Macroeconomy Amid Trade War

Clashes of the titans in trade May prolong the struggling state.

Bangladesh Bureau of Statistics (BBS) divulged that inflation again increased to 9.87% in May. It is highly likely to see another round of hike in policy rate in the next monetary policy statement. A 1% increase will make the policy rate 9.5%,narrowing the gap between current inflation rate and policy rate. Fitch ratings downgrade of Bangladesh's credit rating will make foreign credit harder for the public and private sector. Bangladesh Finance Minister is optimistic about getting the third instalment of IMF credit package. IMF in its last board meeting in May cleared credit package for Ecuador.

Things turn out to be difficult for the government. Revenue shortfall,dependence on domestic borrowing from banks,lack of foreign credit and FDI will cause further depreciation of taka against US dollar. Central bank's stated policy of containing the inflation rate to 7.5% may be prolonged and face serious hurdle in the wake of trade war between China and USA.

So far US federal fund rate is being stuck at 5.33%. Federal Reserve System has no intention to lower it as it sees inflation will take time to ease. Moreover, lowering the interest rate will raise the US treasury bond price,facilitating the process of ditching US treasury assets by govts not happy with US policies. Meanwhile Chinese policy rate is now 3.45% and it may go down further. It will make Chinese goods even cheaper. Let's draw a rough sketch on how the macroeconomic situation will prevail in the country given different policy rates in USA and China and trade tensions between the two countries.

Fed funds rate:5.33%
Chinese policy rate: 3.45%
If the current policy rates prevail and the countries engage in tariff and trade war, then Bangladesh has to further depreciate the currency since value addition condition to US-bound goods will also get tougher. However, special treatment to US cotton made garments may give some favor. But to meet the extra cost emanating from trade restrictions, Bangladesh has to depreciate its currency further to give the exporters some kind of favor. On the other hand, Bangladesh has to continue its contractionary policy for a longer period to mitigate the inflationary pressure.

Fed funds rate: More than 5.33%
Chinese policy rate: Less than 3.45%
It will be hard to get foreign credit and assistance in US dollar. Dollar-based investment and return will be lucrative in the West and few will be reluctant to invest here where timely repatriation of profit is under scanner. Meanwhile, Chinese credit will be cheaper. Both the government and private sector will hinge on Chinese Yuan,easing the pressure on US dollar. Weakening of Yuan may increase Chinese share of EU export market, putting pressure on Bangladesh's export to EU. EU will unlikely to get tougher on China in the wake of a trade war in a bid to neutralize it against Russia. In this situation, taka has to be depreciated more than the previous scenario against the stronger US dollar and to stall the dollar flight. Amid tight monetary policy, the central bank may resort to money supplying measures,further worsening the inflation. More rise in policy rate and delay in stabilizing the macroeconomy. More reliance on Chinese credit and deepening trade ties between China and Bangladesh.

Fed funds rate: Less than 5.33%
Chinese policy rate: Less than 3.45%
It will help Bangladesh getting foreign credit in US dollar. Less pressure on forex reserve and taka. Ongoing monetary policy may go as usual and goals may be attained in the anticipated time. No large depreciation of taka is needed to make the goods more competitive. Easing of import restrictions on capital machinery may increase economic activity. Cheaper foreign goods/ingredients may ease inflationary pressure. Economic recovery will be early. This is an ideal case for Bangladesh as both the Yuan and US dollar credit will be available at an affordable rate in the wake of a trade war. Bangladesh may have to convert a significant amount of its US dollar assets into other IMF SDR currency or to procure gold if there is further unease in the relations between Bangladesh and USA.

Since access to foreign credit gets tougher for Bangladesh, Bangladesh has to prolong its austerity measures. In all three cases ,we see that Bangladesh has to continue raising policy rate and depreciating its currency. Likelihood of the occurrences of the cases would further depict a grimmer picture . Most optimistic scenario/case(the last one) for Bangladesh is less likely to happen. In a heated trade war,US will not lower the policy rate. The second one (worst for Bangladesh) will have a better chance to emerge than the first one. We have to further tighten our belt.