Inflation

Inflation, which some economists have dubbed as the cruelest tax of all, is eroding purchasing power of consumers, especially the fixed and low income groups of people in net commodity importing countries, around the world. Following the persistent highinflation regimes in the late 1970s and early 1980s (largely due to two oil shocks), inflation rates have varied an average of two to three percent in the industrialised countries and fell to single-digit levels in many developing countries since the 1990s.1 It is widely viewed that globalisation has had a positive impact on prices for over one and a half decade by heightening competition both on the demand and supply side. However, the specter of inflation has once again become a major concern for central bankers and policy makers around the world, as many countries have been experiencing high inflation largely owing to a notable increase in commodity prices. The prices of cereals, petroleum products, edible oil, and metals are skyrocketing in the international markets in recent years.

Reasons for inflation

Bangladesh has no specific reason of inflation at present. Inflation is increasing more and more for several reasons. But all reasons are not equally important. Some reasons influence more and some reasons influence less. Our economists, businessmen and other involved parties with economics have identified nine reasons of inflation after the observation of last several months. The nine reasons of inflation are: 1) Lower growth in agricultural sector 2) Raising price in world market 3) Raising price of fuel 4) Decreasing the price of money 5) Raising the supply of money 6) Financial enrichment 7) Raising the income from foreigner 8) Syndicate in market 9) Taking initiative against corruption. At present our caretaker government is considering these reasons of inflation and taking appropriate initiatives for improving the condition of economy of Bangladesh. We hope we will be able to overcome the problem of inflation very soon. In Asia, Bangladesh is one of the hardest hit by the current wave of agflation and oil price hike. The economy has been observing double digit inflation growth on point-topoint basis since July 2007.In Bangladesh, the correlation between per capita income and food weight in total Consumer Price Index (CPI3) is one of the highest in the world and the economy is vulnerable to a sharp hike in fuel and non-fuel commodity prices. An International Monetary Fund (IMF) study shows that the direct impact of food prices on headline inflation5 has been a staggering 55.9 percent in developing Asia in 2007, whereas the figure was 34.1 percent in the period of 2000-06.

The State of Inflation in Bangladesh

According to the Bangladesh Bureau of Statistics (BBS), the overall inflation in Bangladesh was 8.66 percent on 12-month annual average and 11.21 percent on point-to-point basis in November 2007; whereas the food-inflation hit 13.83 percent in the same period. Figure 3 reflects the inflation scenarios in Bangladesh. The trends clearly show that both the 12-month average and the point-to-point inflation are steady since January 2007. Inflation in Bangladesh: Supply Side Perspectives

Fig 1

Analysis of the Recent Trends in Inflation

Figure-1 demonstrates the trends of Bangladesh inflation by depicting month-wise data of general, food and non-food consumer price inflation (annualized 3-month moving average) from FY03 to FY06. The purpose of using 3-month average instead of traditional12-month in calculating inflation is to capture the dynamics implicit in the recent price data. 2 It is observed from the figure that inflation maintained a highly erratic movement ranging from 14.82 percent in November 04 to (-)3.04 percent in February 06. The volatility of the inflation behavior can be largely attributed to the food sector. The food inflation seems to have severely fluctuated within the range between (-)6.75 in February 06 to 21.88 in November 04. By contrast, the non-food sector inflation showed arelatively steady pattern reflecting less seasonality. The fluctuation in food inflation is, in part, a manifestation of the typical seasonality in food production and the developments in the global commodity market. It would, therefore, be important to recognize the role of the cost/supply side phenomena in explaining Bangladesh inflation. As seen in the Figure-1, the inflation rate was over 5 percent during a significant number of months. It is also evident that the incidence of high food inflation is responsible for this situation. Except for a few instances, food inflation continued to be well above non-food inflation during the whole period. Moreover, whereas non-food inflation hardly exceeded 5 percent, the food inflation was higher than 5 percent almost as a rule. An analysis of the latest trends reveals that general and food inflation simultaneously started declining after November 05, reaching the lowest level in February 06 and then

registering a sharp uptrend to end up with 11.02 and 15.53 percent respectively in the last month of FY06. The non-food inflation, although moderate, followed a similar pattern before reaching 4.3 percent at the end of the period. These trends appear to capture a broader seasonal behaviour of prices in Bangladesh at least as seen in the data from FY04 to FY06. The surge in food inflation in the 4th quarter of FY06 does not appear to be related to seasonality, as the behavior of food prices in the comparable period of the previous two years, i.e., FY05 and FY04 indicates little volatility. The actual inflation in the latter dates ranged between 2.67 percent (FY04) and 6.27 percent (FY05). Further exploration of the source of the FY06 (4th quarter) price hike therefore appears urgent. Labour Cost Wage, the labour cost, is often seen as the key reason behind cost-push inflation. Wage increase without any commensurate increase in productivity kicks off a wage-price spiral, allowing for sustained inflation. Analysis of the movements of nominal wage rate inflation generally gives an idea about the labor cost scenario. The time path of the nominal wage inflation portrayed in Figure-2 suggests that in Bangladesh, the wage inflation has been pretty stable at above 5 percent per annum with some short-term fluctuations over the period from July 03 to June 06. Under the assumption of little or no improvement of workers productivity growth, wage inflation at such high level is an indication of cost escalation over time. However, whether the accelerated cost has translated into inflation is not clearly observable in the figure. An analysis of the correlation matrix presented in Box-1 is useful in exploring the precise link between labor cost and inflation. It is seen from the matrix that wage rate inflation has statistically significant association only with rural food inflation (coefficient of 0.22) at the 10-percent level of significance during the period from FY00 to FY06. It, therefore, appears that wage inflation cannot be a dominant factor in explaining the price behavior in Bangladesh. This is what one would normally expect in a labor surplus environment Figure-2: Labor Cost and Inflation (annualized 3-month moving average)

Import Cost Typically import occupies a significant place in the Bangladesh economy, accounting for as high as above 20 percent or more of GDP in FY06. At the margin, most of the essential food items (for example, sugar, rice, wheat, onion and edible oil) and, more generally, machineries, intermediate goods and raw materials used in production are imported. Cost of imports can, therefore, be expected to have a substantial influence on domestic inflation

directly (through final goods) or indirectly (through intermediate goods). According to available statistics, import price index (MPI) of Bangladesh has continuously soared over time which is reflected by an almost straight upward curve in Figure-3: Import Cost and Inflation (12-month moving average)

Figure-3. The figure also depicts the inflation trend. Comparison among the trends in import price index and inflation provides an observation about the relationship between these indices. It is seen that although during the period from FY97 to FY01 the relationship is somewhat ambiguous, the co-movement from FY01 onward appears robust. To verify this relationship, a separate correlation matrix has been constructedusing yearly data for the period from FY01 to FY06.3 The correlation analysis, presented in the Fig-2, reveals that while the relationships between import price index and categories of non-food inflation (urban and rural) are insignificant, the former is found to have economically as well as statistically highly significant association with the categories of food inflation (urban and rural). The positive association is suggestive of the hypothesis that the surge in inflation is in part a supply side phenomenon.4 Evidently, the reasons for increase in import price are twofold- exchange rate depreciation and increase in international commodity prices. Exchange Rate Exchange rate exerts inflationary pressure mainly via import prices. Historically, exchange rate in Bangladesh exhibited steady increase over time. The period average BDT-USD exchange rate was recorded at 61.39 during FY05 in comparison to 40.20 and 50.31 during FY95 and FY00 respectively. The comparable FY06 figure rose to 67.08 as the currency remained under pressure during the first three quarters of the fiscal year. The inflation in the fourth quarter of FY06 (Figure-1) seems to have been prompted by a sharp increase in the exchange rate throughout the second quarter and part of the third quarter of the same fiscal. 5 The contribution of the exchange rate depreciation to inflationary pressure has been attested to by the results of the said correlation analysis (Box-1). Accordingly, exchange rate is seen to be uniformly correlated with all categories of inflation (rural food, rural non-food, urban food and urban non-food) at the 1-percent level of significance, the coefficients being 0.34, 0.29, 0.36 and 0.37 respectively.

Oil Price Being a fundamental input of production, oil constitutes a significant portion of production cost in every sector of the economy. In spite of some recent adjustments in the administered price of energy products, much of the increased cost of imported fuel has not been passed on to end users, especially on diesel and kerosene. However, the correlation analysis (Box-1) provides evidence that an increase in the diesel price (proxy for oil price) stimulates inflation via increases in both food and non-food prices in both urban and rural areas. This is plausibly due to the fact that diesel is used intensively regardless of sector (food or non-food, urban or rural). The correlation coefficients are estimated as 0.36, 0.30, 0.41 and 0.32 for rural food, rural non-food, urban food and urban non-food sector respectively. Supply Shortage Production in agriculture and fisheries sectors in Bangladesh is still subject to the whims of nature to a notable extent. It has been claimed that one of the main causes of the highfood inflation throughout the FY05 was poor harvest of aus, aman and wheat crops.6 The yearly production of these three crops went down by 18.12, 14.76 and 22.11 percent respectively in FY05 over the FY04.7 An instance of price hike due to this fall of production is that the price (per kg) of aman rice rose within the range of BDT 16 to 19 in FY05 from the range of BDT 14 to 16 in FY04. Market Syndication Unfair cartel among the suppliers might seriously hamper the course of the economy by engendering inflation via the creation of a false supply shortage even during a period of robust growth in production. Such an undesirable event allegedly occurred in FY06 when the food inflation remained high (7.76 percent) in the same fiscal year despite the growth in food production (4.49 percent8 vis--vis 2.21 percent in FY05). Monopolistic control of several food items such as sugar, onion, pulses and edible oil by market syndication seems to have led this situation.9 Obviously such manipulation is a type of supply side disturbance. Policy Implications The above analysis carries an important signal for the policy makers. In an effort to subdue inflation they have to keep a sharp eye not only on the demand phenomena, but also on the cost behavior in the relevant period. Unfortunately, there is hardly any market oriented policy move on the part of fiscal or monetary authorities that can be taken for checking the cost induced inflation. On the fiscal side, although cutting down of the indirect tax on commodities is often proposed as a remedial measure, it only makes a temporary contribution to reducing inflation. Long term continuation of such policy may cause continuous erosion of the government exchequer. Some also argue in favour of government control on wage increases that are not supported by the corresponding increase in productivity to resist wageprice spiral. In Bangladesh, however, the presence of powerful trade unions tend to render the implementation of such control almost impossible. On a positive note, however, our analysis did not find any noteworthy impact of wage growth on inflation. It is widely recognized, however, that government can effectively use its legal powers to break up the market syndication and thus improve competitiveness of the distribution network. On the monetary side, in the absence of any direct controlling instrument, Bangladesh Bank can initiate some case specific counter-action. Bangladesh Bank can take over some responsibilities such as monitoring modalities of Letter of Credit (L/C) operation so that market forces determines the exchange rate in a process that remains free from much speculative transactions. One example of a move in this direction is that the Governor of the

state of one who lacks a usual or socially acceptable amount of money or material possessions

Poverty
Poverty is said to exist when people lack the means to satisfy their basic needs. In this context, the identification of poor people first requires a determination of what constitutes basic needs. These may be defined as narrowly as "those necessary for survival" or as broadly as "those reflecting the prevailing standard of living in the community." The first criterion would cover only those people near the borderline of starvation or death from exposure; the second would extend to people whose nutrition, housing, and clothing, though adequate to preserve life, do not measure up to those of the population as a whole. The problem of definition is further compounded by the noneconomic connotations that the word poverty has acquired. Poverty has been associated, for example, with poor health, low levels of education or skills, an inability or an unwillingness to work, high rates of disruptive or disorderly behaviour, and improvidence. While these attributes have often been found to exist with poverty, their inclusion in a definition of poverty would tend to obscure the relation between them and the inability to provide for one's basic needs. Whatever definition one uses, authorities and laypersons alike commonly assume that the effects of poverty are harmful to both individuals and society.

Recent poverty trends in Bangladesh Sizeable poverty reduction occurred in Bangladesh between 2000 and 2005, as well as over the longer 15-year time horizon of 1991-2005. Poverty headcount rates based on both upper and lower poverty lines using the Cost of Basic Needs (CBN) method show that the proportion of poor in the population declined considerably between 2000 and 2005. Trends in other measures of poverty indicate that the improvements were not limited to reductions in the size of the poor population relative to the total population, but also in the level and distribution of consumption among the poor. The improvements also occurred at similar rates for urban and rural areas. Furthermore, the extent of poverty reduction in Bangladesh between 2000 and 2005 was on par or higher than what was seen in other countries in South Asia during similar periods. This was partly due to GDP growth rates that compared well with the region, as well as no appreciable increase in consumption inequality during this period. Poverty estimates national, rural and urban Consumption growth and distributional changes The rapid decline in poverty during 2000-05 was driven by sizeable growth in per capita consumption expenditure. Per capita consumption expenditure from HIES increased by 12 percent in real terms between 2000 and 2005 an average annual growth rate of 2.3 percent (Table 3). While the increase in percentage terms was higher for rural areas (12 percent) than urban areas (5percent), real per capita expenditure in 2005 was still 39 percent higher for urban areas than for rural areas.

The estimates of consumption growth from HIES are also broadly consistent with Bangladeshs macroeconomic performance during the period 2000-05. Annual average growth in real GDP per capita was 3.3 percent and that of private consumption per capita (a component of GDP) was 2.8 percent. The growth in private consumption component was also higher during 2000-05 than any previous period since 1990, which is consistent with 2000-05 being the years of highest poverty reduction (Figure 3). The services sector now accounts for more than 50% of GDP while agriculture has declined from 25 percent to 19 percent between 2000 and 2005. Industry accounted for 26% of GDP in 2005 with the Ready Made Garment sector being the main source of manufacturing growth.

How growth was distributed among different consumption groups Can be seen in greater detail from Growth Incidence Curves (GICs) that indicate the annual average growth of per capita consumption for percentiles of the population. These show that the highest growth in consumption during 2000-2005 occurred for the bottom 20 percent and top 10 percent of the population (Figure 5). Furthermore, growth rate for the bottom 30 percent is higher than the mean of growth rates (of all percentiles). The fact that the mean of growth rates is very close to the growth rate of mean consumption suggests that on the whole, growth in consumption during 2000-2005 was equitable across consumption groups in percentage or relative terms. Consistent with the growth trends, relative inequality as measured by the Gini index of per capita real consumption for the country showed no change between 2000 and 2005 These results are consistent with the growth and inequality trends described above growth in national and rural consumption averages has been substantial along with little change in relative inequality, while a lower rate of consumption growth in urban areas has been accompanied by some reduction in relative inequality.

Concluding remarks This paper has shown that rapid poverty reduction in Bangladesh during 2000-2005, whichoccurred in both urban and rural areas, was a result of strong growth in average consumption levels. Moreover, there was no increase in inequality in the relative sense, i.e. the growth in consumption occurred at similar rates for the poor and non-poor alike, resulting in a elasticity of poverty reduction to growth that was higher than most South Asian countries. Extrapolating forward from the historical estimates of elasticity, Bangladesh is therefore poised to attain (and surpass) the MDG target of halving its poverty headcount rate from the 1991 level by 2015 if the current GDP growth rate is maintained, provided the trend in distributional changes does not depart from what was seen in recent years. Underlying the overall positive picture, the country still faces significant challenges. While relative inequality has not worsened, similar rates of consumption growth for upper and lower ends of the distribution imply that absolute inequality, i.e. the size of the gaps between the rich and the poor, has widened. The poor in Bangladesh, particularly the 25 percent of the population who are below the lower poverty line, still consume at very low levels. Further work is necessary to understand the factors that are responsible for limiting the income/consumption of the poor, as well as the multi-dimensional nature of poverty going beyond consumption. The analysis at a geographically disaggregated level shows that the pattern of poverty reduction has been highly uneven across regions. Poverty has declined rapidly in Dhaka, Chittagong and Sylhet divisions in recent years, while remaining stagnant in Rajshahi and Barisal and increasing in Khulna division. On the whole, between-division differences seem to have widened slightly from 2000 to 2005. More importantly, analysis at a lower level of disaggregation (old zillas), hints at an emerging regional divide in the country. There appears some convergence towards a lower poverty rate in the eastern part of the country, and particularly among areas neighboring the most affluent Dhaka zilla. In contrast, the western part of the country has seen much smaller reduction in poverty, and there is no pattern of convergence with some of the (old) zillas in fact becoming poorer in 2005. Whether such a pattern of poverty reduction is a result of an increasing positive impact of the main urban center of the country (Dhaka) on neighboring areas, is a question to be explored in future work. Related to this would also be the important question of what factors explain the regional differences in poverty incidence and rate of poverty reduction in other words, what region/area specific characteristics are responsible for certain regions to lag behind the rest of the country. These issues are explored in greater depth in a separate background paper for the Poverty

Information Sources 1. Inflation in Bangladesh: Supply Side Perspectives Policy Analysis Unit Research Department Bangladesh Bank 2. www.bangladeshbank.org.bd 3. The causative factors of Inflation in Bangladesh Rasheda Khanoim and Md Mafizur Rahman Dept Of Economics Iniversity Of Chittagong