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Quarterly Economic Update, Bangladesh, June 2007

Dhaka, Bangladesh, 31 July 2007

Summary
During FY2007, economic growth remained strong, propelled by rising domestic and external demand. Although Bangladesh carried out a few fiscal reform measures, revenue performance remains weak. Robust growth in exports and workers' remittances contributed to a favorable balance of payments outcome. Rising domestic demand pressures and an increase in international prices fueled inflation.

Agriculture
Agriculture growth during FY2007 is estimated at 3.2%, lower than the postflood high growth of 4.9% in FY2006. Although growth in crops and animal farming subsectors slowed, growth in forest and fisheries subsectors rose compared with the preceding year. The avian flu outbreak in the country affected the output of animal farming. The steady rise in inland and marine catches contributed to higher growth in fisheries. Despite unfavorable weather and disruption in inputs, production of food crops is estimated at 27.6 million tons, driven by a good boro crop. Production of jute and potato increased; production of minor crops such as pulses, spices, sugarcane, fruits, vegetables, and tobacco, is expected to be similar to that of the preceding year.

Industry and Services
Industrial growth during FY2007 is estimated at 9.5% compared with 9.7% in FY2006. The growth in manufacturing (11.2%), driven by the garments sector, was higher than 10.8% in the preceding year. The growth in both medium- and large-scale manufacturing (11.2%) and small-scale manufacturing (10.8%) contributed to output expansion. But the manufacturing performed below its potential because of infrastructure constraints, particularly electricity shortages and disruptions. The growth in power, gas, and water supply together slowed to 5.4% from 7.7% last year because of a setback in electricity generation. The growth in construction declined to 7.1% from 8.3% because of the higher price of construction materials and downsizing of the annual development program (ADP). Growth in the services sector in FY2007 is estimated at 6.7%, up from 6.4% in FY2006, aided by a rapid growth in industry and foreign trade.

Economic Growth
GDP growth is estimated at 6.5% in FY2007, slightly lower than 6.6% in FY2006 because of moderating growth of agriculture. Growth was underpinned by steady expansion in manufacturing and continued buoyancy in services. Private consumption was the main driver of growth, bolstered by strong remittance inflows. At 24.3% of GDP, investment during FY2007 was lower than 24.7% in the preceding year caused by a decline in public investment while private investment rose modestly. Showing an upsurge in remittance inflows, gross national savings in FY2007 increased sharply to 29.2% of GDP. Bangladesh holds strong potential for higher GDP growth of 7%−8% over the medium term. Risks that could affect growth prospects include political uncertainty, infrastructure constraints, vulnerability of the garment sector to intensified global competition and flooding. Bangladesh needs to upgrade infrastructure and extend a more supportive environment for new and existing FDI. The country has not yet decided on several large FDI proposals amounting $11 billion in important sectors, including energy, steel, fertilizer, tourism, and petrochemicals. Long delays may drive investors to other countries.

Fiscal Management
In FY2007, revenue collection fell short of projection. Despite an increase in current expenditures, overall expenditures were contained by decreasing development spending. As a result, the fiscal deficit remained on target at 3.7% of GDP with domestic financing of 2.1 % of GDP and foreign financing of 1.6% of GDP. Unless revenue collection increases significantly, the higher spending needed for faster economic growth and rapid poverty reduction cannot be met without pushing fiscal deficits to unsustainable levels. Major reforms are needed to overhaul tax administration and expand tax base. The fuel price adjustments of 16%–21% in April 2007 reduced Bangladesh Petroleum Corporation (BPC) losses, bringing domestic prices of diesel and kerosene to 83% of breakeven in June 2007. The Government's assumption of BPC's overdue bank loans through a bond issue of $1.1 billion is a desirable move. To avoid reaccumulation of BPC losses and nonperforming loans of nationalized commercial banks, the Government needs to introduce an automatic price adjustment mechanism.

Monetary Developments
In December 2006, broad money growth reached a record 22%. With better control in monetary management, growth in broad money decreased after March 2007, reaching 18.3% in May 2007. Growth in domestic credit has been contained, but growth in net foreign assets remained high in response to the surge in exports and workers' remittances leading to a sizable foreign exchange reserves buildup. The fourth half-yearly monetary policy statement (mid-July 2007) of central bank aims to continue the cautious monetary policy stance keeping in view the prevailing price situation and excess liquidity in the banking system, while supporting sustainable output growth.

Balance of Payments
During the first 11 months of FY2007, export (16.5%) and imports (17.4%) grew strongly. The rising trade deficit was more than offset by the surge in workers' remittances (25%) showing a surplus of $468 million in the current account. Based on the latest balance of payments data, the current account surplus in FY2007 is estimated at 0.7% of GDP compared with 0.9% of GDP in the preceding year. Foreign exchange reserves stood at $5,077 million on 30 June 2007, an increase of $1,593 million from the end of June 2006.

Inflation
On a point-to-point basis, inflation climbed up to 8.1% in May 2007, from 5.9% in January 2007. Food inflation increased from 6.7% to 8.4%, and nonfood inflation increased from 5% to 7.8%. The rising domestic demand pressures aided by higher incomes and continued high monetary and credit growth mainly fueled inflationary pressures. As domestic prices are increasingly linked to international prices due to globalization, the increase in international food and commodity prices also aided inflation. The administrative measures undertaken by the government have not succeeded in containing inflation.

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