries particularly competitors of Bangladesh in respect of export specifically garment exports have depreciated. Well firstly, Bangladesh taka has also depreciated as current rate is about taka 84.9. And two years back, it was somewhere around 80 per dollar. But of course, the magnitude of the depreciation is probably somewhat lower compared to other countries. So, the question is, whether a devaluation will increase our exports?

Now, the basic argument underlying exchange rate devaluation is that it will lead to more revenue for Bangladeshi producers. Therefore, they will increase their supply in the international market and they will move along the supply curve. But there are a number of issues that might arise from such a move. First of all, unlike countries such as China or India, our exports are heavily dependent on imported inputs. So if there is a devaluation, the cost of production will also increase because the imported inputs.

Another problem that may arise is that, an exchange rate depreciation might increase domestic inflation. Now when the domestic inflation increases there will be pressure from the workforce to raise their salary level leading to an increase in the cost of production.

Thirdly, if the exchange rate is deprecated, foreign buyers may try to negotiate for a lower price in dollar terms. The purpose of devaluation is to ensure producers get more money for the same dollar value. However, often the exporter complains that the foreign buyers are constantly pressing for reduction of prices and in fact, the unit prices have gone down in recent time. So if they succeed in negotiating a lower dollar price, that means the part of the benefit of devaluation will be transferred to the foreign buyers.

So there are concerns but that does not mean that we should not give some thought to further the generative evaluation, but I think it should be the implications that I have just mentioned should be carefully analyzed and then on that basis they should take a decision. So, just because there is some demand from some quarters, the central bank should not execute such a measure without making a thorough examination of the potential consequences of devaluation.

I have found that money supply and inflation are not very much directly related in Bangladesh.The primary factor which is responsible for inflation in Bangladesh is the exchange rate. If the exchange rate de-values, inflation increases.

Due to the falling stock market index, small investors are losing their investments and facing an uncertain future? (General investors lost Tk 15,000 crore, due to falling index) What are the remedial policy initiatives that can be taken to rekindle faith in the stock market and bring back investors?
It is indeed very unfortunate that the stock market index has been falling for quite some time and in fact, now it has sunk even lower, the DSC index lost 76 points and it is now 4,419 which is less than half of the highest index that was in December 2012 (9812). There are a number of reasons for this eventuality. First, from time to time, it has been observed that there was a lack of coordination and understanding among the various regulatory authorities.

For example at some point, Bangladesh Bank had put a limit on the investment by the banks in the stock market. Then they also imposed the requirement that subsidiaries of the banks, which may be a mutual fund or non-bank financial institutions, their investment would also be counted as a part of investment by the bank. Thirdly, it was also postulated that investment by the commercial banks in the unlisted company’s shares would also be treated as a part of the overall investment. Now, these things had a negative effect on this stock market and later on, Bangladesh Bank retracted the decisions, so the problems have been solved to some extent. However, incidents like this create a lack of confidence in the overall market scenario.

Concurrently, there have been other regulatory issues. For example at one point, Titas gas decided to reduce the wheeling charges of gas that had an effect on the stock market because of substantial shares in the stock market. Then the problem with Grameenphone which still remains alive because there has been no resolution of the conflicting claims by the stakeholders and regulatory boards. GP is the single largest company in this stock market, so the news had a negative effect on the stock market. Additionally, the banking sector has been riddled with ever-rising problems of non-performing loans. According to the latest count on September 2019, the amount of NPL was Tk 114 lakh crores which both in absolute terms and in total proportions is the highest in recent history. So this huge volume of NPL is causing loss of confidence in the banking system. And the growth of deposits into the banking system has been falling. As a result, banking sector shares have gone down and it is still this sector as a whole account for a substantial portion of the total stock market capitalization.

In addition, the banking sector problems create another situation where some of the investors borrow money from the banks and invest in the stock market. But because of slowing down of deposits, the banks are not in a position to extend credit to the private sector and the growth of credit to the private sector has come down now to about 10% which is way below the monetary policy target of 16% plus. These factors coupled with the GP crisis started a panic selling in the market. So these are the main reasons behind the distress of the stock market.

The banks are not in a position to extend credit to the private sector and the growth of credit to the private sector has come down now to about 10% which is way below the monetary policy target of 16% plus.

The standard transmission channel of monetary policy is that an increase in the money supply would cause a reduction in interest rate; this would lead to a rise in investment and thereby higher aggregate demand and higher GDP. The experience in Bangladesh shows that this link does not work effectively, what is the reason behind that?
Well for a country like Bangladesh monetary policy is not very effective. Because a large part of the money supply comes from net foreign assets, which is dependent on exports and remittance where Bangladesh Bank has very little control over. Borrowing by the government is also part of the money supply, where the central bank has no control over. And the same thing applies also to various other government bodies that are autonomous and statutory corporations. So a large part of the money supply is outside the control of the central bank.

There isn’t really a strong link between money supply and interest rate. And that’s partly because our banks especially the private banks do not operate on the basis of competitive principles they set the interest rates both for lending and deposit collusively and as a result, even there have been many years and money supply has increased but the interest rate has actually gone up. Consequently, monetary policy, in general, is not effective in Bangladesh and is not an effective tool to control inflation. So given all those points that I mentioned. I don’t think monetary policy in Bangladesh can be very effective in accelerating GDP growth.

The purpose of devaluation is to ensure producers get more money for the same dollar value. However, often the exporter complains that the foreign buyers are constantly pressing for reduction of prices and in fact the unit prices have gone down in decent time.So if they succeed in negotiating a lower dollar price, that means the part of the benefit of devaluation will be transferred to the foreign buyers.

What can be done to ensure the effectiveness of monetary policy in containing inflation?
I have found that money supply and inflation are not very much directly related to Bangladesh. The primary factor which is responsible for inflation in Bangladesh is the exchange rate. If the exchange rate de-values, inflation increases.

The second issue is that, as we are importing raw materials and capital goods. Prices in the international market affect our inflation and we cannot free ourselves from that problem because it would be unthinkable to be able to substitute those imported inputs with domestic production in the near future.

So, I don’t see any particular way in which monetary policy can be made more effective in containing inflation. However, we may try to increase domestic supply of goods and services through use of monetary policy. The Bangladesh Bank and also the commercial banks themselves ensure that the credit that is flowing to the private sector is actually used. For productive investment then the domestic supply of various goods and services will increase and that will have a positive effect.

Unfortunately in many cases, the credit that flows is not used for productive purposes, some of it goes into the trade. I have seen that the agricultural loan is given to someone who uses to buy a motorcycle or to construct a house. So, these are not reproductive investments. In some cases, there are complaints and that the money is actually eventually sort of smuggled out of the country. So the objective should be to make use of monetary policy to increase the supply of output. So that if the supply increases then price level is likely to come down.

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