Budget management should ensure fiscal prudence
A B Siddique:
Since the 1990s there have been visible changes in the monetary policy framework as part of the restructuring efforts of the economy. At the same time, many changes have been made in Bangladesh Bank’s currency management which has created a means to ensure more efficient currency circulation.
In the past, the financial sector was characterized by fragmentation, financial markets were underdeveloped and policy implementation tools were few in number.
Since the beginning of the reform process, there have been major changes in both structure and tools that have brought financial management more in line with the market system.
Market-friendly monetary policy encourages the judicious use of indirect instruments.
In summary, significant changes in the formulation and implementation of monetary policy have taken place since the late 1990s, which have made the formulation and implementation of monetary policy more transparent, increased reliance on indirect rather than direct instruments of monetary control, and the absence of trade-offs between inflation and unemployment more directly incorporated into policy.
It may be noted that Bangladesh Bank uses repo, reverse repo and Bangladesh Bank Bill as rate instruments as a means of implementing monetary policy which influences the prices of financial and real sectors in order to achieve expected inflation.
In annual financial operations, the reserve currency is taken as practical target and intermediate target or broad currency is used.
The assumption applied here is that there is a direct effect of monetary aggregate variable growth on the domestic price level. Therefore, Bangladesh Bank aims to stabilize prices by controlling the growth of the overall currency.
In fact, Bangladesh Bank sets a rate on the reserve currency which is considered to be in line with the target inflation.
It is believed that the growth of the reserve currency will ensure a growth of the broad currency that is consistent with targeted inflation and adequate liquidity in the economy.
But if the link between the reserve currency and it weakens, which could be through improvements in the financial sector or access to the more diversified financial assets, then a new course of monetary policy may need to be adopted.
The dual objectives of monetary policy to stabilize prices and ensure availability of adequate credit to the productive sectors of the economy to support growth have remained unchanged in Bangladesh since independence, although their relative importance has changed somewhat at different times in the light of circumstances.
On the other hand, financial market reforms have been carried out to improve the effectiveness of the monetary policy transmission system.
These included regulatory and legal changes, institutional infrastructure building, market structure harmonization and technological infrastructure development.
However, the reform process is still in force as an ongoing process.
It should be noted here that for the proper functioning of monetary policy, it is important to ensure balanced development of all the main components of the money market.
Notable among these are: (a) money market, which is the main instrument of monetary policy; (b) credit markets, which are important for the flow of resources to the productive sector of the economy; (c) capital markets, which provide long-term capital; (d) Government securities market which is important from the point of view of developing a reliable risk-free income stream; and (e) the foreign exchange market, which is important for external sector management.
It is necessary to achieve holistic and connected development of these markets and at the same time necessary strengthening of regulatory system.
There are several channels working in Bangladesh for linking revenue and finance sector. These include government borrowing programs, government loan guarantees and government investment in the financial sector.
Among these, the government’s borrowing program is relatively large, both gross and net.
The banking sector buys most of the government securities. Moreover, the scope of deficit financing and bond financing should also be considered in particular fiscal linkages.
Post-independence Bangladesh’s macroeconomics has seen more ‘fiscal hyper-efficiency’ rather than ‘fiscal neutrality’ resulting in increased fiscal deficit financing largely due to the massive government borrowing program that ensued.
Unfortunately, in the public sector-led development phase of this period, this policy created a wide gap between debt income and expenditure instead of creating a strong cycle of development.
Because the assets created by such huge borrowing were insufficient and failed to deliver the expected results.
In many cases ‘flexible budget constraints’ arose mainly due to easy financing and low credit, which created long-term macro-imbalances. Such budget management was unable to ensure fiscal prudence.
As a result, monetary policy was constrained by large and long-term fiscal deficits. From this it can be said that the macroeconomic imbalances of the period were at least partly controlled by the fiscal-financial sector linkages.
In the post-reform era, with the continued liberalization of the economy and the development of the domestic financial market, the relationship between Bangladesh Bank and the government took a new turn.
With clarity of policy objectives and greater freedom to use instruments to achieve monetary policy objectives, the operational structure of Bangladesh Bank has also changed considerably.
Several signs of evolving revenue and financial sector linkages are now visible in Bangladesh.
As a result, Bangladesh economy is able to show sufficient strength in dealing with foreign pressure and maintaining overall stability.
Despite these positive developments, Bangladesh Bank needs to take more efforts to ensure meaningful autonomy of the institution to play its proper role as the overall authority of the financial sector.
Three important constraints need to be addressed to ensure effective autonomy in policy making.
First, the continued dominance of fiscal policy, which has resulted in a growing disparity between government revenue and expenditure, and which has often forced Bangladesh Bank to finance involuntary deficits.
Second, the predominance of state-owned financial institutions and non-financial public institutions blur the distinction between government-only and government-designated public sectors.
Third, the relatively underdeveloped system of money markets hampers the effectiveness of monetary policy.
The reform program initiated in the 1990s that effectively transformed Bangladesh into an ‘open economy’ included a number of measures that involved eliminating fiscal-monetary policy mismatches such as adopting an annual and acceptable system instead of the ad-hoc treasury bill issue system and automatic financing to ensure that revenue and expenditure are in balance. Temporal asymmetries can be eliminated by using market-based interest rates instead of fixed interest rates.
Bangladesh needs to be able to cope with the current situation, which arises through the trade-offs between liberal international capital flows, effective monetary policy and stable exchange rates.
In the context of the current situation, fiscal empowerment is considered necessary for obvious reasons.
Although the current level of fiscal deficit is considered to be within Bangladesh’s tolerance, the capacity to deal with any unforeseen situation is very limited.
Specifically, the nature of the current fiscal policy has largely limited the effectiveness of monetary policy in dealing with any contingencies, maintaining price stability and limiting expected inflation.
(The writer is a journalist.)
