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GLOBAL ECONOMIC CRISIS: IMPACT ON BANGLADESH AND POLICY RESPONSE

Ahsan Mansur

Executive Summary

I. Adverse Impact of the Global Economic CrisisBangladesh economy is significantly linked with the global economy through trade in goods and services.Although Bangladesh financial sector was largely untouched by the global financial crisis, the real economyis experiencing its adverse impacts primarily through three channels: slower export growth; moderation inthe inflow of workers remittances; and dampened investment and consumer sentiment. The second roundimpacts of the crisis are also being felt on the real economy through a general slowdown in overalleconomic growth, slower revenue growth, declining imports and excess liquidity in the banking system dueto slower demand for domestic credit.

Exports slowed down markedly. In the first quarter of FY 09 (Fiscal year starting from July 1, 2008) exports

increased by 42.4% in dollar terms. Reflecting the impact of the global crisis, export growth slowed down toonly 1.54% during October-April 2009 over the corresponding period preceding year. Almost all categoriesof exports, except textile (essentially garments and knitwear) declined at double-digit rates. Textile exportsalso slowed down to only 2.7 % by April 2009. Total shortfall in exports during October-June 2009 isestimated to be about $2.1 billion.

Inflow of remittances, while still growing, is slowing down rapidly. Growth of workers remittances hasslowed down 14.7% during January-March 2009 compared with 43.5% in the first quarter of FY09. Numberof workers going abroad has been declining at an accelerating pace, declining by 38% during January-March 2009. New data on the number of deportees also show a marked increase from 4800 in January toaround 8-9,000 per month thereafter. While no precise estimate of the loss of remittance from the workers is

available, the total amount could be about $0.37 billion, if remittance growth could be sustained at the paceof last fiscal year.

The government is facing significant fiscal constraints because of the shortfall in revenues due to lowerimport payments and slower domestic activity. The shortfall in revenue, primarily from import-based taxeswas already Tk20 billion in FY09. The government has already lowered the revenue target for FY10 to15%, compared with much higher targets set in recent years. However, because of the expected decline inimport values in the coming months--as evidenced through the decline in letters of credit (LCs) opened inrecent monthsthere is significant downside risk in realizing this modest target. The projected shortfallcould be in the range of 3%-5% or equivalent to $230-380 million.

II.

Policy Response through the Budget and the Associated RisksThe stance of fiscal policy is expansionary in FY10 budget, with fiscal deficit increasing to 5% of GDP,compared with 4.1 percent in FY09. This countercyclical stance is appropriate, given the weakness in theeconomy and, if implemented fully, will help boost domestic demand and employment generation. Theresponse is also measured, taking into account the financing constraints from domestic and external sources.The countercyclical stance is to be carried out through planned higher spending on the Annual DevelopmentPlan (ADP), spending under PPP infrastructure projects, and a sizable allocation ($715 million) for helpingthe sectors adversely affected by the global crisis. Combined allocations under these two categories have


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been increased by 65% in order to boosting domestic demand in a reversible manner and at the same timeaiming to reduce the infrastructure gap. While the expansionary stance as envisaged in the budget isappropriate, for this to have a positive impact on domestic demand the investment plan would need to beimplemented effectively.

The task however would not be easy. First, the planned surge in ADP spending, reversing the decliningtrend in recent years, would be a challenging task. It will require significant strengthening ofimplementation capacity, perhaps some modifications in the procurement rules, and close monitoring of theimplementing agencies. Second, any shortfall in revenue and/or external financing would limitgovernments ability to finance the spending plan due to crowding out of private sector credit.

About 15.2% of total non-development and development budget (2.5% of GDP) has been allocated for thesocial safety net and social empowerment programs. The existing safety net programs have beenstrengthened and some new programs have been introduced. Total allocation to the safety net andempowerment programs has been increased by 25.2% in the FY10 budget.

I. Sound Macroeconomic ManagementSound macroeconomic management has always been the central focus of successive Bangladeshgovernments, despite frequent external and domestic shocks. The current budget and the associated policiesare in line with this tradition. Inflation is currently at about 5%, and after allowing for a modest pickup withthe rebound in global commodity prices, has been targeted to be limited at 6.5% in FY10. Monetary policy,while being accommodative as announced by the Bangladesh Bank, would need to be proactive and prudenttaking into account the developments in the domestic economy.

Fiscal management in Bangladesh has always been prudent, and the expansionary stance of FY10 would nothave any significant impact on debt sustainability of Bangladesh. Debt sustainability analysis prepared bythe IMF indicates that Bangladeshs primary deficit has always been less than what is required for

stabilizing public debt in relation to GDP and that performance is likely to hold in the future, pointing to asteady decline in the total public debt to GDP ratio from 46.5% in 2007 to only 33.1% by 2028.The outlook is even better from external debt sustainability perspective. The present value of external debtis projected to decline from 17.1% of GDP in 2007 to only 8.8% of GDP by 2028, despite a steadyreduction of the grant element of external debt by 10 percentage points to 38% over this period. The debtservice-to-exports ratio, currently at about 5%, is also projected to decline to only 2.5% by 2028.

The two major risks to the macroeconomic management arise from possible shortfalls in revenue collectionand in the ambitious target for mobilization of external financing. Domestic financing requirement, asenvisaged in the budget, is already quite high at 15 percent of beginning stock of broad money. The targetfor external financing is already very ambitious at $2.6 billion in FY10, compared with the historical

average of $1.8 billion. Any shortfall in external financing from this target will force the government to cutADP spending to protect private sector credit, thereby undermining the governments expansionary fiscalstance.

GLOBAL ECONOMIC CRISIS: IMPACT ON BANGLADESH AND POLICY RESPONSE

I. Introduction


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Bangladesh economy is significantly linked with the global economy through trade in goods and services.However, its financial sector was largely untouched by the financial crisis that hit the financial institutionsof major industrial economies, because of its tight capital control and limited linkage of its financialinstitutions with the rest of the world. As the financial crisis hit the real economy across the globe,

Bangladesh economy also started to experience the adverse effect primarily through three channels: slowerexport growth; moderation in the inflow of workers remittances; and dampened investment and consumersentiment. The second round impact of the crisis is also being felt on the real economy through a generalslowdown in manufacturing activity, slower revenue growth, declining imports and excess liquidity in thebanking system (due to slower demand for domestic credit).

The Government has set up a high-level task force to monitor the impact of the recession and recommendmeasures to assist the vulnerable sectors of the economy in coping with the crisis. The Government hadannounced a preliminary package of measures in April 2009 to boost business confidence by providingfinancial support to selected affected sectors. A sizable amount of resources have also been committed in

the FY10 budget (fiscal year beginning in July 1, 2009) to support the adversely affected sectors of theeconomy. The stance of fiscal policy has also been made expansionary in order to boost domestic demandprimarily through higher spending on capital program and social safety net.

The objective of this study is to: identify the channels through which Bangladesh is being impacted by theglobal economic recession; assess its impact on various sectors of the domestic economy; and the size andappropriateness of the authorities policy response, with particular focus on the policy stance announced inthe new budget. The paper also identifies the major uncertainties on the macroeconomic front due to thecrisis and the risks in implementing the expansionary fiscal stance announced by the government.

The paper essentially concludes that while Bangladesh financial sector was largely bypassed by thefinancial crisis, the adverse impact on the domestic economy through trade and remittance channels havealready been quite significant and likely to further intensify in the coming months. The governments policy response has been measured and appropriate taking into account the financial constraints it isoperating on the fiscal front. The major risks in implementing the governments countercyclical fiscalstance comes from its limited capacity to implement the ambitious investment program, and potentialshortfalls in achieving the budgeted revenue target and in mobilizing the stipulated external financing.Increased external financing would certainly enhance the governments capacity to respond as plannedwithout undermining continued macroeconomic stability.

II. Background

Despite numerous shocks of external and domestic origin, Bangladeshs economic performance has beenimpressive in recent years. Significant gains have been made on both macroeconomic front and social sectordevelopment including poverty alleviation. Real economic growth has been sustained at around 6 percentrate, inflation averaged around 5-6 percent except during the commodity price shock of 2008, and externalcurrent account balance been consistently in surplus due to buoyant export and remittance inflows. Gains onsocial indicators have also been impressive although much remains to be done with 40 percent of population


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still below the poverty line.

The macroeconomic performance is the outcome of prudent demand management policy pursued byvarious governments over a sustained period. By limiting the level of fiscal deficit in relation to GDP well below the level considered debt stabilizing, both the debt-to-GDP and debt service ratios have declined

significantly over time and are currently at levels considered enviable for any developing country. Soundmacroeconomic management has enabled the country to withstand major external shocks while sustainingits growth momentum. The economy was severely tested in FY08 when it passed through two rounds offlood, hit by the catastrophic major cyclone Sidr with major loss of life and destruction of property andcrops, and the external shock resulting from surging petroleum and other commodity prices. Despite thesenumerous shocks, which impacted Bangladesh more than any other comparator country, the economyexpanded by 6 percent and recorded a sizable external current account surplus.

The economy rebounded very strongly since the beginning of 2008 and gained further momentum in thefirst quarter of FY09 (July-September 2008) before the starting of the global meltdown. In this quarter,export receipts grew by almost 42.4 percent, import payments increased by 34.9 percent, workersremittances surged (43.5 percent), private sector credit expanded rapidly (26.5 percent), and firms were inthe midst of expanding their production capacity. The overall bullish environment was also reflected in the


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index of manufacturing which increased by more than [12] percent and term lending for investment(increasing by 30 percent).

Up until the end of first quarter, all indicators were pointing to a robust macroeconomic outlook for FY10with growth reaching up to 7 percent and containing inflationary pressure was the only major challenge for

the government. Governments intensified efforts to boost agricultural output was also paying dividend withsuccessive bumper rice crops. Bangladeshi textile exporters were solidly booked and looking forward to arecord year. Upsetting this bright outlook came the global economic crisis in October 2008. Initially therewas a general perception that Bangladesh would be largely spared given its limited linkages with the globalcapital market. However, as the crisis moved from the Wall Street to the main streets of the United States,its impact started to be felt in Bangladesh.

I. Key Channels of Transmission: First Round EffectsIt is generally agreed that the direct impact of the crisis on the Bangladesh economy, if any, is to be feltprimarily through three channels: financial sector contagion; foreign trade; and workers remittances. Theextent of transmission however depends on the linkage and exposure of the sector to the rest of the world.

a. Financial sector contagion

Bangladeshs financial sector did not experience any turbulence arising from the meltdown in the globalfinancial sector due to its limited connectivity with the international financial system. Extensive capitalcontrols, strict guidelines on net foreign exposure of the Bangladeshi financial institutions, and controls onquality/types of investments that financial institutions are allowed to make limited the exposure ofBangladeshi financial institutions and their potential losses. The prompt steps taken by the BangladeshBank by asking all financial institutions to deposit their foreign assets with it and converting them to safeassets helped minimize any loss from the collapse of many international financial institutions. Thesedevelopments notwithstanding, because of the sharp movements in the exchange rates among major

currencies, Bangladesh Bank had to incur a sizable valuation loss in its holding of foreign assets. In theimmediate aftermath the amount of the valuation loss was estimated to be more than $800 million.

Stock markets in Bangladesh suffered only moderate losses relative to its global counterparts. At the peak ofthe global financial meltdown when major stock markets lost almost one-third to half of their marketcapitalization, Dhaka Stock Exchange (DSE) was hovering in record territories. This development wasattributable primarily to the following factors:


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y Limited foreign investment in the Bangladesh assetmarket. Foreign investment in the stock market wasestimated to be only about 3 percent. A large part of thisforeign portfolio investment reportedly moved out of thestock market .However, since the overall exposure was

relatively small, its impact on the domestic market wasnot noticeable.

y There was a general perception that Bangladesh economywill weather the financial sector meltdown because oflimited or no exposure to toxic assets and the export sectorbeing protected by the so called Wall Mart Effect.

y Real estate sector in Bangladesh is not at all leveragedand did not experience any softening in prices, despiteunprecedented appreciations (ranging between 250-350percent)recorded in recent years.

y Profitability of the banking sector, the most important component of the financial sector, has

improved significantly (Table 2) and expected to remain healthy despite the global recession. Theamount of nonperforming assets of the banking system has steadily declined in recent years throughbetter risk management and quality control and was not expected to deteriorate despite the globalcrisis.


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Since the financial sector inBangladesh, dominated bycommercial banks, has not beendirectly affected by the crisis abroad,there was no liquidity and financial

crisis in the domestic economy.Deposit growth and credit demand both remained healthy (Table 3) andasset quality was not adverselyaffected by the first round impact ofthe crisis. There was also no visibleadverse impact on the availability oftrade financing for Bangladeshiexporters and importers. The declinein trade flows in dollar terms wasprimarily due to the global collapse in

commodity prices and the associatedreduction in the amount of letters ofcredit for export and import shipmentsin value terms. The decline in creditgrowth in recent months is primarilyattributable to lower commodityprices (depressing value of trade) andslowdown in exports (see below).


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b. Foreign trade

After a very strong first quarter, exportsslowed down markedly since October2008. Almost all categories of exports

registered a marked slowdown(readymade garments and knitwear) ora sharp decline (almost all exportsexcept textiles). Total export receiptswere sharply slowed down after thefirst quarter of FY09 (fiscal year beginning July 1). During the periodOctober to April 2009, export growthslowed down to only 1.5 percent. Inparticular, in the month of April 2009,export receipts declined by 2.5 percent

(Table 4).

The extent of the fall in export receipts,the speed of the fall, and the broad basewere unprecedented in Bangladesh, andcan only be explained by the externaldemand and price developments. A product-by-product trend analysis, based on actual monthly data of recent years through September, and comparing the trend with post-September export outturns, provides a basis for estimating the export shortfall resulting from the globaleconomic crisis. During the first quarter (July-September) most categories of exports exceeded the trend by

significant margins. The total excess over the trend is estimated to be $523 million during July-September2008, pointing to a very strong outlook for export receipts.


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The outlook changed sharply since October2008, with the beginning of the economic crisisin the industrial countries (the majordestinations of Bangladeshi exports). In the period since October 2008, all categories of

exports fell significantly (middle panel of Table5). And the cumulative shortfall through Aprilbased on actual outturn is estimated to be about$1.6 billion relative to its recent trend. Three-fourths of the shortfall is attributable to textileproducts and other exports categories, while allother important export categories also recordedsignificant shortfalls. The panel charts forvarious commodities [Boxes 1(a) & 1(b)]clearly show how conspicuous has been thedrop in exports of various major exports

relative to their respective trend lines.Recent developments and a review of otherindicators, point to a continued decline inexport receipts through the end of FY09 (end-June) and the cumulative export shortfallthrough June 2009 is estimated to be about $2.1 billion. Because of the relatively better performance of the textile sector, whichaccounts for two-thirds of Bangladesh exports,

the shortfall from this sector was limited to less than $800 million during October-June 2009 period. Overthe same period, the shortfalls on account of frozen food ($197 million), jute and jute goods ($144 million),

leather ($114 million), and agricultural products ($46 million) were also sizable.


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National minor export items like ceramics, lightengineering products, pharmaceutical products,handmade arts and crafts, etc. registered the mostdrop in value. The estimated shortfall in thesenontraditional products, which despite theirnarrow base were experiencing rapid growth inrecent years, is estimated to be almost $800million during this period. This more than one-third shortfall in the export of these products is asignificant blow for these promising Bangladeshiemerging exports.

It is noteworthy that, Bangladesh textile sectoris the most competitive in the world despitenumerous bottlenecks on the domestic frontand the sector was able to increase its relativeshares in the European Union and US marketsduring the crisis. Despite the slowdown intextile exports, Bangladeshs relativeperformance has been very strong. It has beenthe best performer among all textile exportingcountries to the EU and US markets, allowingit to improve its relative position vis--vis itscompetitors.(Table 6 and 7).


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c. Workers remittances

Inflow of workers remittances, while still growing in dollar terms, is decelerating rapidly and the numberof workers going abroad has declined sharply. Growth of workers remittances has slowed down to [15.5]percent during January to June 2009, compared with 43.5 percent growth recorded in the first quarter of FY09. (Table 8) The slowdown in remittance is attributable to the decline is the numbers of workers goingabroad every month since December of 2008.

Monthly rate of departure declined from 91,999 in January2008 to 38,568 by June 2009 (Table 9). Much of the increasein the growth of workers going abroad during 2007-2008originated from the GCC countries following the oil pricesurge. The decline in the number of workers going abroad inrecent months also originated from the GCC countries in theaftermath decline in oil prices due to the global recession.Cutbacks and postponement of investment plans in the GCCcountries have contributed to this reduction in labor demand.

The continued growth in inflow of remittances is attributable tothe lagged effect of the large number of workers who left thecountry through October/November 2008.Generally it takesseveral months before the workers start remitting money home.After calling for this lag, the growth rate of remittance shoulddecline further in the coming months. On the possible side,overseas employment to countries other than the GCC and

European countries to remain buoyant increasing to around 90,000 persons per month.


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I. Second Round Effects of the Crisis

The adverse impact of the marked slowdown in export and remittance growth is spreading on to the broader domesticeconomy. Exports and remittances together amount to more than one quarter of Bangladesh GDP and have been theimportant factors contributing to domestic growth. Millions of ordinary Bangladeshi households across the countryare the direct beneficiaries of remittance inflows and a large part of domestic demand expansion also depends on suchinflows.

The uncertainties about economic outlookcreated by the global economic crisis havecontributed to slower investment by the privatesector. Even the firms which are expandingtheir volume of production arepostponing/delaying their investment programs

in order to ride out the rough time in the globaleconomy. Reflecting this sentiment, demandfor industrial term loans decreased by 9.6 percent during July-March FY09 comparedwith a 66 percent increase recorded in thecorresponding period of preceding fiscal year(Table 10).

The government is also facing a significant taxrevenue shortfall due to lower imports andslower domestic activity. The revenue

performance was in surplus during Jul-Sep2008 but thereafter sharply turned into agrowing shortfall. The shortfall in tax revenue, primarily from import-based taxes, was more

than Tk 20 billion in FY 09. After achieving record growth in revenue in FY08 (27 percent), thegovernment set the NBR tax revenue target at Tk. 545 billion for FY09. At that time it was envisaged thatthe targeted NBR revenue growth of 15.5% was not ambitious compared with its recent performance. In theevent, NBR achieved 12.2 percent growth through May 2009, compared with 23.8 percent in thecorresponding period in FY 2007-08. All major taxes recorded sluggishness growth after September 2008(Figures 3 and 4).


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The government responded to theslowdown in economic activity with amodest incentive package. In March2009, a fiscal stimulus package in theamount of Tk 34.2 billion was

announced by the government to supportthe sectors adversely affected by theglobal meltdown and also to support theagriculture sector. As part of thepackage, cash incentives were increasedfor adversely impacted sectors likeleather (2.5 percentage points to 17.5 percent) and frozen foods (2.5 percentage points to 12.5 percent).Totalallocations for the export sectors was Tk.4.5 billion. Larger allocations were made

for agriculture, power and Social Safetynet Programs under the special incentive package (Table 11). The package alsoallowed for greater flexibility withrespect to repayment of bank loans forall manufacturing exporters. Fundingsunder different special refinancingschemes were also increased for thesmall and medium enterprises and the housing industry.

I. Macroeconomic Outlook and Budget for the Next Fiscal Year

The macroeconomic outlook for FY10 remains difficult. All indicators of domestic and global origins pointto a slower first half followed by a possible rebound in the second half of FY10. The government hasannounced the budget for the new fiscal year (FY10) on June 11. This is the first budget of the newgovernment reflecting their election promises. This is also the first budget prepared against the backdrop ofthe global financial and economic crisis. These two issues make this budget a special one, and the budgethas taken these factors into account through an expansionary fiscal stance. The analysis presented belowindicates that, while the expansionary stance is appropriate under the current sluggish macroeconomicenvironment, major challenges lie in implementing the large investment programs envisaged under theAnnual Development Plan (ADP) and the new initiative under public private partnership (PPP)

arrangement. The possibility of crowding out of the private sector may also undermine the governmentsintended fiscal stance.

a. Macroeconomic setting

The two most important macroeconomic parameters anchoring the budget are real economic growth and the general


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price level. The target rates for economic growth and inflation are 5.5 percent and 6.5 percent respectively.Considering the state and pace of recovery of the world economy, domestic investment climate, domestic demandsituation and developments in commodity prices these two targets appear reasonable. Projections suggest that overalleconomic growth during the first half and second half of FY10 will be around 5 percent and 6 percent, respectively,leading to an average annual growth of 5.5 percent. During the last fiscal year, agriculture grew at 4.6 percent whichis almost 1 percentage point higher than its historical

average of 3.6 percent (Table 12). Following three consecutive bumper rice crops, agricultural growth isalso likely to return to its historical average in the next fiscal year. Farmers not getting the right price fortheir most recent rice crop may also act as a negative incentive for higher agriculture output.


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Manufacturing sector performance is significantly dependent on export sector developments and thusindirectly on the health of the global economy. It is projected that world economy would continue tostruggle/shrink in the first half of FY10 before moving to a recovery phase. In the mean time , bothdomestic and foreign demand for Bangladeshi products are expected to remain subdued due to slowergrowth in remittance inflows and lower demand for exports leading to a slower manufacturing growth (5

percent) in this half. The world economy is expected to enter into a recovery phase in the second half ofFY10, which should contribute to a rise in aggregate domestic demand (through higher exports andremittances) and a consequent rebound in manufacturing sector growth to 7 percent.

A review of growth projections of some neighboringand emerging economies also supports governmentscautious growth outlook for the Bangladesh economy.In particular, growth projections for FY10 compared tothe pre-financial crisis period (i.e. FY08) arerespectively 2 and 2.5 percentage points lower for

India and Pakistan. The corresponding projections forChina and Vietnam are respectively 4.5 and 2percentage points lower. In this context, the projectedslowdown in Bangladesh by 0.7 percentage point inFY10 compared to the pre-crisis year, although mayappears somewhat optimistic, essentially reflectsBangladeshs better performance relative to othersduring the global meltdown (Figure 5).

a. Policy response through the budget

By setting the fiscal deficit at 5% of GDP, the budget aims to inject additional stimulus amounting to aboutone percent of GDP into the economy. This stimulus would largely result from the planned ADP and PPPspending. These two items in the budget together, if implemented fully, would amount to a 44 percentincrease in government capital spending. From a demand management perspective, such a boost in spendinggrowth would be most desirable since it would be easily reversible when the economy rebounds. In additionto boosting domestic activity, the planned spending (if executed effectively) will also help reduce theinfrastructure gap and contribute to future growth potential.

Consistent with the governments political commitment to alleviate poverty, about 15.2 percent of total non-development and development budget (2.5 percent of GDP) has been allocated for the social safety net andsocial empowerment programs (Table 13) The existing safety net programs have been strengthened andsome new programs have been introduced. The major components of the social spending programs includecash transfer programs; food security program; microcredit


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program; employment generation program; and stipend program for students. Total allocation to the safety

net and empowerment programs has been increased by 25.1 percent in the FY10 budget.

Coverage of poor people under the direct cash transfer programs has been increased by 42.4 percent to 7.5million persons. Total allocation for this purpose has been increased by 12 percent to Tk 54.7 billion in theFY10 budget. Allocations for food security programs have been increased by 11.3 percent to TK 58.8billion to cover almost 89 million people through open market sales, vulnerable group development (VGD),and vulnerable group feeding (VGF), test relief and other programs. The newly created employmentgeneration program for the ultra poor received TK 11.8 billion to offer employment for 4.9 million personsfor a certain period. Spending through the development budget under the stipend program (Tk 11 billion)and nutrition program (Tk 2.4 billion) have been increased by 22 percent and 36 percent, respectively.

The government has also announced to continue the incentive package announced in April 2008 through thenext fiscal year and expand that further based on how the situation evolves. To this end a Tk 50 billion fundhas been established in FY10 budget. This consolidated fund will allow the government to have thisflexibility in its operation and respond to the problem faced by different sectors in a timely manner. Thecash incentives announced in the first stimulus package will also continue and the funds will be disbursed insix-monthly instruments through Bangladesh Bank. The power sector is also expected to get a substantialpart of the stimulus package.


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Risks in Achieving Fiscal Objective

The Expansionary Fiscal Stance May beUndermined by the Implementation Challenge

The challenge lies in effective implementation. Inrecent years, ADP implementation has always beenmuch lower than its targets. The size of ADP hasdeclined by half in relation to GDP over the years. Areview of the last five fiscal years actual against thetargets suggests an average 15 percent shortfall in ADPimplementation. The key factors contributing to theunsatisfactory implementation of the ADP are: (i)complex procurement policy; (ii) inadequate capacityof the implementing agencies; and (iii) a lack of proper

monitoring of the agencies implementing the ADP.Because of these constraining factors, ADP utilizationhas always fallen short of the target, and failed to growin line with the growing needs of the economy.Certainly this declining trend in public investment must stop, and efforts need to be taken on theimplementation side. The government may need to reexamine the procurement policies and rationalize themas appropriate without compromising on the necessary safeguards. Efficiency of the governmentimplementation ministries and agencies must be enhanced by strengthening their administrative capacityand accountability. Finally, close monitoring of the agencies implementing the ambitious ADP programwould be needed for the program to reach its target level. Otherwise, actual ADP implementation wouldonly be limited to around Taka 260 billion in FY10.

As a new and welcomed initiative PPP has its own challenges

The current process of project selection and implementation based on the ADP framework has proved to beincreasingly ineffective in meeting todays challenges. While the ADP model for providing publicinfrastructure investment worked during the 1970s and 1980s--when domestic resource base was small andthe country was largely dependent on foreign multilateral and bilateral assistance to carry out its publicsector investment program--it is increasingly apparent that this approach is no longer an adequatemechanism. Recognizing the limitations of traditional ADP-based approach for delivery of power and otherinfrastructure, the government has rightly embarked on the new PPP initiative. The initial allocation for this

purpose is respectable at Tk 25 billion (about $350 million) and the government is committed to add more,if needed. By leveraging private sector investment under various modes of PPP operations and risk sharing,if effectively executed, the program should be able to catalyze more than $1 billion in new investment (Box2).

Effective and prompt launching of the program however would be extremely challenging. The major taskswould include: putting in place the proper regulatory framework either by revising the current Private SectorInvestment Guideline (PSIG) of 2004 or enacting a new PPP Law; establishing the PPP Cell with proper


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institutional framework, manpower support, and resource base; considering the issues relating to aseparate tax incentive regime for PPP projects; and putting in place the viability gap funding mechanismsto attract private sector investment in the socially desirable infrastructure projects.

Only after these initial steps are in place, the government would be able to attract private sector investment

by addressing other important issues like: ensuring competitiveness and transparency in the bidding process,investment pricing and financing aspects, and careful matching between asset and liability and cash flow.The government has to develop technical capacity for reviewing the financial and economic viability of PPPprojects because success will depend largely on aspects relating to costing, pricing and risk sharing. Thelegal framework would lay down the obligations of the private sector partners, allow provisions for costrecovery, and address compensation and redress mechanisms. The success will ultimately depend onestablishing comprehensive policies and regulatory frameworks for competitive and transparent bidding,appropriate risk sharing and financial returns, and dispute settlement mechanism.

BOX 2. Why PPP in Bangladesh?

Shortfall in infrastructures investment: Currently Bangladesh invests about 24-25 percent of GDP and thelevel of investment has stabilized at that level over the last [5] years. With this level of domestic investment,Bangladesh has sustained its GDP growth at about 6 percent. Boosting GDP growth to a higher trajectory of8-10 percent will require additional investments of about 10-12 percentage points to 35-37 percent of GDPby 2021 (Chart 1). A large part of that additional investment should also go to the infrastructure sector,given Bangladeshs huge investment gap in the infrastructure sector. Bangladesh lags behind its mostregional comparators in terms of provision of basic infrastructure services (Table 1).


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International Experience with Infrastructure Investment:Most emerging economies have successfully tapped privatesector funding for infrastructure investment (Table 2). InBangladesh, virtually no private investment has taken place

outside the telecom sector. The one billion dollar investmentin energy though 2007 pales compared with the levels ofinvestment in China and India. Private sector investment inemerging market infrastructure is a relatively new but arapidly growing phenomenon. The amount of investmentcommitments to infrastructure in emerging markets withprivate participation has almost tripled in dollar terms tomore than $150 billion by 2007.Bangladesh has almostcompletely missed out on this account.


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The outlook for infrastructure investment in emerging markets is remarkably bright (Table 3). According toMerrill Lynch, emerging markets estimated annual infrastructure investment will reach $2.2 trillion during2008-11. China leads the pack with annual infrastructure investment of $725 billion, followed by GCCcountries, Russia, India and Brazil. The renewed thrust on infrastructure in China and India, the two largestregional economies and the two fastest growing economies in the world, are particularly noteworthy.


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What is the Lesson for Bangladesh?Bangladeshs private sector, which currentlybears the major burden of investment (19% outof 24% of GDP) but has played only a minor rolein building infrastructure will have to be

mobilized to share a larger portion of futureinvestment in power, port, and transportinfrastructure. The private sector could beinvolved in various PPP modes, such as Build,Own and Operate (BOO) or Build Own andTransfer (BOT) basis. In the Bangladesh context,it would not be reasonable to expect ODAinflows of more than $2.5 billion a year over thelong term. In this scenario, PPP format holds thebest prospect both as an effective alternative formobilizing adequate resources for implementing

large or small infrastructure projects of thefuture.


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Other challenges in the budget complicating its management

While implementation of the investment programs under the ADP and PPP arrangements will remain majorhurdles, there are a number of other risks associated with the budget. The first area to look for is on therevenue side due to the current weakness of the economy. The other area of concern is on the externalfinancing side. These two factors together could pose a major problem for the private sector since the

combined shortfall may seriously crowd out private sector borrowing.

How realistic is the revenue target?

In the coming fiscal year when the government needs the most revenue to finance its ambitious spendingplans, revenue potential will be constrained by two factors: (i) growth in NBR taxes would be subdued dueto lower import prices and the effect of slower economic growth as it has already happened in FY09; and(ii) a lower nontax base after adjusting for the one-time factors like a large transfer from the Bangladesh


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Telecom Regulatory Authority. Furthermore, domestic demand would also be less buoyant because ofslower growth in remittance inflows.

Accordingly, revenue growth is not expected to be more than 10-12 percent, even with some measures to

increase revenue. The budget aims to realize a higher proportion of tax revenue from domestic based taxes(i.e. income tax and domestic VAT), and that is appropriate from both short-term macroeconomicperspective and longer-term fiscal strategy. Accordingly, the budget expects to increase the share of incometax by 3 percentage points to 27percent [Figure 8(a) & 8(b)]. This shift in emphasis would need to besustained over a very long time, since at 73 percent the share of indirect taxes in Bangladesh is highpointing to a regressive structure of the tax system.

The budget however targets a 15% increase in NBRrevenue. Although this may appear significantly lower

than the growth rates set in the last five budgets, thistarget is ambitious under the prevailing macroeconomicenvironment. In recent budgets, growth in NBR revenuewas set between 17 and 19 percent and in almost everyyear (except FY08 due to special factors) growth in taxrevenues fell well short of their targets by significantmargins (Figure 9). The 15% growth rate would bedifficult to achieve due to falling import values in the firsthalf of the fiscal year. Other factors like slower economicgrowth and the potential incentive for evading/hidingtaxes to take advantage the 10% tax on undeclared/illegal

income instead of paying taxes at much higher legal rateswould also contribute to slower revenue growth.


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Crowding-out of the private sector is a real concern ofthe business community

Outstanding Debt, % of GDP

Debt Services, % of Export earnings

Because of the lack of depth in the financial system, the main problem that the authorities often face is notthe level of fiscal deficit but the financing of the deficit in a noninflationary manner. Debt sustainability isnot a major issue in Bangladesh due to the declining trend in public debt with respect to GDP. However,because of the relatively narrow base of the financial sectorwith financial assets to GDP ratio being oneof the lowestthe government is extremely constrained in its reliance on domestic financing of the budget.Traditionally, this problem has been addressed through reliance on external financing. This year will be noexception, although owing to the larger size of the deficit, the dependence on both domestic and foreignfinancing will be correspondingly higher.Ambitious spending plans, combined with an optimistic revenue target, have accentuated the risk for the budget deficit to exceed the 5 percent of GDP target leading to a correspondingly higher borrowingrequirement. A significant part of the budget deficit is expected to be financed from external sourcesrequiring the government to secure $2.6 billion in grants and loans. In the historical context level offinancing target is very high and any shortfall in realizing this would also lead to a further higher borrowingrequirement from the domestic banking system. Scenarios based on projections for monetary aggregates(Table 14) demonstrate that the large deficit financing from the banking system as envisaged in the budgetwould seriously limit the availability of credit for the private sector. Estimates based on 15.5 percentexpansion in money supply (i.e. broad money M2) as envisaged in Bangladesh Banks Monetary Policy

Statement, and allowing for government borrowing of Tk. 167.5 billion from the bank system as envisagedin the budget, would limit private sector credit growth to only 10.2percent in FY10. This scenarioessentially rules out Bangladesh Banks ability to contain monetary expansion below this level in the eventinflationary pressures accentuates.


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It does not require much imagination for one to conclude that, in the event of a significant shortfall in

external financing, the government would be forced to cut its spending plan. An average historical level ofexternal borrowing amounting $1.8 billion per year, would lead to a correspondingly higher governmentborrowing requirement from the banking system. As shown in last column of Table 14, a borrowing level ofthis magnitude is simply not possible without sharply reducing private sector borrowing from the bankingsystem. Certainly such a scenario is not conceivable and will force the government to reduce its spendingsharply.

I. How to Mitigate the Risks

As discussed above, there are two types of risks to the governments injection of stimulus into the economy.First, is the failure to carry out the investment plan in the manner stated in the budget; and Second, thetensions between the intended expansionary fiscal stance and the objective of providing for adequate bankfinancing (credit) for the private sector within the overall monetary policy framework (on the assumptionthat government succeeds in implementing the announced ADP and PPP programs). At present governmentadministrative machineries are not geared up for carrying out the investment plan, real economic activity issluggish, and banks are awash with excess liquidity. Although the possibility of such tensions may appearremote under these circumstances, things are likely to change very rapidly once the real economy picks up


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by early 2010 and the government administrative machineries gear up for implementing the investmentprograms. Mitigating these two risks will be the key challenge.

a. Boosting governments capacity to implement the ADP

The government is fully cognizant of the implementation challenge because of the ambitious size of theADP. Accordingly, the authorities are proceeding with the following approach:

y Reforming the time consuming and complex approval process for project approval.

y Emphasizing advanced procurement plans to ease the difficulties to some extent and alsoconsidering some amendments in both the Public Procurement Rules (PPR) and Public ProcurementRules (PPR).

y Paying greater attention to the efficiency of project directors, given their crucial role in projectimplementation.

y Bringing the 10 ministries, which implement 78 percent of the ADP, under some special andintensive monitoring arrangement

y Monitoring some of the major projects through Critical Path Method process by establishing a taskforce.

These initiatives notwithstanding, the task will be difficult and only time will prove to what extent thegovernments efforts would be successful in this regard. The authorities would also need to be careful, whileamending the PPA and PPR, so that adequate safeguards remain in place to ensure proper utilization of theresources.

b. Effective Operationalization of the PPP program with proper safeguards

The Finance Minister in his Budget Speech outlined in broad terms the new PPP Strategy for leveraging

public resources with private sector capital to meet Bangladeshs growing infrastructure gap. Specifically,the key elements of the new framework included Tk 21 billion ($294 million) allocated to a new institutionto be set up called Bangladesh Infrastructure Investment Fund (BIIF), Tk 3 billion ($42 million) to aViability Gap Fund (VGF) and Tk 1 billion ($14million) to a PPP technical assistance fund. All these are tobe coordinated through a PPP Cell that will be established within the Ministry of Finance (MOF).

Although no further detail was announced, the Finance Minister made a commitment in his budget speechstating: According to our plan we hope that the PPP budget management will be fully operational bySeptember next. This target, while appropriate, is certainly very ambitious. The issues are complex and

challenging on many fronts including risk transfers between the public and private sector in draftingconcession agreements, limited capacity within government ministries, financial structuring and financingas well as developing a good pipeline of bankable projects.

It will be critical to secure some early PPP successes by putting in place a transparent and efficient systemwithin the stipulated timeframe. Successful implementation of a few PPP projects will instill confidence in


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the PPP process. It is only by working through the gradual process and by gaining experience; BangladeshsPPP framework and operations will be firmly established. Certainly the process will evolve and mature overtime and past experience will guide the future evolution/direction.

There should also be a programme of education and training not only within government but also involvingthe private sector, both in terms of prospective infrastructure sponsor companies as well as financialinstitutions that may provide debt finance. There is also the need for an effective two-way flow ofinformation between the private sector and PPP policymakers.

The authorities are already working on a short-term program aimed at implementing the necessarily legaland administrative steps by the stipulated September 30, 2009 deadline. Some important issues which wouldrequire careful deliberations in the context of putting in place an appropriate PPP framework include:

y Assessing the appropriateness of the current Private Sector Investment Guideline (PSIG) of2004 and the specific recommendations for making it more functional and investor friendly inorder to achieve the objectives stated in the 2009/10 budget speech and the background policypaper of the Ministry of Finance. Will Bangladesh need a separate PPP Law eventually? Theassessment should be based on national and international experience with PPP projects.

y The likely role, objectives and staffing of the proposed PPP Cell and its interactions with therelevant government line ministries and agencies.

y Preferential Tax regime(s), if any, to be offered to various types of PPP projects.

y Issues related to the Viability Gap Fund (VGF) and the Bangladesh Infrastructure InvestmentFund (BIIF) based on international best practices.

y Preparation of a program for launching the process of education/two-way information flow withthe private sector starting with initial discussion seminars with various channels at federations.Outlining the content and structure of the PPP website: www.PPPinBangladesh.com

In ensuring the long-term growth and sustainability of Bangladeshs PPP program, it is critical that theregulatory framework and operational guidelines are drafted appropriately with careful consideration ofissues such as transparency and integrity of the PPP process, risk-sharing between the public and private


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sectors, need for a preferential tax and tariff regimes, if any, for the PPP projects, and effective monitoringand enforcement of contract terms. Incorporating global best practices in resolving/addressing theseimportant issues would help put the PPP program on a right track. Bangladeshs development partners (likeADB and World Bank IFC) can play important catalyzing roles in this regard, by sharing their expertise andexperience with the Government of Bangladesh.

c. Securing external financial assurance for the budget

The problem will certainly be more acute if there is a significant shortfall in the non-project components offoreign financing. The budget envisages Tk. 35 billion ($500 million) as special support/credit fordevelopment. The authorities expect to secure this amount from the Asian Development Bank (ADB) andthe World Bank as budget support. Discussions are underway with both institutions in this regard.

The authorities are also aware of the potential shortfall in revenue arising from the slower economic growthand disbursement in project aid. Accordingly, they have also initiated discussions on securing funding underthe ADBs newly established Countercyclical Support Facility. They are of the view that if their effortssucceed in getting more external financing for budget support, it would help them offset, at least in part, anypotential shortfall in revenue and help reduce governments recourse to domestic bank financing.

This additional financing through CSF will reduce the potential crowding out of the domestic private sectorcredit by reducing government borrowing by an equivalent amount. As shown in Table 14, disbursement of$500 million under the CSF will reduce bank financing requirement of the government TK 35 billionallowing for credit to the private sector to increase to 11.9 percent in FY10 within the same overallexpansion limit of broad money (15.5 percent)as targeted under the Monetary Policy Statement. Even underthis scenario, there any significant shortfall in tax revenue, the government would not be able to help avoida severe squeeze on private sector credit. Then the government should make efforts to secure additionalfunding from other sectors.

Macroeconomic management in Bangladesh has always been prudent, and the proposed increase inborrowing under the CSF will not have any significant impact on debt sustainability. IMF debt sustainabilityanalysis indicates that Bangladeshs primary deficit has always been less than what is required forstabilizing public debt in relation to GDP and that performance is expected to hold in the future, pointing toa steady decline in the debt to GDP ratio from [46.5] percent in FY08 to 33 percent by FY 28. The proposedCSF financing will not have any adverse impact on the overall (total) public debt level of Bangladesh, sinceit will only change the composition of public debt. Foreign component of public debt will go up by $500million, while domestic borrowing requirement and consequently domestic debt will be lower by anequivalent amount.

On debt servicing, the change in the composition of public debt in favor of foreign debt as a matter of factmay have a favorable impact in two important ways:

y Interest payments on external debt would be less than the interest payments on borrowing fromdomestic sources by issuing debt of equivalent maturity. Interest rate on 5-year domestic debt


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instruments is 12.5 percent while the rate of interest payable on CSF borrowing would be about [5]percent. Although there is uncertainty about the movement of the interest rates during the 5-yearperiod and there could be costs associated with exchange rate movements, the spread between thedomestic interest rate and the CSF borrowing rate is wide enough to make it less costly to borrowfrom the ADB source.

y By allowing more credit to flow to the private sector and also facilitating capital spending by thegovernment sector, the CSF would also allow for a more effective execution of the countercyclicalfiscal policy announced in the budget and thereby boost domestic activity. Such positive economicimpacts would also enhance public sectors capacity to service debt.

Servicing of external debt however will increase. But that should not be a problem, given Bangladeshslow and declining external debt service ratio, comfortable and growing levels of official foreignexchange reserves of the central bank, its track record of strong balance of payments positioncharacterized by both external current account and overall balance payments surplus positions.

a. Initiating structural reforms to mobilize revenue and bringing abouta structural shift in the composition of tax revenue

Bangladeshs tax-to-GDP ratio is one of the lowest in the world (Table15). This is the most important weakness of the Bangladesh fiscal system andit seriously handicaps governments ability to provide public services in asatisfactory manner. While very little can be done on the revenue side in theshort term, the authorities need to initiate structural reforms to enhance theelasticity of the NBR tax system and broaden the tax base. The adoption of anew reform effort to improve the value added tax (VAT) system and strengthentax administration and making it taxpayer friendly under a DIFID supportedtechnical assistance program would be very important in this regard.

In the short term, given the declining import payments, the emphasis should on collecting more revenuefrom the direct tax system. Governments efforts to expand the tax net to upazila level and identify newtaxpayers through taxpayers surveys in different localities are appropriate in this regard. Establishment ofa National Tax Tribunal to settle the outstanding large number of income tax, VAT and customs relatedcourt cases will also help through collection of outstanding of tax arrears.

I. Concluding Observations

Bangladeshs economic performance has been quite resilient to the global economic meltdown. Itsmacroeconomic performance has been much better than expected by many external observers andregionally its performance has been one of the best. These favorable overall performancenotwithstanding, there has been a significant loss of income through marked slowdowns in exportgrowth, workers going abroad with new jobs, and inflow of remittances. All these adverse externaldevelopments have contributed to a marked slowdown in domestic consumption and investment throughincreased uncertainty. Economic growth has slowed down to below 6 percent and the outlook for thenext fiscal year is also less buoyant at about 5.5 percent. The slowdown is also going to make the task of


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fighting poverty and achieving other millennium development goals more difficult.

The government has rightly adopted an expansionary fiscal policy in the context of the new budget,although implementation of the associated investment program will face a number of challenges. On theone hand, successful implementation of the ADP, PPP initiative and poverty alleviation programs will

be central elements of tackling the adverse impacts of the external environment. On the other hand,shortfalls in revenue mobilization and external financing would seriously limit the governments abilityto inject fiscal stimulus without crowding out private sector credit. The only way to mitigate the tensions between the fiscal and monetary programs would be to increase external financing for budgetsupport. Direct budget support (not tied to projects) through CSF and public expenditure supportfacility of the ADB and from similar facilities of the World Bank would go a long way in addressing theproblem.

Since Bangladeshs foreign debt is at a manageable level and the external debt service burden is lowrelative to exports of goods and services and is on a rapidly declining trend such borrowing would notcreate any noticeable impact on Bangladeshs capacity to pay. As a matter of fact, by reducing domestic

borrowing this support will help private sector economic activity and also reduce the overall debtservicing cost by limiting the growth of more expensive domestic debt.

Current economic environment requires exceptional efforts on the part of the government and itsdevelopment partners. The government must do its part, but given its precarious revenue situation, italso needs exceptional levels of financial support from its development partners. The support has to bein the form of budget financing to boost its fiscal spending plans, overcome potential revenue shortfallsand avoid crowding out of the private sector. With additional support, the government should be able tomaintain macroeconomic stability and achieve its stated growth objective for FY10.


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