Economy

The Economic Consequences

Jyoti Rahman

No, not the economic consequences of Grameen Bank, nor of micro-credit – those would be about the effectiveness of these institutions and programmes on poverty alleviation – but of Dr Yunus. Or rather, the economic consequences of the way Dr Yunus is being treated by the political establishment – that's the subject of this article.

Regardless of where each of us stands on any of these issues, we need to understand that the way things have unfolded present some serious economic risks. And the most significant of these risks comes from a possible loss of credibility of the Bangladesh Bank.

Let's think through this carefully.

Whatever the legal technicalities, there is every reason to believe that the Bangladesh Bank wrote to Dr Yunus relieving him from his duties at the Grameen Bank at the government's behest. That is, the Bank acted not as a non-partisan technocratic body, but as just another government agency carrying out the political decisions of the executive branch of the state.

Dr Mohammad Yunus, Photo: star file

This stands in sharp contrast to how a central bank is supposed to behave when managing a fiat currency. According to the modern theory and practice of central banking, the bank should manage the supply of money and credit in the economy to maintain macroeconomic stability. In practice, this means keeping one or more of inflation, the exchange rate, asset markets, or the financial system on a steady and sustainable path. And the central bank is left alone by the politicians in carrying out this task.

This doesn't mean the central bank is a law unto itself. Rather, the modern practice holds that the central bankers should be appointed by the elected politicians, mandated with a clear task, and be held accountable to the appropriate parliamentary body. However, for the day-to-day operations, the central banker should be kept as far away from politics as possible.

When the central banker gets drawn into the muck of politics, the bank loses credibility.

The private sector needs to believe that the central bank is managing credit flows or money supply based on its assessment of the economic conditions and outlook. If the private sector came to believe that the central banker moves on the basis of political exigencies of the government, then that credibility is destroyed.

What happens without credibility? In the extreme, paper money loses its value.

Every note of Bangladeshi taka contains the words 'Chahiba matro ihar bahokke ... dite badhyo thakibe'. Let's think about these words for a second. These words are only valid as long as people believe that they are valid – that is, as long as the Bangladesh Bank has credibility. In the extreme, if all credibility is gone, a taka note is just another piece of paper, nothing more.

This is too extreme? Perhaps. But the less extreme risks are pretty severe too.

In his statement on the matter, BRAC's Sir Fazle Abed noted:

“A big capital of such organisations is the intrinsic community level trust that they have earned. This trust element must not be underestimated. If this trust is lost, then there may be delinquencies, intentional refusal to repay loans or large-scale withdrawal of savings by the members.”

Suppose the worst were to happen, and there is a run on Grameen Bank. Is our banking system safe from a contagion crisis? Will other, commercial, banks be secure from a systemic run?

As it happens, our banking system is probably under significant stress already. In January, when share prices plunged, the commercial banks were reported to have been 'persuaded' to shore up the market. Hard data are yet to become available, but anecdotally, many commercial banks may already hold assets of dubious quality. The whole episode has already raised questions about the central bank's competence.

All else equal, the banking system will be a lot more secure if depositors can trust the Bangladesh Bank – that is, if the Bank has credibility. In this climate, anything that worsens the Bank's shaky credibility can lead to a full blown banking and financial crisis.

And if anyone needs a reminder of what a financial crisis means, they can look at what happened to the United States and Europe in the wake of the collapse of Lehman Brothers in September 2008.

A crisis could be triggered in the external sector too. As political unrest spreads around the Arab world, our already-softening remittance could nosedive, just as rising oil prices fuel inflation. A credible central bank can calm the market and maintain both the exchange rate and inflation on a steady path. A central bank that indulges in political hatchet jobs, on the other hand, is likely to compound the problem.

And even if none of these came to pass, in an already high inflation environment, a less credible Bangladesh Bank will find it harder to reign in further price hikes. The central bank has consistently overshot its money supply growth target in recent years. Even the government's centralised wage-setting boards don't use the Bank's inflation forecasts. Now, the market will find it even less convincing that the Bank can or will do anything about inflation. Expectations of future price rises will only raise prices today.

Meanwhile, foreign investors are not likely to look kindly upon a country where the central bank ignores its key tasks and indulges in political games.

Even the best case scenario then might be one of high inflation and lacklustre foreign investment!

The economic consequences of Dr Yunus saga can be dire indeed. His detractors could well rue the way they handled the situation. The problem is, 160 million Bangladeshis would have to suffer the economic consequences of their folly.

Jyoti Rahman is an applied macroeconomist.