Bangladesh is suffering from significant balance of payments difficulties for a considerable period which have caused multiple economic problems. Some have regarded these sufficiently serious to be called a crisis. Although the government and Bangladesh Bank are insisting on a narrative of no shortage of foreign currencies, it has few takers since both commercial banks and business enterprises are suffering from difficulties in arranging foreign exchange to cover their business needs, and newspapers are awash with reports of shortages. Even students studying abroad have been denied access to formal sources of foreign exchange. The government narrative also flies in the face of its desperate attempts to reduce import, obviously made to ease the exchange market pressure. The external vulnerability of the country has also raised foreign concern. Moody's has recently placed Bangladesh's credit ratings on review for a downgrade.
The attempt to reduce import in the face of balance of payments crises is not new in the countries of the Indian sub-continent; it is as old as the independence of these countries from the yoke of the British colonial empire. All sub-continental governments resorted to the same import restriction policies when under balance of payments stress with more or less the same result -little improvements of balance of payments, but stagnation of the economy.
The policy of import restriction recently implemented by Bangladesh Bank in response to the current balance of payments difficulties is novel. The trade policy is the domain of the Ministry of Finance, but in this case Bangladesh Bank (BB) has used its financial power to raise the cost of import of certain 'luxury' goods that it considered less necessary, through letter of credit (LC) margins. This has a similar impact as that of tariffs, but easier to implement. Unlike tariffs, it does not yield any revenue for the government.
The other method BB has adopted is essentially a law and order action. It is investigating the prices quoted in the letters of credit to detect any misinvoicing, which is widely believed to be an important determinant of the large spike in import payments, and hence the very large trade and current account deficits in 2021-22 (FY22). BB is apparently satisfied that its methods are working since import LC values have declined.
Ironically much of the problem could be traced to the stubborn insistence of BB on maintaining the overvaluation of the taka in the face of persistent current account deficits. The fixing of the interest rate added to the difficulties. These led to substantial exchange market pressure which worsened over time.
What then transpired is the classic case of capital flight. Business people as well as people with sufficient excess funds clearly saw the loss they would suffer (or the gains they would fail to make) when the pressure became unbearable and BB finally depreciated the taka. In a country where the capital market is free, a similar situation would have led to an outflow of funds through formal channels to more reliable currencies. Since the government does not allow such free movement of capital these people found other ways, including misinvoicing and hundi, to achieve the same result.
Import cannot be the objective of trade policy since any import value can be unsustainable if the export value is consistently lower. What matters for sustainable trade is the state of the trade balance or the current account balance. The most recent data released by BB show that the current account balance of the country for July-October FY23 has worsened very considerably relative to the same quarter of FY22. The import of goods (and services) has also increased. The import restriction policies have not improved the balance of payments, at most the growth rate of import has been reduced from its unusually high value last year. It should be borne in mind that if import remains suppressed, it could have some deleterious impact on the economy as most of the import is production-related.
The consequences of such a policy should be expected given our past experience. Throughout the first two decades of independence, when a slew of import restriction measures such as tariffs, para-tariffs, quotas and outright bans were imposed to restrict the import value resulted in increasingly dismal trade outcomes. By the early 1990s the current account became unsustainable. The finance minister of a new government, elected for the first time in a free, fair and inclusive election held under a non-partisan caretaker government in 1991, changed the direction of trade policy by introducing considerable trade liberalisation measures that reduced import barriers.
These measures worked miraculously. The age-old current account deficit turned into a surplus for the first time for three years in a row. (Note that the spectacular growth of the ready-made garments industry for more than 12 years since the late 1970s did not achieve such a result.) The current account then reverted back to persistent deficits. It turned into surplus again when the same minister returned to office in 2001. This time the surplus continued till 2015-16 (except for 2004-05) which allowed the accumulation of very substantial international reserves equivalent to nine months' import. The current account turned into deficits thereafter, which eventually eroded the stock of international reserves with the normal consequences. Our own experience with the balance of payments difficulties of the earlier decades should have indicated that greater trade liberalisation, rather than illiberal trade, was the way forward.
A greater awareness of introductory macroeconomics would have helped to understand that while trade restrictions might help to increase the volume and composition of export or import, trade policies do not affect the trade balance (see N. G. Mankiw, Principles of Macroeconomics, 4th ed., p.424). The latter is determined by more fundamental forces. An important derivative from the national income identity is another identity: CAD = (I - S) + BD, i.e., the current account deficit is identically equal to the sum of the investment-saving balance of the private sector and the government budget deficit.
The budget deficit is the excess of government spending over its revenue while the investment-saving balance is the excess of spending of the private sector over its income. Thus the current account deficit is simply the excess of spending of the nation over its income. As this identity always holds true, the current account balance is determined jointly by the investment-saving balance of the private sector and the government budget deficit.
Since these are not necessarily influenced by trade policies, such policies are unlikely to improve the trade or the current account balance. Their impact on individual products, which are restricted by trade policies, could be lost in the maze of compensatory general equilibrium changes in other variables, especially the real exchange rate. The current account balance of July-October FY23, which was substantially greater than that of the same period of the previous year, is consistent with this theoretical view.
Government agencies do not provide any estimate of private saving. However, it can be deduced from the budget deficit and the current account deficit. The budget was in the red by Tk 1.73 trillion taka in FY22, or about US$20 billion, which was more than the current account deficit of US$18.7 billion. Thus, the private sector balance must have been around $1.3 billion, which partly funded the budget deficit.
It should be obvious that any reduction in the current account deficit requires either a reduction in the budget deficit or an increase in the private net saving. But any increase in the latter will in the short run result in a reduction of private investment. This implies that a more productive use of national surplus will be either mostly wasted in government spending or diverted to less productive government investment.
No amount of fiddling with distortionary trade policies will improve the current account situation. On the contrary, such distortions could become permanent features of the economy further eroding its efficiency. If the government is serious about reducing a full blown economic crisis it needs to tamp down its budget deficit.
The author is Professor of Economics, Independent University, Bangladesh.
