Policy Research Institute - PRI Bangladesh

The Policy Research Institute of Bangladesh (PRI) is a private, nonprofit, nonpartisan research organization dedicated to promoting a greater understanding of the Bangladesh economy, its key policy challenges, domestically, and in a rapidly integrating global marketplace.

Bangladesh economy in the midst of European financial crisis

Published: Wednesday, Dec 21, 2011

Anniversary Issue 2011 (Part Two)

Bangladesh economy in the midst of European financial crisis



Soon after emerging from the devastating effects of the Global Economic

Recession, the world economy once again is entering into another unsettling and challenging environment/period due to the rapidly unfolding Euro debt crisis. As Bangladesh is getting integrated with the global economy through trade, a significant deterioration in the external environment, particularly when Eurozone economies is the single largest destination of our exports, EU debt crisis is certainly going to impact Bangladesh economy. The issue is how badly we are going to be impacted and through what channels.

The table below helps us to compare the recent global and EU real growth outlook with the growth performance during the global economic crisis of 2009:

 

Actual Data

Projections (April-11)

Projections (Oct-11)

OECD Projections

 

2008

2009

2010

2011

2012

2011

2012

2011

2012

World Output

2.8

-0.7

5.1

4.4

4.5

4.0

4.0

 

 

Advanced Economies

0.2

-3.7

3.1

2.4

2.6

1.6

1.9

 

 

United States

0.0

-3.5

3.0

2.8

2.9

1.5

1.8

1.7

2.0

Euro Area

0.5

-4.3

1.8

1.6

1.8

1.6

1.1

1.6

0.2

Emerging and Developing Economies

6.0

2.8

7.3

6.5

6.5

6.4

6.1

 

 

Developing Asia

7.7

7.2

9.5

8.4

8.4

8.2

8.0

 

 

China

9.6

9.2

10.3

9.6

9.5

9.5

9.0

 

 

India

6.4

6.8

10.1

8.2

7.8

7.8

7.5

 

 

World Trade Volume (Goods & Services)

2.9

-10.7

12.8

7.4

6.9

7.5

5.8

6.7

4.8

Source: IMF World Economic Outlook April and October, 2011; OECD Preliminary Report,28th November, 2011.

A few comparisons can be made of the two episodes. First, while real GDP in the Euro area declined by 4.3% in 2009, nobody is projecting such a deep recession in the Euro area due to the current debt crisis. Second, current expectation is that the Euro area may enter into a recession or no-growth phase, although for some hard-hit economies the loss of output could be much more severe. Third, the point to note is that the revisions to the growth outlook for the Asian economies are relatively minor. Finally, the comparison of the two epic episodes also indicates that the impact of the EU debt crisis on the global economy is expected to be less than the earlier global economic crisis and its impact on Bangladesh should be examined against this broader international context.

The paper discusses the key channels of transmission through which Bangladesh economy may be impacted by the rapidly unfolding European Union debt crisis. The presentation starts by examining the current macroeconomic setting and the short- and medium-term objectives set by the government in its FY12 budget and Sixth Five Year Plan. The presentation then draws on the experience of Bangladesh during the recent global economic crisis of FY09. 
As in the past, the impact of the current EU debt crisis, the slowdown of export demand and economic activity in the EU and a broad range of industrialized countries including the United States, are expected to materialize through the following channels:

  • Financial
  • International Trade
  • Remittances
  • Access to external financing

While drawing on the lessons learnt from the FY09 Global Economic Crisis, the presentation also highlights the ways in which the transmission channels and the extent of the impact of the crisis may be different during the current EU debt crisis from what it was in the previous global crisis in FY09. The presentation will also try to focus on some of the macroeconomic tensions which have emerged in recent months in Bangladesh. In particular, the combined effect of the accelerating inflation, balance of payment pressures and depreciation of the Bangladesh taka exchange rate, a run-away subsidy bill and the excessive borrowing by the government from the banking system makes the domestic environment significantly less favorable than the domestic macroeconomic environment at the time of the global economic crisis of FY09. Current domestic macroeconomic imbalances may be exacerbated by the external shocks originating from the EU debt crisis, thereby undermining the short- and medium-term growth and poverty alleviation objectives of the government.

Although Bangladesh financial sector was largely untouched by the global meltdown of 2009, the real economy experienced its adverse impacts primarily through three channels:  slower export growth; moderation in the inflow of workers’ remittances; and dampened investment and consumer sentiment. The second round impacts of the crisis were also being felt on the real economy through a general slowdown in overall economic growth, slower revenue growth, declining imports and excess liquidity in the banking system due to slower demand for domestic credit. 
Channels of transmission

Financial channel: Bangladesh’s financial sector did not experience any turbulence arising from the meltdown in the global financial sector during FY09 due to its limited connectivity with the international financial system. The banking sector, which dominates the financial sector in Bangladesh, remained healthy as it was not much linked and exposed to the global economy. Profitability of the banking sector improved significantly despite the global financial crisis of 2008-09 and all basic banking sector prudential indicators continued to improve.


Performance of the Overall Banking System

 

Net NPL Ratios

Profitability Ratios

Year

 

Return on Assets

Return on Equity

2003

18.80

0.50

9.80

2004

9.80

0.70

13.00

2005

7.20

0.60

12.40

2006

7.10

0.80

14.10

2007

5.10

0.90

13.80

2008

2.80

1.20

15.60

2009

1.70

1.40

21.70

Jun-10

1.67

1.58

22.94

Source: Bangladesh Bank

There was no sign of liquidity shortage in the banking system in FY09– rather there was excess liquidity due to deceleration in credit growth. The deceleration of credit growth in FY09 was primarily attributable to lower commodity prices (depressing value of trade) and a slowdown of exports in value terms.

Exposure of the capital market to foreign portfolio investment was minimal and it still remains so.  During FY 09, when all stock markets across the globe recorded sharp decline in their stock price indices, the general indices in Bangladesh continued to increase.  Hence it is expected that external shocks originating from the EU debt crisis will not have any noticeable impact on the financial sector including the capital market this time as well. Bangladesh capital market has its own problems and domestic issues will continue to dominate market performance/developments in the coming months.

International trade channel: Exports had slowed down markedly beginning October 2008. Almost all categories of exports registered a marked slowdown (readymade garments and knitwear) or a sharp decline (almost all exports except textiles). Total shortfall in export proceeds during October-June 2009 was estimated to be about $2.1 billion.

It is noteworthy that, Bangladesh textile sector is the most competitive in the world despite numerous bottlenecks on the domestic front and the sector was able to increase its relative shares in the European Union and US markets during the crisis. Despite the slowdown in textile exports, Bangladesh’s relative performance has been very strong. It has been the best performer among all textile exporting countries to the EU and US markets, allowing it to improve its relative position vis-à-vis its competitors.

In line with the previous episode (FY08-09), this time also there is sign of decline in global and Bangladesh exports. This situation will be getting worse in the coming months. Despite some slow down from the prior quarters, export to the EU has remained healthy through August 2011. The high growth rate of 30% experienced in Jul-Aug will probably not last and a further deceleration in export growth to the EU is expected.

G1

Despite some expected slowdown in exports to the Euro region, we do not expect exports to that region decline in value and volume terms because of the following reasons:

  • As indicated in various global projections, while some EU countries will certainly enter into a recession, for the EU region as a whole the depth of the recession, if any, will be much shallow.
  • Bangladesh has received the benefits of the change in the rules of origin beginning in 2001, and the positive impact of that should be felt in the coming months in its textile exports.
  • Diversion of textile orders from China is expected to continue and should be an important beneficiary of that process.

Inflow of worker’s remittances: FY09 experience has showed that number of workers leaving for abroad declined stridently. The decline continued for some time through end – 2010. However, the trend has reversed and a strong pick up in this number since Q1, 2011 has been observed. In Q3, 2011 (or Q1, FY 12) the number of workers going abroad increased by 68% over the corresponding quarter of the previous year.

G2

Inflow of remittances picked up somewhat in the final quarter of FY11 with overall growth limited to [6%] for the year whereas it has slowed down during the previous crisis. The primary reason for the difference in the migration situation and outlook is attributable to the following factors:

  • Much of the Bangladeshi workers migrate to the oil exporting Gulf countries, where economic activity and employment opportunities are driven by developments in crude oil prices.
  • During the global economic crisis, crude oil price (Dubai Index) declined to only $41/barrel from an all time peak of $131/barrel. In contrast, during the current episode, crude oil prices are still above $104 and are likely to hover around $100/barrel level in the coming months.
  • In the midst of he ongoing Arab Spring Revolution, all oil exporting Gulf countries have increased government spending significantly—leading to growing demand for manpower.
  • Some new markets are also opening up in the region including Iraq, Lebanon and Libya.

G3Source: World Bank

External financing channel: Traditionally, in an open market economy, a global or regional crisis tends to constrain market based financing. Thus it would be very difficult for Bangladesh Government to access international capital market by issuing sovereign bonds or borrowing from foreign financial institutions.

However, Bangladesh traditionally depends on official bilateral and multilateral external financing.  During the global economic crisis there was not much of an impact on external financing because of the drying up of official and multilateral financing. The problem of lower foreign aid in recent years was primarily attributable to slower project utilisation rather than adverse external factors. A shortfall in the pipeline of foreign aid is not expected due to the crisis but there are concerns whether the major economies such the EU impacted by growing fiscal and debt problems would be able to fulfill their existing and new commitments under various bilateral and multilateral/global initiatives.

Macroeconomic objectives and tensions of domestic origin: While we do not expect external shocks arising from the EU debt crisis to have any severe effect on our economy, there are a number of areas where serious pressures have emerged which, if unattended, may potentially undermine macroeconomic stability.  Some of the important areas are highlighted below.
Price stability will be key to macroeconomic management and growth:Upward inflationary trend is continuing and in September it reached the highest level since 1998 at more than 12%. Inflationary pressures worsened during most of FY11 despite bumper rice and other food (potato, fruits and vegetables) production, as domestic demand increased and international food price continued creeping upward.

G4

Persistently high food price inflation has pushed non-food inflation upward with some lags. The country failed to meet the target of 6.5% in FY 11 and under current circumstances achieving the target inflation of 7.5% in FY12 seems unlikely.

Inflation hurts the poor more than businesses or the affluent sections of the society. Food inflation hurts the poor even more. Asset price inflation (real estate and land in particular) in an environment of already high asset price level, seriously limits upward mobility of the poor and is therefore an immediate challenge for the policymakers. It has to be addressed through monetary management, improvement in demand management (fiscal policy) and removal/alleviation of supply constraints (higher imports, domestic production, etc.).  By increasing speculative investment in unproductive assets, higher inflation also leads to misallocation of resources from more productive activities.

Deteriorating Balance of Payments (BOP) situation and exchange market instability: The Balance of Payments (BOP) situation of Bangladesh has deteriorated markedly in recent months. The twin effects of surging import payments for goods and services as well as the slowdown of remittance inflows in recent months have more than offset the large gain in export growth, contributing to a rapid deterioration in the BOP situation and outlook.  The surge in imports (growing by about 40% in FY11) resulting from strong domestic demand and higher global commodity and petroleum prices led to a sharp deterioration in the trade balance. Although exports grew by more than 40% in FY11, the external trade deficit worsened by 42%, reaching a record high of $7.3 billion. Services and income accounts deficits also continued to grow at a fast pace, contributing to a wider payments gap which could only be filled by inflow of workers’ remittances.
Similar trends are continuing in Q1 of FY12, albeit both imports and exports growing at a mere moderate pace of 23%.

The deteriorating BOP situation and tensions in the money market have contributed to a significant depreciation of the nominal exchange rate of the taka against the dollar and other major currencies. Taka depreciated by 14% over the last one year. Only by limiting the supply of taka and by increasing the rate of return on Taka denominated financial assets the economy will be able to enhance attractiveness of the Taka and protect its value against all major currencies.
Given the surplus position in the external current account of FY11, the exchange market should not have come under pressure if Bangladesh’s capital and financial accounts were healthy.  Bangladesh suffers from chronic weakness in its capital and financial accounts due to its failure in attracting foreign direct investment (FDI) and dwindling foreign aid disbursements. Bangladesh’s inability to attract FDI at a scale and pace consistent with the investment needs of the economy is perhaps the single most important failure in its economic management, making it dependent on official external financing.

FDI (Bill USD)

 

2009

2010

Bangladesh

0.7

1.0

China

114.2

185.1

India

35.6

24.2

Pakistan

2.3

2.0

Vietnam

7.6

8.0

For a country like Bangladesh, it is generally quite normal to have a small deficit in the external current account balance. However, for that to be sustainable we need to have comfortable surplus positions in the financial and capital accounts. Bangladesh should try to attract at least $2.5-3 billion FDI per year. Such an outcome would have contributed to an increase in the level of investment by 2-3 percent of GDP and helped contain balance of payments pressures despite much higher levels of imports. The pipeline of foreign aid has increased to a record high level of about $12 billion, while Bangladesh Bank’s foreign exchange reserves are under pressure.
Recent fiscal developments: Fiscal developments in FY 10 and FY 11 indicate that fiscal policy did not contribute to the domestic demand pressures and to the expansion of liquidity in the economy. However, fiscal policy management has become more challenging in FY12 due to expenditure pressures emerging from a number of sources such as surging food prices, agricultural input subsidy and fuel and electricity subsidies due to high cost rental/peaking power plants and higher cost of crude oil. The subsidy bill, historically limited to much less than 1% of GDP, was budgeted to increase to 2.43% in FY12. In the event, however, due to inadequate and delays in domestic price adjustments, the amount of subsidies demanded by the relevant ministries is estimated to be 5.4% of GDP and even after some further belt-tightening the subsidy bill is estimated to be more than 4% of GDP in FY12.

If these emerging spending pressures are not actively managed through upward adjustment and rationalization of prices, fiscal policy may also become a source of instability by accentuating the already mounting liquidity and inflationary pressures.

Capital market developments needs to be better managed: The recent bubble in the stock market was primarily driven by five major factors: excess liquidity growth; structural increase in retail investors; a lack of supply of stocks through IPOs; excessive investment by commercial banks in the capital markets; and frequent regulatory interventions increasing moral hazard.
At the end of November 2011, DSE General Index remained at 5268 and with the average PE ratio was at 13.35. The level of the PE ratio is now quite attractive, compared with the situation last year same time when it was at 29.71.

Capital market over exposure and subsequent correction have contributed in part to the liquidity crisis in the banking system.

Concluding observations: Bangladesh’s economic performance has been quite resilient to the global economic meltdown of FY08-09. Its macroeconomic performance has been much better than expected by many external observers and regionally its performance had been one of the best. 
Lessons learnt from that experience can be applied in understanding the implications of the currently unfolding EU debt crisis. Based on the experience of the past episode, it can be concluded that the EU debt crisis should have a relatively minor impact on Bangladesh’s economic outlook.

The primary source of the current macroeconomic instability in Bangladesh originated largely from the so called “accommodative” monetary policy of Bangladesh Bank. Years of liquidity expansion at rates well beyond what is considered appropriate for sustaining economic activity and growth have contributed to asset price inflation, including the stock market bubble and its subsequent burst. The pace of liquidity expansion and the liquidity overhang need to be addressed urgently through tightened monetary policy and sterilization operations. Bangladesh Bank needs to adhere strictly to its own announced target for broad money.

In the current fiscal year (FY12), appropriate monetary and fiscal policy mix will be the critical requirement for addressing the existing and emerging macroeconomic pressures in the economy. Bangladesh Bank alone would not be able to deliver on the appropriate policy mix and on the monetary targets without strong policy support from the fiscal side.

The kind of economic policy package that would be needed to bring the situation under control will be politically unpleasant, because the key elements of such a package should be tighter monetary policy stance (resulting further higher interest rates), increasing and rationalizing prices of petroleum products and gas (including CNG), increasing electricity tariff and prices of fertilizers and diesel for agricultural use. Bangladesh economy is at a crossroad. It will be interesting to observe how the policymakers of the government will tackle the ongoing and emerging macroeconomic tensions in the coming months.

....................................................
Dr. Ahsan H. Mansur is executive director of Policy Research Institute. He can be reached at:  ahsanmansur@gmail.com

Speech