Bangladesh: Fifth and Sixth Reviews Under the Extended Credit Facility Arrangement
Author:
International Monetary Fund. Asia and Pacific Dept
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Publication Date:
10 Nov 2015
eISBN:
9781513512525
Language:
English
Keywords:
ISCR; CR; ECF arrangement; debt; upside inflation risk; prudent fiscal policy; support from the Extended Credit Facility; government finance statistics yearbook; Bangladesh authority; Bangladesh authorities; headline inflation; return on assets; Imports; Global
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The current Extended Credit Facility (ECF) arrangement, approved in April 2012, is drawing to a close. Over its three years, macroeconomic stability has been buttressed: growth is strong, inflation has eased, the public debt-to-GDP ratio has remained stable, and foreign reserves remain adequate. Progress on revenue mobilization, however, has been weak. Political uncertainty remains a key risk to the outlook.

Abstract

The current Extended Credit Facility (ECF) arrangement, approved in April 2012, is drawing to a close. Over its three years, macroeconomic stability has been buttressed: growth is strong, inflation has eased, the public debt-to-GDP ratio has remained stable, and foreign reserves remain adequate. Progress on revenue mobilization, however, has been weak. Political uncertainty remains a key risk to the outlook.

Context

1. Macroeconomic performance has been strong under the ECF arrangement. Real GDP growth has been resilient, inflation has eased, public debt has been broadly flat as a share of GDP, and the country’s international reserves are at adequate levels. Bangladesh has also continued to make strides on poverty reduction, while income inequality has remained relatively constant since the mid-1990s, defying rising regional trends. Progress on revenue mobilization has been disappointing, however, with weak revenue outturns and significant delays in VAT implementation.

2. While violence and unrest have abated recently, political uncertainty remains. Relative calm prevailed through most of 2014. Violence, transport blockades, and demonstrations (hartals) returned this year after the first anniversary of the January 2014 general elections and remained intense through March 2015. While unrest has eased more recently, the main opposition parties continue to question the legitimacy of the 2014 elections and call for fresh elections to take place under a non-partisan caretaker government.

3. Program performance has been generally good, except on revenue mobilization. All performance criteria (PCs) for June and December 2014 were met, while most indicative targets were also met (Figure 1). Continuous PCs have also been met on available data through end-August 2015. However, tax revenue has systematically underperformed. Similarly, while structural benchmarks (SBs) for July and December 2014 were completed, those for June and September 2014 were not, although they were remedied by prior actions. In particular, significant delays and uncertainty in the implementation of the new VAT led to postponing the fifth ECF review. With the ECF arrangement originally expiring in April 2015, the last two reviews were combined and extensions of the arrangement, first to July 31 and then to October 31, 2015, were approved by the IMF Executive Board to allow for completion of the prior actions. The prior actions have now been completed. Macroeconomic outcomes for end-August 2015 were in line with staff projections provided to help assess performance during the second ECF extension period (Table 1).

Figure 1.
Figure 1.

Bangladesh: Selected Performance Criteria and Indicative Targets

Citation: IMF Staff Country Reports 2015, 304; 10.5089/9781513512525.002.A001

Sources: Bangladesh authorities; and IMF staff calculations.1/ Data for July and August 2015 are provisional. The “+” markers indicate the staff projections for end-FY15 set at the time of the fourth review and for August 2015 set at the time of the request for extension of the ECF arrangement through October 31, 2015.2/ Maturing in more than one year and contracted by the public sector and/or guaranteed by the central government or Bangladesh Bank. Data as of September 30, 2015.
Table 1.

Bangladesh: Selected Macroeconomic Indicators 1/

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Sources: Data provided by Bangladesh authorities; and IMF staff calculations and projections.

Staff projections for August 2015 were included in the request for extension of the ECF arrangement through October 31, 2015 (EBS/15/85, July 24, 2015). For definition of these indicators, please see the Technical Memorandum of Understanding for the arrangement (IMF Country Report No. 14/149).

Evaluated at the program exchange rate.

Recent Economic Developments, Near-Term Outlook, and Risks

Macroeconomic performance in FY15 (July 2014-June 2015) was broadly in line with staff’s expectation at the time of the fourth ECF review. Staff’s baseline projections for FY16 see continued stability.

uA01fig02

Bangladesh: Selected Indicators, Apr. 2011–Jul. 2015

(Year-on-year percent change, 3mma)

Citation: IMF Staff Country Reports 2015, 304; 10.5089/9781513512525.002.A001

Sources: Bangladesh authorities; and IMF staff calculations.

4. Growth has remained resilient despite episodes of political unrest. Domestic demand recovered in the first half of FY15 (H1FY15), supported by remittances and public investment. Imports went up strongly, but taxes, private sector credit, and exports remained subdued. With political tensions resurfacing in January 2015, several of these activity indicators slowed down, but exports recovered slightly. The authorities’ provisional estimate for FY15 real GDP growth was 6½ percent (FY14: 6.1 percent),1 higher than suggested by economic activity indicators. Should calm prevail, staff expects growth to be at 6½ percent in FY16, buoyed by higher public sector wages, steady remittance inflows, and public investment (Table 2).

Table 2.

Bangladesh: Selected Economic Indicators, FY2013–17 1/

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Sources: Bangladesh authorities; World Bank, World Development Indicators; and IMF staff estimates and projections.

Fiscal year begins July 1.

Includes non-ADP capital spending, net lending, food account surplus (−)/deficit (+), and extraordinary expenditures.

Reserve money excludes liabilities arising from banks’ foreign currency clearing accounts at Bangladesh Bank (BB) and nonbank deposits at BB.

Imports are based on customs data.

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

Bangladesh: The New FY06 Base GDP

The Bangladesh Bureau of Statistics has introduced a national accounts series based on industry sector weights from FY06, to update the base period from FY96. Under the rebased series the weight attributed to the services sector grows from 54 percent to 56 percent of total GDP, while industry and agriculture lose share. Furthermore, the level of nominal GDP is about 15½ percent higher for FY13 than old-base GDP.

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Bangladesh: Sectoral Shares in GDP under the Current and Previous Base, 2013

(In percent)

Citation: IMF Staff Country Reports 2015, 304; 10.5089/9781513512525.002.A001

Source: Bangladesh Bureau of Statistics.
uA01fig04

Bangladesh: Real GDP Growth Under the Current and Previous Base

(In percent)

Citation: IMF Staff Country Reports 2015, 304; 10.5089/9781513512525.002.A001

Source: Bangladesh Bureau of Statistics.

Macroeconomic Indicators for FY13 under the Old and New GDP Base

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Sources: Bangladesh authorities; and IMF staff calculations.

5. Inflation eased in FY15. Headline inflation fell from 7½ percent (y/y) in May 2014 to around 6 percent in November 2014, driven by a decline in food prices on the back of a good rice harvest and lower global prices, and has remained broadly stable since (Table 2). Nonfood inflation has also been stable, helped by prudent monetary policy and below-expectations monetary and credit growth outturns (Table 3). The decline in global oil prices has had no impact on inflation as domestic fuel prices have been kept unchanged (Box 2). Headline inflation is expected to hold steady in FY16 averaging 6½ percent, with nonfood inflation edging slightly up on account of higher wages and electricity and gas tariff increases. Temporarily higher inflation is expected in FY17 as the new VAT comes on stream.

Table 3.

Bangladesh: Monetary Accounts, June 2012–June 2016 1/

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

At constant program exchange rates as of June 30, 2011.

Liabilities arising from banks’ foreign currency clearing accounts at BB and nonbank deposits at BB are included in “Other items, net.”

For program monitorting purposes net credit to the central government by the banking system is reported following the definition adopted under the program, as described in section III.D of the Technical Memorandum of Understanding (IMF Country Report No. 14/149).

Bangladesh: Impact From Lower Global Oil Prices

Fuel prices are administered in Bangladesh, adjusted on a discretionary basis, and typically kept below import costs. The resulting subsidy cost is borne by the central government via transfers to cover the operating losses of Bangladesh Petroleum Corporation (BPC), which has a near-monopoly over oil imports.

With global fuel prices declining in 2014 and domestic prices kept unchanged, fuel subsidies have turned negative. The resulting oil windfall has accrued to the public sector, which has saved it. Therefore, there is no impact on growth or inflation. The impact on the fiscal and current account balances is as follows:

Current account. The oil windfall (that is, the decline in the oil import bill for a given volume of oil imports) is estimated at 0.8 percent of GDP in FY15 and 1.2 percent of GDP in FY16. Given forward oil import contracts, lower oil prices are only fully reflected in FY16. With the public sector saving the entire windfall, the current account should improve one-for-one, ceteris paribus. But many other things have changed to offset the windfall.

Fiscal. With prices of imported fuel falling below domestic retail prices, BPC has moved into an operating profit. The baseline assumes that the authorities do not adjust retail prices, and that BPC uses the windfall to pay down debt, build up bank deposits, and undertake capital expenditure. In addition, the government saves the subsidy transfer to BPC that had been projected under higher oil price assumptions.

Bangladesh: Changes in the Current Account Balance

(In percent of GDP, relative to 4th ECF Review Staff Report, May 2014)

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Source: IMF staff estimates.

A positive number denotes a reduction in imports (i.e., it contributes positively to the change in the current account balance).

Bangladesh: Allocation of Direct Gains from Global Oil Price Decline

(In percent of GDP, relative to 4th ECF Review Staff Report, May 2014)

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Source: IMF staff estimates.

Under the assumption of no change in administered domestic fuel prices.

uA01fig05

Bangladesh: Consumer Price Index (CPI) Aug. 2011-Aug. 2015

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2015, 304; 10.5089/9781513512525.002.A001

Source: Bangladesh authorities.

6. The current account has swung into a small deficit. In FY15 import growth was strong, as expected, while exports were weak reflecting slower external demand and adjustments in the garment industry to stricter safety standards (Figures 2–3). Remittance growth has bounced back, helped by a normalization in worker outflows to the Gulf countries. Bangladesh Bank (BB) has continued to accumulate reserves, which significantly outperformed program PCs on the back of aid-financed inflows and small, but growing, private capital flows, and remain adequate at over 5½ months of imports. The current account deficit is expected to widen in FY16 as import growth continues to outpace export growth (Table 4).

Figure 2.
Figure 2.

Bangladesh: Exports and Remittances

Citation: IMF Staff Country Reports 2015, 304; 10.5089/9781513512525.002.A001

Sources: Bangladesh authorities; CEIC Data Company Ltd.; Eurostat; U.S. Department of Commerce; and IMF staff calculations.
Figure 3.
Figure 3.

Bangladesh: Real and External Sector Developments

Citation: IMF Staff Country Reports 2015, 304; 10.5089/9781513512525.002.A001

Sources: Bangladesh authorities; CEIC Data Company Ltd.; and IMF staff calculations.
Table 4.

Bangladesh: Balance of Payments, FY2013–20 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.

Imports are based on customs data.

Excludes official capital grants reported in the capital account.

Gross and net international reserves for the projection period do not include valuation adjustments. Net international reserves are reported at market exchange rates. For definitions of gross and net international reserves under the program, please see section III.B of the Technical Memorandum of Understanding (IMF Country Report No. 14/149).

uA01fig06

Bangladesh: Imports and Exports, Sep. 2011–Jul. 2015

(Year-on-year percent change, 3mma)

Citation: IMF Staff Country Reports 2015, 304; 10.5089/9781513512525.002.A001

Sources: Bangladesh authorities; and IMF staff calculations.

7. Export weakness has been compounded by a steady appreciation of the real effective exchange rate (REER). Sterilized FX purchases have kept the taka/US$ rate stable (while also maintaining reserve money within target, see Figure 4). However, the REER has appreciated sharply as the US dollar gained strength globally, eroding export competitiveness (though Bangladesh retains a significant labor cost advantage over competitors).

Figure 4.
Figure 4.

Bangladesh: Monetary and Financial Market Developments

Citation: IMF Staff Country Reports 2015, 304; 10.5089/9781513512525.002.A001

Sources: Bangladesh authorities; CEIC Data Company Ltd.; and IMF staff calculations.
uA01fig07

Contributions to Change in REER

(Year-on-year, in percentage points, positive change = appreciation; as of Aug 2015)

Citation: IMF Staff Country Reports 2015, 304; 10.5089/9781513512525.002.A001

Sources: IMF, Information Notice System and staff calculations.

8. The fiscal deficit in FY15 is estimated to have been higher than expected, on account of weak revenue performance (Table 5). Tax collections, particularly for income taxes, fell short of staff projections at the time of the February-March 2015 mission by about ½ percentage point of GDP, with the political violence in the January-March 2015 period likely a contributing factor. Nontax revenues were also weaker than expected in FY15 owing to lower profit transfers from state-owned enterprises. Expenditures, on the other hand, were also restrained, reflecting lower fuel subsidies (Box 2) and weaker-than-expected public investment, in part owing to political unrest (Figure 5). The program floor for social-related spending, however, was observed in FY15. On the whole, the fiscal deficit (excluding grants) is estimated by staff at 4.2 percent of GDP in FY15, higher than had been projected at the time of the February-March 2015 mission (3½ percent of GDP; FY14 outturn: 3½ percent of GDP).2 On the financing side, a significant pick up in public demand for national savings certificates (NSCs) allowed net bank credit to the central government (a PC) to stay well below the originally programmed amount.3 The pick-up in NSC uptake was triggered by a rising wedge vis-à-vis bank deposit rates, as surplus liquidity led to a drop in the average deposit rate of about 1½ percentage point since early 2014. In May 2015 the authorities cut the rates on several NSCs by 1½–2 percentage points, but the spread with deposit rates is still significant.

Figure 5.
Figure 5.

Bangladesh: Fiscal Developments 1/

Citation: IMF Staff Country Reports 2015, 304; 10.5089/9781513512525.002.A001

Sources: Bangladesh authorities; CEIC Data Company Ltd.; and IMF staff calculations.1/ Tax collections data are as reported by the Office of the Controller General of Accounts. FY15 data reflects staff estimates.
Table 5a.

Bangladesh: Central Government Operations, FY2013–17 1/

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

Fiscal year begins July 1. Cash basis, unless otherwise specified. FY15 provisional estimates reflect data from the Controller General of Accounts as of October 4, 2015.

Comprise budget allocations for safety net programs and other social-related spending, pensions and gratuities, and direct subsidies for food and to the and export sectors. Other subsidy-related costs (i.e., lending to large energy-related state-owned enterprises (SOEs)) are included in net lending.

Includes special bonds issued to the state-owned commercial banks for the noncash securitization of past subsidy-related loans made to Bangladesh Petroleum Corporation, consistent with the earlier treatment in the fiscal accounts of similar operations. For definitions of bank and nonbank financing under the program, please see sections II and III.D, respectively, of the Technical Memorandum of Understanding (IMF Country Report 14/149).

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

Comprise food and agriculture and export sector subsidies, as well as subsidy-based lending to large energy-related SOEs.

Table 5b.

Bangladesh: Central Government Operations, GFSM 2001 Classification, FY2013–17 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.

Includes statistical discrepancy.

Excludes deposits of autonomous and semi-autonomous bodies.

9. Weaknesses remain in the banking sector. Profitability in the banking sector worsened in 2014 and so far in 2015, and capital adequacy deteriorated as nonperforming loans (NPLs) remained high, despite a temporary relaxation of guidelines on loan rescheduling (Table 6). As in the past, these trends were driven by state-owned banks, where asset quality problems have remained rife.

Table 6.

Bangladesh: Financial Soundness Indicators of Scheduled Banks, 2012–15 1/

(In percent, end-of-period unless otherwise mentioned)

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Sources: Bangladesh Bank; and IMF staff calculations.

Official data are reported as “unadjusted”, while staff adjustments (see footnotes below) are reported as “adjusted”. “…” indicates data not available. State-owned commercial banks are Agrani Bank, Janata Bank, Rupali Bank, and Sonali Bank. BASIC Bank is included under specialized development banks.

An adjustment is made to exclude special accounts set up in state-owned commercial banks’ balance sheets, which contain the accumulated losses arising from the difference in market and book value of assets. These amounts are deducted from state-owned commercial banks’ assets and regulatory capital. From June 2015, Bangladesh Bank started adjusting away these accumulated losses from banks’ capital position, which staff was doing earlier. Additional adjustments to capital is made by staff (based on information from Bangladesh Bank) for banks that availed themselves to the temporary relaxation in loan rescheduling rules between December 2013 and June 2014.

New loan classification and provisioning regulations became effective with the financial statement for end-December 2012.

From December 2013 nonperforming loans are adjusted for the staff estimated impact (based on information from Bangladesh Bank) of temporary relaxation in loan rescheduling rules.

Bangladesh Bank defines return on equity (ROE) as the ratio of net income after provision and taxes to regulatory capital. Discrete jumps in ROE of state-owned banks reflect a combination of movements in operating profits and capital positions.

Bangladesh Bank defines return on assets (ROA) as the ratio of net income after provision and taxes to total assets.

Gross income defined as operational income before provisions and taxes.

uA01fig08

Bangladesh: Contributions to Growth in NBR Tax Revenue, FY13:Q1– FY15:Q4

(In percentage points, year-on-year)

Citation: IMF Staff Country Reports 2015, 304; 10.5089/9781513512525.002.A001

Sources: Bangladesh authorities; and IMF staff calculations.
uA01fig09

Bangladesh: Scheduled Banks’ Nonperforming Loans (NPL) Dec. 2007 – Jun. 2015 1/

(In percent of total loans)

Citation: IMF Staff Country Reports 2015, 304; 10.5089/9781513512525.002.A001

Source: Bangladesh authorities.1/ New and stricter NPL rules became effective December 2012. Not adjusted for impact of temporary relaxation in loan rescheduling rules announced in December 2013.
uA01fig10

Bangladesh: Sceduled Banks’ Return on Assets (ROA) Dec. 2007 – Jun. 2015 1/

(In percent)

Citation: IMF Staff Country Reports 2015, 304; 10.5089/9781513512525.002.A001

Source: Bangladesh authorities.1/ As reported by Bangladesh Bank on an annualized basis and defined as the ratio of net income after provision and taxes to total assets.

10. Risks to the near-term outlook are dominated by domestic factors (Box 3). The main risk is a resumption of political violence, which could lower growth, affect confidence, and push inflation up. Successful VAT implementation will also be critical to address rising fiscal pressures and ensure long-term debt sustainability. On the external side, a protracted slowdown in key export markets (particularly the EU, Bangladesh’s main export destination) could hurt exports. This could be exacerbated by a sustained REER appreciation. On the other hand, a slowdown in large emerging markets would have limited impact as Bangladesh’s trade ties with these economies are small. Global financial volatility would also have little direct impact as Bangladesh’s international financial linkages remain limited.

Bangladesh: Risk Assessment Matrix 1/

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Source: IMF staff.
1/ The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path. The RAM lists staff’s assessment of the most likely scenarios to materialize and their relative likelihood. Potential impact of the shocks does not incorporate the combined impact of multiple shocks. The RAM reflects staff views on sources of risk and overall level of concerns at the time of discussions with the authorities.

Policy Discussions

Discussions centered on preserving macroeconomic stability while pressing ahead with further reforms, with emphasis on VAT implementation. The authorities’ policy framework and reform agenda is described in the accompanying Memorandum of Economic and Financial Policies (MEFP).

A. Macroeconomic Policies: Preserving Stability

11. Fiscal policy stance in FY16 (MEFP, ¶5). Continuing with historical practice, the Budget for FY16 projects a steep increase in tax collections (despite the lack of significant tax policy measures) and a sharp increase in capital spending (despite weak implementation capacity).4 The most notable measure in the FY16 Budget is a hike in public sector pay, the first since FY10, following the recommendations of a Pay Commission (total impact: about one percent of GDP) (Box 4). Projecting forward the weak revenue performance in FY15, staff expects the fiscal deficit (excluding grants) to rise to 4.7 percent of GDP in FY16. This increase in the deficit in the context of prospective robust economic growth underlines the importance of successful VAT implementation to help finance new spending pressures. Contingency plans will be important to avoid further fiscal slippages in the event of continued shortfalls in revenue performance or slower-than-expected growth.

Bangladesh: The 2015 Review of Public Sector Pay in Historical and International Perspective

Background: Base pay rates and allowances received by government employees are reviewed by commissions formed on an ad hoc basis, typically every five years. Pay and allowances (P&A) had last been reviewed in FY09. As an interim measure, the government paid a ‘Dearness Allowance’ in FY14 and FY15 worth on average 20 per cent of an employee’s pay. In FY14, a National Pay and Service Commission was established to review P&A in the central government, state-owned enterprises, police forces, Bangladesh Bank, state-owned financial institutions, autonomous institutions, and judicial bodies. A separate commission was formed for the armed forces. Both Commissions submitted reports to the government in mid-FY15.

The 2015 pay increase: The commissions recommended approximately doubling base pay for all grades, as well as significant changes to allowances. The government is implementing the recommended increases to base pay (excl. allowances) in FY16. Total allowances are expected to be increased significantly from FY17. In total, P&A expenditures are forecast to rise from 1.9 per cent of GDP in FY15 to 2.9 per cent of GDP by FY17. While the size of the forecast increase (as a percentage of GDP) is larger than those following previous pay reviews, P&A in Bangladesh will remain relatively low compared to other low income countries (see charts).

uA01fig11

Bangladesh: Central Government Pay and Allowances, FY90–17 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 2015, 304; 10.5089/9781513512525.002.A001

Sources: Bangladesh authorities; and IMF staff calculations and projections.1/ Vertical lines indicate year of pay review decisions and the dotted line indicates IMF staff projections.
uA01fig12

Compensation of Employees 1/ Budgetary central government; average FY06–11

(In percent of GDP)

Citation: IMF Staff Country Reports 2015, 304; 10.5089/9781513512525.002.A001

Sources: IMF, World Economic Outlook; and Government Finance Statistics Yearbook.1/ Compensation of employees is defined by GFSM2001.2/ For Bangladesh, IMF staff projection for FY17 is shown by a diamond marker.3/ For India, data cover general government.4/ Average of Ethiopia, Ghana, Kenya, Kyrgyz Republic, Lao, Moldova, Mongolia, Nicaragua, Nigeria, Sierra Leone, and Zambia.
uA01fig13

Compensation of Employees 1/ Budgetary central government, average FY06–11

(In percent of revenue, including grants)

Citation: IMF Staff Country Reports 2015, 304; 10.5089/9781513512525.002.A001

Sources: IMF, World Economic Outlook; and Government Finance Statistics Yearbook.1/ Compensation of employees is defined by GFSM2001.2/ For Bangladesh, IMF staff projection for FY17 is shown by a diamond marker.3/ For India, data cover general government.4/ Average of Ethiopia, Ghana, Kenya, Kyrgyz Republic, Lao, Moldova, Mongolia, Nicaragua, Nigeria, Sierra Leone, and Zambia.
uA01fig14

Compensation of Employees 1/ Budgetary central government, average FY06–11

(In percent of expenditure)

Citation: IMF Staff Country Reports 2015, 304; 10.5089/9781513512525.002.A001

Sources: IMF, World Economic Outlook; and Government Finance Statistics Yearbook.1/ Compensation of Employees is defined by GFSM2001.2/ For Bangladesh, IMF staff projection for FY17 is shown by a diamond marker.3/ For India, data cover general government.4/ Average of Ethiopia, Ghana, Kenya, Kyrgyz Republic, Lao, Moldova, Mongolia, Nicaragua, Nigeria, Sierra Leone, and Zambia.

12. Debt sustainability. Under the staff’s baseline scenario, the central government’s debt-to-GDP ratio would remain broadly stable at about 34 percent of GDP over the medium term. The attached Debt Sustainability Analysis (DSA) concludes that Bangladesh remains at low risk of debt distress, contingent on successful enhancement of revenue collections over the medium term.

13. Monetary and exchange rate policies (MEFP, ¶12). The hike in public sector pay poses upside risks to inflation. The authorities are vigilant (monetary targets in their Monetary Policy Statement for July-December 2015 are in line with staff’s), and stand ready to adjust the reserve money target as needed, while ensuring sufficient credit flows to the economy. The authorities are also determined to use sterilized FX interventions to maintain reserve adequacy and prevent a further sharp appreciation of the REER, while allowing the taka/US$ exchange rate to depreciate should market forces push it in that direction. Staff agrees with this position.

B. Structural Fiscal Reforms: The Challenge of Creating Fiscal Space

14. The need to boost revenue. Bangladesh has one of the world’s lowest tax-to-GDP ratios, while expenditures on infrastructure and social spending are also low compared with countries at similar levels of development. To support faster and more inclusive growth, Bangladesh needs to boost domestic revenues to create fiscal space for growth-critical expenditures. The authorities’ main instrument to expand revenue is the new VAT, which will boost collections by broadening the base, strengthening tax administration, and reducing evasion on income and customs taxes. In addition, the VAT is designed to protect the poor and small businesses, and will reduce taxpayers’ compliance costs through a simpler, single rate structure and electronic filing. Staff’s baseline assumes that the new VAT will yield additional revenues of 2 percent of GDP (including indirect impact through other taxes) by FY20. The DSA’s alternative scenario shows that, in the absence of these revenues, public debt becomes unsustainable.

15. Status of VAT implementation (MEFP, ¶ 6-7). Implementation of VAT suffered significant setbacks in 2014 after the procurement of software (a SB for June 2014) was rejected on technical grounds and that of a project management consultancy (PMC) had to be restarted. As a result, the VAT launch date was delayed by a year to July 2016, with the new date announced through a gazette notification in April 2015 (prior action). The procurements for the PMC and for an information technology (IT) provider were completed in June and July 2015, respectively (both prior actions). Timely deployment of the IT platform under the PMC is a key operational requirement for a VAT launch in July 2016, complemented by ongoing internal NBR restructuring and taxpayer education programs.

16. Amendments to the VAT Act (MEFP, ¶7). In late 2014 the government formed a joint committee with the main business federation to look into concerns they had raised on the new VAT. The committee submitted its report in January 2015. After extensive discussions, the authorities decided to adopt only one change: to increase the enlistment threshold from Tk 2.4 million of annual turnover to Tk 3 million, to help small businesses.5 This amendment was passed by Parliament in September 2015 (prior action).

17. Tax administration reforms (MEFP, ¶8). The authorities have made further progress on the automation of tax registration, reporting, administration, and collections.

18. Energy subsidies (MEFP, ¶9). With domestic fuel prices kept unchanged against a significant fall in global oil prices, the state-owned Bangladesh Petroleum Corporation (BPC) is expected to make operating profits, allowing the authorities to reduce fuel subsidies (Box 2). While BPC’s external debt has fallen, and met the program targets, BPC borrowings from domestic banks contributed to the nonobservance of the target on bank credit to the three main state-owned enterprises. On the other hand, subsidies for electricity generation rose in FY15 on account of increased reliance on costly liquid fuel-based power plants, keeping total energy subsidies broadly unchanged as a share of GDP. The authorities raised electricity and gas prices from September 2015, which will help bring down subsidies and increase profits for energy-related state-owned enterprises for given energy consumption volumes. To rationalize energy subsidies further, the authorities should: (a) align domestic fuel prices with international prices; and (b) expedite cost-saving power projects. Contracts with rental power plants should be renegotiated as some of these plants are now allowed to import fuel directly at below domestic market prices.

19. Strengthening financial reporting in BPC (MEFP, ¶10). The authorities have stressed their commitment to improve BPC’s financial management. A professional financial manager has been appointed and financial reporting software was adopted. However, weaknesses remain in producing monthly cash flow statements and financial accounts. The authorities could not appoint a globally-reputed firm to complete an external audit of BPC’s FY13 accounts (a September 2014 SB). In addition to initial delays and lack of interest from prospective bidders, the authorities explained that there were legal obstacles that prevented international firms from auditing BPC’s accounts. To remove these, in October 2015 the authorities submitted to Parliament amendments to the BPC charter (prior action). The process of appointing a globally-reputed firm to audit BPC’s financial accounts should be reinitiated.

20. Treasury cash flow and public debt management (MEFP, ¶ 11). The authorities have prepared a treasury cash flow framework, and the Fund is providing technical assistance to support implementation. The contracting of nonconcessional external borrowing has remained below PC targets, and continues to be concentrated in critical power and transportation sectors. Improved inter-agency coordination has also helped in renegotiating the terms of some of these loans. A guideline on loan guarantees was issued in July 2014 (a SB) and is being strictly followed, and a medium-term debt management strategy was approved in late 2014. The authorities should consider a further reduction in the NSC rates, as the wedge between these and bank deposit rates creates financial disintermediation, pushes up bank lending rates, and increases government’s borrowing costs.

C. Further Strengthening the Financial Sector

21. Banking supervision (MEFP, ¶14). The authorities have taken strong actions against financial misconduct at a specialized bank where malfeasance was unearthed: they replaced its entire board of directors, fired its managing director, and partially recapitalized it. They also appointed observers in two private banks where deteriorating corporate governance was reported. However, there has also been regulatory forbearance: following a temporary relaxation of loan rescheduling guidelines between December 2013 and June 2014, about 4½ percent of outstanding loans as of end-2014 were rescheduled. In January 2015, BB again allowed banks to restructure loans above Tk 5 billion under relaxed rules until June 2015. These policies artificially boost bank balance sheets but do not correct the underlying weakness in lending practices. The authorities have agreed to revise the policy on large loan restructuring by end-2015 to better reflect risks. Also, BB has published a roadmap for implementation of Basel III by 2019, and is strengthening its risk-based supervisions with assistance from the Fund.

22. Reforming the SOCBs (MEFP, ¶16). Some progress has been made in reforming the SOCBs. However, balance sheets only reflect improvements with a lag: about one-third of SOCB loans are under stress once adjustments are made for rescheduled loans. The authorities have focused reforms on the following areas:

  • Governance. New chairmen and directors were appointed in some SOCBs, vetted by BB. A review of these banks’ internal control and compliance policies was completed by BB (a December 2014 SB) and found significant shortcomings in internal audit practices and in various aspects of risk management (loan origination and approval, internal control, management and board oversight). Systematic and firm oversight by BB (with steep penalties for noncompliance) is needed in all these areas to ensure sustained improvements.

  • Strengthening SOCB balance sheets. While governance is being improved, efforts have been made to strengthen SOCB balance sheets through partial recapitalization and improved loan recovery, with credit growth limits as a stop-gap measure. In this regard, performance under the memoranda of understanding signed between SOCBs and BB has been mixed: while credit growth limits were complied with, loan recovery has been well below target. SOCBs have now signed performance contracts with the government to reinforce good practices. Further recapitalization should continue to be conditional on tangible improvements in governance. The authorities are also gradually adjusting SOCBs’ regulatory capital for past NPLs (currently classified as “goodwill”), which will help reflect their capital position more accurately.

  • Automation. Banks continue to move ahead with branch automation and are expected to complete the process by end-2016, though progress has been slow and uneven.

23. Other issues (MEFP, ¶15). Bangladesh Bank is monitoring progress in bringing banks’ exposure to the capital market in line with the applicable limit by July 2016, as per the amended Bank Companies Act. To protect bank balance sheets and depositors’ interests, the authorities should dismiss any demand for forbearance in implementing this provision. Progress regarding BB’s contingency planning and lender of last resort policies (LOLR) has been slow on account of capacity constraints and the need for legislative amendments. Bangladesh Bank should continue to monitor external borrowing by the private non-financial sector, which is increasing, albeit from a low base, and might pose risks going forward.

D. Boosting Inclusive Growth

24. Poverty reduction and social safety nets (MEFP, ¶17 and ¶19). A mid-term review of the Sixth Five Year Plan (FY11-15), submitted in parallel to the IMF Executive Board by way of an Annual Performance Review of their poverty reduction strategy, found that the poverty rate fell from 31.5 percent in FY10 to 27.6 percent in FY13, helped by worker outflows. The authorities’ Seventh Five Year Plan is being finalized with measures aimed at further reducing poverty. With a multitude of social safety net programs under operation, the authorities need to streamline and better target these programs. A poverty database is under construction with support from the World Bank.

25. Facilitating investment (MEFP, ¶20). The authorities have further liberalized regulations on current account transactions and simplified several FX reporting routines (a December 2014 SB). Moreover, BB has eased procedures for valuation of foreign investments in unlisted companies for repatriation purposes, and allowed foreign companies to borrow from their parent without prior approval. Amendments to the Foreign Exchange Regulation Act, 1947 that further liberalize FX provisions were passed by Parliament in September 2015, and a new Customs Act has been drafted to simplify administrative procedures.

26. Labor rights and safety standards (MEFP, ¶18). Improvements are being made in factory and labor safety standards in the garment industry. The authorities are also enhancing official inspection capacity, including through recruitment of new inspectors. The number of trade unions in the garment industry has risen significantly since the passage of the amended Labor Act in July 2013, while a new law strengthening labor rights within export-processing zones is being drafted.

Other Program Issues

27. Safeguards recommendations (MEFP, ¶13). For the second consecutive year BB undertook an external audit of its FY14 accounts by a reputed global accounting firm, and again obtained unqualified audit opinions. Remedial actions on the findings of the management letters for the FY13 and FY14 accounts are also being completed. However, contrary to staff’s recommendation, the authorities decided to engage a globally-affiliated local firm (instead of a reputable global firm) for the external audit of BB’s FY15 accounts. The authorities argued that they wanted to give a role to local firms and that the high standards set by the global firm in the past two years would be required for the FY15 audit. Several safeguards recommendations remain outstanding, including on strengthening internal audit functions, progress on which is hampered by capacity constraints.

28. Financing assurances. Bangladesh’s external accounts remain fully financed, supporting its capacity to repay the Fund (Tables 6–7)

Table 7.

Bangladesh: External Financing Requirements and Sources, FY2013–20 1/

(In millions of U.S. dollars)

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

Fiscal year begins July 1.

Staff Appraisal

29. Overview. The authorities’ policy program supported by the ECF arrangement has been largely successful: over the past three years, prudent economic policies have helped lower nonfood inflation, keep the public debt-to-GDP ratio stable at a moderate level, and triple foreign exchange reserves. Growth has remained strong at over 6 percent, capital spending has increased as a share of GDP, social spending has been protected, energy subsidies have been cut, and poverty has come down. Progress has also been made on structural reforms, notably the passage of the new VAT Act (November 2012) and the Bank Companies Act (July 2013). However, performance on revenue collection has been poor. This, together with new spending pressures, has led to higher fiscal deficits. Other important challenges remain, including infrastructure bottlenecks and weak state-owned banks.

30. Near-term outlook and risks. Growth is expected to remain strong at 6½ percent in FY16, supported by higher public sector wages, public investment and remittances, as well as improved confidence. The current account balance will be in a moderate deficit, but international reserves are expected to grow broadly in line with imports. The main risk to the outlook is a resurgence of political unrest.

31. Monetary and exchange rate policy. The authorities’ commitment to prudent monetary policy has been commendable. With risks to inflation now tilted to the upside, BB should remain vigilant and adjust its reserve money target as needed while ensuring sufficient room for credit expansion. Recent sterilized exchange rate intervention was warranted against the background of strong real effective appreciation.

32. Fiscal policy stance. The fiscal deficit is expected to widen further in FY16, mainly on account of the implementation of the first public sector pay hike in six years. This temporary fiscal expansion is still consistent with keeping debt stable over the medium term at the current moderate levels.

33. Revenue reforms. Boosting tax revenue is critical to provide fiscal space for development spending, and implementation of the new VAT by July 2016 is the authorities’ main instrument to achieve it. The new VAT is designed to protect the poor and small businesses, will make tax administration more transparent, and will reduce taxpayers’ compliance costs. Improved revenue performance over the medium term is also critical to sustain Bangladesh’s low risk of external debt distress. The authorities should continue to press ahead with VAT implementation while expanding taxpayer education programs and engaging actively with relevant stakeholders to explain why the VAT is instrumental to boost inclusive growth and poverty reduction. Against weak revenue outturns over the past two years, the authorities should also step up efforts to strengthen collections and meet their revenue targets.

34. Other structural fiscal reforms. The authorities have made good progress in reducing the fiscal cost of inefficient and regressive energy subsidies. Going forward, they can further rationalize subsidies by systematically aligning domestic fuel prices with global prices. They should also improve financial reporting at BPC, including through an external audit by a globally-reputed firm. To protect the poor more effectively, the authorities should continue to focus on streamlining the many social safety net programs and improving their targeting.

35. Financial sector reforms. To safeguard financial stability, BB should continue to strengthen risk-based supervision and avoid regulatory forbearance. The authorities have taken welcome steps to improve the governance and capital position of SOCBs. Further progress is needed, and systematic regulatory breaches by SOCBs or other banks should be penalized. The authorities should continue to implement prudential limits on banks’ exposure to the capital market by July 2016 and adopt necessary legislation to strengthen contingency planning and LOLR policies. The move to reduce interest rates on the NSCs is welcome, and a further reduction to close the wedge with deposit rates should be considered.

36. Removing bottlenecks for inclusive growth. The authorities have implemented a range of structural reforms over the past three years to boost inclusive growth, including easing foreign exchange regulations to improve the business climate; focusing public investment and nonconcessional external borrowing on growth-critical areas (particularly power and transportation); and improving labor and factory safety standards in the garment industry. These efforts are welcome and should be maintained, complemented by a strengthening of social safety nets.

37. Central bank safeguards. The authorities should resume appointment of a reputed global audit firm from next year to conduct the audit of BB’s financial accounts. This would ensure an international best practice audit, in compliance with the 2011 safeguards recommendations. The internal audit functions at BB should also be strengthened further.

38. Staff recommendations. The objectives of the program have been largely achieved, and policies broadly implemented as envisaged. The one significant policy deviation—implementation of the new VAT—is being remedied and the authorities are committed to implementation by July 2016. In addition, all performance criteria and prior actions were met, and macroeconomic stability has been maintained. On this basis, staff recommends completion of the combined fifth and sixth (and last) reviews under the ECF arrangement.

Table 8.

Bangladesh: Indicators of the Capacity to Repay the IMF, FY2014–26 1/ 2/

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Source: IMF staff estimates and projections.

Fiscal year begins July 1.

Includes the ECF arrangement with an access level of 120 percent of quota.

Total public debt service, including IMF repayments.

Table 9.

Bangladesh: Proposed Schedule of Disbursements and Timing of ECF Arrangement Reviews 1/

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Source: IMF.

For reviews that have already been completed, the date refers to the actual Board date when the review was completed.

The fifth review was combined with the sixth review.

Appendix I. Letter of Intent

October 5, 2015

Ms. Christine Lagarde

Managing Director

International Monetary Fund

Washington, D.C. 20431

Dear Ms. Lagarde:

The Extended Credit Facility (ECF) arrangement between the Government of Bangladesh and the International Monetary Fund (IMF) is coming to an end. This is therefore a fitting moment to take stock of what has been achieved in the three and a half years since the start of the arrangement.

Our policy program under the ECF has played an important role in supporting strong economic performance and macroeconomic stability in Bangladesh. Growth averaged 6.2 percent over the program period, driven mainly by higher public investment and exports, and poverty has continued to fall. Non-food inflation has nearly halved during the lifetime of the program. Our external position is much stronger and foreign reserves are significantly higher at 6 months of prospective imports. We have also consistently maintained fiscal discipline and public debt remains sustainable.

In addition, we have made good progress on structural reforms. However, we have faced delays in the completion of some structural benchmarks, in particular with regards to the introduction of a new value added tax (VAT), a key tax reform to boost fiscal space. Nonetheless, the government has taken remedial measures. The VAT implementation is back on track and we are firmly committed to its launch in July 2016. Moreover, we have met all the performance criteria and completed all prior actions for the combined fifth and sixth reviews under the ECF arrangement. We sincerely appreciate the IMF Executive Board’s approval of our request for an extension of the ECF arrangement through October 31, 2015, which provided more time for completion of the prior actions. Against this backdrop, we request completion of the fifth and sixth reviews, the two final reviews under the ECF arrangement, and access to the associated disbursements totaling SDR 182.845 million.

Going forward, our focus remains on preserving macroeconomic stability, supporting high growth and sustaining efforts in poverty reduction. Structural reforms will center on stepping up revenue collections anchored by the new VAT law to help finance higher spending in critical infrastructure and social safety nets; strengthening the state-owned commercial banks and the state-owned enterprises; further improving public financial management; and enhancing the business climate. The attached Memorandum of Economic and Financial Policies (MEFP) details the achievements under the government’s economic program, and provides an update on our economic policies in the post-program period ahead. We believe that the commitments in the MEFP are well aligned with our long-term development goals enshrined in our national development strategy, the Seventh Five Year Plan.

On behalf of the Government of Bangladesh, I would like to thank the IMF for the support provided under the ECF, and look forward to a continued close policy dialogue.

We authorize publication of this Letter of Intent and its attachments, as well as the accompanying staff report.

Sincerely yours,

Attachments: Memorandum of Economic and Financial Policies

Attachment I. Memorandum of Economic and Financial Policies

OCTOBER 5, 2015

This memorandum updates the May 11, 2014 Memorandum of Economic and Financial Policies (MEFP) under the Government of Bangladesh’s Extended Credit Facility (ECF) arrangement. It reports on developments and policies at the time of the combined 5th and 6th reviews under the ECF arrangement (hereinafter referred to as the review). While this is the last review under the arrangement, the memorandum contains our policy framework and objectives going forward.

A. Political Transition

1. Main achievements under the program. As the ECF draws to an end, it is opportune to take stock of the many achievements since its wake: international reserves have been rebuilt to comfortable levels, inflation has steadily come down, growth has remained high and stable, and the public debt-to-GDP ratio has also remained stable. All of this has been underpinned by prudent monetary and fiscal policies. Moreover, capital spending under the Annual Development Program (ADP) has increased as a share of GDP; domestic tariff increases have helped contain fuel and electricity subsidies (further helped by lower global prices more recently); social spending has been protected as share of GDP; and poverty has continued to fall (from 31.5 percent in 2010 to 24.7 percent in 2014). Finally, major structural reforms have been introduced, notably the passage of a new VAT Act in November 2012 and of an amended Bank Companies Act (BCA) in July 2013, laying the foundation for significantly higher fiscal revenue and for stronger banking sector supervision and regulation, respectively.

2. Macroeconomic conditions. After the January 2014 general elections, calm and normalcy returned and economic activity recovered, although there was some unrest in the third quarter of FY15. Our provisional estimate of real GDP growth in FY15 puts it at 6.5 percent, with domestic demand supported by a rebound in worker remittances and higher wages in the garment industry. Export growth has moderated as the ready-made garment (RMG) industry adjusts to higher labor and factory safety standards and growth in key export markets (notably Europe) remains slow. Nevertheless, we have continued to shore up international reserves. Inflation has eased further, anchored by prudent monetary and fiscal policies, strong domestic harvests, and lower global commodity prices.

B. Fiscal Policy and Public Financial Management

3. Fiscal performance in FY14. Tax collections by the National Board of Revenue (NBR) fell well short (by over half of a percentage point of GDP) of the program indicative target (IT) for end-June 2014, the fifth test date of the ECF arrangement. Revenue across all different tax categories was affected by weak investment and slower economic activity in the first half of the fiscal year. At the same time, we kept current expenditures under control, while the January 2014 elections led to delays in ADP execution. As a result, the overall fiscal deficit (excluding grants) for FY14 was 3.5 percent of GDP, below the program target, and we met our performance criterion (PC) on net credit to the central government (NCCG) by the banking system at end-June 2014. Social-related spending was above the program IT floor for June 2014.

4. Fiscal performance in FY15. Tax revenues have been weaker than expected and fell just short of the program IT floor for December 2014 (the test date for the sixth ECF review), but significantly underperformed by end-FY15 relative to our targets, owing in part to unrest-related disruptions in the third quarter of FY15. At the same time, expenditure remained contained, helped by lower fuel subsidies as we have kept domestic fuel prices unchanged against a steep decline in their global prices. Together with a much higher-than-expected take-up of National Savings Certificates (NSCs), this has kept the NCCG below the PC targets. Our preliminary data suggest that the overall fiscal deficit (excluding grants) in FY15 was at the target of 3.8 percent of GDP agreed at the time of the fourth ECF review. However, in light of the expected reconciliation of expenditure items, we see risks that the final deficit numbers might exceed the target.

5. Fiscal policy objectives for FY16. We will continue to maintain a prudent fiscal policy stance, anchored by the target to keep the overall fiscal deficit (excluding grants) around 4½ percent of GDP in FY16. This will help safeguard macroeconomic stability and allow the government debt-to-GDP ratio to remain stable or decline gradually. Based on the report issued by the Pay Commission in December 2014, the Cabinet has approved an increase in pay and allowances for civil servants and, following historical practice, will do so over more than one fiscal year, starting in FY16. The impact of the pay increase will be partially offset by fiscal gains from the oil price decline (paragraph 9). We will also increase priority public investment and social-related spending. ADP spending will focus on critical transport and power infrastructure, and is projected to rise in FY16 and over the medium term. To finance this as well as a sizeable increase in well-targeted social spending, we will strengthen our efforts to boost tax revenues. Our main strategies and policies in this regard are outlined below.

6. Protecting the integrity of the new VAT law. Before submission to Parliament in 2012, the new VAT law underwent extensive consultations with stakeholders. Despite this, the new law has come under criticism by segments of the business community. To look into their concerns, we formed a joint committee with the Federation of Bangladesh Chambers of Commerce and Industry (FBCCI). In its report, issued in January 2015, the committee recommended several amendments to the VAT Act, including a higher enlistment threshold for the turnover tax and introduction of multiple rates. The FBCCI also recommended weakening the administrative powers of the NBR and greater scope for the government to grant exemptions. After careful consideration, the Government of Bangladesh has decided as follows:

  • To accept the recommendation to increase the enlistment threshold, and raise it from Tk 2.4 million of annual turnover to Tk 3 million (that is, the 3 percent turnover tax will apply to businesses with annual turnover between Tk 3 million and Tk 8 million, while the VAT, at a rate of 15 percent, will apply to businesses with annual turnover of Tk 8 million or more, as currently envisaged in the new VAT law). An amendment to the VAT Act to adopt this increase in the enlistment threshold was passed by Parliament in September 2015 (a prior action for this review).

  • To consider adding, in the rules and regulations for the new VAT Act, one or two highly socially sensitive goods or services to the list of exemptions from VAT.

  • To reject all other recommendations from the committee.

The rationale for these decisions is to protect the basic principles of the new VAT law, including: a creditable VAT with a single rate of 15 percent; a tax base determined on the basis of actual transaction values; no preapproved values or truncated bases; and limited exemptions. Preserving these principles is essential to achieve the objectives and main benefits of the new VAT law, including: boosting fiscal space for social protection and much needed investment in power and transport infrastructure; facilitating business operations and reducing compliance costs; eliminating the scope for taxpayer harassment; and protecting small businesses through a minimum tax threshold and poor households through exemptions of basic consumption items.

7. Pressing ahead with VAT implementation. Implementation of the new VAT law is a key policy priority of this government. We have made progress in several areas of implementation. For instance, we have appointed a full-time director, full-time deputy directors, and 15 full-time staff for the project implementation unit (PIU). The PIU has been provided with new premises adequately equipped with all necessary facilities and supplies. To prepare NBR staff for the upcoming online VAT, we have also begun staff training programs at the national and local levels. However, VAT implementation has fallen behind schedule and will be delayed by one year from the original schedule following the rejection in July 2014 by the Cabinet Committee on Government Purchases (CCGP) of the procurement for the project’s computer software. The CCGP concluded that the required procedures for international procurements had not been strictly followed, highlighted inefficiencies in procuring software and hardware separately, and ordered NBR to restart the process, combining the tenders for software and hardware. There have also been delays in other areas of VAT implementation, including the procurement of a project management consultancy (PMC) to manage the implementation process, which was also forced to restart following errors in the documents submitted by bidders. These delays required moving the launch date for the new VAT from July 2015 to July 2016. The government is firmly committed to implementing the new VAT law by the rescheduled date of July 2016. In order to minimize delays and the risk of further setbacks, we will:

  • Continue to press ahead expeditiously on the different processes required for VAT implementation. NBR is working on this, in consultation with the Central Procurement Technical Unit (CPTU) regarding procurement procedures. To keep implementation moving forward, we have completed the following critical milestones:

    • (i) Public announcement via Gazette notification of the revised VAT launch date of July 1, 2016 for the new VAT law (a prior action for this review; completed in April 2015).

    • (ii) Approval by the CCGP of the procurement for the PMC (a prior action; completed in June 2015).

    • (iii) Approval by the CCGP of the combined tender for procuring hardware, software, networking and support services (a prior action; completed in July 2015).

  • Strengthen reporting procedures. Progress reports on VAT implementation against the current plan will continue to be provided by the PIU to the NBR Chairman on a monthly basis. In turn, the NBR Chairman will continue to provide the Honorable Finance Minister with monthly summary reports on progress in implementing the new VAT, along with full explanations for any delays against the revised VAT implementation timetable approved by the Minister.

  • Engage in taxpayer education. We have launched programs to explain to taxpayers and the general public, through workshops and information campaigns, the benefits that this modern VAT law will have for the business community and for the economy as a whole, as well as clarify the differences between VAT and supplementary duty reforms and their separate implementation timetables.

8. Other revenue-enhancing measures. In addition to the measures listed above on VAT implementation, we will take other steps to boost government revenue:

  • Other tax reforms. We are in the process of drafting a new Direct Tax Code, which will broaden the tax base by eliminating exemptions. This law should be revenue-neutral or enhancing.

  • Stronger revenue administration. We continue to make progress in improving revenue administration by automating tax reporting and collection. Some large corporate taxpayers are now able to make VAT payments electronically, and we are working to expand coverage. For income tax purposes, taxpayers will be identified by unique “e-TIN” identification numbers. Approximately 1.7 million “e-TINs” have been issued, around two-fifths of which to new taxpayers as of end-August 2015. An electronic payment facility for individual taxpayers has been operating for some time. Further, we have contracted an international firm for the provision of software required to establish an electronic filing system for income tax returns. We aim to have these electronic systems fully operational by the end of FY16. In addition, a new Customs Act has been drafted that simplifies administration procedures in line with international best practice and WTO principles. The procedures established under the new Act will be consistent with the ongoing automation of tax administration, including the use of ASYCUDA World software which is now in operation to collect information necessary for the payment of import-related taxes. The draft is expected to be submitted to Parliament soon. We are also attempting to make our customs administration procedures consistent with those of other countries in the region.

9. Subsidy policies. We remain committed to containing the cost of subsidies and replacing them with targeted transfers to the poor, while making the fiscal cost of subsidies more transparent. Effective September 2015 we raised electricity and natural gas tariffs. And, against a backdrop of significantly lower global fuel prices, we have so far not adjusted domestic fuel prices. This has allowed Bangladesh Petroleum Corporation (BPC) to make operating profits, which will be used in the first instance to lower its debt (BPC’s stock of short-term external financing for oil imports was reduced well below the corresponding IT ceilings for end-June and end-December 2014). The fiscal savings can be channeled to well-targeted social spending for the poor. Should global fuel prices increase again, we will adjust prices up as needed to keep domestic average fuel prices not more than Tk 10 per liter below international prices. We will continue to make regular budgetary transfers to cover the cost of energy-related and fertilizer subsidies incurred by state-owned enterprises (SOEs).

10. SOE reforms. We remain committed to strengthening BPC’s financial management and reporting. In this regard, we have improved and regularized the production of monthly cash flow statements for BPC. Also, BPC has already adopted automated financial reporting software. However, there have been significant delays in other areas. The recruitment of a professional financial advisor, initially hampered by lack of qualified applicants, was only completed in March 2015. The procurement of a global firm to audit (in association with a local firm) BPC’s financial statements for FY13 (a September 2014 structural benchmark), has been delayed by complaints by local audit firms that current legislation prevents foreign firms from conducting an audit of BPC. To remove this legal hurdle in the BPC Act 2015, the government submitted to Parliament legislation allowing international audit firms to conduct audits for BPC (a prior action for this review; completed in October 2015). We are also exploring technical assistance to strengthen BPC’s financial reporting.

11. Public debt and cash flow management. Although with some delays, we have developed a pilot framework for cash flow forecasting. The framework is still being tested, and we will request further technical assistance in this area as needed. The medium-term debt strategy was approved by the Honorable Minister of Finance in late 2014. Based on one of the findings of the Debt Management Performance Assessment (DeMPA) conducted by the World Bank, we adopted in July 2014 guidelines for the approval and issuance of loan guarantees provided by the government (a structural benchmark). These will help contain and better monitor the government’s contingent liabilities. To eliminate the distortions and potential financial disintermediation effects from the rising wedge between interest rates on bank deposit and NSCs, and to contain the increasing interest cost from the unexpectedly large flows into NSCs, we reduced the interest rate on NSCs in May 2015. Inter-agency coordination on external borrowing has continued to strengthen, and the requirement to have qualified staff from the Ministry of Finance in external debt negotiations is being observed. As part of the ramping up of public investment, we expect external concessional and nonconcessional borrowing to increase, with funds continuing to center on projects in education as well as power, transportation, telecommunications, and other infrastructures to help meet our critical development needs.

C. Monetary Policy and Central Bank Financial Reporting

12. Monetary and exchange rate policy. We will continue to anchor monetary policy on a reserve money target. Reserve money met our end-June and end-December 2014 targets, but exceeded the end-September 2014 target by a significant margin, as demand for liquidity increased sharply ahead of two important religious festivals in late September and early October. Monetary policy has remained prudent in calendar year 2015, and aims at bringing average inflation down to 6.2 percent by end-FY16 (as per BB’s July 2015 Monetary Policy Statement) while allowing adequate private sector credit growth. There are upside risks to inflation arising from the rebound in domestic demand and recent increases in retail energy prices. We are monitoring non-food inflation closely and will adjust reserve money as necessary. International reserves have remained on an upward trend, comfortably exceeding the PC targets for June and December 2014. BB will continue to build up reserves in order to preserve reserve adequacy, sterilizing as required to meet our reserve money targets. In light of the strong real appreciation of the taka since early 2014, driven mainly by the appreciation of the US dollar against other currencies (notably the euro), we will allow the taka to depreciate if market forces move it in that direction.

13. Central bank financial reporting. We are taking several steps to improve BB’s financial reporting. External audits of BB’s FY13 and FY14 financial accounts were conducted by a global firm and received unqualified audit opinions. We have made progress in implementing the recommendations in the management letter for these external audits. To further strengthen BB’s internal control environment, we are working toward improving risk management in key departments, developing risk rating reports, integrating different information technology platforms, and reviewing their operational risks. We intend to continue improving BB’s financial reporting by conducting external audits by globally-affiliated local audit firms, including for BB’s FY15 accounts.

D. Financial Sector Reforms

14. Banking system supervision: Loan rescheduling and restructuring. BB brought the temporary relaxation of loan rescheduling guidelines, announced in December 2013, to an end in June 2014. To help struggling corporate groups, BB issued a circular in January 2015 allowing banks to restructure large loans (above Tk 5 billion) under relaxed rules up until end-June 2015. To mitigate the moral hazard that these policies may potentially create, BB will revise by December 2015 the guidelines and circulars on loan rescheduling and restructuring under the following principles:

  • Upon rescheduling/restructuring a loan, the bank will have to write off an amount equal to the difference between the recorded amount of the original loan and the net present value of the contractual cash flows from the rescheduled/restructured loan.

  • The provisioning requirement for the rescheduled/restructured loan will not be changed unless the borrower has serviced the rescheduled/restructured loan regularly for at least six months after rescheduling/restructuring or, if no contractual cash flows are expected from the borrower for a period longer than 6 months, until at least two of the contractual cash flows have been made by the borrower.

15. Banking system supervision: Other areas. We have continued to make progress in other areas to strengthen financial supervision:

  • Enforcement. Using its enhanced powers under the amended (BCA), BB has taken disciplinary actions against banks where severe irregularities have been found (including, in one case, recommending the removal of the entire board of directors, which the government accepted). We will continue to impose very strong sanctions in case of noncompliance with prudential rules and regulations.

  • Stock market exposures. BB has directed banks with stock market exposures above the permissible limit to present plans to bring them down to within the ceiling by July 2016, and in the meantime is strictly enforcing that banks do not increase their exposures further.

  • Contingency planning. Progress is being made in setting up stronger bank resolution and lender of last resort (LOLR) facilities, under the roadmap approved in September 2013, within the existing legal framework. However, amendments may be required to the relevant legislation.

  • Private sector external borrowing. Local corporations have continued to expand their external borrowing in foreign currency to take advantage of low international interest rates. We are closely monitoring this borrowing and weighing any possible risks it may pose to the domestic financial system.

16. Strengthening the state-owned commercial banks (SOCBs). We will continue to focus on improving the governance, balance sheets, and financial reporting of the SOCBs. To this end, we are taking measures in different fronts:

  • Governance. We appointed new chairmen and directors for the boards of several SOCBs, vetted by BB as per the fit and proper criteria established in the amended BCA. We are committed to continue appointing competent directors, holding them strictly accountable, and cooperating with BB in ensuring strong punitive actions in the event of any irregularities. BB completed the assessment of SOCBs’ compliance with their new internal control and compliance (ICC) policies (a structural benchmark for December 2014). This assessment found that SOCBs had weak internal audit processes that were, in turn, inadequately supervised by their boards and management To address these issues, BB has asked SOCBs to report on compliance with ICC policies as of March and June 2015, and will conduct further inspections to verify those reports.

  • Enforcement. We will continue to impose strong and escalating regulatory sanctions in case of noncompliance with the MoUs, particularly regarding areas which are directly under the control of banks, such as credit growth and single borrower exposures and related lending.

  • Strengthening of SOCB balance sheets. In FY15 we recapitalized one SOCB by Tk 7.1 billion, with another Tk 12 billion going to a specialized development bank. We reiterate our commitment to continue to strengthen the SOCBs’ capital position in line with regulatory capital adequacy standards, conditional on progress on actions agreed under the MOUs and in the business plans approved by the SOCBs. In addition to BB’s MoU with SOCBs, the government has signed performance contracts with their boards and management. BB is also monitoring SOCBs’ loan recovery efforts together with the government.

  • Branch automation. We have made progress under the branch automation plan approved in March 2014. In 2014, nearly 400 SOCB branches (about 11 percent of the total) were brought under the Core Banking System software. We will ensure that SOCBs follow their automation targets to be able to complete the entire process by end-2016.

E. Reforms to Boost Growth and Inclusion

17. Poverty reduction strategy. Our poverty reduction strategy is anchored in our Sixth Five Year Plan (FY11-15), under which we have seen a reduction in the poverty rate from 31.5 percent in 2010 to 24.7 percent in 2014 A mid-term implementation review of the first three years of the plan found that, while domestic employment creation fell short of target, the poverty reduction target remains on track (based on preliminary estimates), supported by higher than expected overseas employment.

18. Labor and safety standards. We have achieved significant improvements in labor rights and factory safety standards in collaboration with all relevant stakeholders.

19. Social safety nets. We will continue to work on strengthening the efficiency and transparency of social safety net programs, including by developing a comprehensive poverty database. We met the IT on social-related expenditure for June, September and December 2014

20. Trade and investment reforms. To help facilitate business transactions, deepen local capital markets, and attract foreign direct investment, we have continued to make progress towards a gradual liberalization of exchange regulations on current and capital account in accordance with the roadmap approved in September 2013. BB adopted the necessary amendments to foreign exchange regulations and reporting routines for current account transactions (a structural benchmark for December 2014). In addition, in September 2015 Parliament passed amendments to the Foreign Exchange Regulation Act. We are also pressing ahead with reforms to rationalize our trade policies by reducing the dispersion and average level of protection, as well as the incidence of waivers and exemptions. We have drafted a new Customs Act that will simplify the administration of customs duties (see paragraph 8, second bullet). We will also continue to reduce supply bottlenecks and the cost of doing business by focusing public investment on projects with high development impact.

Table 1.

Bangladesh: Quantitative Performance Criteria (PC) and Indicative Targets (IT) 1/ 2/

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Fiscal year begins July 1. Cell marked by “…” indicates that the cell is not applicable for that particular date.

For definitions of these quantitative targets and the applicable adjustors please see the Technical Memorandum of Understanding for the arrangement (IMF Country Report No. 14/149).

Evaluated at the program exchange rate.

These performance criteria are applicable on a continuous basis, i.e., the targets are monitored continuously during each period.

Information available as of September 30, 2015.

Table 2.

Bangladesh: Structural Benchmarks and Prior Actions under the ECF Arrangement

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1

A new GDP series was adopted last year (Box 1). As a result, ratios to GDP are not directly comparable with those in earlier staff reports.

2

The authorities’ preliminary estimate of the FY15 deficit is 3.8 percent of GDP. However, in line with precedent, this is likely to be revised up. Staff’s higher estimate is based on average historical revisions to preliminary data.

3

At the end of FY15, there was also an unusually high (estimated at ¾ percent of GDP) “cash float”; that is, expenditure that took place in FY15 but whose payments were only cashed in early FY16.

4

See IMF Country Report No. 14/149. Relative to actual outturns, the Budget has overstated the overall fiscal deficit each year over FY09-14 by an average of 0.8 percent of GDP. The FY16 Budget projects a deficit of 5 percent of GDP.

5

The single 15 percent VAT rate applies to businesses with annual turnovers of Tk 8 million or more. A 3 percent turnover tax is applicable to businesses with annual turnovers between the enlistment threshold and Tk 8 million.

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Cover IMF Staff Country Reports
Bangladesh: Fifth and Sixth Reviews Under the Extended Credit Facility Arrangement-Press Release and Staff Report
Author:
International Monetary Fund. Asia and Pacific Dept
Volume/Issue:
Volume 2015: Issue 304
Publisher:
International Monetary Fund
ISBN:
9781513512525
ISSN:
1934-7685
Pages:
67
DOI:
https://doi.org/10.5089/9781513512525.002
  • Figure 1.
    View in gallery
    Figure 1.

    Bangladesh: Selected Performance Criteria and Indicative Targets

  • View in gallery

    Bangladesh: Selected Indicators, Apr. 2011–Jul. 2015

    (Year-on-year percent change, 3mma)

  • View in gallery

    Bangladesh: Sectoral Shares in GDP under the Current and Previous Base, 2013

    (In percent)

  • View in gallery

    Bangladesh: Real GDP Growth Under the Current and Previous Base

    (In percent)

  • View in gallery

    Bangladesh: Consumer Price Index (CPI) Aug. 2011-Aug. 2015

    (Year-on-year percent change)

  • Figure 2.
    View in gallery
    Figure 2.

    Bangladesh: Exports and Remittances

  • Figure 3.
    View in gallery
    Figure 3.

    Bangladesh: Real and External Sector Developments

  • View in gallery

    Bangladesh: Imports and Exports, Sep. 2011–Jul. 2015

    (Year-on-year percent change, 3mma)

  • Figure 4.
    View in gallery
    Figure 4.

    Bangladesh: Monetary and Financial Market Developments

  • View in gallery

    Contributions to Change in REER

    (Year-on-year, in percentage points, positive change = appreciation; as of Aug 2015)

  • Figure 5.
    View in gallery
    Figure 5.

    Bangladesh: Fiscal Developments 1/

  • View in gallery

    Bangladesh: Contributions to Growth in NBR Tax Revenue, FY13:Q1– FY15:Q4

    (In percentage points, year-on-year)

  • View in gallery

    Bangladesh: Scheduled Banks’ Nonperforming Loans (NPL) Dec. 2007 – Jun. 2015 1/

    (In percent of total loans)

  • View in gallery

    Bangladesh: Sceduled Banks’ Return on Assets (ROA) Dec. 2007 – Jun. 2015 1/

    (In percent)

  • View in gallery

    Bangladesh: Central Government Pay and Allowances, FY90–17 1/

    (In percent of GDP)

  • View in gallery

    Compensation of Employees 1/ Budgetary central government; average FY06–11

    (In percent of GDP)

  • View in gallery

    Compensation of Employees 1/ Budgetary central government, average FY06–11

    (In percent of revenue, including grants)

  • View in gallery

    Compensation of Employees 1/ Budgetary central government, average FY06–11

    (In percent of expenditure)

  • View in gallery
Figure 1.

Bangladesh: Selected Performance Criteria and Indicative Targets

Bangladesh: Selected Indicators, Apr. 2011–Jul. 2015

(Year-on-year percent change, 3mma)

Bangladesh: Sectoral Shares in GDP under the Current and Previous Base, 2013

(In percent)

Bangladesh: Real GDP Growth Under the Current and Previous Base

(In percent)

Bangladesh: Consumer Price Index (CPI) Aug. 2011-Aug. 2015

(Year-on-year percent change)
Figure 2.

Bangladesh: Exports and Remittances
Figure 3.

Bangladesh: Real and External Sector Developments

Bangladesh: Imports and Exports, Sep. 2011–Jul. 2015

(Year-on-year percent change, 3mma)
Figure 4.

Bangladesh: Monetary and Financial Market Developments

Contributions to Change in REER

(Year-on-year, in percentage points, positive change = appreciation; as of Aug 2015)
Figure 5.

Bangladesh: Fiscal Developments 1/

Bangladesh: Contributions to Growth in NBR Tax Revenue, FY13:Q1– FY15:Q4

(In percentage points, year-on-year)

Bangladesh: Scheduled Banks’ Nonperforming Loans (NPL) Dec. 2007 – Jun. 2015 1/

(In percent of total loans)

Bangladesh: Sceduled Banks’ Return on Assets (ROA) Dec. 2007 – Jun. 2015 1/

(In percent)

Bangladesh: Central Government Pay and Allowances, FY90–17 1/

(In percent of GDP)

Compensation of Employees 1/ Budgetary central government; average FY06–11

(In percent of GDP)

Compensation of Employees 1/ Budgetary central government, average FY06–11

(In percent of revenue, including grants)

Compensation of Employees 1/ Budgetary central government, average FY06–11

(In percent of expenditure)