Bangladesh: Staff Report for the 2005 Article IV Consultation, Third Review Under the Poverty Reduction and Growth Facility, and Request for Waiver of Performance Criterion, Extension of the Arrangement, and Rephasing
Author: International Monetary Fund
Publication Date:
22 Jul 2005
eISBN:
9781451979916
Language:
English
Keywords:
ISCR; CR; PRGF arrangement; exchange market pressure; PRGF loan; budget; Bangladesh authorities; Bangladeshi authorities; government of Bangladesh; authorities' strategy; market share
Download PDF (881.4 KB)

This 2005 Article IV Consultation highlights that since the last Article IV Consultation, Bangladesh’s economy has continued to expand, supported by a stable macroeconomic environment and progress in implementing structural reforms, broadly in line with the recommendations made by the IMF Executive Board. Good progress has been made in strengthening the banking system. Bangladesh Bank has raised minimum capital requirements, taken steps to reduce insider lending, and improved the institutional framework for the prudential supervision of the financial system.

Abstract

This 2005 Article IV Consultation highlights that since the last Article IV Consultation, Bangladesh’s economy has continued to expand, supported by a stable macroeconomic environment and progress in implementing structural reforms, broadly in line with the recommendations made by the IMF Executive Board. Good progress has been made in strengthening the banking system. Bangladesh Bank has raised minimum capital requirements, taken steps to reduce insider lending, and improved the institutional framework for the prudential supervision of the financial system.

I. Introduction and Perspective

1. Bangladesh’s reform efforts since the early 1990s have resulted in significant economic and social improvements with steady GDP growth and manageable inflation. Real GDP growth accelerated to an average of about 5 percent, from 4 percent in the 1980s. This performance was underpinned by rising agricultural and nonfarm rural output and a rapid expansion in exports of ready made garments (RMG).

2. Robust GDP growth, together with improved access to education and healthcare, has allowed Bangladesh to make good progress toward meeting some of the MDGs. During the 1990s, poverty indicators have improved, malnutrition has declined, and gender equality has been enhanced. Enrollment and completion rates for primary school rose sharply and adult literacy rates improved in the past decade. Significant progress was made in reducing child malnutrition, maternal mortality, and rural poverty (Table 1).

Table 1.

Bangladesh: Millennium Development Goals, 1990-2003

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Sources: World Bank; and Fund staff estimates.Note: In some cases the data are for earlier or later years than those stated.

targets: Halve, between 1990 and 2015, the proportion of people whose income is less than US$1 a day. Halve, between 1990 and 2015, the proportion of people who suffer from hunger.

target: Ensure that, by 2015, children everywhere, boys and girls alike, will be able to complete a full course of primary schooling.

target: Eliminate gender disparity in primary and secondary education preferably by 2005 and to all levels of education no later than 2015.

target: Reduce by two-thirds, between 1990 and 2015, the under-five mortality rate.

target: Reduce by three-quarters, between 1990 and 2015, the maternal mortality ratio.

targets: Have halted by 2015, and begun to reverse, the spread of HIV/AIDS. Have halted by 2015, and begun to reverse, the incidence of malaria and other major diseases.

targets: Integrate the principles of sustainable development into country policies and programs and reverse the loss of environmental resources. Halve, by 2015, the proportion of people without sustainable access to safe drinking water. By 2020, to have achieved a significant improvement in the lives of at least 100 million slum dwellers.

targets: Develop further an open, rule-based, predictable, nondiscriminatory trading and financial system. Address the special needs of the least developed countries. Address the special needs of landlocked countries and small island developing states. Deal comprehensively with the debt problems of developing countries through national and international measures in order to make debt sustainable in the long term. In cooperation with developing countries, develop and implement strategies for decent and productive work for youth. In cooperation with pharmaceutical companies, provide access to affordable, essential drugs in developing countries. In cooperation with the private sector, make available the benefits of new technologies, especially information and communications.

3. Despite these achievements, Bangladesh still remains among the poorest countries in the region, requiring much faster economic growth if the MDGs are to be met by 2015. Four key structural impediments to growth are: physical infrastructure bottlenecks; inadequate human capital investment; a relatively restrictive trade regime that has an anti-export bias; and the high cost of doing business that has been accentuated by poor economic governance. These problems have discouraged private investment, especially foreign direct investment (FDI), and led to inefficient allocation of public resources, reflected in part by the poor financial conditions of the NCBs and the large SOEs.

4. Bangladesh’s revenue to GDP ratio and tax base remains among the lowest in the world. As a result, public investment for infrastructure and human capital development has been inadequate as compared to most countries in the region. The budget relies heavily on trade taxes and the development surcharge on energy products, contributing to high production costs for domestic firms and to the weak financial position of energy sector SOEs.

5. While the role of public banks has waned as private banks have grown, poor lending practices and inefficiency continue in the NCBs. This has exerted a drag on growth and generated sizable contingent fiscal liabilities for the government. Though some progress has been achieved in improving lending practices, many loans are still disbursed with little commercial merit and minimal subsequent oversight. A legacy of mismanagement and political interference has resulted in a large stock of nonperforming loans (NPLs) in the NCBs.

6. In June 2003, with the conclusion of the 2003 Article IV consultation, the government adopted a program supported by a PRGF arrangement, aimed at tackling longstanding structural impediments and steering the economy onto a higher growth path with faster poverty reduction. Priorities are given to:

  • Putting public finances on a sound footing through sustained revenue efforts and a shift in spending toward infrastructure and human capital to better support growth and the MDGs, while keeping public debt sustainable.

  • Strengthening the banking system through divestment of NCBs in part or in whole, and, in the interim, taking steps to strengthen bank management and restrain lending to help stem the flow of new bad loans.

  • Reducing the fiscal burden posed by the SOEs through closing/privatizing SOEs in manufacturing and restructuring SOEs in the energy sector, by first putting in place appropriate pricing and regulatory frameworks, followed by a medium-term restructuring plan.

  • Moving to a market-based exchange system and continuing trade reform to reduce external vulnerability.

7. Since the last Article IV consultation, the authorities have maintained macroeconomic stability and advanced the structural reform agenda. The thrust of the authorities’ economic policies has been broadly consistent with Fund advice. However, the pace of reforms has been slower than envisaged due to a difficult political environment and technical capacity constraints. Political confrontation continues and consensus building for reform remains difficult. The investment climate is also being adversely affected by frequent strikes and law and order problems. In concluding the 2003 Article IV consultation,1 Executive Directors cautioned that political confrontation posed a significant risk to the implementation of critical reform measures.

II. Recent Developments

8. Supportive macroeconomic policies have facilitated economic expansion. Real GDP growth is projected at 5¼ percent in FY05 (ending June 30), reflecting a slight deceleration from 5½ percent in FY04 due to the impact of devastating floods last July (Table 2 and Figure 1). The floods damaged major crops, particularly rice.2 This, together with an upswing in global oil and commodity prices, contributed to a surge in inflation in late 2004 (7–8 percent in October–December), though inflation has moderated to 6.2 percent in March 2005 and is projected at an annual average of 6.5 percent in FY05.

Table 2.

Bangladesh: Key Economic Indicators (Program Scenario), FY2003-09 1/

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Sources: Data provided by the Bangladesh authorities; and Fund staff estimates and projections.

Fiscal year begins July 1.

CPI has recently been rebased using FY96 weights.

Consists of other capital, net lending, and food accounts (including check float and discrepancy).

Balance of payments is presented on the basis of BPM5.

Figure 1.
Figure 1.

Bangladesh: Real Sector Indicators, FY1996-2005

Citation: IMF Staff Country Reports 2005, 241; 10.5089/9781451979916.002.A001

Sources: Data provided by the Bangladesh authorities; and Fund staff estimates and projections.1/ Estimates for 2003/04; Projections for 2004/05.

9. To help mitigate the flood impact, the government provided sizable funds for rehabilitation in the rural areas. This effort is supported by donor assistance ($200 million from the World Bank, $185 million from the AsDB, and $35 million from DFID to be disbursed in the next two–three years.

uA01fig01

Inflation

(y-o-y, percent change)

Citation: IMF Staff Country Reports 2005, 241; 10.5089/9781451979916.002.A001

uA01fig02

Fiscal Performance

(in percent of GDP)

Citation: IMF Staff Country Reports 2005, 241; 10.5089/9781451979916.002.A001

10. As in the previous two years, the fiscal stance has been prudent, with the overall budget deficit estimated at 4.2 percent of GDP in FY05 (from 3.2 percent in FY04), reflecting in part flood relief efforts (Table 3 and Figure 2). Revenue is projected to increase by 16 percent in FY05 (compared to 9 percent in FY04), provided a strong effort is made in the fourth quarter. This outcome, however, still falls short of the revenue effort of 0.4 percentage point of GDP in the revised FY05 budget, reflecting delays in the implementation of tax administrative reforms and lingering weaknesses in audit and collection enforcement. Total spending is projected to be 0.2 percent of GDP lower than in the revised budget, on account of lower-than-projected development expenditure. The structure of deficit financing remains sound, with domestic financing capped at 2 percent of GDP, whereas external financing continues to be on concessional terms.

Table 3.

Bangladesh: Central Government Operations, FY2003–09 1/

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Sources: Data provided by the Bangladesh authorities; and Fund staff estimates.

Fiscal year ends June 30.

Including externally financed flood-related expenditure.

Figure 2.
Figure 2.

Bangladesh: Fiscal Sector Indicators, FY1996-2005

Citation: IMF Staff Country Reports 2005, 241; 10.5089/9781451979916.002.A001

Sources: Data provided by the Bangladesh authorities; and Fund staff estimates and projections.1/ Projections for 2004/05.2/ The decline in net foreign financing in 2003/04 is attributable to a one-time delay in the disbursement of the World Bank loan under the DSC.

11. The external position strengthened in 2003–04, but pressures emerged at the beginning of 2005. Export earnings have moderated since November 2004, reflecting mainly a sharp decline in prices associated with the elimination of MFA quotas on January 1, 2005. Imports have grown rapidly due to higher oil and commodity prices, an increase in food imports, and stronger demand for investment goods (Table 4 and Figure 3). Oil imports are estimated to exceed forecast levels by about $500 million in FY05. Given potential food shortages, the government approved an additional $200 million for imports of rice and wheat in the second half of FY05. The external current account is projected to move to a deficit of $1.1 billion (or 1.8 percent of GDP) in FY05, from near balance in FY04.

Table 4.

Bangladesh: Balance of Payments, FY2003-09 1/

(In millions of U.S. dollars, unless otherwise indicated)

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Sources: Data provided by the Bangladesh authorities; and Fund staff estimates and projections.

Fiscal year begins July 1. Balance of payments is presented on the basis of BPM5.

Excludes official capital grants.

Loans only. For FY05 includes flood-related donor assistance of US$123 million, plus World Bank loans (DSC II and education) totaling another US$300 million that were originally planned for FY04.

Includes Asian Clearing Union balances.

Gross foreign reserves of Bangladesh Bank, including resident foreign currency deposits.

In percent of current earnings defined as the sum of exports of goods, nonfactor services, and private transfers.

Figure 3.
Figure 3.

Bangladesh: External Sector Indicators, FY1999-2005

Citation: IMF Staff Country Reports 2005, 241; 10.5089/9781451979916.002.A001

Sources: Data provided by the Bangladesh authorities; IMF, Information Notices System, International Financial Statistic; and Fund staff estimates and projections.1/ Estimates for 2003/04; Projections for 2004/05.
uA01fig03

International Reserves and REER

Citation: IMF Staff Country Reports 2005, 241; 10.5089/9781451979916.002.A001

12. Since floating the exchange rate in May 2003, the taka has depreciated by 9 percent and 5 percent in nominal and real effective terms. The authorities have confined their interventions to building reserves and to countering disorderly market conditions during a period of generally favorable balance of payment conditions. The foreign exchange market, however, had not been truly tested in an adverse situation until early 2005 when the economy was confronted by multiple external shocks. To ease pressure, Bangladesh Bank (BB) sold some foreign exchange reserves in January while allowing the taka to depreciate by 5 percent against the U.S. dollar. As pressures continued, BB resorted to moral suasion through the NCBs to curtail the movement of the exchange rate, while allowing them to run shortfalls in their net open foreign exchange positions. Taking into account higher payments for oil imports, gross international reserves are projected at $2.7 billion at end-June 2005 (2.4 months of imports), after peaking at $3.2 billion at end-2004.

13. Monetary policy has been supportive of growth, but an accommodative stance in early 2005 contributed to pressures on the exchange market. Reflecting in part lending to the agricultural sector for flood rehabilitation and strong demand for credit in a low interest rate environment, reserve money growth has accelerated since late 2004, while growth of private sector credit and broad money have also increased sharply (Tables 5–6, Figure 4). A decline in real interest rates led to a slowdown in the net sales of treasury securities by BB, with many banks holding treasury securities only up to the limit under the Statutory Liquidity Requirement.

Table 5.

Bangladesh: Central Bank Balance Sheet, June 2004-June 2006

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Sources: Data provided by the Bangladeshi authorities; and Fund staff estimates and projections.

Calculated from monetary data using end of period exchange rates.

Calculated using program exchange rates (rates for FY05 as of end-March 2004).

Calculated using program exchange rates (rates for FY06 as of end-March 2005).

In April 2004, Bangladesh Bank revised its accounting standards in line with IAS best practises.

Table 6.

Bangladesh: Monetary Program, June 2004-June 2006

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Sources: Data provided by the Bangladeshi authorities; and Fund staff estimates and projections.

In April 2004, Bangladesh Bank revised its accounting standards in line with IAS best practises.