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Asian Development Outlook 2004 : II. Economic Trends and Prospects in Developing Asia : South Asia
Bangladesh GDP growth in FY2003 strengthened due to a recovery in agriculture and a pickup in industry. Growth is likely to improve further in FY2004-FY2005 on the back of a recovery in global demand and structural adjustment measures undertaken by the Government in support of its poverty reduction strategy. To mitigate the risks stemming from the phaseout of the MFA, competitiveness in the garment industry should be improved. Economic Assessment GDP growth for FY2003 (ended June 2003) is provisionally estimated to have strengthened to 5.3% from 4.4% in FY2002. Faster growth was initiated by a recovery in agriculture and a pickup in industry. The increase in agricultural output-3.3% in FY2003 from near stagnation a year earlier-was due mainly to a rebound in food grain production, which rose by 3.0% following a 3.2% decline the previous year. The rebound reflected favorable weather, an expansion in area of high-yield variety rice cultivated, and higher domestic rice prices. Growth in industrial output rose to 7.3% from 6.5% in FY2002 on account of more robust manufacturing activity. The rise in growth from 4.6% to 6.0% in medium- and large-scale manufacturing output was underpinned by a recovery in the export-oriented chemicals, processed foods, and knitwear and garment subsectors. The output of domestic market-oriented small-scale manufacturing also saw strong growth while the power, gas, and water supply subsectors (which support manufacturing activity) rose significantly. Growth in construction, however, slowed marginally to 8.3% from 8.6% due to an ongoing oversupply of commercial buildings and apartments. Higher export-oriented manufacturing and food grain production led to increases in wholesale and retail trade, and transport, storage, and communications activities, boosting growth in overall services sector activity (about half of GDP) to 5.8% from 5.4% in FY2002.
On an expenditure basis, GDP growth in FY2003 was underpinned by a rise in private consumption and public investment. Higher agricultural output and a recovery in the export-oriented garment industry boosted rural and urban disposable incomes and markedly raised growth of private consumption expenditures to 5.9% from 4.9% in FY2002. Even though expenditures on the Government’s Annual Development Programme (ADP) fell short of target, public investment increased to 6.7% of GDP in FY2003 from 6.4% the previous year, as utilization of the ADP was stepped up. Private investment, however, moderated to 16.5% of GDP from 16.8% in FY2002, reflecting constraints on activity posed by infrastructure bottlenecks (particularly in power, roads, and ports), rigidities in factor markets, and weak governance. As a result, growth in gross fixed capital formation slowed to 6.4% in FY2003 from 8.2% the previous year. Although below target, government revenue collection in FY2003 increased by 12.4%. The gain reflected budgetary measures adopted during the year as well as improved tax administration; however, as a share of GDP, revenues remained low at only 10.4%. Overall expenditures in FY2003 were also slightly below target, with current expenditures overshooting the budgeted amount by 5.6% and ADP expenditures undershooting by 10.9%. Higher than targeted current expenditures were mainly due to higher than budgeted interest payments, which now account for 14.8% of total revenues. ADP expenditures were lower than targeted because projects of low priority, those showing little implementation progress, and those with unsustainable costs were dropped. As a result, the overall fiscal deficit for FY2003 narrowed to 4.2% of GDP from 4.6% of GDP a year earlier, but still slightly exceeded the 4.0% target. Domestic resources financed 45.3% of the deficit while foreign financing (almost entirely concessional loans) covered the remainder. In FY2003, broad money (M2) supply growth rose to 15.6% from 13.1% in FY2002, with a sharp rise in net foreign assets of the banking system accounting for nearly one third of the growth. The increase in domestic credit during this period fell to 9.5% due to a contraction in credit to the public sector on account of reduced budgetary financing requirements. Private sector credit growth, however, edged up slightly from the previous year to nearly 15%, reflecting steady growth in domestic economic activity. Inflation rose steadily to 4.4% in June 2003 from 2.8% in June 2002. On a year-on-year basis, it picked up to 5.0% in June 2003 from 3.6% 12 months earlier. Unlike recent years, food prices were the main factor. Despite higher food grain production, the food price rise can partly be attributed to a reduction in food procurement and distribution by the Government, due to the monetization of some of its food distribution schemes under the safety net programs. Another element in the food price rise was the increase in fuel prices in January 2003 (energy amounts to over 30% of the input costs of food grain production). Nonfood prices, which remained at a relatively high level during the first half of FY2003, came down in the latter half of the year on account of greater exchange rate stability and a tighter fiscal stance. Although both rural and urban inflation accelerated in FY2003 relative to FY2002, the former (4.7%) remained higher than the latter (3.5%). This stems from greater availability of cheaper imports in urban areas and an increase in transport costs to rural areas. Although higher inflation offset, to some extent, nominal wage increases in manufacturing (15.4%), agriculture (8.0%), construction (7.4%), and fisheries (6.4%), except for fisheries the rate of increase in real wages for these production sectors exceeded that of the preceding year. The higher real wage increase for manufacturing, relative to agriculture and fisheries, reinforces the observed trend of poverty incidence falling at a faster rate in urban areas than in rural areas. During FY2003, merchandise exports and imports grew by 9.5% and 13.0%, respectively, from the FY2002 level, to $6.5 billion and $8.7 billion. This marked a strong rebound from FY2002 when both sides of the account fell. Export growth was broad based, with frozen foods, tea, chemical products, raw jute, and knitwear posting double-digit growth. After months of decline, readymade garments, which account for about 50% of exports, recorded a steady upturn in value from April 2003, as strong volume growth offset low unit values. The higher volume of garment exports can, to some extent, be attributed to the ongoing consolidation process in the industry. Import growth was also broad based, with particularly large increases evident for rice, edible oils, sugar, and oil products. The surge in rice imports, in turn, is grounded in rising rice prices in the domestic market, lower rice prices in international markets, and declining inflows of food aid. Reflecting a higher base, the growth in imports offset the increase in exports, and led to a widening of the trade deficit to $2.2 billion in FY2003 from $1.8 billion the previous year. This improvement was reinforced by a significantly larger financial account-due to higher inflows of medium- and long-term loans and FDI-and widened the overall balance-of-payments surplus to $899 million in FY2003, from $365 million in the preceding year. The large overall balance, which was buoyed by disbursements from the World Bank’s Development Support Credit and IMF’s PRGF, raised foreign exchange reserves to $2.5 billion at end-FY2003 from $1.6 billion at end-FY2002. Outstanding external debt at end-FY2003 amounted to $16.9 billion, a slight increase over the end-FY2002 level of $16.2 billion, though as a share of GDP it decreased to 32.6% from 34.0% over the same period. Also over this period, due to the improvement in exports, debt service as a proportion of exports declined to 5.6% from 6.3%. Policy Developments The Government formulated its interim poverty reduction strategy paper, called the National Strategy for Economic Growth, Poverty Reduction and Social Development (NSEGPRSD), which seeks to reduce by half the incidence of income poverty by 2015. The NSEGPRSD and the Government’s commitment to prepare a full poverty reduction strategy by end-2004 provided the basis for obtaining concessional assistance from IMF’s PRGF and the World Bank’s Development Support Credit. Underpinning the NSEGPRSD is a medium-term (FY2004-FY2006) macroeconomic framework that seeks to raise economic growth to 6.5% and bring down inflation to 4.0% by FY2006, as well as contain the fiscal deficit to under 5% of GDP during the period. To help achieve these goals, the Government has embarked on a program of reform measures aimed at maintaining macroeconomic stability while addressing structural constraints on faster economic growth. These include (i) further fiscal reforms involving a sustained revenue effort and a shift in spending toward infrastructure and human capital formation, (ii) reform of the banking sector to reduce the fiscal risk of NPLs and to bring down the high cost of funding investment, (iii) reform of SOEs to reduce their burden on the budget and enhance the role of private sector-led growth, and (iv) trade reforms to improve competitiveness. The FY2004 budget seeks implementation of the fiscal priorities identified in the medium-term macroeconomic framework. While the fiscal deficit target for FY2004 has been increased to 4.8% of GDP in view of the greater availability of concessional aid, several measures were taken to strengthen public resource management. For instance, the economic composition of recurrent expenditures is set to improve with higher allocations for the social sector and for operation and maintenance, and reduced allocations for subsidies. There is also an emphasis on making development expenditures more effective, by improving public service delivery and by expanding private sector participation in the provision of infrastructure services. Achieving the deficit target for FY2004 will largely depend on achieving the revenue target that is budgeted to increase by 16.2%, well above the 12.4% performance in FY2003, but data for the first 6 months of FY2004 indicate that revenue collection fell marginally short of its target for the period. Accordingly, there can be no letup in ongoing revenue mobilization efforts to plug leakages, improve compliance, reduce exemptions, and enhance cost recovery. On the structural front, utility tariffs and energy prices have been revised upward, while Bangladesh Bank has been granted greater autonomy and expanded authority to conduct monetary and exchange rate policy and to supervise all banks. In the context of the four nationalized commercial banks (NCBs), steps have been taken to introduce professional management contracts to three NCBs and to privatize the other. With regard to private commercial banks, their minimum paid-up capital has been increased, and their boards have been strengthened by new rules on the composition and tenure of bank directors. Having improved the institutional capacity of Bangladesh Bank and developed a more market-based monetary framework to control inflation, the authorities floated the taka at the end of May 2003 by withdrawing the official band for buying and selling rates against the dollar (fixed in January 2002 at Tk57.4 and Tk58.4, respectively). Monetary policy, which remained tight in the runup to the float, has recently been eased as the taka continued to show great stability. In November 2003, Bangladesh Bank reduced the statutory liquidity requirement from 20% to 16%, and lowered its bank rate from 6% to 5%. M2 growth during the first 5 months of FY2004 has, however, moderated to 3.9% due to a further reduction in credit growth to the public sector. The latter is a result of ongoing downsizing of SOEs, upward revision of utility tariffs, and a slower pace of ADP implementation. Notwithstanding recent progress in structural adjustment, the outstanding reform agenda for the NCBs and SOEs remains long and much more needs to be done in the area of economic governance reforms, especially in public resource management. Significant effort will be required to halve income poverty by 2015, since it is estimated that it would require an acceleration of GDP growth to at least 7% in the medium term. Such a rate will require substantially higher investment and new sources of growth. Although much more public investment in infrastructure and social services is urgently needed, prospects for this are limited due to the very low government revenue base, weak project implementation capacity, and significant fiscal obligations, including the recapitalization of NCBs and retrenchment costs of employees at loss-incurring SOEs. Private investment, moreover, is hampered by infrastructure bottlenecks, a weak and shallow financial system, a shortage of skilled labor, and a host of governance issues ranging from an ineffectual policy and regulatory environment and poor public service delivery, to bureaucratic inefficiency and endemic corruption. The scope for future expansion of rice production, the main driving force in agriculture, is limited while prospects for the garment industry, the main engine of growth in manufacturing, appear uncertain with the phaseout of the MFA at end-2004. Outlook for 2004-2005 GDP growth in FY2004 is expected to increase to 5.7%, lifted by expansion in both domestic and external demand. Although year-on-year data for the first quarter of FY2004 indicate that growth in medium- and large-scale manufacturing output moderated to 3.0% from 5.2% in FY2003, more recent data on manufactured exports, and on imports of industrial raw material and industrial credit suggest a strong recovery that would bring manufacturing growth up to its expectation for FY2004. Agricultural growth is expected to increase, with preliminary indications of a bumper aman (winter-harvest) crop. A higher budgeted fiscal deficit for FY2004 and a more relaxed monetary stance are expected to spur domestic demand. Services sector activities, particularly trade, transport, and finance are likely to show notable improvement with the anticipated further recovery in export-oriented manufacturing and continued strong food crop production. Assuming normal weather, GDP growth is likely to strengthen further to 6.0% in FY2005. Although growth in manufactured exports is projected to moderate with the phaseout of the MFA at end-2004, domestic-oriented private economic activity is expected to strengthen as the Government makes progress on structural and economic reforms. Annual average inflation, which picked up to 5.1% in November 2003, is likely to moderate due to an anticipated increase in domestic food grain production and lower global commodity prices. Inflation is expected to end FY2004 at around 4.7%. In FY2005, it is forecast at 4.2%; although the taka is likely to depreciate somewhat on account of a deteriorating current account balance, this pressure on prices will likely be offset by further moderation in global commodity prices (both oil and non-oil). During the first 5 months of FY2004, year-on-year exports strengthened by 13.2%, with strong growth evident for knitwear, woven garments, frozen foods, and chemical products. Imports also experienced robust growth, and year on year in the first 4 months of FY2004 were up by 18.4%. A breakdown of import data indicates continuing large increases for food grains, both rice and wheat. Large increases in imports were also evident for inputs into the garment industry, suggesting that further recovery is under way. Imports of capital goods rose strongly during this period, which augurs well for expanded domestic industrial activity. As in the recent past, the growth in imports offset the rise in exports, and led to a widening of the trade deficit to $486 million in the first 4 months of FY2004 from $263 million in the same period of FY2003. The higher trade deficit was accompanied by a significant fall in the growth rate of worker remittances to 7.3%, compared with 32.9% in the year-earlier period, because the number of people leaving to work abroad barely increased between the two periods. This has been attributed to instability in the Middle East and a fallout from the ongoing “war on terror.” As a result of these developments, in the first 4 months of FY2004 the surplus on the current account (excluding grants) narrowed to $321 million from $558 million in the same period of the previous year. If these developments in imports, exports, and worker remittances continue, the current account surplus is likely to fall considerably during the remainder of FY2004, but remain marginally positive. The current account is likely to move to a deficit of 1.5% of GDP in FY2005 as import growth continues to outpace the growth in exports that will be adversely affected by the MFA phaseout. However, due to the likely availability of greater concessional assistance associated with the Government’s poverty reduction program, such a deficit is sustainable. The macroeconomic prospects for FY2004-FY2005 appear favorable with upside potential from a more buoyant global economy. However, there are risks in the outlook that threaten to undo the recent gains in socioeconomic progress. Unless further improvements in competitiveness are attained in the garment industry, the end of the MFA era may result in a substantial shift in sourcing to strong, large competitors such as the PRC and India. A sudden, very large switch would have a highly adverse impact on the balance of payments, currency, price stability, and employment generation in Bangladesh. Instability in the Middle East remains a source of concern for the country, as its large earnings from labor exports hinge on stability in the region. Moreover, the Government faces significant fiscal obligations in the period ahead, which, if not dealt with appropriately, could threaten budgetary targets and economic stability.
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The higher trade deficit was, however, more than covered by a 22.4% improvement, to $3.1 billion, in worker remittances in FY2003 (Figure 2.14). As a consequence, the surplus on the current account (excluding official grants) rose to $268 million from $171 million in FY2002.
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