Recent Macroeconomic Developments

2. The Bangladesh economy continues to achieve robust real GDP growth despite the global economic slowdown. Preliminary estimates show that the economy expanded by 6.3 percent in FY12 supported by strong domestic demand and impressive remittance inflows. Moreover, ongoing measures to reduce supply bottlenecks in power, energy, and communication sectors have appeared to encourage private investment and promote real economic growth. In particular, since the present government took power, an additional 3,900 MW of electricity has been added to the national grid till December 2012.

3. Adjustments in macroeconomic and financial policies together with the assistance under the IMF’s Extended Credit Facility (ECF) have helped ease external pressures. Further, timely fiscal consolidation and moderate monetary tightening have eased inflationary pressures in the second half of FY12. Point to point inflation has decreased to about 7.7 percent in December 2012 from the double digit level in March 2012. The exchange rate remains market-based and its volatility is lower now than in 2011. High remittance inflows have compensated the impact of sluggish export growth. Accordingly, foreign exchange reserves have gradually increased and amount to around four months of import cover.

4. With strong revenue collection efforts and expenditure restraint, the overall budget deficit (excluding grants) is estimated to be around 4 percent of GDP in FY12. Fuel and electricity subsidies have been contained by adjusting administered prices. Government borrowing from the banking system in FY12 remained within budgetary parameters and did not crowd out private sector credit growth. A similarly prudent fiscal stance has been sustained in the first seven months of FY13.

5. Restrained monetary policy ensured that major monetary aggregates were close to program targets in FY12. In recent months, high remittance inflows, which are not fully sterilized, has led to minor over-shooting of broad money; however, key program targets for Net Domestic Assets of Bangladesh Bank and reserve money growth are on track. The new monetary policy stance, even after a half a percentage point reduction in repo rates announced in late January 2013, is essentially a continuation of the restrained stance.

6. The authorities aim to uphold this policy stance under the ECF program to achieve sustained growth, keep inflation below 8 percent and preserve external stability in FY13. Meanwhile, the authorities have met all the quantitative performance criteria under the ECF supported program as of end-June 2012 and most of the indicative targets as of end-June and end-September 2012. The authorities have also met a number of structural benchmarks so far and they are committed to pursue reforms to strengthen the fiscal position and monetary management and operations. They are also committed to improve financial sector stability, as well as the trade and investment environment, as outlined in the Memorandum of Economic and Financial Policies (MEFP).

Fiscal Policy

7. In order to maintain a sound fiscal policy position in FY13 and beyond, the authorities envisage pursuing additional tax reforms, strengthening revenue administration, improving public financial management, containing energy and fertilizer subsidies, increasing efficiency and transparency of key social safety net programs, enhancing debt management capacity and limiting contingent liabilities and related fiscal risks. These continuous reform programs are expected to generate additional domestic revenues, make government spending more efficient and thus improve debt sustainability.

8. The authorities plan to increase tax revenue by 0.6-0.8 percent of GDP every year for providing adequate resources for their social and physical infrastructure projects in the medium term. The National Parliament approved a milestone piece of legislation on the value added tax (VAT) in November 2012. This law is expected to bring in a modern tax regime over the next few years. In this connection, the authorities aim to prepare a VAT implementation plan with a schedule, and will also frame VAT rules and regulations. Besides this, the modernization plan (2011-2016) of the National Board of Revenue (NBR) includes reform programs for improving revenue administration including further automation, upgrading customs software and rolling out alternative dispute resolution mechanisms (ADR) to all jurisdictions.

9. The authorities have already fixed quarterly limits on the issuance of new payment orders by line ministries with a view to improving cash management and expenditure controls. They also aim to encompass all line ministries within the integrated budgeting and accounting framework in FY13. The Annual Development Program (ADP) projects under the ten largest line ministries are being monitored regularly to enhance the pace of their implementation. The authorities also plan to issue a formal project formulation and appraisal technical manual in FY13. Fuel and electricity prices have been adjusted several times since 2011 to contain energy and fertilizer subsidies and to increase space for social spending. Moreover, a technical committee has been established to monitor the commitments and payments for fertilizer subsidies. The authorities are committed to contain subsidy costs by adjusting domestic fuel prices, capping fertilizer subsidies, and replacing rental power plants with lower cost base power plants within the shortest possible time.

10. A draft debt management strategy (DMS) has been prepared in August 2012 for strengthening capacity to monitor debt sustainability. The authorities aim to complete the installation of UNCTAD’s Debt Management and Financial Analysis System for efficient recording of external debt flows in FY13. Other intended reform measures in this area include preparing a diagnostic study on the Government Provident Fund (GPF), aligning yields of National Savings Certificates (NSCs) with market-based rates, aligning taxation of interest on NSCs with other government debt instruments and revamping diaspora bonds.

11. With a view to containing fiscal risks associated with contingent liabilities, the authorities aim to keep limits on new non-concessional external debt maturing in more than one year, while emphasizing such borrowing to be on adequately assessed projects in major infrastructure sectors. However, as they could not observe the performance criteria (PC) following a new loan contract associated with nuclear power development and defense related purchases with the Russian Federation, the authorities request a waiver of the continuous performance criteria on new concessional external debt maturing in more than one year contracted or guaranteed by the public sector. In this context, the authorities are taking remedial steps to strengthen debt management practices by improving official projections of loans and guarantees through regular consultation with recently established budget wings in line ministries to ensure that new commitments are fully included in the government’s annual borrowing plan and adequately guide the setting of program debt ceiling limits. In addition, the authorities are steadfast about ensuring transparency in all external borrowing, through proper monitoring and accounting in the medium-term fiscal and debt sustainability frameworks.

12. The authorities are actively contemplating various options of a new financing framework for construction of the Padma Bridge following the recent withdrawal of their funding request to the World Bank. The authorities will formulate alternative financing arrangements, including with other development partners, while ensuring that the near-term resource needs for the construction of the bridge fall within the quantitative performance criteria and indicative targets. The Government has also formed a technical committee to report on the modalities, timing and amount of a future sovereign bond issue that could be used to fund high-impact infrastructure projects like the Padma Bridge. The objective would be to encapsulate this type of borrowing under future program debt ceilings. The authorities would like to assure the Executive Board that they remain committed to meeting quantitative targets and policy commitments and will consider various financing options for large infrastructure projects carefully in order to ensure consistency with macroeconomic stability and debt sustainability objectives as set out in the MEFP.

Monetary and Exchange Rate Policy

13. The authorities intend to maintain a moderately restrained monetary policy approach to contain inflation and to support growth. Bangladesh Bank (BB) will accumulate reserves depending on market conditions and will avoid pegging the exchange rate keeping in view the strong performance in the net international reserves (NIR) in recent months. Improving the monetary transmission mechanism through strengthening the secondary market for government securities remains an ongoing objective. Recent measures taken towards this end include enhancing shorter dated instruments of bills/bonds issues and launching an electronic trading platform on the BB’s window.

Financial Sector Reforms

14. The authorities recognize that strengthening financial sector governance and oversight, and bringing necessary legal and prudential reforms would reduce risks in the financial sector and improve monetary management. In this connection, the authorities have already taken some measures; others will be implemented in due course. Recent measures taken include: the issuance of new loan classification and provisioning standards by the BB to help banks’ gain sound financial position and reduce systemic risks; initiation of online reporting requirements for financial transactions; and strengthening onsite and offsite vigilance. The authorities also intend to submit amendments to the Banking Companies Act (BCA) to improve governance, particularly of state-owned commercial banks (SOCBs), and to enhance the BB’s supervisory and regulatory role. The BB will also initiate special diagnostic examinations of the four SOCBs in early 2013. For the securities market, the authorities’ priority is to pass the Demutualization Act, which will shape major elements of the demutualization models for the stock exchanges.

Trade and Investment Climate Reforms

15. The authorities are aware that creating an appropriate environment for public private partnerships and trade reforms is essential for improving the trade and investment climate. To this end, the Public-Private Partnership (PPP) office is now fully operational and a set of manuals for its support has already been completed. The authorities also plan to submit the PPP law to the Parliament in FY13. Other measures in the pipeline include reviewing the Foreign Exchange Regulation Act (FERA) and completing a Diagnostic Trade Integration study.

Access to the second disbursement under the ECF program

16. The authorities believe that the policies and programs being implemented will further strengthen their efforts to maintain macroeconomic stability and meet growth targets as set out in the Vision 2021 document aiming to elevate the country to middle-income status in the next decade.

17. In this context, the Bangladesh authorities request the completion of the first review and access to the second disbursement in the amount of SDR 91.423 million to maintain the strong external position and to support the ongoing reform agenda. They also take the opportunity to confirm that they are committed to implementing the policies as outlined in the MEFP. They will continue to maintain a close policy dialogue with the IMF and also pursue technical assistance from the IMF and other development partners in support of the reform agenda. They are also prepared to consult with the IMF in advance of revisions to the policies contained in the MEFP. They also authorize publication of the Letter of Intent and its attachments.