2008 Article IV Consultation: Staff Report; Staff Supplement; Staff Statement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Bangladesh

Bangladesh’s 2008 Article IV Consultation reports that growth picked up strongly from a slow start to the year with rebounds in agriculture and garment exports playing a leading role. Strong growth of remittances and increased external assistance helped support the balance of payments in the face of rising import costs. An impressive increase in government revenues, bringing state-owned enterprise losses onto the budget, and the substantial increase in administered prices have been significant achievements.


Bangladesh’s 2008 Article IV Consultation reports that growth picked up strongly from a slow start to the year with rebounds in agriculture and garment exports playing a leading role. Strong growth of remittances and increased external assistance helped support the balance of payments in the face of rising import costs. An impressive increase in government revenues, bringing state-owned enterprise losses onto the budget, and the substantial increase in administered prices have been significant achievements.

I. Background

1. The political environment is uncertain ahead of December’s national elections. The military–backed caretaker government (CTG) that assumed control in January 2007 remains in power. Following a massive voter registration campaign, national elections have been announced for December 2008, and some elements of the state of emergency have been lifted to allow restricted political activity. The leaders of the two main political parties are both on trial for corruption with their parties threatening to boycott the elections unless they are released from jail. Although the trials continue, one leader has been freed to seek medical treatment abroad and discussions with both parties continue with the aim of ensuring participation of all major parties in the elections. The calm atmosphere surrounding the municipal elections in early August suggests there are reasons to be optimistic about the likelihood of orderly national elections.

2. Despite impressive gains in recent years, Bangladesh remains very poor. Sustained growth, averaging 5½ percent a year since the mid–1990s, enabled poverty rates to be reduced to 40 percent in 2005 from 50 percent in 1995. Significant progress has been made toward meeting the millennium development goals (MDGs), especially with respect to education, child mortality, and gender equality (Table 7). Per capita income, however, is still only about $550 and the country is vulnerable to natural disasters and climate change. This was demonstrated by the devastating twin floods and cyclone in late 2007 that destroyed crops and homes in rural areas, left at least 4,400 dead, and displaced millions. These disasters and the simultaneous increase in food prices have pushed some groups back over the poverty line. Preliminary estimates by the World Bank suggest that, owing to significant growth in incomes during 2006–08, poverty rates are still somewhat lower than the 2005 estimates despite these setbacks.


Proportion of People Under Poverty Line

Citation: IMF Staff Country Reports 2008, 334; 10.5089/9781451804263.002.A001

3. The food supply crisis of early 2008 has passed, but the poor still suffer from high prices. Rice shortages resulting from last year’s natural disasters have dissipated as a result of a strong rice harvest in April–June. Regional export bans for rice and indications that producers and millers may be holding rice in anticipation of further price increases have, though, kept food prices relatively high (much higher than in neighboring India), particularly in urban areas. The authorities are procuring rice from domestic and international markets and recommenced open–market sales in late–August.


Wholesale Price of Rice in India & Bangladesh: Jul 2007 to Jul 2008

(Taka per Kg)

Citation: IMF Staff Country Reports 2008, 334; 10.5089/9781451804263.002.A001

II. Recent Economic Developments

4. Macroeconomic performance has been remarkably resilient in a year of multiple natural disasters and elevated food and fuel prices (Figures 1 and 2). Since the 2007 Article IV consultation, growth momentum has been maintained, exports and remittances continued to grow strongly, and revenue collections improved.

  • Growth in FY08 remained strong at above 6 percent. Early in the year, private sector activity was suppressed by political uncertainty, and fear about an outbreak of avian flu. This was compounded by the natural disasters that heavily damaged the November rice crop and also affected shrimp harvests. However, bumper harvests of wheat, potatoes and the main rice crop in late April, a rapid pickup in garments exports, and some resurgence of industrial activity compensated in the second half of the year.

  • Inflation remains uncomfortably high despite delays in passing through fuel price increases. CPI inflation averaged almost 10 percent during FY08, driven mainly by high international food prices and the April 2007 fuel price increase. With the effects of that increase receding, year–on–year inflation dropped to 7½ percent in April–May 2008, but increased again to 10 percent in June 2008 and is expected to remain at double–digit levels with the increase in administered fuel prices implemented on July 1, which averaged around 40 percent.

  • Government revenue collection improved impressively in FY08. Improved taxpayer compliance, particularly on income tax, and collection of arrears contributed to a 27 percent increase in revenues. This allowed budget targets to be exceeded (by ½ percent of GDP) for the first time in recent history.

  • The overall fiscal deficit for FY08 is estimated to be below the budget target. Despite increased social spending arising from disaster relief operations and better coverage of SOE losses related to administered fuel and fertilizer prices, the deficit is expected to be less than 3½ percent of GDP (excluding a 1.4 percent of GDP debt operation to cover earlier losses of the state–owned petroleum company). The deficit was contained by the higher revenue and a reprioritization of spending, while increased external assistance allowed domestic financing to remain around 2½ percent of GDP.

  • Growth in money aggregates moderated last year, but has started to increase. Money growth fell in the first half of FY08, but picked up rapidly in the last part of the period. Broad and reserve money growth stood at 17½ percent and 20½ percent respectively at end–June. Private sector credit growth accelerated even faster, in part due to the need to finance increased food imports, and reached 25 percent in June.

  • The nominal exchange rate remained stable in dollar terms in FY08, but depreciated by 6½ percent in effective terms as the dollar’s value decreased in international markets. Intervention by Bangladesh Bank (BB) was moderate.

  • International reserves grew moderately. Extremely strong remittance growth, a pickup in garments exports, and external assistance, including from the Fund’s ENDA, moderated the effect on reserves of increased import demand and high international commodity prices. Gross reserves increased to US$6.1 billion (2¾ months of prospective imports).

Figure 1.
Figure 1.

Bangladesh: Real and Fiscal Sector Indicators, FY2001–09 1/

Citation: IMF Staff Country Reports 2008, 334; 10.5089/9781451804263.002.A001

Sources: Data provided by the Bangladesh authorities; IMF, Information Notice System, International Financial Statistics; and Fund staff projections.1/ Projection for 08/09.2/ For 07/08 excludes BPC debt operation.
Figure 2.
Figure 2.

Bangladesh: Monetary and External Sector Indicators, FY2001–09

Citation: IMF Staff Country Reports 2008, 334; 10.5089/9781451804263.002.A001

Sources: Data provided by the Bangladesh authorities; IMF, Information Notice System, International Financial Statistics; and Fund staff estimates and projections.1/ Projection for 08/09.

5. Progress has been made on structural policies, including in the governance area, but the pace of reform has been constrained by the domestic political environment.

  • The CTG initially made encouraging progress, making much–needed adjustments to domestic fuel prices in April 2007, and corporatizing state–owned commercial banks (SCBs). Public financial management and revenue administration reforms were given renewed impetus and progress was made in setting up a primary dealer system for government securities. The CTG also proceeded with governance reforms, including by reconstituting the Anti–Corruption Commission and strengthening the Election Commission. A truth and accountability commission, tasked to look into past corruption, began operation in early August.

  • However, the pace of reform subsequently slowed as the sensitivity of the government to public opinion grew, and addressing natural disasters and food shortages took center stage. The divestment of state–owned Rupali bank, which was a centerpiece of the financial sector reform program, failed when the buyer pulled out of the deal. Administered prices were unchanged throughout FY08 despite the rapid increase in purchase prices.

  • Recent months saw the CTG belatedly responding to international price increases as losses in SOEs became untenable. In addition to the July fuel price increase of around 40 percent, retail prices for compressed natural gas for transport (a marginal portion of overall sales) and fertilizer prices were doubled. Proposed increases of around 50 percent in electricity and other natural gas prices are currently under regulatory review.

III. Economic Outlook

6. Growth could slow while current challenges are addressed, before moving up toward its potential over the medium term. Staff stressed that policy actions to bring inflation under control are likely to create some temporary headwinds to economic momentum. However, growth should increase to around 7 percent over the medium term. Indeed, the good FY08 performance, in the face of strong countervailing pressures, could indicate stronger underlying growth potential than assumed in staff’s baseline projections. Continued improvements in agriculture and expansion in domestic services and construction as Bangladesh capitalizes on high regional momentum will be key drivers of this growth. The external current account should remain broadly in balance, with export and remittance growth offsetting growth in imports arising from price rises and investment. External assistance and gradually increasing capital inflows would underpin a steady increase in international reserves.

Medium-Term Macroeconomic Framework

article image

7. There are, however, significant risks.

  • The external environment is particularly uncertain at present—a sustained further increase in oil prices is not assumed in staff’s baseline projections, but is certainly possible. Such an increase would put the balance of payments and fiscal position under significant stress and further reduce near–term growth prospects.

  • The slowdown in early FY08 demonstrated the damaging effects that political uncertainty can have on economic growth. A further period of major upheaval leading up to the national elections could undermine short–term growth prospects, and distract the authorities from taking needed policy measures.

  • The external sector depends mainly on garments and remittances for inflows.1 Although the outlook appears optimistic, both are vulnerable to shocks: garments from external demand, domestic labor unrest, and changes in market access; and remittances from changes in labor regulations in the Middle East. A deterioration in the outlook for both could cause significant external pressure, particularly as official capital and FDI remain relatively low compared to peers in Asia.

  • External debt is sustainable with low risk of distress. However, taking into account domestic debt, the risk of distress would be moderate particularly because of the vulnerability of the debt ratios to slower growth. Contingent liabilities arising from SOEs and low revenue collections are additional sources of risk.2

  • Climate change poses a significant risk to longer–term growth. As recent events demonstrate, Bangladesh’s economic base is vulnerable to potential changes in sea levels and local climactic conditions.

IV. Macroeconomic Policy Discussions

8. The CTG is committed to leaving a sustainable macroeconomic position to the next administration. The authorities emphasized the recent increases in administered prices as evidence of their commitment. These price rises were politically difficult, particularly in the light of the surge in food prices in early 2008, but essential to leave a workable fiscal position to the next government. The authorities also stressed the importance of leaving adequate public food stocks at the end of their tenure.

9. Discussions focused on the policies required to maintain near–term macroeconomic stability and underpin sustained poverty reduction. The authorities broadly agreed with staff’s medium–term scenario, but were more optimistic about near–term growth prospects and the likelihood of inflation returning to single digits without significant policy adjustments as supply shocks dissipate. Staff welcomed the authorities’ commitment to maintaining a sound economic position, noting in particular the improvements in fiscal management. However, staff stressed that further economic policy actions would likely be required in the coming months to deal with emerging inflationary pressures and to renew momentum on the structural reform agenda.

A. Containing Inflation

10. Staff viewed inflation as the main near–term macroeconomic policy issue. Recent fuel price increases will intensify underlying inflationary pressures. Staff stressed that policy making needed to take into account that, in contrast to the last fuel price increase in April 2007, demand side pressures were now evident. Growth in monetary aggregates is increasing quite rapidly. Private credit growth has reached 25 percent and currency in circulation grew by 12 percent in just the last two months of FY08. Expectations of inflation are becoming internalized in public and private wage settlements, and government current spending is set to increase significantly. With high international commodity prices and monetary policy remaining accommodative, staff believed inflation is likely to remain in double digits throughout FY09.


Annual Growth in Monetary Aggregates

(January 2007 - June 2008)

Citation: IMF Staff Country Reports 2008, 334; 10.5089/9781451804263.002.A001

11. BB’s recent monetary policy statement foresees a continuation of the policy stance adopted in FY08. Policy rates have been constant over the last 18 months with the central bank reverse repo rate remaining at 6½ percent and rates on short term government securities increasing by only a few basis points to 7½ percent. BB’s six–monthly monetary policy statement was released immediately following the Article IV discussions. It did leave the door open for monetary policy actions to counter inflationary pressures, but maintained a bias toward accommodating credit demand, particularly to key growth–driving sectors. This stance reflects the authorities’ assessment that inflation is driven mainly by external supply–side factors, which cannot be addressed by monetary policy actions.


Interest Rates


Citation: IMF Staff Country Reports 2008, 334; 10.5089/9781451804263.002.A001

12. Staff emphasized that a shift in policy is needed to prevent inflation becoming entrenched. With a decline in economic activity in the first half of FY08 and money growth slowing, BB’s neutral position (keeping interest rates and market liquidity steady) was appropriate. With circumstances now different, and policy rates well below projected inflation, staff urged BB to act quickly to send a signal of its intention to fight inflation through a small preemptive increase in interest rates. Staff acknowledged BB’s concern to avoid putting the brakes on private sector growth, but stressed that the authorities’ selectively accommodative monetary policy focusing on key sectors would not be effective in addressing a macroeconomic inflation problem. Staff also emphasized that inflation hits the poor hardest, and that actions in the short term to contain expectations would be less harmful to growth than more aggressive later actions to reverse entrenched inflation. The authorities indicated that they would monitor conditions closely and take monetary policy action if needed, but overall were much more sanguine about inflation risks than staff.

B. Improving Exchange Rate Management

13. BB has kept the dollar exchange rate stable to guard against intensifying imported inflation pressures. Staff noted that this rigidity had not yet seriously constrained external competitiveness, largely due to the depreciation of the nominal effective rate in line with the dollar.3 Staff stressed, however, that these circumstances cannot be expected to continue, and going forward larger movements in the dollar–taka rate are likely to be needed to support policy objectives.


Exchange Rate Movements (2007–08)

(January 2007=100)

Citation: IMF Staff Country Reports 2008, 334; 10.5089/9781451804263.002.A001

14. The real exchange rate remained in line with its equilibrium level on a broad range of measures (Box 1). The real effective rate appreciated somewhat in FY08 as a result of domestic inflation without unduly constraining external competitiveness.4

Bangladesh: Equilibrium Exchange Rate Assessment and External Stability

Staff assessed the equilibrium exchange rate using a number of single-country econometric techniques. More advanced multi-country and dynamic assessments are hampered by the lack of a long-time series of data and the lack of availability of suitable panel data. Analysis therefore focused on a relatively short sample period under three different single country approaches (Chapter I of the Selected Issues paper provides details of the analysis).

All assessment techniques found that the real exchange rate and the external current account balance were in line with their estimated equilibrium values. The macro balance approach finds that the underlying equilibrium current account balance is in line with its equilibrium value and is expected to remain so going forward. Projected current account balances are well within levels needed to maintain external sustainability. Direct estimates of the equilibrium real exchange rate also suggest that the taka is close to its equilibrium level.


Equilibrium Current Account

(percent of GDP)

Citation: IMF Staff Country Reports 2008, 334; 10.5089/9781451804263.002.A001


Equilibrium Real Exchange Rate 1990-2007

(in natural logarithm)

Citation: IMF Staff Country Reports 2008, 334; 10.5089/9781451804263.002.A001

Macroeconomic policies are in line with external stability. The current account has remained broadly in balance for a number of years. Continued strong export and remittance growth are expected to underpin this into the medium term. Public external debt is sustainable with low risk of distress—although domestic contingent liabilities increase the risk of distress to public debt. Capital account flows are mainly long term and are not subject to significant liquidity risks.

15. Greater exchange rate movement would provide more flexibility in macroeconomic policy making and would help develop the interbank market. Staff noted that a somewhat tighter monetary stance would support BB’s preference to use the exchange rate to counter imported inflation while moderating the need to sell international reserves to influence the exchange rate. The authorities agreed that more flexibility in the exchange rate would be desirable, but did not see the need for significant exchange rate movements in the near term. Staff urged the removal of the remaining exchange restriction—on the transferability of funds in nonresident taka accounts. The authorities, however, still saw a risk that removing it could precipitate capital outflows and, given the still low reserve position, were not prepared to commit to a timetable for its removal.

C. Deepening the Financial Sector

16. Successful financial sector development is a keystone to securing future growth potential. A deep and liquid financial sector provides resources to support private sector growth and improves the environment for monetary policy. The financial sector in Bangladesh remains dominated by banks, and private banks are growing rapidly as they expand their loan portfolios and raise capital to be Basel II compliant in 2009. The assets of the private banks grew by around 25 percent in FY08 and their financial soundness strengthened. The stock market is also growing in importance and now accounts for around 20 percent of financial sector assets.


Dhaka Stock Market

(January 2006 - July 2008)

Citation: IMF Staff Country Reports 2008, 334; 10.5089/9781451804263.002.A001

17. Staff welcomed the progress that had been made in a number of isolated areas, but cautioned that Bangladesh was still behind its comparators. Actions taken to strengthen the regulatory and prudential framework of BB, corporatize and improve the management of the SCBs, automate stock trading, and establish a government securities market are essential foundations for financial sector development. However, the remaining agenda are large and there now needs to be a comprehensive vision for the financial sector and stronger support for market development, with BB taking a prominent leadership role. Staff stressed that as part of that effort, and to protect itself from potential vulnerabilities, BB needs to build on the reforms it has already made in its internal operations to ensure that they are in line with best international practice. The authorities concurred and stressed that they intended to reinvigorate their efforts to improve their surveillance of the financial sector, particularly as rapid increases in lending have the potential to undermine credit quality. In this regard, they requested technical assistance (TA) from the Fund to help them improve their stress testing, but did not want to request an Financial Sector Assessment Program (FSAP) update at this time pending further work on their own self–assessment.

Banking Sector Financial Soundness Indicators


article image

18. The SCBs still undermine the efficiency of the financial system. While their market share is declining, they still account for over 30 percent of total banking sector assets and remain mainly moribund, with negative capital and high (30 percent) NPL ratios. Divestment plans appear to be at a standstill following the failure of the Rupali Bank sale. Staff stressed that accelerating progress on strengthening all the SCBs’ financial positions was important to foster financial sector development and reduce the government’s contingent liabilities. Formulating a renewed plan for divestment should be a high priority. The authorities planned to strengthen monitoring of the performance indicators for the chief executives of the SCBs and pointed to the forthcoming Annual General Meetings as a chance to strengthen their Boards.

19. Financial sector deepening requires the development of an active secondary market in government paper, which will also assist in monetary policy implementation. However, the operation of the primary dealer system for government securities needs to be improved before an active secondary market can develop. The key constraining factor is the authorities’ inflexibility on interest rates that undermines the auction process and results in substantial devolvement of securities onto the primary dealers. Staff urged the authorities to yield more to current market pressures for upward movement in rates, which would have beneficial impacts for financial sector deepening and would be consistent with shorter–term monetary policy requirements. BB stressed that it was moving gradually in this direction, but was conscious of the impacts on government debt service and on the growth of credit to the private sector. Staff welcomed BB’s efforts to improve the regulatory framework, including issuing new mark–to–market and liquid reserves regulations and revising the commission system for primary dealers, and encouraged continued dialogue with the banks to iron out remaining regulatory issues.

20. Reinvigorating the foreign exchange market would complement reforms in the government debt market. However, a vibrant foreign exchange market will not develop in the absence of greater movements in the exchange rate. In line with its advice on exchange rate policy, staff encouraged BB to put in place measures to encourage trading, including stricter enforcement of open position limits, and allowing banks to engage in uncovered forward trades and two–way quotes on a more consistent basis.5

D. Building on Improvements in Fiscal Management

21. The FY09 budget foresees a widening of the budget deficit to finance a substantial expansion of social safety net programs. It looks to maintain FY08’s gain in the share of tax revenue in GDP despite the fact that FY08 performance was boosted by some one-off collections of tax arrears (up to ½ percent of GDP). In response to the social stresses arising from the recent natural disasters and rapid escalation of food and fuel prices, the expenditure side of the budget accommodates a broadening in the scope of existing safety net programs and introduces a new cash-for-work scheme that will cover 2 million rural families during the 100 days between harvests. The total cost of these expansions is around ½ percent of GDP. Allocations for subsidies to SOEs, mainly arising from administered prices that do not cover costs, were kept broadly at FY08 levels (Box 2) and the annual development program (ADP) allocation was set at a lower–than–normal level to take account of systematic under–implementation.

Fiscal Indicators FY07-09

(percent of GDP)

article image

Excluding debt operation to cover previous BPC losses.

Bangladesh: Subsidies and State-Owned Enterprises

SOE losses, arising mainly from administered prices that do not cover input costs, reached around 3 percent of GDP in FY08. Losses were concentrated in four main enterprises: the petroleum company (BPC), fertilizer company (BCIC), power company (PDB), and Biman Bangladesh Airlines. Budgetary transfers covered around 60 percent of these losses, a substantial improvement on recent years, with the rest covered by bank credit and arrears.

Slow-moving fuel and fertilizer price adjustments in the face of rapidly rising input costs are a challenge to fiscal sustainability. Fertilizer prices were adjusted in June 2008 for the first time in 12 years. Fuel price increases in 2007 and 2008 were large, but still failed to keep pace with international price movements. At the beginning of FY09 both are well below the levels needed to cover import costs.

Key State-Owned Enterprises: FY08 Losses

(percent of GDP)

article image
Source: Bangladesh Authorities and Fund Staff Estimates
  • Without further price increases and with current international oil and fertilizer prices, SOE losses could reach 3¼ percent of GDP in FY09, slightly higher than the FY08 level.

  • The FY09 budget assumes transfers of around 2½ percent of GDP, leaving a gap of around ¾ percent of GDP (taka 40 billion) to be covered by expenditure prioritization.

  • Each additional $10 on the international oil price would add Tk 20 billion to the overall subsidy or would require about a 10 percent increase in domestic fuel prices.


Fertilizer Import and Selling Price Indices


Citation: IMF Staff Country Reports 2008, 334; 10.5089/9781451804263.002.A001

Reforms in the operations of SOEs would also improve the fiscal position. Although pricing mechanisms contribute significantly to the poor financial state of many SOEs, losses also stem from inefficiency and lack of investment. Continuing with reforms to improve operations and divesting attractive SOEs are important elements of the fiscal reform process.

22. Staff emphasized that keeping to the macroeconomic targets of the FY09 budget will be important to prevent putting further pressure on inflation. In normal circumstances, it would have been preferable to have a less expansionary budget. However, given the need to strengthen social safety nets while further improving coverage of SOE losses, the budget’s targets are appropriate, particularly given the authorities’ prudent recent record on fiscal management. The gains in tax compliance and the improvement in the base achieved in FY08 should allow the budget target for revenue to be met and perhaps even exceeded. Staff stressed that given inflationary pressures any excess revenue should be used to reduce the overall deficit and domestic financing. Ensuring safety net programs, particularly the new 100 days employment generation program, are well targeted and minimize leakages will be important to safeguard the quality of the expenditure expansion.

23. The substantial hike in fuel and fertilizer prices may not be sufficient to keep within the budget’s subsidy provisions. The authorities confirmed that they intend, as far as possible, to cover SOE losses arising from administered prices through budgetary transfers. Volatility in international commodity markets, however, makes it unusually difficult to forecast the fiscal burden of administered prices. Staff’s baseline projection suggests potential overruns of around Tk 40 billion (Box 2). In these circumstances staff supported the authorities’ plans to cover them from within the expenditure envelope.6 Staff stressed that any additional SOE losses arising from international price rises should be met by domestic price increases so that priority spending on key social and development programs are not further compromised. The authorities agreed in principle, but noted the political difficulty in further increasing prices. In this context, the authorities stressed that staff’s preference for a framework that will allow prices to automatically adjust to full cost coverage could only be considered in the medium term.

24. Staff and the authorities agreed that in the medium–term fiscal policy should return to a path of lower deficits. The FY09 budget is intended to be a temporary deviation from the restrained fiscal position—an overall deficit below 4 percent of GDP and domestic financing below 2 percent of GDP—that has served Bangladesh well in the recent past. In this context, staff welcomed that the draft Public Resource and Budget Management Ordinance was close to approval. The Ordinance will set fiscal policy within a clear institutional framework—that restricts domestic financing to be below 3 percent of GDP and total public debt below 60 percent of GDP—and will improve fiscal transparency and accountability, especially for future governments. Staff stressed that the Ordinance’s quantitative framework should not be seen as targets and that, in normal circumstances, fiscal policy should aim to operate well below the Ordinance’s ceilings. This is particularly important given the moderate risks of debt distress arising in part from the significant contingent liabilities in the SOE sector. The establishment of a macro–fiscal unit within the Ministry of Finance (MOF) that is being supported by Fund TA was particularly welcome in this regard.

25. Increased revenue remains the preeminent medium–term fiscal policy goal. Bangladesh’s revenue performance has been persistently below the levels of its regional peers. Improvements have been frustrated by a complex and inefficient policy framework, widespread evasion, and poor administration.7 Despite some erosion in the tax base in the FY09 budget, particularly the expansion of tax holidays (albeit on a temporary basis), improvements in administration and enforcement that are already underway can underpin continued marginal increases in the revenue to GDP ratio (Box 3).8 A complete modernization of tax legislation will, however, be required to deliver the gains in revenue needed to underpin the medium term macroeconomic framework. Staff urged that work on redrafting income tax and VAT legislation be taken forward quickly. The authorities agreed that legislation needed updating, but preferred a more gradual approach, particularly for income tax where they prefer to progressively amend the existing legislation rather than adopt a new act in its entirety. The authorities acknowledged that updating the VAT legislation is key to improving the efficiency of the tax system and plan to begin drafting a new law soon.

Tax Revenue to GDP—Selected Asian Countries

(In percent)

article image
Source: IMF staff reports

The fiscal year ends on June 30;

Non-resource revenues

26. The fiscal space provided by improved revenue needs to be used to increase the level and quality of public expenditure.

  • Generalized subsidies that primarily benefit the better off, reaching 3 percent of GDP in FY08 and FY09, represent a significant constraint on the ability to increase spending on social services and infrastructure that are necessary to sustain poverty reduction and achieve the MDGs.

  • The Medium–Term Budget Framework (MTBF) provides a good basis for reorienting revenue gains and savings from reducing subsidies. The authorities intend to refine it by reviewing the success of line ministries in achieving their own MTBF performance indicators. Staff welcomed this initiative and encouraged the MOF to roll out the initiative to all spending ministries within two to three years.

  • Staff urged the authorities to take concrete steps to increase the implementation rate of the ADP, noting that public investment remains too low to address development needs. These include the reconstruction of infrastructure and housing destroyed in FY08’s natural disasters, which have only small allocations in the FY09 ADP. The authorities agreed that increasing the ADP was a key priority. They noted, however, that the recent slowing in the pace of ADP spending reflected their efforts to stamp out corruption in implementation and have consequently led to an improvement in the quality of ADP spending. They also noted that a more comprehensive rehabilitation program in response to last November’s cyclone is still under discussion with key donors. Staff welcomed any improvement in the quality of development spending and encouraged further efforts to address administrative and capacity constraints, including through better coordination with donors.

  • Staff noted that maintaining control over public sector wage increases, particularly in the context of the 2009 Public Wage Commission, will also be important in maintaining fiscal space and moderating the benchmark these increases could set for the private sector. As was done after the 2005 Pay Commission, increases in pay and allowances will need to be phased in over several fiscal years to make the fiscal burden manageable.

Bangladesh: Revenue Administration Reforms

Revenue administration reform picked up in FY08. The institutional framework for separating tax policy from administration has been established and a new unit will begin work by the end of the year. The two Large Taxpayer Units (LTUs) have been placed under the control of a single member at the National Board of Revenue, which should further improve enforcement. Revenue gains in FY08 reflect improvements in taxpayer compliance arising in part from the authorities’ new universal self–assessment scheme, efforts to increase registration, and enhance taxpayer education.

Staff and the authorities agreed on a wide–ranging agenda of actions that will further improve administration and enforcement. In the VAT area, actions focus on improving case selection and efficiency of audit and simplifying registration procedures. In customs, the authorities intend to continue reducing the number of zero–rated commodities and incorporating duty exemptions into the customs law. Further reform of the unified LTUs, which are the backbone of revenue collections, focuses on streamlining audits and expanding the coverage beyond Dhaka. Spreading the unified taxpayer identification number beyond large taxpayers is a crucial measure to improve enforcement as is improving the functioning of the disputes and appeals procedure and more rigorously applying penalties for non payment.

V. Other Issues

27. The macroeconomic framework of the draft Poverty Reduction Strategy Paper (PRSP) is broadly in line with staff’s projections and the medium–term budget framework. Staff noted the substantial work that has gone into producing the comprehensive strategy in such a short period of time and emphasized that the transitional nature of the current administration heightens the importance of broad consultation. However, the accelerated timetable has thus far meant that consultation with civil society and the donor community has been limited.

28. Improving the quality and timeliness of economic statistics would improve policy making. Some improvements have been made, notably in streamlining public sector coverage in the fiscal accounts and on–going work on a new CPI consumption basket. Key priorities going forward are strengthening balance of payment statistics through improving the consistency of trade data and developing international investment statistics, improving the source data for national accounts statistics and introducing more frequent and timely dissemination practices, and moving toward GFSM2001 standards for fiscal statistics.

VI. Staff Appraisal

29. Macroeconomic performance has been remarkably resilient in a year of multiple natural disasters and elevated food and fuel prices. Growth picked up strongly from a slow start to the year with rebounds in agriculture and garment exports playing a leading role. Increases in remittances and external assistance helped support the balance of payments in the face of rising import costs. The fiscal position was supported by a significant improvement in revenue collections, which helped offset increasing energy and fertilizer subsidies and larger outlays on safety nets. Nevertheless, life has become more difficult for large segments of the population. The natural disasters and subsequent rapid food price increases of early 2008 put severe pressure on incomes, particularly of the urban and landless rural poor, reversing some of the recent reductions in poverty.

30. The authorities have made significant efforts to maintain a stable macroeconomic situation. This is particularly evident in the fiscal sector, where there has been significant strengthening of the revenue position and most SOE losses have been brought onto the budget. The recent increase in administered prices was a bold step and prevented a deterioration in SOE finances, but more still needs to be done to improve their position.

31. Preventing an increase in inflation is the immediate policy concern. With fiscal policy focusing on sustaining revenue collections and strengthening safety nets to address the social impact of higher commodity prices, monetary policy needs to adjust to contain inflationary pressures. A preemptive movement in interest rates would rein in increasing inflation expectations and help prevent high inflation from becoming entrenched. Higher inflation directly hurts the poor and vulnerable; delaying action could be more harmful to growth prospects as it would require larger and more aggressive policy responses in the future.

32. Greater flexibility in the exchange rate would support monetary policy objectives without placing undue pressure on the international reserve position. While staff judges the current level of the exchange rate to be in line with medium–term fundamentals, more day–to–day movement in the rate would provide greater flexibility in macroeconomic policy making and deepen the foreign exchange market. As there is no timetable for the removal of the one remaining exchange restriction on the transferability of funds in nonresident taka accounts, staff does not recommend its approval.

33. Keeping to the macroeconomic targets of the FY09 budget will prevent putting further pressure on inflation. Despite inflationary pressures, the budget’s expansionary stance is defendable given recent fiscal prudence and the need to address the social impact of natural disasters and higher food prices while further improving budget coverage of SOE losses. Given the pressures, however, any revenue collections in excess of the budget should be used to reduce domestic financing. If international oil prices rise further, additional SOE losses should be met by further administered price increases so that priority spending is not compromised.

34. Macroeconomic policies are consistent with external stability and the medium–term outlook remains favorable. Near–term growth may slow slightly as inflation is brought under control, but should increase to around 7 percent over the medium term as structural reforms feed through and Bangladesh capitalizes on high regional growth. Macroeconomic policies are consistent with external stability. The external current account is expected to stay broadly in balance as continued growth in exports and remittances is expected to offset higher imports. Capital flows are mainly long term and not subject to significant liquidity risk and public debt is sustainable.

35. There are, however, significant risks. In particular, a sustained further increase in oil prices would put the balance of payments and fiscal position under significant stress and further reduce near–term growth prospects. Poor governance and inadequate infrastructure, particularly in the power sector, remain the main constraints to investor confidence and need to be addressed to avoid a sustained slowdown in growth that could put the sustainability of debt ratios in jeopardy. There are also moderate risks of domestic debt distress stemming from large contingent liabilities in the SOE sector. Climate change is a major long–term challenge and will require careful coordination with donors in planning adaptive measures.

36. Further financial sector development is needed to allow Bangladesh to achieve its growth potential. Despite some recent progress, the overall development of the sector is behind comparator countries. Strengthening the SCBs’ financial position with a view to eventual divestment is crucial to improve banking sector efficiency. Allowing interest rates in the primary auction for government securities to be market determined will give impetus to an active secondary market, which is vital for financial sector deepening.

37. In the medium term, increased revenue is crucial to allow fiscal policy to return to a lower deficit path. The FY09 budget should be a temporary deviation from the restrained fiscal position that has served Bangladesh well in the recent past. Achieving the revenue gains needed to allow increased public expenditure will require moving quickly forward with revisions that modernize income tax and value–added tax legislation together with sustained improvements in administration and enforcement. Reducing open–ended price subsidies and replacing them with more affordable and better–targeted social safety nets will also provide fiscal space for increases in public investment and provision of social services.

38. Continued improvement in the quality and timeliness of economic statistics would improve policy making. Priorities in the near term include improving the compilation and dissemination of national accounts statistics, and strengthening balance of payments statistics.

39. It is recommended that the next Article IV consultation with Bangladesh take place within the standard 12–month cycle.

Table 1.

Bangladesh: Key Economic Indicators, FY2004–14 1/

Nominal GDP: US$79 billion

Main export (percent of total): garment (75)

Population (FY08): 142.5 million

GDP per capita (FY08): US$554

Poverty rate (FY05): 40.8 percent

FDI (percent of GDP): US$760 million (1.1)

Government debt: 43.8 percent of GDP

Foreign government debt: 62 percent of total government debt

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

Fiscal year begins July 1.

CPI uses FY96 weights.

Consists of other capital, net lending, food account balances, check float and discrepancy.

Includes assumption of BPC liabilities of 1.4 percent of GDP in FY08.

Table 2.

Bangladesh: Balance of Payments, FY2005–09 1/

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

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

Fiscal year begins July 1.

Excludes official capital grants.

Includes trade credits, long–term borrowing, short–term financing for Bangladesh Petroleum Company (BPC), commercial bank net borrowing, and errors and omissions.

Gross official reserves less foreign liabilities of Bangaldesh Bank and balances in commercial bank foreign currency clearing accounts.

Table 3.

Bangladesh: Central Government Operations, FY2006–09 1/

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

Fiscal year begins July 1. Cash basis unless otherwise specified.

Include food account surplus(–)/deficit(+) and extraordinary expenditures.

Includes bonds (Tk 10 billion) issued to a nationalized commercial bank to assume BPC’s liabilities.

Includes bonds (Tk 75 billion) issued to three nationalized commercial banks to assume BPC’s liabilities.

Table 4.

Bangladesh: Central Bank Balance Sheet, June 2006-June 2009

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

Calculated from monetary data using end-of-period exchange rates.

Liabilites from banks’ foreign currency clearing accounts and non-bank deposits are not included in reserves.

Table 5.

Bangladesh: Monetary Survey, June 2006-June 2009

article image
Sources: Data provided by the Bangladesh authorities; and Fund staff estimates and projections.
Table 6.

Bangladesh: Financial Soundness Indicators

article image
Sources: Bangladesh Bank; and Fund staff estimates.
Table 7.

Bangladesh: Millennium Development Goals, 1990–2007 1/

article image
Sources: Bangladesh Planning Commission and United Nations Development Program