Something to worry about

2 August, 2008 - Surging oil and food prices mixed with cheap credit have pushed Bhutan’s inflation up to 8.85 percent and inflicted enormous pain on its poor. So far it has shown little sign that it will stop. Experts say that to mend the hurt will need bold measures and pay hike is not one of them.

Inflation is a sustained increase in the average price of goods and services in an economy. During such times, money loses purchasing power since each unit of currency can now buy progressively fewer goods. The National Statistics Bureau records show that the ngultrum has lost 25 percent of its value in the past four and a half years to inflation.

Food accounts for much of the Bhutan consumer-price index and is, therefore, of huge concern to poor urban Bhutanese, who spend nearly half their income feeding their families. This is true for Sonam Rinchen, 24, a civil service driver, who looks after five family members in the capital. “Food prices are killing me,” he said. The rest of his income is spent on house rent. Although, he said, he had substituted less expensive items and forgone some, he still incurred debt almost every month.

The inflation has also shrunk people’s real value of savings because bank interest rate is now lower than inflation, and has led to negative real interest rates. At 8.85 percent inflation, a Bhutanese who receives 6 percent interest on his savings is today collecting real interest rate of (negative) -2.85 percent.

Some officials argue that, since Bhutan imports 70 percent (2006) of consumer goods from India, inflation in Bhutan is a spillover from India which is, at the moment, stung by a high inflation of 12 percent. Experts, though, say there were strong domestic reasons as well.

According to the head of the research and statistics division, Pushpalal Chhetri, of the royal monetary authority (RMA), one of the major causes was the rising expenditure, year after year, of the government. The country’s total expenditure during 2006-07 was Nu 18.30 billion, a 33 percent rise from the previous year.

Pushpalal said that the rapid growth in public spending created many economic jobs in the country, which led to rise in incomes and demand, and drove up import of consumption goods. With credit readily available at low interest, Bhutanese also took out more loans for high-end goods such as homes and cars. More homes and cars meant additional import of raw material and fuel. High-speed diesel from India topped Bhutan’s commodity import list at Nu 1.50 billion in 2006-07.

This excess demand not only sent up food prices but also depleted government’s rupee reserves, said Pushpalal. To stave off the deficit, RMA borrowed Rs 2.0 billion from the state bank of India. It also sold US$ 25 million from its hard currency reserves to pump rupees into the economy.

“All this happened because of loose credit in the market,” said Pushpalal.

RMA moves
To tighten supply of money in the market, RMA increased the cash reserve ratio (CRR), or the share of deposits banks must keep on hand, in September 2007, from 13 to 15 percent, and stopped paying interest on it. It increased the reserves requirement for its housing loans.

It also increased the volume of its discount bills from Nu 100 million to Nu 2,000 million and the interest rates on it from 3.5 to 5 percent. Bank’s deposit rate was only about 2.5 percent.

The idea was to shrink deposits in the banks and eventually pressure them to increase their lending rates since RMA’s actions rendered deposits in the banks expensive. When lending rates go up, people will demand fewer cars and build less houses. The measure was aimed to cool inflation.

The RMA policy managed to bring down banks’ excess liquidity from Nu 7 billion to Nu 4 billion. But the lending rates remained the same. And inflation rose from 6 percent at the time to 8.85 percent today.

Part of the problem could be that banks like the Bhutan national bank (BNB), which has a huge clientele of depositors and borrowers, countered RMA’s moves with their own. BNB increased its corporate deposits interest from 2.5 percent to 5 percent, equalling RMA’s rate, and personal deposit interest from 6 percent to 6.5 percent. The raise prevented its clients from making an all out flight to RMA.

Experts, therefore, feel that it’s not just monetary but also fiscal policies that are needed to curb inflation. If government increases tax on “luxury items” like cars, people will stop buying them and reduce the import of fuel, they contend. The head of the planning and policy division, Kinzang, of the ministry of finance (MoF), said that the government was studying possible taxation measures, but declined to elaborate for fear of stoking market speculation.

So will salary raise help cushion people from inflationary pressure? “It will add fuel to fire,” said RMA’s Pushpalal. Pay hike would further pump people’s capacity to spend more, increase house rents and spread to other consumption goods as well, nudging inflation further up. A team from the International Monetary Fund (IMF) this week cautioned officials against the raise of civil service salary.

Will subsidy on fuel help? It will worsen the situation because it will encourage more consumption and imports, said MoF’s Kinzang. At any rate, fuel already comes at a subsidised rate from India.

There are some, who hope that the recent raises in the interest rate and CRR in India to bring down inflation, will decrease Bhutan’s inflation as well. There are others, who feel that serious monetary tightening is not warranted: higher inflation, they say, is due solely to spikes in food prices, caused by temporary supply shocks and speculation. Higher interest rates cannot call forth more tomatoes or grain. They expect inflation to ease sooner or later. “Monetary tools will have little impact because we import our consumption goods from India,” said BNB managing director, Kipchu Tshering. Few also say the worst is over.

RMA, however, says it might increase its interest beyond 5 percent on its discount bills to rein in inflation.

Using one’s onions
Experts say that, because food has a much bigger weight in household spending, not only is Bhutan more prone to a surge in inflation, but the social and political consequences could also be more severe, if nothing is done about it. The longer it is allowed to climb, the greater the danger to future economic growth.

“When things become expensive, businessmen simply increase their prices and the salaried, somehow, muddle through,” farmer Ap Sha Gyeltshen from Babesa told a Kuensel reporter recently. “It is us the farmers who suffer the most from rising prices. Fertilizers and essentials become dearer. And our source of income, farming, is the same as before.”

Ruling politicians in India have a wise regard for the onion, which on occasion has proved as potent at removing governments as at flavouring the nation’s curries. In 1998 a coalition led by the Bharatiya Janata Party (BJP) was defeated in a Delhi state election after a six-fold rise in onion prices. The present Bhutanese government would do well to heed this wisdom, say observers.

Source: http://www.kuenselonline.com