Policy Research Institute - PRI Bangladesh

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Anniversary Issue-2016 2nd Instalment-Harvesting the China factor

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Published: Tuesday, Nov 22, 2016

ANNIVERSARY ISSUE-2016-2nd INSTALMENT

Posted : 22 Nov, 2016 00:00:00

 

 

Bangladesh's 'Look East' Policy

Harvesting the China factor

Sadiq Ahmed

Harvesting the China factor

Bangladesh exports have made steady progress in gaining access to Western markets.  This progress gathered momentum in the wake of the readymade garments (RMG) revolution. In FY2016 Bangladesh exported commodities worth $34.2 billion growing from a mere $4.1 billion in FY1996. The annual growth of export was an astounding 11.2%. RMG accounts for some 82% of total exports. In FY 2015, some 72% of total exports went to USA, Canada and European Union (EU) countries.  The eastern advanced economies of China, Japan and Korea accounted for merely 2%, 3% and 1% respectively of the Bangladesh export markets. The pattern of foreign direct investment (FDI)inflows is similarly dominated by the western advanced countries.

There is now a rethinking in Bangladesh to diversify the economic relations with a greater focus on the three large eastern economies of China, Japan and Korea through the Look-East Policy.  This is not accidental.  These economies, especially China, have now emerged as global economic powerhouses with large domestic markets and plenty of surplus capital that could be deployed to developing economies like Bangladesh.  Although the Look-East Policy is yet to take centre stage with a clearly defined strategy and implementation mechanism, the recent visit of the Chinese President (October 14, 2016) has opened up exciting possibilities for Bangladesh.  This article explores the significance of this development for Bangladesh and provides some ideas about how Bangladesh might harvest this potential moving forward.

As a first step, it will be useful to see where China fits in best in terms of helping Bangladesh secure its own development objectives and targets.  Following a successful transition to lower middle income country status in 2015 and attaining considerable progress with reducing poverty, Bangladesh now aspires to reach upper middle country (UMIC) status in FY2031; it also seeks to eliminate extreme poverty in this time frame.  These are ambitious targets and will require considerable investments, policies and institutional reforms.  China may contribute to this development challenge through at least four channels: knowledge transfer; exports; FDI inflows; and infrastructure investments.

For over three decades, China has been the fastest growing economy of the world. It is also the leading global example of export-led growth.  China has successfully transformed its agrarian economy into a manufacturing powerhouse that in turn has been fueled by solid penetration in the global manufacturing markets.

Considerable social progress has also been made in terms of poverty reduction and development of human skills.  While there are numerous unique features of this experience including the political system, there are broad lessons that can be beneficial for Bangladesh.  A coherent approach to knowledge transfer involving research, policy-level exchange, and business and people-level interactions can provide useful inputs to policy formulation in Bangladesh to facilitate its own journey to achieve UMIC status and eliminate extreme poverty.

Harvesting the China factor

Bangladesh can also benefit directly from China through better trade, investments, infrastructure support and regional cooperation.  The opportunities from trade, investment and infrastructure are best understood by looking at China's global strengths.  China is the world's largest economy when gross national income (GNI) is measured in purchasing power parity (PPP) terms.  According to the IMF World Economic Outlook 2016, total GNI for China in PPP terms stood at $20.9 trillion as compared with $18.6 trillion for USA (Figure 1).  In nominal dollars, China is the second largest economy at $11.8 trillion (16% of world total) as compared with $18.6 trillion (25% of world total) for USA.

Harvesting the China factor

China is the world's largest exporting country (Figure 2).  According to the World Trade Organization (WTO) data, China's merchandise exports stood at $2275 billion in 2015 (13% of world total). Exports from the world's second largest exporting country, USA, amounted to $1505.  The roles are reversed when imports are considered.  The value of the world's largest importer USA stood at $2308 billion (14% of world total) as compared with $1682 billion (10% of world total) for the second largest importing country China.

China's total foreign investments and construction contracts in other countries is estimated by the American Heritage Enterprise (AHE) as $1.2 trillion between 2005 and 2016 in some 40 countries.  In 2015 investments alone amounted to $110 billion, which is the highest ever for China.  The largest recipients are USA and Australia. China's total foreign reserves amounted to $3.51 trillion in June 2016 (4.8% of World GDP and 70% higher than India's GDP of $2.1 trillion).  This is the world's largest foreign reserves holdings.  The second largest reserve is with Japan at a distant $1.33 trillion (Figure 3).

Harvesting the China factor

Clearly, China is a global economic powerhouse in terms of GDP, international trade and availability of international liquidity. It has a huge domestic market and substantial financial resources. While many advanced countries are facing a tight budget and shortage of capital, China has huge amount of liquid resources and investible funds.  An important policy question for Bangladesh is to what extent it is taking advantage of this highly favourable economic environment in China through stronger cooperation to bolster its own GDP, trade and investments.

Data shows that except for sourcing its imports, Bangladesh is way behind in its China outreach.  China is Bangladesh's largest source of imports-- some $8.2 billion in FY2015, which is 20.2% of total imports.  As compared to this, Bangladeshi exports to China were a meagre $808 million in FY2016, which is only 2% of total exports.  It has grown from 19 million in FY2002 (1% of total exports), but it is still very, very small.   The major exports to China in FY2016 were: RMG (41%); leather (33%); and jute products (10%).  In contrast, Bangladesh imports a large range of products from China including cotton and textiles, machineries, electronic products, cement, fertilizer, tyre, raw silk and a range of consumer products. China has a modest investment presence in Bangladesh with almost all investments in RMG.  FDI from China is estimated at only $50 million in FY 2015. China is supporting infrastructure development with involvement in about 10 road/bridges projects.

It is obvious that there is tremendous scope for greater economic cooperation with China. In addition to knowledge transfer discussed above, there are 4 major priority areas for future engagement.

Harvesting the China factor

Expand exports from Bangladesh to China:  Presently Bangladesh exports accounts for only 0.04% of China's total imports.  Even if Bangladesh were to increase this to 0.1%, there will be a dramatic increase to $1.7 billion.  Achieving this level of exports should be a short-term target for Bangladesh.  The enabling environment for achieving this goal is good.  China has allowed Bangladesh duty free access to almost all exports.  This is a huge opportunity.  There is some scope for negotiating better access by changing the rules of origin restrictions.  But the most important policy actions relate to domestic policies in Bangladesh to improve labour productivity, increase domestic investment and improve incentives and competitiveness for export products.

An important step will be to better understand the Chinese home market. Home to the world's second largest economy (in nominal dollars) and the largest country in terms of population (1.4 billion or 19% of the world's total), the Chinese domestic market is almost unlimited from the perspective of a small economy like Bangladesh.  Some research effort to understand the Chinese market and its demand for imports is very important.  This research could be sponsored by the government as a public service but also complemented by the private sector through the various chambers of commerce. Trade delegations from the Bangladesh private sector could similarly engage with the Chinese leaders of commerce to explore market potential.  Part of the analysis should look at the changing cost structure in China as labour cost goes up to see where higher-cost domestic production will likely shift to sources of lower cost imports.  This shift is already obvious in the case of RMG that explains the growing RMG exports from Bangladesh to China. New joint ventures with Chinese FDI will likely benefit this process.  But there is a need to find a broader range of products including agro-processing and processed food products that might find a market in China.

Increase FDI:  China has huge foreign reserves and makes large investments abroad ($110 billion in 2015).  If Bangladesh can get even 1% of that FDI per year, that will be a big jump in its total FDI. This can again be a short term target.  Once again, the enabling environment is sound.  China has expressed strong interest in establishing export processing zones (EPZs) in Dhaka and Chittagong. Concerted efforts must be made to fast-track these expressions of interest into real investments.  FDI must also be strategic.  Here Bangladesh can learn considerably from the Chinese experience with manufacturing development and export market penetration.  China opened up its doors widely to a range of manufacturing enterprises that are world leaders in terms of quality, sophistication and technology especially from the USA.  Through this infusion, China not only gained income and employment but importantly two long-term strategic advantages.  First, it gained knowledge in terms of cutting-edge production technology. Second, through learning-by-doing a huge domestic skill base was created.  China further supplemented this effort by sending talented students to some of the top universities of USA.  This strategy of skill development and technology adaptation has been at the heart of China's newly gained reputation as a low-cost producer of a range of high-tech consumer durables.

Build infrastructure: Bangladesh's infrastructure needs are large.  China has excellent construction capacity and huge financial resources. With concerted effort and planning, Bangladesh can get substantial Chinese assistance in rebuilding infrastructure.  Here Bangladesh has to do some homework and develop strong negotiation skills.  It must also select investment priorities carefully and pay attention to the quality of investment proposals including total cost and financing terms.

Negotiating infrastructure projects is a hard-earned skill and the government needs to invest in it. Any project at any cost is a recipe for disaster.  For example, the Sri Lanka experience with infrastructure development using Chinese financing has not been very positive due to lack of proper oversight in the selection of projects and inadequate attention to debt servicing capacities.  This was bad planning by Sri Lanka and illustrates the importance of due diligence.  So, for infrastructure projects that typically involve considerable amount of money and debt service payments can be substantial, the name of the game is quality and not quantity. Statements like "we got $10 billion of projects from China" may not be a good thing unless it is backed up by a due diligence exercise that looks at the relevance and priority of the projects in the context of Bangladesh development; looks carefully at the design of each project; and does a proper cost-benefit analysis to ensure their sustainability in terms of financial and economic rates of return.

Promote the BCIM and the Silk Route Revival initiatives:  There is a proposal to develop the Bangladesh-China-India-Myanmar (BCIM) economic corridor as a wide ranging economic cooperation agreement.  The BCIM is an excellent idea that Bangladesh should support and promote.  This forum will not only provide solid investment options and transit connectivity, it will also provide a forum for resolving disputes relating to such tricky issues as water sharing, transit fees,  cost-sharing arrangements and even diplomatic and security issues.

More broadly, there is a very good case to be made to revive the ancient silk route trading paths.  China has expressed a strong interest to support this revival.  Historically, there were two broadly used trading paths between Europe and China.  The land route that traversed through the Middle East and Central Asia to China (yellow path in Map 1); and the maritime path that travelled through the ports of the south-eastern countries along the south china sea and the Bay of Bengal, then on through the ports of the Arabian Sea countries and the middle eastern ports along the Red Sea and the Mediterranean Sea.   The silk route trading brought in prosperity all along the trading countries that participated in this trade. This is a powerful reminder from ancient history that artificial trade and transit barriers must give way to better connectivity and unhindered trade to enable economic prosperity.  Needless to say, security concerns and national interests will remain paramount but they can be reconciled with the gains from trade and transit though better economic cooperation

The potential gains for Bangladesh is particularly large.  The revival of the silk route will connect Bangladesh with China and other East Asian countries on the southeast front, while it will connect on the western front with India, Central Asia, Middle East and Europe.  Owing to its strategic location as the gateway to the East and the West on the land front and its open access to sea on the South, Bangladesh can serve as a regional hub for both land transit trade and sea transit trade. The income and employment from trading and transit services can be a huge boost for Bangladesh.  There are famous modern examples of countries that have achieved prosperity through establishing modern and advanced sea-trading outposts including Rotterdam in the Netherlands, Singapore and Hongkong. Bangladesh can learn from their experiences and join with China in pushing the silk route endeavour.

Develop strong implementation capacity: In the realm of cooperation, Memorandum of Understanding (MOUs) is relatively easy to get.  This typically happens as a part of a state visit of the highest level dignitaries. There is a lot of publicity and celebrations on these MOUs.  But when it comes to actual benefits there is often not much to show because of weak implementation.  For example, Bangladesh and India signed a historic cooperation agreement in January 2010.  After nearly 7 years, the implementation progress has been slow.  Some progress has been achieved in strengthening trade and connectivity through road, rail and river networks.   Progress has also been made in energy trade.  But compared to the potential, this progress is modest. The land and river ports remain outdated and congested; the road, rail and river networks are underdeveloped; energy trade growth is very slow.  Importantly, the use of the $1.0 billion soft credit pipeline extended by India to Bangladesh for developing the transport and energy networks has been very slow.

The MOUs signed with China in the wake of the visit of the Chines President are many and hold high promise provided they are properly used and on time. There are several important points to note. 

First, in the case of FDI agreements the most important challenge for the government is to ensure that all regulatory bottlenecks and clearances are resolved swiftly and professionally. Employment and environmental standards have to be met but these should be done with least bureaucracy and delays. Similarly, land acquisition and utility connections must be provided with as much ease as possible.  These two areas are listed as the weakest link of the Doing Business indicators prepared by the International Finance Corporation (IFC) and largely explain the very low rating for the Ease of Doing Business in Bangladesh.   

Second, public sector infrastructure projects must be reviewed very carefully for potential benefit, cost (both capital cost and loan terms) and proper design.  Proper cost-benefit analysis must be undertaken to reassure that the financial and economic rates of return are satisfactory.  Wherever possible, the government should seek competitive bidding within Chinese firms.

Third and very importantly, utmost attention must be given to the implementation capacity constraint in Bangladesh. For large capital intensive investment projects the time value of money is of immense importance.  Project completion delays and cost over-runs as experienced with large projects like the Dhaka-Chittagong 4- laning highway and the Padma Bridge can cause huge loss of potential benefit and lead to low financial and economic rates of return and net present value even with the use of low social discount rates (5-7%).   The time value of money consideration must enter as a major variable in choosing any infrastructure projects irrespective of who is financing it.

In conclusion, the policy effort to strengthen Bangladesh-China economic cooperation is a hugely positive initiative.  But Bangladesh must prepare itself better by doing its homework to enable a sound implementation of this policy. A partnership with the private sector and the national research institutions can be helpful in doing the proper homework.

Dr Sadiq Ahmed is Vice Chairman of Policy Research Institute of Bangladesh. Email: Sadidiqahmed1952@gmail.com

http://print.thefinancialexpress-bd.com/2016/11/22/157313

 

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