Macroeconomy Amid Trade War II

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

In the previous piece ,I depicted a rough sketch on the macroeconomic situation amid a trade war between the US and China. Let's add few other factors to make the sketch a bit clearer. Here I start with adding the crude oil price. The previous piece is based on the assumption that crude oil price is $70/barrel. Now let's see what the scenarios will look like when the crude oil price is more than $70/barrel and when it is less than $70/barrel.

Crude oil price: More than $70/barrel

Fed funds rate:5.33%
Chinese policy rate: 3.45%

It will put pressure on existing import. It has the potential to worsen inflationary pressure. Continuation of policy rate hike for a long period. But tax revenue from oil import will rise. Depreciation is needed to make contend exporters. But depreciation of taka will also raise the revenue. Remittances from the Middle Eastern countries may rise.

Fed funds rate: More than 5.33%
Chinese policy rate: Less than 3.45%
It will worsen the strain of import expenditure. As foreign credits will be hard to get, financing existing import expenditure will see an uphill task. Exporters' cost of manufacturing goods will also rise. More depreciation is needed than the previous case. Inflationary pressure will be higher than the previous scenario. Interest rate hike will be higher and continuation of this policy will be longer than the previous scenario. Revenue earnings from depreciation will be higher but import bill of oil and food grain and other necessary items will cast shadow over it. Remittances may be lower than the previous scenario. Part of the oil revenue may be invested abroad and the the rest will be invested in local domestic infrastructure project. Chinese credit/FDI bound to US may enter Middle East amid trade war. China financed infrastructure project in the Middle East may see less participation of South Asian work force.

Fed funds rate: Less than 5.33%
Chinese policy rate: Less than 3.45%
Less stress on import spending. No depreciation is needed. It will put pressure on revenue earning if NBR fails to meet its target. Remittances will rise. Most of the oil revenue from high oil prices will be invested back in the Middle East. More Bangladeshi workers may find jobs in these countries. Part of the money may be invested in Bangladesh, giving a sigh of relief to Bangladeshi private sector that heavily depends on Dubai and Singapore based banks for foreign credit.

Crude oil price: Less than $70/barrel

Fed funds rate:5.33%
Chinese policy rate: 3.45%
Less pressure on import spending on oil. It will help easing the inflationary pressure. Economic recovery will be early. However, less Bangladeshi workers may find jobs in the Middle East. No bigger depreciation is needed. Chinese investment in Bangladesh may rise.

Fed funds rate: More than 5.33%
Chinese policy rate: Less than 3.45%
Depreciation is needed but less than the default scenario ($70/barrel). Inflationary situation will be better than the default scenario. China will be in a much more comfortable position to grab large share of EU market with weakened Yuan and low oil price. More Chinese credit and FDI for the Middle Eastern infrastructure projects may shrink the opportunity of Bangladesh workers. Less remittance flow than other scenarios. Money supplying measures by Bangladesh Bank will be less than the $70/barrel scenario. Chinese investment in Bangladesh will rise.

Fed funds rate: Less than 5.33%
Chinese policy rate: Less than 3.45%
More foreign credit and FDI will come to Bangladesh. Inflationary situation will be better than all scenarios described so far.Ongoing contractionary monetary policy will not last long. Economic recovery will be earlier than any other scenarios.

CA Deficit: How Worst It Could Be

High oil price and dollar-euro parity Cause a hole in macro stability.

Events in Sri Lanka and the record current account deficit have pressed the panic button in Bangladesh. Despite repeated claims from the govt, rising fuel and commodity prices in the international market may further worsen the current account deficit. Last week,Bangladesh govt started a negotiation with IMF for a total credit of $4.5 billion for the next 3 years as budget assistance. Argument put forward for taking such a credit is that it bears low interest and it can be availed now before things turn into worse like Sri Lanka.

Despite a record inflow of remittances($900 million approx) in the week of Eid-ul-Azha,things have not improved much. Dollar market is still volatile and Bangladesh Bank regularly intervenes by selling US dollar. Current account deficit now stands at $15 billion. Bangladesh Petroleum Corporation (BPC) requires a subsidy of $2 billion to meet the import need of gas and oil. Bangladesh’s export destinations are mired in crisis. Increase in US policy rates may curb the inflation in United States, but investment in US may take a hit, further worsening the job prospect in US and casting a shadow over export order.Former IMF economist Kenneth Rogoff anticipates a covid recovery in China may push up again the price of oil in international market¹. If it happens,then there may be another blow to the inflation situation,tightening the consumer pockets of US consumer. In Europe, fall of euro against US dollar (appreciation of dollar against euro due to rise in policy rate in US) means our exporters will get less Taka against the same volume of exports to Europe. In addition, recession in Europe is more likely as investors would prefer America over Europe due to higher return on dollar there. And Europe will lose its competitiveness due to dollar euro parity and rising inflation at home. New York Times columnist Thomas L. Friedman fears the war in Ukraine may prolong to the winter as it is the best alternative for Russia to get some favorable outcome from this war². Due to gas supply uncertainty, Europeans have to ration their available supply in this winter.Rising cost at home and harsh winter may push NATO to influence Ukraine to cut a compromising deal with Russia. That means a prolonged war in Europe coupled with rising oil prices cast shadow over our export earnings. As fuel prices may be higher,our import spending may also be higher. This means our Taka may depreciate further. And remember next year(end) is the election year. Years during,before and after election generally witness big depreciation (see table)³.

Year	Exch.Rate(TK/$)
1990-91	35.67
1991-92	38.15
1995-96	40.84
1996-97	42.70
2000-01	53.96
2001-02	57.44
2008-09	68.80
2009-10	69.18

Source:Bangladesh Economic Review 2019

As Monsoon is not over ,govt fears further flood across the country by August. If it happens, then it will have further pressure on food security programs,prompting government to increase its spending on food import.Moreover,rising oil price also means we have to increase spending on irrigation during winter. So falling remittances, rising import expenditures may further worsen our current account deficit.

Notes And References

1. “Global Oil And Gas Prices Have Been Highly Volatile--- What Will Happen Next?”,Kenneth Rogoff,July 5,2022,The Guardian. For more read https://www.theguardian.com/business/2022/jul/05/global-oil-gas-prices-supply-demand-us-europe
2. “Ukraine War Is About To Enter A Dangerous Phase”,Thomas L. Friedman,July 12,2022,New York Times. For more read at https://www.nytimes.com/2022/07/12/opinion/ukraine-russia-putin.html
3. Bangladesh Economic Review 2019

Make Good Use Of BPC Subsidy

Falling oil price salvages BPC subsidy,
Retail store sustains consumer activity.
Oil price ushers good news for irrigation,
No evidence of its role in rice price reduction.
Reviving consumer activity and food security
Calls for distribution of spared BPC subsidy.

All-time-low crude oil price extends the spell of profitability for Bangladesh Petroleum Corporation, country’s biggest corporation. Earlier government had provided the much needed fund to subsidize its operation. Higher oil prices made inroads into BPC’s profitability, as evident from the graph. Prior to 2015, BPC regularly incurred loss. Since 2015, it has been treading along the profit-making path. Thanks to oil price less than $70/barrel.

Meanwhile, govt handed out huge subsidy to BPC between 2009 and 2015. The highest was Tk 13557.83 crore in 2013. Back then crude was selling at US$ 108.41/barrel. Since 2015, amount of subsidy has declined to zero. On average govt provided Tk4512.204 crore of subsidy between 2009 and 2015.

Lower oil price relieved the govt from providing huge subsidy to BPC. In the time of pandemic, this is indeed a good news. Salvaged subsidy money could easily be mobilized to help sectors which are in dire conditions. Instead of making frantic requests to other nations for rescuing ailing economy, govt can make good use of this money.

Shops and supermarkets will incur heavy loss, some unsolicited news report says that it will stand at Tk1200 billion, as pandemic lockdowns stall eid shopping activities across Bangladesh. Ramadan and Eid sales jointly account for quarter/half of supermarkets’ annual sales. At the onset of this pandemic, association of shop and grocery owners made frantic plea to govt to give them monetary support. Most of these shops generate employment and act as catalyst to consumerism. Indefinite lockdown makes a dent in their operational expenditure and consumer activity. Many manufacturing and consumer good companies supply them good in the form of credit. Their money also gets locked into coronavirus confinement measures. BPC subsidy money, at least part of it, could be channeled out to help shop owners to meet their operational expenses. The platform of the shop owners could facilitate the distribution of the compensation among the members. Money at the hand of shop owners, in turn, will help clearing the bill of consumer good supplier. So the ecosystem prevailed in the grocery business prior to pandemic will get back into function.

Another sector that can be benefited from the falling oil price and spared BPC subsidy is the agriculture. The winter crop Boro hinges heavily on irrigation. Irrigation consumes lots of fuel. So the irrigation cost will be lower in the wake of lower oil price. By the same token, production cost of urea will be much lower as its key ingredient methane or natural gas is a substitute of crude oil in energy market. LNG prices will be lower in any fall in crude oil price.

However, it is not quite evident whether crude oil price plays any role in influencing the rice price.

I did a little analysis to see whether crude price and Boro production played any role in shaping the price of rice between 2009 and 2018. Data were picked from Bangladesh Economic Review 2018. Durbin-Watson statistic for 10 observations and 2 explanatory variables reported no autocorrelation (d=1.952). Later logarithmic transformation were carried out and regression ran on transformed variables. Result looked like this:

lnRice_t = -44.377-0.17115lnCrude_t+4.950lnBoro_t

(t=-3.62,p=0.008,se=12.20) (t=-1.63,p=0.147,se=0.105) (t=3.94,p=0.005,se=1.254)
(F=8.208, p=0.0146)
where lnRice_t= log natural of coarse rice price at t,
lnCrude_t= log natural of crude oil price at t,
lnBoro_t = log natural of Boro price at t.

Note that crude oil price coefficient turned out to be not significant and negative sign before it calls into question our typical belief.

Boro coefficient, appeared significant in the result, says that holding everything constant a 1% increase in Boro production led to 4.95% increase in coarse price rise in the given period. Well, rice price certainly does not depend on these two variables , there are other factors too. Production of other varieties, food inflation, calamities etc also play a role in shaping price of rice. Inclusion of these variables may yield a meaningful result.

Nevertheless, there will be no denying that part of the saved BPC should also go to provide cash support to the farmers. For instance, the money can be allotted to purchase paddy from farmers at a higher price as part of government’s ongoing rice purchase program. Or it can be used to provide soft agricultural credit. Like the platform of shop owners, agricultural cooperatives can be formed to steer management of the incentive program.

Falling oil price leaves the government some fund, used to give subsidy and finance development expenditure, to cogitate on where to spend them in the time of pandemic. Agriculture and retail stores vie for getting a hold of it. Both are crucial to revive the ecosystem of consumer activity and ensure food security. Instead of swallowing costly bait of foreign credit , govt should make good use of this salvaged subsidy.

Oil Price And Current Account Balance

Could drop in oil price augur good for economy?
Searched the answer spending hours many,
Data on current account and crude oil price
Revealed an unpleasant surprise.
Contrary to belief, current account sustained deficit
Slide from $70 may also hurt forex receipt.
IRF says oil price shock has lasting effect,
This time, positive outcome is what I expect.

In international market, crude oil price hit a nadir after two leading producers had failed to reach agreement on production level.

A local news report says it augurs good for Bangladesh Petroleum Corporation, Bangladesh’s biggest corporation with annual turnover of Tk 250 billion, since government will no longer have to subsidize its operations and it will again walk along the profit-making path.

Lower oil price also means cost of import and cost of production will be much lower. This is happening when aggregate demand in the world market is falling. Investment and infrastructure projects are being postponed. However, export orders are also being called off.

I was keen to look at what it means for current account balance (CAB), which registered negative for the last couple of years. I gathered the old crude oil price data from my earlier analysis on BPC profit/loss, delving macrotrend and updated it for $33 / barrel in 2020. I gleaned the data on CAB from Bangladesh Bank website. Data for 2020 were only available for July-December period.

Since crude oil price influences import and export item prices, it is assumed that current account balance depends on crude oil price.

A quick look at the data revealed that between 2010 and 2020, economy witnessed current account deficit when the crude oil price was well below the $70/barrel, a much talked about price to sustain the economies of Middle East. It is contrary to the belief that a fall in crude oil price improves current account balance. I am still in that group of believers. It is also important to note that Bangladesh embarked upon big infrastructure and investment projects in the given period. Maybe that is the reason for big current account deficit. As I was interested to see the impact of crude oil price on CAB, I needed to fit a model.

Source: Bangladesh Bank & Macrotrend

First, I carried out some diagnostic Check. Time series data called for autocorrelation check. Durbin-Watson statistic (d=1.22 for 11 observations and 1 explanatory variable) fell into indecisive zone. So I went for modified Durbin-Watson check. It reported positive autocorrelation( d=1.22 < d_u = 1.324).

However, I did not transform the regression to make it generalized difference equation. I worked on the serially correlated data and checked for stationarity. To check for stationarity, following regressions were constructed:

🔺 CAB_t = a + b CAB_t-1 + ct + d 🔺 CAB_t-1
🔺 Crude_t = a + b Crude_t-1 + ct + d 🔺 Crude_t-1
Where 🔺 CAB_t= Differences at current account balances at t,
CAB_t-1 = current account balances at t-1,
🔺 Crude_t= Differences at crude oil prices at t,
Crude_t-1= crude oil price at t-1,
🔺 Crude_t-1= Differences at crude oil prices at t-1,
t = a time trend variable, here year.

Tau statistics of slope coefficients of lagged CAB and Crude, -2.33 & -2.3 , in absolute terms were smaller than ADF critical tau statistics at 5% level, -3.4620, and at 1% level , -4.067. So I did not reject the null hypothesis that b=0 or CAB and Crude show an unit root or they are nonstationary.

Please note that first differences of CAB and Crude did not turn out to be stationary. I did not have patience to difference further and to see at what level they became stationary. So both CAB and Crude, for the sake of simplicity, were integrated of order d, I(d).

To check for cointegration, I first regressed CAB on Crude and got the residuals. Then I ran the following regression:

🔺 resid_t = b resid_t-1 + c 🔺 resid_t-1

At 5% level, critical value , reported in J Hamilton’s Time Series Analysis was -3.37. Since computed -2.79 was greater than -3.37, I did not reject the null hypothesis of no cointegration or residuals are nonstationary.

In this case, CAB and Crude were I(d) series and were not cointegrated. So, I went for a VAR model :

🔺 CAB_t = b₁ 🔺 CAB_t-1 + b₂ 🔺 CAB_t-2+ b₃ 🔺 Crude_t-1 + b₄ 🔺 Crude_t-2+ v_t^🔺CAB

🔺 Crude_t = c₁ 🔺CAB_t-1 + c₂ 🔺 CAB_t-2+ c₃ 🔺 Crude_t-1 + c₄ 🔺 Crude_t-2+ v_t^{🔺 Crude}

VAR model did not fit well as reported by F( for 🔺CAB F= 0.8960, p= 0.54 and for 🔺Crude F= 0.048 , p= 0.99). However I was keen to see the Impulse Response Function(IRF), which shows the effect of a shock to an endogenous variable on itself and on other endogenous variables.

An orthogonalized shock to Crude was reciprocated once or twice by CAB and it died out seven or eight periods later, as shown in the graph. The effect of Crude oil price shock on CAB did not wither away instantly and lasted for quite some time.

Analyzing the data for the last 10 years, it was noticed that Bangladesh sustained current account deficit for the last couple of years when the oil price was well below $70/barrel. However, current account deficit deteriorated when the crude oil price increased. Check the price rise when $86/barrel became $107/barrel in 2011, $53.72/barrel rose to $55.71/barrel in 2017 and $55.71/barrel increased to $66.87/ barrel in 2018. Two things became clear: first, increase in crude oil price evidently hurt current account balance; second, price below $70/barrel did not always generate a current account surplus.

My understanding of the situation is that prices lower than $70/barrel stall many investment and construction projects in the Middle Eastern countries where many Bangladeshis work. As construction work halts , they may be laid off. Remittances, rescuer of current account balance , may also get affected. In addition, higher oil prices generate revenue for investment in many of the occidental countries, contributing to increase in household income. That means more spending on apparel items , leading more orders for Bangladeshi garment factories. This may not last as that high oil price driven revenue may dry up , hurting investment and household income in those countries. So our apparel export may also take a hit because of this. By the way, this is considered without taking into account the Corona effect.

And from the graph it was seen that any rise or fall in Crude oil price had a lasting effect on the current account balance. Could it be different for this time?