BOP crisis. A prescription to bangladesh policy maker

BOP crisis: a classic scenario

1. Export dollars are used to purchase necessary imports: oil, capital goods, and pharmaceutical drugs.

2. A fall in the world price of the country’s export reduces export earnings.

3. At the same time a rise in oil prices increases the import bill.

4. Result: current account deficit explodes.

5. Must be financed somehow: initially by drawing down foreign exchange reserves. Then by borrowing abroad: say IMF, WB.

6. Developing country whose main source of export dollars is an agricultural commodity: tea, rubber, cocoa, etc.

After the intensification of the financial crisis :

Ø      Exchange rate markets have turned more unstable.

Ø      Equity markets experienced a strong downward adjustment.

Ø      Country risk spreads spiked.

Ø      The stock of international reserves either stopped growing or decreased.

Ø      Credit growth has slowed down considerably in most developing economies.

Experience from past financial crises show that they have negative effects on poverty and welfare, and tend to slowdown progress towards the MDGs.

Unemployment rates are increasing; together with real wages reduction impede household’s ability to provide adequate food and necessities.

Employment is shifting from dynamic exports oriented sectors to low productivity informal sectors.

Declining in remittance and migrant return could undermine poverty gains.

The reduction of systemic risk entails:

Ø      Liquidity facility as a permanent component.

Ø      The consideration of surveillance as a public good.

Ø      A consistent and widely accepted regulation and supervision framework is required.

Improvement in governance requires:

Ø      Incorporate the demands and adequate representation of developed and developing countries.

Ø      Reflect the current and growing role of emerging market economies.

Ø      Include an active role for the United Nations and other Bretton Woods institutions.

Causes of financial crises

◦         Fragility of financial systems

◦         Intermediation, asset-liability mismatch

◦         Strategic complementarity

Amplifying factors

◦         Imperfect knowledge and herd behavior

◦         Credit and high leverage

Collapse of asset prices

◦         Liquidity problems

◦         Possible contagion

Regulatory failures

Policy for Bangladesh government and Bangladesh bank and ministry of finance

Need a permanent stabilization or counter-cyclical fund

1. Need to encourage competitiveness through policy incentives and tax cuts. So that new opportunities can be seized

2.  Encourage capacity expansion, technology up gradation and build up of key inventories

3. Selective bail-out for smaller firms – mostly in terms of easy credit and repayment terms

4. Should aggressively pursue an expansionary monetary and fiscal policy, encourage consumption of domestically produced goods, inject purchasing power in the farm sector

5. Impact on RMG and textile sectors require close monitoring – only those units that have adopted good management practices and cut all extra costs should get benefits

6. Should insistently pursue an expansionary monetary and fiscal policy, encourage consumption of domestically produced goods, inject purchasing power in the farm sector

7. Need to pay particular attention to selected sectors for example leather, jute and sea food;

8. It is now clear that low farm prices for rice is also an impact of the GFC – this will have a

9. Overall: the focus should be on the medium term, post-recession policy rather than being immersed in immediate problems and concerns.

World bank/IMF requirements

—        Fiscal discipline.

• Increased public expenditure on primary health care, primary education, and infrastructure.
• Tax reform (to lower marginal rates and broaden the tax base).

• Financial liberalization.
• A competitive exchange rate.
• Trade liberalization.
• Liberalization of FDI inflows.
• Privatization
• Deregulation

• Secure property rights.

Lessons from the Crisis

—        Avoid high volatility in monetary policy

—        Appropriate response of monetary policy to asset prices

—        Manage capital flow volatility

—        Look for signs of over leveraging

—        Active dynamic financial regulation

◦         Capital buffers, dynamic provisioning

◦         Look for regulatory arbitrage incentives/ possibilities