Why is inflation so sticky in Bangladesh?

Last year, due to the twin shocks of Covid-19 and the Ukraine war, inflation rates skyrocketed all over the world, including in Bangladesh.

A year on, the world economy seems to have somewhat recovered from these shocks and inflation numbers are going down worldwide. In the United States, inflation plunged to 6.0% in February 2023, down 3.1 percentage points from its peak of 9.1% in June 2022. In the European Union, inflation came down to 8.5% in February 2023, declining 2.1 percentage points from its peak of 10.6% in October 2022.  

In India, inflation fell 1.4 percentage points between April 2022 (7.8%) and February 2023 (6.4%). Inflation fell an impressive  3.9 percentage points in Thailand, falling from 7.7% in June 2022 to 3.8% in February 2023.

However, In Bangladesh inflation rate rose to 8.78% in February. 

According to the Bangladesh Bureau of Statistics, it was up 21 basis points from the 8.57% reported in January. In December, it was 8.71%. Point-to-point food inflation increased to 8.13% in February, up from 7.76% the previous month. Non-food inflation fell slightly in February, from 9.84% in January to 9.82% in February.

So, why is inflation extra sticky in Bangladesh? 

This persistent high inflation is referred to as stickiness. This is one of the most challenging aspects of inflation. Inflation can be slow to adjust to changes in economic conditions, and it often persists even after the factors that caused it have dissipated. 

"The persistent 9% inflation in Bangladesh over the past eight months is hurting the poor, the low-income, and the middle-income groups fairly substantially," according to Sadiq Ahmed, vice chairman of the Policy Research Institute of Bangladesh.

But the inflation situation seems stickier in Bangladesh than in other countries. Shouldn't our economy follow the global trend of sinking inflation?

"Yes, there is a partial relationship between global and local inflation. But there are some things beyond the global inflation frame. Our capacity to import has gone down and the dollar price is still high," said Dr Khondaker Golam Moazzem, research director of the Centre for Policy Dialogue (CPD). 

There is also the fact that we are struggling to provide the energy support needed for producing goods. Not being able to import enough goods is a phenomenon unique to developing countries like Bangladesh," he added.

On the one hand, we are not being able to import enough goods, so prices are going up and on the other hand, since the dollar price is still high, we are being forced to import goods at higher prices so Dr Moazzem is of the opinion that "there is some imported inflation as well".

"On the production side of things, we are not being able to import adequate feed, fertilisers and seeds. Due to the price increase of feed, the price of chicken is going up. Due to the shortage of fertiliser, the price is increasing for farmers; there is also an impact on production as well. We are also not being able to import non-essential food items, leading to price hikes. 

"These phenomena are unique to the Bangladesh economy. So, even though global inflation might be coming down, I don't see the inflation rate coming down very soon in Bangladesh. In fact, the high inflation spiral we are in will continue for some time," Dr Moazzem said.

There are other factors at play here as well. There are two types of inflation: food and non-food. And the workings of each type of inflation can vary.

When it comes to the food market, there is the preponderance of some big players, who control a significant portion of the market. 

"If they can increase prices once, they don't let it come down as easily. If there is a 10% increase in prices due to market conditions, even if things go back to the way they were, prices come down by only 3%. That makes inflation sticky. This happens due to market power," said Zahid Hussain, former Lead Economist of the World Bank, Dhaka office, adding, "The formal term for this phenomenon is an oligopolistic monopoly."

In an oligopolistic competition, each seller assumes if they decrease prices, my competitor will decrease prices as well. So they don't have the incentive to decrease prices as they can't lure away customers from competitors with lower prices. So, in such market conditions if prices go up due to external shocks sellers do not have much of a reason to lower prices.

Another factor that contributes to the stickiness of inflation is the behaviour of consumers and businesses. Consumers and businesses may be reluctant to change their behaviour in response to changes in prices. 

For example, if the price of gasoline increases, consumers may not immediately reduce their driving because they are accustomed to a certain level of mobility. Similarly, businesses may be reluctant to change their production processes in response to changes in input prices because they have invested heavily in their existing processes.

Dr Hussain believes pent-up demand due to the pandemic also played a role here. "Since people consumed less during the Covid-19 period, they had a pent-up demand for consumption. And market leaders who can set prices have taken advantage of this situation."

This behaviour can create a self-reinforcing cycle of inflation. If prices increase, consumers may continue to purchase goods and services at higher prices, which encourages suppliers to maintain or increase their prices. Any company would naturally like to always be able to raise prices without taking a major hit to market share.

Similarly, if input prices increase, businesses may continue to produce goods and services at higher costs, which can lead to higher prices for consumers.

Companies might simply use disruptions to the supply chain to justify raising prices for their goods and services, allowing them to increase profit margins. And, in the past couple of years, businesses have been able to point to a smorgasbord of "once-in-a-lifetime" emergencies caused by the pandemic and Russia's invasion of Ukraine, which has effectively roiled everything from semiconductor production to commodities markets and shipping.

"People's thoughts on the economy are shaped by narratives. If they are constantly told prices will go up before they actually go up. After they actually go up, they are more accepting," stated Dr Hussain.

How can we unstick inflation?

Worldwide, inflation management is one of the topmost priorities for the central bank. Central banks can control the growth of credit to manage inflation through their policies.

"Bangladesh Bank must act fast and with determination to lower the growth of credit by abandoning the 6/9 interest rate policy and using interest rate flexibly. It should also fast track the development of a secondary market for T-bills to facilitate interest rate-based monetary policy management," explained Sadiq. 

"The government should support this inflation control strategy of the Bangladesh Bank by keeping fiscal deficits below 5% of GDP, phasing the implementation of large capital-intensive projects, and mobilising low-cost foreign financing for the budget deficit," he added.

"To stop price shock we have fixed dollar prices. But this in turn has caused a quantity shock. The dollar has dried up on the market. If we had a floating dollar rate, there would not be such restrictions on LCs. Yes prices would have gone up initially but there would have been a supply-side response which would have brought down prices eventually," stated Dr Hussain.

Some experts rethink the austerity measures taken by the government should also be backed by other policy measures. "We should have cut down on domestically financed projects both import intensive and local cost intensive in the budget. If we had cut down on import-intensive projects the demand for dollars would have eased down a little and as a result, we would not have had to put any restrictions on LCs — which would ultimately bring down prices," opined Dr Hussain.

"Local cost-intensive projects inject money into the economy leading to increased demand and higher prices," he added.

Some experts however believe there is little we can do at the moment given the current conundrum Bangladesh finds itself in. "Our ability to take measures is somewhat limited. When your reserve is low and you simply can't import enough goods, there will, of course, be an impact on the market. One measure would be making way for importing more goods but we are not in a situation to do that." Dr Moazzem.

But Dr Moazzem believes one effective measure is to monitor the domestic markets better – not just at the retail level but at the wholesale as well as the production level.

"If we can do that we might not be able to bring down the inflation rate but at least it will even out at the level market forces dictate. We need to keep an eye on non-market factors influencing prices," concluded Dr Moazzem.