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.

Dark clouds and silver lining on the horizon

Published: Wednesday, Dec 21, 2011

Anniversary Issue 2011(Part One)

Dark clouds and silver lining on the horizon

For the Bangladesh economy, the year 2011 has been a mixed bag of good news and

bad news. The good news comes from the phenomenal export success achieved over the fiscal year ending in June 2011. The bad news comes from several emerging macroeconomic imbalances that signal trouble for the economy in the near term while undermining growth prospects over the medium- to long-term. The Padma Bridge financing episode will remain a sore point in the bid for bridging a major transport infrastructure gap in the country.

At this time last year, the outlook could not have been better despite a slow global recovery. Exports were surging thus prompting a major resurgence of employment and output in the manufacturing sector. Bumper harvests kept agricultural growth ticking. The targeted rate of GDP growth of 6.7% appeared comfortably reachable - and it did; perhaps even exceeded. However, lax monetary and credit policies of three past years ultimately let the inflation geni out of the bottle to present challenges of internal - and eventually - external imbalances. And attempts to solve the energy crisis with high cost generation options created fiscal imbalances that threaten to haunt us for a long time to come. Persistent instability in the stock market, rapid depreciation of the Taka, a growing subsidy bill in the budget, rising public sector deficits, and difficulties in mobilizing foreign financing, among others, appear to cast dark shadows over economic prospects in the medium term.

Standing at the closing days of 2011, the economic outlook for 2012 thus appears less rosy than a year before. The state of the global economy is partly to blame, apart from adverse domestic developments mentioned earlier. As we all know by now, the long touted global recovery failed to materialize giving way to a series of unprecedented change of governments in Greece and Italy. We see Germany and France putting all their economic might to save the Eurozone from collapsing on the anvil of debt distress of some of its members - Greece, Italy, and perhaps Spain and Portugal. Even the mighty US economy suffers from debt overhang as its public debt outstanding creeps up to unsustainable levels reaching 100% of GDP. The US Congress is so sharply divided along political lines that a bipartisan super committee set up to reach agreement on cutting $1.2 trillion of future deficits quite pathetically failed to do its job. The combination of the financial crisis of 2008-9 and the debt distress of several affluent economies of the world have led to widespread uncertainty in the global investment climate thus making the unemployment situation in leading western economies worse and leaving equity markets around the world gyrating without a sense of direction. Given this abject scenario, the International Monetary Fund, in its much-watched Global Economic Outlook, has tried to put the best possible face on a still unraveling global economy by projecting a modest output growth of 4% in 2012 (Table 1), the same as in 2011, with global trade slowing down to under 6% from 7.5% estimated for 2011.

T1

It is the latter outlook that bodes ill for Bangladesh, now heavily dependent on global markets for its exports that account for much of its job creation, income, and growth.

Good News: Growth spurt in FY2011

Prompted by record exports which posted 41% growth in the last fiscal year,the economy rebounded from the modest slump of the previous year. According to our estimates, export production now make up as much as 60% of manufacturing output and manufacturing exports are 90% of total exports, thus making Bangladesh a unique LDC exporting predominantly manufactured goods.

A close look at the sectoral performance indicates the targeted 6.7% growth rate was perhaps bettered, because of record growth in manufacturing output and exports. The coveted 7-8% growth appears close at hand - but will it materialize on a sustainable basis? That is the million dollar question.

T2

Table 2 presents a summary of GDP and sectoral growth for FY10-11 with the outlook for FY12. In this table I have deviated slightly from the official figures in light of current developments and near-term outlook. FY10 are official figures from BBS, FY11 present our estimates based on provisional figures from BBS. FY12 are projections. Questions have been raised by the economist community regarding the official growth figures of FY10 during a global slump when our exports grew barely 4%. Questions have also been raised about the agricultural growth figure of 5.2% when growth in foodgrain production, the mainstay of the crop sector, was barely 2%. On the plus side, FY11 official estimates of growth appear to be under-stated as manufacturing growth of 9.5% is based on the November 2010 figures of Quantum Index of Industrial Production. QIP index of May 2011 show manufacturing growth to be a whopping 16.4% for the July-May period. Using only a conservative figure of 12% for manufacturing growth in FY11 (a record) yields GDP growth figures of 7.1% -- higher than the official estimate of 6.7%. As export growth numbers in FY12 predictably cool off, FY12 projections with minor modifications from the Second Five Year Plan document appear in line with overall outlook for output growth today. The point to note is that exports and manufacturing output have now become key determinants of GDP growth rather than the traditional agricultural production.

F1_copy

Technical analysts will note that GDP growth, for the most part, continues to be determined by factor accumulation (labor and capital) rather than rise in their productivity. Under these circumstances, sustained higher growth can only be had from an increase in Gross Domestic Investment (GDI), which, as a percentage of GDP, has been stagnant for too long (Fig.1). A breakthrough in investment is long overdue. Without that happening, even a 7% growth rate would not be sustainable, let alone 8% growth which requires 30%+ investment rate. As can be observed, the break from a decadal average of 4.8% growth in the 1990s, to 5.8% average growth in the last decade was prompted by a rise in the investment rate from 17% in FY95 to 24% in FY2000. Between now and 2015, Gross Domestic Investment (GDI) must rise to about 30% of GDP if the economy is to achieve the coveted 8% growth by the end of the Sixth Plan period. That is a formidable challenge and the trend of the past decade does not give one much hope, unless radical changes take place in the investment climate and economic policies that prompt massive and effective private and public investment in infrastructure over the next three years.

F2

It is instructive to see Bangladesh's reasonable growth performance in a comparative light. Fig.2 gives us a sense of how the Bangladesh economy performed relative to some of its comparators in the past three years. Eyeballing the above chart gives the impression that Bangladesh is keeping pace with the likes of Indonesia and Vietnam but falling behind India and China. The challenge for us is to catch up with the growth rates recorded by India and China. India's experience is worth noting. India's current Prime Minister, Manmohan Singh, is largely credited with turning the economyaround to enable it to break out of its historical rate of growth (2-3%) to its current high growth rate of 8%+. What did India do that is most striking? For one, it opened up its economy - moving from being a closed economy for over 50 years to becoming an open economy with a much liberalized trade and investment regime. Nobody doubts that Bangladesh has the potential to achieve those rates of growth in the future if we can get our act together. India's trade policy conversion is clearly one act to follow.

Bad News: Dark Clouds over macroeconomic management

Macroeconomic stability is an essential pre-requisite and a necessary condition for sustained high growth performance. With the exception of a few occasional lapses Bangladesh has been credited with maintaining decent macroeconomic balance for the past two decades primarily through sensible management of its revenue resources and expenditures that kept fiscal deficits and public debt -- domestic and foreign -- within prudent limits. That situation appears to be coming under strain as several events of the past year demonstrate.

Adverse movements in several macroeconomic indicators summarize the threat to macroeconomic stability: (i) alarming rise in the rate of inflation which has now crossed double digits; (ii) rapidly growing subsidy bill of the budget arising from high cost power projects and mounting deficits of public enterprises; (iii) growing imbalance in the trade account of the balance of payments (goods and non-factor services); (iv) rapid depreciation of the taka; (v) persistent instability in the stock market; and (vi) difficulties in mobilising foreign financing.

Inflation geni is out of the bottle

F3

F4

2011 has seen the highest level of inflation in recent memory. For nearly 15 months in a row, the economy has been presented with rising inflation - a clear sign of macroeconomic instability. The inflation geni is out of the bottle! Taming it will be a formidable task for the monetary authorities. Point-to-point inflation in October inched up past 12%, egged on by both rising food and non-food inflation (Fig.3). Average inflation shows clear sign of trending upwards without relenting (Fig.4). Bangladesh Bank's classic balancing act of ensuring price stability while accommodating growth appears doomed for the time being, at least. The strategy of restricting inflation in FY11 to the budgetary target of 6.5% did not bear fruit, nor does it seem likely that the same goal can be achieved at the close of the FY12 fiscal year.

What is causing this uptick in inflation? A rise in international price of food grain, commodities, and petroleum are the first culprit. When international prices feed domestic inflation, there are only limited options available to domestic policy makers. Nevertheless, inflation trends are worrisome and if allowed to persist, as experienced in the past, non-food inflation will follow suit as it generally follows food inflation with a lag. This phenomenon is already visible in Bangladesh economy.

International food price hike (FAO food price index grew by 20% in December 2010) and India's double digit inflation throughout FY10, together with increased domestic demand in Bangladesh, are major contributors of the food price hike in the domestic market. The combination of expanding domestic demand and hike in international commodity prices weighed in on inflationary pressures during most of FY11 despite bumper rice and other food (potato, fruits and vegetables) production.

F5

By all indications, lax monetary management during much of the past three years has not helped the fight against inflation either. With M2 growth of 19-22% (Fig.5), money supply has been running well ahead of the value of goods and services produced, as measured by the growth of nominal GDP of around 13-14%. Despite setting targets of 18% money supply growth, BB seems unable to pull the reins on credit growth for lack of control over rising deficits of the public sector and a feeble approach to private credit restraint through interest rate hikes. Though money growth slowed down slightly in the final quarter of FY11 as Bangladesh Bank increased the cash reserve requirement (CRR) by 0.5 percentage point in December 2010 and as it sold foreign currency from its reserve, this tightening appears at best too little too late. Furthermore, rising global commodity prices seems to have offset the impact of recent monetary tightening. Under the circumstances, the target of 6.5% annual average inflation in FY11 could not be achieved and the rate of inflation (point-to-point) accelerated to almost 12%, where it is expected to remain at the close of 2011.

Inflation hurts the poor more than businesses or the affluent sections of 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 policymakers. It has to be addressed through a combination of monetary management, improvement in demand management (fiscal policy) and removal/alleviation of supply constraints (higher imports at lower tariffs, domestic production, etc.).

The silver lining: Surge in tax revenue

Booming external trade and initiation of a few reform measures in VAT and income tax seemed to be paying rich dividends, as NBR tax revenues continue to grow at rapid rates during the past two fiscal years. The improvement appears to be fairly broad-based across all heads of revenue - both domestic- and trade-based (Table 4), with a whopping 27.8% growth in FY11, compared to 15% growth during FY05-09. Lest this give anyone cause for complacency, it is worth reminding that Bangladesh has one of the lowest tax-GDP ratio amongst South Asian countries and other comparators. Though the tax-GDP ratio crossed the 10% mark in FY11, it will take fundamental changes in the tax system to make it dynamic enough to yield the kind of tax-GDP ratio that is needed to finance the mounting public expenditure outlays for infrastructure of the future in order to get to middle income status by 2021.

T4

F6

Record of the past two years indicate notable progress in resource mobilization which appears to have been done by gearing up implementation capacity in the tax system and plugging some loopholes. Small changes in VAT and income tax administration have yielded large gains in revenue. The task is far from over but there are some good early signs that should prompt the tax authority to continue its efforts over the long term. The overall tax system is crying for fundamental and somewhat radical reforms to modernize and get the tax system out of the quagmire of a low tax-GDP ratio in a fast growing economy. However, it is also critical that this be done without undermining business and investment incentives which have been driving the high growth performance of the economy.

In the aggregate, we find that while the revenue targets were exceeded in FY11 public expenditure under-performed, the reason for which has now become legend - deficiencies in ADP utilization. Were it not for the mounting subsidy bill which is estimated at 3.5% of GDP in FY11, public outlay would have fallen way short of budget. In consequence, once again the overall fiscal deficit remained below the budgeted figure of 5% of GDP (Fig.6), which is again planned for FY12. This time around, it looks like the subsidy bill might cause the deficit target to be met.

Clouds over fiscal management

There are some questions regarding the extent to which fiscal policy might have contributed to domestic demand pressures and liquidity expansion already discussed. If so, can fiscal policy be called upon to take pressures off monetary policy tightening? In FY10, fiscal deficit was well below the budgeted figure of 5% of GDP and, with good revenue collection, the government sector was a net payer to the banking system - thus reducing its overall (net) borrowing from the banking system. That trend continued in the first half of FY11 due to strong NBR revenue collection and under-utilization of ADP. But the situation changed in the second half of FY11 as the pace of ADP utilization improved and the subsidy bill ballooned. The outlook for FY12 looks unsettled.

In FY11, the government borrowed Tk.204 billion from the banking sector to finance the fiscal deficit as opposed to actually giving back Tk. 38 billion to the banking system in FY10. Planned domestic borrowing was Tk.206 billion, but the government only borrowed Tk.86 billion. In FY11, the government actually borrowed what it had planned - Tk. 236 billion. Has that led a crowding out of private borrowing for investment? Actually not. Of the Tk.204 billion, Tk.96 billion came from Bangladesh Bank. While the remaining came from commercial banks, it is also true that there was a huge transfer of deposits from National Savings Certificates (Jatiya Sanchaypatra) to bank deposits, due to fall in NSC rates and rise in bank interest rates. So the crowding out effect was minimal. Nevertheless, borrowings from BB simply resulted in creation of high powered money which, with a money multiplier of 4, resulted in four-fold increase in broad money (M2). It turns out that most of this was done in May-June 2011. The effect of this large-scale monetization of the fiscal deficit, if not sterilized, would end up in higher inflation or a further depreciation of the exchange rate. Indications are that bank financing of the budget during the first quarter of FY12 has increased sharply and are being accommodated through borrowings from BB.

Power sector subsidies accentuate fiscal deficits

Bangladesh's promising growth performance of the past decade has resulted in power shortages as power generation failed to keep pace with rising demand. The Sixth Plan postulates the economy losing more than 0.5% of GDP each year due to power shortage alone. To eliminate this constraint has become a national imperative. The task has been given the highest priority by the government but success has been slow in coming.

Solving the power problem at the earliest is now a national imperative. The economic benefits of an early solution to this problem can readily outweigh whatever financial costs that might be incurred in the short run simply because power shortages have become a binding constraint on higher growth. All would agree that this must be overcome at the earliest. However, not to be overlooked is the significant budgetary burden stemming from the subsidies to PDB and BPC needed to cover the high cost of diesel/furnace oil based power projects and rental power plants. 

The government has had to resort to desperate moves to meet the power sector challenge, opting for high cost rental power plants and fuel oil based generation being among them. To be fair, there has been some progress in the power sector with about 1500MW of new generation added to the sector in the past couple of years (Table 3). Consequently, government estimates suggest the average load shedding has come down from 1200-1500 MW in April 2010 to 1000-1200 MW in April 2011.

T3

But, as we all know, this has come at great fiscal costs, which have the potential to undermine macroeconomic stability, as the subsidy burden in the budget has shot up to unsustainable levels. The subsidies in power sector alone has increased from BDT 9.94 billion in FY10 to BDT 42 billion in FY11 and will further increase to BDT 52 billion in FY12. Such surge in subsidies is a massive challenge in the fiscal sector for the government. With a tax-GDP ratio of around 10%, spending 37% of tax collections on power sector subsidy appears unsustainable. Indeed, public enterprises supplying electricity, petroleum, and fertilizer (BPDB, BPC, BCIC) are accumulating huge losses (financed by budgetary subsidies) owing to the gap between cost of production and prices they are allowed to charge to consumers. While gains from eliminating the power constraint is critical, it is important to keep in mind that this does not come at the expense of macroeconomic stability.

Export performance: Silver lining in external sector

The sharp turnaround in world output growth in 2010, from negative growth of 2009, provided much needed stimulus to emerging market exports. On the back of what appeared to be a global recovery, export surge was experienced by several countries such as India, Indonesia, Vietnam, Cambodia, and Bangladesh. For Bangladesh, the surge began roughly around July of the last fiscal year, and continued unabated until end June 2011, clocking a record growth rate of 41% for the entire year (Fig.8). What is striking is that growth was broad-based and not just limited to RMG exports. Non-RMG and primary exports have all posted healthy gains (Fig.9-10). That momentum has continued, albeit slower at 21%, into the FY12 fiscal year as seen from the data for July-October 2011. This can still be described as superior performance in light of the slowdown in global trade that has been predicted in IMF Global Outlook. On the basis of current trends, we project this fiscal year to close with export growth of about 16.7%, which is still highly satisfactory. The challenging task for policymakers and entrepreneurs is to keep the momentum going for the long-term as nothing can be taken for granted in the competitive world market where Bangladesh is only one small player.

F_8

F_9
f_10
It is time to take note of the new economic inter-relationships. Fortunes of the Bangladesh economy are now heavily dependent on export performance, which in turn depends on the state of the global economy. Thus prosperity or decline in the global economy affects growth performance of the Bangladesh economy much more today than in the past. This is because of greater integration with the world economy through trade indicated by the rise in trade-GDP ratio from 19% in 1990 to 43% at the close of FY11.

Sharp rise in import bill in 2011

With exports surging, imports cannot be far behind. Such is the nature of a globalized production regime of which our RMG sector is a classic example. Exports today no longer require all inputs to be home-grown or home-made. Competitive advantage in any product is best exploited by mining global supply chains rather than trying to produce everything at home. Most American cars are not made 100% in the USA because so many parts are manufactured all over the world. So it is not surprising that our export surge has also led to an import surge that should not come as a surprise. Import growth of 41.8% in FY11 almost mimicked export growth of 41% (Tables 4-5).

T45
Balance of payments under strain

However, the import-export linkage is only part of the external sector story. The balance of payments situation has deteriorated markedly in FY11 due to the sharp decline in the balance of trade account (import and export of goods and non-factor services). Yet, the current account surplus in the balance of payments turned in a modest surplus in FY11, thanks to sustained though subdued growth of remittances, thus continuing the surpluses of the past six years running. Import demand was at an all time high. Superior export performance was the first to drive up import demand. This was further accentuated by the spillover effects of excessive domestic liquidity in the demand for imports, rising global commodity prices, growing demand for heavily subsidized fuel and fertilizer, rising imports of capital goods for power and other infrastructure, and alleged over-invoicing of capital imports. This growing demand for imports has not been matched by availability of foreign financing from official sources or from direct foreign investment. At the same time, earnings from inflow of remittances, the second largest source of foreign exchange, has plateaued, though remaining slightly above FY10 levels (Fig.7).

The slowdown in remittances appears fairly broad-based, including in particular from the oil producing Gulf countries, which accounts for 60% of all workers' remittances. Data on migrant workers (from Bureau of Manpower, Employment and Training - BMET) shows that departures to Saudi Arabia - the country which traditionally received the highest number of migrant workers - has plummeted, while migration to other Middle Eastern countries and East Asia have also fallen significantly. The loss of Saudi labor market to Bangladeshi workers is particularly noteworthy since this economy is importing labor from many other countries to sustain its oil-financed infrastructure programs. Increasing migration of labor significantly will require unlocking of the Saudi market through economic diplomacy (Fig. 11A & 11B).

F6

F7

F8

What caused the pressure in the exchange market despite the modest current account surplus? The problem lies in the next account of the BOP: financial and capital account. Lately, this account has shown weakness due to two reasons: (a) dwindling foreign aid disbursements, and (b) failure to attract more FDI. For a developing country like Bangladesh which needs growing imports to invest in infrastructure and manufactures, the ideal situation is to have a modest but sustainable current account deficit which is adequately compensated by a surplus position in the financial and capital account. In the case of Bangladesh, failure to have a vibrant financial and capital account in the event of rising trade deficits will give rise to challenges of macroeconomic management of the kind seen recently.

The net result of adverse developments in the current and capital account of the BOP is that foreign exchange reserves has come under severe pressure causing the exchange rate to depreciate rapidly (Fig.12). What is striking is that this depreciation is not helping exports as the real effective exchange rate (REER) continues to appreciate, thanks to the significantly higher inflation in Bangladesh relative to global inflation.

F9

Trade policy developments: The non-story

Bangladesh aspires to become a middle income country by 2021. That hope is predicated on raising its current 7 per cent annual growth rate of GDP to 8-10 per cent or more on a sustainable basis for the next decade. Does trade policy matter? Sure it does. There is no doubt that the nature of trade policy during this period will play a supportive or restraining role in achieving the targeted rate of growth. Historical evidence around the globe point to the fact that high performing economies (those growing at annual rates of 7-8 per cent or more for long periods) also have the most open trade regimes, particularly during the periods of high performance. 

So, standing at the close of 2011, is it possible to say that Bangladesh trade policy is on track to support higher growth during this decade? Perhaps not. Here are some indications. The overall outcome over two decades of liberalization is as follows: while Bangladesh reduced tariffs, -- rapidly at first, and gradually later -- other countries in the South Asia region and across the globe moved much faster. Consequently, despite two decades of liberalization, judged by the level of average protective tariffs, Bangladesh today has among the most restrictive trade regimes in South Asia, if not in the world, according to leading analysts of global trade regimes. Only a few years ago, India would have claimed that distinction but not anymore. 

F10
T6

A review of the tariff structure and trends confirms this view (Fig.13 and Table 6). With trade related quantitative restrictions out of the way, tariffs remain the principal instrument of trade policy in Bangladesh. What is surprising is the rise in protective tariffs in recent years with an increasing role of para-tariffs (supplementary and regulatory duties, etc.). What is evident is that para-tariffs have been contributing significantly to nominal protection. Though average customs duty has been on a secular decline, the emergence of para-tariffs sustained a higher level of average NPR contributing as much as 49% in FY12 (12.94 out of 26.5) to this indicator of protection!

The argument for lowering tariffs further should not be based on whether or not Bangladesh has outstanding commitments to WTO but rather on the adverse consequences of high tariffs on competition and productivity, export performance and long-term industrial growth. Fundamentally, a tariff is a subsidy on import substitute production and a tax on exports. The idea that protecting import substitutes with high tariffs will eventually make them competitive is old hat. It did not happen with RMG, footwear, nor shipbuilding. Thankfully, production and export of readymade garments were outside the sphere of influence of tariffs because of the free trade channel they enjoyed from the outset.

The point to reflect is whether Bangladesh is so hard pressed for revenue that it has to keep average tariffs close to the levels one finds in countries like Iran (23.5%), Tunisia (21.5%), Maldives (21.5%), Djibouti (27.8%), or should it have tariffs similar to Vietnam (11.7%) and Thailand (10%). High revenue dependence on trade taxes could be a constraint to trade liberalization in and of itself when the principal focus turns on tariff reduction. Cross-country evidence

seems to support the argument that lower reliance on import taxes makes it easier to implement trade liberalization policies that entail significant reduction in tariffs. For Bangladesh that is a problem if one looks at the relative importance of import tax revenue in the revenue basket and in relation to economic activity. True, a strategic shift has been taking place as NBR gradually shifts focus from trade-based taxes to domestic-based taxes. Yet, as a share of GDP, import-based taxes have been steady at 3.5% of GDP or more during FY00-11. Bangladesh is not out of the "low tax-GDP ratio" environment as that ratio still hovers around 10% of GDP. In the circumstances, the revenue authority (NBR), which is responsible for generating the resources to finance growing demands on public expenditure and is dedicated to a strategy of raising the tax-GDP ratio, is still unable to cut loose from its reliance on trade taxes, as many other economies have done. Cross-country evidence shows that economies with a low import-based tax to GDP ratio have found it easier to accelerate trade liberalization through tariff reduction (e.g. China, India, Vietnam, Thailand, Malaysia) compared to those economies having a higher ratio (e.g. Bangladesh). This provides one more cogent reason why Bangladesh authorities would be resistant to trade liberalization through tariff reduction. What is disconcerting is to find the structure of Bangladesh tariffs not only lacking optimal balance between revenue and protection objectives but their level and complexity create a general anti-export bias which undermines export incentives and competitiveness and impedes diversification of exports.

That said, the economy does face a challenge which cannot be ignored. The vision of attaining middle income country status by 2021 is predicated upon a lifting of the economy's growth rate to an average of 8-10 percent for the present decade. Can that sort of high performance be achieved with a trade regime that is internationally ranked among the most restrictive? Only very open economies with low tariffs have been able to reach that kind of high performance on a sustainable basis. It is highly unlikely that Bangladesh can be an exception. So if the objective of high sustainable growth is to be realized, what are the policy options available for Bangladesh?

First, doing nothing and simply muddling through the status quo of non-commital trade policy is not an option that will allow Bangladesh to become a high performing economy in the medium- or the long-term. A proactive stance that keeps exports (including potential exports) internationally competitive and facilitates trade is the only viable option for the future. Failing which Bangladesh is destined to remain a one product export (RMG) economy for the foreseeable future. Although the export market of RMG remains wide open (Bangladesh exported $19 billion in FY11 in a global textile market of $350 billion), it is unlikely that Bangladesh can expect to become a high performing economy riding on the shoulders of one export product. Higher growth will have to be export driven, particularly in manufactures, but more products will certainly have to emerge in the export basket. The case for a vigorous pursuit of export product diversification is thus made. But it would have to rest on a package of policies that are directed to overcome the significant anti-export bias that prevails in the policy environment. One way to do that is to allow duty-free bonded imports of inputs to all potential and emerging exports. Lately, footwear exports and ship-building have been given similar treatment with duty-free imported inputs within the bonded warehouse system and the results are becoming evident with the rapid expansion of footwear exports and the surprising emergence of exports of ocean-going ships. Other exports are waiting in the wings to emerge by taking advantage of Bangladesh's unparalleled labor cost competitiveness. Duty-free imported inputs (under an effective bonded system) coupled with a package of incentives to overcome anti-export bias has become the need of the hour.

Whither capital market?

As the curtain comes down on 2011, it has to be described as a bad year for the capital market. After performing better than most global equity markets in 2008 and 2009, Bangladesh stock indices once again led the way with a resounding 95% rise in the DGEN index in 2010 till December while market capitalization crossed 50% of GDP from 27% at the beginning of the year. As the situation was unsustainable, a massive correction started in January 2011, with the DGEN index tumbling by 41.6 % to its lowest level of 5203 points on 28th February 2011. Thereafter, the market has remained volatile without any clear direction.

After about two years of "irrational exuberance" in the capital market, euphoria has given way to all round pessimism. The DGEN, now 45% off its Dec 2010 peak, has prompted aggressive regulatory intervention from the government, most recently in the form of the 21 point plan unveiled by the SEC on November 24. The jury is still out on how effective this will be since the artificial support typically looses out to underlying fundamentals. History of equity markets has shown that when stock prices are driven up more by speculative behavior of investors than by market fundamentals, bursting of the "bubble" is an inevitability. So it was for the country's stock market - almost a repeat of the 1996 episode. We all agree that a vibrant equity market can serve as an important conduit for mobilizing scarce capital and channeling them into industrial investment and fueling growth. But this cannot happen when the capital market succumbs to speculative behavior of investors showing all the traits of a casino driven predominantly by hot money and speculation.

Five major factors are to blame for the present predicament of our stock market: (a) excess liquidity growth of the past three years or so, (b) flood of retail investors (BO accounts) driven by "greed", (c) lack of supply of scripts through IPOs, (d) excessive "hot money" invested by commercial banks in the stock market, and (e) moral hazard created by frequent albeit futile regulatory interventions by the SEC, the capital market watchdog. It would have been best for the SEC to focus all its efforts in ensuring that market players played by the rules rather than making intermittent vain attempts to prop up the stock index.

Economic outlook for 2012

In terms of output and exports, growth, jobs, and poverty reduction, 2011 was a stellar year in which Bangladesh was able to seize some of the opportunities that a slowly recovering global economy had to offer. By end of this calendar year, exports are expected to register growth of about 30% -- a record. The surprising part is that this occurred despite power and infrastructure constraints that prevented substantial amounts of new investment from taking place. It goes to the sagacity and foresight of our entrepreneurs that they were able to invest in sufficient excess capacity in the past to seize opportunities created by any surge in global demand. Whether this is sustainable in the near term without removal of power and infrastructure constraints raises a big question mark. True, the global outlook for trade growth in 2012 is muted, yet, the fact that Bangladesh is slowly gaining a larger share of the RMG exports market suggests continual and robust export growth provided trade logistics are functioning and domestic capacities are being expanded. Alongside the likes of China and Vietnam, "Made in Bangladesh" has become a known and dependable brand for readymade garments all over Europe and North America, in big name departmental stores from Blumingdale to WalMart to Marks & Spencer, and a variety of smaller outlets across the continents. Korea, Taiwan, Hong Kong, all created beachheads in developed markets starting with textiles and then moved on to more technologically sophisticated products. Now, the world of export opportunities has opened up for Bangladesh. Is Bangladesh ready?

Last year, in my assessment of the state of the economy 2010, I talked about a "window of opportunity" that was unraveling right in our neighborhood. With wages rising, China is fast becoming uncompetitive in most of its labor-intensive exports, such as textiles, shoes, furniture, toys, electrical and electronic goods, auto parts, plastic products, kitchenware, and a host of consumer and intermediate goods. Foreign investors in these sectors are searching hard for alternative locations to set up industries. Vietnam, Indonesia, and India are already positioning themselves to capture part of the Chinese pie. Bangladesh can beat the competition as it can still tout the lowest labor costs among its competitors. This opportunity will not last if it is not seized within the next 2-3 years. Our performance in attracting FDI was pathetic in 2010-11, to say the least: barely $1 billion a year, compared to $8 billion in Vietnam and $24 billion in India. Even war-torn Pakistan got $2 billion of FDI. It is time to end soul searching and get cracking - not by words but by deeds.

All in all, 2011 will go down in our economic history as a year palpably mixed with hope and despair. Thanks to a rebound in manufacturing growth buoyed by record exports, I estimate annual GDP growth for FY11 to have reached the 7% milestone, and is expected to stay that way for FY12, provided political environment does not get over-heated enough to impede domestic production and export activity. Before we exult in this achievement, it would be important to acknowledge the creeping dark clouds that now hang over the firmament of macroeconomic management - the scourge of inflation being first among them. Besides, some lapses in coordination of fiscal and monetary management described earlier is also leading to adverse developments in equity, credit, and foreign exchange markets that threaten to undermine macroeconomic stability that was historically the strong point of Bangladesh economic policy. Letting these problems fester for too long may ultimately cost the country much more than the short-term political discomfort of taking corrective action now. Let us also be reminded that sustained macroeconomic stability is a sine qua non for high growth and poverty reduction. Yet, it would be fair to acknowledge that the political backdrop for 2012 looks ominous for any economic policy brinkmanship, with the political tradition of confrontation leaving no scope for bipartisanship as far as the eye can see.

How does 2011 performance look in the context of global developments? For the world economy, 2011 is closing on a sour note and a less optimistic outlook for 2012. The Eurozone, built on foundations of sound economic management of all members, is distressed by the burden of deficits and debt of some of its members - Greece, Italy, Spain, and Portugal. Analysts are still assessing whether the rescue plan to save the Eurozone from collapse engineered by Germany and France will work. The US economy is burdened by some 25 million of its citizens unemployed (fully or partly) with its public debt approaching 100% of GDP, and no signs of a bipartisan understanding on how to pull the economy out of its present predicament. "Occupy Wall Street" movement, started by disgruntled citizens who lost out in the economic malaise while corporate managers enriched themselves, has spread across continents and shows no sign of going away anytime soon. To be sure, these external developments pose an imminent challenge to Bangladesh's economic progress because of its growing integration with the world economy. 

The world economy presents both opportunities and challenges. It is up to us to make the best use of both by getting our own house in order - economically and politically.

....................................................
Dr. Sattar is Chairman, Policy Research Institute. Competent research support was provided by PRI economist, Biplab Kumar Dutta

Speech