1st PRI Quarterly Policy Briefs

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PRI Quar t erly Policy Br iefs on

Bangladesh Econom y

June 2012

Policy Research Instit ut e of Bangladesh (PRI) Departm ent for In tern ational Developm ent (DFID)



ii

PRI Quarterly Policy Briefs on Bangladesh Economy June 2012

Contents

Summary .................................................................................................................................. iv

I. FY13 Budget and Its Challenges ................................................................................... 1

Introduction ..................................................................................................................1 Global economic outlook................................................................................................1

The New Budget.............................................................................................................3

Key Recommendations ...................................................................................................6

II. Is Bangladesh Bank’s Monetary Policy Stance Working? ............................................ 8

Background ...................................................................................................................8

Execution of Monetary Policy in Recent Years ...............................................................8

Fiscal and Monetary Policy Coordination.......................................................................9

Are Monetary Developments Compatible with IMF Performance Criteria andBenchmarks?............................................................................................................... 10

Is the Tightened Monetary Policy Working?................................................................. 11

Future Challenges and Recommendations for Monetary Management .................... ... 11

III. Explaining Inflation in Bangladesh ............................................................................ 13

Background ................................................................................................................. 13

The Policy Debate........................................................................................................ 13

Quantitative Analysis................................................................................................... 13

Summarizing the Key Empirical Results....................................................................... 16

Implications for Policies............................................................................................... 16

Agenda for Further Research....................................................................................... 16

IV. Is Trade Policy Losing Direction? ................................................................................ 17

Background ................................................................................................................. 17

Launch of DTIS and Impending Trade Policy Review ................................................... 17

Global Economic Environment and Outlook for 2013........................... ................. ...... 17

Evolution of Trade Policy in Bangladesh ...................................................................... 18

Budget 2013 and Tariff Adjustments........................................................................... 19

Trade Policy Losing Direction ...................................................................................... 20

Summarizing the Key findings..................................................................................... 21

Policy Recommendations............................................................................................ 21



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List of Tables

Table 1.1: Overview of the World Economic Outlook Projections ........................................ 1

Table 1.2: Fiscal Outturn (BDT in billions) .............................................................................. 2

Table 1.5: Sectoral Allocation of Government Expenditure .................................................. 6

Table 1.6: NBR Tax Revenue Performance .............................................................................. 6

Table 2.1: Monetary Targets for End June 2012 ................................................................... 10

Table 4.1: Outlook of Global Output and Trade ................................................................... 17

Table 4.2: Progress in tariff rationalization FY01-13 ........................................................... 18

Table 4.3: Average Nominal Protection Rate, Dispersion, Maximum and General............ 19

List of Figures

Figure 1.1: Remittance (Million USD) ...................................................................................... 2

Figure 1.2: Foreign Aid Flows .................................................................................................. 2

Figure 1.3: Total subsidy and sectoral allocation................................................................... 2

Figure 1.4: Export to EU; Growth ............................................................................................. 4

Figure 1.5: Planned and Actual Public Investment ................................................................ 4

Figure 1.6: Trend in ADP Implementation .............................................................................. 4

Figure 1.7: SUBSIDY-GDP ratio ................................................................................................ 5

Figure 2.1: Monetary Policy Targets Vs Actual, in Recent Years ........................................... 8

Figure 2.2: Advance to Deposit Ratio (%) ............................................................................... 8

Figure 2.3: Point to Point Inflation .......................................................................................... 9

Figure 2.4: Exchange Rate ....................................................................................................... 9

Figure 2.5: Repo Rate and CRR ................................................................................................ 9

Figure 2.6: Private and Public Sector Development ............................................................ 10 Figure 2.7: Distribution of Domestic Credit Flow ................................................................. 10

Figure 2.8: Share of Public Sector Credit in Total Domestic Credit Stock ........................... 10

Figure 2.9: Crude oil price in Dubai ($/bbl) ........................................................................... 11

Figure 2.10: Domestic Credit Development ......................................................................... 11

Figure 3.1: Recent Bangladesh Inflation, point to point...................................................... 13

Figure 4.1: Average Nominal Protection Trends .................................................................. 19

Figure 4.2: NPR trends and emergence of para-tariffs ........................................................ 20

Figure 4.3: Average NPR by Import Categories .................................................................... 20



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Summary

FY13 Budget and its Challenges

The budget for Fiscal year 2013 (FY13) has been announced against the backdrop of mixedperformance in the preceding year in t erms of macroeconomic and fiscal management.

In FY12, the global economy has been undergoing new and tougher challenges with theunfolding Euro Zone Debt Crisis and the aftershocks of the Financial Crisis of 2008-09.Bangladesh has been significantly impacted through the trade channel but overall hasfared reasonably well with real GDP growth at 6.3%.

A surge in subsidy payments (primarily for fuel, electricity and agricult ure), a short fall in aidutilization in the first half of FY12, fragile balance of payment situation, and excessiveborrowing by the government from the banking system complicated fiscal managementand contributed to stagnation of domestic investment. Healthy remittance inflows helpedcontain balance of payments (BOP) pressures and the stellar performance in terms of revenue collection helped fiscal management.

The growth target (7.2% in real terms) in Budget FY13 seems overly optimistic under thecurrent global economic environment and stagnant level of domestic investment. Itsrealization will require double-digits manufacturing sector growth, which is unlikely to

materialize given the depressed outlook for exports to the EU and the USA which accountfor more than 80% of Bangladeshi exports.

Faster ADP utilization and limiting subsidies to the budgeted levels will remain as majorchallenges for fiscal management in Budget FY13. Price adjustments for fuel andelectricity, in the context of a comprehensive medium-term subsidy reduction strategy andwith extensive public discussion to build political consensus, will the appropriate way toproceed.

The revenue target is ambitious, but attainable, if efforts to broaden the tax net throughmodernization and strengthening of tax administration are sustained. The thrust on VATand income tax is appropriate and given Bangladesh’s relatively low VAT and income taxproductivity, there is enormous scope for higher revenue growth.

On the expenditure side, Awami League government’s traditional thrust on social sectorsand safety net programs for poverty alleviation has been maintained in FY13 budget. Thetop three recipients of budgetary allocations are education, agriculture, and localgovernment and rural development. Social security and welfare, power and energy, andhealth sectors also received high priori ty.

Is Bangladesh Bank’s Monetary Policy Stance Working?

Bangladesh Bank (BB) generally recognizes the imperative for prudent monetary policyand accordingly establishes quantitative targets for key monetary aggregates. However, inrecent years actual implementation fell short of the targets as monetary policy was“accommodative” to meet the growing demand of various sectors. Most monetary targetswere exceeded by wide margins every year leading to build up of inflationary pressures,asset price bubbles and balance of payments pressures.

Taking these developments into account, BB’s Monetary Policy Statement (MPS) of January2012 stated to “pursue a restrained monetary growth path consistent with curbinginflationary and external sector pressures…..” Monetary tightening measures which wereinitiated since March 2011 by BB through corrective measures like increasing the policyrates, removing the cap on lending rates, and allowing the exchange rate to bedetermined by market forces.

At a time when monetary policy started to become tighter due to BB measures,government borrowing from the banking system increased sharply, exceeding the full-year borrowing target within 5 months after the beginning of the fiscal year. Thisunsynchronized fiscal-monetary policy mix crowded out private sector credit up to



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November 2011 and led to tensions in the money market. The situation however changedmarkedly since December 2011, due to corrective measures on the fiscal side which helpedrestrain public sector borrowing from the banking system.

The tightening measures helped contain the expansion of monetary aggregates: growth of broad money decelerated to 17% by April 2012 from 21.3% in FY11; private sector creditgrowth declined to 18.2% over the same period compared with 25.8% in FY11. As of end-April 2012, monetary developments were broadly in line with BB’s monetary targets for

end-June 2012 as stated in MPS for January to June 2012 and also with the monetarytargets set under the IMF ECF program.

Tighter monetary policy has helped contain inflation and stabilize the exchange rate in thesecond half of FY12. Achieving the inflation target of 7.5% set in FY13 would bechallenging but attainable. It will require continued monetary restraint, and favorabledomestic and external supply/price developments. On its part, BB should focus primarilyon achieving the quantitative targets and not on policy instruments like interest rates.Maintaining the right mix between fiscal and monetary policies in the new fiscal year andbeyond will be important for the success of monetary policy.

Explaining inflation in Bangladesh

Bangladesh has experienced frequent inflat ionary episodes since independence. Most

recently inflation has been increasing since June 2009, rising from an average of 2.3%during 2008/09 to a peak of 12% in September 2011. The inflation rate declined to 9.9% inApril 2012. The rapid rate of inflation has become a major economic and social problem.

Quantitative time series analysis using data from 1981-2011 shows that the rate of growth

of money supply is a major determinant of inflation over the long term. International food

prices have short-term effects on inflation but are not a factor underlying long-term

inflation.

Quantitative results show that the inflation determines nominal exchange ratedepreciation and not the other way round. The causality from inflation to exchange rate isa very powerful and fundamental result for policy making. The main message is that if wewant to have a stable exchange rate over the longer term, we need to keep the rate of inflation low and closely aligned to international inflation.

GDP growth and inflation are negatively correlated over the longer term. So, there is noevidence that higher rate of GDP growth requires higher inflation (beyond a thresholdlevel of 4-5%).

Fiscal policy will need t o be consistent with the targets of prudent monetary management.Accommodating sustained international price increases in fuel prices through budgetarysubsidies that is financed through borrowing from the Bangladesh Bank is inconsistentwith sound monetary management and inflation control.

Is Trade Policy Losing Direction?

Trade liberalization is stalled; but no clear direction has emerged since the dawn of thenew century. The structure of incentives underlying the trade regime favors production of

domestic import substitutes over exports, creating an inherent anti-export bias. Although the RMG sector is free from the shackles of high tariffs on inputs or outputs,

other exports or potential exports are not.

Tariff and para-tariff proposals in FY2013 budget signals continuation of the recent trendof rising average nominal protection and wider dispersion of the tariff structure. Whilepara-tariffs have been emerging as significant component of nominal tariffs, for the firsttime, its share has exceeded average custom duty.

While nominal tariffs on inputs (basic raw materials and intermediate goods) continue tofall, those on final consumer goods trend upwards, thus widening the wedge between



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average tariffs on outputs and inputs, augmenting tariff escalation at the last stage of processing.

FY2013 budget proposals on trade policy do not appear to be inconformity with thearticulation of the kind of t rade policy needed to improve export performance and supportthe high growth needed to reach middle income status by 2021.

Policy recommendations made in the policy brief include: (i) changing the trade policy

stance to support growth; (ii) putt ing back the trade liberalization agenda/program backon track, which will entail reduction of both the average nominal tariff rate and thedispersion of the tariff structure since tariff escalation breeds inefficiency and underminecompetitiveness of firms in the long run; (iii) scaling down of top tariff rates along withpara-tariffs to give domestic customers relief; and (iv) balancing the interests of bothproducers and consumers in trade policy formulation.



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I. FY13 Budget and Its Challenges

Ahsan Mansur

Introduction

The budget for FY13 has been announced by the Honorable

Finance Minister on June 7, 2012, against the backdrop of mixed performance in the preceding year in terms of macroeconomic and fiscal management. Global economicoutlook and Bangladesh’s export prospects have alsodeteriorated markedly because of further deepening of theEuro-Zone Debt Crisis. The budget would be last full-yearbudget for the current government before facing electionsand it has been unveiled in an environment of intensifyingpolitical uncertainty. The budget targets an acceleration of real GDP growth to 7.2% and a sharp deceleration of inflation to 7.5%, while consolidating Government’s effortstowards improved macroeconomic stability and furtheralleviation of poverty.

This policy note analyzes the emerging challenges inimplementing the budget taking into account issues thatemerged in implementing the FY12 budget. Morespecifically, following a brief review of the backgroundagainst which the budget has been unveiled, it focuses on:whether the growth target will be achievable and itsimplications for fiscal management. This note is also anexercise in pointing out the major issues/factors that mustbe handled with vigilance in order to achieve the goals thathave been set out in the new budget. Issues relating to theinflation target and the underlying policies have beencovered in the second policy brief.

Global economic outlook

Bangladesh has been somewhat sheltered from the fullbrunt of the global economic recession of 2008-09 due itslimited international financial integration. The Euro ZoneDebt Crisis however is growing grimmer and its shockwavesare already being felt across the world through variouschannels. The Industrial World–the destination of Bangladeshi exports--has entered int o an extended phase of slow growth or recession induced by the Euro Zone debtcrisis.

Table 1.1: Overview of the World Economic Outlook

ProjectionsIMF 2009 2010 2011 2012 2013 P

GDP at constant prices

(% change)

World Output -0.6 5.2 3.9 3.5 4.1

Advanced Economics -3.6 3.2 1.6 1.4 2.0

Euro Zone -4.3 1.9 1.4 -0.32 0.9

Emerging and DevelopingEconomics

2.8 7.5 6.2 5.7 6.1

Developing Asia 7.1 9.7 7.8 7.3 7.9

Continue....

World Trade Volume

(goods and services) -10.5 12.9 5.8 4.0 5.6

Commodity Prices (USD)(% change)

Oil -36.3 27.9 31.6 10.3 -4.11

Nonfuel (CommodityNon-Fuel Price Index )

-15.7 26.3 17.8 -10.3 -2.1

Source: World Economic Outlook Database April 2012 Edition

Real GDP growth in most major regions of the world isexpected to be lower in 2012 in comparison to 2011, withthe Euro Zone expected to grow negatively. The slowdownin GDP growth in Asia and the developing world is beingpartly caused by mellowing of the growth spurt of largeeconomies like China and India.

A review of Bangladesh’s macroeconomic performance inFY12 shows that the estimated real GDP growth rate of 6.3%,although lower than the 7% target set earlier, is respectable.The moderate slowdown in growth—which is broadly in linewith the predictions of professional bodies—is attributableto the slowdown in exports and the dampening of generalinvestors’ sentiment which led to a deceleration in theperformance of the manufacturing and services sectors as

well as private investment. However, the effect wascushioned to a certain extent due domestic demand,supported by continued strong inflow of remittances whichhelped sustain domestic economic activity and revenueperformance. There has also been a decline in agricultureperformance which is a bit surprising, but perhaps owing tothe decline in agricultural products prices in the globalmarket.

Even though Bangladesh did not perform as well as it hadset out to in terms of GDP growth, its performance has beenbetter than its Asian counterparts like India, China etc, whohave experienced a more pronounced decline in growththis year in comparison to the last. While Bangladesh has

been affected primarily through the export channel, thecomparator countries have been affected through trade aswell as financial channels like FDI and portfolio investment.

0

2

4

6

8

10

12

2009 2010 2011 2012

G D P G r o w t h ( % )

China India Bangladesh Vietnam



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Figure 1.1: Remittance (Million USD)

Source: Bangla desh Bank

Remittance inflows provided the much needed supportfrom the demand side:As previously mentioned, inflow of workers’ remittances has been a saving grace for Bangladeshin FY12 with the country possibly recoding the highest

growth in remittance inflows in the world. Initial worries thatthere could be a massive reflow of Bangladeshis from abroaddue to the ‘Arab Spring’ as well as global economicslowdown did not materialize at all. It is expected that solong the crude oil prices remain around $70-$80 per barrel,much of the investment programs in the GCC region willcontinue to be implemented along with strong demand forexpatriate workers. The number of workers going abroad hasrebounded strongly in FY12 and the outlook remainsfavorable therefore providing a safety net for the externalcurrent account and foreign exchange balances in theupcoming fiscal year.

Figure 1.2: Foreign Aid Flows

The foreign aid flow has been on a declining trend when wecompare the data for FY10 and FY11 (July-May). In FY12,especially based on data for July- November, it seemed likethe declining trend would continue. However, aidutilization/disbursements improved markedly sinceDecember 2011 and continued on an upward trend for theremainder of the fiscal year (Figure 1.2). Total and net aiddisbursements in FY12 (July-May) was 17.7% and 23.2%higher, respectively, over the corresponding period in FY11.

This increase in fund inflows also helped containgovernment domestic borrowing from the banking systemover the corresponding period. Much better utilization of foreign aid in the second half of FY12 enabled thegovernment to limit the level of bank financing well belowthe target set under the IMF program and the revisedbudget. The target for domestic borrowing from the banking

system in FY13—which has been set at Tk. 230 billion—would only be attainable if the authorities once againsucceed in utilizing external financing along the linestargeted in the budget.

Table 1.2: Fiscal Outturn (BDT in billions)FY11 FY12 (B) FY12 (RB) FY13 (B)

Total Revenue 929.9 1183.85 1148.85 1396.7

NBR Tax 790.92 918 923.7 1122.59

Other Revenue 160.95 225.85 225.15 274.11

Total Expenditure 1283 1636 1612.13 1917.4

Current Expenditure 796 879 918.23 979.02

Of Which

Interest Payments 157 180 198 233.02

Subsidy 92.69 92.88 122.63 144.45Transfer Payments 222.14 253.11 253.9 241.82

ADP Expenditure 390 460 410.8 550

Others Expenditures(Including BlockAllocations)

97 297 283.1 15.94

Overall Balance -353.1 -452.15 -463.28 -520.7

(% of GDP) -4.20% -4.92% -5.06% -5.00%Source: Min istry of Finance

While Bangladesh Bank has averted a balance of payments crisis in FY11 by allowing the domesticlending rates and the exchange rate freely determined

by market forces, the balance of payments situationcontinued to remain fragile in FY12. The external trade

account deficit grew by 13% between July-March FY12 incomparison to the corresponding period in the previousfiscal year. Despite the buoyant inflow of remit tances (by13%), the current account balance declined by 22% to US$456 million during the first 9 months of FY12. The level of foreign exchange reserves declined further by US$ 0.5 billionto below the psychologically important $10 billion level atthe moment.

Figure 1.3: Total subsidy and sectoral allocation

Source: Medium-term Budget Framework ( MTBF)

FY 09

FY 11

FY 12

0

200

400

600

800

1000

1200

1400

Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May

0

500

1000

1500

J u l - N o v

D e c - M a y

J u l - N o v

D e c - M a y

J u l - N o v

D e c - M a y

FY10 FY11 FY12

$1,237

$675 $614

$846

$419

$1,300

$989

$302 $323$485

$79

$916

i n m i l l i o n U S $

Total Aid Net Aid

0

50

100

150

200250

300

350

FY 07 FY 08 FY 09 FY 10 FY 11 FY 12 FY 13BTotal Subsidy Fuel (BPC) Agriculture Electricity (PDB)



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Fiscal management got complicated by a surge in

subsidy payments and a shortfall in aid utilization. Thesubsidy budget was exceeded by a substantial margin owingto increased funds required for the agriculture, fuel (BPC)and electricity (PDB) sectors which accounted for the over70% of the total subsidy in the revised budget. The risingprice of fuel in the international market and a markedly

higher volume of imports associated with the liquid fuelbased, together with delays in adjusting domesticadministered prices of fuel and electricity, led to a surge inbudgetary subsidies in FY12. The resulting increase ingovernment borrowing from the banking system exceededthe annual target by December 2011, created a liquiditycrunch in the money market by crowding out the privatesector.

While the government faced problems in its expenditure

management, its revenue performance exceededexpectations and helped fiscal management. The NBRrevenue surplus is expected to be about BDT 8.4 billion inFY12, despite a marked slowdown in non-oil imports andassociated import stage taxes. As is the case every year,actual ADP implementation is expected to fall shy of itstarget in FY12 by about 10.87% of the original budget. Thisdevelopment together with better than budgeted revenueperformance, helped contain the overall fiscal deficitincluding grants to about 4% of GDP, below the originalbudget target. Some corrective measures to contain subsidythrough several rounds of petroleum and electricity pricesadjustments played a crucial role in improving fiscalmanagement in the second half of FY12. As a result,government borrowing from the banking system whichsurged to BDT [180] billion at end-November, remainedstable at similar levels by end-April 2012. This level of fiscal

deficit and debt is consistent with fiscal sustainability.However, the distribution of financing still remains aproblem, as external financing (net) has been stagnant ordeclined in dollar terms in recent years due to government’sinability to implement foreign funded ADP projects.

The New Budget

Budget FY13 is the fourth budget of present governmentand the penultimate one before it goes for re-election. Thisbudget therefore not only has economic ramifications forthe country, the government also has a lot riding on it tomeet their political aspirations. This budget is by far thebiggest budget in the country’s history in both absolute and

relative terms, respectively, at BDT 1.9 trillion or 18.4% of GDP.

While many analysts have characterized the size of thebudget as politically driven, we believe that an 18% increasein spending may not be considered expansionary given thatthe nominal GDP growth rate would be more than 15%. Thedeficit level of 4.5% of GDP (including grants) is very much inline with past budgets and consistent with debtsustainability. At this crossroad with election ahead, the

government had two basic options: (i) to go for an electionoriented populist budget with much higher spending andoverall deficit; or (ii) strive for maintaining macroeconomicstability through a prudent fiscal stance with fiscal deficitlimited to 5% of GDP. We believe that the authorities haveopted for the second option in order to restoremacroeconomic stability by containing inflation, easing

money market tensions by avoiding crowding out of theprivate sector, and achieving a respectable growth rate evenif it may not reach the ambit ious target of 7.2%.

The budget deficit (including grants) for FY13 at 4.5%indicates that the fiscal stance will remain more or less thesame as in most other years. Nevertheless, we believe thatthe government will face enormous challenges inimplementing the budget and achieving themacroeconomic objectives in several areas includingachieving growth and inflation objectives; containing thesurging subsidy bill; implementing the donor-fundedprojects included in the ADP; achieving the ambitiousrevenue target; and alleviating poverty through better

management and targeting of social spending.

FY10 FY11 FY12 (P)FY13

(SFYP)

Sectors Growth Rate (%)

Agriculture 5.2 5.1 2.5 4.4

Industry 6.5 8.2 9.5 9.9

of which

Manufacturing 6.5 9.4 9.810.1

Services 6.5 6.2 6.1 7.1

GDP 6.1 6.7 6.3 7.2

Share as % of GDP

Agriculture 20.5 20.3 20.0 19.3

Industry 29.9 29.9 30.4 31.3

of whichManufacturing 17.9 17.9 18.4 19.0

Services 49.7 49.8 49.6 49.4Source: Sixth Five- Year Pla n (SFYP)

We consider the growth target as overly optimistic under

the current global economic environment and stagnantlevel of domestic investment. The budget envisages astrong rebound in economic growth to 7.2% despitesignificant downside risks and a sharp reduction in inflationto 7.5% through better co-ordination in fiscal and monetarypolicy. It also aims to bring forth more equitable distributionin income and thus reduce poverty level through moreequitable growth and higher social sector spending. In the

remainder of this policy brief we present the challenges thatthe authorities will face in achieving the growth target andin implementing the budget during the course of the year.

Double-digit manufacturing sector expansion is a pre-requisite for higher growth.The analysis presented in theSixth Five Year Plan (SFYP) indicates that even with a sharprebound in agriculture output, achieving 7.2% real GDPgrowth will require the manufacturing sector to grow bymore than 10%. Given that the manufacturing sector is



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heavily dependent on the export sector which is facing aslowdown due to the EU debt crisis, such a strongperformance in the manufacturing sector is unlikely tomaterialize. Furthermore, the investment level (both publicand private sector) required for achieving or sustaininggrowth rates in excess of 7% is unlikely to materialize inFY13, given the shortfall in investment experience in recent

years.

Figure 1.4: Export to EU; Growth

Despite resilience, Bangladesh cannot avoid a fall inexports to the industrial countries. The export sector of the country has performed quite resiliently even in the faceof the global recession of recent years. While the globaltrade in value terms declined by more than 30% at itsbottom, Bangladesh’s export decline was limited to 11.7% atits worst. In line with the previous episode (FY 08-09),

currently there are signs of a significant slowdown in globaland Bangladesh exports. This situation will probablydeteriorate further in next few months. Unlike the pastepisode (global economic crisis) this time the economicslump in the Euro Zone is likely to be much more protracted.The recovery process this time will probably be moreprolonged taking the form of ‘U’ instead of the ‘V’ shape as itwas in 2008-09. As the Euro Zone receives the largestamount of Bangladesh’s exports slowdowns in that regioncould have quite an adverse effect on our exports.

Both public and private sector investment are runningwell below their desired/required levels. Investment-public and private- is usually supposed to be the growth

trigger for most economies and Bangladesh is no exception.Increasing the Investment/GDP ratio to much higher levelswas always considered to be critically important forachieving growth rates ranging from 7% to 8% under theSFYP. After completion of 2 years under the SFYP, theinvestment level still remains at about 25%, where it hasbeen hovering for many years, compared with the target of 29% of GDP by FY13 under the SFYP.

Figure 1.5: Planned and Actual Public Investment

Source: Sixth Fi ve-Yea r Plan (SFYP)

The implicit target for investment set out in the FY13

budget seems even more unattainable for severalreasons like the current unstable political environment,labor unrests and shutdowns in the RMG export sector,inadequate energy and infrastructural support to name afew. All these factors tend to act as a disincentive forinvestors and thereby will most probably lead to decline ininvestment flows. In FY12, actual public investment fell short

of the SFYP target for public investment. The targetedincrease in public investment in FY13 also falls short of theSFYP target. The situation is much worse with private sectorinvestment. The shortfall in private investment in FY12 wasabout 2% of GDP. Private sector investment would need toreach 23% of GDP in FY13 from about 18% level in FY12. Aformidable task indeed!

Figure 1.6: Trend in ADP Implementation

1.9

20.7

-13.0

52.4

7.3

15.916.7

19.5

-13

-5.5

-20.0

-10.0

0.0

10.0

20.0

30.0

40.0

50.0

60.0

J u l - S e p

O c t - D e

c

J a n - M a

r

A p r - J u

n

J u l - S e p

O c t - D e

c

J a n - M a

r

A p r - J u

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J u l - S e p

O c t - D e

c

J a n - M a

r

A p r - J u

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O c t - D e

c

J a n - f e b

FY 09 FY 10 FY 11 FY 12

Value In EUROS (million) Qnty_In_100KG

0

2

4

6

8

FY10 FY11 FY12 FY13(e)

% o f G D P

SFYP Publ ic Investment Actual Publ ic Investment

16

18

20

22

24

FY10 FY11 FY12 FY13(e)

% o

f G D P

SFYP Private Investment Actual Private Investment

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

F Y 0 5

F Y 0 6

F Y 0 7

F Y 0 8

F Y 0 9

F Y 1 0

F Y 1 1

F Y 1 2 R B

F Y 1 3 B

( % )

ADP/GDP ratio



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FY 11 B FY 11 RB FY 12 B FY 12

RB FY 13 B

No. of ADP projects 916 1185 1039 1228 1037

Increase/decrease 269 189

Original/ Revised ADP

budget (BDT in billions)

356.8 338.08 460 410 550

Increase/decrease -18.72 -50

Source: Planning Com mission and M inistry of Finance

ADP utilization has been a common shortcoming of the

government in the past and therefore chances are highthat the trend will continue in FY13 as well. However,significant gains have been made on two fronts. Because of the large size of the ADP allocation, despite theimplementation shortfall, actual growth in ADP spendinghas been respectable in recent years. The pace of utilizationhas increased significantly since FY10, compared to earlieryears. The result of these two favorable developments is a

steady increase in implemented ADP size in relation to GDPin recent years. From the lowest level of close to 3% of GDPin FY 09, the size of ADP is expected to increase by 1.5-2percentage points to about 5% of GDP in FY13. Nevertheless,there are other problems with the project selection process.

There are too many projects under the ADP, constrainingadequate funding and thereby limiting the capacity tocomplete the projects on time. Every year the size of the ADPis reduced significantly through a mid-year review exercise.But a large number of new projects averaging about 200 areadded to the revised ADP. Furthermore, 507 projects havebeen added in FY12 RB without any fund allocation. These

issues raise questions regarding both the adequacy of theselection process and quality of projects under the ADP.

Figure 1.7: SUBSIDY-GDP ratio

Source: Medium-Term Budget Framework (MTBF)

In FY12, if we include the amount deferred to the next year,the amount of budgetary subsidy on an accrual basis wouldamount to 4.5% of GDP.

The subsidy in the power sector has been particularlynoticeable as the figure has been revised up by aconsiderable amount over the budgeted figure:

Fiscal costs associated with the power sector

strategy far exceeded the original estimates;

If unchecked, costs will be much higher in the

coming years because more rental power plants will

be in operation; and

There will be longer than usual delays in

implementing the medium and large power plants

due to problem in securing finance.

The overall size of energy subsidies has grown rapidly inrecent years due to rising import costs and inadequate costrecovery, undermining the fiscal position and overallmacroeconomic stability. Notwithstanding significant fueland electricity prices adjustments over the past year, moreupward adjustments in petroleum and electricity priceswould be necessary in FY13, given the projected importcosts and available budgetary financing.

To contain fuel subsidies, the government has planned tomove to an automatic adjustment formula by December2012, which will ensure full pass-through of changes ininternational prices (an important IMF program benchmark).Implementation of such an automatic adjustment

mechanism, if adopted, would help stabilize budgetarysubsidy for fuel.

Subsidy reduction is a politically sensitive issue. Politicalconsensus and support from the people will be critical forsustainable reduction in subsidies. A carefully preparedsubsidy reduction strategy will help create awareness aboutthis issue and engender political support for the cause.

It must also be recognized here that a power sectorgeneration plan based on larger gas and coal fired plants is amust for the growth strategy and fiscal sustainability.Without plans for utilizing domestic coal, BOP and fiscalsector vulnerabilities would persist.

0.00%

1.00%

2.00%

3.00%

4.00%

FY 09 FY 10 FY 11 FY 12B FY 12RB FY 13B

2.28%

3.30% 3.32%

0

50

100

150

200

250

300

350

B D T i n b i l l i o n s

Tota l Subs idy Total Energy Subsi dy (PDB & Fuel)



6


Table 1.5: Sectoral Allocation of Government

ExpenditureGrowth in Real terms (%) As % of Total Expenditure

FY10AFY11

AFY12RB

FY13B FY10A FY11A FY12RB FY13B

Local

Government

and Rural

Development

15.7 15.6 7.4 10.1 9.6 10.1 9.5 9.6

Defense

Service37.9 14.9 1.5 -2 10.4 10.9 9.6 8.7

Education and

Technolog22 11.3 -9.2 9.9 18.4 18.6 14.8 14.9

Health 19.3 6.7 5.2 6.5 7.2 7 6.4 6.3

Social Security

and Welfare-18.4 6.7 20.1 -1.1 8 7.8 8.1 7.4

Power andEnergy

32.6 92.1 2.8 11.5 4 7 6.3 6.4

Agriculture 6.1 6.7 4.2 -6.3 12.8 12.4 11.3 9.7

Others 22.6 -1.9 47.2 18.7 29.6 26.4 33.9 37

Total

Programme

Expenditure

16.3 10.1 14.3 8.9 100 100 100 100

Source: Ministry of Finance

The thrust on social sectors and safety net programs forpoverty alleviation has been maintained.A broad reviewof budgetary appropriations indicates that the thrust of thebudget in FY13 is appropriately on the social sector. The topthree recipients of budgetary allocations are for education,agriculture, local government and rural development, socialsecurity and welfare, and health. The share of defensespending has been following a declining trend, which isexpected to continue in FY13. Allocation to agriculture hasdeclined both in relative and real terms, perhaps due to thesubsidy reduction strategy. The power and energy sector isthe highest in terms of real growth in expenditure. Suchsocial sector and expenditures on power sector if conducted

consistently and properly could lead to substantial changesin both sectors and improve standard of living of the people.

Table 1.6: NBR Tax Revenue Performance

FY10 FY11 FY1 FY13(Budget)

Growth Rate(As Percentage Change)

Total NBR Revenue 18.1 27.8 16.6 21.5

of Which:

Income Tax 23.2 32.2 24.2 25.8

Value Added Ta 15.6 29.6 13.9 18.0

Custom Dut 9.8 15.3 6.6 15.0

(% of Total NBR Revenue

Income Tax 26.4 27.6 28.5 31.4

Value Added Ta 38.3 37.5 38.0 36.0

Custom Dut 17.8 16.6 15.0 12.9

Source: Ministry of Fina nce, Bangla desh

On the revenue side, the target is ambitious but

attainable if efforts to broaden the tax net throughmodernization and strengthening of tax administration

are sustained. The revenue target is ambitious because,except for two years FY08 and FY11, NBR had never recordedsuch a high target in recent years. Nevertheless, it is also truethat NBR has exceeded its budget targets for the 3rd

consecutive year through FY12, which gives someconfidence to this ambitious target.

As in recent years, realization of the NBR revenue targetwould critically depend on success in maintaining themomentum in revenue generation from income tax andVAT:

On the income tax side, a number of important

revenue augmenting measures have been adopted,

including: higher minimum tax; keeping the

exempt ion level unchanged at Tk. 180,000, despite its

reduction in real terms through inflation; broadening

the scope of tax withholding, effective operation of

the alternative dispute resolution(ADR) mechanism,

higher tax rate for exporters, etc.

The downside risks relating to the FY13 revenue

target primarily originate from the slower expected

GDP growth.

There is no major change in the VAT regime in FY13.

The thrust is primarily on strengthening and

modernization of tax administration to enhance

efficiency of the VAT system.

Given Bangladesh’s relatively low VAT and income taxproductivity, there is potential scope for realizing the targetif NBRmodernization efforts are continued.

Key Recommendations

Overall, the FY13 budget is ambitious requiring vigilance

and perseverance for its effective implementation. Its properimplementation will require focusing on the following

issues:

The targeted domestic borrowing from the banking

system at Tk. 230 billion is already very high, and any

shortfall in revenue, domestic non-bank financing

through national savings bonds/certificates, and

external financing will further increase recourse to

bank financing and thereby crowd out the private

sector and/or monetization of borrowing

undermining growth and inflation objectives.

On the expenditure side, limiting the subsidy bill to

the budgeted level would require firm actions in the

form of price adjustments for petroleum products and

electricity. The measures must not be delayed, as was

the case last year.

The authorities should prepare a comprehensive

medium-term subsidy reduction strategy and hold



8


II. Is Bangladesh Bank’s Monetary Policy

Stance Working?

Ahsan Mansur

Background

In order to tackle the growing inflationary pressure andincreased balance of payments vulnerability, BangladeshBank announced a shift in its monetary policy stance inJanuary 2012. By November 2011, the general inflationreached almost 12%, the highest level since 1998, andgovernment borrowing from the banking system to financebudgetary operations already crossed the borrowing limitestablished in the budget for the whole year. Increasedimport payments associated with higher petroleum pricesand volume of imports, started to exert pressures on theexchange rate and the level of foreign exchange reserves.

Taking these developments into account, Bangladesh Bank’s

Monetary Policy Statement (MPS) of January 2012, stated to“pursue a restrained monetary growth path consistent withcurbing inflationary and external sector pressures, whileensuring adequate private sector credit to stimulateinclusive growth.” Following successive years of significantdeviations between the announced MPS stances and theirimplementation, in the guise of so called “accommodative”monetary policy, there was a certain amount of skepticismabout Bangladesh Bank’s resolve in pursuing a restrainedmonetary policy in line with the quantitative monetarytargets. There is also widespread realization that BB’s recentinability to firmly adhere to its announced MPSquantitativetargets have fueled inflation, created asset market bubbles,and weakened Bangladesh’s BOP position.

This policy brief aims to: determine whether BB is indeedseriously pursuing the intended policy stance announced inthe January 2012 MPS; examine the coordination betweenmonetary and fiscal policy to avoid crowding out of theprivate sector; compare the developments of monetaryaggregates and appropriateness of the policy stance withthe commitments made under the IMF supported ECFprogram; and assess the effectiveness of the policy stance interms of containing inflation, stabilizing the exchange rateand BOP pressures.

Execution of Monetary Policy in Recent Years

BB generally recognized the imperative for prudentmonetary policy and accordingly established quantitativetargets for key monetary aggregates in each and every MPSin recent years. However, actual implementation fell wellshort of the requirement. BB put a cap on the lending rate of commercial banks and did not respond forcefully whenmonetary aggregates exceeded the intended levels by widemargins. BB characterized this policy stance as“accommodative” to meet the credit needs of a growing

economy. As a result , most monetary targets were exceededby wide margins every year.

Figure 2.1: Monetary Policy Targets Vs Actual, in Recent Years

This mismatch between announced policy and actual

implementation continued up to March 2011. AlthoughBB increased the Cash Reserve Rati o (CRR) for the first time inMay 2010 and the Repo Rate in August 2010, monetarytightening, as reflected through monetary aggregates didnot take place due to inadequacy of the measures and lackof strong surveillance on banks. In particular, at times thecredit to deposits ratio of commercial banks exceeded thelevels considered prudent in part due to inadequatemonitoring and surveillance.

Figure 2.2: Advance to Deposit Ratio (%)

The destabilizing impact of such monetary expansionwas visible on both domestic and external fronts. On thedomestic front, a sharp rise in inflation and asset pricesessentially resulted from excess liquidity in the economy. CPIinflation reached almost 12% in September 2011 on a point-to-point basis which was highest since 1998.

1 5 . 5

1 6 . 7

1 5 . 2

1 6 1 7 1

6

2 2 . 4

2 4 . 2

2 1 . 3 2

5 . 8

1 7 . 2

1 8

. 2

Broad

money

(M2)

growth

Private

sector

credit

growth

Broad

money

(M2)

growth

Private

sector

credit

growth

Broad

money

(M2)

growth

Private

sector

credit

growth

FY 10 FY 11 FY 12

Target Actual

A p r i l 2 0 1 2

A p r i l 2 0 1 2

74

75

76

77

78

79

80

81

82

83

J u n - 0 9

O c t - 0 9

F e b - 1 0

J u n - 1 0

O c t - 1 0

F e b - 1 1

J u n - 1 1

O c t - 1 1

F e b - 1 2

(%)



9


Figure 2.3: Point to Point Inflation

The impact of monetary expansion on asset prices was

quite costly for the economy. The liquidity expansionhelped create a large bubble in the already overvaluedcapital market. Real estate prices also experienced anunprecedented surge. On the other hand, significantlyhigher inflation than Bangladesh’s major trading partnersreduced competitiveness of domestic products and made

imports cheaper in real terms. These developments, coupledwith increased domestic demand due to monetaryexpansion above reasonable level, widened the trade deficit.The resulting balance of payments pressure contributed to amarked depreciation of the Taka, following a long period of relative exchange rate stability.

Figure 2.4: Exchange Rate

Against this backdrop, the need for monetary tighteningbecame pressing by end-February 2011. Althoughsomewhat late, BB took a series of monetary tighteningmeasures and private sector credit growth started decliningbeginning in the last quarter of FY11.

Figure 2.5: Repo Rate and CRR

Before March 2011 BB never looked like adhering to itsmonetary policy targets. As the BOP situation becomeunsustainable with imports growing by more than 40% anda large BOP financing gap was emerging, beginning March2012, BB started to respond proactively by tighteningmonetary and demand management policies. In particular:

The repo rate has been revised upward for 5 timesbetween March 2011 and January 2012.

The Cash Reserve Requirement (CRR) was alsoincreased by 0.5 percentage point to 6% inNovember 2010.

BB was stricter in maintaining credit to depositratio of commercial banks within the permissiblelevel this time around and the cap on commerciallending rates was removed except for somestrategic sectors.

The exchange rate of Taka was also allowed to be

freely determined by market forces to stem the runon reserves.

These tightening measures helped contain the expansion of monetary aggregates close to the monetary targets of BB forend-June 2012. If monetary targets are achieved for FY12,which is a realistic possibility, this will be for the first timeafter failures in achieving so in two consecutive years with‘accommodative’ monetary stance.

Fiscal and Monetary Policy Coordination

Right policy mix is a precondition for the success of macroeconomic management. Bangladesh has had a long

tradition of good fiscal and public debt management. Fiscaldeficit has generally been limited at or below 5% of GDP andexternal financing primarily limited to concessionalborrowing from multilateral and bilateral official sources. Asnoted in the Policy Brief on FY13 Budget, fiscal managementin FY12 was complicated by two emerging problemsassociated with: a surge in subsidy payments in the first half of FY12 due to delays in implementing necessary priceadjustments; and a precipitous fall in foreign financing inpart due to slower implementation of foreign fundedprojects and lower disbursement of program or budgetfinancing.

At a time when monetary policy started to become tighterdue to BB measures described above, governmentborrowing from the banking system surged due to thecombined effect of the sharp increase in subsidy paymentsand the collapse of foreign financing (net). At its worstpoints, more than 60% of domestic credit expansion wasdiverted to budget financing in June 2012, which furtherincreased to 100% in July. Because of this lack of fiscal andmonetary policy coordination, the monetary tighteningmeasure contributed to a significant level of crowding out of the private sector in the first half of FY12 and created the

9.15

7.46

12.72

0

5

10

15

J a n - 0 9

M a r - 0 9

M a y - 0 9

J u l - 0 9

S e p - 0 9

N o v - 0 9

J a n - 1 0

M a r - 1 0

M a y - 1 0

J u l - 1 0

S e p - 1 0

N o v - 1 0

J a n - 1 1

M a r - 1 1

M a y - 1 1

J u l - 1 1

S e p - 1 1

N o v - 1 1

J a n - 1 2

M a r - 1 2

M a y - 1 2

(%)General Food Non-Food

Source: BB

83.5

81.9

60

65

70

75

80

85

F Y 0 8

F Y 0 9

F Y 1 0

F Y 1 1

J u l - 1 1

A u g - 1 1

S e p - 1 1

O c t - 1 1

N o v - 1 1

D e c - 1 1

J a n - 1 2

F e b - 1 2

M a r - 1 2

A p r - 1 2

M a y - 1 2

T a k a p e r U S D

4.0

5.0

6.0

7.0

8.0

J a n - 1 0

M a r - 1 0

M a y - 1 0

J u l - 1 0

S e p - 1 0

N o v - 1 0

J a n - 1 1

M a r - 1 1

M a y - 1 1

J u l - 1 1

S e p - 1 1

N o v - 1 1

J a n - 1 2

M a r - 1 2

M a y - 1 2

Repo Rate CRR

Tighter monetary target

implementation

Loose monetary targetimplementation



10


perception that monetary policy was excessively tight.Increased public sector borrowing sharply reduced the spacefor private sector borrowing. Much of the private sectorcredit contraction was because of increased public sectorborrowing, while the slowdown in the overall domesticcredit growth was relatively modest.

Figure 2.6: Private and Public Sector Development

It is interesting to note that public sector borrowing wasalready on an upward trend since April 2010. However,initially this did not lead to crowding out because in initialmonths public sector borrowing was relatively modest andmonetary tightening was yet to be taken. As total domesticcredit kept on growing from about 13% in January-April2010 to the peak level of almost 30% March 2011, there wasscope for accommodating both private and public sectorcredit growth. Crowding out particularly took place duringApril to November 2011. During this period 43% of domesticcredit flow went to the public sector, which is much higherthan the usual 20% share of this sector. This period can becharacterized as “unsynchronized fiscal-monetary policymix”.

Figure 2.7: Distribution of Domestic Credit Flow

The situation changed markedly since December 2011, due to corrective measures on the fiscal side, primarilythrough containment of subsidies. During December-April2012--for a full 5-month period and mostly in the second half

of the fiscal year when borrowing requirement generallygoes up--public sector borrowing was marginally negative.The share of public sector credit in t otal credit , whichincreased from less than 19% in December 2010 to 23.4% inNovember 2011, came down to 21.8% by April 2012. Thisindeed has been a remarkable turnaround.

Figure 2.8: Share of Public Sector Credit in TotalDomestic Credit Stock

Are Monetary Developments Compatible with IMF

Performance Criteria and Benchmarks?

On the backdrop of rising BOP pressures andmacroeconomic tensions, Bangladesh has adopted astabilization program which is being supported by the IMFunder its Extended Credit Facili t ies (ECF). The ECF willprovide financial support in the amount of SDR 640 millionover a three year period. First tranche under thisarrangement was disbursed in last April. Under this program,Bangladesh Government has established certainquantitative monetary targets, consistent with its inflationand BOP objectives, some of which are performance criteria

and some are quantitative benchmarks under the program.Further disbursements are condit ional upon achieving thesetargets.

Table 2.1: Monetary Targets for End June 2012ECFBenchmark/

PerformanceCriteria MPS

Actual

Apr-12

Reserve money(eop stock in bi llions

of Taka); BM 1014 1007 917

NDA of BB(eop stock in b illions of Taka); PC 550 418*

Net credit to the central

government (NCCG) by the banking

system(ceiling, cumulative changefrom the beginning of the fiscal year,in bill ions of taka); PC

252 165.6

* Figure of end March. PC=Performance Criteria; and BM= Benchmark

Bangladesh is firmly on track towards achieving the

monetary targets set under the IMF ECF program. Monetary targets stated in the MPS for January-June 2012were also broadly in line with the ECF. The ECF arrangementhas a ceiling on reserve money expansion (indicative target).By end June 2012 reserve money must be kept under 13%

21.04

54.39

32.38

18.22

-10

0

10

20

30

40

50

60

J a n - 1 0

M a r - 1 0

M a y - 1 0

J u l - 1 0

S e p - 1 0

N o v - 1 0

J a n - 1 1

M a r - 1 1

M a y - 1 1

J u l - 1 1

S e p - 1 1

N o v - 1 1

J a n - 1 2

M a r - 1 2

Domestic Credit Public Sector Credit

Private Sector Credit

Dec-10, 18.7

Nov-11, 23.4

Apr-12, 21.8

18

20

22

24

26

28

30

O c t - 0 6

A p r - 0 7

O c t - 0 7

A p r - 0 8

O c t - 0 8

A p r - 0 9

O c t - 0 9

A p r - 1 0

O c t - 1 0

A p r - 1 1

O c t - 1 1

A p r - 1 2

(%)



11


on year-on-year basis. In last April actual growth rate was10.17. In case of government borrowing from the bankingsector, although in terms of growth rate up to Apri l is higherthan the ceiling, borrowing can be kept under the ceilinggiven the government’s recent success in limiting bankborrowing. Government has cushion of around Tk. 86 billionin this regard.

Is the Tightened Monetary Policy Working?

The objective of monetary tightening was to restore bothinternal and external imbalances by taming inflation andthereby also stabilizing the exchange rate. From the Figure2.3 we can see that inflation is trending downward and camedown t o 9.15% in May from the peak level of 11.97% in lastSeptember. Growth in import payments decelerated sharplydespite much higher oil-related payments. As shown inFigure 2.4, after a sharp depreciation of the Taka, theexchange rate has remained stable throughout the secondhalf of FY12.

In FY13 budget, the government has set the inflation targetat 7.5%. Like monetary targets, inflation targets stated inFY10 and FY11 budgets were also not achieved. Thusquestions have been raised about government’s ability andseriousness in realizing the inflation target for FY13.

We are of the view that, if BB adheres to the monetarytargets stated in the MPS and the ECF arrangement with

the IMF, and maintains a similar policy stance for FY13,bringing the inflation rate down to the target level of 7.5% will be challenging but doable. Continued prudentmonetary tightening and favorable external environmentwould be preconditions for realizing the inflation objective.Coincidentally, global economic slowdown has beenpushing both fuel and non-fuel commodity pricesdownward, from their recent peak levels in April 2011. Crudeoil price has come down by more than 20% since March2012 due to comfortable global inventory position and aslowdown in demand growth both from industrialized andemerging economies. Given the global economic outlook,the weakening process may continue in the coming months.The terms-of-trade gains resulting from the decline in globalprices will not only help stabilize domestic prices but alsoreduce pressure on the current account balance.

Figure 2.9: Crude oil price in Dubai ($/bbl)

Recent developments in India will also have a favorableimpact on domestic prices. Monetary tightening by RBI andlower domestic demand has reduced India’s inflation in2012. After reaching a recent high level, food prices in Indiahas come down significantly and remained at around thatlevel in recent months. Bumper harvests have stabilized foodprices in India and are expected to remain stable in coming

months. Depreciation of Indian currency has also madeIndian food/commodity prices cheaper in terms of BDT inrecent months.

Above all, domestic supply situation of basic commoditieslike rice, potato and vegetables have generally been verygood with bumper outputs in most products. Following thebumper boro crop rice prices have declined significantly andare likely to remain stable in the coming months.

The favorable supply situation at home and abroad,combined with prudent demand management throughmonetary and fiscal policies should help realize the inflationtarget.

Future Challenges and Recommendations for

Monetary Management

Monetary development since last January has been movingin the right direction to achieve the MPS targets andquantitative limits established under the ECF. Achieving theend-June targets will require BB to firmly adhere to itsmonetary targets.

Figure 2.10: Domestic Credit Development

Jul-08, 131.22

Dec-

08, 41.00

Mar-

12, 122.28

28-

Jun, 92.00

0

20

40

60

80

100

120140

J a n - 0 6

J u l - 0 6

J a n - 0 7

J u l - 0 7

J a n - 0 8

J u l - 0 8

J a n - 0 9

J u l - 0 9

J a n - 1 0

J u l - 1 0

J a n - 1 1

J u l - 1 1

J a n - 1 2

22.45

27.41

19.1

10

20

30

40

Domestic Credit

FY 12 FY 11

MPS Average FY06-FY10

34.4533.55

31.0

-5

5

15

25

35

45

55

65 Public Sector Credit

19.45

25.84

16.0

10

20

30

40

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

Private Sector Credit



12


The other challenge will be to maintain the right policy

mix by properly synchronizing fiscal policy with themonetary stance. This issue of policy mix will be especiallyimportant since the government is approaching final year of its tenure. As other sources of deficit financing become moredifficult t o secure, the government may become tempted torely more heavily on bank borrowing.

In its monetary policy operationsBB should focus primarilyon the quantitative targets and not on policy

instruments like interest rates. It is beyond the capacity of any central bank to influence or target both, and BB is noexception.

Like most developing countries, transmission of monetarypolicy is considered inefficient in Bangladesh. Development

of the treasury bills and bond market will be keys toenhance the transmission mechanism.



13


III. Explaining Inflation in Bangladesh1

Sadiq Ahmed

Background

Bangladesh has been experiencing a rapid growth in the

general price level in recent years. The rate of inflation hascrept up steadily since July 2009, rising from an average of 2.3% during 2008/09 to a peak of 12% in September 2011(Figure 3.1). The inflation rate declined to 9.9% in April 2012.The rapid rate of inflation has become a major economic andsocial problem. Unless this is tackled forcefully and withsome urgency it could become a substantial politicaldebacle for the Government when it seeks re-election in thenext 18 months. It is also important that right policy choicesare made in the effort to control inflation based on soundanalysis.

Figure 3.1: Recent Bangladesh Inflation, point to point

Source: Bangla desh Bank

The Policy Debate

There is much policy debate, often influenced by populistperceptions, about what factors cause inflation. One populardebate concerns the role of nominal exchange rate inmanaging inflation. There are quite a few policy makers,researchers and business who believe that the depreciationof the exchange rate is the primary culprit underlying rapidinflation in Bangladesh. This group believes that thegovernment should basically pursue a fixed nominalexchange rate policy. The underlying logic is the standard

cost-push argument for inflation. Exchange rate raises thetaka price of imported inputs that pushes up the cost of production and that in turn fuels inflation.

The other debate is the role of international commodityprices. The rising global food and fuel prices are seen as the

1 This policy note is based on a longer research paper in progress. The longer

paper provides all quantitative results and the database for the regression

results.

main culprit underlying inflation in Bangladesh. In thisdebate inflation is temporary and the government has littlecontrol over inflation except to make efforts to insulatedomestic food and fuel prices from rising through pricecontrols and subsidies. The inf luence of this populistargument on policy making is large and illustrated by therapidly growing subsidy bill of the government that has now

run into almost 4% of GDP, equivalent to over 35% of totaltax revenue.

A third major policy debate is the perceived trade-off between growth and inflation. The argument here is thatdeveloping countries like Bangladesh have no choice but totolerate significant inflation as a price for economic growthand development. This is a more substantive argumentbased on quantitative research done by the BangladeshBank that argues that there is a trade-off between inflationand growth well upto 6-8% rate of inflation. Efforts to reduceinflation below this threshold level will have an adverseeffect on growth.

The policy debate suggests that there is considerableconfusion and disagreement on the nature of inflation inBangladesh and factors that explain inflation. Given theseissues it is important that policy analysis for inflation controlmust be based on a careful review of the data and properquantitative analysis.

Quantitative Analysis

Time series data and related analysis can be very helpful inunderstanding macroeconomic developments, makingprojections for the future and developing policy responsesto tackle unhappy macroeconomic outcomes. The analysisof inflation is a good example of how proper time seriesanalysis can help the government to control inflation andstabilize the macroeconomy. We will like to stress theimportance of “proper time series analysis” because in itsabsence we can easily reach erroneous conclusions that, if applied to policy making, can do substantial damage to themacroeconomy.

Stationarity and Causality Tests for Proper Time SeriesAnalysis

A key requirement of this “proper” analysis is to first startwith a good theory about causality. Many things tend tomove together over time. Without a sound analysis of how

developments are correlated and what is the cause and whatis the effect there is either a risk of spurious correlation ormis-specification of the relationship. Economic theory helpsavoid the problem of spurious correlation, but it sometimesdoes not help identi fy the causality. This problem of establishing causality in time series data has received a greatdeal of attention in quantitative economic research andconsiderable progress has been made in recent years to helpidentify proper causality, thereby facilitating better policymaking and economic forecasting.

0

2

4

6

8

10

12

14

16

N o v - 0 9

D e c - 0 9

J a n - 1 0

F e b - 1 0

M a r - 1 0

A p r - 1 0

M a y - 1 0

J u n - 1 0

J u l - 1 0

A u g - 1 0

S e p - 1 0

O c t - 1 0

N o v - 1 0

D e c - 1 0

J a n - 1 1

F e b - 1 1

M a r - 1 1

A p r - 1 1

M a y - 1 1

J u n - 1 1

J u l - 1 1

A u g - 1 1

S e p - 1 1

O c t - 1 1

N o v - 1 1

D e c - 1 1

J a n - 1 2

F e b - 1 2

M a r - 1 2

A p r - 1 2

%General Food Non-Food



14


Working independently in different time periods, tworesearchers, Clive Granger of the University of Nottingham inEngland and Christopher Sims of the Princeton University inUSA, pioneered the quantitative methods for establishingcausality. Both received the Nobel Prize in Economics;Granger in 2003 (unfortunately he died in 2009) and Sims in2011. The statistical technique developed to establish

causality is known as the Granger-Sims test.

Good practice quantitative research using time series datafirst needs to ensure that the data are “stationary” (to enablemeaningful predictions) and that causality is establishedusing the Granger-Sims test before deciding which variableis the cause (also called the independent or exogenousvariable) and which variable is the effect (also known as thedependent variable or endogenous variable).

Inflation and GDP Growth Models for Bangladesh

Turning to the Bangladesh situation, we need testablemodel to quantitatively determine the factors that explain

inflation. Drawing from economic literature and the policydebate in Bangladesh, there are basically three models of inflation. The simplest model, which appeals most topopulists and is well understood in Bangladesh, is the cost-push model of inflation where the rate of inflation isdetermined by cost factors such as international food andfuel prices, other sources of imported inflation reflected byworld inf lation, and the nominal exchange rate changes. Thesecond model is the well-known monetarist hypothesispopularized by Nobel Laureate Milton Friedman whereinflation is determined by the excess of monetary growthover the rate of growth of GDP. In this model inflation ispurely a monetary phenomenon. The third and more widelyaccepted model is one that combines both cost-push andmonetary factors. Which factor dominates at any point intime is determined on the basis of proper time seriesanalysis.

For this paper we develop a generalized inflation model thatcombines both cost-push and monetarist variables. Themodel is specified as follows:

INF= f (GM 2, GGDP, DNER, GIFP),

Where:

INF= rate of inflat ion;

GM2= growth of broad m oney;

GGDP= rate of grow th o f GDP; DNER= depreciation of th e nom inal exchan ge rate;

GIFP= rate of growt h of int ernationa l food prices.

The model basically says that inflation is determined by therate of growth of money supply (broadly defined), the rate of growth of GDP, the nominal exchange rate, and the rate of growth of international food prices. Other cost factors suchas international inflation could also be introduced and willbe considered as we go along.

Since there is a policy debate surrounding the relationshipbetween inflation and rate of growth of GDP, we alsoestimate a model for GDP growth that allows for feedbackfrom inflation to GDP growth and money supply growth toGDP growth. A simple GDP growth model is specified below.

GGDP= f (GM 2, INF, INV/ GDP, GLab, T/GDP),

Where: GGDP= rate of growt h of GDP;

INF= rate of inflati on;

GM2= rate of growth of broad mon ey;

INV/GDP= investm ent rat e;

GLab= grow th rat e of labor force

T/ GDP= trade t o GDP ratio

The GDP growth model says that the growth of GDPdepends upon the rate of investment, the growth of laborforce, trade to GDP ratio (to allow for openness effect), therate of inflation and the rate of growth of money supply.

Stationarity Test Results

The data we use is from 1981-2011, which gives a fairly largenumber of observations to estimate stable long-termrelationships between the variables. Before we estimatethese two equations, we need to test for “stationarity” and“causality”. The standard Dickey-Fuller stationarity testsshow that the data for GDP growth, Inflation, M2 growth,International food price inflation, Depreciation of thenominal exchange rate, and Labor force growth are all zeroorder stationary. The investment rate is not zero orderstationary. However, the investment level (INV) is zero orderstationary. Similarly, the trade to GDP ratio is not zero orderstationary but the change in the ratio (D T/GDP) is stationary.

Granger Causality Test Results

Mere evidence of correlation does not indicate causality.Economic theory can help. Thus, there is lit tle debate aboutthe causality of the following relationships: world food priceinflation causes domestic inflation; labor force growthcauses GDP growth; investment rate causes GDP growth;and trade-openness causes GDP growth. However causalityrelationship between inflation and money supply growth;between GDP growth and inflation; between GDP andmoney supply growth; and between inflation and nominalexchange rate changes are debatable. So the data werechecked for causality using the Granger causality test. Theresults are:

1) Inflation and GDP growth do not Granger cause eachother.

2) M2 growth Granger causes Inflation but not the other wayround.

3) Inflation Granger causes Nominal exchange ratedepreciation but not the other way round



15


4) GDP and M2 growth Granger cause each other

The result that inflation causes exchange rate depreciationrather than the other way round indicates that it cannot beused as a determinant of inflation. The joint causalitybetween GDP growth and M2 growth suggests that M2cannot be used on the right hand side of GDP growth

equation. Instead an instrumental variable (growth of private credit GPC) is used after ensuring its stationarity,Granger causality test and relevance as an instrument.

Estimation Results for Inflation

The estimated regression result for inflation equation isshown below:

INF= 8.28 (0.002) + 0.21(0.010) GM2+ 0.015 (0.66) GIFP- 0.99 (0.026) GGDP

R-squared= 0.3183; Adj. R-squared= 0.2425; p valu es in brackets

The results show that the growth of broad money (GM2) has

a strong and positive effect on domestic inflation (INF), whileGDP growth has a strong and negative effect on inflation.These results are consistent with the findings of many otherresearches. International food price inflation has the rightsign but its coefficient is not significant, suggesting thatwhile it may play a significant role in the short-term it is not asignificant factor for long-term inflation. Introduction of international inflation variable did not show up assignificant.

Estimation Results for GDP Growth

The estimated regression result for the GDP growth equationis shown below:

GGDP= 4.39 (0.00) + 0.0031 (0.00) INV + 0.172 (0.355) GPC -0.14 (0.056) INF+0.069 (0.218 ) D T/GD P -0.098 (0.626) GLF

R-squared= 0.615; Adj R-squa red= 0.61; p val ues in bracket

The results show that investment (INV) is a strong andpositive determinant of GDP growth. Inflation (INF) has astrong and negative relationship with GDP growth. Growthof private credit (GPC) has the correct sign but its coefficientis insignificant. Trade liberalization

(D T/GDP) has a positive effect on GDP growth, although itscoefficient has a relatively low significance. The labor forcegrowth (GLF) variable comes up insignificant and with thewrong sign. This could reflect a measurement problem.

Is There Evidence of Growth-Inflation Trade-Off?

One contentious issue in Bangladesh is the presumed t rade-off between inflation and growth. In the results we presentabove, the relationship between GDP growth rate andinflation for Bangladesh is unambiguously negative. Thismakes imminent economic sense. High inflation distortsinvestor preferences as well as consumer behavior that t end

to hurt growth. In particular inflation tends to be associatedwith asset price bubbles that cause resources to be divertedto real estate and unnecessary build-up of commoditystocks. It also tends to hurt financial savings.

In the estimates reported in this paper, the relationshipbetween growth and inflation is assumed to be linear. The

proponents of the trade-off argument base this on apresumed non-linear relationship. The argument here is thatthe relationship between inflation and growth is posit ive upto a certain thresh-hold level of inflation. Once the thresholdlevel is crossed, the relationship becomes negative.Empirical research seeks to find this threshold level of inflation. Research done by Bangladesh Bank has come upwith results that suggest that the threshold level of inflationis 6-8%. For India, the threshold level was found to bebetween 4.5-5%.

It is reasonable to expect that a 4-5% rate of inflation mightbe needed to provide the flexibility of resource mobility forgrowth in a developing country like Bangladesh. But the 6-

8% threshold range is too large and further research isneeded to come up with more definite results. It is alsoimportant that data used for estimation is properly filteredto ensure stationarity before estimation is done. Theresearch should also explain why an 8% inflation rate isnecessary to achieve higher growth and how significant, if atall, is the trade-off. As we explain below, in an environmentof low global inflation, especially in USA (2-3% inflation rateper year), targeting an inflation rate that is much in excess of the US inflation will tend to depreciate the Bangladeshcurrency (since the Dollar serves as the reserve currency) andconflict with the objective of exchange rate stabilit y.

Causality Between Inflation and Exchange Rate Changes

The Granger test for causality showed that inflation causesexchange rate depreciation and not the other way round.The economic rationale for this is that as inflation rateincreases it tends to appreciate the Bangladesh currencywhich increases imports and reduces exports. This exertspressure on the nominal exchange rate, which thendepreciates. The exchange rate is also influenced by theinflow of net foreign capital. The higher the net inflow, thehigher the tendency of the nominal exchange rate toappreciate and vice versa.

Accordingly, the rate of depreciation of the nominal

exchange rate variable was empirically tested with thefollowing results:

DN ER= 0.76 (0.02) (INF –USINF) +0.35 (0.58) N CI

R-squared = 0.28; Adj R-squa red= 0.23; p values in bracket

DNER= depreciation rate of taka vis-a-vis US dollar;INF= Bangladesh inflation rate; USINF = USinflationrate; NCI= net capital inflows.



17


IV. Is Trade Policy Losing Direction?

Zaidi Sattar

Background

Bangladesh aspires to become a middle income country by

2021. That hope is predicated on raising its current 6-6.5percent annual growt h rate of GDP to 8 percent or more on asustainable basis for the next decade. There is no doubt thatthe nature of trade policy during this period will play asupport ive or restraining role in achieving the targeted rateof growth. Historical evidence around the globe point to t hefact that high performing economies (those growing atannual rates of 7-8 percent for long periods) also have themost open trade regimes, particularly during the periods of high performance. This relationship was validated in aseminal cross-country research paper by David Dollar andArt Kraay (2001), which also concluded that growth wasgood for the poor.

In the late 1990s, Bangladesh was listed by analysts amongthe “most globalized” developing economies on the basis of its trade openness and progressive integration with theworld economy. The expectation was that, in two decades orso, Bangladesh would be ranked among the most openeconomies of the developing world. That did not happen, asprogress in trade liberalization stalled after a decade of tariff rationalization and removal of trade-related quantitativerestrictions. Is the current trade policy stance consistent withBangladesh’s long-term growth and poverty reductiongoals?

Annual budgets in Bangladesh have a major role in carving

out the trade policy stance following some measure of consultations with business chambers and otherstakeholders. FY2013 budget is no different as the tariff andpara-tariff adjustments proposed provide the direction andcontours of trade policy which will have an impact on theincentive regime that will affect decisions of investors,producers, exporters, importers, and consumers.Employment, growth, and poverty reduction are theeventual outcome of these decisions. That makes a criticalreview of budgetary proposals on trade taxes important forpolicy.

Launch of DTIS and Impending Trade Policy Review

The year 2012 is critical for trade policy. After a spectacularyear in export performance, the sharp slowdown this yearhas raised concerns about the sustainability of exportgrowth. The Government, in cooperation with the WorldBank, has launched the preparation of a Diagnostic TradeIntegration Study (DTIS), a study that seeks to identifyhindrances to greater integration of Bangladesh into themulti lateral t rading system. The DTIS will reflect the aboveconcerns on sustainability of export growth, and will buildon existing work and fill knowledge gaps where necessary.

Later this year, the periodic Trade Policy Review onBangladesh is also expected to take place at the WTO. Thus,given the fact that Bangladesh aspires to become a middleincome country by 2021, which would definitely require atrade policy orientation that is supportive of high exportperformance and rapid GDP growth, it has become anational imperative to review the state of play in t rade policy

and mould it in the right direction. The Budget for FY2013has been launched but no changes in trade policy directionsare evident from the tariff proposals.

Global Economic Environment and Outlook for2013

Because of progressive integration of the Bangladesheconomy with global trade and finance, it cannot beimmune to external developments. The global economy hasbeen slowly trying to recover from the lasting effects of theglobal financial crisis of 2008. A modest uptick wasnoticeable in the US economy as consumption andinventory investment picked up along with the credit andlabor markets. But recent events- especially those in the Euroarea -- has imposed fresh uncertainties on the globaleconomic outlook for 2012 (Table 4.1). IMF’s latest GlobalEconomic Outlook projects world output and trade to slowin 2012 with a modest pick up in 2013. The future of theEuropean Economic and Monetary Union has becomeincreasingly uncertain with mounting sovereign debtcausing significant increases in sovereign bond rates andunwillingness of a large fraction of the population of affected EU countries to

Table 4.1: Outlook of Global Output and Trade

2009 2010 2011 2012 2013P

GDP (% change)

World -0.6 5.3 3.9 3.5 4.1

Advanced economies -3.6 3.2 1.6 1.4 2.0

Euro area -4.3 1.9 1.4 -0.3 0.9

Emerging anddeveloping economies

2.8 7.5 6.2 5.7 6.0

Developing Asia 7.1 9.7 7.8 7.3 7.9

Trade Volume (% change)

World -10.5 12.9 5.8 4.0 5.6

Import s of goods and

services

World -10.9 12.7 5.8 4.2 5.6

Exports of goods a nd

services

World -10.2 13.0 5.8 3.9 5.7

Source: IMF Global Economic Outlook Apri l 2012

accept austerity measures to ensure fiscal consolidation. Theimpact of the Euro zone crisis is being felt by the developingAsian nations through the export and financial channels



19


Accordingly, the following notable trends could beobserved. The average tariffs showed a modest but gradualdecline until FY09 (Table 4. 2). However, this decline was ledby reduction in input duties rather than duties on finalgoods. The top rate which declined to 25% in FY05,remained stuck at that level since then. More notable wasthe emergence of para-tariffs like regulatory duties (RD) and

supplementary duties (SD)2. The overall outcome over twodecades of liberalization is as follows: while Bangladeshreduced tariffs, -- rapidly at first, and gradually later -- othercountries in the South Asia region and across the globegenerally moved faster. Consequently, despite two decadesof liberalization, judged by the level of average protectivetariffs, Bangladesh continues to be listed among countrieswith relati vely restrictive trade regimes3.

Budget 2013 and Tariff Adjustments

The budget comes in the wake of macroeconomicchallenges stemming from rising pressures on internal andexternal balances in the past year. Years of generally prudent

macroeconomic management have laid a solid foundationfor macroeconomic stability that is a vital precondition forrapid growth. It is also important to safeguard the strongmacroeconomic fundamentals that have been built, by notdeviating from sound macroeconomic principles. Therefore,the greatest challenge in budget implementation lies inmaking sure that there is optimal degree of fiscal andmonetary policy coordination to keep inflation undercontrol, exchange rate stable, ease pressures on the balanceof payments, and yet leave enough space for private sectorto invest and fuel growth. Ensuring macroeconomic stabil ityin the face of these challenges requires mobilizing adequatedomestic resources to finance public expenditures on

infrastructure, health and education, and therefore thegovernment has put a lot of focus on raising revenuethrough tax and non-tax measures.

Though a gradual shift is taking place from reliance on tradetaxes to domestic taxes, customs revenue still account forsome 40% of tax revenue. A number of proposals to adjusttariffs and para-tariffs have been made in the budget. Asingle message of trade policy that stands out in the budgetstatement is that the changes are done to assist localindustries. Indeed, that might be so, at least for the timebeing. But just as a pampered child often becomes unfit toface the real world, industries propped up by highprotection for too long are likely to face eventual decline as

greater global competition is unleashed in coming years.Like before, there is no announcement regarding how longsuch industry assistance through protective tariffs willcontinue. And the measures tend to be ad hoc in nature,without any background research about how muchprotection is justified, and for how long. Also, since

2An infrastructure development surcharge (IDSC) of 4% was abolished in

FY07.3

Bangladesh ranks 86th

among 110 countries in World Bank’s Overall Trade

Restrictiveness Index (2009); Hong Kong, China being number 1.

protection is not uniform, we find no rationale for thevariable rates of protection given to different products. So,while the benefits of protection are inequitable, it isconsumers who end up paying the protection tax,indefinitely. This can hardly be justified under any policyprinciple.

Before we proceed to discuss the implications of tariff changes in Budget FY2013, a snapshot of tariff trends overthe last two decades may be gleaned from Figure 4.1. Whatis evident is the gradual decline of average tariffs until aboutFY09, following which there is an uptick that continues tothe current budget. Though average CD has been on thedecline, para-tariffs have emerged as a rising component topush up average NPR.

Figure 4.1: Average Nominal Protection Trends(FY 92-FY13)

Nevertheless, a quick review of the increase and decrease of customs duty (CD) and supplementary duty (SD) rates islikely to lead one to believe that the predominant objectivethis time perhaps was higher revenue mobilization thanprotection, though the latter outcome is consequential and,by and large, welcomed by the import substitutingproducers. In a few cases (43 tariff lines), CD on intermediategoods and basic raw materials were reduced. For a largenumber of tariff l ines (413), SD was raised.

Table 4.3: Average Nominal Protection Rate, Dispersion,Maximum and General

Protective Rate for MFN Tariff Lines, FY 2000-01 to 2012-13

Fiscal YearAverage Nominal

Tariffs (NPR)Coefficient of

variationGeneral

Maximum NPR

2000-01 28.23 74.00 59.00

2001-02 29.12 76.49 43.00

2002-03 26.42 84.86 52.00

2003-04 29.10 89.00 53.00

2004-05 26.52 96.38 60.00

2005-06 26.46 102.57 72.002006-07 24.27 93.25 69.00

2007-08 22.48 107.61 72.50

2008-09 20.08 126.89 72.50

2009-10 23.88 153.38 79.00

2010-11 23.74 156.34 79.00

2011-12(Budget)*

26.51 165.12 88.00

2012-13(Budget-

Proposals)28.30 156.90 88.00

Source: PRI Tariff Database and staff estimation; (*) post-budget changes are not reflected

0

20

4060

80

F Y 9 2

F Y 9 3

F Y 9 4

F Y 9 5

F Y 9 6

F Y 9 7

F Y 9 8

F Y 9 9

F Y 0 0

F Y 0 1

F Y 0 2

F Y 0 3

F Y 0 4

F Y 0 5

F Y 0 6

F Y 0 7

F Y 0 8

F Y 0 9

F Y 1 0

F Y 1 1

F Y 1 2

F Y 1 3 ( B )

(%)Avg. CD Avg. Para Tarrif Avg. NPR

Source: NBR ASYCUDA dat abase



20


Assessment of tariff adjustments can be summarized fromTable 3 as follows:

Upward trend of average tariffs for the past threeyears is maintained.

Tariff spread is also rising as evidenced fromincrease in coefficient of variation

General maximum NPR has also been rising;excluding rates on cars, alcoholic beverages, andtobacco, there are still about 500.tariff lines withNPR exceeding 100%.

Para-tariffs take the lead . Para-tariffs – import taxes andlevies other than custom duties – have slowly emerged as adominant set of trade taxes since the middle of the pastdecade. Supplementary duty (SD) and regulatory duty (RD)seems to have become standard instruments for raisingrevenue or offering protection to domestic importsubstituting industries, so much so that in FY2013, its sharein average NPR has, for the first time, exceeded that of CD(52% of 28.3, Figure 4.2).

Figure 4.2: NPR trends and emergence of para-tariffs(FY 00-FY13)

Though SD was introduced in 1991 under the VAT Act, andwas meant to be a trade-neutral tax. Like the VAT,increasingly, it has come to be applied in a non-neutralfashion, i.e. it is not applied equally on imports as well asdomestic sales. Indeed, it has become an expedientinstrument of protection through its differential applicati on(higher rates on imports; lower or zero rates applied toimport substitutes). Likewise, RD is now seen to be used onan ad hoc basis every year, only on imports, aimed primarilyto raise protection to domestic industries, though NBRhopes it will generate extra revenue. The fact that there ishardly any objection from the producer community againstthese applications testifies to their favorable impact onprotection. So far, such rampant use of para-tariffs seems tohave escaped attention of WTO Trade Policy Review, since

cross-country tariff comparisons available in UNCTAD’sCOMTRADE database do not have information on para-tariffs. However, information on para-tariffs are beingcompiled and would soon become an irritant in multilateraltrade discussions.

Tariff escalation without end . One of the key features of tariff reform was the move towards uniformity. Thus from 20odd CD tariff slabs, the tariff structure is now characterizedby four non-zero slabs of 3,5,12, and 25. The system presents

low tariffs of 3-5 percent for basic raw materials and capitalgoods, 12 percent for intermediate goods, and the top rateof 25 percent for final goods. However, on top of the 25% forfinal goods, for a large group of products that are produceddomestically, SD and RD are generously applied. Thus tariff escalation is the highest at the last stage of processing –from intermediate goods to final goods.

Figure 4.3: Average NPR by Import Categories

What is notable is that, since FY09, the wedge between theaverage NPR on inputs and final consumer goods is rising

(Figure 4.3), thus augmenting effecting rates of protection. Itappears to be the outcome of pre-budget consultations withproducer groups only, without anyone speaking for theconsumers who will eventually pay the protection tax(higher price) and also suffer welfare losses from lack of choice. In the short-term, enterprise profit s may be proppedup, but, over the long run, this trend is likely to have adverseconsequences on productivity and competitiveness of firmsthat enjoy protection without an end period in sight.

Trade Policy Losing Direction

A substantial portion of trade policy for the coming year(FY2013) has been formulated under this budget, thanks to

the proposals regarding adjustment of trade taxes. Theseadjustments affect profitability of import substituteproduction on the one hand and export competitiveness onthe other with serious implications for trade as well asgrowth prospects. The budget essentially perpetuates theprevious tariff stance with the singular statement of supportto domestic (import substituting) industries. Is it soundpolicy in light of global competitive challenges andBangladesh’s goal of attaining higher growth and reachingmiddle income status by 2021?

As it is, tariff protection levels in Bangladesh have beendescribed by analysts as high. As mentioned earlier,Bangladesh regularly is being listed by multilateral observersas having a relatively restrictive trade regime. Continuationof this stance might prop up current profitability of importsubstituting firms. But import substitute production cateringto the domestic market cannot create jobs for the twomillion people added to the workforce each year. Exportproduction can. Research based on history and globalexperience indicates that such protection for long periods isbound to create inefficiency and undermine exportcompetit iveness in global markets. We need to reflect i f this




is the kind of trade regime that will yield the 7-8% GDPgrowth rate in the medium-term, and 8-10% growth rateover the long-term, as envisaged in the Sixth Five Year Plan(2011-15) and the Perspective Plan (2010-21). Internationalevidence shows that hitherto developing countries thatgrew at 7-8% rate for a decade were completely t ransformedfrom low-income to middle income countries; but their

growth record was characterized by open trade regimes --not the kind of trade regime we are pursuing.

The SFYP articulates a strategy for diversifying exports anddeveloping a dynamic manufacturing sector. It states, “thestructure of incentives created by the trade policy regimestill favors the production of domestic import substitutesand creates barriers for emergence of new export industriesand expansion of export industries not benefitting fromspecial measures”. The SFYP then proposes removal of theremaining anti-export bias to create a neutral policy regimebetween import substitution and export promotion in orderto focus both on manufactures that have export potentialand industries which already export but whose potentialsare not fully realized. It appears that these propositions havenot been taken on board in formulating the FY2013 budget.

Summarizing the Key findings

Trade liberalization is stalled; but no clear direction has

emerged since the dawn of the new century.

Although the RMG sector is free from the shackles of

high tariffs on inputs or outputs, other exports or

potential exports are not.

The structure of incentives underlying the trade regime

favors production of domestic import substitutes over

exports, creating an inherent ant i-export bias. Tariff and para-tariff proposals in FY2013 budget signals

continuation of the recent trend of rising average

nominal protection and wider dispersion of the tariff

structure.

While para-tariffs have been emerging as significant

component of nominal tariffs, for the first time, its share

has exceeded average custom duty.

While nominal tariffs on inputs (basic raw materials and

intermediate goods) continue to fall, those on final

consumer goods trend upwards, thus widening the

wedge between average tariffs on outputs and inputs,

augmenting tariff escalation at the last stage of processing.

FY2013 budget proposals on trade policy do not appear

to be inconformity with the articulation of the kind of

trade policy needed to improve export performance and

support the high growth needed to reach middle

income status by 2021.

Policy Recommendations

Trade policy orientation needs to change in order tosupport high growth.

Trade liberalization needs to be put back on track. For

that, average nominal tariffs and their dispersion bothhave to be reduced.

The wedge between input and output tariffs is wide,and getting wider. The highest difference lies betweentariff on intermediates (12%) and tariff on final goods(25%+RD+SD). Such tariff escalation breeds inefficiencyand undermines competitiveness of firms in the longrun.

It is high time for the top tariff rate, along with para-tariffs, to be scaled down, to give domestic consumerssome relief.

In framing trade policy, policymakers must balanceinterests of producers and consumers – the latter group

is not organized like the former.

References

Dollar, David and Kraay, Art (2001). “Grow th is Good for th e Poor ,” Policy Research Working Paper, The World Bank.

Sattar, Z. (2012). “Trade Policy Developm ents and t he Way Forward ”, in Leading Issues in Bangladesh Development,Sadiq Ahmed (ed), University Press Ltd., Dhaka.

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