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Balance of payments: Recent developments and implications

March 10, 2012

Recent data released by Bangladesh Bank suggest that the pressure on the balance of payments has subsided somewhat. The stock of international reserves that had dipped below $9 billion a few weeks ago recovered and temporarily crossed the 10 billion dollar mark. This improvement has halted the slide in the dollar value of taka. The Tk/$ exchange rate had depreciated sharply to nearly Tk 85/US$, but the replenished stock of international reserves has pushed it up to about Tk 82/US$. Although it is too early to be confident that the improvement will last long, the monetary authorities must have felt relieved at this turn of events after several months of unfavourable developments. Indeed they might interpret this, with some justification, as the outcome of the monetary policy. There are at least three factors behind this improvement in the balance of payments. First, export earnings during the first six months of this fiscal year (July-Dec 2011) rose by 14.7 percent. Although this is much less than the very robust growth of 40.9 percent during the corresponding period last year, it may be regarded as a good performance given the recessive international economic environment. The export sector has again proved its resilience and competitive strength. Second, remittances from workers overseas have also grown well (9.3 percent during July-Dec 2011) after recording the lowest growth rate of this millennium during the last fiscal year (6 percent). The recovery in remittances occurred despite there being little progress in reopening some of the major labour markets in Muslim countries. It has been attributed to a substantial increase in the number of workers going to other destinations and the depreciation of taka. Third, import growth decelerated to 16.9 percent during the July-December 2011 period compared to 36.6 percent growth during the corresponding period of the previous year. The large depreciation of the exchange value of taka is believed to have played a role in this deceleration. The value of exports goods and services and remittances during the first half of 2011-12 exceeded that of imports such that the current account was in surplus during the JulyDecember 2011 period after temporarily moving into a deficit in November 2011. A reduction in the import demand is widely regarded as a good thing for the economy, especially among policymakers. It was explicitly stated to be an important objective of the current monetary policy. A slower import growth is usually interpreted as a switch to domestic goods and hence a boost to domestic production. However, this is not the full story. A very robust empirical finding of macroeconomics is the positive relationship between import and income; many macroeconomic theories are based in an essential way on such a relationship. A substantial slowdown in import may then be indicative of a slowdown in income growth rather than being a boost to domestic output. This is especially relevant in the case of Bangladesh. Table 1 below, drawn up from recent data provided by Bangladesh Bank, shows the structure of imports of the country. A striking feature of this structure is the unimportance of consumer products, which account for only about a ninth of the total import payments. Furthermore, most of the products in this category comprise food items such as cereals, sugar and edible oil. When the domestic production of cereals is adequate, the import of cereals declines such that the total import of consumer goods may also decline, and conversely. Good harvests of rice crops during the last year have permitted a very substantial reduction of cereal imports (61.8 percent) during July-December 2011.

*All growth rates are July-December over July-December of the previous year The next four categories of imports listed in the table, viz. intermediate goods, industrial raw materials, capital machinery and machinery for miscellaneous industry are all production related. The first two are directly related to current production while the last two are related mainly to future production (investment). These four categories of imports accounted for 61.3 percent of the total import payments in July-November 2011-12. Import of petroleum and petroleum products used up another 12.7 percent. These are also mostly used for production purposes such as electricity generation and transportation. Thus nearly three-quarters of the total import payments were directly related to current production and investment activities. The unimportance of non-essential consumer goods in the total import basket makes a policy to improve the balance of payments through curtailing so-called luxury consumption goods a non-starter. Any significant reduction in total import by such a blunt instrument as depreciation is likely to directly impact on productionrelated imports. It is well-known that the impact of a recession is usually felt first in investment activities; investment spending declines much more than total output. Hence, the policy to substantially reduce the total import bill would most likely imply a reduction in the import of production-related goods. BB data strongly suggest that this will happen during the second half of the current fiscal year. BB releases on a regular basis the value of letter of credit (LC) openings and settlements by various import categories. LC openings are a fairly accurate indicator of the import demand, while LC settlements show the realised demand. The value of LC openings during July-December 2011 shows a large 34.8 percent decline in the demand for capital machinery imports in stark contrast to a large 85.2 percent increase last year. This is indicative of the magnitude of the drop in actual capital machinery import that would eventuate during the second half of 201112. Another worrisome matter is the significant decline in industrial raw materials (8.7 percent). Either the industries are cutting back on production or running down their inventories. Total LC openings for all categories of imports (which will show up as the total import payments later) have also declined by 5.8 percent. But LC openings for import of petroleum and petroleum products have skyrocketed (103.4 percent). The reason for this perverse response of petroleum import demand to depreciation is the new demand of the gas-guzzling rental power plants. Government subsidies make their demand largely immune to depreciation or an increase in prices. Such a growth in import is not healthy for the economy. The large reductions in the LC openings for capital machinery, industrial raw materials as well as total imports are indicative of a slowing economy led perhaps by a slump in investment demand. Several macroeconomic indicators have moved in the wrong direction in the recent past. Table 2 shows the growth rates of some relevant variables. The variables listed under A are known to be positively correlated with

output (at least up to an upper limit), while those under B are thought to be negatively related. There is some evidence that at low levels, inflation may be positively related, or at least not harmful, to output; but there is little doubt that at high levels it exerts a powerful negative impact. At a double digit level, inflation might be regarded as a negative influence on output in Bangladesh, or at least not very helpful. All the variables listed under A have declined substantially between July-December 2010 and 2011. There has been an insignificant increase in the net amount of industrial loan disbursement during the first six months of the current fiscal year compared to over 34 percent increase during the same period of the previous fiscal year. The situation with agricultural loan is much grimmer. It declined by nearly 8 percent as against a healthy 11.2 percent increase last year. The growth of credit to the private sector has also decelerated substantially.

Table 2: Growth rates of Selected Macro-indicators These numbers together with the large reduction in the import of capital machinery and industrial raw materials and the increase in the loan rate would be indicative of a slump in investment relative to last year and a slowing economy. Much of the industrial growth is contributed by the export sector, but this sector has also decelerated. Its contribution to GDP growth will be less than what it was last year. A slowdown in industrial production is also suggested by a large reduction in the growth of VAT collection which declined from over 27 percent last year to only 9 percent this year (domestic VAT declined from 31 to 13 percent). It has just been reported in the media that the aman output of this fiscal year was virtually unchanged from that of the last year (Financial Express, March 3). The US Department of Agriculture has predicted a slight fall in this years boro output (Banik Barta, March 3). Such a reduction in grain output is not altogether unexpected. Poor harvest prices and large increases in the prices of inputs such as fertilisers and diesel have greatly reduced the profitability of production. Since aman and boro crops are the mainstay of agriculture, it would seem that this year we cannot expect a high growth of total agricultural output. With stagnant grain output, import requirements could rise again in the future months. The performance of the economy during the first half of the current fiscal year does not suggest a robust growth. The economy seems to have lost the momentum gained during the previous two years. While the current international economic environment might have played a part, the main problem has been inappropriate domestic policies. It will be difficult to achieve even a 6 percent growth rate unless there is a turn around. The government needs to take a hard look at its options. M A Taslim is a professor of the Department of Economics, University of Dhaka.