Rising inflation is a major, perhaps the most important, economic issue facing the country. As fellow blogger Amer noted back in May: inflation up, government down. We touched on inflation in here and here. As is widely noted, recent rises in inflation are driven by food prices. In this post, I cover two possible reasons why food prices in Bangladesh continue to rise. The first one is macroeconomic, and I show some charts as evidence. The second one is microeconomic, and I have only anecdotal evidence in its support. As always, looking forward to a good discussion.

Macroeconomic explanation

As Rumi Ahmed notes in his blog, food price inflation is a worldwide phenomenon. It’s no secret that our food market is quite strongly linked with that of India. So what happens in the food market in India affects us. Chart 1 shows how food prices have evolved over the past 8 years in Bangladesh and India.

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Couple of observations can be made.
1. Up until late 2003, food prices in both countries moved similarly. This is not to say that one kg rice cost the same in the two countries. What this means is that up until late 2003, the price of rice went up or down in similar fashion in both countries.
2. Bangladeshi prices started rising in 2003-04, about a year before Indian prices. By mid-2007, Bangladeshi prices were over 50% their mid-2003 level. Indian prices rose by only about 35% in this time.
What’s going on here?

Chart 2 shows how the taka has depreciated against the Indian rupee since 2003. One Indian rupee cost 1.20 taka in late 2002. In mid-2007 the rate was 1.70 taka per rupee. That is, whatever cost 1 rupee in late 2002 now costs 50 paisa more in Bangladesh.

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Now we can tell a story. As the taka started to depreciate against the rupee, Indian imports became more expensive in Bangladesh. So, even before Indian food prices started to rise, our prices were taking off. Of course, once Indian prices started to rise, it only made matters worse.

If a depreciation of the taka is the problem then is appreciating taka the solution? If the taka appreciates, then it will hurt our exporters.

Exports have done really well in the past few years. See this Economist article — a rare piece of good news. Exports could be growing because of a weak taka which makes exports competitive internationally. But then agaon. we import most of our intermediate machineries, and a weak taka makes them expensive. One can argue that instead of a weak taka, a much more important reason why our exports are doing better is because the developed economies are growing strongly, and as a result they demand more of our exports and our workers can earn more in overseas labour markets.

Since rupee is the primary import currency, especially for food essentials, depreciation against rupee has only inflationary impact, and no competitiveness gain. If the rupee exchange rate is stabilized at say 1.50 taka, then the taka would appreciate a bit against both US dollar and euro, but it will probably still be about 80 taka against euro and 60 taka against the greenback. Given the strength in the global economy (notwithstanding recent market volatility), this would still keep exports growing.

Microeconomic explanations

In addition to the macroeconomic story above, one can tell microeconomic stories about food price inflation. One such story involves corrupt businessmen, in cahoots with political big wigs, forming cartels and syndicate that keep prices high artificially. This story has never made much sense to me. Syndicates may cause prices to jump initially, they shouldn’t cause prices to remain high or continue to rise. Think about it. Say a top politician gets all the rice traders in his palace and asks them to raise the price, how high would the price go? The price cannot go too high because beyond a certain point, people will simply stop eating rice. So their must be a ceiling beyond which prices could rise.

Okay, maybe we haven’t reached that ceiling yet. Suppose this is the case. But even in this case, what is stopping one businessman to undercut all the others and sell at a lower price? Wouldn’t this businessman capture the entire market? This is exactly what happened in the oil market in the 1980s. After the OPEC raised the price of crude oil in the 1970s, Saudi Arabia and Gulf countries started to lower prices to capture market share. So why wouldn’t the Bangladeshi rice traders do exactly the same? Ah, but no businessman would dare oppose the political king pin — this was the stock standard reply before January. Of course this answer is no longer credible.

There are, however, two other microeconomic stories one could tell about why food prices had jumped above and beyond what would be expected from global macroeconomic causes.

First one involves food stock buffers. Since the late 1970s, Bangladesh had slowly built up a food stock buffer system. This was government-run, and unlike most other government-run things, this actually worked reasonably well under successive governments. This is why, despite floods and other natural disasters, food prices remained reasonably stable during the 1980s and 1990s.

In the early years of the last government, it was noted by the Finance ministry, possibly with some advice from WB/IMF, that the food buffer system was government-run and should be privatised or outsourced. Now, obviously the market didn’t work too well in the early 1970s and we had the 1974 famine (Amartya Sen found in his research that more than political problems, it was a food price issue that caused the famine). So one should have been skeptical about this policy initiative. At the very least, this outsourcing should have been done very carefully.

My understanding, based on discussions with government officers and other practitioners, is that the Agriculture and Food ministries failed abysmally in implementing this policy. As a result, when the supply started drying up in the global market and prices started to rise, government found itself unable to curb the inflation. A better buffer system wouldn’t have prevented the price rise, but it would have smoothened the process. In addition, some argue that the agriculture ministry also deserves blame for failing to provide adequate support to farmers and as a result domestic food supply was hurt.

Another microeconomic story involves the way the current government has gone about it its ‘clean up drive’. In the first weeks of the January changeover, security forces demolished haat and bazaars across the country. Since then, its anti-corruption drive has frightened businessmen in every sector. As a result, it’s no surprise that prices are rising.

Unfortunately, I don’t have any data-based evidence to support either of these stories, and it would be great of anyone can shed some light. But most ominously, if these micro stories are correct, then the government’s ability to curb further price rises is quite limited. And going forward, things do look very uncertain.

Update

Feels like a such a long time ago that we discussed prices. As promised, here’s a chart showing taka against the US dollar and euro.

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