Investment opportunities in Bangladesh

Goldman Sachs expects that, within the next 50 years, 5 of the G-7 nations will be replaced by

emerging economies. Many of these economies have large population, cheap labor and high

levels of productivity. The Bangladeshi economy possesses these characteristics, leading

Goldman Sachs to include the country in its list of “The Next Eleven (or N-11)” - economies that

are expected to have a high potential for driving the global growth in the 21st century. Similarly,

Citi Group has also included Bangladesh in its list of 3G (Global Growth Generator) countries.

Given the immense potentials of Bangladesh, there has been a lot of interest on this small

economy, as a new destination for foreign investments (both direct and portfolio). On the

backdrop of the Middle East crisis, which made many emerging market funds somewhat

reluctant about investing there, this interest is likely to increase further very soon. One question

that arises for foreign investors is how correlated Bangladesh is with the global economy. This

report, aims to find to what extent such correlations exist (in terms of the economy and capital

markets), where the major exposure of the country are, and whether foreign investments would

benefit from diversification.

The Macro Economy

Stable growth, very little correlation with the global economy: Bangladesh has experienced

very stable economic growth over the last decade. Figure 1 compares the GDP growth rate of

Bangladesh with the world, the USA (a proxy for the developed economies), and Vietnam and

Pakistan (which are taken as proxy for other N-11 countries). We find that over a period of 10

years (2001 to 2010), Bangladesh has maintained a more or less stable growth rate, much higher

than those of advanced economies. Moreover, GDP growth of Pakistan and Vietnam, though in

some cases higher than Bangladesh, has fluctuated quite a bit.

Figure 2 shows a five year moving correlation of the growth rate of the world economy and

Bangladesh over a period of 26 years (1984 to 2010). We start tracking data after the 1980s to

remove the effect of any structural changes that may have been brought on by the country’s

independence in 1971. The figure shows that the moving correlation varied from strongly

positive to negative over the period concerned. What is interesting is that the correlation

decreases, or in some cases becomes negative in times when the US economy goes through a

recession. For instance, the US economy experienced a recession in the early 1990s (July 1990 –

March 1991), due to the oil price shock and S&L crisis. At that time, we find a very strong

negative correlation between the global economy and Bangladesh. Similarly, during the early

2000s the US economy went into another recession following the “Dotcom crash” and the 9/11

attack. During this session again, we see the moving correlation for Bangladesh to be declining.

Finally, we see that during the most recent financial crisis of 2008, the moving correlation

dipped down from 0.96 to 0.37.

One important issue that must be noted however is that over time, there has been a more or less

upward trend in the moving correlations, signifying that the Bangladeshi economy is becoming

more and more linked with movements of the global economy, as linkages increase.

Inflation under control, but dictated by global food prices: We compare the inflation rate of

Bangladesh with that of the United States and the two comparable economies – Vietnam and

Pakistan (Figure 3). We see that all four economies follow similar trends in inflation, even

though the rate for Bangladesh has not fluctuated as much as that of Vietnam and Pakistan.

Inflation rate peaked in 2008, prior to the global financial crisis, with rates reaching to about

10% in Bangladesh, while it soared to 23.1% and 20.3% in Vietnam and Pakistan, respectively.

On average, inflation rates in these two economies have also been higher than that of Bangladesh

Inflation in Bangladesh is mostly driven by food prices, given the large weight of food in CPI

calculations. Our earlier report on “Inflation in Bangladesh: Driven by global phenomena” found

that much of the food price increase can be attributed to global food price hikes. Figure 4 shows

food inflation trends in Bangladesh along with the World Food Index (WFI) of the Food and

Agriculture Organization (FAO). We see that on average food inflation in Bangladesh follows

the trend in global food prices quite closely, signifying that the country still has large exposure to

global economy in this regard.

Capital Markets

High returns, low correlation with global markets - diversification benefits possible:

We use data for a little more than 10 years (January 2001 to March 2011) to show how correlated

the Bangladeshi capital market is with the rest of the world. We compare the S&P 500 index (to

see stock market performance of the United States) and MSCI World Index (as a proxy for

global stock performance) with our own BRAC EPL Index (BEPL) over the mentioned time

period. We also compare BEPL with the MSCI Emerging Market Index (MXEF). The reason for

using BEPL rather than our benchmark index DSE General Index (DGEN) is that we believe that

there are discrepancies in the calculation methodology of DGEN. Hence, the DGEN returns are

likely to be more suppressed than actual returns experienced.

Figure 9 shows how returns from the S&P 500, MSCI World Index and MXEF compare with

returns from BEPL. The figure shows values of the said indices in rebased form for comparisons.

Please note that the axes for S&P 500, MSC World Index and MXEF are different from that of

BEPL (which is shown on the right-hand axis). It can be understood from the figure that the

Bangladeshi stock market has given returns substantially greater than the S&P 500 and the world

as a whole, even if the eventual correction in December was also quite enormous. Returns from

emerging markets were also high in spite of the correction in 2008 due to the global financial

crisis. It should be noted that while all three indices (MSCI World, S&P 500 and MXEF) faced

severe corrections during the financial crisis, no effects were be observed in the Bangladeshi

market.

In order to provide a more in-depth analysis of market movements, we calculate a 5 year moving

correlation of BEPL monthly returns with that of the other three mentioned indices. Figure 10

shows moving correlation of BEPL returns with the S&P 500 and MSCI World returns. We find

that overall, the correlation reverts to zero (for both indices), even if in recent times (following

the 2008 crisis) the correlation has largely been negative. Finally, figure 11 shows the 5 year

moving correlation for monthly returns of BEPL and MXEF. The correlation trend here is

strikingly similar to that of figure 10.

In conclusion, we provide the following table to show how returns from the Bangladeshi capital

market compares with the MSCI World Index, S&P 500 and MSCI Emerging Markets Index:

We believe that Bangladesh offers unique opportunity to global investors in terms of return

enhancement and risk mitigation. With robust growth outlook and younger listed corporations,

equity returns are very promising. At the same time, semi-segmented Bangladesh economy and

capital market will lower the volatility of globally invested portfolios.

Bangladesh’s Leather Industry

Leather industry is an old manufacturing sub-sector in Bangladesh with a long heritage of over

five decades. This is an agro based bi-product industry integrated with locally available

indigenous raw materials (hides and skins) having tremendous potentials for export development

and sustained growth along a considerably long duration of time length.

Sub-segments of this industry are -

1. Finished Leather

2. Leather Goods

Sector Highlights:

1. The labor-intensive leather industry is well suited to Bangladesh having cheap and

abundant labor.

2. Bangladesh has a domestic supply of good quality raw material, as hides and skins are

a by-product of large livestock industry.

3. Adequate government support in the form of tax holidays, duty free imports of raw

materials and machinery for export-oriented leather market

4. The industry lacks domestic technology and expertise and local support industries such

as chemicals are still under-developed.

Investment Incentive:

1. Present Government is in the process of setting up of separate Leather Zone relocating

the existing industry sites to an well-organized place.

2. New FDI inflow is highly encouraged and foreign investors are welcome to have the

opportunity.

Leather industry is a vital component of Bangladesh economy in terms of foreign exchange

earnings since it is the third highest foreign exchange earner after RMG and frozen food. The

industry is generally export based. More than 80% of leather and leather products of Bangladesh

are marketed abroad, mostly in the form of crushed leather, finished leather, leather garments,

and footwear. More than 200 modern tannery units are now in operation in the industry. With the

exception of a few tanneries located in Chittagong and other places of the country, tanneries

located mostly in the Hazaribagh area of Dhaka city. The country's share in the world leather

market is still very insignificant with a share of 0.36% of world leather trade in 2004. An

important characteristic of the leather industry in Bangladesh is its rather poor domestic demand.

This promising sector is suffering from a host of problems including problems related to

management and infusion of advanced technology and innovative and integrative marketing

strategy. Issues related to concerns for the environment generated by the tanneries and health and

hygiene factors for both the tannery workers and the people living nearby continue to haunt the

image and operational efficiency of the sector.

Industry Profile

The leather industry in Bangladesh is well established and is an important foreign exchange

earner. The industry is entirely in the private sector which has proved to be fully capable of

handling it. Out of the total 207 tanneries of Bangladesh, 186 are located haphazardly in

Hazaribagh area in Dhaka where 84 per cent of the total supply of hides and skins are processed

in a highly congested area of only 70 acres of land. The unplanned tanneries at Hazaribagh do

not have supporting infrastructure facilities. No tannery in the area has effluent treatment

facilities, posing a grave threat to environment. The industry, however, is in the process of

shifting to Savar in consideration of the pollution it cast upon the Dhaka City and because of an

acute lack of space for expansion and modernization.

Over 50 manufacturers are producing various leather items such as footwear, travel goods,

suitcases, briefcases, fashion accessories, belts, wallets, hand bags, case holders etc. for overseas

export. Most of the small tanneries are family owned and operated as cottage type industries.

Many of them are established as proprietorship or partnership. The larger tanneries are basically

public or private limited companies. Only a few tanneries have proper accounting practices and

financial controls in place to define their profitability and financial condition.

The principal raw materials for this industry are cowhides and goat skin. The annual domestic

supply of hides and skins is around 200 million square feet, consisting of 63.98% Cowhides,

32.74% goat skin, 1.09% Sheep skin and 2.219% buffalo hides. Local Consumption of leather is

around one fifth of the total output and the rest 80% is exported in the form of Crust leather

(75%), and finished leather (20%), Footwear and leather goods (5%). Though there has been

some appreciable improvement in animal husbandry and butcher's techniques in Bangladesh in

recent times, it may take quite some time to reach the international standard. The Black Bengal

and other variants of goat skin from Bangladesh enjoy an excellent reputation for quality

worldwide. At present, the leather sector accounts for 3-4 per cent of total export earnings.

According to Bangladesh Export Promotion Bureau (EPB), contribution of leather sector to total

GDP was 0.32% in 2005.

At present leather and leather products are exported to about 53 countries of the world. The

major importing countries are: Italy, Brazil, Germany, Singapore, China and the USA. EPB

sources report that export earning from leather goods was US$ 287.78 million in 2004-2005, out

of which, about 80% are from leather and the rest is from finished leather goods. Figure-2

exhibits that the export growth rate of Bangladesh leather sector declined initially in the year

1998-1999 because there was economic recession in Bangladesh due to massive flood. During

this period (from 1998 to 2005), the growth rate was highest in 2000-2001 (16.32%). In the year

2002-2003 export growth rate was negative because of the global economic recession as a

consequence of the War in Iraq, the Twin Tower (9/11) incident, rise of international terrorism,

fundamentalist orientations, etc. Export growth rate for the year 2004-2005 was 8.22%. Foreign

investment to the industrial leather sector of Bangladesh has been very limited. Till March 2003,

the total foreign investment in the industrial leather sector was $136.12 million, which is only

1.33 per cent of the total foreign direct investment into the country.

This sector is also a major employer of semi-skilled workers, which is a vital step towards

alleviating unemployment. Information obtained from a number of credible sources exhibits that

in total (accumulated) 741,000 people are employed directly or indirectly in leather and its sub-

sectors. 200,000 people are involved in raw hide collection and supply and 50,000 are working in

tanning industry. About 300,000 workers are associated with retailing of leather. Currently it is

estimated that about 150,000 persons are employed in the footwear industry, 30,000 persons are

in leather goods industry and another 8000 persons are involved in exporting of leather and by

product processing. (Source: BCLT, LSBPC, ILO, BBS, GTZ, RSMA and ITC-ATF) Despite

having a great potential for growth, the net results of development efforts undertaken for the

leather export sector of Bangladesh have been far from impressive due to the poor quality of

processing, illegal export to India, poor technological base, inadequate financing, low value

addition, lack of marketing skill, incorrect planning and improper implementation.

Industry Life Cycle: Growth Potential

The leather industry with over Taka 160 billion annual export earnings is the country’s third

biggest foreign exchange earner after the RMG and the frozen food sectors. Local and foreign

experts believe that this sector could replicate the successes of the Readymade Garment (RMG)

sector if the government and genuine entrepreneurs join hands for effective cooperation and

develop the sector with a comprehensive strategic plan. Leather industry is growing all over the

world – both in market potentials and in installed capacity. For Bangladesh, export earning only

from leather was US$ 207 million in 2001- 2002 and it is expected to reach US$ 235 million in

2005-2006 as the demand for quality raw material for finished leather goods is increasing in

developed countries. The size of the global footwear market is enormous as well. A thorough

analysis of the historic data shows that factors like demographic composition, depth and reach of

urbanization and distribution of wealth have consistently shaped the growth of the footwear

industry. Though till now Bangladesh has shown poor performance in the leather goods sector, it

has a good growth potential if entrepreneurs can avail modern technology to diversify their

products and designs according to international market trends and apply modern tools for

marketing & promotion.

Realizing this sector’s growth potential, Bangladesh Government has reiterated its decision to

treat the industry as one of the thrust sectors and reduce interest rates for industrial credit to this

sector to seven percent (7%). The government has decided to develop a leather industrial area at

Savar, outside Dhaka where tanneries from Dhaka would be shifted to free the Hazaribagh area

and the river Buriganga in general, where most of the tanneries are concentrated, of pollution.

About 200 leather units would be re- located at the new site with modern waste-treatment plants

to create a healthy environment. Presently, many of the advanced communities consider

Bangladesh as a worthwhile investment destination due primarily to: (i) an abundance of a

marked low-wage labour force, and (ii) the existence of export processing zones and facilities

including incentives like tax holidays for 10 years. A report of Japan-Bangladesh Business

Associations including Japanese Commerce and Industry Association (SHOO-KOO-KAI) shows

in clear terms that remarkable economic development and concentration of massive FDI within a

short period of time in China, increasing labour costs in Thailand, and inadequate domestic

market for high-income groups in Vietnam, is leading Japan to think of investing more in

Bangladesh, particularly in area like leather. Also about 10% of the total population of

Bangladesh (14 million) is recognized to have an income level comparable to that of their rich

country counterparts. Assuming that two pairs of footwear are purchased by a person in this

group, the demand for footwear would be 20 million pairs per year. Hence, there is a large latent

domestic market for quality footwear and other leather goods in Bangladesh as well.

SWOT Analysis

The SWOT Analysis presented above along with the existing & projection of demand trend

of Bangladesh leather sector (section 3.4) and the growth potential of Bangladesh’s leather

sector (section 3.6) give us a strong signal that the leather sector in Bangladesh has all the

basic elements for a sustainable rate of growth in the future. What is essential now is to

prepare and adopt strategic plan, set organizational structures in government and industry to

implement their plan and evaluate the achievements in the light of emerging markets and

technological factors and revise the strategic plan accordingly for the next five to ten years.

The EPB made forecast of export growth targets of less than 4% per year is too pessimistic

for this sector. Bangladesh should forecast to attain a 5-7% growth in export earnings from

leather sector and combine necessary acts together for that purpose

Capital Markets Composition

Year APEX ADELCHI FOOTWEAR LTD APEX TANNERY BATA SHOE

Basic

EPS

NAV per

Share

Net Profit

After Tax

(mn)

Year

End P/E

%

Dividend 

Basic

EPS

NAV per

Share

Net

Profit

After Tax

(mn)

Year End

P/E

%

Divide

nd 

Basic

EPS

NAV

per

Share

Net

Profit

After

Tax

(mn)

Y

e

ar

E

n

d

P/

E

%

Di

vi

d

e

n

d 

2000 13.72 213.76   10.29 14.55 12.00 -9.48 176.76 -14.44 -15.72 12.00

2001 10.61 214.37   7.96 19.72 10.00 16.01 151.39 24.41 10.57 12.00

2002 10.96 215.33 8.22 19.53 10.00 16.65 170.88 25.37 12.61 15.00

2003 18.83 218.75   14.12 12.87 14.00 14.74 394.82 22.47 14.24 12.00

2004 57.43 254.18 43.07 9.11 20.00 11.39 392.65 17.35 29.86 12.00

2005 60.60 292.78 45.45 5.92 22.00 21.30 400.95 32.47 10.51 13.00

2006 66.55 334.33   49.92 6.99 25.00 28.07 412.49 42.78 8.91 15.00

2007 225.81 535.15 169.36 9.61 25.00,

50%B

17.56 430.05   26.76 16.99 17.00

2008 168.74 500.39 189.83 14.13 30.00 16.21 429.26 24.70 82.13 17.00

2009 188.03 653.42 211.53 13.74 35.00 98.18 510.44 149.63 12.48 21.00

2010 202.87 645.39   228.2320.27 40.00 93.74 562.52 142.85 15.82 25.00

2011 n/a n/a n/a n/a n/a n/a n/a   n/a  n/a   n/a