Bangladesh Economy: Present State And Short-term Outlook

Bangladesh Economy: Present State And Short-term Outlook By Prof. Ayubur Rahman Bhuyan Organized By Islamic Economics Research Bureau

Introduction • Despite global economic recession and weak growth in manufacturing, power and mining sectors, the Bangladesh economy managed a respectable 5.9 percent growth in FY09, which is well above the Multilateral Financial Institutions’ forecasts of 4.5 to 5.0 percent. • A moderately good growth of agriculture had offset the slow growth in industry and services sectors. Without the contribution of agriculture, the overall GDP growth could be much lower (see the Appendix Table). • Keeping in view the ongoing global economic recession, Government has set a moderate 6.0% growth target for GDP in the current fiscal (2009-10), but seeks to achieve higher growth rates in the next four years – 6.8% in 2010-11, 7.5% in 2011-12, and 8.0% in 2012-13 and thereafter. The question is: Are these growth targets achievable? • Despite the downward revision of the IMF growth forecast to 5% or less, we believe a 6%+ growth is quite possible. (See Appendix Table)

Introduction Contd…………01 • Looking at the current performance of the economy and the behaviour of principal macroeconomic indicators, this paper examines the prospect and possibilities of achieving the targeted GDP growth in the near and the medium term. • The performance of social sectors (education, health), the financial sectors (banking, insurance, capital market), labour market behaviour and the employment situation are not touched in this paper. IERB may engage specialists for undertaking thorough studies in these fields and organize seminar sessions on each of these areas.

Saving and Investment • High rates of saving and investment are essential prerequisites for high economic growth, but domestic saving in Bangladesh, on which investment greatly depends, has remained stagnant at around 20.0% of GDP in the past few years (Table 1). Table 1: Saving and Investment (as percent of GDP) Source: Bangladesh Bureau of Statistics. P = Provisional

Saving and Investment Contd………..01 • Stagnant saving implies that consumers have to allocate incremental shares of their incomes for consumption, possibly because of higher prices. • Public saving having been always negative in the country (as indicated by rising budget deficits), domestic saving in the country comes essentially from the private sector. But private saving is low because of low per capita incomes. • Higher incomes, and hence higher saving, can be obtained by higher economic growth. Hence, for domestic saving to rise, there is the need for achieving faster economic growth. • National saving rate has demonstrated encouraging movements since FY2004-05, due mainly to a robust remittance growth, but remittance inflows generally go to add to the country’s foreign exchange reserves and are hardly used for investment purposes.

Saving and Investment Contd………..02 • Because of low domestic saving rates, gross capital formation has slowed down consistently in the recent years. Gross investment as proportion of GDP was 24.7% in FY2005-06 but it fell to 24.2% in FY2008-09 (Table 1) • The main reason behind the slowing down of investment has been a secular decline in public investment, which, as proportion of GDP, fell to a historic low of 4.6% in FY2008-09 from 6.2% in FY2004-05. • As public investment did not increase, the private investment did not roll in either. • The decline in public investment is visible in the current fiscal as well. Only Tk 1347 crore or just about 4.4% of the total ADP outlay of Tk 30500 crore has been implemented in the first two months (July-August) of the current fiscal year.

Saving and Investment Contd………..03 • The decline in investment is apparent in the significant drop in the import of capital machinery (by 22.36%) and industrial raw materials (by 20.81%) in July-August of the current fiscal. • With Bangladesh remaining in the shadow of the global financial crisis, domestic investment plans have taken a back seat. Demand for bank loans is slack. Banks are sitting on piles of excess liquidity. This is a worrying sign and does not bode well for the country’s medium term economic outlook. • Surplus liquidity now (August 2009) is about Tk 38000 crore, up from about Tk 35000 crore in June 2009, and about Tk 13000 crore in June 2008.

Saving and Investment Contd………..04 • The state-owned banks’ loan/deposit ratio is 59% and that of the private banks is 87%. This depicts a gloomy investment scenario for the state-owned banks in particular and for the banking sector as a whole. • The existing excess liquidity (worth about $5.4 billion) alone will not drive future investment growth, however. The country needs a lot more money to spend on physical infrastructure, and, in particular, power and gas, which is a major cause of the sluggish private investment in the country. • The power sector alone will need as much as $10 billion of new investment, which cannot be funded by domestic investors. Large doses of FDI will be needed for that purpose.

Required Investments for achieving the Targeted GDP Growth • The targeted GDP growth in the present and in the coming years will require a considerable increase in investment – perhaps worth almost an additional 2% of GDP every year over the last fiscal year’s benchmark. • Preliminary estimates by the Finance Division show an investment shortfall of $1.04 billion in FY2009-10. The shortfall will rise to $9.40 billion in 2013-14, when the cumulative shortfall will stand at $28 billion (see Table 2)

Table 2: Investments Needed to Achieve the Targeted Growth Rate (2009-10 to 2013-14) Required Investments for achieving the Targeted GDP Growth Contd…………01 Source: Finance Division, Ministry of Finance

Required Investments for achieving the Targeted GDP Growth Contd…………02 • The additional investment would require resource mobilization by increased revenue earnings, larger inflows of foreign aid, and increased foreign and domestic investment. • To attract investment, whether domestic or foreign, the country’s policy makers will need to focus on how to create a ‘good investment climate’.

Foreign Investment Scenario • Because of the paucity of domestic resources, there is the need for more FDI in the country. But even though Bangladesh offers highly attractive incentives for that purpose, the volume of FDI has remained historically low in this country. • In per capita terms, FDI in Bangladesh in 2008 was only $7, as compared to $31 in India and $32 in Pakistan (UNCTAD, World Investment Report 2009). • Among the reasons behind low FDI inflows are such negative factors as weak governance, administrative hassles, poor conditions of infrastructure (roads, ports etc), corruption in public services, poor law and order conditions, and above all, inadequate and erratic supply of power and gas, which discourage investors to invest in the country.

Foreign Investment Scenario Contd………..01 • In 2008, FDI inflow to Bangladesh was $1.09 billion, the highest so far in its history, but it has been falling thereafter as BB and BOI data indicate. • According to Bangladesh Bank data, FDI inflow has dropped by 37 percent to $126 million in July-August months of 2009. In the same period of last year. FDI inflow was $201 million. Registration of new investment with the Board of Investment has also fallen significantly in this period. • Portfolio investment worth $25 million has been withdrawn from the capital market in July-August 2009, compared to an inflow of $8 million in the corresponding period last year. • Also, it will be necessary to look into the findings and suggestions of various international organizations about the investment situation in the country.

Foreign Investment Scenario Contd………..02 • A survey conducted by the Japan External Trade Organization (JETRO) in May 2009 reveals that as an investment destination Bangladesh is gradually losing its attractiveness to foreign investors because of relatively high and growing investment-related costs (high corporate tax rates, expensive internet tariffs, high container transportation cost etc). The JETRO survey also finds a significant gap between existing government policies and their implementation in practice (policy inconsistency). • The World Bank’s Worldwide Governance Indicators (WGI), published in June 2009, reports that Bangladesh has performed poorly in the rule of law, government effectiveness, and regulatory quality, all of which are among important determinants of the country’s investment climate. • The World Economic Forum’s regular annual publication “the Global Competitiveness Report” for 2009, released on 8 September, ranks Bangladesh’s infrastructure among the worst in the world.

Foreign Investment Scenario Contd………..03 • Government should take note of and draw lessons from these reports and take appropriate action to address issues that impede investment, improve the investment climate, and make the country an attractive destination for overseas investors. • The Public Private Partnership (PPP) model adopted in this year’s budget has a high potential to draw substantial investments from local and foreign investors. It is, however, still in a preparatory stage. The Government should speedily complete the preparatory work and take steps to implement the model immediately.

Key Features of Investment Climate • The business community always complains about the absence of a favourable investment climate in the country. But, what is an investment climate? • Investment climate can be defined as the “policy, institutional and behavioural environment, both present and expected, that influences the returns and risks associated with investment”. • This environment is generally seen as having three main features: macroeconomic conditions, governance, and infrastructure. • Macroeconomic factors include such issues as fiscal, monetary, and exchange rate policies, and political stability.

Key Features of Investment Climate Contd………01 • Governance relates to government interactions with business, which typically mean regulation and corruption, both of which affect the cost of starting and running a business. • Infrastructure refers to the quality and quantity of physical infrastructure (such as power, transport, and telecommunications). More broadly, it can also refer to financial infrastructure (such as banking) – or access to finance. • Apart from the three features mentioned above, the extent of international integration as understood from the country’s trade openness (measured by the ratio of imports plus exports to GDP) and the availability of a large workforce with sufficient education and technological know-how are also crucial elements of the investment climate. • In respect of all the components of the investment climate mentioned above, Bangladesh compares highly unfavourably with other competing countries. The issue, therefore, needs to be addressed very seriously by the government.

Agriculture Real Sector Performance • Agriculture provides the country with the much-needed food security and also supplies raw materials to domestic industries. • The agriculture sector depicted good growth in the previous fiscal but there is no scope for complacency. • The FAO has already put Bangladesh on a list of 31 food-insecure countries. All round effort will therefore be needed to sustain the high growth of the sector. • In order to sustain the high growth of agriculture and achieve the targeted food production (Table 3), Government must ensure timely and adequate supply of agricultural credit, fertilizer, quality seeds and other agricultural inputs, and continue to provide, and, if necessary, enhance the prevailing subsidies on fertilizer, diesel and electricity to this sector.

Table 3: Food situation (in lakh metric tons) Real Sector Performance Contd……….01 * After 12% deduction for FY08, FY09 and FY10 and 10% deduction for other years for seed, feed, waste etc. R = Revised E = Estimated T = Target Source: Bangladesh Bank

Industry and Services Sectors • The industry and services sector growth has been below their potential. • The manufacturing sub-sector within industry has started to feel the impact of global recession as evidenced by the fall in exports of manufactures. So is the growth of the large services sector (see the Appendix Table). • The dominant causes of these sectors’ low growth are, however, indigenous, viz., under-developed physical infrastructure, insufficient and irregular power and gas supply, high interest rates on bank loans, and a host of non-economic factors like poor law and order conditions. • In particular, the slow growth of electricity and the severe gas crisis pose a threat not only to industrial growth but also to the development of all other sectors of the economy. Every conceivable action will need to be taken to remedy these problems.

Power, Gas and Coal • The Government is committed to increase power generation capacity to 5000 MW by 2011 and 7000 MW by 2013, to meet the growing need for electricity in the country. • There is currently a daily shortfall of about 1800 MW, which will inevitably increase if new generation capacity is not added forthwith. • The overall supply hovers around 3700 MW against the peak hour demand for over 5500 MW, while the demand is growing by 500 MW a year.

Power, Gas and Coal Contd………01 • According to the Power Sector Master Plan’s assessment, electricity generation must be increased by at least 4600MW by 2013. • The hard reality is, however, that the country does not at the moment have enough additional supply of gas to achieve the desired increase in electricity generation. • The country’s natural gas reserves are depleting fast. The volume of proven recoverable reserves in the country at present is only 7.7 tcf. There has been no gas exploration since 1998 and hence there has been no major discovery of gas fields thereafter.

Power, Gas and Coal Contd……….02 • In order to meet the growing need for gas by the power sector as well as by many other industrial, commercial and household consumers, gas exploration effort will need to be intensified. • For offshore gas exploration to begin, however, the government will need to first resolve the disputes on maritime boundary with India and Myanmar – a time-consuming process. • As natural gas will continue to be in short supply until new gas fields are discovered and territorial disputes are resolved, Government should seriously consider using coal alongside gas for power generation. • Bangladesh has now an estimated reserve of about 2.9 billion metric tons of coal in its five coal fields. Assuming a 30 percent recovery rate, the available coal reserves are equivalent to 20 tcf of natural gas.

Power, Gas and Coal Contd……….03 • At present coal extraction is going on only in Barapukuria Coal Mines. The mining of Phulbari Coal Mines has been stopped over disagreements on two main issues – open pit versus deep shaft mining, and compensation and rehabilitation of affected families. • Government must quickly address the concerns of various groups regarding these issues and pave ground for starting coal mining at Phulbari and other coal fields of the country. • There is thus no quick fix for solving the country’s power sector problems. The exploration of gas and any successful discovery of new gas fields will take at least 5-6 years. The development of coal mines and construction of coal-based power plants will also take at least 5-6 years. • While an enduring solution of the power crisis could thus be found only in the medium and long term, Government could take some immediate measures like rehabilitation and maintenance of old power plants, reduction of system loss etc., which might enhance the medium term prospects and, to some extent, improve the present situation as well.

Money and Credit • Against a background of continued macroeconomic stability, Bangladesh Bank has been pursuing a less restrictive monetary policy since the beginning of the previous fiscal year. • However, term lending by banks has not increased despite the cut in the lending rates because of both domestic and external factors. • Private sector credit growth has decelerated to 14.2% in July 2009, from the 26.1% growth witnessed in the first quarter of the previous fiscal.

Money and Credit Contd……..01 • Credit to Government, on the other hand, rose by 19.31 percent compared to the same period of the previous year. • Consumer credit has marked a sharp increase – houses, cars, and purchases against credit cards – mainly because of poor demand for productive credit, and huge excess liquidity in banks.

Global Economic Recession, Unemployment and the Government’s Stimulus Package • In common with many other countries, the global economic recession has had an adverse impact on the employment situation in Bangladesh. • According to a recent CPD-ILO study, the slowdown in industrial sector growth might push up the country’s unemployment rate to 3.7 percent in the current fiscal (FY2009-10) from the estimated 3.6 percent in the past two years. • In jute mills, a lot of temporary workers have been laid off. • Because of declining demand in export markets, the knitwear industry, which normally recruits 300,000 new workers every year, has not offered any new employment in the current fiscal.

Global Economic Recession, Unemployment and the Government’s Stimulus Package Contd…….01 • Employment has shrunken in the large informal sector as well. • The key to employment generation is increased investment in productive economic activities. • Hence, broad-based government policy will be needed to encourage investment in setting up new plants and expanding old ones, and extend policy assistance to recession-hit industries for their revival and expansion.

Global Economic Recession, Unemployment and the Government’s Stimulus Package Contd…….02 • The government has adopted a stimulus package of Tk 5000 crore in this year’s budget to moderate the impact of global recession by extending cash support to affected sectors. • While the move is well-intended, we are inclined to suggest that the right type of policy supports, for example, lower interest rates on bank loans, greater access to credit for the private sector, and tax facilities rather than cash assistance would be more effective in easing the impact of global recession on the recession-hit sectors. • Needless to mention, no policy support will produce the desired result unless there is a significant improvement in energy and gas sectors.

Collection of Government Revenue • Tax revenue collection has slowed down significantly in the first quarter of the current fiscal. The declining trend observed in revenue collection in Q4 of FY09 continues. • Revenue collection from customs duties, which accounts for 41% of the total revenue target of Tk. 610 billion, has registered a negative 3% growth, while the growth of revenues from domestic VAT, income tax and non-NBR sources has decelerated considerably. • The slide in commodity prices in the global market, duty cut in sugar and edible oil, decline in the import of luxury goods and machinery, and stuck-up revenue worth Tk. 4.07 billion with BPC are the major causes of low revenue collection.

Collection of Government Revenue Contd………01 • Total revenue collection of customs duty, income tax and VAT posted an 8.20% growth in the first quarter of FY10 while at least 17% growth is needed for achieving the revenue collection target in FY10. • The revenue collection in FY09 had fallen 5 percent short of the annual target. The FY10 budget lays down a bigger revenue target, and, therefore, in order to avoid similar or even a greater shortfall, the government’s revenue raising effort will need to be intensified.

Exports • Export earnings have gone down by 3.3 percent in the first two months (July-August) and may decline further if the global recession deepens. • Attempting to raise exports by providing export subsidies would not be a sound policy as that would tantamount to subsidizing rich country consumers at the expense of the country’s (poor) taxpayers. • Boosting export growth would be difficult if the country’s major trading partners remained engulfed in recession. Nevertheless, efforts should be stepped up to maintain the existing export shares in these traditional markets.

Exports Contd……….01 • At the same time, new export markets in the emerging economies as well as in the regional markets (e.g., SAFTA and BIMSTEC) will need to be explored. • Efforts should be intensified to obtain duty-free access for Bangladesh’s exports to developed and advanced developing country markets. • Exporters will need to improve the price and quality competitiveness of their products. • It will be particularly important to keep the exchange rate favourable to exporters by preventing any appreciation of the Taka, so that the price competitiveness of the country’s exports is not impaired in the world market.

Foreign Exchange Reserves and Remittances • Foreign exchange reserves held by the Bangladesh Bank stood at US$ 9560 million at the end of October 2009 – a 28.0 percent increase over the June 2009 figure. • Foreign exchange reserve at present is equivalent to 4.2 months of estimated goods imports of the country. • The foreign exchange remittances stabilized, albeit at a low level, in August 2009 after falling sharply in the previous two quarters due to weak global economic conditions. • During July-August 2009 remittances increased by US$ 278 million or 18.01 percent to US$ 1821 million compared to US$ 1543 million during the same period of last year.

Price Situation • The average inflation rate came down to 6.0 percent in July 2009 from 10.1 percent in the first quarter of FY 2009 (Table 5). • On point to point basis, the inflation rate fell to 2.2 percent in June 2009 from 5.0 percent in March 2009 and 10.0 percent in June 2008, but started to rise again, reaching 4.7 percent in August 2009 (Table 5). • The point-to-point food inflation rose to 4.93 percent in August 2009, although it, dropped to as low as 0.25 percent in June 2009, down from 14.01 percent in the same month of the previous year (Table 6). • On the other hand, the downward trend in the inflation rate of non-food items has continued, falling from 7.19 percent in the first quarter of FY2008-09 to 4.54 percent in August 2009, the second month of the current fiscal (Table 6).

Table 4: Average and Point-to-point Inflation Price Situation Contd……….01 Source: Bangladesh Bureau of Statistics Table 5: Food and Non-Food Inflation (Point-to-point) Source: Bangladesh Bureau of Statistics

Price Situation Contd……….02 • That the point to point food inflation rate, after coming down to 0.25 percent in June 2009, has started to rise again is a cause of concern. • Food prices in the global market play a major role in inflation in Bangladesh. Global food production is already facing uncertainty. Prices of food and oil are already on the rise in many countries. • Banks are awash with excess liquidity – Tk. 38000 crore. If the excess liquidity flows into the market by way of unproductive credit, inflation rate may rise further. • Bangladesh Bank’s “reverse repo” operations have been largely ineffective in mopping up the excess liquidity. It must devise alternative strategies for that purpose.

Price Situation Contd……….03 • However, as is generally believed, inflation in Bangladesh is caused essentially by supply-side bottlenecks, which can hardly be removed by monetary policy. • Therefore, instead of adopting a restrictive demand management policy for reducing the inflationary pressure, a greater reliance should be placed on fiscal policy measures that would reduce production costs, and enhance production and supplies. • The central bank could in fact play a better role in inflation control by adopting an accommodative monetary policy that would allow the private sector a greater access to credit for sectors having relatively greater potential for expanding output and employment. • The only way to prevent too much money chasing too few goods is to increase real sector production.

Appendix Table: Sector Share in GDP and Growth Rate by Sector Source: Bangladesh Bureau of Statistics. P = Provisional E = Our Estimate

Thanks

Bangladesh Economy: Present State And Short-term Outlook