Last update on: Sun Mar 9, 2025 10:23 AM
Navigating the labyrinth of macroeconomic management is particularly challenging during periods of interim leadership. The fine equilibrium between fiscal, monetary, and structural policies takes on heightened significance.
This delicate balance of tightening and loosening measures, coupled with the alleviation of binding structural constraints, is pivotal in shaping the economic path. It impacts everything from inflation trends to public sentiment and confidence.
Encouraging but not reassuring
The February inflation data, while somewhat promising, does not convincingly indicate a shift towards a disinflationary trend.
The overall inflation rate fell due to a decline in food prices for the second consecutive month since December 2024. However, non-food inflation rose, with increases in categories such as clothing, footwear, health, recreation, and miscellaneous items.
As a result, the overall state of inflation remains concerning, with no clear evidence from the data suggesting a need for a monetary policy shift.
The deflation in food prices, particularly during peak supply seasons, is likely temporary, along with the diminishing effects of recent floods.
Lower tax rates on some essential food items, import liberalization, and exchange rate stability also contribute to the reduction in inflation.
The rise in non-food inflation likely reflects the recent VAT rate increases and heightened demand driven by booming remittances.
Given the evolving nature of these factors, it is evident that the current inflationary pressures require maintaining a tight monetary policy.
The persistence of non-food inflation underscores the complexity of the inflation landscape, where selective price reductions are insufficient to mitigate overall inflationary trends.
The jury is out on policies
Recently, the Bangladesh Bank reduced the cash reserve ratio to 3 percent on a daily basis while maintaining a bi-weekly average of 4 percent.
The policy rate has remained unchanged at 10 percent, with a 300-basis-point corridor since October 2024. Positive real terms for the nominal policy rate were observed only in January and February, at 0.06 percent and 0.68 percent, respectively.
The yield curve for government bonds experienced a downward shift, exhibiting fluctuations as government borrowing from banks decreased and there was a heightened aversion to private credit risk exposure.
Students of macroeconomic principles should retain their faith in the power of tight monetary policies to mitigate inflation.
The inescapable inference is that the real policy rate has not been sufficiently high nor maintained positive long enough to evaluate its success.
Its outcomes could either lead to a high societal cost or achieve the desired effect with minimal collateral damage.
Policymakers must rely on prevailing economic wisdom, remaining flexible and open-minded in their approach.
There is significant room for improvement in monetary-fiscal coordination to combat inflation. The upcoming FY26 budget must tackle this challenge directly.
If our primary aim is stabilisation, there is little room for risky policy moves such as broad subsidy expansion or major tax cuts, especially when the key factors that influence incentivisation, redistribution, or inflation reduction remain unchanged.
The agenda for action
Without structural policy reforms that eventually lead to productivity enhancements in the foreseeable future, or ideally right away, there is minimal scope for increasing overall spending beyond Tk 7-7.25 lakh crore in FY26.
This presumes that the budget deficit cannot exceed Tk 2-2.25 lakh crore and that revenues surpassing Tk 5 lakh crore are unattainable. Financing even this level of deficit will exert pressure on the flow of credit to the private sector unless deposit growth significantly exceeds the Tk 1.23 lakh crore observed over the twelve months ending December 2024 and/or net foreign financing accelerates beyond its usual pace.
The FY26 budget will serve not only as a litmus test for the interim government’s fiscal prudence but also reflect its dedication to enacting the economic reforms proposed in the White Paper and the Task Force Report.
The core issue is not the novelty of the recommendations but their relevance and feasibility. Relevance encompasses understanding the appropriate timing for each high-level recommendation, while feasibility involves translating the recommendations into practical steps.
Disregarding the recommendations on the grounds of their perceived lack of novelty amounts to disengagement from reform. This is not the case in areas such as banking, energy, taxation, and public expenditure, where progress, though slow, is indeed occurring.
However, they remain inconspicuous because their results are not immediately apparent.
What is their incentive?
Structural reforms necessarily involve short-term hardships for long-term gains. Given that the interim government will bear the brunt of these hardships, what incentive does it have to expedite the completion of these reforms, knowing it will not be in power post-election?
An interim government not elected by the populace, freed from the pressures of seeking re-election, is unencumbered by the populist motivations that often pivot reigning incumbents against reforms.
This temporary administration is uniquely positioned to take decisive action, as its most significant risk is the cessation of its governance, which is inevitable anyway.
However, it may still find it difficult to avoid populist measures, either due to a genuine, albeit potentially misguided, belief in their ability to enhance social welfare through such measures or because such decisions serve certain interests best. The path of least resistance could be tempting if it exists. These are the so-called “low-hanging fruits.” The risks and rewards associated with all these options are, if anything, uncertain.
One legacy the interim government would fervently wish to avoid is bequeathing a macroeconomic landscape as dismal as the one it inherited.
Should this eventuality transpire, the populace’s inevitable inquiry will resonate: “What did you accomplish, Sirs?” Thus, there exists no refuge from risk. We harbour the hope that the interim government’s economic management team will align themselves with the right side of history regarding economic policy and institutional reforms.
