Poverty reduction and shared prosperity

The governance environment may have been barely adequate thus far to cope with an economy breaking out of extreme poverty and low growth. Bangladesh needs to create a system of governance that can successfully manage the interactions between the state and a well-functioning globally integrated economy.
Managing such an economy requires inputs that markets do not easily provide: infrastructure, security, rules, standards, certifications, training, and so on. These can be provided only by professionally competent and well-funded government agencies operating in a system that decentralises power to identify problems, work out solutions and monitor performance.
The non-elected state institutions -- higher judiciary or the higher echelons of civil bureaucracy or the Election Commission or the Anti-corruption Commission (ACC) and other watch dog bodies -- need total confidence of the public. Without restoring the credibility of these institutions, governance will not grow out of patronage politics, says Bangladesh Development Update published by the World Bank in October last. Following is the full text of the report:
There is no survey-based evidence on what has happened to poverty since 2010. However, it is reasonable to assume that the sustained GDP growth rate in excess of 6 per cent, a decent 3.3 per cent agricultural growth, and remittance growth of 6.7 per cent on average since 2010 contributed to maintaining the 1.74 percentage point annual decline observed during 2000-2010. There have also been corresponding improvements in several social indicators such as life expectancy and the fertility rate. The poverty incidence, based on Bangladesh's national poverty line, is projected to have declined to 24.47 per cent by 2014.  UNDP's Human Development Report 2014 finds a significant decline in Bangladesh's Multidimensional Poverty Index from 0.292 in 2007 to 0.237 in 2011.  This remarkable progress in poverty reduction is attributable to a decline in population growth rate and the changing age structure, increases in labour income, internal and external migration, improved connectivity, and the government's targeted safety net program.
The income of the bottom 40 per cent is likely to have continued to increase because of increased employment and wages. Total domestic employment is estimated to have increased from 51.9 million in FY10 to 56.5 million in FY13. The shortfall in GDP growth relative to the Sixth Plan target reduced the overall domestic job creation, but manpower exports abroad more than compensated. As a result, the total number of additional labour who found employment in the domestic market or abroad exceeded the number added to the labour force. Consequently, the unemployment rate is likely to have decreased. Agricultural real wages have continued to increase.
Consolidating the gains in human development and moving further up remain as big challenges which Bangladesh needs to tackle relentlessly.
In the Human Development Index 2013, Bangladesh's ranking improved by one step relative to 2012. Bangladesh graduated from Low Human Development (LHD) category to Medium Human Development (MHD) category. In 2012, Bangladesh was below Congo, Solomon Islands, Sao Tome and Kenya at the top of 45 LHD category countries. In 2013, Congo, Sao Tome and Bangladesh graduated to MHD, with Bangladesh ranking third from the bottom in this list. Countries like Nepal, Kenya, Pakistan, Nigeria, Zimbabwe, Tanzania and Ethiopia continued to be in the LHD category.
Bangladesh graduated to the MHD category despite an increase in the cut-off point for the category from 0.535 in 2013 to 0.550 in the 2014 index. It surpassed not only last year's cut-off point but also its increase this year. This testifies the robustness of the magnitude of increase in Bangladesh's HDI 2013score relative to the Human Development Index (HDI) 2012.Bangladesh's recent progress has been impressive on both Gross National Income (GNI) per capita and life expectancy (Table 1).

* GNI per capita has grown rapidly because of growth in GDP per capita and remittance per capita. Sustained acceleration of GDP growth, declining population growth rate, and continued growth of the stock of Bangladeshis working abroad contributed to growth in GNI and remittance per capita. Most recent research evidence reconfirm that remittances contribute significantly to poverty reduction both directly by augmenting the income of the receiving families and indirectly by contributing to local level development.
* Bangladesh has made impressive gains in the health MDGs, increasing the odds of surviving through childhood and pregnancy and controlling the burden of communicable disease. The health sector (government and NGO providers) has continually incorporated proven cost-effective interventions, which have contributed to the impact of health services. The development of a highly pluralistic health system environment characterised by the participation of a multiplicity of different stakeholders and agents and by ad hoc, diffused forms of management has contributed to these outcomes by creating conditions for rapid change.  With donor support, the government has focused attention on expanding access to services and strengthening governance.
* Bangladesh has improved access and completion at all levels of education, especially at the primary level. As a result of massive expansion of supply, targeted stipends to bring the poorest and girls into schools and continued investments in education, Bangladesh achieved almost universal access in primary education. The primary net enrolment rate (NER) is most recently reported as 93 per cent. Enrolment in pre-primary is low at 23 per cent (2009). Primary, lower secondary and secondary education completion have systematically increased over time. Thirty-six per cent of people aged 41-50 in 2010 have completed primary education; whereas that same share among people aged 15-19 is 76 per cent, indicating that the share of primary school completers has more than doubled in 30 years.
* Still, the system in health and education remains challenged on the governance front, particularly in holding civil service employees accountable for performance, and associated with the strong centralisation of authorities and decision making.
There is no reason for complacency. Bangladesh has achieved the MHD category before (2007 for instance), but later slipped back, due to both methodological changes and a slowdown in progress on human development. A recent International Labour Organisation (ILO) report finds that 53.4 per cent of youth leave primary school before completion. The combined effects of the ongoing demographic transition and the growing labour force participation of women are increasing the size and share of working population. Providing quality jobs to new entrants and increasing productivity of the employed population in agriculture and services are major challenges.
Recent Economic Developments
Growth recovery has begun with return of political stability
During the first half of FY14, the Bangladesh economy weathered severe disruptions in production, transport, and service delivery. The second half was remarkably stable, although lingering political uncertainties lingered resulted in a deceleration in private investment growth, which constrained the transmission of the relative macroeconomic stability into higher economic growth. Bangladesh Bureau of Statistics (BBS) provisionally estimated FY14 GDP growth at 6.1 per cent (Figure1).

Most analysts expected the economic growth in FY14 to be between 5.5-6.0 per cent in view of political unrest in the first half of the fiscal year and the trends of associated growth correlates.
According to BBS, growth was driven by the industry sector, notwithstanding a decline in industrial growth from 9.6 per cent in FY13 to 8.4 per cent in FY14. Industrial growth decline reflected slower growth of manufacturing from10.3 per cent in FY13 to 8.7 per cent in FY14. Construction sector registered a growth rate of 8.6 per cent, the highest in the last five years despite prolonged disruption in activities in the first half due to work stoppages (hartals) and blockades. Agriculture growth is projected to have improved to 3.4 per cent from 2.5 per cent in the previous year. This is not implausible, given good harvests of aman rice and aus rice.

The biggest surprise is the estimated growth rate for the services sector, which increased to 5.8 per cent in FY14 from 5.5 per cent in FY13. All the nine sub-sectors are projected to have grown at a higher rate relative to FY13. Political turmoil affected the services sector most badly, yet the BBS estimates show a significant improvement in the performance of the sectors presumably more adversely affected by political unrest -- land transport, wholesale and retail trade, hotels, restaurants, real estate, renting, and business activities.
On the expenditure side, the share of private consumption in GDP declined by about 1.5 percentage points while the share of private investment declined by 0.36 percentage points. Remittances declined by 1.6 per cent. The public investment rate on the other hand increased from 6.6 per cent of GDP in FY13 to 7.3 per cent of GDP in FY14. The deficit in external resource balance (export minus import) in FY14 shrank significantly with increase in export-GDP ratio from 19.5 per cent in FY13 to 19.8 per cent in FY14 while the import-GDP ratio declined from 26.8 per cent to 25.2 per cent. The national savings stagnated at 30.5 per cent, although still 1.85 percentage points higher than the domestic investment rate. The excess of national savings over investments reflect weaknesses in the domestic investment climate. Bangladesh is not able to redeploy its entire national savings in the domestic economy. An emerging economy like Bangladesh is expected to have deficits in its current account driven by strong imports of capital machinery and intermediate inputs. While imports appear to have recovered relative to last year, the growth rate is still in single digit, a significant part of which came from increase in food and other consumer goods imports.
The FY15 budget has set a very ambitious 7.3 per cent growth target. Achieving this will require the total investment to GDP ratio to rise by over 5 percentage points -- from 28.7 per cent in FY14 to 33.8 per cent (new 2005/06 base). This cannot happen without a major rise in the private investment rate. The other source of growth could be increased capacity utilisation, but the potential is limited because, according to the recently released Enterprise Survey (ES) 2013 by the IFC, Bangladeshi manufacturing firms report very high levels of capacity utilization. Average capacity utilisation for Bangladesh is 84 per cent whereas the average for 122 countries with ES data is 73 per cent. Labour productivity increases in Bangladesh historically has predominantly come from capital accumulation. Total factor productivity (TFP) growth has remained rather small. Findings of an Asian Development Bank (ADB) study also suggest that the gap between actual output and estimated potential output is small.
Inflation is still high but stable
The overall inflation increased to 7.4 per cent in FY14 relative to 6.8 per cent in FY13, driven largely by increases in food inflation (Figure4). For the first time in FY14, year-on-year inflation came down below 7 per cent in June, but the average for the whole year has exceeded the 7 per cent target. Food inflation rose in FY14 while non-food inflation declined. These were closely linked with the political turmoil experienced in the first half of FY14. The food supply chain was severely disrupted due to nation-wide and regional strikes (hartals) and blockades. At the same time non-food inflation declined in the face of lower domestic demand. In addition, the exchange rate of the taka was stable and broad money growth declined.
The rising trend of food inflation towards the end of FY14 is largely explained by the higher retail price of rice. Indeed, during the harvest season for boro rice, prices at the retail levels were significantly higher than the same period in the previous year. The widening gap between wholesale and retail rice and flour prices after January 2014 suggests that middlemen in the food distribution network may have raised their margins to make up for losses during the disruptions. One notable feature of recent food inflation is the narrowing gap between rural and urban food inflation. The higher rural food inflation could be due to the higher purchasing power due to rural wage growth and expanded safety net coverage.
Non-food inflation declined from 9.2 per cent in FY13 to 5.5 per cent in FY14. The decline encompassed all sub-categories of non-food inflation -- clothing, footwear, rent, lighting, household equipment, transport, communication, medical care, recreation, and entertainment. It therefore looks very much like a demand driven phenomena in which remittance decline, slow pace of economic activity due to uncertainties and structural bottlenecks, and prudent monetary management contributed. Stability in global oil prices helped contain the cost-push to non-food inflation.
Increase in the overall BOP surplus contributed to continued accumulation of foreign exchange reserves
Despite a lower trade deficit, the current account surplus narrowed last fiscal year because of declines in remittances and increased deficit in the services account. The impact of the current account surplus on the overall balance of payments was reinforced by surplus in the financial account; despite a decline in foreign direct investment (FDI) inflows and a sharp increase in outflows on account of trade credit. The financial account surplus came largely from a reversal of errors and omissions fromUS$752 million outflows in FY13 into US$504 million inflow in FY14 and increase in net medium and long-term official loans.
The overall balance of payments surplus increased from US$5.1 billion in FY13 to about US$5.5 billion in FY14, creating an excess supply of foreign exchange relative to demand in the foreign exchange market. This led to an upward pressure on the nominal exchange rate. Bangladesh Bank remained active on the buying side of the foreign exchange market to prevent any significant exchange rate appreciation. BB's net purchase of foreign currencies amounted toUS$2.35 billion during first half of FY14 and US$2.80 billion in the second half. Reserve accumulation reached US$21.6 billion at the end of June 2014, sufficient to cover nearly six months of projected goods and non-factor services imports.
The exchange rate has remained stable between Tk 77 and Tk 78 per US dollar in recent months. The difference between the unofficial market rate and the inter-bank rate has remained very small, indicating a very stable foreign
exchange market. The difference between the Real Effective Exchange Rate based nominal rate and the inter-bank rate has shrunk in recent weeks, indicating that the nominal exchange rate is in line with the economic fundamentals. BB's interventions in the foreign exchange market have limited the loss of external competitiveness by stemming any significant nominal appreciation of the taka. However, because of a small nominal appreciation and higher domestic inflation, the real effective exchange rate appreciated by 8.5 per cent in FY14 relative to FY13.
Monetary management remained on course
BB succeeded in keeping the FY14 broad money and reserve money growth below target rates of 17per cent and 16.2 per cent, respectively. Broad money growth slowed to 16.1 per cent while reserve money growth increased to 15.5 per cent relative to FY13.BB had to contain growth of net domestic assets to counter the overshooting of target for net foreign asset growth. Private sector credit growth remained subdued at 12.3 per cent. Policy rates were not changed despite pressures from stakeholders. With ample liquidity created by BB purchases of foreign exchange, sterilisation operations had to be stepped up which adversely affected BB profitability. To mitigate the rise in BB's interest costs, the Cash Reserve Requirement was increased from 6 per cent to 6.5 per cent in June 2014 after nearly three and a half years. BB conducted Treasury bills auctions regularly. With excess liquidity, the T-bills were in high demand which resulted in declining interest rates on instruments of all maturities. Weak private investment due to political uncertainty and deteriorating infrastructure and increased international borrowing by the corporate sector contributed to perpetuation of weak private demand for domestic credit.
Financial sector not out of the woods yet
Credit and risk management status is unsatisfactory in the banking sector. There has been a steady rise in non-performing loans (NPLs) to 10.75 per cent in June 2014, up from 10.5 per cent in March 2014 and 6.1 per cent in December 2011. Defaulted loans in the banking sector increased to Tk 513.45 billion as of June 30, 2014 from Tk405.83 billion as of December 31, 2013 -- an increase of over 26 per cent in six months. Some of these banks also require recapitalisation and cleaning up of unrecognised loan losses from ever-greening of loans, weak loan classification and provisioning requirements, especially in SCBs.

The banking sector faces risks due to low capital base in State-owned Commercial Banks (SCBs) which account for a quarter of the assets of the banking system. Asset quality in the SCBs deteriorated in FY14. The deterioration reflected both the impact of disruptions caused by political unrest as well as the lagged effects of poor lending decisions in the past. With over 70 per cent of financial assets in the banking system, banking assets to GDP at 77 per cent and deposits to GDP at 60 per cent, risks in the SCBs are systemically significant.
l The Capital Adequacy Ratio (CAR) of the scheduled banks stood at 10.68 per cent at the end of June, which was 11.52 per cent six months ago.
l Nine banks failed to keep the minimum required capital. Their capital shortfall collectively stood at Tk119.33 billion which pulled down the overall capital base of the banking sector.
lThe banking sector faced a capital shortfall of Tk8.48 billion in the first half of 2014 against the required capital of Tk645.42 billion.
l Capital shortfall in the SCBs stood at Tk14.42 billion with 8.65 per cent CAR as of June 30, 2014 while shortfall in the four state-owned specialised banks rose to Tk 75.24 billon in the first half of 2014 from a shortfall of Tk63.82 billion as of December 31, 2013. Their CAR was negative 13.68 per cent as of June, 2014.
The government on its part, injected Tk 50 billion (US$633 million) for recapitalisation of state-owned banks in FY14 and made a budgetary allocation of Tk 55 billion (US$729 million) for FY15.
Excess liquidity in the banking system has increased. In the second half of FY14 call money rates declined to around 6 or 7 per cent since their peaks (20 per cent) in early 2012. At the retail level both deposit and lending rates fell in the second half of FY14, but interest rate spreads have on average increased -- from 4.99 per cent in January 2014 to 5.22 per cent in May 2014. The deposit rates have fallen faster than lending rates. Domestic lending rates have fallen due to lower cost of funds for banks, lower demand for credit as well as increasing competition from overseas lenders whose lending rates are in single digits.
For the capital market, overall, 2014 has been a year of some recovery and relative stability. The stock index gained grounds in the second half of FY14 after remaining sluggish in the first half. The benchmark index of Dhaka Stock Exchange, DSEX, gained 5 per cent between January and June. The uptrend started at the beginning of the calendar year, following national parliamentary election on January 5, 2014. DSEX reached its peak at 4,845 on February 6, 2014. However, the post-election euphoria dissipated shortly and the benchmark index lost 5.7 per cent in the following five months, reaching its lowest at 4,363 on June 23, 2014.From July onward it moved within a band of 4,400 to 4,600. Stocks with good fundamentals marked higher return compared to the overall return on the market portfolio. DS30, the blue chip index, marked a sustained 12.7 per cent yield, which is more than double the return on the benchmark index (5 per cent).
The trade volume improved between January and June, 2014. Average daily turnover exceeded the Tk6 plus billion in January 2014 for the first time after 2011, when the average daily turnover was Tk 6.6 billion following the 2010 market crash. Improvement in the average daily turnover was also a result of the euphoria associated with the January 2014 national election. After declining to around Tk 3 billion in May, daily turnover started picking up again from early August and crossed Tk 6.0 billion mark again on September 4, 2014.Recent episodes of volatility in emerging markets have so far had negligible impacts on Bangladesh's financial markets, with continued strong performance in stock markets helped by a return of foreign portfolio investment flows.
Bangladesh Bank has begun implementing the new provisions related to lending and the banks' exposure to stock markets under the amended Banking Companies Act. It has also taken steps to implement the plans to strengthen the bank resolution and lender of last resort frameworks. The financial policy for FY14 sought to strengthen credit and debt markets by taking steps to improve corporate governance, supervisory capacity, stimulate higher demand for government securities and broaden financing options. The enhanced authority given to BB over the appointment and dismissal of senior management in SCBs in the 2013 revisions to the Bank Companies Act has been exercised providing a clear signal to the industry. The temporary relaxation of loan classification and provisioning policy introduced during the December 2013 turmoil expired in June 2014. However, some of the rescheduled loans, particularly of SCBs, have become non-performing again. BB has set financial improvement plans with the four SCBs and Basic Bank which include differential ceilings on loan growth. Debt markets are  becoming active with several recent auctions over-subscribed and a sharp fall in devolvement from 26.6 per cent in the first half of FY14 to 5.3 per cent in the second half.
Fiscal policy plagued by revenue and development budget implementation shortfall
The overall budget deficit narrowed to 3.1 per cent of GDP in FY14, from 3.9 per cent in FY13, while the share of non-bank financing of the deficit increased (Figure10). Net external financing declined from 1.5 per cent of GDP in FY13 to 1.1 per cent in FY14. The shortfall in foreign finances (in terms of both foreign grants and net foreign borrowing) was offset by a boom in sales of national savings bonds. Net sale of National Savings Directorate (NSD) certificates surpassed the budget target by a significant margin. Consequently, government borrowing from banking sources remained below budget target and the government managed to repay its debt to the Bangladesh Bank and other short term loans under 'other non-bank sources'. Public debt to GDP ratio remained on a downward path with external debt at about one half of total public debt.
Having surpassed budgetary targets for three years in a row prior to FY13, the National Board of Revenue (NBR) faced a revenue shortfall in FY14, when compared to the budget target, for the second year in a row. Although tax revenue collection gained some momentum in the second half, it failed to recover fully from the slowdown experienced in the first half of FY14 resulting in weaker revenue growth relative to FY13 across most revenue categories. As a result, in FY14, NBR targets were revised downward for the first time since FY09. Although efforts from non-NBR and non-tax sources have also lagged behind the target growth in FY14, they maintained performance at 0.3 and 1.8 per cent of GDP as in FY13. NBR attempted to boost tax collection by launching a drive focused on collection of unpaid taxes by tax dodgers and through resolution of pending tax related disputes in a speedy manner with limited results.
Sluggish expenditure growth compensated for the shortfall in revenue mobilisation in containing the budget deficit. The sluggish growth is attributable mainly to low implementation of the Annual Development Programme (ADP) and restraints on subsidies, transfers and net lending. Progress on the implementation of ADP was slow in the first eleven months followed by about 20 percentage point increase in the implementation rate in June alone. No major breakthrough could be achieved in addressing the year-end bunching problem in ADP implementation (Figure12). There has been inadequate visible improvement in the management of ADP implementation in a way as to improve the quality of public investments.
Implementation the main challenge in the FY15 budget
The overall FY15 budget deficit target is prudent (less than 5 per cent of GDP), notwithstanding somewhat ambitious revenue targets. The Revenue-to-GDP ratio is projected to increase by over 1 percentage point. This is not beyond the realm of possibility since such an increase was achieved in FY11, but it has been rather rare. The Expenditure-to-GDP ratio is projected to increase by about 0.7 percentage points -- slightly less than the 0.8 percentage point annual increase achieved on average in last five years.

Improving the quality of ADP implementation is difficult when the number of projects keep increasing. The size of the ADP in FY15 is envisaged to increase by 34 per cent from the FY14 revised ADP. Usual problems of too many projects with too little allocation have not been addressed. The FY15 ADP includes 959 new projects in addition to the 1034 ongoing ones. Of the new projects, there are 683 unapproved projects that are proposed to be financed from domestic sources and 276 unapproved ones expected to be funded from external sources. Most of the unapproved projects are for constructing rural roads, bridges and culverts, and expanding power distribution lines which are generally undertaken by some ministries and agencies under pressure. The highest number of such projects is related to those of the Roads and Highways Department (RHD), the Railway Ministry, Local Government Division (LGD), and Bangladesh Water Development Board (BWDB).
Expenditures on subsidies in FY15 are projected to decline to Tk 260.5 billion, compared with Tk 323.8 billion in FY14 conditional on upward adjustments in fuel and electricity prices. The government has committed to provide budgetary transfers of subsidy cost to the state-owned enterprises (SOEs) on a regular basis and improve financial reporting by SOEs. The government released the full FY14 budget allocation of Tk 134.5 billion to settle part of the past liabilities of Bangladesh Petroleum Corporation (BPC) and Bangladesh Power Development Board (BPDB) to banks and other creditors.
Steady implementation of the new VAT law and stronger revenue administration will be needed to go beyond the cyclical recovery in revenue in FY15. Bangladesh will enter FY15 on the heels of a disappointing revenue performance in FY14. In the FY14 budget, the government had set an ambitious NBR revenue target of Tk. 1,360 billion which was 25.2 per cent higher than the FY13 actual. Achieving this would have been very challenging even under normal circumstances. Economic slowdown exacerbated by shutdowns and strikes made its achievement even more difficult, resulting in only 10.5 per cent NBR revenue growth in FY14. The revenue growth slowed across the board, although the deceleration was dominated by trade based taxes which grew by only 3.2 per cent. Both VAT (domestic) and income tax revenue growth have been well below the rates of growth required to achieve their respective budget targets. The government has already reduced the Advance Income Tax on exports which will remain effective throughout FY15. In this context of a weakened tax effort, achieving the one percentage point increase in the tax-to-GDP ratio will be a huge challenge. Delay in the implementation of the new VAT law will make it even tougher.
The composition of deficit financing can be improved by ensuring that the net foreign financing target is met. Foreign financing is a lot cheaper with an effective interest rate of less than one per cent. The effective interest rate on domestic debt is around 11.4 per cent. Increasing foreign financing will require a significant increase in the disbursement rate from the outstanding aid commitment, which is over US$19 billion. Meeting the target will require a 22 per cent disbursement rate in FY15. The only way this can be achieved is through prioritised attention to large and high impact aided projects.
Inability to meet the net foreign financing target will not necessarily mean greater than targeted reliance on domestic financing because foreign financing shortfalls usually arise from the inability to spend on the aided projects. However, the relationship is not one-to-one and domestic bank financing target of about Tk 350 billion is rather large and may constrain private credit growth if private investment demand picks up. It may also challenge achieving the inflation target. The government will need to tread carefully on this front.
Structural reforms
Structural reforms progressed, but the pace is slow. The fourth review of the IMF's ECF arrangement has been successfully completed as all performance criteria at the test date for the fourth review were met and the structural benchmarks have been completed.
Trade tax rationalisation: The nominal protection rate declined further. The average nominal protection declined further to 26.7 per cent in FY15 from 28.1 per cent in FY14. This was due mainly to the rationalisation of the supplementary duty (SD) structure. In FY15, the SD regime has been changed from 10 slab structures to 12 slab structures with SD on 770 items moving mainly to the next nearest lower slab. As a result, average effective supplementary duty at import stage declined from 11.9 per cent in FY14 to 10.7 per cent in FY15. The rationalisation of supplementary duty primarily impacted final consumer goods as average nominal protection declined from 50.7 per cent in FY14 to 47.8 per cent in FY15. However, there was an increase in average nominal protection on raw materials and capital goods by 0.2 percentage points and 0.1 percentage points respectively. Average rate of para tariff as well as share of para tariffs in nominal protection decreased, respectively from 14.9 per cent in FY14 to 13.5 per cent in FY15 and from 53 per cent in FY14 to 50.7 per cent in FY15.
The Bangladeshi Cabinet approved the draft "Bangladesh Export Processing Zone (EPZ) Labour Act, 2014" allowing EPZ workers the right to form trade unions. Protecting the freedom of association and collective bargaining rights of the EPZ workers was a critical action highlighted both in the Sustainability Compact of the EU and the action plan provided by the United States (US) in order to improve labour conditions and reinstate Generalised System of Preferences (GSP) privilege in the US. The law is consistent with the amendments made in the Bangladesh Labour Act 2013 and maintains all the existing amenities of the EPZ workers. According to this proposed law, to form a union in a factory, at least 30 per cent of the workers have to submit application for registering an association with the Bangladesh Export Processing Zone Authority (BEPZA). After registration, union's executive committee will be elected for one year. Effective and swift implementation of this law will be crucial. However, the implementation progress on the amended Bangladesh Labour Act 2013 has been rather slow due to weak monitoring and follow up. There have been several other policy reforms with respect to the ready-made garment (RMG) sector. AnnexA provides an update on garment sector reforms since the Rana Plaza tragedy, when a building collapsed in Dhaka, killing more than 1,100 RMG workers. The government has increased cash incentives for RMG exporters by 0.25 per cent. In addition, RMG exporters exporting new products or exporting to markets other than the European Union, the United States, and Canada will receive cash incentives of 3 per cent, up from the existing 2 per cent. These will be effective for the products exported from January 1, 2014 until June 30, 2015. Tax at source on cash incentives has also been reduced from 5 per cent to 3 per cent. A special tax rate of 10 per cent that the RMG exporters enjoyed on their export earnings since FY06 has been withdrawn. The exporters will now be taxed at the normal tax bracket which is 35 per cent for private limited companies and up to 30 per cent for individual taxpayers.  Earlier, the government had reduced the Advance Income Tax at source from 0.8 per cent to 0.3 per cent.
The Government has decided in principle to collect tolls in phases from all vehicles using highways. Tolls will be collected from the 21,481 km highways of which 3,544 km national, 4,278 km regional and 13,659 km inter-district and bridges over 200 meters under the RHD. The Local Government Engineering Department (LGED), which is responsible for the road networks up to the villages, remains out of the purview of the policy. There will be a Tk 300 "base toll" for national highways, Tk 200 for regional highways, and Tk 100 for inter-district highways. Some highways will be designated as "important" and their base toll will be Tk 400. Vehicles have been divided into 13 categories for the toll collection. The toll collected will go to the Road Fund and will be spent on development and maintenance of the road infrastructures across the country. The toll will be collected by appointing contractors through bidding or open auction and by the RHD itself if there is no taker.  Preventing political rent-seeking in the name of tolls and ensuring transparency in usage of collected funds will be a challenge during implementation of this policy.
The FY15 budget introduced some revenue reforms. These include a new income tax slab of 30 per cent for incomes above Tk 44.2 lakh. A surcharge of 20 per cent will be imposed on individuals with wealth between Tk. 200 million (US$2.5 million) to Tk 300million (US$3.8 million) and 30 per cent on assets above Tk 300 million. The tax exemption limit for women and senior citizens has increased by Tk 2,5000 and for physically challenged people by Tk 50,000. The corporate tax on non-publicly traded companies has been reduced to 35 per cent from 37.5 per cent. Turnover tax has been reduced to 0.3 per cent from 0.5 per cent. New revenue generation measures include increase of tax rate at the source on the deeded value of land from 3 per cent to 4 per cent in areas other than the important commercial and posh areas within the jurisdiction of the Dhaka city development authority, RAJUK, and the Chittagong Development Authority. Besides, tax at source has been imposed at 3 per cent, 2 per cent and 1 per cent on the registration value in other city corporations and municipalities at district headquarters, other municipalities, and other areas outside municipalities respectively. One per cent surcharge on mobile phone usage has been introduced. In addition, a green tax of1per cent has been imposed on an ad valorem basis on all kinds of products manufactured by polluting industries. The tariff value of crude petroleum has been increased from US$32 per barrel to US$40 per barrel while the tariff value of other refined petroleum products has increased by 9 cents per litre. These are expected to increase indirect tax revenues.
BB has relaxed foreign exchange regulations on repatriation of sale proceeds of non-resident equity investment in unlisted companies and private limited companies. Under the new regulation, BB will now accept fair value of the shares as on the date of sale, based on the appropriate combination of three valuation approaches (net asset value approach, market-value approach, and discounted cash flow approach) rather than using only the net asset value approach. The net asset value approach is considered a conservative valuation as it does not take into account the intangible assets of a company leading to investors not getting the fair value of shares when repatriating their investments. BB expects this liberalisation to contribute to a rise in foreign investment through the private equity channel.
The Speedy Supply of Power and Energy (Special Provision) Amendment Act 2014 has been passed. This legislation increases the effectiveness of the controversial provision of providing indemnity to the authority from the court of law for implementing any power or energy projects till October 11, 2018. Any power or energy projects can be implemented without going through the existing lengthy procurement process in order to expedite implementation. This law was first enacted in 2010 for two years and then extended for another two years in 2012.
Cabinet approved the National Broadcasting Policy, 2014, the first of its kind in Bangladesh. The policy will be gradually implemented by a yet-to-be-constituted independent "National Broadcast Commission." The Chairman and members of the commission will be selected through a search committee. Although the policy has been formed allegedly to ensure freedom of speech, transparency and accountability of the media, stakeholders are terming it a draconian policy that will enable the government to take control of the media.
A constitutional amendment bill to restore the national parliament's authority to impeach Supreme Court (SC) judge has been approved by the parliament. The existing provision in the constitution requires the Supreme Judicial Council (SJC) comprising of the chief justice and two senior judges of the Appellate Division to investigate allegation of misconduct and incapacity against any SC judge and make necessary recommendations. According to the amendment, the parliament will regulate the impeachment procedure and investigation against a SC judge by enacting a law.
Outlook and risks
Immediate global outlook is fragile
A less optimistic outlook for several emerging markets combined with a weak first quarter in 2014 in the United States led the IMF to mark down global growth projection for 2014 by 0.3 per cent to 3.4 per cent.  However, the global growth projection for 2015 remains at 4 per cent with somewhat stronger growth expected in some advanced economies next year. Downside risks remain a concern. Financial market risks include higher-than-expected U.S. long-term rates and a reversal of recent risk spread and volatility compression. Global growth could be weaker for longer, given the lack of robust momentum in advanced economies despite very low interest rates and the easing of other brakes to the recovery. In some major emerging market economies, the negative growth effects of supply-side constraints and the tightening of financial conditions over the past year could be more protracted.
Bangladesh's ability to diversify export markets will depend on the strength of growth in emerging economies. Growth in emerging markets and developing economies is projected to fall to 4.4 per cent in 2014 and then strengthen to 5 per cent in 2015. Growth in 2014 in China is projected to be 7.4 per cent due to limited and targeted policy measures to support activity in the second half of the year, including tax relief for small and medium enterprises, accelerated fiscal and infrastructure spending, and targeted cuts in required reserve ratios. Growth in India appears to have bottomed out, and activity is projected to pick up gradually after the post-election recovery in business sentiment, offsetting the effect of an unfavourable monsoon on agricultural growth. In a number of major emerging market economies, growth projections for 2014-15 have been marked down. Tighter financial conditions in Brazil and continued weakness in business and consumer confidence are holding back investment and dampening consumption growth. Weaker construction and a slower U.S. recovery are projected to result in slower growth in 2014 relative to the previous forecast. In Russia, investment is expected to remain weaker for longer, given geopolitical tensions. Growth in South Africa is expected to stay sluggish as a result of electricity constraints and labour conflicts.
Regional inflation and international commodity prices are key risks to Bangladesh. Crude oil prices have been remarkably stable in the first half of 2014althoughtheyreached a six-month high in June due to re-escalated turbulence in Iraq. Increased geopolitical risks could lead to sharply higher oil prices. Global food prices have increased somewhat over the past six months from their low levels last year. Supply concerns emerged for various food commodities due to adverse weather and disease. However, international food prices declined to a four year low between July and August. Global food prices are expected to remain stable in the near term.
Sustaining growth recovery is the key challenge
GDP growth in Bangladesh is most likely to recover in FY15. It is projected to rise to 6.2 per cent, driven by stronger domestic demand resulting from increased public investment in infrastructure, some revival in private investment activities, and domestic consumption growth getting a boost from remittance recovery and implementation of wage increases in the garment industry. Export growth in the first two months of FY15 dipped to 2.1 per cent with garment export growth dipping to 1.7 per cent. However, non-RMG exports recovered somewhat relative to last year. Remittances have rebounded significantly with 18.8 per cent growth in the first two months relative to the same period the previous year. Although flooding this year has lasted longer than last year, the crop production outlook is still very positive. As usual, ADP implementation till August has been tiny -- only 4.8 per cent of the total FY15 ADP.
 Growth recovery cannot be sustained without mitigating the infrastructure deficit. Infrastructure investment increased from less than 1 per cent of GDP in FY09 to about 2 per cent in FY13,  still considerably lower than the 7-10 per cent needed annually for next ten years.  Key infrastructure pillars are energy and transport. Bangladesh has made some progress in improving its competitiveness ratings, most visibly in electricity supply. But comparison of infrastructure indicators among different Asian countries show Bangladesh is still deficient on the quality of infrastructure compared with different Asian countries except Myanmar. Even Pakistan, which ranks lower than Bangladesh in country competitiveness, is ahead on the quality of its roads and port infrastructure. The infrastructure gap is especially large with competitors like Sri Lanka, India and Cambodia. Bangladesh needs to pay stronger attention to efficient implementation of infrastructure investments along with necessary institutional changes relating to policy making and regulation.
The availability of serviced land is the other binding constraint for sustained growth enhancement. The land market is dysfunctional. Bangladesh has achieved limited success in establishing Export Processing Zones (EPZs) and none whatsoever yet in establishing Special Economic Zones (SEZs). The establishment of SEZs is hindered by a number of bottlenecks including infrastructure support for connecting with ports and airports with world class roads and rail links along with efficient services. Deficiencies in the availability and quality of power and gas are an equally important constraint as are water and drainage connections, effluent treatment, and other basic facilities.
Macroeconomic stability is expected to be maintained
Underlying inflationary pressures, as reflected in non-food inflation, are expected to maintain a downward trend on continued policy restraint. However, higher wages and administered price adjustments pose upside risks to inflation. Bangladesh Bank has set a 6.5 per cent inflation target for FY15. Year-on-year inflation increased in July reflecting increase in non-food inflation while food inflation softened. Recent recovery in economic activity aided by stability, revival of income growth in services and a significant moderation of remittance decline is likely to have contributed to temporary increase in non-food inflation in July. The overall year-on-year inflation declined from 7.04 per cent in July to 6.91 per cent in August, thanks to a fall in food prices in the international markets and stable situation in domestic market. Food inflation dropped to 7.67 per cent in August from 7.94 per cent in the previous month. Non-food inflation, however, increased marginally in August to 5.76 per cent from 5.71 per cent in July because of rise in house rent, cost of transportation, education and medical expenses and other non-food items.
Achieving the FY15 inflation target will depend on international price trends as well as domestic demand and supply conditions. Internationally, despite favourable prospects for cereal supplies, several uncertainties hanging over the near future, exerting upward pressures on prices, such as weather in the United States and possible escalation of geopolitical tensions in the Arab world or Ukraine. However, what will matter most for Bangladesh are domestic supply-demand conditions and macroeconomic management. Inflation may be adversely affected if current floods are prolonged and domestic demand is boosted by the monetary effects of a surge in remittances. The 5 per cent budget deficit target, if achieved, is unlikely to be inflationary if it is not monetised. The monetary policy statement for FY15 maintains a cautionary stance to ensure price and exchange rate stability as it did in the year just past.
Challenges in Monetary Management
The monetary stance for FY15 targets a monetary growth path which aims to reduce average inflation to 6.5 per cent by end FY15 while remaining supportive to growth. Specifically BB will aim to contain reserve money growth to 15.5 per cent and broad money growth to 16.0 per cent. The space for private sector credit growth of 16.5 per cent (including foreign borrowing by local corporates) is in line with output growth targets and is sufficient to accommodate any substantial rise in investment. The projected pick-up in economic activity in FY15 should absorb some of the current excess liquidity.
The challenge in implementing the monetary policy is to strike a proper balance between accommodation and stabilisation. BB has met this challenge reasonably well in recent years. Although the June increase in the cash reserve ratio (CRR) is likely to have been driven by BB's rising interest costs associated with reverse-repo operations, it still signals a tightening of monetary policy. Tightening may have been motivated by inflation being still higher than the target. In the current state of the economy, continuity of the stance pursued in the previous MPS is a step in the right direction. The balance between stabilisation and accommodation this year need not differ from that of last year. BB is expected to refrain from loosening monetary policy to cover the shortage in fiscal policy or to compensate for policy failings in the stock market or public banks. Focus on the stability of the inflation and exchange rates will continue.

Under low excess capacity and structural constraints on capacity expansion, monetary accommodation is likely to fuel inflation with little, if any, favourable impact on growth. BB should therefore err on the side of stable inflation and exchange rate. Should upside risks to inflation materialise, BB would need to tighten reserve money growth and consider exchange rate to appreciate within limits without hurting external competitiveness.
Slippage in structural reforms and political stability are major concerns
Domestic factors dominate risks to near-term outlook. A resurgence of political unrest, even if it is not as ferocious and as long as experienced in the last half of 2013, is the principal risk for the near term. This will depress private investment, push up inflation and potentially put reserves under pressure. Lack of visible progress in upgrading labour and safety standards in garment factories could trigger loss of preferential access to EU markets. The inability to reopen job opportunities in the Middle-East clouds the sustainability of remittance growth prospects. These are high impact risks, particularly when combined with the possibility of a protracted slowdown in advanced economies. The deterioration in the state banks' financial solvency could challenge fiscal sustainability and constrain the availability of resources for public investment. An oil price shock from heightened geopolitical tensions in the Middle East, or protracted slow growth in trading partner economies, would adversely affect inflation and the balance of payments. Bangladesh's closed capital account limits its vulnerability to global financial volatility, but a large depreciation of the Indian rupee could strain deepening and diversification of Bangladesh's exports, particularly in garments, footwear, and light manufacturing.
Even if all the conditions are growth friendly, growth may still elude Bangladesh unless there is confidence about political stability and policy continuity. Bangladesh is well known as a case of growth governance conundrum. The governance environment may have been barely adequate thus far to cope with an economy breaking out of extreme poverty and low growth. Bangladesh needs to create a system of governance that can successfully manage the interactions between the state and a well-functioning globally integrated economy. Managing such an economy requires inputs that markets do not easily provide: infrastructure, security, rules, standards, certifications, training, and so on. These can be provided only by professionally competent and well-funded government agencies operating in a system that decentralises power to identify problems, work out solutions and monitor performance. The non-elected state institutions -- higher judiciary or the higher echelons of civil bureaucracy or the Election Commission or the Anti-corruption Commission (ACC) and other watch dog bodies -- need total confidence of the public. Without restoring the credibility of these institutions, governance will not grow out of patronage politics.
Bank support and activities
At the end of FY14, The World Bank Group's Bangladesh portfolio had 63 projects, including 32 International Development Agency (IDA) credits, 16 Trust Fund (TF) projects, and 15 co-financing Trust Funds, with a net commitment of US$7.2 billion. In addition, there are two regional projects, an IDA credit for the Regional Strengthening Cooperation for Wildlife Protection Project, the national portion of which is a commitment of US$36 million; and a TF for Engaging the Poor in South Asia Project (CARTA), the national portion of which is US$640,000. Disbursements in FY14 reached US$944 million, with the disbursement ratio of 23.1 per cent for IDA/TF projects. FY14 disbursement was around 23.4 per cent higher than FY13 disbursements.
New commitments in FY14 increased as well. Eight new IDA projects (US$1.89 billion, of which US$1.6 billion in new IDA commitments and over US US$200 million in re-programmed commitments) and 10 new TFs (US$131.75 million) were approved in FY14. The approved operations are a combination of successful follow-on and new projects as well as smaller yet innovative pilot operations. Some significant approvals among these have been:
* The US$600million Rural Electricity Transmission and Distribution Project aims to reduce system losses and enhance capacity in the rural distribution network of primarily the eastern part of Bangladesh. The development objective is to improve the reliability and quality of supply of electricity to rural consumers in Bangladesh through improvements in technical efficiency of the rural distribution system. The project is also expected to support transmission enhancements by the Power Grid Company of Bangladesh (PGCB).
* The US$410million Municipal Governance and Services Project aims to improve municipal governance and basic urban services in participating Urban Local Bodies (ULBs), and to improve the recipients' capacity to respond promptly and effectively to an eligible crisis or emergency. The project development objective (PDO) will be achieved through an integrated approach including improving planning, resource management, accountability and social inclusiveness.
* The US$265million Secondary Education Quality and Access Enhancement Project aim to improve the quality of secondary education, systematically monitor learning outcomes, and to increase access and equity in project sub-districts (upazilas). The original project implementation targets have already been achieved, and 100 per cent of the original credit has been disbursed.
In terms of Analytic and Advisory Activities (AAA) and Technical Assistance (TA), to ensure and extend the development work in Bangladesh, the World Bank has completed a number of important analytical activities, including a policy note for the new government, poverty mapping, a diagnostic trade integration study, and various studies related to climate change, and to public financial management. The Bank remains a committed partner with Bangladesh and will continue to work significantly to reduce poverty and bring prosperity to all Bangladeshis, focusing on the poor mostly.