The case against monetary easing

The monetary policy for the second half of 2013 (The calendar year) is coming up. There are widespread rumors that this will be an expansionary monetary policy with a potential policy rate cut. Some even go to the extent of saying that reserve requirements will be reduced. As an analyst, I strongly believe that an expansionary monetary policy would be the wrong move, and maintaining the status quo would be the more prudent policy decision.

Before I delve into my arguments let me try to understand what can prompt the central bank to go for monetary easing. The only factor that comes to my mind is the sharp decline in private sector credit growth which stood at 11.43% at the end of May 2013. Despite the decline in loan demand, lending and deposit rates remained quite sticky and have not been coming down as much as the central bank would have liked. So, maybe the central bank believes that further easing would cause interest rates to decline and thus spur credit growth and investment in the economy.

I have two major points against this theory.

First, I believe that the slowdown in credit growth was less due to high-interest rates and more due to the global economy, political violence, etc. We have also seen in the past that credit growth comes down during the election year and thus 2013 was no exception. No businessman in his right mind would go for heavy investment in such an uncertain situation. If that is the case, then going for further monetary easing would not really spur growth at all. Credit demand would normalize once the election is over by itself without a monetary stimulus.

Secondly, we do know that there is enough liquidity in the banking system. As per a Financial Express report, loanable excess liquidity rose to BDT 695 bn in April 2013 from BDT 456 bn in June 2012. M2 growth is around 18% as of March 2013 driven largely by unsterilized dollar buying by the central bank. This is quite high by any global standards and going for further monetary easing is quite risky from an inflationary standpoint. The situation reminds me of the 2009-10 periods when the central bank went for unsterilized dollar buying to prevent the BDT from appreciating. The result was a stock market bubble and double-digit inflation. The real estate market also was in a bubble-like situation and has been correcting it ever since. We surely do not want a repeat of that situation.

I think that policymakers should put more attention to supply-side bottlenecks such as energy and infrastructural constraints. Trying to boost GDP growth during times when ‘real’ demand is low, will only haunt the economy in the future.

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