Published : 20 Apr 2013, 01:10 AM
The external balance of the economy is apparently in good health. The current account has remained positive for eight years in a row. The robust flow of remittances continues unabated. Exports are growing at a respectable rate. The coffer of the nation is brimming with foreign reserves. There has been an unprecedented strengthening of the domestic currency since January 2012. Ordinarily these should imply a robust health of not only the external balance, but also the national economy. However, appearances sometimes can be misleading.
The stock of international reserves now stands at nearly $14 billion. It is enough to pay for our imports of about five months. This is a comfortable level of reserves albeit not nearly as good as some of the Asian countries. The comfort level is also suggested by the expansive comments about the reserves made by some government leaders.
The stock of reserves could be compared to the bank account of a company or an individual. The size of the account is usually regarded as an indicator of the health of the account holder: the larger the account the more prosperous the holder. However, there are situations in which the size of the account can be misleading. For example, a large size of the account could be due to large bank loans taken out by the company (or the individual) on which it eventually defaults (recall Destiny or Hallmark). It is not just the size of the account, but also how it was acquired that matter.
The stock of international reserves can be built up in many ways, and some of these do not necessarily augur well for the economy. If the government borrows, say two billion dollars, from the international market at a high interest rate, the reserves will go up by two billion dollars soon after the deal is done. But the government will have incurred a liability of paying hefty interest charges and the principal during the period of the loan. Unless the borrowed money is put to good use, the stock of reserves could be at a lower level than that when the loan was taken.
Chart 1 shows the monthly movement of international reserves since July 2002. The stock of reserves grew steadily till the end of 2008, increasing by $4.2 billion during this five and half year period. But the very next year reserves made a quantum leap of $4.8 billion to stand at $10.3 billion at the end of the year. The level of reserves remained virtually unchanged during the next two and half years. But during the first eight months of FY2012-13 the reserves again increased sharply by $3.5 billion to reach $13.8 billion.
It is sometimes suggested that the robust flow of remittances caused these sharp increases. However, the time series of remittances does not support such a conclusion. The steadily rising inflow of remittances certainly contributed to the trend growth of reserves, but the spurts are unlikely to have been caused by such inflows. The growth of remittance inflow was particularly strong in 2008 but reserves did not increase much, which however shot up the next year when the remittance growth had declined markedly.
Chart 1 reveals a strong relationship between a sharp increase in reserves and a collapse of imports. When imports grew around the trend, the stock of reserves also grew randomly around the trend. But when imports fell off sharply, the stock of reserves shot up.
A reduction in the level of imports has exactly the same immediate implication on the overall balance of payments, and hence on the reserves, as an increase in exports or remittances. If imports had grown this year at the same low rate as that of the last year (5.47 percent), total import payments during the first eight months would have been about $3 billion higher than what was actually spent, and consequently reserves would have been lower by this amount. The stock of reserves would then have grown around its trend path. Thus it would seem that the principal factor assisting the large growth of reserves during this fiscal year was the sharp reduction in imports.
The other factor that helped the growth of reserves is foreign loans. The government has recently allowed some corporations to borrow money from overseas at commercial terms (bdnews24.com, 9 April 2013). This decision is intimately linked to the monetary policy of the country. By allowing overseas borrowing, the monetary authorities have prevented both a tightening of the domestic credit market and a reduction of the reserves.
The collapse of imports this fiscal year is due partly to the global economic slowdown and partly to the monetary policy. The global slowdown has reduced the import demand of our important trade partners and hence, our export receipts (for example, the growth rate of export to the USA has fallen off from an average of nearly 15 percent during 2010 and 2011 to almost zero in 2012). Since the import contents of our principal export products are fairly high, the reduction in export shipments has directly contributed to the reduction of our import demand.
The monetary policy of the country has been contractionary during the last year or so. Bangladesh Bank has reduced the growth rate of credit supply from 27.4 percent in 2010-11 to 19.6 percent in 2011-12 in consonance with the terms of an agreement with the IMF. The credit growth declined to only 7 percent during the first 8 months of 2012-13. Private credit grew by only 6.3 percent. Such modest rates of credit growth presage a slowing economy. BB has already revised its forecast of GDP growth downward considerably. Revised forecasts of international organisations are even lower.
One of the macro variables that declines during an economic slowdown is import demand since it is strongly related to income. It is only to be expected that imports will fall off during the current year. Imports have already declined by 7 percent during the first 8 months of FY2012-13. A matter of particular concern is that the import of capital machinery has declined by 18.5 percent and that of machinery for miscellaneous industries by 10.2 percent. These are suggestive of a large fall in investment during the first eight months of 2012-13. This dims the growth prospect of the future.
The decline in imports that we are experiencing now is a strong indication of an economic slowdown. The temporary sharp increase in reserves is due mainly to this slowdown and not to the vibrancy of the economy. Reserves cannot be increased indefinitely by reducing imports. Sooner or later falling imports will worsen the balance of payments and reserves rather than improve them.
Similarly the balance of payments and reserves can be improved by foreign borrowing only temporarily. Such borrowing is advisable only as short term fix when other sustainable adjustments are being made. If the economic situation does not improve, there will be a large hole in the balance of payments in the near future when the amortisation of the loans falls due, and this hole will need to be plugged from other sources.
The problems the economy is facing now are real problems which will not be resolved by monetary measures. The slump in investment demand cannot be reversed by tinkering with just interest rates and credit. The business sector, as well as others, is anticipating several months of political turmoil. The global slowdown, especially EU economic slump, will continue this year according to IMF forecasts. Power and infrastructure problems that dog the economy are likely to remain unaddressed or even worsen if the government continues with its business-as-usual attitude.
Each of the previous four governments since including the last caretaker government succeeded in significantly raising the average growth performance of the economy during its tenure (see Chart 2). The economy was poised for a leap to 7 percent growth trajectory in 2011-12. Unfortunately that golden opportunity has been sacrificed at the altar of corruption and confrontational politics. For the first time we shall have a fall in the average growth. It is particularly galling that the military-backed caretaker government that ruled under very adverse domestic and international circumstances such as repeated floods, food price explosion, public apathy, a financial meltdown and a deep recession in the West had a superior record of performance than that of the current elected government which did not face any major disasters except perhaps those of its own making.
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M. A. Taslim is the Chairman and Professor of the Department of Economics, University of Dhaka.