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Bangladesh economy faces headwinds

Muhammad Mahmood | December 19, 2023 00:00:00

Bangladesh Bank headquarter in Dhaka —FE Photo

A recent World Bank report (October 4, 2023) says, "Bangladesh has strong track record of growth and development, even in times of elevated global uncertainty. A robust demographic dividend, strong ready-made garment (RMG) exports, resilient remittance inflows, and a stable macroeconomic condition have supported rapid economic growth over the past two decades." It then adds, "From being one of the poorest nations at birth in 1971, Bangladesh reached lower-middle income status in 2015. It is on track to graduate from the UN's Least Developed Countries (LDCs) list in 2026." It further lauds Bangladesh's economic achievements saying that the country "has an inspiring story of growth and development, aspiring to be an upper-middle income country by 2031." In fact, Bangladesh aspires to become a developed, prosperous and higher-income country by 2041. The IMF has assured its continuing support to achieve this aspiration.

Early this year (2023) the IMF approved a US$4.7 billion loan sought by the Bangladesh government. Of this, US$3.3 billion was granted under the Extended Credit Facility/Extended Fund Facility and US$1.4 billion under the Resilience and Sustainability Facility for Bangladesh. Also, another US$ 1 billion loan has been requested from the World Bank and an estimated US$2.5billion loan from other multilateral agencies and donor countries such as Japan. Such a need for the IMF assistance and from other sources is indicative that the country faces newly emerging economic challenges.

In fact, the economy is facing challenges on multiple fronts such as rising inflation, balance of payment deficit along with a budget deficit, declining foreign exchange reserves, contraction in remittances, a depreciating currency, rising income inequality and the demand-supply imbalance in the energy sector. Now added to these challenges is the ailing banking sector crippled by loan defaults i.e., non-performing loans. Above all, Bangladesh is particularly vulnerable to the effects of climate change.

The balance of payments situation summarises the economic transactions of an economy with the rest of the world. These transactions include exports and imports of goods, services and financial assets. Bangladesh is not only running a deficit on current account but on the financial account as well in its balance of payments. During the fiscal year 2022-23, Bangladesh ran a current account deficit of $3.34 billion and a financial account deficit of $2.14 billion. The country is also experiencing a fall in foreign direct investment further adding to the problem. It is to be noted that a financial account measures the increase or decrease in a country's ownership of international assets.

As balance of payments difficulties intensify, the scope for monetary policy actions become increasingly very constrained by the need to protect foreign currency reserves in countries like Bangladesh or those having fixed exchange rate regimes. Therefore, these countries are most likely to ration imports or impose exchange rate control.

Export accounting for a very low share of GDP is a problem for Bangladesh. The share fell to 15.32 per cent in 2019 from a peak of 20.16 per cent in 2012. It further fell to 12.18 per cent in 2020 and now for 2022-23 it stands at 7.7 per cent. To add to the problem the inflow of remittances has also slowed down. Remittances are the second largest contributor to the current account after exports. Bangladesh's narrow export base (RMG accounted for 84.5 per cent of Bangladesh's total exports valued at nearly US$47 billion in 2022-23) and an over-reliance on remittances have exposed the economy to external shocks.

With such a low export to GDP ratio, Bangladesh can be considered a closed economy. Bangladesh indeed remains a relatively closed economy with tariff barriers that are above the already high South Asian average and twice the average of lower middle-income countries, the group which Bangladesh will join in two years time. Such an inward-looking trade policy not only encourages rent seeking activities but also discourages diversifying away from RMG.

Furthermore, it is generally considered that the taka remains overvalued when viewed in terms of the real effective exchange rate (REER) despite the taka depreciating in recent times. As volumes of imports and exports are sensitive to REER, the overvalued taka makes exports relatively more expensive and imports relatively cheaper.

Consequently, Bangladesh now faces balance of payments difficulties as reflected in the declining foreign exchange reserve which according to the International Monetary Fund's (IMF) accounting system, currently stands at US$20.90 billion compared to US$48 billion in 2021. However, some question that figure and believe the reserve to be around US$18 billion.

It appears the reserves crisis is having an impact on imports. Imports declined by about 14 per cent between July and November this year as the central bank is tightening its grip on import flows of what is described as luxury goods (see FE, December 15). But such a direct intervention to control imports by the central bank is consistent with countries experiencing foreign exchange reserve crisis but unlikely to resolve the crisis. In fact, trying to address the reserve problem via import controls can lead to creating problems somewhere else such as growth, inflation, revenue collection etc.

Continuing trade deficits are also causing the taka to depreciate against the US dollar. It is estimated that the taka depreciated by 31 per cent over more than a year in November 2023 (see FE, December 11) and the currency depreciation often contributes to inflation. In fact, Bangladesh is now facing rising inflationary pressures - inflation standing at 9.5 per cent in November this year.

Bangladesh achieved annual GDP growth over 6 per cent in the last two decades or so, but to continue to follow a steady path to growth Bangladesh needs to prioritise its development needs by focusing on streamlining the trade regime to enable the country to create an open and competitive environment with a diversified exports basket based on comparative advantage using productivity enhancing skilled labour and technology rather than relying on cheap labour.

In May this year, the UN Special Raporteur on extreme poverty and human rights, Olivier De Schutter in a report on Bangladesh said that Bangladesh must move away from its reliance on cheap labour if it is to ensure right based development. He further said, "Bangladesh's development has largely been driven by one export sector - the ready-made garments industry - which is highly dependent on keeping wages low", then further added, "A country's comparative advantage cannot lie in keeping people poor."

Bangladesh also runs a budget deficit which stands at Tk 261,785 crore, which is 5.2 per cent of GDP for the fiscal year 2023-24. Almost two-thirds of public revenue is derived from indirect taxes and a third from direct taxes. Reliance on indirect taxes, especially consumption taxes, is viewed as regressive and such taxes negatively affect income redistribution via the taxation system.

Despite achieving steady economic growth over the last two decades, income distribution appears to be getting more skewed towards the upper income brackets as reflected in the widely used Gini Index for measuring income inequality. The Gini Index has increased considerably over the last decade and a quarter. The country's Gini Index rose to 0.499 in 2022 relative to 0.482 in 2016 and 0.458 in 2010 indicating deteriorating income inequality which can lead to exacerbating poverty.

Tax and transfer systems play a key role in lowering overall income inequality. Therefore, both fiscal discipline and fiscal reforms are needed to generate more revenue using more direct taxation rather than the current reliance on indirect taxation. The reoriented taxation policy will help to mitigate not only rising income inequality using the taxation system but also budget deficits. In fact, income inequality is not only an economic problem but also a social and political problem. Economic policy prescriptions are, therefore, much more than just about achieving economic efficiency. They fundamentally also require fairness.

Many economists believe that a budget deficit leads to a current account deficit. In macroeconomics it is known as the twin deficit hypothesis. A budget deficit caused by tax cuts or financed by borrowing (domestic and /or foreign) or both results in increased consumption of imported goods causing the current account deficit to widen.The twin deficit problem will make a country a debtor to the rest of the world and will weaken the value of the currency, thereby further aggravating external imbalances.

The banking industry in the country is currently undergoing intense instability. On October 1, this year Bangladesh Bank claimed that the total amount of defaulted loans rose to Tk 1,560.39 billion in June from Tk. 1,316.2 billion in March. The bank notes that the accumulation of non-performing loans heightens threat to the stability of the financial sector.

The banking industry also suffered a major setback in 2022 when 11 banks faced a collective shortfall of US$3.1 billion. Any further increased instability in the banking sector can lead to a crisis of confidence and that rapidly will move to the broader financial system. This will have serious consequences for the economy.

The global Financial Integrity data show that US$61.6 billion was moved out of the country between 2005 and 2014. Furthermore, Bangladesh lost US$7.53 billion accounting for 17.95 per cent of trade per year on average between 2008-2017 through trade mis-invoicing which is a conduit for money laundering and tax evasion. According to GFI, this figure could rise to US$14 billion per year by 2030.

Bangladesh is also facing an energy crisis due largely to a heavy reliance on imported fuels estimated at about US$ 2.5 billion a year for power generation and also a lack of renewables and cleantech alternatives. In fact, instead of moving towards exploring renewable energy sources, Bangladesh turned to the use of more fossil fuels such as coal, oil and LNG. With a depreciating currency, a reliance on imported fuels for power generation has led to significant rise in power generation costs. As a result, it is estimated that the cost of electricity generation went up by 33 per cent in 2021-22.

Power cuts have disrupted activities in several sectors including agriculture and manufacturing, especially with serious implications for the RMG industry. Power cuts have also exacerbated public suffering, as the country is trying to combat the impacts of climate change such as heat waves and soaring temperatures reaching around 40c. Now to further compound the energy problem, Bangladesh is struggling to pay fuel import bills due to foreign exchange shortages.

Climate change is a critical issue in Bangladesh as it is one of the most vulnerable countries to the effects of climate change. In fact, it is widely recognised that Bangladesh faces among climate change impacted countries the highest levels of climate exposure globally. Bangladesh produces a tiny fraction of greenhouse emission (0.59 per cent) causing climate change, yet according to Germanwatch's 2021 Global Climate Risk Index (CRI), Bangladesh ranked seventh in the list of countries most affected by climate calamities during the period 2000-2019.

The data clearly show that during this period Bangladesh suffered economic losses worth US$3.72 billion and witnessed 185 extreme weather events due to climate change. Rising sea levels, floods and cyclones, just to name a few impacts of climate change, make Bangladesh one of the most climate change vulnerable countries in the world. An average person in Bangladesh emits 0.5 metric ton of CO2 compared to 15.12 metric tons per person in the US, yet Bangladesh is overwhelmingly bearing the brunt of climate change caused by high emitting developed countries.

Climate and growth and development are increasingly becoming intertwined. Therefore, Bangladesh's vulnerability to climate change and natural disasters requires climate change adaptation and disaster risk reduction by enhancing resilience to future shocks. There is a need to integrate responses to climate change and adaptation measures to achieve green growth which will support sustainable growth and poverty reduction. That will require to build enhanced state capacity and societal resilience.

Overall, to address these economic challenges Bangladesh needs to build enhanced state capacity and reorient its economic policy approach by focusing not only on price competitiveness alone but also on innovation by harnessing the new technological frontiers using skilled labour with an emphasis on fairer distribution of income. Such a reorientation of economic policy will enable the country to achieve sustainable economic growth and development.

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