Fed's Policy Rate Hike And Its Consequences

Fed's policy rate hike Hurts investment and job alike. Addressing deficit and inflation May lead to pick unapproved coalition.

The Federal Reserve System’s decision to hike policy rate further is a great cause of concern for Bangladesh. It is likely to depreciate Taka's value against dollar.Bangladesh is already under IMF prescription and has taken a credit of $4.7 billion to address budget deficit. Sloppy economic management, fuel price hike due to war in Ukraine and US policy rate hike have made a dent into the economy.

In addition, as the country is heading for next general election, clandestine capital flight under the disguise of genuine trade flow continues unabated. Huge demand of dollars has already reflected in continuous fall of Taka.

In 1990-91,rate of taka was Tk 35.67/USD . In 1991-92,it was Tk 38.14/USD.In 1996-97, it was Tk 42.70/USD. In 1997-98,it was Tk 45.46/USD. In 2000-2001,it became Tk 53.95/USD. In 2001-02,it was Tk 57.43/USD. In 2005-06, it was Tk 67.07/USD. In 2007-08,it became Tk 68.60/USD.Biggest depreciation came this year. Now in the open market Taka is being sold at Tk 107/USD.In general,big depreciation of Taka against US dollar is observed before and after election year.

When Fed's policy rate rises,investment from rest of the world goes to the USA. It is because return on investment is higher in the USA than anywhere else.Deposits at American banks pays more. However,bonds and stocks' prices go down*.At the same time,cost on investment also increases as the lending rate rises in response to policy rate hike. So we see more job cuts,fewer expansion of businesses and tightening of wallet by household. At one hand,consumption of foreign goods fall ,on the other hand,foreigners bring their dollars to the US legitimately and illegitimately. Often this kind of capital flight pushes up the property prices in the USA.

Last year,Bangladesh became the second largest exporter of RMG items to Europe. It is unclear whether Europe’s policy to discourage Chinese export or its slow response to Fed's policy rate hike played the key role in Bangladesh’s export success. But many exporters do not bring their export proceeds in time. It is reflected at the end of each fiscal year.Mismatch ranges between few millions to a billion US dollar. IMF has already stressed to maintain unitary exchange rate regime by the end of this fiscal year. In addition, it also suggested to raise Tax-GDP ratio significantly. Though depreciation of Taka is an incentive to exporter ,increasing business cost,deteriorating law and order and higher return abroad may drive further capital flight.

Rising cost of Dollar may also aggravate import of essential commodities. Government is running a rationing program of providing essential commodities at affordable prices to 10 million poor families. As most of the commodities are importable, strong dollar is likely to increase the cost of such program. Moreover, higher prices of utility has also increased household's expenditure. To subsidize agricultural inputs in order to ensure food security,govt has to raise subsidy amid IMF's insistence on downsizing subsidy. Earlier govt printed money to dole out to the problematic banks. Govt may further print money to subsidize its programs. This will evidently push the price levels up.

“Greenfield investment in Bangladesh was declined by 59% in 2022.”

--UNCTAD

Both the inflation and Fed policy rate hike may prompt the Bangladesh Bank to raise the policy rate further at home. This means lesser investment at home in future as cost of doing business and cost of investment are likely to rise in Bangladesh. According to a report by UNCTAD, investment on relocating factories from Occidental countries to Bangladesh was declined by 59% in 2022¹**. The latest development may further erode the investment prospect in Bangladesh. Growing deficit may lead Bangladesh to solicit Middle Eastern countries for more recruitment and special arrangement on fertilizer production.

In brief,US policy rate hike has already cast a shadow over Bangladesh economy that has been bleeding from mismanagement and corruption for quite some time. Strong dollar may further weaken Taka and rising fuel cost and inflationary pressure may push Bangladesh embracing further strategic ties that are not endorsed by the Parliament.

Notes And References

1. "Bangladesh Investment Flow Declines Sharply In 2022:UNCTAD",The Business Standard, March 08,2023.For more read at https://www.tbsnews.net/economy/bangladeshs-investment-flows-decline-sharply-2022-unctad-596462

[Update:This piece has been updated twice on March 14,2023 by me:
*First update,7:58 Bangladesh Standard Time,includes a correction on the relationship between bonds and interest rate.
**Second one,at 14:50 Bandladesh Standard Time,is the reference to UNCTAD report.]