Bangladesh Economy: The Big Picture

Economy is no longer a business of economists alone. Both the prime minister and the opposition leader have offered contrasting views about the state of the economy. Amidst much confusion it is imperative to know which way the economy is headed.

There is no denying that the economy faces some short-term challenges — persistent double-digit inflation is eroding poor and middle class families’ purchasing power, high government borrowing threatens to crowd out private investment and the liquidity problem is hurting the business and costing Bangladesh’s most important price-exchange rate. However, the economy has some pluses as compensation — robust export performance and marginal growth in remittances amidst global crisis and sustained agriculture growth are some of them.

Nevertheless, there is one major development in the global economy that is hurting the Bangladesh economy badly — economic crises generally cause the decline of commodity prices. However, this time is apparently different. The reason is that emerging markets are now new engines of global growth replacing the developed world. There is little sign that commodity prices, particularly of energy, will abate anytime soon thanks to strong demand from developing and emerging economies. Even in the case of the United States, energy prices have driven 2011 inflation with fuel oil surged 25%.

Moreover, commodities are priced in US dollars. When the value of the dollar weakens against other major currencies, the prices of commodities generally move up. While the dollar index is on decline the Bangladesh taka rather depreciates vis-à-vis the US dollar. As a result, importers are ending up paying more, eventually passing the extra cost through to the consumers. Further, demand for imported petroleum in the country has increased tremendously to fuel the quick rental electricity plants. All these developments have put severe pressure on the balance of payments (BoP).

Now the government has little option but to seek an International Monetary Fund (IMF) bailout to address the BoP problem. Since there is no free lunch the government has to adjust energy prices and rein-in borrowing from the banking sector, among others, to access the IMF fund. This means some pro-poor programmes, including subsidies, have to be curtailed.

On higher government borrowing, both the IMF and a section of economists have similar views that the borrowing has to be reined-in. The point to ponder is whether higher government borrowing that led to fiscal deficit is necessarily bad. Subsidising energy, except for very limited subsidies targeted at highly vulnerable sections of the society, has bad effects, as documented in the Growth Commission Report 2010 that examined what policies worked for thirteen successful economies that sustained high growth rates for over 25 years after World War II. But the report also cautioned that “reduction of fiscal deficits, because of short-term macroeconomic compulsions, by cutting expenditure on infrastructure investment or other public spending that yields large social returns in the long run is also a bad policy.”

The advantage Bangladesh has is that its external debt is less than 25% of its GDP — which is one of the lowest in the world. Moreover, it has better growth prospects. The government should not completely surrender its policy autonomy to the IMF, curtailing its development expenditures and jeopardising the economy’s medium to long-term prospects. This brings the next critical issue concerning the economy. While the existing short-term challenges need to be addressed sooner rather than later, they should not be at the cost of the country’s medium-term potential. What are the prospects that the economy offers?

The economy still shows much promise to grow at 7% to 8% in the near future because of the age of economic convergence, favourable demographic changes, steady urbanisation, strong domestic demand and better social indicators, among others.

First, according to economic catch-up theory, the lower the initial level of per capita income the higher will tend to be the subsequent growth. This can be achieved by high rates of capital accumulation as well as the diffusion of technology from more technically advanced economies. Liberalisation of Foreign Direct Investment (FDI) is indispensable regarding this.

Second, Bangladesh’s demographic window opens with the rising share of working-age population and declining dependency ratios, generating savings and investible surplus. This is a once in a lifetime opportunity to transform the country from lower to middle-income, maybe even higher middle-income country, if East Asia is of any inspiration. It was no accident that the stock-market capitalisation went up over 45% of the country’s GDP in 2010 from merely 10% even a couple of years ago. But with the underdeveloped corporate sector (reflected in shortage of primary shares in the equity market) and poor regulations nearly half of that money was wiped out from the financial system.

Nevertheless, demographic transition is a continuous process, and the short-term decline in savings (also owing to inflation) is likely to recover if enough jobs are created by reforming the economy, making room for the private sector. Moreover, to transform “demographic window” into “demographic dividend” the state must invest heavily in health and education. Otherwise, this will become a demographic burden rather than an asset.

Third, with steady economic growth, the pace of urbanisation will continue to grow given their positive nexus. The state should play a proactive role to expedite the pace of urbanisation and facilitate basic infrastructure and utility services. Successful urbanisation requires huge funding, and a lion’s share of this can be channelled from non-banks, from home and abroad, expediting financial sector reform. It also needs reforming of the tax system that now heavily favours the wealthiest.

Financial sector reform should be a priority, making the central bank a de facto independent institution. India’s example is worth looking at since it has developed one of the best financial systems among emerging markets, creating multiple avenues to ensure much needed external finance. The recent deadlock in financing the Padma Bridge by relying on donor agencies is yet another reminder that the country must develop a sophisticated financial system that could channel finance through various avenues to build its badly needed infrastructure.

Last but not the least is the fact that, though it has been less appreciated at home, Bangladesh’s success in social sector can support its growth efforts significantly. It is estimated that the actual growth rate of South Asia has been at least one percentage point lower than the potential growth owing to the gender imbalance. Bangladesh’s stride as far as gender balances is concerned is a positive one.

In materialising Bangladesh’s medium to long-term prospects, the challenges are not merely its unstable politics, poor governance and weak institutions. Interestingly, with all these adverse factors, Bangladesh has demonstrated steady growth in the past — what many call the “Bangladesh Paradox.” Some argue that higher than the current growth is only possible if those binding growth constraints are addressed. There is also a worrying trend — the rise of “illiberal state.” Instead of promoting the development of private sector and the social sector the state uses its different organs to discriminate business outfits, giving a wrong signal to FDI and further weakening the institutions.

That said, Bangladesh economy today is at the crossroads. The short-term challenges could markedly destabilise the economy’s macroeconomic stability, jeopardising the country’s medium-term prospects, if not addressed prudently. However, crises also offer some opportunities. It is high time to reform the economy, particularly the financial sector, to materialise the country’s medium-term economic potential.

The writer is a Visiting Research Fellow at the Institute of Governance Studies (IGS), BRAC University.

This post originally appeared at The Daily Star and is posted with permission.

One Response to "Bangladesh Economy: The Big Picture"

  1. CorruptedArtery   December 28, 2011 at 5:51 pm

    A very interesting and helpful article…

    I think a big issue that is missed in the article, however, is that country has a huge energy / power generation shortfall – and until that is resolved, many of the other issues cannot be resolved. It is from energy security, and confidence born from it, and from the sustained and unbroken generation and supply of power that an economy can grow.

    There are an enormous number of companies and industries that would be interested in relocating parts of their businesses / activities to Bangladesh, but cannot do so until investment and business operating conditions are improved. Bangladesh's people are potentially its biggest resource. Bangladesh offers a labour market that is one third the cost of China's – and half of what it costs in India. In global times such as these, when margins are more finely and precariously balanced than ever before, labour costs matter enormously.

    Bangladesh has no substantial open employment or jobs market as such. Most employment is gained by people through unofficial routes and by unofficial means – ] through nepotism and close contacts, bribes and payments etc. A proper employment / labour market would be created by the establishing of widespread foreign investment – by the relocation of business operations, previously situated elsewhere, to Bangladesh. But this requires resolution to the energy crisis.

    What are the solutions to the energy crisis?!

    This is a complex question – with the practical movements [ or lack of ] affected by the politics of the time, and sadly, the failures of the political classes. The country's gas supplies are running down, with new exploration programmes only being agreed more recently [ but that will take time realise ]. The country imports fuel oil to support power generation via the quick rental power programme; this produces very costly power, that will undoubtedly impact upon inflation. We know that inflation already runs into double digits. How can the poor accommodate this?! For the majority of Bangladesh, this is just another blow.

    The answer lies in the mineral resources of the country. There exists billions tonnes of high quality coal. But the Government of Bangladesh remains paralysed with regards to moving to finalise the much awaited Coal Policy. Instead, there is talk of importing coal. How can this be? How can this be a solution? The costs would be unbearable! The impacts on the balance of payments and inflation, in turn, would be nothing short of disastrous.

    Instead, too, the country continues to rely foreign aid and remittances. It is time that Bangladesh ended this unhealthy over-reliance on outside finance. But to do this – to become more independent and self-sufficient – the country needs to use the resources it finds within its own territory. And it need to do this in the most economic and technically appropriate way.

    If the Government of Bangladesh can make the right decisions, then it is possible for Bangladesh to experience double digit growth, while at the same time, curb inflation – and in the process, have a very real and lasting impact on the lives of the many millions of ordinary Bangladeshis.