bangladesh quarterly economic update - june 2007

7/28/2019 Bangladesh Quarterly Economic Update - June 2007

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June 2005

QuarterlyEconomic

Update

June 2007

BANGLADESH


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Bangladesh Resident Mission

Asian Development Bank

All rights reserved

Bangladesh Resident Mission

Plot E-31, Sher-e-Bangla Nagar

Dhaka 1207

Bangladesh

[email protected]

BRM website: http://www.adb.org/BRM

ADB website: http://www.adb.org

Asian Development Bank

June 2007

The Quarterly Economic Update (QEU) is prepared by the Economics Unit of the Bangladesh Resident Mission, Asian Development

Bank (ADB). The views expressed in the QEU are those of the authors and do not necessarily reflect the views of the ADB or its member

governments. The QEU is published in March, June, September and December.


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BANGLADESH

QuarterlyEconomic

Update

June 2007


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CONTENTSPage

MACROECONOMIC DEVELOPMENTS 1

Highlights 1Sector Performance and Economic Growth 1

Agriculture 1Industry 2Services 5Economic Growth 5

Fiscal Management 6Monetary and Financial Developments 8Balance of Payments 10Inflation and Exchange Rates 11Capital Market 12

THE FY2008 BUDGET 14

Revenue Measures 15

Tax and Tariff Policy Reforms 15Income Tax 15Import Duty Structure 16Value-Added Tax 17

Expenditure Measures 17Social Sectors 18Physical Infrastructure 18

Agriculture and Rural Development 19Social Empowerment and Social Safety Net 19

Fiscal Deficit and its Financing 20

OVERSEAS WORKERS REMITTANCES 21

Migrants Destinations 21

Effect on Balance of Payments 22Absorption of Oil Price Shocks 22Effects on Households 23Incentives 23Recent Surge in Migration 24Hurdles of Official Transfers 25Challenges and Threats 25Improving Inflow of Remittances 26Conclusion 28

NOTES

(i) The fiscal year (FY) of the Government ends on 30 June.(ii) In this report, $ refers to US dollars.

Vice President L. Jin, Operations Group 1Director General K. Senga, South Asia Department (SARD)Country Director H. Du, Bangladesh Resident Mission (BRM), SARD

Team leader R. K. Khan, Head, Economics Unit, BRM, SARDTeam members M. Z. Hossain, Senior Economist, BRM, SARD

S. Anwar, Economist, BRM, SARDB. K. Dey, Assistant Economics Analyst, BRM, SARD


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MACROECONOMIC DEVELOPMENTS

Highlights

Gross domestic product (GDP) growth is estimated at6.5% in FY2007.

Growth performance was underpinned by steadyexpansion of manufacturing and services.

Although Bangladesh carried out a few fiscal reformmeasures, revenue performance remains weak.

Even with a cautious monetary policy, broad moneygrowth remains high.

Robust growth in exports and workers remittancescontributed to a favorable balance of payments

outcome.

Rising domestic demand pressures and an increase ininternational prices fueled inflation.

Sector Performance and Economic Growth

1. During FY2007, economic performance remainedstrong, propelled by rising domestic and external demand.Robust growth in services and export industry offset lowergrowth in agriculture. The growth was supported by risingprivate investment, bolstered by credit growth and a surge

in workers remittances.

Agriculture

2. Agriculture growth during FY2007 is estimated at3.2%, lower than the postflood high growth of 4.9% inFY2006 (Figure 1). Lack of adequate rainfall and disruptionin agriculture inputs, including fertilizer and irrigation,adversely affected production. Although growth in cropsand animal farming subsectors slowed, growth in forestand fisheries subsectors rose compared with the precedingyear. The avian flu outbreak in the country affected the

output of animal farming. The steady rise in inland andmarine catches contributed to higher growth in fisheries.

Figure 1. Agriculture Growth

0.0

1.0

2.0

3.0

4.0

5.0

6.0

FY02 FY03 FY04 FY05 FY06 FY07

%

Estimate

3. Production of food crops is estimated at 27.6 milliontons, implying a 1.1% increase over the last year (Figure2). Aus, the first rice crop of the year, was planted on 0.9million hectares. Production of 1.5 million tons was 16.7%less than the 1.8 million tons in FY2006. This was theresult of insufficient rain during the flowering stage and


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continued diminishing area of cultivation, giving way tocompeting and more profitable crops and vegetables suchas boro (winter rice crop), maize, summer vegetables, andspices. The aman (summer rice crop) was planted on 5.3million hectares, with production at 10.8 million tons, thesame as in FY2006. Although the area under aman

cultivation was slightly smaller than in the previous year,the yield rate was stable. Aman cultivation has beenhampered in many parts of the country due to droughtduring the entire transplantation period and short supply offertilizer, insecticide, and other inputs. Also, the supply ofelectricity was inadequate for the operation of irrigationpumps.

Figure 2. Foodgrain Production

0

5

10

15

20

25

30

FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06

Million TonsAus Aman Bor o Wheat Tota l Foodgr ain Pr oduc

E

4. The harvesting of the boro crop, which istraditionally the largest crop of the year, is complete.Encouraged by higher domestic prices, farmers broughtmore land under boro farming. The Department of

Agriculture Extension (DAE) fixed an all-time record borofarming target following last years bumper production.DAE and other government agencies encouragedincreased use of high-yielding-variety seeds by ensuringadequate supply of seeds and necessary inputs, includingfertilizer and insecticides. Plantation areas under boro cropincreased to 4.4 million hectares, an increase of 7.3% overFY2006. Despite the sterility of paddy reported in somedistricts and some disruption in the delivery of key inputs,such as diesel fuel and fertilizer, the boro crop is expectedto be 14.6 million tons, an increase of 4.3% over 14.0million tons in FY2006. Although the area under wheat

cultivation declined, wheat production is estimated at 0.7million tons, unchanged from FY2006. Because of theincreasing commercial viability of maize cultivationcompared with wheat, farmers are substituting maize forwheat in their crop rotations.

5. Among other crops, jute production increased by5.7% and potato production by 5.8%. The production ofminor crops such as pulses, spices, sugarcane, fruits,vegetables, and tobacco, which contributed 30% to thetotal output of the crop subsector, is expected to be similarto that of the preceding year.

Industry

6. The industry sector recorded robust growth causedby a steady expansion in export-oriented manufacturingand a rise in domestic demand. Sector growth duringFY2007 is estimated at 9.5% compared with 9.7% inFY2006. The growth of mining and quarrying (10.0%) andmanufacturing (11.2%) was higher than 9.3% and 10.8%

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respectively in the preceding year. Although manufacturingexpanded at a steady pace, it performed below its potentialbecause of infrastructure constraints, particularly electricityshortages and disruptions. The growth in power, gas, andwater supply together slowed to 5.4% from 7.7% last yearbecause of a setback in electricity generation. The growth

in construction declined to 7.1% from 8.3% because of thehigher price of construction materials and downsizing ofthe annual development program (ADP).

7. Growth in manufacturing was largely lifted by asteady increase in external demand for garments. In thefirst 9 months (July 2006March 2007) of FY2007, outputof medium- and large-scale manufacturing expanded by astrong 11.2% compared with the same period of FY2006(Figure 3). Production of woven garments, knitwear,textiles, pharmaceuticals, wood products, iron and steel,ceramic, cement, and plastic products recorded steady

growth. The output of small-scale manufacturing increasedby 10.8% (Figure 4), with production of rice milling, dairyproducts, knitwear, leather products, footwear, woodenfurniture, paper and paper products, and nonmetallicmineral products increasing significantly.

Figure 3. Quantum Index of Medium &Large Scale

Manufacturing Production (Base: 1988-89=100)

200

220

240

260

280300

320

340

360

380

400

Jul Aug Sep Oct Nov Dec Jan Feb

Index FY2006 FY2007

8. Garment exports grew by a robust 28% during thefirst half of FY2007. But growth slowed to 17% duringJulyMay of FY2007 (Figure 5). According to BangladeshGarment Buying Houses Association, buy orders droppedby about 30% during the first half of 2007. Several factorsare responsible for this slowdown including labor unrest in

the garment industry in mid-2006 and political turmoilduring OctoberDecember 2006 at the end of the tenure ofthe last elected government. As shipments and deadlineswere delayed, some buyers may have moved to othercountries such as the Peoples Republic of China (PRC)and Viet Nam. Some buyers curtailed orders because ofdecreased sales and buildup of inventory in their outlets.Major garment owners are optimistic that orders will pickup from July 2007 with demand for summer and fall. Theindustrys ambition to double exports to $16 billion in 3years will require improving international credibility,productivity, and infrastructure.

9. Despite a few setbacks, buyers still reportsatisfaction with Bangladesh suppliers and their ability toproduce quality garments in a reasonable time and topermit flexibility in orders. Many also describe Bangladeshas the lowest cost supplier. Some major internationalbuyers recently established a permanent presence inBangladesh. But the country still runs the risk of facingtough competition in its two largest marketsthe European

Figure 4. Quantum Index of Small Scale Manufacturing

Production (Base: 1995-96=100)

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220240

260

Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec

FY05 FY06 FY07

Index

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Union (EU) and the United States (US)in the near futureas the safeguard quota on the PRC is due to expire in2008. Much of Bangladeshs competitive advantagecurrently depends on its abundant low-cost labor, flexibleexchange rate, and close ties with some large buyers. Todeal with the intense competition from the PRC, the

industry needs to increase productivitythe ultimatedeciding factor. This will require major investments intechnology and vocational training programs. Improvingroads, rail, ports, and power supply; and streamliningcustoms procedures at all points of entry and exit are alsocritical. Power shortages hamper production and increasecost because in-house power generation (using mostlydiesel generators) is expensive. Infrastructure constraintsand cumbersome customs procedures severely handicapthe industrys competitiveness by slowing export/importactivities, and increasing lead time. Lead time for localexporters is about 1 month more than that of major

competitors. Reducing lead time is critical if Bangladeshwants to produce high-value-added products that requireprompt availability of quality fabrics and other materials.

Figure 5. Growth in Exports

33.7

19.8

13.114.617.3 14.4

20.9

16.5

0

5

10

1520

25

30

35

40

July-May, FY06 July-May, FY07

%

Knitwear Products Woven Garments Others Overall Exports

10. Weak vertical integration in the woven industrymeans that meeting the rules of origin requirements in theEU is difficult; the EU has granted duty-free access toBangladesh. Although knit garments can generally meetthe eligibility requirements because they have highdomestic value-added content (strong backward linkage),woven garments that heavily rely on imported fabricencounter problems. But the situation is set to improve as

new investments in textile recently increased. The countrycurrently depends too heavily on EU and US markets.Producers should try to explore new opportunities in otherparts of the world. The PRC has offered Bangladesh duty-free access for 84 items, including some garment andtextile products. India recently agreed to allow export of 6million pieces of apparel duty free. These markets need tobe researched and accessed.

11. A generally improved business climaterangingfrom better infrastructure to better governancewill attractmore foreign direct investment (FDI) in the sector; this may

boost competitiveness of the entire industry. Evidence of astrong correlation between foreign investments (andtechnology) and productivity improvement is compelling.

Figure 6. Share of Exports (Jul-May, FY07)

Woven Garments

38%

Knitwear Products

37%Others

25%

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Services

12. Growth in the services sector in FY2007 isestimated at 6.7%, up from 6.4% in FY2006. Rapid growthin industry and foreign trade aided steady expansion in thesector. Wholesale and retail trade; transport;

telecommunications; and community, social, and personalservices increased substantially. The mobile phoneservices market continued to drive telecommunicationsbecause of strong consumer demand for mobile phones.Increased production of drama and telefilms for privatetelevision channels fuelled growth of community, social,and personal services. The increased number of healthcare service providers also contributed to sector growth.

Figure 7. Sources of Real GDP Growth

5.3

6.36.0

6.6 6.5

0

1

2

3

4

Economic Growth

13. GDP growth is estimated at 6.5% in FY2007,

slightly lower than 6.6% in FY2006 because of moderatinggrowth of agriculture following the postflood high growth ofFY2006 (figures 7 and 8). Growth was underpinned bysteady expansion in manufacturing and continuedbuoyancy in services. Private consumption was the maindriver of growth, bolstered by strong remittance inflows. At24.3% of GDP, investment during FY2007 was lower than24.7% in the preceding year caused by a decline in publicinvestment while private investment rose modestly (Figure9). Showing an upsurge in remittance inflows, grossnational savings in FY2007 increased sharply to 29.2% ofGDP (Figure 10).

14. Bangladesh holds strong potential for higher GDPgrowth of 7%8% over the medium term. Risks that couldaffect growth prospects include political uncertainty,infrastructure constraints, and vulnerability of the garmentsubsector to intensified global competition.

15. A recent survey by Japan External TradeOrganization found that the cost of investment inBangladesh is getting cheaper. The survey of investment-related cost comparison, conducted in 30 Asian cities on32 cost components,1 rates Bangladesh as the cheapestfor nine components, including legal minimum wages;

1

The cost components include workers wages; engineers salaries;salaries of midlevel managers; legal minimum wages; social securityratio; nominal wage increase rate; cost of land area of an industrialestate; fee for office space; telephone installation fee; mobileconnection fee; per minute call charge for fixed and mobiletelephones; Internet connection fee; monthly basic fee for using theInternet; cost of 1 kilowatt-hour of electricity; cost of gas and water;container freight cost; per liter cost of gasoline and diesel; corporateand personal income tax rate; percentage of value-added tax;percentage tax on interest remitted to Japan; percentage tax ondividend remitted to Japan; and other related costs.

5

6

7

FY '03 FY '04 FY '05 FY '06 FY '07

% A gri cul tur e Ind us tr y Se rv ices GD P g ro wt h

Estimate

Figure 8: Sectoral Growth Rate of Real GDP

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12

FY00 FY 01 FY02 FY03 FY04 FY05 FY06 FY07

% Agriculture Industry Services

Estima

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social security burden; office rent; and monthly basiccharge for mobile phone, gas, and water. But some costsincluding that of land, broadband (512 kilobits per second)Internet service, new connection fee for fixed telephonelines, container transportation cost, and rate of corporatetax are high and need attention. For the route to the portsof Yokohama and Los Angeles, the cost of transportationfrom Chittagong Port is higher than that from Mumbai Port,even after offsetting the proportional cost due togeographical longer distance. This is because the largecontainer ships cannot come to Chittagong Port due to itsshallow draft; therefore, transshipment of containersbecomes necessary either at Singapore or Colombo. Thecost of container transport is a large element affecting thecountrys export competitiveness. Poor infrastructure andutility services, fragile law and order, sudden changes ingovernment policies, delay in letter of credit settlement,and political volatility are among hidden costs that affectinvestors.

Figure 9: Investment

0.0

5.0

10.0

15.0

20.0

25.0

30.0

FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 F

% GDP

Total Investment Public Investment Private Investment

Es

16. The decreasing investment cost is an importantdevelopment for Bangladesh as foreign firms areincreasingly looking for cheaper places to invest to cut costand uplift competitiveness. But to take advantage of this,Bangladesh needs to upgrade infrastructure and extend amore supportive environment for new and existing FDI. Thecountry has not yet decided on several very large FDIproposals amounting $11 billion in important sectors,including coal mining, power, steel, fertilizer, hotel, tourism,and petrochemicals. Long delays may drive investors toother countries, which will further dim the FDI outlook inBangladesh.

Figure 10: National Savings

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25

30

35

FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 F

% GDP

Est

Fiscal Management

17. In FY2007, revenue collection fell short ofprojection. Despite an increase in current expenditures,overall expenditures were contained by decreasingdevelopment spending. As a result, the fiscal deficitremained on target at 3.7% of GDP with domesticfinancing of 2.1 % of GDP aided by an increase in foreignfinancing to 1.6% of GDP, rising from 1.2% in FY2006.

113124

153 156

7187

3 3

340 370

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Billion

Taka

Domestic Indirect

Taxes

Impo rt Taxe s In co me Taxes Oth er Taxe s To ta l

Figure 11. Revenue Collection by NBR

FY2 00 6 FY2 00 7

18. Although Bangladesh carried out a few fiscal reform

measures over the past years, revenue performanceremains weak. Bangladeshs tax effort (tax-GDP ratio) of8.4% of GDP in FY2007 is much lower than the averagefor low income countries. This low tax effort reflects mainlylow domestic taxes. Bangladeshs revenue (10.6% of GDPin FY2007) and its recent trend compare unfavorably with

Asian (16.3% of GDP) and sub-Saharan African countries(18.4% of GDP). Although Bangladesh has high nominaltax rates for corporate income tax and value-added tax

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(VAT), it has much lower revenue productivity (tax effortdivided by the nominal tax rate) compared with other Asiancountries. Unless revenue collection increasessignificantly, the higher expenditure needed for fastereconomic growth and rapid poverty reduction cannot bemet without pushing fiscal deficits to unsustainable levels.

Major reforms to address systemic problems, includingthose from narrow bases riddled with exemptions,exclusions, and incentives; and rigidities in the tax lawsrelating to main tax instruments, will be needed to ensurelarge increases in tax revenues. FY2007 revenuecollection increased by 10.3% over FY2006; the targetedgrowth was 17.1%. Revenue collection from NationalBoard of Revenue taxes increased by only 8.8%, althoughit was targeted to increase by 19.2% (Figure 11).

According to the revised estimates, income tax collectionincreased by 28.2% and VAT by 10.4%. Supplementaryduty collections actually declined by 4.7% as against

projected growth of 20.5%. Customs duty increased byonly 0.5% compared with targeted growth of 15.2%.

Achieving the 15.8% revenue growth target for FY2008 willrequire extraordinary efforts from the tax mechanisms, withintensive supervision and monitoring of revenue collection,especially for indirect taxes.

Figure 12. Revenue-GDP Ratio

9.0

9.5

10.0

10.5

.0

FY01 FY02 FY03 FY04 FY05 FY06 FY

%

Estim

11

19. In FY2007, total expenditure was 4.2% below thebudget target, with current expenditure higher by 5.2%,although the development expenditure (mainly ADP) waslower by a sizable 17.6% mainly due to resourceinadequacy and implementation capacity constraints. At

14.3% of GDP, total expenditure fell short of the povertyreduction strategy target of 15.9%. Current expendituregrowth exceeded the budget target of 14.1% and reached20.1% due to the increased expenditure associated withthe canceled elections and the slack in budgetarydiscipline during the first quarter of FY2007. In FY2008,development expenditure is targeted to increase by 21.6%compared with the 0.7% decline in FY2007. Accomplishingthe development program will be a challenge and willrequire close attention and institutional capacitydevelopment to ensure faster project implementation with afocus on expediting project-related procurement.

20. The Government introduced a new mechanism forbank borrowing in FY2007, under the supervision of theCash and Debt Management Committee. The newmechanism provides higher advance limits on ways andmeans, and auctioning of treasury bills and bonds basedon volumes preannounced at the onset of the borrowingcalendar. This separates Bangladesh Banks role ingovernment debt management from its monetary policy

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functions, and makes the Governments borrowingrequirements more predictable. However no automaticmechanism yet limits government borrowing within thebudgetary ceiling. The Cash and Debt ManagementCommittees concurrence to allow Bangladesh Bank to off-load treasury bills and bonds held by it at a cut-off rate (to

make up for the shortage of market supply of fundsrequired by the Government) to primary dealers willencourage the latter to create a secondary market forgovernment securities. This will reduce the need forBangladesh Bank to absorb primary issues of governmentsecurities, and contribute to improved monetarymanagement by Bangladesh Bank. To focus greaterattention to budget implementation, the authorities inFY2008 budget allocated resources to ministries coveringthe key sectors for conducting special or performanceaudits through engaging private sector audit firms. The fuelprice adjustments of 16%21% implemented in April 2007

reduced Bangladesh Petroleum Corporation (BPC) losses,bringing domestic prices of diesel and kerosene to 83% ofbreakeven in June 2007. But BPC sold other products atprofit. The Governments assumption of BPCs overduebank loans through a bond issue of $1.1 billion in theFY2008 budget is a desirable move. To avoidreaccumulation of BPC losses and nonperforming loans ofnationalized commercial banks (NCBs), the Governmentneeds to introduce an automatic price adjustmentmechanism and improve BPCs operating efficiency.

Monetary and Financial Developments

21. In continuation of the trend during the past fewyears, money and credit growth rates remained high inFY2007. On a year-on-year basis, in December 2006broad money growth reached 22% and domestic creditgrowth 21% (Figure 13). With better control in monetarymanagement, growth in broad money decreased afterMarch 2007, reaching 18.3% in May 2007; domestic creditwas at 16.2%. Reserve money growth declined, reaching23% in May 2007 from 38% in December 2006. Althoughgrowth in money supply fell, growth is much higher thanprogrammed (14.7%) and the nominal GDP growth rate of

12.5% in FY2007. Growth in domestic credit has beencontained, but growth in net foreign assets remained highat 39% in May 2007, in response to the surge in exportsand workers remittances leading to a sizable foreignexchange reserves buildup. Growth of credit to the privatesector declined to 15.6% in May 2007 from 17.1% in May2006; but growth of credit to the Government remainedhigh at 22.6% in May 2007 to make up for the shortfall inrevenue collection.

Figure 13. Growth of Broad Money & Domestic Credit

12.0

14.0

16.0

18.0

20.0

22.0

24.0

May

'06

Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr

%Broad Money Domestic Credit

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22. In implementing monetary policy to provideadequate liquidity to the economy, while attempting tomoderate inflationary pressures, Bangladesh Bankconducted auctions of treasury bills of different maturitiesalong with repo and reverse repo operations. The yield on

28-day treasury bills increased from 7.1% in June 2006 to7.3% in June 2007 (Figure 16). The reverse repo rate alsoincreased from 6% in June 2006 to 6.5% in June 2007(Figure 16). The tightened policy stance and reintroductionof Bangladesh Bank bills in October 2006 somewhatsucceeded in decelerating growth of money and privatesector credit and limiting inflation despite risinginternational prices. Call money rates declined from 10.8%in June 2006 to 7.2% in December 2006, and then rose to7.7% in June 2007. The fourth half-yearly monetary policystatement (mid-July 2007) aims to continue the cautiousmonetary policy stance keeping in view the prevailing price

situation and excess liquidity in the banking system, whilesupporting sustainable output growth. Attention is alsogiven to the need to adjust smoothly to the likely internaland external shocks to the economy. Monetary policy iscentered on a targeted real GDP growth rate andsustainable rate of inflation. The annual monetary programof the central bank, based on these targets, employsreserve money and broad money as intermediate targetswhile tracking other asset and liability indicators.

23. In the backdrop of broad and reserve moneygrowth exceeding monetary program targets during

FY2007, as explained in the fourth monetary policystatement, Bangladesh Bank might review the policyinterest rates and revise interest rates of shorter tenureinstruments and statutory liquidity ratio and cash reserverequirements upward to ease pressure on domestic prices.Domestic credit is projected to increase in FY2008 by13.8% and private sector credit by 14.5%, while broadmoney is projected to increase by 15%. Bank borrowing tofinance the fiscal deficit, if contained within theprogrammed growth of 11%, will not create majorobstacles in the smooth operation of monetary policy.Despite adopting a cautious monetary policy stance,

Bangladesh Bank is committed to ensuring flows of creditto agriculture, small and medium-sized enterprises(SMEs), and housing; sectors traditionally not adequatelyserved by the market. The planned introduction byBangladesh Bank of refinancing schemes for housingloans for lower and middle income groups will, whileaddressing the acute housing problem, provideemployment to many people.

Figure 14. Sources of Broad Money (M2)

0

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10001200

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Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

[May'0

FY05 FY06 FY07

Net Foreign Assets Net Domestic AssetsBillion Tk.

Figure 15. Components of Domestic Credit

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Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

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FY05 FY06 FY07

Billion Tk.Credit to Govt. Credit to Other Public Credit to Private Sector

Figure 16. Selected Interest Rates

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6

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16

18

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22

Jul

'05

Sep Nov Jan

'06

Mar May Jul Sep Nov Jan

'07

Mar M

%28-Day T. B i ll Reverse repo rate Cal l money rate Lending rate

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24. Despite improvement, gross nonperforming loans(NPLs) of the banks remain high. NPLs declined from17.5% in first quarter of 2005 to 13.8% in the first quarterof 2007 (Figure 17). Net NPLs (net of provisions) declinedto 5.1% from 8.6% in the period. Gross NPLs of NCBsremain high (24.9%). High lending rates due mainly to the

large number of NPLs of state-owned banks and weakfinancial intermediation discourage investment and reducethe financial sectors contribution to economic growth.Interest rate spreads also remain high, reflecting bankinginefficiencies that need to be addressed. Bangladesh Bankhas made progress in adopting international best practicein prudential regulations and improving banks compliancewith reporting and risk management. Closer adherence isneeded to best practice standards for banks accounting,loan classification, and provisioning requirements (theprovisioning ratio remains low except in foreign banks).Certain banks remain undercapitalized. The recent

increase in the capital adequacy ratio to 10% is a positivestep. So is the decision to have all commercial banks creditrated; this is to be updated annually by a reputable credit-rating agency to safeguard depositors and prospectiveinvestors interests. The sale of Rupali Bank (one of thefour NCBs) has been concluded, although handover of thebank is experiencing unexplained delay. The Governmenthas corporatized the other three NCBs, bringing themunder Bangladesh Banks supervisory and regulatorycontrol and enhancing their operating autonomy andaccountability.

Figure 17. Gross Nonperforming Loan Ratios by Type of Bank

17.515.8 15.3

13.615.4

16.6

14.313.2 13.8

0

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20

25

30

35

40

45

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1

2005 2006 2007(p

%

Nationalized Commercial Banks Specialized Banks

Private Commercial Banks Foreign Commercial BanksAll Banks

Balance of Payments

25. In the first half of F2007, export growth was 25.8%.But growth slowed as the year progressed; growth was16.5% during JulyMay of FY2007. The main source of theslowdown was the progressively lower growth in knitwear,recording 32% growth until December 2006, but decliningto 19.8% during JulyMay of FY2007. Woven garmentsexports grew by 24.1% until December 2006, but growthdeclined to 14.7% during July 2006May 2007. To retaincompetitiveness, especially once the transitionalsafeguards on exports from the PRC expire in 2008 and

given increased competition from Viet Nam following itsaccession to the World Trade Organization in January2007, Bangladesh needs to reduce the lead time forgarment producers, upgrade labor skills, and improve portinfrastructure. Exports continue to concentrate on wovengarments and knitwear, which have a 75% share in totalexports. Despite potential, the share of other productsremains limited. During the first 11 months of FY2007,exports of engineering products and frozen foods recorded

Figure 18: Trends in Export (fob) & Import (cif)

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May

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07

Million $Export Import

Figure 19. Workers' Remittances

1882

2501

30623372

3848

4802

0

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2000

3000

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5000

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7000

FY01 FY02 FY03 FY04 FY05 FY06

Million $

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impressive growth. The performance of traditional products,namely raw jute, jute goods, and tea, showed decliningtrends; while leather exports increased marginally. Importsgrew by 17.4% in the first 11 months of FY2007. Imports ofrice; wheat; and food items including sugar, pulses, andedible oil steadily increased. Growth in imports of these

items seems to have a bearing on the price movements ofthese items in the domestic markets. Import of petroleumproducts, textiles, yarn, cotton, and capital machineryshowed healthy growth.

26. The trade deficit during JulyMay of FY2007 grewby 20.2% over the corresponding period of FY2006. Thisrise was more than offset by the surge in workersremittances (25%) leading to a surplus of $468 million inthe current account, from a surplus of $477 million in thesame period of preceding year. The steep rise in thesurplus in the financial account (mainly due to a surge in

other short-term loans) coupled with the notable increase inthe capital account surplus substantially increased thesurplus in overall balance. Based on the latest balance ofpayments data, the current account surplus in FY2007 isestimated at 0.7% of GDP compared with 0.9% of GDP inthe 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 (Figure 20).

Figure 20. Gross Foreign Exchange Reserves

34843245

36053447 3543 3534

39893739

4157 42004538 443

0

1000

2000

3000

4000

5000

6000

Jun

06

Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr Ma

Million $

Inflation and Exchange Rates

27. On a point-to-point basis, inflation increased to

8.1% in May 2007, from 5.9% in January 2007 (Figure 21).Food inflation increased from 6.7% to 8.4%, and nonfoodinflation increased from 5% to 7.8%. On an annual averagebasis, the inflation rate reached 7.1% in May 2007 from6.7% in January 2007 (Figure 22).

Figure 21. Inflation (Point-to-Point)

2

4

6

8

10

May

06

Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr M

% Consumer Price Index Food Non-food

28. Inflationary pressures steadily mounted from thebeginning of this decade from 1.9% in FY2001, to 2.8% inFY2002, 4.4% in FY2003, 5.8% in FY2004, 6.5% inFY2005, and 7.2% in FY2006. As GDP growth remainedstable with a rising trend during the period, domesticsupply-side developments are unlikely to have put major

pressure on prices. The rising domestic demand pressuresaided by higher incomes and continued high monetary andcredit growth mainly fueled inflationary pressures in thedomestic economy in FY2007, as in earlier years. Takadepreciation was not an important factor in FY2007, whenthe taka: dollar exchange rate remained fairly stable. Thesurge in exports and remittances that pushed up thegrowth of net foreign assets to 39.2% with a share of25.4% in broad money growth in May 2007 contributed to

Figure 22. Infla tion, 12-Month Moving Average

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

May

06

Jun Jul Aug Sep Oc t Nov Dec Jan Feb Mar Ap

%

11


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inflation in FY2007. As domestic prices are increasinglylinked to international prices due to globalization, theincrease in international food and commodity prices, due torise in demand in emerging market countries and weakcrop outlook in USA and Australia, also aided inflation.

29. To stop rising prices, the Government initiatedseveral measures including withdrawing duties onessentials, increasing public sector import of food grains,making provisions for diesel and fertilizer subsidies,resorting to actions against hoarding, and widening thesafety net programs. Also the banks started providingcredit facilities on softer terms to new importers, reducedletters of credit margins for food imports, and areexpanding agriculture credit. In view of higher internationalfood prices and given the large share of food in computinginflation, these measures are unlikely to have any majorimpact in terms of dampening inflationary pressures.

Figure 23. Domestic Open Market Retail Prices of

Foodgrains

12

13

14

1516

17

18

19

20

21

Jun

06

Ju l Aug Sep Oc t Nov Dec Jan Feb Mar Apr May

Tk. per kg Coarse Rice Wheat

30. Containing prevailing inflationary trends is more of ademand management exercise, and requires cautiousmonetary policy. Bangladesh Banks monetary program tocontain annual average inflation within 6.5%7.0% forFY2008 therefore appears well-advised (paras. 2223).The healthy foreign exchange reserves allow scope forencouraging imports of necessities putting downwardpressure on domestic prices. Letting markets fornecessities function normally without administrative actionsthat cause disruptions to the supply chain will also beimportant.

31. The pressure on the exchange rate moderated,reflecting the buildup of foreign exchange reservesbecause of the increase in remittances and exportearnings. The taka appreciated (with fluctuations) by 1.3%against the US dollar between the end of June 2006 andend of June 2007 (Figure 25). Bangladesh Bankspurchase of sizeable foreign exchange from the marketsince January 2007, while restraining further takaappreciation, increased its net foreign assets contributingto increase in reserve money. The rate was Tk69.1: $1 atend-January 2007, remaining stable and appreciating

slightly to Tk68.8: $1 at end-June 2007.

Figure 24. International Rice and Wheat Prices

100

150

200

250

300

350

Jul

05

Sep

05

Nov

05

Jan

06

Mar

06

May

06

Jul

06

Sep

06

Nov

06

Jan

07

Mar

07

Thai 5% Parboiled Long Grain Rice US (All Wheat)

$/Metric Ton

Figure 25. Nominal Exchange Rate (Taka-Dollar) and REER

Index

56

58

60

62

64

66

68

70

72

74Taka per $

Nominal Exchange Rate REER Index

Capital Market

32. The capital market registered a strong bullish trendduring the second half of FY2007, and started the newfiscal year in similar style (figures 26 and 27). Turnoverremained strong, while share prices soared. The DhakaStock Exchange general index climbed to 2,149.32 at the

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end of June 2007. It gained 539.81 points since December2006, highlighting a 34% rise, and crossing the 2,000-pointmark for the first time. Market capitalization went over$7.0 billion, increasing the market capitalization to GDPratio to about 11% from a meager 6% a year ago. Politicalvolatility at the end of 2006 (OctoberDecember), during

the transition from an elected to a caretaker government,took a heavy toll on the stock market and other sectors ofthe economy. But stock prices bounced back sharply at thebeginning of 2007, when a new caretaker government tookoffice. The market recovered from the prolonged bearishtrend and trading activity was bolstered. Although marketprices experienced temporary ups and downs, increasedparticipation by institutional, retail, and foreign portfolioinvestors kept it buoyant in the end. Some liquidity in thebanking system aided the process. Chittagong StockExchange, the other bourse located in the port city,followed similar trends.

Figure 26. Dhaka Stock Exchange: Market Capitaliza tion

and General Index

0

100

200

300

400

500

600

2006 M S 2007

Tk billion

0

500

100

150

200

250

IndexMarket Capitalization General Index

33. The supply of good quality shares needs to beincreased to prevent any possible overheating of themarket caused by high demand for shares, but limitedsupply. The supply-side constraints can be significantlyreduced if major state-owned enterprises including theNCBs and some private sector telecommunicationscompanies float their shares. The new caretakerGovernment has taken initiatives to encourage theseentities to release shares and the investors to activelyparticipate in the bond market. Biman Bangladesh Airlines,the state-owned airliner, is set to become a public limited

company under this scheme. If successfully implemented,this will reduce some government budgetary pressure.

34. Policies may be geared to support financialdeepening through workers remittance securitization tochannel this fund from consumption to investment.Remittance flows at $6.0 billion in FY2007 are a stablesource of foreign currency, which can be used to financeproductive investments such as SME development. Still amajor part of the remittances enter the country throughillegal channels, which could be directed to legal routes ifattractive savings instruments are designed. This can ease

the financing constraints of small businesses with noaccess to banks stimulating economic growth

Figure 27. Chittagong Stock Exchange: Market

Capitalization and Selective Index

0

50

100

150

200

250

300

350

400

450

2006 M S 2007

Tk billion

0

500

1000

1500

2000

2500

3000

3500

4000

IndexMarket Capitalization Selective Index

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THE FY2008 BUDGET

35. The advisor for finance presented the budgetproposals for FY2008 on 7 June 2007. With no politicalagenda, the budget has been a challenging exercise forthe caretaker Government in the backdrop of rising oil

prices, higher domestic inflation, weak revenue outturn,and slow pace of project implementation. The budgetadheres to the framework defined by the countrys povertyreduction strategy (PRS), the duration of which is extendedby a year to June 2008. The medium-term macroeconomicframework, within which the budget is defined, targets 7%growth and 6.5% inflation for FY2008 and assumes greatermonetary and fiscal policy coordination, significant baseexpansion for taxes, and absence of major internal andexternal shocks (figures 28 and 29). The budget earmarks57% of total resources to direct and indirect povertyreduction activities. The main thrust of the budget is to

create a stable environment for accelerated economicgrowth, focusing on removing obstacles to smooth privatesector operations and rapid poverty reduction. In the thirdyear of PRS implementation, the budget is set atTk796 billion (15% of GDP) with Tk265 billion for ADPexpenditure and the remaining Tk531 billion for currentexpenditure, food for work, and employment generationand development programs outside the ADP. Thedomestic revenue earning of Tk573 billion (10.8% of GDP)will finance the major share of expenditure; the remainderwill be financed by domestic borrowing and foreignfinancing (Table1).

Figure 28: Growth Rate of GDP

4.9

5.9

5.3

4.4

5.3

6.3

6.0

6.6 6.5

7

3

4

5

6

7

8

FY '99 FY '00 FY '01 FY '02 FY '03 FY '04 FY '05 FY '06 FY '07 FY '0

%

Estimate Forecas

Figure 29: Average Inflation Rate

1.9

2.8

4.4

5.8

6.5

7.2 7.06

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

FY01 FY02 FY03 FY04 FY05 FY06 FY 07 FY08

%

Forecas

Table 1: Budget at a Glance(Tk billion)

ItemFY2008

(A)FY2007

Revised (B) A/B% A in % of GDP

Total Revenue 573 495 116 10.8Tax Revenue 458 393 117 8.6Nontax Revenue 115 102 113 2.2

Total Expenditure 796 668 119 15.0Current Expenditure 529 445 118 10.0ADP 265 216 122 5.0Other Development Expenditures (net) 2 7 29 0.0

Fiscal Deficit 223 173 129 -4.2External Resources (Net) 106 73 145 2.0

Foreign Grants 43 22 195 0.8Foreign Loans 63 51 124 1.2Financing of Deficit 223 173 129 4.2Domestic Resources 117 100 111 2.2Domestic Bank Borrowing 72 65 111 1.3Domestic Non-BankBorrowing

45 35 129 0.9

Source: FY2008 National Budget Documents.

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Revenue Measures

36. Total revenues are expected to increase by 16% inFY2008 compared with the revised estimates for FY2007,because of strengthening tax administration, streamliningcollection systems, amending VAT laws and procedures,

and widening VAT coverage. Tax revenues are expectedto grow by 17% and nontax revenues by 13%. This willincrease the revenueGDP ratio to 10.8% in FY2008 from10.6% in FY2007 (Figure 31). Even at 10.8% of GDP,revenue collection is low and has been a cause forconcern, impeding efforts to mount desired publicexpenditure programs. Efforts need to be concentrated tosubstantially augment revenues, especially from indirecttaxes. Although past and ongoing reforms reduceddependence on trade taxes by design, income tax anddomestic consumption taxes have not yet assumed acompensating revenue role. While import taxes as a share

of GDP are higher than comparators in the Asian region,the domestic direct and indirect tax collection is muchlower than in comparators. Achieving the ambitiousrevenue target for FY2008 will be a challenging taskconsidering the large shortage of field staff mainly inindirect tax administration.

Figure 30: Annual Growth in Revenue

4.9

8.4

13.2

14.5

12.5

13.8

10.7

14.5

10.3

0

2

4

6

8

10

12

14

16

18

FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07

%

Tax and Tariff Policy Reforms

Income Tax

37. Continuing the past trend, the budget seeks to shift

emphasis away from reliance on trade taxes to incometaxes and VAT. This is dictated by the irreversible trends ofglobalization and market reforms reducing revenues fromimport-based taxes; and the need to reduce dependenceon these taxes, which distort resource allocation and makerevenues hostage to balance of payments considerations.The budget seeks to simplify tax assessment and paymentprocedures and promote voluntary compliance, andattaches importance to enhancing transparency andaccountability of tax authorities. Also the budget adoptsmeasures to curtail the discretionary authority of taxofficials. To provide relief to individual taxpayers and

encourage tax payment, the budget raises the tax-exemptincome limit and extends income tax brackets. To motivatevoluntary tax payment, the budget introduces universalself-assessment procedures. Changes in income tax laware introduced to simplify and modernize tax collectionprocedures. To encourage disclosure of higher income, themeasure introduced last fiscal year of allowing 10% taxrebates on additional tax paid by individuals at the highestrate of 25% who declare more than 10% additional income

Figure 31: Revenue-GDP Ratio

9.08.4

9.0

10.1 10.3 10.1 10.3 10.310.6 10.8

0

2

4

6

8

10

12

FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08

% GDP T ax N on -T ax T ot al R ev enue

Budget

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is retained. Tax rates for companies remain unchanged;but if mobile phone operators are listed with the stockexchange, the applicable rates for them will be reducedfrom 45% to 35%. The tax holiday facility extended to solarenergy plants will promote alternative sources of energyuse, reducing pressure on conventional energy and

extending the tax rebate facility to nonresidents. Theabolition of advance income tax on government bonds willhelp create a bond market, and the exemption from tax onincome from zero coupon bonds will diversify investmentsources.

Import Duty Structure

38. The decision to abolish the infrastructuredevelopment surcharge (IDSC) will simplify the tariff regime.The compression of tariff bands by raising duties for rawmaterials from 5% to 10%, and intermediate goods from

12% to 15%, keeping duties for finished product unchangedat 25% (with no IDSC), will moderate effective protection ofdomestic industries. Under the new rate structure, 3.3% oftotal harmonized system tariff lines (8% in the FY2007budget) will be assessed at 0% duty, 28.3% at 10% duty,26.7% at 15% duty, and 41.7% at 25% duty. Under thebudget, the average custom duty rate is increased to13.44% from 12.21% in FY2007. But the average nominalprotection will fall to 17.81% compared with 19.28% in theprevious year because of abolishing IDSC (Figure 32). Toremain competitive, domestic industries will need toincrease efficiency. The merger of supplementary duty rates

will simplify assessment of imported goods. Withdrawingzero duty on textile machinery, computers and computeraccessories, and agricultural pumpsin the face ofsuggestions to keep them unchangedreflects theauthorities desperate attempt to raise revenue. Withdrawingimport duties on crude edible oil and lentils, and notchanging the 0% duties on other necessities, will moderatemarket prices of these essentials. Reduction of duties ontrucks using compressed natural gas from 25% to 10% willencourage import of these more environment-friendlyvehicles; while increasing import duties from 5% to 15% oncompletely built unit, compressed natural gas buses will

promote the assembly industry for such buses. Although notapplied trade-neutrally and contradicting the spirit of theVAT law, the imposition of supplementary duty only at theimport stage for metal-framed furniture and plastic productswill provide protection to the domestic metal furniture andplastic industry. The extension of the bonding period up to 2years will encourage export-oriented industry. Systemicimprovements in bond procedures will streamline customsadministration and help exports.

Figure 32: Average Nominal Protection

20.9

19.3

17.8

16

17

18

19

20

21

22

FY2006 FY2007 FY2008

%

Budget

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Value-Added Tax

39. Simplifications in the VAT Act provisions and ruleswill encourage tax payments voluntarily and introducegreater transparency in tax administration. Withdrawing

turnover tax facility for a large number of goods andservices and bringing them under VAT purview irrespectiveof the annual turnover will widen the tax base and increasecollection.

Figure 33: Annual Growth in Expenditure

13.814.9

2.1

13.4

8.3

13.0 12.7

9.8 9.5

0

5

10

15

20

25


%

Budg

Expenditure Measures

40. In the FY2008 budget, the Medium-Term BudgetaryFramework (MTBF), which provides medium-term budgetestimates with the objective of allocating resources tostrategic priorities while ensuring consistency of allocationswith overall fiscal objectives, was extended from 10 to 14

ministries. The MTBF is intended to strengthen fiscalmanagement and grant greater autonomy to line ministriesfor more flexibly managing resource allocation. Serving asa link between the PRS and annual budget, and seeking toremove demarcations between revenue and developmentexpenditures, the MTBF aims to establish consistencybetween policy, planning, and budgeting. Asacknowledged in the budget speech, realizing the fullbenefits of the MTBF will take time and require enhancedinstitutional capacity of the ministries.

41. Public expenditure in FY2008 is projected to rise by

19% over the revised estimate for FY2007, with currentexpenditure increasing by 18% and ADP expenditure by22%. The public expenditure to GDP ratio is projected torise from 14.3% in FY2007 to 15% in FY2008. ADPimplementation will present a difficult challenge in view ofthe weak institutional capacity and require concertedefforts to address impediments to timely and efficientproject formulation and implementation. Emphasis in thebudget on improving procurement and strengtheningmonitoring and evaluation of public spending will contributeto streamlining project implementation. Reducing thenumber of projects and increasing project selectivity in

terms of pro-poor growth will improve development impactof resource allocation. The decision to post information onresource allocation and utilization by sector andgeographic division for priority projects will enhancetransparency and accountability of public spending andcontribute to increasing the effectiveness of projectimplementation. The emphasis on regional parity in linewith national priorities and resource availability togetherwith the increased allocation for agriculture, rural

Figure 34: Expenditure-GDP Ratio

13.8 13.5 14.014.8

13.7 13.314.0 14.0 14.3

15.0

-2

0

2

4

6

8

10

12

14

16


% GDP

Current Expenditure ADP Others Total Expenditure

Budg

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development, and water resources will improve the povertyreduction focus of the budget. Continuing past trends,priority is attached to sectors with potential for economicgrowth, poverty reduction, and human development.

Social Sectors

42. For social infrastructure development, educationand health receive priority, with 22% of the total allocation.The emphasis on research and investment in highereducation and introduction of financial grants for researchin physical, life, and mathematical sciences will encouragequality research in these important areas. The promotion ofgender parity in primary and secondary education and thedecision to appoint the majority of primary teachers fromthe female candidates will contribute to empoweringwomen and allowing women to play greater roles in, andbenefit from, the development process. Attention needs to

be given to appointing qualified teachers to raise educationquality, and stipends must reach the targeted beneficiaries.The decision to link performance with allocations for salarysubventions for nongovernment schools will ensure thatthe large spending is properly utilized. The allocation foreducation and technology is increased by 13.5% over therevised FY2007 budget. In the health sector, a 10.3%higher allocation over the revised FY2007 budget isprovided, but greater attention needs to be given toimproving health service delivery. The decision to involvethe private sector in delivering health services throughmanagement contracts will improve the quality of health

services. Increasing the involvement of nongovernmentorganizations in population control and prevention ofmalnutrition and contagious diseases will help to moreeffectively address the human dimensions of poverty.

Figure 35: Sectoral Shares in Public Expenditure in FY08

Pension3.9%

Subsidies5.3%

Others

7.9%

Defence

5.8%

Social Security& Welfare4.8%

Public Order & Security5.2%

Public Administration,

2.4%

Miscellaneous Non-DevelopmentInvestment

0.8%

Agriculture5.7%

Health6.6%

Energy & Power5.8%

Local Govt. & RuraDevelopment

9.3%

Transport&

Communication8.5%

Interest

13.5%

Education & IT

14.5%

Physical Infrastructure

43. Power supply shortage is the most criticalconstraint to growth, employment creation, and povertyreduction. Measures adopted to add generation capacityand improve power plant maintenance to bridge theincreasing gap between power demand and supply need

to be implemented with utmost priority. In thecommunication sector, a large increase in allocations toroad and railway maintenance is made; ensuring efficientand transparent utilization of these allocations is veryimportant, along with attention to the cost and quality ofwork. The information technology subsector also receivesattention in the budget considering its immense importancein disseminating information.

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Agriculture and Rural Development

44. The emphasis on agricultural research anddevelopment for increasing yield and productivity is well-placed considering the growth and employment generationpotential of this sector. The decision to subsidize farmers

to offset the effects of increased cost of diesel will providerelief to them, although ensuring that the money reachesthe intended beneficiaries will be a challenge. The budgetfocuses on increasing the fertilizer subsidy and enhancingthe target for agricultural credit. The benefits of subsidiesmust reach small and marginal farmers. Minimizingharassment and irregularities in the provision of credit willbe essential. Fisheries and livestock also have majoremployment and poverty reduction potential and this isaddressed in the budget. The priority attached to improvingrural communication is important for linking farms andproduction centers with markets and growth centers.

Social Empowerment and Social Safety Net

45. The budget seeks to highlight the share of totalallocation devoted to gender equality expenditure (directand indirect), which increases to 24% of the total budgetfrom 22% in FY2007. Initiatives are under way to preparegender budgeting. A pilot program to reduce maternal andinfant mortality by providing an allowance is introduced,which will contribute to safe motherhood for poor mothers.The allowance for widowed and destitute women isincreased, and the coverage of the scheme is widened.

Allocations are made for microcredit programs to createemployment opportunities for women. More funds areallocated for acid-burnt and disabled women, garmentworkers, stipends for female students, nutrition andvocational training for women, and creation of employmentopportunities for destitute women. Increased allocations forchild development, freedom fighters welfare, andrehabilitation of senior citizens and displaced people areincluded. The budget provides sizable allocations foremployment generation in rural areas under theGovernments microcredit programs (outside ministry-based programs); these will create significant rural

employment in the next fiscal year.

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Fiscal Deficit and its Financing

46. The fiscal deficit projected for FY2008 is 4.2% ofGDP, higher than 3.7% in FY2007 (Figure 36). Althoughthe Government assumed the accumulated default loansof BPC ($1.1 billion) by issuing treasury bonds to the

creditor banks, this will not affect the Governmentsbudgetary position or the deficit in the current fiscal year,as no cash payments will be involved. This will also notaffect the money supply position (these bonds do notqualify for meeting banks statutory liquidity ratio). Tofinance the deficit of 4.2% of GDP, domestic bank andnonbank borrowing will meet the equivalent of 2.2% ofGDP, and foreign loans and grants will account for 2% ofGDP. Interest payments on domestic and foreign debts willincrease from 15.9% of domestic revenue in FY2007 to18.8% of the projected revenue in FY2008.

Figure 36: Fiscal Deficit

0

1

2

3

4

5

6

7


% GDPFiscal Deficit Net Foreign Financing Net Domestic Financing

Budg

Figure 37: Sources of Financing Public Expenditure in FY08

Foreign Financing

16%

Domestic Financing

13%

Non-Tax Revenue

13%

Tax Revenue (Non-NBR)

3%

Tax Revenue (NBR)

55%

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OVERSEAS WORKERS REMITTANCES

47. Workers remittances are funds transferred bymigrants working in foreign countries to their homecountry. Although these funds are often cyclical, they havehelped many countries meet their international payment

obligations while benefiting the migrants family members.In Bangladesh, remittances have been a less volatilesource of foreign currency compared with exports andforeign aid. Faced with unemployment, underemployment,and low wages at home, Bangladeshi workers havemigrated, in large numbers, to countries with more buoyantlabor market conditions. Between 1976 and June 2007,about 4.9 million workers went abroad. Cumulativeremittances during this period amounted to around$44.5 billion. From a meager $848 million in FY1992,remittances rose to about $6.0 billion or 9% of GDP inFY2007, averaging 20% growth during the last 5 years

(Figure 38 and 39). On an average, remittances make up3.5% of South Asias GDP. Steady growth in remittanceshelped the country sustain comfortable external balances.Remittances are higher than the combined flows of FDIand aid disbursements. Increasing access of poor peopleto remittances fuelled poverty reduction and fosteredhuman development.

Figure 38. Remittances as % of

Bangladesh's GDP

8.8%

6.4%

5.9%

4.0%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

FY2001 FY2003 FY2005 FY2007

Migrants Destinations

48. Most of the remittances in Bangladesh aregenerated from the Middle East, followed by the US,

United Kingdom, Malaysia, Germany, and other countries.The boom in oil revenues in the Middle East since the mid-1970s has created many job opportunities for Bangladeshiworkers. Between 1976 and June 2007, about 47% of allmigrants went to Saudi Arabia, 16% to United ArabEmirates, and 10% to Kuwait. This highlights thedominance of the Middle East as the migrants destination.

About 63% of the remittance flow in FY2007 wasgenerated from the region, although this share declinedfrom a high of 80% in FY2001 because of a gradual rise inmigration to other parts of the world. In FY2007, about29% of the remittances came from Saudi Arabia, followed

by 15% each from the US and United Kingdom, 13% fromthe United Arab Emirates, and 11% from Kuwait. OtherMiddle East countries contributed about 10%, with the restof the world including Germany, Japan, and Malaysiacontributing the remainder (Figure 40).

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Effect on Balance of Payments

49. The greater inflow of remittances helped sustainmacroeconomic stability by improving the countrys currentaccount position, foreign currency reserves, and externaldebt servicing capability. $44.5 billion in remittances

received since 1976 is higher than $43 billion of foreign aidreceived by the country in this period. Unlike foreign loans,remittances are unrequited transfers; and no futurerepayment liability exists. The country needs significantforeign exchange to import capital machinery, rawmaterials, and consumer goods, and to service externaldebt. In FY2006, the ratio of imports to GDP was 21% andexports to GDP 17%, resulting in trade account deficits.But because of strong inflow of remittances, the currentaccount balance showed a surplus of 0.9% of GDP inFY2006. In FY2006, the remittance flows were about 167%of the trade deficit and 46% of merchandise exports.

Despite heightened external pressures, continuedbuoyancy in remittances translated into a strong foreigncurrency reserve of about $5.1 billion at the end ofFY2007. Robust remittance flows helped reduce the debtservice ratio to 4.1% in FY2006 from as high as 6.6% inFY2001. It has enabled the country to maintain balance ofpayment surpluses for more than 5 years in a row, despitetrade imbalances and stagnant FDI.

Figure 39. Annual Remittance Flows

to Bangladesh

4,802

5,979

3,848

3,3723,062

2,501

1,882

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

FY01 FY02 FY03 FY04 FY05 FY06 FY07

$ million

Absorption of Oil Price Shocks

50. Remittance receipts in Bangladesh provide a

cushion against oil price shocks. Since the majority of itsout-of-country workers are in oil-exporting countries, theyare likely to earn and send home more when the oil pricerises. Empirical evidence suggests a strong positivecorrelation between oil prices and remittance receipts inBangladesh.2 The correlation coefficient of detrendedremittances and oil prices is 52%. Statistically significantregression models suggest that a $1 rise in the oil priceleads to $8 million in additional remittance receipts. Thisincrease in foreign financing helps cushion consumptionand investment against permanent increases in theinternational oil price.

2International Monetary Fund (IMF). June 2007. Bangladesh: Selected Issues. IMF Country Report No. 07/230.Dhaka. Available: www.imf.org.

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Effect on Households

51. Remittances play an important role for householdsby increasing income and savings, improving the standardof living; and reducing poverty. Households receivingremittances are often among the poorest segment of the

population, which makes this an effective buffer againstearnings disparity. Poor recipients mainly use remittancesto finance subsistence consumption. For many families,remittances constitute an essential source of extra income,allowing them to meet some basic necessities such ashealth and education; and open up opportunities forhouseholds to invest in productive activities or smallbusinesses. This contributes to poverty reduction, bothdirectly through transfers to low-income groups, andindirectly through the effects of remittances on the demandfor labor and labor-intensive goods and services. It holdsthe potential to be a source of finance for developing

SMEs in geographically dispersed locations. Most SMEs inBangladesh still have difficulty obtaining loans from banksand other formal financial institutions, and have to rely onfamily borrowing for financing. Remittances can play acritical role in partly closing this gap. They can also financethe cost of sending other members of the recipient familiesfor employment abroad.

Figure 40. Remittance Flows to

Bangladesh by Country of Origin

(FY2007*)

Saudi

Arabia,

29%

UAE,

13%Kuwait,

11%

USA,

15%

UK, 15%

Others,

17%

*JulyMay

52. Despite many benefits, remittances have someshortcomings. They often result in rise in consumption andnot always in investment. Although remittances areprocyclical, causing higher likelihood of consumer price

inflation, the relationship between remittances and inflationin Bangladesh is not strong. But as a sizable part of theremittances is used to purchase land, they may lead toincreased land prices in small villages with a highconcentration of remitters. Farmers and other low-incomegroups involved in agriculture, livestock, fisheries,horticulture, or similar activities that rely heavily on theavailability of land may suffer if a large area of land isowned by a few families. To make the best use ofremittances, most needs to be diverted into productiveuses such as SME development.

Incentives

53. The Government has undertaken measures toincrease the flow of remittances. Various schemes such aswage earners development bonds, nonresident foreigncurrency deposit account, and national savings schemeswere introduced to provide incentives to migrant workers tosubmit remittances. The principal amount of investment inwage earners development bonds can be repatriated

23


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becoming more cautious about the rules and regulations inthe sending countries in fear of funds being frozen orconfiscated in suspect of terrorism financing or moneylaundering.

Figure 42. Destination of Emigrants

from Bangladesh

(Cumulative: 1976June 2007)

Kuwait10%

UAE16%

Oman5%

Malaysia8%

Others11%

Singapore%

SaudiArabia

47%

Hurdles of Official Transfers

57. The remitters encounter numerous problems insending their remittances through the official channel,especially to remote areas of the country. The process ofsending remittances through banks is slower and morecumbersome than with the informal channels. Paper workand documentation requirements are heavy, which theworkers find difficult to accomplish. Lack of knowledge ofbanking procedures is a hindrance, particularly for the lesseducated; while many recipients do not even have bankaccounts. In addition, remittance documents (e.g., draftsand money orders) may get lost in transit. But the process

of sending money through informal channels is simpler andquicker; and involves less paperwork. According to variousestimates, remittances sent through the official channelsconstitute only 50% of total remittances including thatremitted through hundi. While a week, on average, mightbe required to receive remittances sent through the banks,most informal channels do not take more than 3 days. Thehundi system relies on trust and goodwill; and is efficient.Hundi operators maintain complete secrecy oftransactions. The system requires much lessdocumentation, speeding up the whole process. It is alsomore profitable as the remitters get a premium exchange

rate, which is often significantly higher than the official rate.A prime reason why hundi is a thriving activity is thedemand for hard currency to finance smuggling and otherillegal trade. Despite improvement, the hundi-smugglingnexus still exists; and a large proportion of foreignexchange sent through informal channels supports asizable illegal trade in goods. It is also believed to beaiding the process of capital flight out of Bangladesh.

Absence of investment opportunities, political instability,and inadequate social security is also discouraging theinflow of remittances through the official channels.

Challenges and Threats

58. Remittances have increased very rapidly during thelast decade. If the country can sustain the present pace inmigration, remittances will continue to rise. But somechallenges exist. The global economic slowdown,particularly in the developed countries and Middle East,may have an adverse impact on labor recruitment fromlabor-exporting countries. Future economic downswings

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61. The hundi-smuggling network needs to beaddressed and dismantled on a priority basis. Since thesurvival of the hundi system depends to a great extent onthe demand for remittance money to finance illegalinternational transactions, policy actions must focus on

reducing incentives for such trade. As long as incentivesfor smuggling and other illegal transactions in internationaltrade remain, hundi operators will find innovative ways totransfer remittances through informal channels. Themarket-oriented floating exchange rate system hasprovided a good incentive for official transfer ofremittances, and discouraged illegal trade to a largeextent. Increasing public awareness of the benefits of thelegal banking system and potential hazards of informaltransfers will greatly help those who are unaware. Althoughinternational efforts to disarm money laundering havealready created much concern among many, others still

need to be properly informed. 60.2%

39.8%

41.5%

58.5%

0% 20% 40% 60% 80%

FY2004

FY2007*

Figure 44. Volume of Remittances

Processed by Public and Private

Banks in Bangladesh

Public Private

*JulyJanuary

62. Regulators and financial institutions of source anddestination countries need to harmonize their legal andcompliance frameworks to enable better functioning of thewhole system. Institutional mechanisms should bestrengthened to increase labor exports. Workers currentlyemployed abroad need to be helped to retain their jobsand understand the legal and cultural requirements of thecountry. The new workforce needs to be encouraged to gettraining and become skilled. More vocational trainingcenters with public-private partnerships need to be in

place. To compete with other countries like the PRC, India,and Philippines, Bangladesh needs to focus on exportingmore skilled labor.

63. The country can significantly bolster the existingbenefits of remittances by making fund transfers easierand cheaper, directing flows from consumption toinvestments, and shifting the existing informal flows intothe formal route. An electronic remittance clearinghouse isurgently needed to ensure standardized remittanceinstructions among participants in the delivery system.Innovative delivery agents such as courier/postal service,

nongovernment organization offices, mobile phone outlets,points of sale, and bank ATM/booths need to be used tocompensate for the limited rural banking network.Institutional effectiveness, accountability, and transparencyof government organizations involved in out-of-countryemployment and expatriate welfare need to bestrengthened to facilitate safe migration and reduce illegalhuman trafficking. Policies should also support financial

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deepening to provide savings instruments for remittances,such as remittance securitization.

64. To meet the challenges and increase remittances,new avenues of employment need to be explored. Priorityshould be given to sending more skilled workers to

command higher wages. The demand for different types ofworkers in different countries should be assessed. Manycountries have a high demand for workers proficient inwelding, electrical works, carpentry, house painting, air-conditioning, refrigeration, and similar work. Somecountries need highly skilled professionals, includingdoctors, nurses, engineers, accountants, and informationtechnology experts. Although getting these jobs mayrequire expensive education and training, the payoffs arehigh.

Conclusion

65. International migration has enabled millions ofBangladeshi workers to find better employment in othercountries. Their remittances have helped the economy byproviding a big chunk of foreign financing. They haveprovided a cushion against some external shocks such asoil price increases. Workers remittances are a goodsource of funds and should be fostered through properpolicies. But remittances cannot substitute for goodmacroeconomic policies, and can be vulnerable to politicaluncertainty and external shocks.

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Asian Development BankBangladesh Resident MissionPlot E-31, Sher-e-Bangla Nagar

h k l d h

About the Asian Development Bank

The work of the Asian Development Bank (ADB) is aimed at improving the welfareof the people in Asia and the Pacific, particularly the 1.9 billion who live on lessthan $2 a day. Despite many success stories, Asia and the Pacific remains home totwo thirds of the worlds poor. ADB is a multilateral development financial institutionowned by 67 members, 48 from the region and 19 from other parts of the globe.ADBs vision is a region free of poverty. Its mission is to help its developing membercountries reduce poverty and improve the quality of life of their citizens.

ADBs main instruments for providing help to its developing member countries arepolicy dialogue, loans, technical assistance, grants, guarantees, and equity investments.ADBs annual lending volume is typically over $7 billion, with technical assistanceusually totaling over $240 million a year.

ADBs headquarters is in Manila. It has 26 other offices around the world and hasmore than 2,000 employees from over 50 countries.