Apolitical budget of non-political government: What does it mean for inflation?

Syeed Ahamed and Jyoti Rahman

Published in Daily Star (11 June 2007)

Joseph Levine, a Hollywood movie director, once said that: “You can fool all the people all the time if the advertising is right and the budget is big enough!” He could not possibly have known how literally successive political governments of Bangladesh followed this approach.

While a non-political government is in office, no budget is apolitical. Like all previous budgets, this, too, sits in its own political context. The government’s political reform agenda is inexorably linked with macroeconomic conditions in general, and rising inflation in particular.

Pundits point to three reasons for the recent rise in inflation: lack of competition, an overheating economy and price rises globally. The current rise in inflation is largely food-price driven — food items comprise nearly three-fifths of the consumer price basket, and food prices have recently outpaced non-food prices by well over 2.5 percentage points.

Conventional wisdom holds that wholesalers and distributors, taking advantage of a lack of effective laws and institutions against anti-competitive behaviour, have engaged in price gouging. What does this budget mean for each of these causes? And what more, if anything, could the government do?

To stabilise food prices, the budget recommends removal of import duty on some essential food items, as well doubling of imports of rice and wheat. While these measures will help, an effective food distribution system would be more effective in stabilising food prices in a non-competitive market dominated by a few big suppliers.

In the longer term, however, there is no substitute for an independent competition watchdog to fight market collusion. This is something that the government should consider as part of its broader institutional reform agenda.

Higher inflation usually points to an overheated economy. In recent periods, increased remittances, revenue from increased exports, and rapid credit growth, have all boosted aggregate demand. Aggregate supply may not have kept pace with demand.

Among other things, energy shortage has hampered the economy’s supply potential. The result has been festering inflation. Against the backdrop of inflation, and without the political pressure faced by a government seeking re-election, the expectation was for a small budget.

This budget is perhaps not as ambitious as some immediate reactions suggest — excluding the liability of Bangladesh Petroleum Corporation, it is only half a percent of GDP higher than the last revised budget.

Nonetheless, there is still a risk that financing the budget would fuel inflation if the government ends up borrowing from the central bank, as this will increase money supply. On the other hand, if borrowing from the commercial banks finances the budget, this would drive up domestic interest rate and discourage private investment.

The economy is already supply-constrained, and a lack of private investment is a major challenge to growth. Crowding out private investment is hardly going to help combat inflation in this environment.

So what could the government do in this area? The revenue budget can only be tackled through reducing the size of the government. This takes time and strong political mandate, and it’s not clear how much the current government can do in this budget except to set in train motions that can be carried through by future political governments.

The government could, however, seek greater foreign financing of the development budget. As it has already embarked on much of the structural reforms — fast tracked privatisation, rationalising energy prices, anti corruption drive — the government should negotiate more foreign financing, preferably through grants.

Further, a larger annual development program (ADP), with ambitious rural development plans, broadening of social safety net, and reassigned old programs of previous half-finished ADP, also poses the risk of increasing money supply. To mitigate this, generation of self-employment at the rural level should be prioritised. Plus, technical assistance projects should be given priority during implementation.

Higher inflation is a regional development and has origins beyond our border — higher fuel prices and rising food prices in the global market have fuelled our inflation. As discussed above, the proposed budget does remove tariffs on food items and increases food import, but the effectiveness of these policies will crucially depend on the microeconomics of food distribution.

In addition to the budgetary measures, exchange rate policies could help protect against high food prices in the global market. An appreciating taka will make imports cheaper. However, this will also make exports dearer.

The government faces a trade-off — should consumers be relieved at the expense of the exports sector? It is a difficult trade-off, and, in any case, without microeconomic policies to ensure competition in the long term and assist food distribution in the short term, exchange rate adjustments by themselves probably won’t stabilise prices.

So what does the proposed budget mean for inflation? The budget proposes some concrete measures to stabilise food prices. Now these need to be reinforced by complementary microeconomic policies. Otherwise, further financing of the budget through borrowing could itself be inflationary.

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