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Rising Production Costs and Their Impact on Inflation in Bangladesh

Rising Production Costs and Their Impact on Inflation in Bangladesh

The economic landscape in Bangladesh is currently marked by a significant increase in production costs, adding substantial pressure to inflation. This situation is further exacerbated by rising loan interest rates and escalating energy tariffs, creating a challenging environment for businesses, industrialists, and consumers alike. The recent changes in Bangladesh Bank’s method of determining loan interest rates have led to a sharp increase in borrowing costs, with rates surpassing 13 percent for bank loans and 15 percent for non-bank financial institutions. This surge in interest rates directly impacts production expenses, forcing businesses to raise prices, which fuels inflation. Concurrently, energy costs have skyrocketed, with gas prices increasing by up to 179 percent and electricity tariffs rising by over 13 percent within the past year. These heightened energy expenses disproportionately affect small businesses, which often operate with thinner margins, causing severe disruptions in production schedules and supply chains. Additionally, frequent power outages and inadequate gas supply further strain industrial operations, leading to reduced productivity and higher operational costs. This combination of increased financial burdens and operational challenges is driving many businesses towards unsustainable losses, reducing their competitiveness in both domestic and international markets. Consequently, consumers face higher prices for goods and services, diminishing their purchasing power and contributing to an overall economic slowdown. The ongoing energy crisis, compounded by a dollar shortage and delayed domestic gas production, suggests that these issues will persist, necessitating comprehensive government intervention and strategic innovations from businesses to mitigate the economic strain and curb inflationary pressures.

 Increasing Loan Interest Rates

The decision by Bangladesh Bank to change the method of determining loan interest rates has led to a sharp increase in the cost of borrowing. Following the removal of the ‘9-6 interest rate’ cap, the interest rate on bank loans has surged past 13 percent, with non-bank financial institutions charging over 15 percent. This increase is a result of the new method, which bases the loan interest rate on the Six Months Moving Average Rate of Treasury Bills (SMART) plus an additional margin. In March 2024, an additional 3.5 percent interest was added to the SMART rate, driving rates higher despite efforts to contain them.

This spike in interest rates has placed significant strain on private investors and consumers. Higher borrowing costs translate directly into increased production expenses for businesses, which in turn leads to higher prices for goods and services in the market. This cycle perpetuates inflation, making it more difficult for consumers to manage their expenses.

 Energy Crisis and Tariff Increases

Adding to the financial strain on businesses is the dramatic rise in energy costs. Since the start of 2023, gas prices have soared by up to 179 percent, and electricity prices have seen two significant hikes: an 8.5 percent increase in February 2024 following a 5 percent increase in March 2023. These rising costs of fuel and electricity disproportionately affect small businesses, which often operate with tighter margins and less financial flexibility.

For instance, small factories with annual export values around Tk 40 crore face electricity and gas bills that have increased by 40 percent compared to the previous year. This steep rise in utility costs, combined with frequent power outages and inadequate gas supply, severely disrupts production. Factories in industrial areas like Ashulia experience power outages for up to five hours during an eight-hour production shift, further hampering their operations.

 Impact on Industries and Consumers

The compounded effect of rising interest rates and energy costs is driving many businesses to the brink. Industrialists report that many are forced to shut down operations or reduce production due to unsustainable losses. The high costs of production are inevitably passed on to consumers, exacerbating the inflationary pressures.

Moreover, the gas crisis shows no signs of abating in the near term. Government officials indicate that due to a dollar crisis, it is not feasible to import sufficient liquefied natural gas (LNG) to meet demand. Plans to increase domestic gas production will take at least two to two-and-a-half years to materialize, suggesting that the energy crisis will persist through 2026. This ongoing uncertainty further discourages investment and expansion in the industrial sector.

 Strategies for Survival:

In response to these challenges, industries are exploring various strategies to mitigate costs. Investments in energy-efficient generators and other cost-saving technologies have become more common as businesses strive to remain competitive. These technologies help reduce long-term operational costs by lowering energy consumption and improving efficiency. Additionally, some businesses are adopting renewable energy sources such as solar panels to decrease reliance on expensive and unstable gas supplies. Despite their potential, these measures often require significant upfront capital, which is harder to secure given the current high-interest rates and liquidity crunch in the banking sector.

To navigate the financial constraints, businesses are also looking at streamlining operations and enhancing supply chain management. By optimizing logistics and reducing waste, companies can cut costs without compromising on production quality. Some industries are also shifting towards more flexible production techniques that allow them to scale operations up or down quickly in response to market demands, thereby minimizing the financial impact of fluctuating production levels.

Moreover, businesses are increasingly turning to digital transformation as a way to enhance efficiency and reduce costs. Automation and digitization of processes can lead to significant savings by minimizing human error, speeding up production times, and enabling better inventory management. While the initial investment in digital technologies can be substantial, the long-term benefits often justify the expenditure.

Another strategy being employed is strategic partnerships and collaborations. By forming alliances with other companies, businesses can share resources and expertise, leading to cost savings and innovation. These partnerships can range from joint ventures and co-manufacturing agreements to shared logistics and distribution networks.

Furthermore, there is a growing emphasis on workforce management. Companies are investing in training and development programs to upskill their employees, ensuring a more productive and versatile workforce. This not only helps in improving efficiency but also reduces the need for hiring additional staff, thereby cutting labor costs.

In summary, while the current economic conditions in Bangladesh pose significant challenges, industries are adopting a multifaceted approach to survival. Through energy efficiency, operational optimization, digital transformation, strategic partnerships, and workforce development, businesses are finding ways to mitigate costs and navigate the turbulent economic landscape.

Supply Chain Disruptions:

The increased cost of borrowing and energy has led to significant supply chain disruptions. Businesses are struggling to maintain inventory levels due to higher costs and delayed production schedules, causing further price hikes and availability issues in the market. With the surge in interest rates, companies face increased financial burdens when attempting to secure the capital needed for purchasing raw materials and maintaining inventory. This has resulted in a tightened cash flow, making it difficult for businesses to operate smoothly.

Additionally, the steep rise in energy costs has disrupted production schedules as companies grapple with frequent power outages and insufficient gas supplies. These interruptions force factories to halt production unexpectedly, leading to delays in fulfilling orders and meeting market demands. As a result, the flow of goods through the supply chain is significantly slowed down, affecting everything from raw material procurement to the delivery of finished products.

These disruptions have a cascading effect on the market, as delayed production and reduced inventory levels lead to shortages of goods. Consumers face higher prices and limited availability, further fueling inflation. Retailers and wholesalers are also impacted, as they struggle to restock shelves and meet customer demands, which can lead to a loss of sales and customer dissatisfaction.

Moreover, international supply chains are not immune to these disruptions. Export-oriented industries in Bangladesh are finding it increasingly difficult to meet global market requirements on time, risking penalties, loss of contracts, and a damaged reputation. The increased costs and delays also reduce the competitiveness of Bangladeshi products in the global market, making it harder for the country to sustain its export growth.

In summary, the combination of higher borrowing costs and escalating energy prices has created a ripple effect of supply chain disruptions, leading to inventory shortages, production delays, and increased market prices. These challenges highlight the urgent need for businesses to adopt more resilient supply chain strategies and for policymakers to address the underlying economic issues to stabilize the market.

 Consumer Purchasing Power:

With inflation driving up the cost of essential goods and services, consumers’ purchasing power is diminishing. This reduction in disposable income is leading to decreased consumer spending, which in turn impacts businesses’ revenues and exacerbates economic slowdown. As prices for basic necessities such as food, fuel, and utilities rise, households find themselves with less money to spend on non-essential items and discretionary goods. This shift in spending behavior not only affects retailers and service providers but also has a broader impact on the entire economy.

Consumers are increasingly forced to prioritize their spending, cutting back on dining out, entertainment, and even health-related expenses. The decrease in demand for these goods and services directly hits businesses, particularly small and medium-sized enterprises (SMEs), which often rely heavily on consumer spending. Lower sales volumes lead to reduced profits, forcing some businesses to scale back operations, lay off employees, or even close down entirely.

This contraction in consumer spending creates a vicious cycle, where businesses’ reduced revenues lead to lower wages and job losses, further decreasing household incomes and spending power. The ripple effects can be seen across various sectors, from retail and hospitality to manufacturing and services, slowing down economic growth and development.

Moreover, the decrease in consumer spending affects the government’s fiscal health. With lower sales, the government collects less in value-added tax (VAT) and other consumption-based taxes, reducing its revenue and limiting its ability to fund public services and infrastructure projects. This can lead to cuts in government spending, further impacting economic activity and growth.

Financial stress also increases among households, as higher living costs mean that people are more likely to fall behind on debt repayments, including mortgages, personal loans, and credit card bills. This can lead to higher default rates, which in turn affect the banking sector by increasing the number of non-performing loans, putting additional pressure on financial institutions.

In summary, the erosion of consumer purchasing power due to inflation is having far-reaching consequences on the economy. Reduced disposable income leads to lower consumer spending, which impacts business revenues and contributes to an economic slowdown. Addressing these issues requires comprehensive measures to control inflation, support consumer incomes, and stimulate economic activity to break the cycle of reduced spending and economic decline.

Export Competitiveness:

Rising production costs are significantly affecting Bangladesh’s competitiveness in the global market. Export-oriented industries, which are critical to the country’s economic growth, are struggling to offer competitive prices due to increased expenses related to borrowing, energy, and raw materials. As a result, Bangladesh risks losing market share to countries with lower production costs, such as Vietnam, India, and Indonesia. These countries benefit from more stable economic conditions, lower energy prices, and more efficient supply chains, allowing them to price their goods more attractively on the international market.

The impact on export competitiveness is multifaceted. First, higher production costs lead to higher prices for Bangladeshi goods, making them less appealing to global buyers who can source similar products at lower costs elsewhere. This is particularly problematic in price-sensitive industries such as textiles and garments, where Bangladesh has traditionally been a strong player. If international buyers shift their orders to other countries, Bangladeshi manufacturers could see a significant drop in export volumes, affecting revenue and profitability.

Second, the higher costs of production also squeeze profit margins for Bangladeshi exporters. Even if they manage to maintain their market share by absorbing some of the increased costs, their profitability will decline. This reduced profitability limits the ability of these businesses to reinvest in technology, expand operations, or improve product quality, further eroding their competitive edge over time.

Third, the uncertainty caused by frequent power outages and inadequate gas supply disrupts production schedules, leading to delays in fulfilling orders. This unreliability can damage the reputation of Bangladeshi exporters, causing international buyers to question their ability to deliver on time and meet quality standards. Consistent delays and supply chain issues can lead to penalties, canceled orders, and loss of long-term contracts.

These challenges also have broader economic implications. A decline in export competitiveness can negatively impact Bangladesh’s trade balance, reducing foreign exchange earnings and increasing the trade deficit. This situation can put additional pressure on the country’s currency, exacerbate inflation, and make it more difficult for the government to manage its fiscal policies effectively.

Moreover, the loss of market share and reduced export revenues can lead to job losses in export-oriented industries, contributing to higher unemployment rates and social instability. The textile and garment sector, for example, employs millions of workers, many of whom could face job insecurity if export orders decline significantly.

In summary, rising production costs are undermining Bangladesh’s export competitiveness, threatening the country’s market share in key industries and potentially leading to long-term negative implications for its trade balance and economic health. Addressing these issues requires strategic interventions to reduce production costs, enhance supply chain reliability, and support exporters in maintaining their competitive edge in the global market.

Policy Measures and Government Support:

There is growing demand for the government to implement supportive measures to alleviate the financial strain on businesses. As rising production costs, energy prices, and loan interest rates continue to challenge the economic landscape, targeted government interventions are essential to help industries cope and maintain production levels. Potential policies that could be considered include subsidies for energy costs, tax reliefs, and financial aid programs.

Subsidies for Energy Costs: One of the most immediate and impactful measures the government could take is to provide subsidies for energy costs. By offsetting a portion of the gas and electricity expenses for industrial users, the government can help reduce the operational costs that are driving inflation and affecting competitiveness. This subsidy could be structured to prioritize sectors that are most critical to the economy and most vulnerable to energy price volatility, such as textiles, manufacturing, and small and medium-sized enterprises (SMEs).

Tax Reliefs: Implementing tax reliefs can provide significant relief to businesses struggling with increased production costs. This could include temporary reductions in corporate tax rates, waivers on certain types of taxes, or deferred tax payments. Such measures would improve cash flow for businesses, allowing them to reinvest in their operations, maintain employment levels, and keep prices more stable. Additionally, offering tax incentives for investments in energy-efficient technologies could encourage businesses to adopt more sustainable practices that reduce long-term energy costs.

Financial Aid Programs: Establishing financial aid programs targeted at sectors hit hardest by the economic challenges can provide much-needed support. These programs could include low-interest loans, grants, or credit guarantees aimed at helping businesses manage their liquidity needs and continue their operations. By easing access to financing, the government can help businesses cover the costs of raw materials, pay their employees, and manage other operational expenses.

Enhanced Access to Credit: In addition to direct financial aid, the government could work with banks to enhance access to credit for businesses. This could involve creating special loan schemes with lower interest rates for key industries or providing guarantees that reduce the risk for banks lending to these sectors. Such measures would help businesses secure the necessary capital to navigate the high-interest-rate environment.

Investment in Infrastructure: To address the issues of power outages and unreliable gas supply, the government should invest in improving the country’s energy infrastructure. This could include expanding the capacity of domestic gas production, upgrading power grids, and investing in renewable energy projects. While these infrastructure improvements may take time to implement, they are crucial for providing long-term stability and reliability to the industrial sector.

Support for Export Industries: Specific policies to support export industries can help maintain Bangladesh’s competitiveness in the global market. These could include export subsidies, support for trade promotion activities, and investment in improving the efficiency of ports and logistics. Enhancing the overall export ecosystem would help businesses reduce costs and improve their ability to compete internationally.

Public-Private Partnerships: Encouraging public-private partnerships (PPPs) can leverage private sector expertise and investment to address some of the structural challenges facing the economy. PPPs can be particularly effective in infrastructure development, where private investment can complement public resources to build and maintain critical energy and transportation projects.

In summary, to alleviate the financial strain on businesses and support economic stability, the government should consider a range of supportive measures, including energy subsidies, tax reliefs, financial aid programs, enhanced access to credit, infrastructure investments, export support, and public-private partnerships. These interventions can help mitigate the impacts of rising production costs, support business continuity, and contribute to the overall economic resilience of Bangladesh.

Technological and Operational Innovations:

To survive in this challenging environment, some businesses are turning to technological and operational innovations. Automation, digitization, and improved supply chain management practices are being adopted to reduce costs and enhance efficiency. These innovations can significantly improve productivity by streamlining operations, reducing human error, and enabling better resource management.

Automation: By incorporating automation into their processes, businesses can reduce labor costs and increase production speed. Automated machinery and robotic systems can perform repetitive tasks more quickly and accurately than human workers, leading to higher output and lower error rates. For example, in the manufacturing sector, the use of automated assembly lines can enhance production efficiency and product consistency, allowing companies to meet demand more effectively while reducing operational costs.

Digitization: The shift towards digitization involves the adoption of digital tools and platforms to manage various aspects of business operations. This includes implementing enterprise resource planning (ERP) systems, customer relationship management (CRM) software, and digital payment solutions. Digitization enables businesses to streamline processes, improve data accuracy, and enhance decision-making capabilities. For instance, digital inventory management systems can help companies maintain optimal stock levels, reducing the costs associated with overstocking or stockouts.

Improved Supply Chain Management: Businesses are also focusing on enhancing their supply chain management practices to mitigate disruptions and reduce costs. This includes adopting just-in-time (JIT) inventory systems, which minimize inventory holding costs by aligning production schedules with demand. Additionally, leveraging advanced analytics and predictive modeling can help companies forecast demand more accurately, optimize logistics, and identify potential bottlenecks in the supply chain.

Challenges for SMEs: Despite the clear benefits, these technological and operational innovations require substantial initial investments, which might not be feasible for all businesses, particularly small and medium-sized enterprises (SMEs). The high costs associated with purchasing new equipment, training staff, and integrating new systems can be prohibitive. SMEs often have limited access to capital and may struggle to secure financing at the high-interest rates prevalent in the current economic climate.

Government and Industry Support: To address these challenges, there is a need for supportive measures from both the government and industry stakeholders. Government initiatives such as grants, low-interest loans, and tax incentives for technology adoption can help alleviate the financial burden on SMEs. Additionally, industry associations and larger corporations can play a role by offering mentorship programs, shared resources, and collaborative platforms that provide SMEs with access to technology and expertise.

Collaborative Innovation Hubs: Establishing innovation hubs and technology parks where businesses can collaborate and share resources can also foster technological advancement. These hubs can provide access to state-of-the-art facilities, research and development support, and networking opportunities, enabling SMEs to experiment with and adopt new technologies without bearing the full cost independently.

In summary, while technological and operational innovations offer significant potential for reducing costs and enhancing efficiency, the substantial initial investments required can be a barrier for many businesses, particularly SMEs. Supportive measures from the government and industry, as well as collaborative initiatives, are essential to enable wider adoption of these innovations and to ensure that all businesses can benefit from the advancements in technology and operational practices.

Conclusion:

The economic challenges in Bangladesh, marked by rising production costs, escalating loan interest rates, and severe energy crises, are creating a difficult environment for businesses and consumers. While efforts to contain inflation through interest rate adjustments are well-intentioned, they are contributing to a vicious cycle of increased costs and reduced economic activity. The government’s initiatives to stabilize the energy supply are crucial, but their long-term timelines mean that industries and consumers will continue to face significant hardships in the interim. Addressing these issues holistically and swiftly is essential to mitigate the economic strain and curb inflationary pressures.

Billal Hossain
Billal Hossainhttps://www.bidibo.xyz/
Billal Hossain, a seasoned professional with a Master's degree in Mathematics, has built a rich and varied career as a banker, economist, and anti-money laundering expert. His journey in the financial sector has seen him in leading roles, notably in AL-Rajhi Banking Inc. in the Kingdom of Saudi Arabia and as Foreign Relations and Correspondent Maintenance Officer of Bank-AL-Bilad. Beyond the confines of traditional finance, Billal has emerged as a prominent writer and commentator, contributing thought-provoking columns and theses to various newspapers and online portals. His expertise spans a wide range of important global issues, including the complexities of economics, political dynamics, the plight of migrant workers, remittances, reserves, and other interrelated aspects. Billal brings a unique analytical perspective to his writing, combining academic rigor with practical insights gained from his banking career. His articles not only demonstrate a deep understanding of complex issues but also provide readers with informed perspectives, bridging the gap between theory and real-world application. Billal Hossain's contributions stand as a testament to his commitment to unraveling the complexities of our interconnected world, providing valuable insights that contribute to a broader and more nuanced understanding of the global economic landscape.

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