Laws and Policies Affecting Industrial and SME DevelopmentExecutive Summary

The report analyses the Industrial Policy 2010 of Bangladesh, which is believed to be the path to rapid industrialization in the country. The government aims to

Achieve the Millennial Development Goals (MDGs) Reduce unemployment and the proportion of the population afflicted by poverty and

hunger to less than a half by 2017 Increase GDP growth rate to 8% in 2013 and to 10% between 2017 and 2012 Achieve the coveted rank to become ‘middle-income country’ and Digital Bangladesh

by 2012 Increase the percentage of GDP for Industrial sector to 40% from 28% by 2021 and

increase labor force employed from the present 16% to 25%

Private sector will spearhead the industrialization drive. The government will be limited to the role of a facilitator, pushing for and creating an enabling environment for attracting increased private investment in areas of dynamic comparative advantage. The policy also recommends for establishing Economic Zones, Industrial Parks, High-Tech Parks, and Private EPZs for rapid and balanced industrial development of the country.

From the analysis, we saw that the Policy 2010 is much better compared to the Policy of 2005. For e.g. the new policy:

recognizes the dominant role of the private sector in industrial development in which the government will act only as a facilitator

lays emphasis on both export orientated and import substituting industries and raising their competitiveness in both domestic and international markets

proposes to give special incentives and support measures to assist women entrepreneurs, and for promoting agro-based and food-processing industries

The major constraints for industrial growth are: limited access to credit, its high cost, legal or illegal, and procedural complexities in

obtaining credit from banks poor physical infrastructure and acute shortage of energy, and unreliable supply of

power and other utilities such as gas and water pervasive corruption in bureaucracy, particularly in the administration responsible for

delivery of public services poor law and order conditions, and

We Recommend: Remove the structural impediments and address the weaknesses in its domestic policy

environment. The root causes of the problem lie in the fundamental governance issues in power infrastructure, finance, enforcement of law and order, and eradication of corruption. Improve on these sectors

Address sector-specific problems New policy towards FDIs Ensure protection of Environment Make the policy simple and easier to implement

The Policy places special attention to the SME and cottage industries to help gradual reduction of the rural to- urban exodus of people in search of employment opportunities, but above all to beef up incomes in rural communities.

Under ‘Industrial Policy 2010´: Govt. will encourage SMEs through providing adequate loan and training programs SME will be re-financed continuously by BB through three re-financing funds.

Women entrepreneurs will get priority for SME loan.

ICT Industries will get priority for govt. assistance

The reforms undertaken by the government had positive impacts reflected in a rapid growth of the sector during the past decade. However, due to weaknesses in the policy, there have been various constraints to SME development in the country: Legal, Regulatory, and Administrative Constraints include unnecessary delays in

obtaining trade license, registering under the Factory Act and with the sponsoring agencies and cumbersome legal procedures.

Lack of access to credit is another constraint. This is due to the reluctance of banks to provide loans to SMEs mainly because of banks' pre-occupation with collateral based lending, Bureaucracy and Corruption.

The share of SME sector in the total public development expenditure is very low. There is also discrimination against SMEs in the fiscal policy with respect to VAT, tax

holiday and wealth tax.

The SMEs need pro-active policies and institutional support in addition to removal of existing policy biases for proper development. Some short-term reforms include-

The development of an SME Development Authority instead of SME foundation Releasing SMEs from labor and tax obligations for at least five years of business

operation

substantial increase in public investment in the sector particularly in the area of training, extension, research, market promotion

Establishing District SME Centers in each district

Middle and long-term actions include- Reviewing of all fiscal laws and amendment of Companies Act 1994 Provision for attractive cash incentives on export Establishment of specialized banks for SMEs A full-blown technology development policy should be followed with technology

development fund. R & D institutions should be established for technical services at the district level.

Industrial Policy 2010

Bangladesh is a developing country and the key to the country’s economic development is rapid industrialization.1 A densely populated country with a population of around 150 million living on a land area of 147570 square kilometer (56977 square miles),2 its economy is dependent mainly on agriculture, which accounts for a fifth of GDP but provides employment to as much as 50 percent of the country’s labor force. Since the country’s population and labor force are growing rapidly every year, it is hardly possible that the growing labor force can ever be absorbed in the agriculture sector, unless the country’s industrial sector is sufficiently developed and expanded to create additional employment opportunities. Given the unfavorable land-man ratio and the under-developed state of the country’s agriculture sector, the key to the generation of productive employment lies in strong economic growth through the structural transformation of the economy away from agriculture and toward industry (Bhuyan, 2005).

The government already had an Industrial policy, which was announced in March 2005, but recently, on 5 September 2010, the government announced a new draft Industrial Policy which has already been approved by The Cabinet Committee and it will replace the old one. The existing laws, according to the government, are not effective enough to quickly formulate and implement development projects for increasing production and supply of electricity. 3

The proposed industrial policy presents an integrated strategy for achieving high economic growth in the country through rapid industrialization. It has been prepared taking into consideration the government’s determination to achieve the Millennium Development Goals (MDGs) by 2015, and halve the number of the unemployed and hunger- and poverty-stricken people by 2017.

To alleviate poverty by creating additional employment opportunities, the proposed policy aims to create job for at least one man per family. It envisages rapid industrialization through short-, medium-, and long-term measures, for raising the rate of GDP growth to 8 percent by 2013, and 10 percent in 2017 and thereafter. The policy reiterates the country’s well-publicized desire to achieve the status of a Digital Bangladesh by 2021. The Policy has been reshaped and gives more emphasis on establishing agro-based industries and raising agricultural production, which will ensure the protection and fair price of agricultural products and employment of a huge number of unemployed people. The proposed policy puts emphasis on private sector industrialization efforts but at the same time vows to reform the public sector enterprises to make them profitable.

In order to further strengthen the country’s industrialization process, the present government has identified the Small and Medium Enterprises (SEMS) as a priority sector and as the driving force for industrialization. The provisions of all facilities for attracting foreign investments have been envisaged in the Industrial Policy. The government has taken an initiative to formulate a separate SME policy to provide entrepreneurs with necessary guidance and strategic support in respect of the establishment of SME industries all over the

1 While the pace of industrialization in developing countries depends in a large measure on factors like factor and resource endowment, country size, geographical location, social mores, and international environment, industrial policy plays a crucial role in influencing industrial growth (James, Naya, and Meier, 1987).

2 While the population density per square kilometer of total area in Bangladesh is 977, the population density per square kilometer of cultivated land is 1600.3 http://www.unbconnect.com/component/news/task-show/id-29530

country. These strategic guidelines will be followed in establishing SMEs across the country. Far-reaching changes have occurred in the past decade in economic and social activities across the globe, especially with regard to the participation, contributions and successes of women in industrial activities. Therefore, the creation of women entrepreneurs and their participation in industrialization have been given considerable prominence in the present Industrial Policy. The establishment of SMEs are a great way to create women entrepreneurs.

The guidelines contained in the new Industrial Policy will help expand planned industrialization in the country, bring about sustainable and continuous industrial growth, and overcome the past failures of industrialization largely. As a result, a sound and prospective foundation of economic development will be established. This will help bring about poverty alleviation, create further employment opportunities, reduce unemployment instances, improve living standards of people, and achieve an overall economic growth in the country.

Policy goals, objectives and strategies

The proposed industrial policy envisages an increase in the industry sector’s share in GDP to 40 percent by 2021 from the present 28 percent, and seeks to raise the proportion of the workforce employed in industry to 25 percent of the country’s total labour force by 2021 from 16 percent now.

The new Policy states that it will make available adequate opportunities for establishing both import-substituting industries that will cater for the domestic market and expanding and developing export-oriented ones to ensure the growth and expansion of the industrial sector. The Policy will also encourage transforming resource-based export industries into process-based ones to create higher value addition in exports.

The Policy gives priority to providing the industrial sector with adequate facilities of electricity, gas and water, and other physical infrastructure like road, rail transport and telecommunications. Agro-based, food processing, and labor-intensive industries will receive priorities in matters of getting fiscal and other incentives. The policy also mentions steps that will be taken to raise investment in the tourism industry and raise its efficiency.

The Policy puts emphasis on the development of small, medium and cottage industries, including giving encouragements to women entrepreneurs, to boost economic growth through creating more jobs. It encourages the growth of SMEs in rural areas to reduce the pressure of migration to urban areas.

The establishment and balanced development of industries in different geographical regions of the country is a core objective of the Policy. To that end, it recommends for establishing Economic Zones, Industrial Parks, High-Tech Parks, and Private EPZs for rapid and balanced industrial development of the country. In particular, it proposes to set up separate economic zones for sectors such as textiles, ceramics and pharmaceutical ingredients. A special law will be enacted for these purposes.

The proposed Policy relies on the premise that a vibrant and dynamic private sector is the key to the country’s rapid industrial growth. The growth and expansion of the private sector will therefore be the main objective of the industrial policy. Public investment shall be limited only to sectors considered crucial on grounds of national security and in areas that might have a crowding-in effect on private sector investment. Government will only play the role of a facilitator.

The new Policy encourages the privatization of public sector enterprises (PSEs) but in the event the government considers it necessary to retain certain PSEs in the public sector, these enterprises will be encouraged as complementary and competitive to private sector industries. The Policy, however, imposes a condition that, while privatizing PSEs, alternative employment of workers that are likely to become redundant after privatization should be ensured.

Public Private Partnership (PPP) shall be an important element in the proposed industrial policy. Under the Policy, PPP projects like flyovers, elevated expressways, monorail, underground rail, economic zones etc will be approved under the Private Sector Infrastructure Guidelines. Funds will be arranged under PPP initiatives for developing infrastructure for industrial clusters, industrial parks, the development of labor-intensive industries, and setting up environment-friendly industries.

The policy will provide necessary protection to local industries from unfair competition from dumped or smuggled imports. It will formulate appropriate measures to tackle problems of sick industries and devise an exit policy for industries that have long remained sick. It will adopt appropriate measures to rehabilitate sick industries, on a case to case basis, but at the same time formulate a law to rid the nation of sick industries.

Sick industries, if found potentially viable, may be converted into public limited companies to make them efficient, competitive, and profitable. Government shall not undertake any new projects to replace sick industries without settling their liabilities. The new Policy is, however, in favor of adopting appropriate reforms in the jute sector, diversifying the uses of jute, and taking measures to make jute industries profitable. It will also seek to improve the management of public sector cotton textile mills to make them efficient and profitable.

The new Policy seeks to make the industrial sector environment-friendly and encourage industrial enterprises to adopt pollution control measures. To that end, Government will ensure that the industrialization process is environment-friendly and conforms to specific WTO agreements and standards.

Classification of Industry and Redefinition of Industry size

The old policy of 2005 classified industries into only three categories: Large, Medium and Small. The new proposed Policy classifies industries into five categories: Large, Medium, Small, Cottage, and Micro.

In addition to reclassifying industries, the proposed Policy has given a uniform definition of the size (large, medium, small, and cottage) of Manufacturing and Service industries in terms of both fixed capital and labor employment.

The number of ‘Thrust Sector industries’ has been brought down to 30 in the 2010 policy from 33 in the 2005 policy. Thrust sector industries are those industries, which, according to the framers of the Policy, have high growth potential. These industries shall be eligible for special fiscal incentives and supports, viz., tax exemption, tax at reduced rates, avoidance of double taxation, etc., and perhaps easier access to credit facilities from banks on concessional terms.

The proposed Policy provides for special incentives to encourage Women Entrepreneurs. Women entrepreneurs, who may either be sole proprietors or hold 51 percent of shares in partnership or joint stock companies, shall be eligible for receiving these special incentives.

(All definitions are listed in the policy provided in the annexure)

Investment Incentives

There is a long list of tax incentives in the proposed policy, viz., tax exemption, tax holiday, accelerated depreciation allowances, tax policy benefits, and incentives for NRBs, equal treatment for local and foreign investors etc.

The prevailing tax holiday facilities (valid until 30 June 2011) shall continue under the proposed Policy. At present, industrial establishments in Dhaka and Chittagong Divisions, except the three hill districts, enjoy 100% tax exemption in the first two years, 50% tax exemption in the next two years, and 25% tax exemption in the fifth and final year. In the case of Rajshahi, Khulna, Sylhet and Barisal Divisions and the 3 hill districts, prevailing tax exemptions are 100% in the first three years, 50% in the next three years, and 25% in the seventh and final year.

The provision of accelerated depreciation allowances shall continue until 30 June 2010. The prevailing four-tier customs duty rate structure shall also continue under the proposed industrial policy. The customs duty rates in force are 2.5% for machinery and spare parts, 5% for basic raw materials, 10% for intermediate products, and 25% for finished products. Also in section 5.7 the policy states that duties and taxes on import of goods which are produced locally will be higher than those applicable to import of raw materials for producing such goods.

Investment of NRBs will be treated at par with FDI. NRBs will enjoy facilities similar to those of foreign investors. NRBs can buy newly issued shares/ debentures of Bangladeshi companies. A quota of 10% has been fixed for NRBs in primary public shares.

The new Policy will ensure that investors can invest without any hassles and undesirable official interference. It calls for the simplification of investment sanctioning procedures and for the removal of all legal complexities, delays and red tape in decision-making to give prompt services to investors.

To meet the demand for industrial term loans, the policy recommends institutional reforms in banks and financial institutions. The capital market shall be strengthened to enable it raise more industrial investment from the secondary market.

The new Policy will encourage both foreign and domestic investment. It will seek to rationalize existing incentives to attract investment in sectors in which the country has a comparative advantage.

Institutional Arrangements for Expanding Industrial Activities

The Policy proposes to adopt well-conceived medium- and long-term measures for the development of the industrial sector and to devise workable and efficient institutional arrangements for expanding industrial activity and a mechanism to monitor the progress in the implementation of industrial sector projects.

The Ministry of Industries shall be the focal point for the promotion of industrial activity. The Board of Investment (BOI) shall be the main agency to assist and develop private sector industrial investment. BSCIC and EPZs will allot industrial plots in their respective areas.

The Policy seeks to make the programs of different training institutes under different ministries engaged in human resource development more dynamic and effective. The training

institutes named in the Policy are Bangladesh Institute of Management (BIM); Bangladesh Institute of Technical Assistance Centre (BITAC); National Productivity Organization (NPO); Small and Cottage Industry Training Institute (SCITI); Training Institute for Chemical Industries (TICI); National Hotel and Tourism Training Institute (NHTTI) of Bangladesh Tourism Corporation; different training institutes under Jute and Textile Ministries and the Corporations under them; and other training institutes under Bangladesh Handloom Board and Bangladesh Sericulture Board.

Implementation, Monitoring and Evaluation

A high-level 15-member body – National Council for Industrial Development (NCID) – with the Prime Minister as president and the Industries Minister as vice-president is proposed in the Policy. NCID shall meet at least once in six months. There shall be a 24-member executive committee of the NCID (ECNCID) with the Industries Minister as its convener.

The Policy refers (paragraphs 16.4 and 16.7) to the Bangladesh Better Business Forum (BBBF) and the Regulatory Reforms Commission (RRC) (formed during the latest Caretaker Government regime) to promote contact and cooperation between industrialists and government policymakers and create a conducive business environment.

There will be a coordination committee (comprising 18 members) to coordinate activities of different government organizations. Programs and action plans of various private sector organizations shall be utilized for effective implementation of the 2010 industrial policy.

Analysis of the Industrial Policy 2012

Reclassification of Industry and Redefinition of Industry Size

A welcome feature of the 2010 industrial policy is that it retains all the good provisions of the 2005 policy. For example,

1) It recognizes the dominant role of the private sector in industrial development in which the government will act only as a facilitator.

2) It lays emphasis on both export orientated and import substituting industries and raising their competitiveness in both domestic and international markets.

3) It proposes to give special incentives and support measures to assist women entrepreneurs, and for promoting agro-based and food-processing industries.

The 2010 Policy has also brought an improvement over the 2005 policy by changing the classification of Industry and giving a new definition of industry size. Thus,

1) The 2010 policy classifies industry into five categories – large, medium, small, micro, and high-tech industries. The 2005 policy classified only three – large, medium, and small.

2) The 2010 policy has also changed the size definition of manufacturing and non-manufacturing industries.

3) The 2005 policy defined the size of manufacturing industries in terms of the amount of fixed capital investment, and the size of non-manufacturing industries in terms of the employment of workers.

4) The 2010 policy has redefined all types of industries – whether manufacturing or non-manufacturing (service) – in terms of both fixed capital and the employment of labor.

5) The industry-related people would definitely appreciate the 2010 industrial policy provision that has recognized micro and high-tech industries as separate categories of industry.

6) The reclassification of industries in the new Policy shall enable micro and high-tech industries avail of the facilities catering for their special needs and problems.

7) The industry-related people would also welcome the redefinition of industry size because, for purpose of ascertaining the presence of anti-competitive or monopoly practices, both capital and employment of labor are necessary to measure the true size of industrial enterprises.

Thrust Sector Industries

In order to turn the industrial sector into a major instrument of economic growth, the new industrial policy has made a long list of thrust sector industries. Although the number of thrust sector industries in the new Policy is fewer (30) than in the 2005 policy (33), the list is still large, even unwieldy.

The list, of course, includes some industries with high potential, but there are others, which do not produce standardized products, require only small amounts of capital, and have very small markets for their products. From what we got from the interviews conducted, the long list of thrust industries may in fact detract attention from the relatively more important ones that genuinely need significant fiscal, financial and infrastructural support.

Moreover, the proposed Policy makes incentives for the thrust sector industries conditional to their performance and contribution to the economy. The incentives will thus not be automatic, which will create confusion among new entrepreneurs that will need guaranteed access to the declared incentives. Declaring some industries as belonging to the thrust sector is not without peril. To cite an example, when garments and leather industries were declared as thrust sectors in the past, many enterprises took advantages of their being so designated and was able to obtain huge amounts of bank loans but later turned loan defaulters. Many banks suffered as a result. (Policy, 1999)

We believe after these considerations, limiting the thrust sectors to a few promising industries would be more realistic and meaningful.

Regulated Industries

The proposed industrial policy includes a large number of industries (17 in all) in the list of Regulated Industries. This provision will require government to frame wide-ranging rules to regulate the related industries thereby increasing the sphere of government, whereas the declared objective and strategy of the industrial policy is to enhance the role of the private sector in industrial activity.

The highly restrictive provision that the registering authorities – BOI, BSCIC, BEPZA etc. – shall not register the regulated industries without the express approval of the concerned Ministry/Organization could hinder private sector initiative. The sphere of Government should be limited essentially to the provision, development and maintenance of essential infrastructure and utilities in which the private sector is unlikely to show any interest, thus withdrawing all unnecessary regulations.

Regulations that are necessary, for example, regulations pertaining to environment, and worker health and safety policies, should be set realistic goals, implemented efficiently, and subjected to periodic review.

Policy Contradictions about Private and Public Sector Involvement

The proposed industrial policy suffers from a contradiction. On the one hand, it recognizes the role of a vibrant private sector in industrial growth, but on the other hand it plans to go ahead with SOEs and calls for raising their profitability. It is hardly likely that an SOE will ever behave like a profit-seeking entity and improve its efficiency (Bhuyan, 2005). Asking a public sector manager to earn profit is like asking a monk to run a casino. Government should not therefore get involved in running businesses. Its role should be that of a facilitator instead.

It is common knowledge that a market economy cannot thrive if there is a large presence of SOEs. The large amounts of accumulated defaulted loans now in the state-owned banks are because of the presence of the public sector in the operation and management of industries. (Bangladesh: Strategy for Sustained Growth, 2009) A lot of bad debt was created in the decade of the 1980s in the name of rescuing the ailing jute industry. At the moment, too, there is an official move to forgive the defaulted loans in the name of reviving the jute industry. It is learnt that in the Agrani Bank alone, government has submitted a proposal to forgive defaulted loan worth Taka 1 crore. (Bhuyan, 2005)

Given the continuing operating losses of SOEs (Alam, 2009), discarding the principle of divesting the loss-making SOEs just for purpose of protecting jobs is fraught with the danger of increasing the number of sick industries. A proper solution of the problem of the ailing SOEs is their outright privatization.

Public Private Partnership (PPP)

The emphasis on PPP in the proposed industrial policy is laudable but the concept is still in a rudimentary stage. Government will need to act expeditiously to devise a transparent mechanism and frame well-defined rules for participating in and mobilizing funds for the PPP projects. Usually in the advanced countries, the debt-equity ratio in PPP projects is 70:304, and in those countries the 70% debt are generally funded by commercial banks, specialized financial institutions, and international financial institutions. In Bangladesh, given the weak state of the capital market, the debt requirement will be much higher. Hence, in order to enable the private sector entrepreneurs to participate in PPP projects, the banking sector should be required to extend credit on easier credit terms. Investment Incentives

Tax Holiday and Accelerated Depreciation Allowances

The continuation of the prevailing tax holiday facility proposed in the Policy would greatly help the private sector industrial entrepreneurs. However, the tax holiday facility should not be limited for a given time period but extended for further periods on case-by-case basis. Area wise tax exemption facilities currently enjoyed by industrial establishments may be made more liberal in the proposed Policy. Thus, in Dhaka and Chittagong Divisions, excluding the three hill districts, the exemption could be extended to a period of seven years (instead of the present five years): 100% in the first four years, 50% in the next two years, and 25% in the final and seventh year. In the other four Divisions and the three hill districts, exemption could be allowed for nine years: 100% in the first five years, 50% in the next three years, and 25% in the next and ninth year. (Bhuyan A. R., 2011)

The business community will surely appreciate the continuation of the provision of accelerated depreciation allowances. Nevertheless, there is a strong case for bringing more industries under the tax holiday facility, because tax holiday is widely regarded as superior to

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accelerated depreciation allowances. Needless to mention, tax holiday facility should be given to specific industries, only if its rationale is established by sound economic criteria.

Other Fiscal Policy Measures

Keeping in view the need of the local industries to remain competitive, it would be advisable to reduce the customs duty rates on machinery and spare parts, basic raw materials, and intermediate products from the prevailing 2.5%, 5%, and 10%, to 0.5%, 2.5%, and 5%, respectively. (Bangladesh: Strategy for Sustained Growth, 2009)

Moreover, according to the interview we conducted, there should not be any VAT or any other duty on the import of machinery and spare parts and basic raw materials. However, a reasonable rate of customs duty may be imposed on intermediate products that have domestic production.

Our take on the Industrial Policy 2010

All successive governments in the country since independence announced policies and strategies for accelerating the process of economic growth through the development of the industrial sector, but the growth of the industrial sector has remained slow.

One may attribute this slow growth to factors like energy shortage, reduced availability of bank credit, poor inflow of foreign direct investment (FDI), labor unrest, poor law and order conditions, as so on, but no less responsible were the inconsistent policies, which vitiated the overall business environment, discouraged investors, and hindered industrial activity in the country. (Bhuyan A. , 2005)

It is the considered view of experts that in order to pave the way for strong growth and expansion of the industrial sector, industrial policies periodically announced by government, should contain appropriate measures to address the aforementioned problems.

To name a few, the common provisions relate to expanding private sector participation in manufacturing, increasing the efficiency of public sector enterprises, liberalizing the import regime, providing incentives to exporters, liberalizing the foreign investment regime, and offering attractive incentives to foreign investors. However, these provisions achieved little by way of raising investment levels or achieving sustained industrial growth.

Major Structural Constraints impeding industrial growth

Major Structural Constraints that hindered industrial growth include

a) limited access to credit, its high cost, legal or illegal, and procedural complexities in obtaining credit from banks

b) poor physical infrastructure

c) acute shortage of energy, and unreliable supply of power and other utilities such as gas and water

d) lack of skilled labor and the tendency for labor to be militant

e) competition from dumped and smuggled imports

f) pervasive corruption in bureaucracy, particularly in the administration responsible for delivery of public services

g) poor law and order conditions, and

h) Growing incidences of crime and extortion at every stage starting from production to distribution and marketing of the products.

The afore-mentioned structural impediments continue to vitiate the business climate and dissuade entrepreneurs to bring in new investment or expand the existing ones. This also explains why foreign investors are not willing to invest in this country despite the availability of attractive incentives.

Why Did Past Industrial Policies fail?

Experts say that the past industrial policies were not effective because they lacked a strategic vision or a clear direction for industrial development. The policies scarcely addressed the hard-core problems that hindered industrial activity, thus making the policy incentives meaningless. There was virtually no recognition in the policies of the supply-side constraints, both structural and policy-induced, that were the major impediments to the expansion of private sector manufacturing industries (Bangladesh: Strategy for Sustained Growth, 2009).

Policy Failures that affected Industrial Growth

Apart from the structural constraints already mentioned, manufacturers faced a number of problems, induced by policy failures. Many entrepreneurs, in particular the foreign investors, complain that most policy reforms in this country are incomplete and remain only in paper. For example, during the early 1990s, the government opened up the economy, lowered tariffs, eliminated quantitative restrictions, and used the floating exchange rate mechanism to promote exports. However, the progress in these reforms was not maintained. Moreover, the lack of complementary reforms to improve the conditions of power infrastructure, telecommunications and financial services has meant below potential benefits from increased openness.

Recommendations

Recommendations for Structural and Policy-induced Constraints

In order to take full advantage of emerging global opportunities, Bangladesh needs to remove the structural impediments and address the weaknesses in its domestic policy environment. The root causes of the problem lie in the fundamental governance issues in power infrastructure, finance, enforcement of law and order, and eradication of corruption. Without improvements in these areas, the mere announcement of an ambitious industrial policy with lofty objectives is unlikely to help achieve a sustained growth of the country’s industrial sector.

Addressing Sector-specific Problems

Apart from addressing the broader issues centering structural and policy-related constraints, the proposed industrial policy should also address the sector-specific problems faced by different industries. While the most common problems faced by all industries are those of infrastructure, capital and technology, some of the problems are specific to particular industries. The proposed industrial policy should incorporate appropriate provisions to periodically monitor and address the specific industry-related problems.

Policy toward Foreign Direct Investment (FDI)

Industrial policy should not consider FDI merely a means of complementing domestic resources for industrialization. It should also ensure that foreign investors bring in new technology in the country. A strict screening of FDI would therefore be necessary5. To that end, the proposed industrial policy should clearly lay down that foreign investors should not be accorded permission to invest and conduct business in this country unless they brought the latest technology.

Protection of the Environment

The proposed industrial policy lays strong emphasis on the protection of the environment and directs manufacturing enterprises to control environmental pollution by setting up effluent treatment plants (ETPs) and strictly comply with environment-related laws and regulations.

While the emphasis on environmental protection is highly welcome, it will be necessary for the government to adopt appropriate measures that will make the private sector enterprises’ tasks easier to take effective steps against environmental pollution and desist from such activities as may cause environmental pollution.

Industrial Policy needs to be simple and easily implementable

The test of a good policy lies in its simplicity and how easy it is to implement. With 16 elaborate chapters, the proposed industrial policy document appears to be rather large. Unduly long and elaborate policy documents may have the unintended effect of the crucially important objectives getting lesser priority. As regards implementation, the availability of adequate resources, whether institutional, financial, or human, will be crucially important. There will be the need for better coordination among concerned ministries and implementing agencies to improve policy implementation.

In addition, the implementation of industrial policy in Bangladesh remained weak in the past because of inherent bureaucratic complexities, red tape, and delays in decision-making. The proposed industrial policy will need to address these problems seriously.

SMEs- a priority sector of the Industry PolicyThe development of small and medium enterprises (SMEs) in developing countries is generally believed to be a desirable end in view of their contribution to decentralized job creation and generation of output. These are the enterprises with less capital investment and more labor absorption, less technology-oriented, using local resources, catering to local/regional demands. The development of these industries contributes to the increase in per capita income, generates immediate employment opportunity; i.e. they are employment generating machine, promotes more equitable distribution of national income, make effective mobilization of untapped capital& human skills, and leads to dispersal of manufacturing activities all over the country, leads to growth of villages, small towns & economically lagging regions; thus promoting balanced regional development. SMEs constitute the dominant source of industrial employment in Bangladesh (80%), and about 90% of the industrial units fall into this category. (Said Baht, 1998)

Present Scenario of SME in BangladeshThe present scenario of SMEs in Bangladesh is highlighted below:

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Around 6 million SMEs are in operation. Contribute around 50 percent of industrial outputs. Employ about 31 million people. Contribute around 25 percent of total GDP About 60 to 65 percent SMEs located outside Dhaka and Chittagong metropolitan city. Most of the SMEs are labor intensive and low capital based. Interest rate of SME loan is between 14 to 20 percent The largest sector in terms of employment generation Around 75 percent contribution to export earning

Contribution of SMEs to national economy:In Bangladesh, SMEs play a significant role for the development of our economy. SMEs contributions are:

1. Creation of employment opportunities2. Up-gradation of GDP growth rate3. Reduction of poverty4. Earning foreign currency5. Industrial raw-material supplier6. Earning govt. Revenue7. Empowering women8. Optimum utilization of latent resources9. Development of standard of living10. Import substitution11. Ensure rural development12. Development of potential entrepreneurs

Evolution of SME policies in BangladeshBefore independence SMEs were neglected seriously and there was no policy base. There was only Karachi Centered “Heavy Industrialization”. In the First Industrial policy, (1971-1975) SMEs were neither given any incentive nor threatened any longer. All the major industries were nationalized following inward looking policy. SME was defined as an enterprise having maximum investment ofTK20.5 million.

The Second Industrial Policy (1975-1981) hardly touched anything related to the development of the SME sector. There was a planned shift from public to private led growth, heading towards “free enterprise system”.

The Third Industrial Policy (1981-1990) was relatively SME-friendly. However, the policy remained only in paper due to no or weak implementation measures in practice. Again further emphasis was given on “free enterprise system”, privatization and export-oriented industrialization. In this phase the definition remained the same as in the First Industrial Policy.

A modest change in policy environment was seen during the Fourth Industrial Policy(1991-1995) but it produced some policy-induced constraints hindering SME development. Preparedness for globalization, privatization and export-oriented industrialization was seen in the industrial policy.Here investment ceiling was extended up to Tk 30 million.

Further emphasis on globalization, privatization and export-oriented industrialization in the Fifth Industrial Policy (1996-2001) continued more policy induced constraints that hindered the development of SMEs..SME sector has been treated as a priority sector in the Industrial Policy 2005. In the policy the development and expansion of SMEs is regarded as a very important medium of achieving industrialisation and economic growth. The Industrial Policy 2005 mentioned that SMEs would be established on a greater scale across the country in order to bring about poverty alleviation, unemployment reduction and creating more employment opportunity so that national economic growth can be attained. To this end, the government has taken an initiative to draw up a separate SME policy with a view to provide necessary guidelines and strategic assistance in respect to establishing SMEs throughout the country.

Government of Bangladesh recently formulated a comprehensive Industrial Policy-2010 by putting special emphasis for developing Small and Medium Enterprises (SMEs) as a thrust sector for balanced and sustainable industrial development in the country to help deal with the challenges of free market economy and globalization.

Govt. policy under ‘Industrial Policy 2010´ for SME

Government will encourage SME entrepreneurs through providing adequate loan and training programs to create strong position of SME.

SME will be re-financed continuously by BB through three re-financing funds.

Women entrepreneurs will get priority for SME loan. 15% of total loan will be for them and the interest rate will be 10%.

ICT Industries will get priority for govt. assistance

For providing promotional support, the following 11 booster sectors have been depressed by The Industrial Policy 2010 of the Government of Bangladesh and the list would be reviewed every three years

Electronics & Electrical Software Development Light engineering and metalworking Agro-processing/agri-business/plantation agriculture/specialist farming/tissue-culture

and related business. Leather making and leather goods Knitwear and readymade garments Plastics & other synthetics Healthcare and diagnostics Educational Services Pharmaceuticals/cosmetics/toiletries Electronics & Electrical Fashion-rich personal effects, wear and consumption goods

Current Institutional Arrangements for SME development 

BSCIC has been the key public sector agency responsible for supporting SME promotion for a long time.

Bangladesh Bank, BASIC Bank, SME Foundation, JUC, Bangladesh Krishi Bank, Janata Bank etc.

The private sector efforts through participation of MIDAS and selected NGOs (especially GB, BRAC and Proshika) have been worked especially in SME promotion.

Effectiveness of SME Assistance Policies and Institutional Arrangements:The economic efficiency and overall performance of the SMEs especially in the developing countries are considerably dependent upon macroeconomic policy environment and specific promotion policies pursued for their benefit. It is thus important to examine the policy environment and institutional support within which the SMEs operate.

The reforms undertaken by Bangladesh since 1980s, as explained earlier, did help remove a large part of the policy bias against SMEs that prevailed earlier. Recent studies confirm that these reforms had positive impacts reflected in a fairly rapid growth of the sector during the past decade. However, the policies have not been pro-active enough to overcome the SMEs’ structural weaknesses. Though promotion of SME development has been a stated objective of successive governments ever since Pakistan days, the broad macro policy regime has continued to remain biased against SME development in many ways. Allocations of public sector investments, trade policies and taxation policies in particular have mostly been anti-SME development in character and contents (ADB, 2002).

The specific promotional policies and support measures such as extension services, financial and physical support from the public sector agencies and the development partners have also not always been adequately effective. Weak and inefficient management and lack of proper implementation of the various policy support measures have rendered various services, such as training, credit marketing and physical infrastructural facilities (through BSCIC’s Industrial Estates Program), much less effective than desired. The private sector efforts through participation of MIDAS, BASIC and selected NGOs (especially GB, BRAC and Proshika) have not so for been adequate especially in SME promotion. Though BSCIC has been the key public sector agency responsible for supporting SME promotion for a long time, its operational efficiency remains weak for a number of structural, administrative, and managerial bottlenecks.

Issues in the SME Policy Based on the interviews conducted with various experts and literature review, we have identified the following major constraints in the policies affecting SME development:

Legal, Regulatory, and Administrative ConstraintsPolicy reforms of the past decade have brought about substantial relaxation in the investment sanctioning procedure. No prior approval is now required for investments involving own finance. However, there are still constraints in the following procedural aspects relating to investment regulations:

Trade License: Investors are required to procure trade license from local government bodies by paying statutory fees. The process involves unnecessary delays, harassment and side payments.

Registration under Factories Act: According to the Factories Act 1965, all manufacturing units employing 10 or more workers are required to be registered with the office of the Chief Inspector of Factories and Establishments. The job of the Factory Inspector is to oversee the working condition and safety measures in the factory. In practice, the regulation has proved to be a major source of delay, harassment and unofficial payments for the investors particularly for those in the SME sub-sector as the existing regulations do not differentiate between different size categories with respect to safety and working conditions requirements.

Registration with Sponsoring Agency: Registration with sponsoring agencies such as theBangladesh Small and Cottage Industries Corporation (BSCIC), Board of Investment(BOI) or Bangladesh Export Processing Zone Authority (BEPZA) is voluntary unless an enterprise wants to avail itself of government incentives. To keep track of private investment in various sub-sectors, registration with the sponsoring agency must be mandatory.

Contract Enforcement and Resolution Inadequacy in the system for contract enforcement and resolution arises from archaic legal system where procedure of adjudication is long drawn out and cumbersome and the system is corrupt. As a result, it is not difficult to delay a scheduled date for hearing. SMEs with low sustaining power often lose out in the long drawn out court battle.

Financial ConstraintsSMEs encounter great difficulties while rising fixed and working capital because of the reluctance of banks to provide loans to SMEs. Banks are unwilling to lend to SMEs because of high processing and monitoring costs of loans to SMEs. The loan application forms for investment financing from banks are long, tedious, and redundant. Since the removal of the interest rate subsidy without the removal of interest band, financial institutions find little incentive to lend to SMEs. SMEs find it difficult to non real estate assets as collateral to obtain loans from the banks.

In the past, the government has attempted to provide SMEs with access to finance through targeted lending. There was a government directive that 5 per cent of a bank's loan portfolio be set aside for small and cottage industry financing. A new bank, namely, the Bank of Small and Cottage Industries (BASIC) was set up in 1988 with the objective of financing the small and cottage industries. There were also attempts to channelize fund received from international agencies such as the Asian Development Bank (ADB) to the sector through private banks. There were provisions of favorable debt equity ratio, special interest rates and credit guarantee scheme. The central bank also issued directives to both public and private commercial banks regarding working capital loans, use of standardized documentation procedure and time limits for credit sanctioning and loan disbursement.

Notwithstanding all these arrangements for financing of SMEs, the actual delivery of institutional credit to this sector has been grossly inadequate. The following seem to be the key factors inhibiting flow of institutional finance to the sector:

Project Preparation and Evaluation: The first problem entrepreneur’s face in seeking institutional finance is with regard to preparation of the project proposal. In spite of directives from the central bank to follow standardized procedure, the loan application process has remained lengthy and cumbersome. The entrepreneur often lacks the ability to formulate a proper project proposal. Even when he prepares the proposal drawing on outside expert

services, there is no guarantee that the proposal will be evaluated properly as the financial institutions themselves lack adequate capability for proper project evaluation.

Collateral Requirements: One of the main factors that have hampered flow of institutional finance into SMEs is banks' pre-occupation with collateral based lending.Traditionally banks have used fixed asset ownership, particularly land ownership as the basis for judging credit-worthiness. This puts SMEs at a relative disadvantage, as large entrepreneurs are often able to get around the problem because of their influence and contacts by putting up collateral of dubious valuation.

Bureaucracy and Corruption: Because of lack of proper autonomy and accountability, the public sector financial institutions are beset with inflexibility, inefficiency, political interventions and corruption. Since the performance of the bank officials is not properly evaluated, they lack the incentive to bring a large number of suitable borrowers, particularly those in the SME sector, within the fold of institutional financing. They adopt a passive and inflexible attitude towards the borrowers either to avoid the risk of making an inappropriate lending or to force the borrower to make side payments for more favorable handling of the loan application

Public Development OutlayAlthough successive five-year plan documents have mentioned development of small, medium and cottage enterprises as priority area, public development expenditure in this sector has not been commensurate with this declared policy. Thus, in the Fourth Five Year Plan, the revised public allocation to this sector was Taka 2,016 million, which was a meager 0.58 per cent of the total public development outlay in the plan. What is even worse, only about 69 per cent of this small allocation were actually invested during the plan period? In the current Fifth Five-Year Plan, the share of the sector in total public development expenditure has gone down even further.

Fiscal Policy:

Fiscal policy in Bangladesh is not particularly tailored to provide support to SMEs, which is pointed out by most SME entrepreneurs as a critical policy constraint hindering SME growth. The following issues are identified:

Value Added Tax:

All cottage industries, except those producing particular products, are exempted from VAT. But, manufacturer, producer or service renderer (other than cottage entrepreneurs), whose annual turnover does not exceed Taka 1.5 million are required to pay Turnover Tax at the rate of 2.5 per cent in lieu of 15 per cent VAT. This limit is too low for small industries. As a result, small industries are subjected to the same 15 per cent VAT as their large-scale counterparts. In addition, supplementary duty is imposed at variable rates on certain categories of consumption goods across all size categories.Finally, excise duty applies to a limited number of items irrespective of size classification.Thus, in terms of indirect taxes, there is virtually no differentiation between SMEs and their large-scale counterparts, which is considered inequitable by most SMEs.

Tax Holiday: Similarly, there are no differentiated treatments of SMEs either with respect to duty on capital machinery or direct taxes. There are provisions of tax holidays for enterprises of all size categories subject to rules and procedures set by the National Board of Revenue.

To avail themselves of tax holiday, enterprises recommended by the relevant sponsoring agencies have to get the approval of the National Board of Revenue which is a cumbersome and lengthy process. The tax holiday, however, is not available to sole proprietorship enterprises which are the usual form of small and cottage industries inBangladesh.

Wealth Tax: Wealth tax is payable by an individual if his net wealth exceeds Taka 2.5 million. As per existing law, no wealth tax is payable by a company, the usual legal form of a large industry. On the other hand, the legal form of small industries is usually sole proprietorship, and hence these enterprises have to pay wealth tax on their business capital.

RecommendationsIn view of the constraints in the policies affecting SMEs, there is a dire need for pro-active policies and institutional support in addition to removal of existing policy biases.

The following short-term, medium term and long-term reforms are recommended:

Short-Term and Immediate Agenda for Action There should be concrete guidelines for the identification of SMEs and database for

extending preferential support to the SMEs.

Certification of SME following simple process by government agencies in partnership with chambers of commerce and industries, trade associations and other private sector representative organizations

In SME related government bodies representatives of NGOs and private sector should be integrated

Instead of SME Foundation, an SME Development Authority should be established, which may be constituted under an SME Act. There may be more transparent and regulated principles and policies on how BSCIC and other SME related bodies should work with the new body.

SMEs should be released from labour and tax obligations for at least five years of business operation

Lack in skills and control mechanism in selection of good proposals must be overcome shortly

Role of Business Development Service providers should be enhanced for reducing credit risk of SME lending.

The service of BDS should be integrated to reduce additional cost for commercial banks and financial institutions. Commercial banks and financial institutions should adopt bundling of loan with BDS to relate financial management and training of SME owners on financial management.

Proper steps should be undertaken to establish financial discipline at an enterprise level so that problems of the SMEs with insufficient equity base, high cost of finance, over ambitious business acceleration, lack of financial management experience, non separation

of business and private expenditure, over expenditure on status symbols such as cars, offices etc could be solved.

Similar to large firms in obtaining an administrative clearance and infrastructure support there should be 'one stop shop' service point under new SME Authority. This one stop service system should foster growth of SMEs to bring the SMEs, particularly small enterprises into the formal economy. Such system should be spread at district levels

SME Award already launched should be made more public, motivated and effective.

There is need for substantial increase in public investment in the sector particularly in the area of training, extension, research, market promotion, etc. A collaborative effort of the government with business associations, non-governmental organizations NGOs and other development partners is recommended in such public outlays.

Training regarding Entrepreneurship Skills, Retraining and Management should be made available through SME authority certified training facilities which should also receive support

Establishing District SME Centres in each district for providing all the support services, clearances, licenses and certificates required by the small entrepreneurs under a single roof.

The procedure of obtaining trade license needs to be simplified and the issuance of the license made automatic subject to payment of requisite fees and declaration by the investor that the proposed investment is in conformity with the rules and regulations and zoning restrictions of the local government authority

The requirements relating to safety and working conditions should be defined separately and realistically for the SMEs and the discretionary powers of the Factory Inspector should be minimized. Registration should be automatic once the investor has declared that the requirements have been complied with.

While getting the Government out of business and greater participation of the private sector are now emphasized as key strategies for development, some public sector participation for desirable monitoring of selected essential public services such as, effective legal and judicial procedures, commercial contracts, land settling arrangements etc. will be necessary.

Middle Term Actions Reviewing of all fiscal laws in force with a view to facilitate and improve growth of the

SMEs.

Companies Act 1994 should be amended to ensure included simplification of procedures enabling SMEs to enter, exit and change their business in response to market signals.

Establishing SME Promotion Council and SME specific Trade Associations for organizing SMEs and providing them with a platform to lobby for favorable government policies

SME Authority and not foundation, should be established to ensure the growth of SME through a coordinated effort

Assisting to SMEs to achieve proper safety at work in compliance with international conventions. Due to this, an interim amendment should be made for extending support to all types of SMEs, including those in the non-manufacturing sectors across the country.

Provision for attractive cash incentives on export and quality improvement should be introduced which helped SMEs in India

Specialized banks for SMEs should be established which should operate on the principle of market economy.

Mandatory SME portfolio with refinancing facilities should be enforced which should ensure the breakthrough of the SMEs in financing. Motivation of the banks should be part of such an initiative

Credit guarantee scheme should be reviewed for making SME finance more effective

Bangladesh Bank should work out specific guidelines for reducing spread of commercial banks, which may help banks offer better loan prices to SMEs.

Advisory services for technological and technical upgrading should be made available for the SMEs. In this regard the idea of deploying industrial extension officers in different parts of the country could be an excellent one which is in practice in Sri Lanka

SMEs should be given opportunities to participate in trade promotion exhibitions. Proper e-commerce with on-line payment system should be designed. Business report on annual basis should be published

Approach of Indian Export Promotion Council to procure orders from buyers and pass them on to the prospective suppliers in the country in this regard could be considered as a laudable initiative

Emphasis should be placed on market orientation of' BDS. The role of the government should include identification of BDS opportunities for SME development, stimulating demand for BDS, and linking BDS providers and SMEs. Private sector, particularly larger

BDS providers should be encouraged through incentives to redesign their products/services focusing on specific BDS requirements of SMEs

The environmental protection institutions should be made more cooperative with theSMEs so that the SMEs get proper guidance and support from it in this regard

There should be incentive-based strategies to achieve environmental compliance.

Legal provisions and procedures, labor laws and social stigma should be redefined and simplified for bankruptcy or closure of SMEs so that ultimate collapse and social and economic costs in such cases could be kept low.

Long-term Actions The support for infrastructure should be redesigned based on expert analysis considering

the needs of the SMEs. The practice in Pakistan to offer land at concession rates may be considered as a model in this regard.

A full-blown technology development policy should be followed with technology development fund. Fragmented approach never works as expected. Collaboration with successful countries in fostering technology development for SMEs should be sought.

R & D institutions should be established for technical services at the district level that include quality control, common facilities for instrumentation, testing and calibration.

Conclusions

A wide array of constraints faced by SMEs and by the Industrial Sector as a whole has been briefly discussed in this report. The government should soon make the necessary reforms in the policies in order to address the constraints. Given the slow growth experience of the industrial sector over the past three decades, the target of raising the industrial sector’s share to 40 percent of GDP by 2021 may appear a little ambitious.

The interviews and literature review reveal that SMEs, especially, have received disproportionately smaller support from the government in terms of policy or fiscal incentives. SMEs, as a group, are weak in echoing their needs and demands. There have been improvements in the sanctioning and other administrative procedures affecting SMEs; further simplification, transparency, and accountability in the policies are necessary to promote SME development. If the state machinery were able to improve the quality of governance, and if all structural and policy obstacles to industrial expansion as identified in the foregoing could be overcome, Bangladesh could expect to achieve a double-digit industrial growth in the coming years and move closer to achieving the target of raising the industry sector’s share in GDP to 35-40% in the next decade as set by the 2010 industrial policy.