Bangladesh
Staff Report for the 2011 Article IV Consultation
Author: International Monetary Fund
Publication Date:
03 Nov 2011
eISBN:
9781463923907
Language:
English
Keywords:
ISCR; CR; real GDP; debt; U.S. dollar; GDP deflator; broad money; banking system; central bank; Imports; Credit
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Growth performance in Bangladesh is improving, but macroeconomic imbalances have also emerged. Medium-term growth targets are likely to intensify macroeconomic pressures if not managed well. Longer-term growth prospects hinge on generating sufficient resources to relieve infrastructure bottlenecks and ensuring a competitive business environment focused on labor-intensive activities. There is a need to build on the momentum of recent reforms. To ensure a stable macroeconomic environment, vigilance is foremost required on the fiscal front. The focus is on accelerating growth-promoting structural reforms, while ensuring a stable macroeconomic environment.

Abstract

Growth performance in Bangladesh is improving, but macroeconomic imbalances have also emerged. Medium-term growth targets are likely to intensify macroeconomic pressures if not managed well. Longer-term growth prospects hinge on generating sufficient resources to relieve infrastructure bottlenecks and ensuring a competitive business environment focused on labor-intensive activities. There is a need to build on the momentum of recent reforms. To ensure a stable macroeconomic environment, vigilance is foremost required on the fiscal front. The focus is on accelerating growth-promoting structural reforms, while ensuring a stable macroeconomic environment.

INTRODUCTION

1. Growth performance in Bangladesh is improving, but macroeconomic imbalances have also emerged. Official estimates place real GDP growth at 6.7 percent in FY11 (July 2010–June 2011), up from 6.1 percent in FY10 and an average of 5.8 percent over the last decade (Table 1). At the same time, inflation is now in double digits, running at a three-year high. Despite record export growth, the balance of payments (BoP) went into a deficit in FY11 for the first time in a decade. As a result, foreign reserves slipped from their highs in late 2010. To absorb external pressures, the taka was allowed to depreciate vis-à-vis the U.S. dollar over the past 12 months, in contrast to the preceding three years, when the exchange rate was kept stable but imbalances built (Figure 1).

Table 1.

Bangladesh: Selected Economic Indicators, FY2009–14 1/

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Sources: Bangladesh authorities; and IMF staff estimates and projections.

Fiscal year begins July 1.

Includes non-ADP capital spending and net lending.

Excludes deposits held in offshore accounts of resident financial institutions, noninvestment grade sovereign bonds, and foreign exchange overdrafts provided by Bangladesh Bank to domestic banks.

Figure 1.
Figure 1.

Bangladesh: Response to External Pressures

Citation: IMF Staff Country Reports 2011, 314; 10.5089/9781463923907.002.A001

Sources: Bangladesh authorities; Bloomberg; CEIC Data Company Ltd; and IMF staff estimates.1/ Sum of net merchandise exports and remittances.2/ Monthly average exchange rates and the sum of foreign exchange interventions (including changes in foreign exchange overdrafts) by BB.3/ Observations for October 2011 are averages and totals through October 11, 2011.4/ Gross reserves excludes deposits held in offshore accounts of resident financial institutions, noninvestment grade sovereign bonds, and the outstanding stock of foreign exchange overdrafts. Observations for September 2011 are as at September 26, 2011.

2. Medium-term growth targets are appropriately ambitious, but they are also likely to intensify macroeconomic pressures if not managed well. Under the government’s Vision 2021 and backed by its Sixth Five-Year Plan (2011–15), growth is targeted to increase to 8 percent by FY15 and 10 percent by FY21.1 If realized, the poverty rate is expected to decline from 31.5 percent in FY10 to 22.0 percent in FY15, driven down by more inclusive growth. Achieving this vision will require Bangladesh to leave behind the low revenue-low investment-low growth equilibrium highlighted by Directors during the last Article IV consultation. Since then, growth has picked up and other signs of progress have emerged, through a rising tax take, higher public investment, and rapidly expanding exports, although each from a small base. Growth in ready-made garment (RMG) exports, in particular, has been a major employment generator, especially for women, who make up 80 percent of the sector’s four million workers. Micro, agricultural, and small-to-medium enterprise credit opportunities continue to multiply. However, the infrastructure deficit is enormous (see Appendix I), foreign direct investment (FDI) remains dismally low (at well under 1 percent of GDP annually), and employment opportunities are still limited, as exemplified by the large number of workers seeking opportunity abroad.

3. The 2011 Article IV consultation focused on accelerating growth-promoting structural reforms, while ensuring a stable macroeconomic environment. Discussions took place against the backdrop of an ongoing dialogue on a possible IMF-supported program.2 In this context, reform priorities of the government are appropriately focused on tax policy and administration, public financial management (PFM), monetary and exchange operations, the financial sector, and the trade and investment regime. They are intended to help bolster growth and poverty reduction efforts and reduce external vulnerability. Until these reforms take hold, BOP pressures are likely to intensify. These pressures, in part, stem from import-intensive investment now on the rise as Bangladesh tackles power, transport, and water supply bottlenecks, which have dampened growth performance. Efforts to address electricity shortages are already leading to a surge in oil and capital goods imports, with the immediate focus of the government’s Power and Energy Sector Road Map on installing fuel-intensive rental power plants to boost the power supply.

RECENT ECONOMIC DEVELOPMENTS AND OUTLOOK

A. Macroeconomic Developments

4. The economy expanded at a strong pace in FY11, but external and inflation pressures also intensified.

  • Growth and inflation: Growth in FY11 was buoyed by services, construction, and manufacturing, led by RMG exports and supported by accommodative policies (Figure 2). Headline inflation has been pushed up the past year primarily by food prices, reaching 11.3 percent (y/y) in August 2011. Nonfood inflation is also on the rise owing to demand pressures, reaching 8.8 percent in August.

  • Balance of payments: External factors and domestic demand conditions contributed to a marked deterioration in the overall BOP in FY11, with external vulnerability on the rise (Box 1). Weak aid inflows added to BOP pressures. Export growth (42 percent), fueled by gains in global market share for RMGs, was more than offset by import growth (42 percent), with its larger base driven up by demand for oil, RMG- and food-related, and capital goods imports, as well as a surge in commodity prices (Table 2 and Figure 3). At the same time, remittances growth slowed, owing to declines in manpower exports since 2009. As a result, the current account surplus eroded by almost 3 percentage points of GDP in FY11 to about 1 percent of GDP. Performance in FY11 deviated from the recent past, when strong remittance growth and suppressed import demand resulted in large current account surpluses and rapid reserves buildup.

  • Gross official reserves were US$10.0 billion at end-FY11 (2.9 months of prospective imports of goods and nonfactor services), compared to US$10.1 billion at end-FY10 (3.4 months of import cover). However, this masks underlying pressures, in part owing to valuation gains (US$639 million) and nonreserve asset sales (US$145 million) by Bangladesh Bank (BB) to help finance the BOP deficit. Reserves stood at US$9.4 billion (2.6 months of import cover) as of end-September 2011.

  • Exchange rate: The taka also came under pressure, having depreciated by around 7 percent against the U.S. dollar over the 12 months to end-September 2011, notwithstanding about US$1.4 billion in official foreign exchange sales by BB, including foreign exchange overdrafts (FXODs), over the same period. In recent months pressures have eased, due partly to seasonal factors, but also owing to increased reliance by Bangladesh Petroleum Corporation (BPC) on short-term nonconcessional suppliers’ credit to finance oil imports.

Figure 2.
Figure 2.

Bangladesh: Real and External Sector Developments

Citation: IMF Staff Country Reports 2011, 314; 10.5089/9781463923907.002.A001

Sources: Bangladesh authorities; CEIC Data Company Ltd.; and IMF staff estimates.1/ ACU: Asian Currency Union.
Table 2.

Bangladesh: Balance of Payments, FY2009–16 1/

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

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Sources: Bangladesh authorities; and IMF staff estimates and projections.

Fiscal year begins July 1.

Excludes official capital grants reported in the capital account.

A large portion of this amount is the difference between exports reported on a customs basis and exports reported on a settlements basis.

Excludes deposits held in offshore accounts of resident financial institutions, noninvestment grade sovereign bonds, and foreign exchange overdrafts provided by Bangladesh Bank to domestic banks.

Figure 3.
Figure 3.

Bangladesh: Export, Import, and Remittances Performance

Citation: IMF Staff Country Reports 2011, 314; 10.5089/9781463923907.002.A001

Sources: Bangladesh authorities; CEIC Data Company Ltd.; Eurostat; U.S. Department of Commerce; Office of Textiles and Apparel; and IMF staff estimates.

Bangladesh: External Vulnerability and Implications of a Global Downturn

Bangladesh’s economy has become increasingly open in recent years, but it still remains insulated compared to regional peers. Despite impressive gains over the past decade, total exports were only 21 percent of GDP in FY11. However, they remain highly concentrated both in terms of products and destinations, which carries some risk, with RMG exports to the E.U. and the U.S. the current mainstay. As a reputable low-cost producer of garments, Bangladesh has gained further global market share in recent years. This trend is expected to continue over the medium term, which could partially mitigate the impact of slow growth in advanced economies.

uA01fig02

Asian LICs: Reserve Adequacy, End-2010 1/

Citation: IMF Staff Country Reports 2011, 314; 10.5089/9781463923907.002.A001

Sources: World Economic Outlook; and IMF staff estimates.1/ Excludes Bhutan, Timor-Leste, and Myanmar.

At a glance, Bangladesh’s susceptibility to a global downturn appears limited, but declining foreign reserves makes it increasingly vulnerable to shocks. Under a scenario with a global downturn akin to the 2008–09 global recession, the current account could deteriorate by an additional ½ percentage point of GDP in FY12, while GDP growth could be lower by up to ¾ percentage point relative to the FY12 baseline. This would translate into additional reserve losses of around US$500 million, bringing foreign reserves down to around two months of forward import cover by end-FY12.

uA01fig03

Exports of Goods and Services, 2010

(In percent of GDP)

Citation: IMF Staff Country Reports 2011, 314; 10.5089/9781463923907.002.A001

Sources: World Economic Outlook, and IMF staff estimates.

Bangladesh’s reserves adequacy is low by most measures, including compared to regional peers. Under the current outlook, foreign reserves are projected to decline to around 1½ months of import cover by FY15—again very low by most standards and pointing to fairly sizable financing and adjustment needs to reduce vulnerability. In the past, Bangladesh often relied on administrative measures and moral suasion to cope with low levels of reserves. However, with the increased openness of the economy, a return to these practices would be counterproductive. Most importantly, it could discourage remittance inflows through formal channels. These flows have become a key driver of the current account in recent years and provided important support again in FY11, notwithstanding a slowdown in their growth.

Bangladesh: External Vulnerability Indicators 1/

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Sources: Bangladesh authorities; and IMF staff estimates and projections.
1Prepared by Gerard Almekinders (APD).

5. The fiscal stance in FY11 was moderately expansionary, with an overall deficit (including grants) estimated at 3.7 percent of GDP (Tables 3 and 4, and Figure 4). While less accommodative than budgeted, the deficit was financed almost entirely domestically, with a sizable portion from BB.

Table 3.

Bangladesh: Central Government Operations, FY2009–13 1/

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Sources: Bangladesh authorities; and IMF staff estimates and projections.

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

Includes food account surplus (-)/deficit (+) and extraordinary expenditures.

Comprises direct subsidies for food and fertilizer and subsidy-related lending to large energy-related state-owned enterprises.

Table 4.

Bangladesh: Central Government Operations, GFSM 2001 Classification, FY2009–12 1/

(In billions of taka)

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Sources: Bangladesh authorities; and IMF staff estimates and projections.

Fiscal year begins July 1.

Includes transfers to Bangladesh Petroleum Corporation and Bangladesh Power Development Board, previously included in net lending.

Includes statistical discrepancy.

Figure 4.
Figure 4.

Bangladesh: Fiscal Developments

Citation: IMF Staff Country Reports 2011, 314; 10.5089/9781463923907.002.A001

Sources: Bangladesh authorities; CEIC Data Company Ltd.; and IMF staff estimates.

  • Revenue: Tax revenue surpassed 10 percent of GDP—a major milestone for Bangladesh, with gains coming mainly through tax buoyancy and administrative reforms (i.e., automation, registration, and enforcement).3 At the same time, nontax revenue missed the mark, reflecting unanticipated delays in collecting telecommunications fees and other receipts.

  • Expenditure: Annual Development Program (ADP) spending increased to 4.2 percent of GDP—its highest level in four years, but still below budget.4 On the other hand, subsidies and transfers, including net lending to BPC, far exceeded the budget. They were driven up by higher-than-anticipated commodity prices, food security measures (see Appendix II), and subsidy-related transfers to energy and fertilizer-related state-owned enterprises (SOEs), notwithstanding recent fuel price and electricity tariff adjustments (Box 2).5 To cover its losses, BPC also received financing from state-owned commercial banks (SOCBs) and the Islamic Development Bank (IsDB), which could eventually bear on the budget.6

  • Budget financing: External aid inflows fell substantially in FY11, elevated in the previous year by crisis-related budget support from the Asian Development Bank (AsDB). Domestic nonbank financing declined further, too, in part due to less favorable tax treatment and nominal yields on National Savings Certificates. Consequently, domestic bank financing rose sharply. Suppressed treasury yields shifted added burden onto BB, directly through increased ways and means advances and overdrafts to the government and indirectly through targeted liquidity support provided to primary dealers to encourage participation in treasury auctions.

6. Monetary policy remained accommodative in FY11, with BB taking only partial tightening measures, despite the prevailing loose credit conditions and inflation pressures (Table 5 and Figure 5). As a result, the central bank missed its reserve money target by a wide margin in FY11. In part, monetary policy effectiveness continues to be constrained by weak anchors and objectives (Box 3). Under these conditions, private credit expanded rapidly in 2010 and the first half of 2011, with growth peaking at a record 29 percent (y/y) this past March. It moderated to 23 percent (y/y) in August 2011 (the latest available data). With some delay, BB began raising its repo rate in August 2010—cumulatively now by 275 bps to the current 7.25 percent, while also increasing its cash reserve requirement in December 2010. Nonetheless, repo auctions continued to be severely oversubscribed in much of FY11 owing to strong credit demand and negative real rates. To address emerging liquidity pressures at banks, BB resorted occasionally to open market purchases, in addition to providing regular and emergency repo support. At the same time, most bank lending rate caps were lifted in March 2011, with a subsequent 200–300 bps rise in their base rates.7 Bank-by-bank credit-to-deposit ratio (CDR) ceilings were imposed around the same time.

Table 5.

Bangladesh: Monetary Accounts, June 2009–June 2012

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Sources: Bangladesh authorities; and IMF staff estimates and projections.

At constant exchange rates.

Liabilities arising from banks’ foreign currency clearing accounts and nonbank deposits are excluded from reserves.

Figure 5.
Figure 5.

Bangladesh: Monetary and Financial Market Developments

Citation: IMF Staff Country Reports 2011, 314; 10.5089/9781463923907.002.A001

Sources: Bangladesh authorities;CEIC Data Company Ltd.; and IMF staff estimates.1/ Interest rates are weighted average of commercial banks.2/ Grameen Phone is not correctly reflected in the DSE index from November 2009.

Bangladesh: The Budgetary Impact of Subsidies1

Subsidy costs in Bangladesh are increasing rapidly, mainly due to higher domestic demand and rising import-related costs of heavily subsidized products—namely fuel, electricity, and fertilizer. Currently, broad subsidies are used to shield consumers from the full impact of price movements. For the largest ones, they are initially absorbed in the financial positions of large state-owned enterprises (SOEs)—namely Bangladesh Petroleum Corporation (BPC, fuel), Bangladesh Power Development Board (BPDB, electricity), and Bangladesh Chemical Industries Corporation (BCIC, fertilizer). Operating losses for these SOEs are, in turn, covered by loans from state-owned commercial banks, direct budget transfers, and/or net lending by government (effectively transfers).

The largest single contributor is fuel subsidies, which could undermine fiscal sustainability absent price adjustments. This cost alone could rise to about 1.6 percent of GDP in FY12 from 1.0 percent in FY11 and 0.1 percent in FY10, mainly due to the lack of pass-through of higher oil prices and rising energy demand. Even after the latest price hike, the retail price of diesel in Bangladesh would have to rise by another 44 percent, by staff estimates, for the BPC to break-even, i.e., to cover its import and operating costs. Higher subsidy costs in FY12 do not factor in potential smuggling to India, where diesel prices at end-September 2011 were about 40 percent higher than in Bangladesh. Electricity and fertilizer related subsidies are expected to be around 1½ percent of GDP in FY12. On the other hand, food-related subsidies, though increasing in FY11, appear to be contained to around ¾ percent of GDP (see Appendix II on food security).

Bangladesh: Subsidies, FY2010–12

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Sources: Bangladesh authorities; and IMF staff estimates.

Denotes estimates.

The government has indicated that budgetary transfers are expected to fully cover SOE losses, a substantial departure from past practice. Still, major reforms to these SOEs are urgently needed to contain costs. Although below-market pricing has contributed significantly to their poor financial state, some losses also stem from operating inefficiencies. Regular audits of these SOEs are critical to improving their financial health.

Without further fuel and electricity price adjustments, subsidies are likely to rise over the medium term. Greatest concern arises from fuel imports for power generation, notably at new rental power units being set up to provide short-term relief to major electricity shortages (see Appendix I on infrastructure development). These units, as well as several new natural-gas fueled power plants, will drive energy demand over the next few years.

Recent and prospective increases in the price of petroleum products will likely have knock-on effects on other SOEs. For instance, electricity tariff adjustments announced in February 2011 may not be sufficient to contain the BPDB’s operating losses if the input costs for its power plants and the newly setup rental power plants rise.

Effect on the poor. Evidence on welfare impact of fuel prices in Bangladesh suggests that there is a high degree of subsidies leakage to mid-to-upper income households. Moving to cost recovery for fuel and electricity would obviate the need for subsidies to loss-making SOEs. Some of the freed-up government resources could be used to enhance safety nets for the most vulnerable groups.

1Prepared by Stella Kaendera (FAD).

7. Financial sector stability remains a concern (Box 4). Despite newly adopted Basel II standards, solvency risk among some banks may be increasing, exacerbated by rising liquidity pressures, stock market exposure, and weak supervisory oversight. Recent external audits of the SOCBs pointed to still lax controls. Financial soundness indicators at these and specialized banks remain significantly weaker than at private banks, notwithstanding some recent improvement (Table 6). Equity markets have been volatile, fueled in part by loose credit conditions. The main Dhaka index has fallen by about a third from its December 2010 all-time high (when total stock market capitalization exceeded 50 percent of GDP), after market valuation tripled during 2009–10. Attempts to cushion the fall by relaxing margin lending requirements for retail investors and providing market support through public financial institutions (including through the new Bangladesh Fund) have potentially elevated fiscal risks and created moral hazard.8 Equity markets remain grossly under-regulated by the Securities and Exchange Commission (SEC) and subject to extensive manipulation, as found by a high-level probe in mid-2011 looking at the preceding market drop.

Table 6.

Bangladesh: Financial Soundness Indicators, 2005–11

(In percent, end-of-period)

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Sources: Bangladesh Bank; and IMF staff estimates.

From 2007, an adjustment is made to exclude special accounts set up in banks’ balance sheets, which contain the accumulated losses arising from the difference in market and book value of assets. These amounts are deducted from banks’ assets and from their regulatory capital.

Bangladesh Bank defines return on equity as the ratio of net income after taxes to regulatory capital.

Bangladesh Bank defines return on assets as the ratio of net income after taxes to total assets.

Data for 2011 are as of end-March.