Is debt monetisation fueling the inflation?

FY2023 was a year full of challenges in fighting inflation. We hear in many discussions that price control by syndicate, supply shock from the Russian War, rapid taka depreciation were the reasons for high inflation.

One of the recent trends we are observing is rapid debt monetisation by the Central Bank.  When the Government needs money, instead of raising taxes or borrowing from the private sector, it takes money from the central bank. In this process known as devolvement, the central bank is rapidly purchasing government securities and financing expenditures.

The government filled more than one-third of the deficit gap by printing money during the year (Figure: 01). Central bank's liability in its balance sheet is increasing at an unprecedented rate. Currently, the outstanding devolvement amount is BDT 1.30 lac crore. This has resulted in a sharp rise in outstanding government borrowing from BB in the last year (Figure 02).

The present yield of most of the treasury securities is below the inflation rate. Bank deposit rates are also below inflation rate. This has created a disequilibrium in the financial market as the real rate of return is negative or near zero. People are holding more cash balances and staying away from the banks as they are not getting enough protection from inflation.

Money supply growth in this period remained almost stable at 10.4 percent. The growth in money supply mainly came from the public sector credit growth of 37 percent vs. private sector credit growth of 11 percent. 

Excess reserve hit its lowest in April 2023 at negative BDT 1,146 thousand crore from the peak of BDT 65,000 thousand crores in June 2021, while inflation was on a high upward trend. It seems counterintuitive, but it can happen in an expansionary monetary policy, followed by an increase in borrowing demand and lastly by limiting production capacity in the economy. 

Expansionary policy was in effect since the pandemic started.  Currency in circulation has become 1.8 times since Covid (1.75 lakh crore in February 2020 vs 3.1 lakh crore in June 2023). Even when private credit growth was low, public credit filled the gap, as stated earlier. And lastly, production capacity was constrained by import restrictions. 

The current account deficit decreased from USD 18.6 billion in FY2022 to USD 3.3 billion in FY2023. The primary reason for such a decrease is the decline in imports (USD 82.5 billion in FY 2022 vs USD 69.5 billion in FY 2023). Import restriction has given birth to a pseudo supply-side shortage locally. We were fearing the dollar reserve will decline more if we do not restrict imports. 

However, the dollar reserve depleted from the highest of USD 48 billion in August 2022 to USD 29.7 billion in July 2023. Twenty-five percent devaluation of Taka happened in two years, despite the dollar sale and non-monetary efforts. 

Price of major essential commodities has fallen to the prewar level globally, but ours has not. FAO food price index declined by 21% from its peak of June 2022. In July 2023, inflation was 3.2 percent in the USA, 7.4 percent in India, 5.4 percent in Eurozone, 4.6 percent in Sri Lanka, 9.7 percent in Bangladesh and it is persisting. 

What started as supply side inflation and was supposed to be temporary, has now become a longer lasting one due to large debt monetisation, despite increase in government borrowing. 

Kazi Ahsan Maruf, CFA and Jnandip Paul work in Ekush Wealth Management Limited. The views shared are personal and not a representation of the working organization.