Global recession and Bangladesh's economic performance
Monday, 28 June 2010
M. A. Taslim
Unlike many other countries, the global recession of 2008-09 was not an unmixed curse for Bangladesh. The principal adverse effect of the recession was a reduction in export revenue in 2009 on the back of a very high growth of 23 per cent in 2008. However, Bangladesh was spared the traumatic export reduction in other countries; its export declined by only 2.0 per cent. It compares rather well to the reductions of 16-35 per cent suffered by exporting giants such as the European Union (EU), China, USA, India, Brazil, Canada and Japan.
On the positive side, the recession brought about a sharp reduction in commodity prices, especially those of fuel oil and cereal. These prices increased sharply during 2007 and until about mid-2008. One consequence of the increase of these prices was a sharp increase in the inflation rate. By mid 2007, the inflation had reached double digit figures and remained at the high level till the third quarter of 2008. At that time, there was a real fear that inflationary expectations were getting entrenched and the economy could suffer from a runaway inflation.
The recession that sharply reduced these prices in the international market also pulled down the domestic prices of cereals and fuel oil and, with these, the general price level. The inflation rate started to fall from October 2008 and continued to fall till July 2009 when it stood at only 3.5 per cent. The specter of inflation was thus avoided for the time being.
The fall in international commodity prices greatly benefited Bangladesh as much of its import consists of cereals, edible and fuel oil and cotton. Total import bill declined markedly. The terms of trade gains ran into hundreds of millions of dollars. The decline in import was also assisted by the slow-down of the national economy that reduced aggregate demand.
A major component of the current account is current transfers by the workers overseas. Curiously, although the rate of emigration fell off sharply after reaching a peak in 2008, remittances kept on increasing throughout 2009 and 2010(April). The robust growth of remittances permitted Bangladesh to enjoy a very healthy current account surplus amounting to about 3.0 per cent of gross domestic product (GDP). This surplus boosted the nation's international reserve stock to more than 10 billion dollar, ie, a doubling of reserves within three years. This became a source of much confidence among the policymakers as well as the people.
As the world economy recovers from the deepest recession since the 1930's, commodity prices are showing signs of upward movement. Crude oil prices rose continuously since February 2008, by April 2010, crude prices doubled. Since fuel prices are strongly linked to cereal prices, it is expected that the latter would rise in the near future. If this transpires, there will be additional pressure on domestic prices.
The domestic inflation rate has already pushed up. By the end of 2009, it had risen to nearly 9.0 per cent and remained thereabout during the next three months. The prospect is for a further increase in the inflation rate. The proposed budget of 2010-11, which hugely increased government expenditure without commensurate increase in revenue, does not raise confidence that the soaring inflation could be contained.
In this situation, a coordinated deployment of fiscal and monetary policy is essential. Monetary policy is already exhibiting signs of laxity. The large balance of payments surplus is also making monetary policy difficult. Indeed, if the policy-makers stick to the current policy of keeping the exchange rate of taka against dollar fairly constant, as it has done in the recent past, monetary policy will lose its potency altogether.
Sterilization of the balance of payments surplus has bloated the stock of international reserves, and, therefore, the net foreign assets of Bangladesh Bank. The latter increased by 37 per cent between June 2009 and April 2010. In order to minimize the monetary impact of such a large increase in the net foreign asset holding, Bangladesh Bank has sterilized the increase, at least partially, by a reduction in net domestic assets.
The capacity of Bangladesh Bank to sterilize has diminished since its holding of domestic assets has declined precipitously. These now constitute only one-sixth of the total reserve money. Thus, much of an increase in international reserves will show up in an increase in the reserve money, which through the reserve multiplier will raise the money supply of the economy.
The money supply during the year April 2009 to April 2010 has risen by 22 per cent. Such a large increase will inevitably exert an upward pressure on the inflation rate with a lag. Unless the international market situation dampens, the chances of which are slim, or there is a concerted move to rein in monetary expansion, the domestic inflation rate will inexorably raise, complicating economic policy-making further.
As mentioned earlier, the export sector has withstood the ravage of the global recession well. There has been much speculation regarding why Bangladeshi exporters were spared the more severe fallout form the recession. During the early months of the recession, when export of Bangladesh actually soared, some people including the leadership of Bangladesh Garments Manufacturers and Exporters Association (BGMEA) hypothesized that falling income due to the recession had forced the people of the importing countries to switch from the higher to the lower priced items. Since Bangladesh produced mostly low-priced goods, especially apparel, the demand for Bangladeshi exports actually increased. The argument essentially implied that Bangladeshi readymade garments (RMG) exports were inferior goods. This has been shown to be false. Most of the top items of apparel export of Bangladesh actually suffered a reduction in the global demand of the EU and the USA. A more sophisticated version of this hypothesis, which has since gained some currency is that the low priced export items of Bangladesh did not suffer as badly during this recession as the more pricey items that other countries export, and consequently exports of Bangladesh also did not suffer much.
This hypothesis too, does not stand up to scrutiny. Exports of some pricey items such as pharmaceuticals, tobacco, confectionary, weapons etc., recorded positive growth in the US market. Furthermore, a large number of countries produce the cheap goods that Bangladesh exports. However, most of them, especially the African and the Central American countries, suffered large reductions in exports to the USA due to the recession. It is only a handful of countries such as Bangladesh, China, Costa Rica, Egypt and Vietnam, which have done well in apparel export. The better performance of these countries when other countries performed poorly, cannot be explained only by the hypothesis above.
The principal reason for Bangladeshi exports holding out well during the recession must be sought in the competitive strength of the RMG industry of Bangladesh. This strength derives from the innovativeness of the entrepreneurs, duty-free access in all developed countries except the USA and, most importantly, an abundant supply of cheap labour.
These advantages enable Bangladeshi exporters to offer cheaper prices than the exporters of competitor countries. Indeed, the unit prices of the top export items of Bangladesh were among the cheapest. Moreover, Bangladeshi exporters have also gained some reputation in the global market as reliable suppliers. Many reputable global apparel companies are now either transferring their manufacturing facilities to, or sourcing their imports from, Bangladesh.
An important question that arises is why the import of apparels by the major importers suffered less during this recession than many other products.
An examination of the import of the USA reveals that import of knitwear (HS61) declined by 12 per cent and that of woven garments (HS62) by 14 per cent. These reductions are much less than the average 26 per cent reduction of imports in 2009. However, there are several commodities at HS two digit level whose import either increased or fell by less than the reduction of knitwear or woven garment import. Some of these commodities are pharmaceuticals, fruits and nuts, cocoa, sugar and confectionary, footwear, fish, food preparations, coffee, tea etc. Note that almost all of these commodities are in the nature of final consumption items.
It is well-known from the theories of consumption that consumer spending does not depend on current income, but rather on permanent income or life cycle income. Permanent (or life cycle) income is less than the actual income during business booms and greater than the actual income during recessions. In other words, permanent (or life cycle) income, being expected income, fluctuates less than the actual income. Since consumption spending is related to permanent income in a stable manner, it fluctuates less than the actual income. This implies that the demand for consumer goods will fluctuate less than fluctuations in actual income.
The demand for non-consumption goods (whether final or intermediate goods) is related to current production (ie income). Consequently, their demand fluctuates, in line with the fluctuation of the current income. Assuming that there is a fixed relationship between imported and domestic component in the consumption of a traceable good a la Armington, the consumer theory implies that the import of consumer goods will fluctuate less than the non-consumption goods. The pattern of the import demand of the USA appears to be consistent with this story.
The export of Bangladesh comprises mostly consumer goods. Indeed, more then 90% of its total exports including knitwear and woven garments, shrimp, pharmaceuticals, ceramics, footwear and home textiles are consumption items. This is in sharp contrast to the exports of China, the USA, the EU, Japan, Canada etc. A large fraction of their exports comprises non-consumption goods and consequently fluctuated more with the recession.
The principal source of the comparative advantage of the apparel exporters, viz. cheap labour, might have been stretched too far and could be under threat; the rising tide of labour unrest points that way. The exporters must find ways of raising productivity other than exploiting cheap labour. This may be achieved through technical innovations and skill up-gradation. Unless the exporters rise to the occasion, their performance may deteriorate in future.
The growth of manufacturing output is currently hobbled by poor infrastructure, especially energy. Gas shortages and frequent electricity outages have raised the cost of production. An improvement in productivity requires that energy problem is solved in a short time.
There does not seem to be much concern about the gravity of the loss of overseas labour market, probably because of the continued increase in remittances. The number of Bangladeshi workers who found jobs overseas in 2009 fell by more than 400,000 relative to 2008. In other words, at least these many workers failed to obtain high quality jobs and swelled the ranks of the unemployed. The government needs to find ways of reopening the overseas job market.
The most important source of productivity growth is skill (education). This aspect of growth has been neglected for very long such that the current workforce lacks in skill. The skill base of the population must be raised; the government should take urgent measures to pass out skilled young men and women from the educational institutes of the country. (The writer is a Professor in Economics at the Dhaka University, and is currently the Chief Executive Officer (CEO), Bangladesh Foreign Trade Institute. The write-up, in the form of a paper, was prepared to initiate discussion on the ESCAP Survey 2010 in a workshop organized by the Economic Research Group (ERG) and the Macroeconomic Division of UN-ESCAP at Sheraton Hotel, Dhaka, on June 26, 2010.)
Unlike many other countries, the global recession of 2008-09 was not an unmixed curse for Bangladesh. The principal adverse effect of the recession was a reduction in export revenue in 2009 on the back of a very high growth of 23 per cent in 2008. However, Bangladesh was spared the traumatic export reduction in other countries; its export declined by only 2.0 per cent. It compares rather well to the reductions of 16-35 per cent suffered by exporting giants such as the European Union (EU), China, USA, India, Brazil, Canada and Japan.
On the positive side, the recession brought about a sharp reduction in commodity prices, especially those of fuel oil and cereal. These prices increased sharply during 2007 and until about mid-2008. One consequence of the increase of these prices was a sharp increase in the inflation rate. By mid 2007, the inflation had reached double digit figures and remained at the high level till the third quarter of 2008. At that time, there was a real fear that inflationary expectations were getting entrenched and the economy could suffer from a runaway inflation.
The recession that sharply reduced these prices in the international market also pulled down the domestic prices of cereals and fuel oil and, with these, the general price level. The inflation rate started to fall from October 2008 and continued to fall till July 2009 when it stood at only 3.5 per cent. The specter of inflation was thus avoided for the time being.
The fall in international commodity prices greatly benefited Bangladesh as much of its import consists of cereals, edible and fuel oil and cotton. Total import bill declined markedly. The terms of trade gains ran into hundreds of millions of dollars. The decline in import was also assisted by the slow-down of the national economy that reduced aggregate demand.
A major component of the current account is current transfers by the workers overseas. Curiously, although the rate of emigration fell off sharply after reaching a peak in 2008, remittances kept on increasing throughout 2009 and 2010(April). The robust growth of remittances permitted Bangladesh to enjoy a very healthy current account surplus amounting to about 3.0 per cent of gross domestic product (GDP). This surplus boosted the nation's international reserve stock to more than 10 billion dollar, ie, a doubling of reserves within three years. This became a source of much confidence among the policymakers as well as the people.
As the world economy recovers from the deepest recession since the 1930's, commodity prices are showing signs of upward movement. Crude oil prices rose continuously since February 2008, by April 2010, crude prices doubled. Since fuel prices are strongly linked to cereal prices, it is expected that the latter would rise in the near future. If this transpires, there will be additional pressure on domestic prices.
The domestic inflation rate has already pushed up. By the end of 2009, it had risen to nearly 9.0 per cent and remained thereabout during the next three months. The prospect is for a further increase in the inflation rate. The proposed budget of 2010-11, which hugely increased government expenditure without commensurate increase in revenue, does not raise confidence that the soaring inflation could be contained.
In this situation, a coordinated deployment of fiscal and monetary policy is essential. Monetary policy is already exhibiting signs of laxity. The large balance of payments surplus is also making monetary policy difficult. Indeed, if the policy-makers stick to the current policy of keeping the exchange rate of taka against dollar fairly constant, as it has done in the recent past, monetary policy will lose its potency altogether.
Sterilization of the balance of payments surplus has bloated the stock of international reserves, and, therefore, the net foreign assets of Bangladesh Bank. The latter increased by 37 per cent between June 2009 and April 2010. In order to minimize the monetary impact of such a large increase in the net foreign asset holding, Bangladesh Bank has sterilized the increase, at least partially, by a reduction in net domestic assets.
The capacity of Bangladesh Bank to sterilize has diminished since its holding of domestic assets has declined precipitously. These now constitute only one-sixth of the total reserve money. Thus, much of an increase in international reserves will show up in an increase in the reserve money, which through the reserve multiplier will raise the money supply of the economy.
The money supply during the year April 2009 to April 2010 has risen by 22 per cent. Such a large increase will inevitably exert an upward pressure on the inflation rate with a lag. Unless the international market situation dampens, the chances of which are slim, or there is a concerted move to rein in monetary expansion, the domestic inflation rate will inexorably raise, complicating economic policy-making further.
As mentioned earlier, the export sector has withstood the ravage of the global recession well. There has been much speculation regarding why Bangladeshi exporters were spared the more severe fallout form the recession. During the early months of the recession, when export of Bangladesh actually soared, some people including the leadership of Bangladesh Garments Manufacturers and Exporters Association (BGMEA) hypothesized that falling income due to the recession had forced the people of the importing countries to switch from the higher to the lower priced items. Since Bangladesh produced mostly low-priced goods, especially apparel, the demand for Bangladeshi exports actually increased. The argument essentially implied that Bangladeshi readymade garments (RMG) exports were inferior goods. This has been shown to be false. Most of the top items of apparel export of Bangladesh actually suffered a reduction in the global demand of the EU and the USA. A more sophisticated version of this hypothesis, which has since gained some currency is that the low priced export items of Bangladesh did not suffer as badly during this recession as the more pricey items that other countries export, and consequently exports of Bangladesh also did not suffer much.
This hypothesis too, does not stand up to scrutiny. Exports of some pricey items such as pharmaceuticals, tobacco, confectionary, weapons etc., recorded positive growth in the US market. Furthermore, a large number of countries produce the cheap goods that Bangladesh exports. However, most of them, especially the African and the Central American countries, suffered large reductions in exports to the USA due to the recession. It is only a handful of countries such as Bangladesh, China, Costa Rica, Egypt and Vietnam, which have done well in apparel export. The better performance of these countries when other countries performed poorly, cannot be explained only by the hypothesis above.
The principal reason for Bangladeshi exports holding out well during the recession must be sought in the competitive strength of the RMG industry of Bangladesh. This strength derives from the innovativeness of the entrepreneurs, duty-free access in all developed countries except the USA and, most importantly, an abundant supply of cheap labour.
These advantages enable Bangladeshi exporters to offer cheaper prices than the exporters of competitor countries. Indeed, the unit prices of the top export items of Bangladesh were among the cheapest. Moreover, Bangladeshi exporters have also gained some reputation in the global market as reliable suppliers. Many reputable global apparel companies are now either transferring their manufacturing facilities to, or sourcing their imports from, Bangladesh.
An important question that arises is why the import of apparels by the major importers suffered less during this recession than many other products.
An examination of the import of the USA reveals that import of knitwear (HS61) declined by 12 per cent and that of woven garments (HS62) by 14 per cent. These reductions are much less than the average 26 per cent reduction of imports in 2009. However, there are several commodities at HS two digit level whose import either increased or fell by less than the reduction of knitwear or woven garment import. Some of these commodities are pharmaceuticals, fruits and nuts, cocoa, sugar and confectionary, footwear, fish, food preparations, coffee, tea etc. Note that almost all of these commodities are in the nature of final consumption items.
It is well-known from the theories of consumption that consumer spending does not depend on current income, but rather on permanent income or life cycle income. Permanent (or life cycle) income is less than the actual income during business booms and greater than the actual income during recessions. In other words, permanent (or life cycle) income, being expected income, fluctuates less than the actual income. Since consumption spending is related to permanent income in a stable manner, it fluctuates less than the actual income. This implies that the demand for consumer goods will fluctuate less than fluctuations in actual income.
The demand for non-consumption goods (whether final or intermediate goods) is related to current production (ie income). Consequently, their demand fluctuates, in line with the fluctuation of the current income. Assuming that there is a fixed relationship between imported and domestic component in the consumption of a traceable good a la Armington, the consumer theory implies that the import of consumer goods will fluctuate less than the non-consumption goods. The pattern of the import demand of the USA appears to be consistent with this story.
The export of Bangladesh comprises mostly consumer goods. Indeed, more then 90% of its total exports including knitwear and woven garments, shrimp, pharmaceuticals, ceramics, footwear and home textiles are consumption items. This is in sharp contrast to the exports of China, the USA, the EU, Japan, Canada etc. A large fraction of their exports comprises non-consumption goods and consequently fluctuated more with the recession.
The principal source of the comparative advantage of the apparel exporters, viz. cheap labour, might have been stretched too far and could be under threat; the rising tide of labour unrest points that way. The exporters must find ways of raising productivity other than exploiting cheap labour. This may be achieved through technical innovations and skill up-gradation. Unless the exporters rise to the occasion, their performance may deteriorate in future.
The growth of manufacturing output is currently hobbled by poor infrastructure, especially energy. Gas shortages and frequent electricity outages have raised the cost of production. An improvement in productivity requires that energy problem is solved in a short time.
There does not seem to be much concern about the gravity of the loss of overseas labour market, probably because of the continued increase in remittances. The number of Bangladeshi workers who found jobs overseas in 2009 fell by more than 400,000 relative to 2008. In other words, at least these many workers failed to obtain high quality jobs and swelled the ranks of the unemployed. The government needs to find ways of reopening the overseas job market.
The most important source of productivity growth is skill (education). This aspect of growth has been neglected for very long such that the current workforce lacks in skill. The skill base of the population must be raised; the government should take urgent measures to pass out skilled young men and women from the educational institutes of the country. (The writer is a Professor in Economics at the Dhaka University, and is currently the Chief Executive Officer (CEO), Bangladesh Foreign Trade Institute. The write-up, in the form of a paper, was prepared to initiate discussion on the ESCAP Survey 2010 in a workshop organized by the Economic Research Group (ERG) and the Macroeconomic Division of UN-ESCAP at Sheraton Hotel, Dhaka, on June 26, 2010.)