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Does stimulus fuel inflationary pressure?

| Updated: January 23, 2021 15:45:55

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Does stimulus fuel inflationary pressure?

The government has announced another round of stimulus packages to support the cottage, small and medium enterprises (CSMEs) and poor people who are negatively affected during the pandemic. For the CSMEs, the government has allocated Tk 15.0 billion while for the poor people, the allocation is Tk 12.0 billion.   By adding these two sets of packages worth Tk 27.0 billion, the total number of stimulus packages reaches 23 and the overall allocation stands at Tk 1.24 trillion. It is equivalent to 4.44 per cent of the country's gross domestic product (GDP).

Providing such a big stimulus package is not a unique thing in Bangladesh. To reverse the devastating effect of the deadly coronavirus on the economy, countries across the world have announced a series of stimulus packages. Economic activities came down to almost a standstill due to lockdown and other measures preventing man and machine mobility to contain the spread of the virus. The halt of economic activities reduced income and spending significantly. In association with the central banks, governments have to step up to revive the economic activities by taking monetary and fiscal measures. In South Asia, India provided a big stimulus package of around 10.0 per cent of the country's GDP. The ratio is only 3.10 per cent in Pakistan. However, the ratio of the stimulus package to GDP does not necessarily indicate effectiveness of the packages.

Though it is intended to support different economic or income-generating activities, much of the success depends on efficient management. Moreover, it has a cost that also needs to be taken into consideration.

WHAT IS IN THEORY: The concept of stimulus package originates from Keynesian economics, which stresses the government spending to cover inadequate private investment and create aggregate demand. Generally, a stimulus package is a bunch of economic measures taken by a government to invigorate a dawdling economy. The measures include easy financing, tax rebates, and policy relaxations to spend and invest in different sectors of the economy. The core idea behind a stimulus package is to boost spending, as spending increases demand, which leads to job growth and ultimately increases income and further boosts spending. Ideally, this cycle continues until the economy recovers from the crisis.

There are two types of economic stimulus -- fiscal stimulus and monetary stimulus. The former includes tax cut, tax credit, new government spending, unemployment benefits and direct payments to individuals and households. Thus it refers to enhancing government consumption or reducing of taxes. The latter is money injection through easy refinancing, rate cut and regulatory and policy relaxations. The objective of monetary stimuli, like the fiscal stimulus, is to boost economic activities by injecting money into the financial system and encouraging credit flow. The government conducts fiscal stimulus while the monetary stimulus is under purview of the central bank. 

Nevertheless, a mixture of both the stimulus is also there, and sometime it may be a bit difficult to differentiate.

STIMULUS IN BANGLADESH: To contain the economic slump due to the pandemic, Bangladesh has adopted fiscal and monetary stimulus packages. Around 70 per cent of the package is monetary. It means the policymakers want to inject liquidity or cash into the economy through different channels. Of the total Tk 1.24 trillion stimuli,  some Tk 600.0 billion is allocated to large industrial units and Cottage, Micro, Small and Medium Enterprises (CMSMEs). The money is going to these industries as working capital loan at subsidised interest rates. The idea behind the low-cost financing is to support these industries' survival so that there is no significant retrenchment of jobs. Allocation for agriculture sector also stood at Tk 150 billion. The export-oriented sector, mainly the ready-made garments (RMG) industry, availed Tk 100 billion support to pay the workers. To ensure the liquidity in the money market, Bangladesh Bank also slashed the policy rates and interest rates and also provided refinancing facility.

No doubt all these measures have successfully injected a significant amount of money into the market as reflected in banks' excess liquidity. Total excess liquid assets stood at Tk 1951.7 billion at the end of November last. At the same time, deposits in banks also registered a growth of 13.0 per cent. All these indicate that there is no shortage of loanable funds in banks, but businesses are also not investing adequately. Moreover, people are trying to save whatever they can during the pandemic. That's why, despite a low-interest rate on deposits, people are parking money in banks to keep their hard-earned income safe.

The surge in liquidity in the economy may add some inflationary pressure. Bangladesh Bank in the latest monetary policy review, released after a break of six years, said: "The recent increasing trend in food inflation related to supply-side disruption may cause some upside risks to the headline inflation." Food inflation hit a record 7.35 per cent in October last, causing sufferings to poor people.  It also pushed the overall inflation closer to 6.50 per cent at the same time. However, food inflation came down to 5.73 per cent in November and declined further to 5.34 per cent in December. General inflation also came down to below 5.50 per cent in the last month, indicating ease of pressure on consumer spending.

However, the central bank is not very comfortable with the declining trend in inflation as it pointed out that the stimulus packages to revive the economic activities may create inflationary pressure in the coming days. "BB's policy relaxations and low-cost refinancing lines of credit along with the government's stimulus packages injected huge liquidity in the economy might also add some risks to increase the headline inflation in the near future," said the Monetary Policy Review 2020 published in the second week of this month.

The rationale behind the proposition is that increased money supply pushes up demand and excess demand pushes inflation. In theory, 'if the money supply increases faster than the growth in real output, it will create inflation as there is more money chasing the same number of goods and services.' If there is a surge in inflation, poor and low-income people will suffer much as their real income will erode more. During the pandemic time, many of them have already lost their jobs or face a pay cut.  Any inflationary pressure is thus not desirable at this time.

Though the government in the national budget set 5.40 per cent ceiling for the annual average inflation rate in the current fiscal year (FY21),  there is nothing wrong if actual rate crosses the ceiling by a small margin.  Higher inflation will ultimately indicate that economy has finally rebounded due to a significant rise in aggregate demand. Growth rate alone will not prove the revival of the economy. It will also indicate the effectiveness of the stimulus package to some extent.  Nevertheless, it is unlikely that the money supply will increase robustly, creating a heavy inflationary pressure due to stimulus package and monetary relaxation. So far, the injection of money through the packages is steady, and the trend is likely to continue in the near future. It is because the banks are disbursing credits under the packages with some cautions. 

It is to be noted that the government has provided the stimulus at a time of pandemic-induced recession when slowdown of overall economic activity is there. Fall of merchandise imports by 8.80 per cent in the first five months (July-November) period of the current fiscal year clearly shows that aggregate demand is still subdued. Thus, it is necessary to ensure cash flow to low-income people to give them some income protection during the period. Moreover, some prudent administrative steps may contain the volatility in food prices to keep the inflationary pressure in check. Monetary measures to control money supply may not bring the desired outcome in this regard.


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