State of the Bangladesh Economy

Transcription

1 State of the Bangladesh Economy Early Signals of FY2005 (First Reading) A paper prepared under the programme Independent Review of Bangladesh s Development (IRBD) implemented by the Centre for Policy Dialogue (CPD) January 15, 2005 B A N G L A D E S H CENTRE FOR POLICY DIALOGUE (CPD) a c i v i l s o c i e t y t h i n k - t a n k House 40C, Road 11, Dhanmondi R/A, Dhaka-1209 Tel: , , ; Fax: cpd@bdonline.com; Website:

2 Credit Dr. Debapriya Bhattacharya, Executive Director, Centre for Policy Dialogue (CPD) was in overall charge of preparing this report. Drafts on various sections were prepared by Professor Mustafizur Rahman, Research Director, CPD (External Sector and MFA Phase-out), Dr. Ananya Raihan, Research Fellow, CPD (Banking Sector and Exchange Rate), Dr. Uttam Kumar Deb, Research Fellow, CPD (Agriculture Situation; Food Security; and PRSP), Dr. Fahmida Khatun, Research Fellow, CPD (Assessment of Flood 2004), Dr. Khondaker Golam Moazzem, Research Fellow, CPD (Investment Scenario in the Private Sector), and Mr. M. Syeed Ahamed, Senior Research Associate, CPD (Macroeconomic Trends). Database development and analysis were carried out by Mr. Mabroor Mahmood, Senior Research Associate (Banking Sector), Mr. Noor Mohammad Wasi Uddin, Research Associate, CPD (Macroeconomic Trends), Mr. Wasel Bin Shadat, Research Associate, CPD (Flood Assessment), Mr. Kazi Mahmudur Rahman, Research Associate, CPD (Investment Scenario), Mr. Syed Saifuddin Hossain, Research Associate, CPD (Flood Assessment), Mr. Md. Masum Billah, System Analyst, CPD (Agriculture Situation and Food Security), Mr. Asif Anwar, Programme Associate, CPD (Flood Assessment), Ms. Farhana Rahman, Programme Associate, CPD (Banking Sector and Exchange Rate), Mr. Narayan Chandra Das, Programme Associate, CPD (Agriculture Situation and Food Security), Mr. Shubhasish Barua, Programme Associate, CPD (Exchange Rate and Investment). CPD: IRBD FY05 (First Interim) ii

3 Expert Group Meeting on CPD-IRBD 2005 (Interim) As part of the CPD-IRBD tradition, CPD organised an Expert Group Consultation Meetings on January 12, 2005 at the CPD Dialogue Room. The First Interim Report on the State of the Bangladesh Economy: Early Signals of FY2005 was shared at this in-house meeting with a distinguished group of policymakers and professionals with direct exposure to macroeconomic policy crafting in the country. Professor Rehman Sobhan, Chairman, CPD chaired the session. CPD-IRBD Research Team acknowledges the participants for sharing their views and comments on the draft report. However, CPD is solely responsible for the observations and analysis made in this paper. A list of the participants of the meeting is provided below in alphabetical order: Dr Q K Ahmad Dr. Quazi Mesbahuddin Ahmed Professor Amirul Islam Chowdhury Dr. Mirza Azizul Islam Mr. M. Hafizuddin Khan Professor Wahiduddin Mahmud Dr. A.K.M. Masihur Rahman Mr. Mustafizur Rahman Dr. Quazi Shahabuddin Mr. M. Syeduzzaman President, Bangladesh Unnayan Parishad (BUP) Member (GED), Planning Commission Former Vice Chancellor, Jahangirnagar University and Former Chairman, Sonali Bank Chairman, Securities and Exchange Commission Former Finance Advisor to the Caretaker Government and Chairman, Public Expenditure Review Commission Former Finance Advisor to the Caretaker Government and Professor, Economics Department, University of Dhaka Former Secretary, ERD, Ministry of Finance Former Chairman, Revenue Reform Commission and Director, Far-East Finance and Investment Director General, Bangladesh Institute of Development Studies (BIDS) Former Finance Minister and Chairman, Bank Asia CPD: IRBD FY05 (First Interim) iii

4 Acronyms ADB - Asian Development Bank ADP - Annual Development Programme BB - Bangladesh Bank BBS - Bangladesh Bureau of Statistics BOI - Board of Investment BTTB - Bangladesh Telegraph and Telephone Board CDBL - Central Depository Bangladesh Limited CPI - Consumer Price Index EPZ - Export Processing Zone FCB - Foreign Commercial Bank FDI - Foreign Direct Investment FFW - Food for Work Forex - Foreign Exchange GDP - Gross Domestic Product GNI - Gross National Income GOB - Government of Bangladesh GSP - Generalized System of Preferences HYV - High Yielding Variety ICMA - Institute of Cost and Management Accountants IMF - International Monetary Fund IPO - Initial Public Offering IPRSP - Interim Poverty Reduction Strategy Paper LC - Letter of Credit MFA - Multi Fibre arrangement MGD - Millennium Development Goal MOFDM- Ministry of Food and Disaster Management MTMF - Medium Term Macroeconomic Framework NCB - Nationalized Commercial Bank CPD: IRBD FY05 (First Interim) iv

5 NER - Nominal Exchange Rate NGO - Government of Bangladesh NSD - National Savings Deposit OMS - Open Market Sale PCB - Private Commercial Bank PRSP - Poverty Reduction Strategy Paper REER - Real Effective Exchange Rate RTA - Regional Trading Agreement SEC - Securities and Exchange Commission SME - Small and Medium Enterprise VAT - Value Added Tax VGD - Vulnerable Group Development VGF - Vulnerable Group Feeding CPD: IRBD FY05 (First Interim) v

6 Table of Content I. INTRODUCTION 1 PART A II. GROWTH, SAVINGS AND INVESTMENT Economic Growth Trend Decelerates? Sources of Growth Service Sector Dominated Per-capita Income Inadequate Savings-Investment to Accelerate Growth 7 III. STATE OF THE FISCAL SECTOR Revenue Receipts Public Expenditure 15 IV. STATE OF THE MONETARY SECTOR Domestic Credit Expansion Government Borrowing and Public Debt Agricultural Credit Industrial Credit Price and Wage Inflation 26 V. STATE OF THE REAL SECTOR Agricultural Production Industrial Production Foreign Investment Capital Market 39 VI. STATE OF THE EXTERNAL SECTOR Export Likely to Survive the Phasing out of MFA Import Sees Robust Growth Especially in Investment Items Opening and Settlement of Import LCs Balance of Payments Regimented Flow of Remittance Continuing Escalation Forex Reserves Continues to Swell Foreign Aid Failed to Supplement Growth Instruments 59 CPD: IRBD FY05 (First Interim) vi

7 PART B VII. ASSESSMENT OF FLOOD Background Damage Assessment Relief and Rehabilitation CPD s Recommendations and GOB Initiatives 67 VIII. MFA PHASE-OUT: EARLY INDICATIONS AND CHALLENGES AHEAD IN FY So Far So Good! Post-MFA Scenario Will be Different Designing an Appropriate Strategy 77 IX. INVESTMENT SCENARIO IN THE PRIVATE SECTOR Major Advances to a Limited Number of Large and Medium Industries Sluggish Trend of Investment in Capital Market Slow Rise of Industrial Consumption of Energy More Promises of FDIs Investment in the Interim Period Concentration in a Limited Number of Large and Medium Industries 86 X. NCBs REFORM: WHERE DOES IT STANDS Reform Agenda Reform Process Consequences 95 XI. PRICES OF ESSENTIAL COMMODITIES, INCREASE IN DIESEL PRICE AND FOOD SECURITY Price Surge of Essential Commodities Trends in Import of Foodgrains Monga in Northern Districts Increase in Diesel Price Implications for Food Security 112 XII. INFLUENCE OF EXCHANGE RATE MOVEMENTS ON EXPORT PERFORMANCE OF BANGLADESH Exchange Rate Behaviour: Is there Any Significant Change Since Floating Mechanism? Export Performance of Bangladesh: Does Exchange Rate Matter? 116 XIII. PRSP AND IPRSP: A COMPARISON OF MEDIUM TERM MACROECONOMIC FRAMEWORK Targets for Economic Growth and Money Supply Government Revenue and Public Expenditure Balance of Payments Conclusion 124 XIV. CONCLUDING BALANCE SHEET 124 CPD: IRBD FY05 (First Interim) vii

8 LIST OF TABLES Table 1: Savings/Investment Scenario FY04-FY05 Table 2: Comparison of Inflation in India, Pakistan and Bangladesh Table 3: Summary of CPD s Damage Estimates Table 4: Comparison of Preliminary Damage Estimates Table 5: Comparison of CPD s Recommendations and GOB Implementation Table 6: Advances Classified by Economic Purposes (Major Manufacturing and Service Sectors) Table 7: Capital Machinery and Industrial Raw Materials Imported for Manufacturing and Service Industries Table 8: Initial Public Offering (IPO) for July-November, FY2004 and FY2005 Table 9: Industrial Consumption of GAS and Electricity Table 10: Prospective FDIs in Bangladesh by Selected Countries Table 11: State-Owned Bank Assets as a Percentage of Total Bank Assets Table 12: Scenario of Manpower Restructuring, Data as of June, 2004 Table 13: Import of Rice (Aid/Commercial/Private) in Bangladesh, 2001/ /05 Table 14: Targets for Economic Growth in IPRSP and PRSP Table 15: Table 16: Table 17: Targets for Money Supply (Percent Change in Money and Credit) in IPRSP and PRSP Targets for Government Revenue and Public Expenditure as Percent of GDP in IPRSP and PRSP Targets for Balance of Payments in IPRSP and PRSP Annex Table 1: State-Ownership vs. Banking Performance in Selected Countries Annex Table 2: Comparatives Picture of Commercial Banks Performance LIST OF FIGURES Figure 1: Trend in GDP Growths Figure 2: Periodic Linear Growth Rates of GDP Figure 3: GDP Growth of Selected South Asian Countries Figure 4: Incremental Growth of Sectors ofgdp: FY91-04 Figure 5: Savings as Percent of GDP during FY91-FY04 Figure 6: Investment as Percent of GDP during FY91-FY04 CPD: IRBD FY05 (First Interim) viii

9 Figure 7: Figure 8: Figure 9: Figure 10: Figure 11: Figure 12: Figure 13: Figure 14: Figure 15: Figure 16: Figure 17: Figure 18: Savings-Investment Gap as Percent of GDP Revenue-GDP Ratio in Bangladesh Revenue-GDp Ratio in Bangladesh (Linear and Average) Revenue Earnings During FY91-FY05 VAT vs Income Tax During FY91-FY05 Taka Release and Expenditure of ADP During the 1 st Quarter of FY02- FY05 Target ADP and Actual Implementation During FY02-FY05 (1 st Quarter) Performance of Major Ministries (in terms of ADP Allocation) Domestic Credit Expansion During July-October FY01 to FY05 Growths in Domestic Credit During July-October FY01 to FY05 Private Sector Share in Domestic Credit During Jul-Oct FY01 to FY05 Growth of Net Government Borrowing During July-October FY05 (pointto-point) Figure 19: Sale and Repayment of NSD Certificate Figure 20: Growths in Agricultural Credit Expansion During July-October FY05 Figure 21: Term Loan for the FY04 and FY05 Figure 22: Working Capital for the FY04 and FY05 Figure 23: Inflation (moving Average) Figure 24: Food Inflation (Point to Point) Figure 25: Wage Inflation (Point to Point) Figure 26: Comparison among India, Pakistan and Bangladesh Figure 27: Inflation During the Flood Year 1998 Figure 28: Growths of Major Industries During July to October of FY04 and FY05 Figure 29: Quantum Index of Production during FY03-05 ( =100) Figure 30: Foreign Investment During FY00-FY04 Figure 31: Foreign Investment During July-September of FY04-05 Figure 32: FDI Flow: Survey and Banking Data Figure 33: Sectoral Composition of Registered FDI in FY04 Figure 34: Entry of IPOs in the Capital Market (Monthly Statistics) Figure 35: Structure of Exports during July-October FY04-05 CPD: IRBD FY05 (First Interim) ix

10 Figure 36: Figure 37: Figure 38: Figure 39: Figure 40: Figure 41: Figure 42: Figure 43: Figure 44: Figure 45: Figure 46: Figure 47: Figure 48: Sectoral Growth of Exports during July-October FY05 Monthly Dynamics of Export Earnings During FY01-05 (Jul-Oct) Decomposition of Export Growth for July-October FY05 Export and Import during FY91-FY04 Imports and Sectoral Growth during the First Quarter of FY01-05 Sectoral Growth of Imports during the First Quarter of FY05 Settlement of LCs during July to November of FY04 and FY05 Fresh Opening of LCs during July to November of FY04 and FY05 Growth Rates of Opening and Settlement of LCs FY05 over FY04 (July to November) Balance of Payments FY97 to FY04 Balance of Payment Scenario During Jul-Sep in FY04-05 Flow of Remittances During Jul-Dec in FY01-FY05 Monthly Trend in the Flow of Remittances During FY04-FY05 Figure 49: Remittances and Foreign Exchanges Reserve: FY91 to FY04 Figure 50: Foreign Exchange Reserves and Equivalent Months of Import Figure 51: Decomposition of Sources of Import Financing Figure 52: Flow of Foreign Aid in Bangladesh During FY90-04 Figure 53: Flow of Foreign Aid During July to October of FY04-05 Figure 54: Declining Foreign Aid in the Context of Stagnated Domestic Savings Figure 55: Global Export of Knit and Woven RMG and their Growth Figure 56: Bangladesh s Export of Apparels (Jul-Oct): FY05 vs FY04 Figure 57: Changes in Market Share (Assets) of Commercial Banks in Bangladesh Figure 58: Incremental Share of Market by Commercial Banks, 1996:2004 Figure 59: Comparative Geographical Distribution of Branches of Commercial Banks Figure 60: Average Wholesale Price of Coarse Rice in Bangladesh: FY01-FY05 Figure 61: Comparison of Domestic Prices of Rice with Import Partly Price: FY00- FY05 Figure 62: Rice Prices and Quantity of Private Rice Imports in Bangladesh, Figure 63: Distribution of Foodgrains through FFW and VGD: 1998/ /05 Figure 64: Depreciation of Some Selected Currencies, Base Period June 2000 CPD: IRBD FY05 (First Interim) x

11 Figure 65: Figure 66: Comparative Movement of Euro-USD Cross Rate in Bangladesh and Global Euro-USD Rates, Monthly Average Movement of EURO-USD Global Exchange Rate and EURO-USD Cross Rate, November 2004 January 10, 2005 Figure 67: Depreciation of Some Selected Currencies, Base Period June 2000 LIST OF BOXES Box 1: Box 2: Box 3: An Enquiry in Factors Influencing Inflation A Balance Sheet of Bangladesh Economy Major Findings of the Thematic Issues CPD: IRBD FY05 (First Interim) xi

12 I. INTRODUCTION The first reading of the Independent Review of Bangladesh s Economy for (FY05) essentially covers the first six months (July-December 2004) of the fiscal year. The review, drawing on official data, has been presented in two analytical components. The first component (Part A) provides a macro-economic overview focussing on the following four major areas. (i) Growth, Saving and Investment (ii) Monetary Sector (iii) Real Economy (iv) External Sector Recognising the relative stability prevailing in the macro-economic situation, the review highlights some sources of its fragility. It raises the question whether the macroeconomic stability of Bangladesh has been rewarded with adequate growth payoff. The review underscores the negative implications of the creeping rise in consumer price index in the backdrop of perceptible credit expansion in both manufacturing and agricultural sector. In the real economy, shortfall in foodgrain production remains the major concern, while capital market has been attracting increased liquidity. The external sector balance is experiencing consolidation, notwithstanding the total phase-out of the apparel quota. The second component (Part B) of the review addresses a select set of issues which would underpin the final outcomes of FY04. These issues are the following: (i) Consequences of Flood 2004 (ii) Impact of MFA Phase-out (iii) Trends in Industrial Investment (iv) NCB Reforms (v) Exchange Rate Movement (vi) Price Rise of Essentials (vii) Finalisation of PRSP CPD: IRBD FY05 (First Interim) 1

13 PART A CPD: IRBD FY05 (First Interim) 2

14 II. GROWTH, SAVINGS AND INVESTMENT 2.1 Economic Growth Momentum Decelerates? Following a decline of the GDP growth rate to 4.2 percent in FY02, the national economy repositioned itself in a five percent plus growth trajectory during the subsequent two years (FY03 and FY04). The economy posted a growth of 5.5 percent in FY04 in line with the I-PRSP target; however such marginal improvement in economic growth rate compares unfavourably with the record figure of 5.9 percent achieved in FY00. The recently finalised national PRSP provides a set of growth targets which has revised downward the figure for FY05 from 6.0 percent to 5.5 percent. PRSP has fixed the GDP growth targets at 6.0 percent and 6.5 percent for FY06 and FY07 respectively. Figure 1 Trend in GDP Growths Source: Computed from Finance Division (2004c) and ERD (2003) Note: * PRSP Targets. It is known that the Bangladesh economy has been experiencing five percent plus growth rate during the past few years. However, when compared with the trend growth rates of 1990s, one can notice a deceleration of national growth rates. The GDP grew at faster rate during the 1990s (4.6 percent linear growth) in comparison to 1980s (3.6 percent linear growth). Within 1990s, the growth momentum was even higher during the second half of the decade in comparison to the first half. The linear growth rate of GDP during CPD: IRBD FY05 (First Interim) 3

15 the period of FY91-95 was 3.95 percent, while during the next five year (FY96-00) it grew at even a faster rate of 4.79 percent. However, taking into account the PRSP target growth of FY05 (5.5 percent), the economy during the FY01-05 is programmed at a linear growth rate of 4.88 percent, indicating a stagnation in its second derivative. 6 5 Figure 2 Periodic Linear Growth Rates of GDP 4 percent FY81-85 FY86-90 FY91-95 FY96-00 FY01-05* Note: * GDP growth for FY05 is based on PRSP Target. Figure 3 GDP Growth Rate of Selected South Asian Countries India 8.1 GDP growth (percent) Pakistan Bangladesh Sri Lanka FY01 FY02 FY03 FY04 FY CPD: IRBD FY05 (First Interim) 4

16 At the same time, when compared with the major countries in the South Asia region, the growth scenario looks moderate for Bangladesh. The GDP growth rates of India (8.1 percent), Pakistan (6.4 percent) and Sri Lanka (6.5 percent) have been higher in FY04 than that of Bangladesh (5.5 percent). The GDP growth target for FY05 also appears to be restrained when compared with other South Asian countries as India, Pakistan and Sri Lanka have targeted growth targets for FY05 at 6.5 percent, 6.5 percent and 7 percent respectively. During the first quarter of FY05, India has already achieved a 7.4 percent growth. 2.2 Sources of Growth Service Sector Dominated The contribution of the real economic sectors to incremental growth has declined to percent in FY04 from percent in FY03. The annual growth of the real economic sector stagnated at 4.60 percent during the last two fiscal years (FY03-04). This is largely because of decline in the incremental growth of agriculture sector, which went from percent in FY03 to percent in FY04. The incremental growth of the service sector has increased to percent in FY04 from percent in FY03 (see figure 4). Figure 4 Incremental Growth of Sectors of GDP: FY FY91 FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 Agriculture Industry Service Source: Computed from CPD (2004) CPD: IRBD FY05 (First Interim) 5

17 The on-going structural transformation of the Bangladesh economy is characterised by falling share of the agriculture sector with marginal increase of the manufacturing in the backdrop of increasing contribution of the service sector. The share of service sector has increased to percent in FY04 from percent in FY03. The real economic sector accounted for percent of the GDP in FY03, which has decreased to percent in FY04. A decade back, the said proportion was percent. This suggests that in spite of improved growth, the evolution of the Bangladesh economy remains biased against modern, industrial transformation, having concomitant implications for sustained growth and equitable income distribution. 2.3 Per-capita Income The per capita GDP and GNI scenario are gradually improving after a decline in FY02. In FY03 the per capita GDP and GNI was recorded to be US$389 and US$411 respectively. In FY04 the corresponding figures are US$421 and US$444 respectively. The annual growth is of 8.23 percent for per capita GDP and 8.03 percent for per capita GNI in terms of US dollars. Once we adjust these figures by the extent of devaluation of US Dollar, the per capita GDP growth comes down to 5.3 percent. It is well known that poverty trends are influenced by the changes in inequality. Income inequality at the national level has increased from 25.9 percent in to 30.6 percent in During the same period, urban inequality was rising at a higher pace- from 30.7 percent in to 36.8 percent in 2000, than rural inequality- from 24.3 percent in to 27.1 percent in 2000 (BBS, 2003). Between and 2000, national income attributable to the poorest 10 percent of the population declined further from the miniscule proportion of 2.24 percent to 1.84 percent. Conversely, the control on the national income by the richest 10 percent of the population increased from percent to percent (ibid). In other words, the income differential between the poorest and the richest increased from 35.7 times to 53.4 times during the second half of 1990s. The sources of rising inequality are linked with the uneven spread of economic and social opportunities, unequal distribution of assets CPD: IRBD FY05 (First Interim) 6

18 especially in respect of human capital and financial capital, growing disparity between urban and rural areas as well as between developed and underdeveloped areas. The IRBD2003 opined that the incremental growth does not automatically benefit the poor in Bangladesh (Bhattacharya, 2004). In this context and also in connection with the completion of the initial year of the I-PRSP, we have not been provided with any assessment on the poverty situation. There is no evidence which suggests that this trend has been reversed during the last couple of years. Absence of such an assessment also fails us to benchmark our programmes regarding MDGs. 2.4 Inadequate Savings-Investment to Accelerate Growth The deceleration of Bangladesh s national growth can be substantiated by the stagnated savings-investment scenario. Recent growth models 1 predicts that higher savings and the related increase in capital accumulation can result in a permanent increase in growth rates as savings determine the national capacity to invest and thus to produce, which in turn affect the economic growth potential. On the contrary, low saving rates have been cited as one of the most serious constraints to sustainable economic growth. In this context, Bangladesh s savings-investment scenario is showing a rather stagnant trend during last few years. Domestic savings has increased marginally to percent of the GDP in FY04 from percent in FY03. The share of national savings to GDP has also showed signs of stagnation in FY04 at percent of GDP against percent in FY03. Though the national savings rate projected in the I-PRSP document for FY04 (23.3 percent) was achieved (thanks to our NRBs for their remittances), the projected domestic savings rate for FY04 (19.0 percent) was not achieved (see table 1). 1 Notion supported by the empirical works of Romer (1986), Lucas (1988), Barro (1991), De Long and Summers (1991). CPD: IRBD FY05 (First Interim) 7

19 TABLE 1 SAVINGS/INVESTMENT SCENARIO FY04-FY05 FY04 Deviation from I-PRSP IPRSP Actual IPRSP FY05 Gross Domestic Savings Gross National Savings Gross Investment (24.20 in PRSP) Private Public Source: Computed from Finance Division (2004c) and ERD (2003) On the other hand, during the last five years (FY00-FY04), the gross investment ratio has increased by only 0.50 percent of the GDP. For example, the ratio was percent in FY00; whilst it crawled only up to percent in FY04. Increasing investment continues to remain one of the core challenges of Bangladesh s macro-economy. In FY04, the country recorded the lowest public investment ratio of the last 14 years, 6.12 percent. The sectors left behind by public investment were not adequately picked up by private investment. Private investment as a share of GDP increased marginally from percent in FY03 to percent in FY04. In this context, the new PRSP has stepped back from forecasting any savings target for the next fiscal year. The only target available is for gross investment which is set at percent of GDP. This is far below the target of IPRSP which was set at 27.0 percent and does not hold the aim to overcome the existing investment stagnation soon. CPD: IRBD FY05 (First Interim) 8

20 30 25 Figure 5 Savings as percent of GDP during FY 91-FY04 Gross National Savings as percent of GDP Gross Domestic Savings 0 FY91 FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05* FY06* Note: * Targets for FY05 and FY06 are based on I-PRSP Figure 6 Investment as percent of GDP during FY 91-FY04 as percent of GDP Gross Investment FY91 FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05* FY06* FY07* Private Investment Public Investment Note: * Gross Investment target for FY05-FY07 is based on PRSP. The breakdown of investment target (private and public) for FY05- FY06 is based on I-PRSP. CPD: IRBD FY05 (First Interim) 9

21 Paradoxically, Bangladesh continues to remain an under-invested country, while its national savings rate (24.49 percent) supposes its gross investment rate (23.58 percent). After the late 1990s, when the savings and investment were almost equal, Bangladesh experienced a net resource gap during FY01 (-0.77 percent) and FY02 (-0.72 percent). Then the idle resource (i.e., excess savings as regard to investment as a ratio of GDP) started climbing up. Figure 7 Savings-Investment Gap as percent of GDP FY91 FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04-1 The idle resource stood at 1.0 percent in FY03 and then with a marginal decline stood at 0.9 percent in FY04 as both investment and savings increased (or rather remained idle) by the same factor. We are failing to convert all our savings into investment as we continue to borrow from foreign sources. Bangladesh needs to pay special attention to encourage savings and to create opportunities for investment. In the context of low bank and NSD interest rates, government needs to encourage savings by increasing variety of savings products, e.g. promotion of other form of savings such as life insurance, provident funds, mutual funds, investment in the stock market etc. CPD: IRBD FY05 (First Interim) 10

22 At the same time, opportunities to invest this savings also needed to be broadened. Savings is not an unconditional panacea for growth. Coherent and consistent long-term policy to encourage investment in a stable socio-political and economic environment is a prerequisite for this growth and development. The absorptive capacity, which is in many ways constrained by the institutional bottlenecks and lack of profitable investment opportunities, is also important for a transitional economy like Bangladesh. Otherwise this excess liquidity of savings will end up with obvious consumption or even flight of capital! 2 In this context it can be mentioned that Bangladesh has experienced a major shift in her consumption pattern during the last four fiscal years. While in the private sector the consumption as percent of GDP has decreased from 77.5 percent in FY01 to 76.3 percent in FY04, the propensity to consume has increased in the public sector, from 4.5 percent in FY01 to 5.4 percent in FY04 (as percent of GDP). 2 CPD-GCR survey reveals that overseas investment by the entrepreneur of this investment-starved country is increasingly becoming a reality, while NRBs are not investing in Bangladesh as much as we want them to. CPD: IRBD FY05 (First Interim) 11

23 III. STATE OF THE FISCAL SECTOR 3.1 Revenue Receipts Inefficient and inadequate revenue mobilisation has been a major weakness for Bangladesh s fiscal sector. The historically low revenue-gdp ratio of Bangladesh experienced a marginal upsurge during the FY00-FY04, when the revenue-gdp ratio increased from 9.0 percent in FY00 to 10.8 percent in FY04. The periodic average of revenue-gdp ratio increased from 8.45 percent in FY91-95 to percent in FY01-04 percent. According to the PRSP target the revenue-gdp ratio will decline to 10.7 percent in FY05. The sluggish trend in revenue collection during the first four months of FY05 substantiates this decline in revenue-gdp ratio. Figure 8 Revenue-GDP Ratio in Bangladesh FY91 FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05* FY06* Tax-GDP Ratio (percent) FY07* The PRSP has set a very defensive set of targets for revenue-gdp ratio for FY06 (11.2 percent) and FY07 (11.7 percent), which is still low when compared with other South Asian countries. This low tax-to-gdp ratio indicates the inefficiency of Bangladesh s tax system in financing public services and redistributing income 3. 3 Assuming that increases in a country's tax-to-gdp ratio often indicate a greater provision of tax-financed services and/or a greater redistributive role of the tax system. CPD: IRBD FY05 (First Interim) 12

24 Figure 9 Revenue-GDP Ratio in Bangladesh (Linear and Average) 12 Revenue-GDP Ratio (period average) 10 Revenue-GDP ratio (percent) 8 Revenue-GDP Ratio (linear) FY91-95 FY96-00 FY01-04 FY05-07* Note: * Figures for FY05-07 are based on PRSP target Latest available figure shows a modest revenue growth by the National Board of Revenue (NBR) as it registered a 9.52 percent growth during the first four months of FY05 over the corresponding figure of the previous fiscal year. During this period (July-October) tax as percent of GDP has increased slightly, from 2.24 percent in FY04 to 2.26 percent in FY05. During the July-October period of FY05, total import related revenue has increased by about 6.46 percent while total internal trade related revenue registered a robust percent growth. Though import related supplementary duty showed a marginal negative growth (-0.17 percent), supplementary duty at the local level registered a moderate percent growth during the period under reporting. Among others, VAT (local), VAT (import) and income tax increased by about percent, percent and percent respectively. The encouraging point to be noted that during this July- October period, the share of direct tax (income tax) has increased from percent in FY04 to percent in FY05. However this share of direct tax is still appallingly low and there is an urgent need for a shift in the composition of revenues away from tax on goods and services towards direct taxes on income and profit. It is to be noted that the NBR component covers more then three quarter of the total revenue income and the CPD: IRBD FY05 (First Interim) 13

25 overall growth observed in the revenue is mainly the contribution of this NBR part, while other parts (non-nbr tax and non-tax) of revenue sources remains stagnant. Figure 10 Revenue Earnings During FY91-FY Non-Tax Revenue Tax Revenue Annual Growth Revenue Earnings (crore Tk) Annual Growth (percent) 0 0 FY91 FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05* Note: * Target for FY05 Figure 11 VAT vs Income Tax During FY91-FY percent of GDP FY91 FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05* VAT as percent of GDP Trend Line Note: * Target for FY05 CPD: IRBD FY05 (First Interim) 14

26 In the context of a declining trend in public investment and stagnated savings-investment scenario at the national level, the major challenge remains for Bangladesh s fiscal policy is to strengthen the effort to mobilise domestic resources to generate a larger share of resources for investment. Reformation of the tax management and providing right incentives to stimulate domestic savings is essential to achieve this goal. 3.2 Public Expenditure Annual Development Programme The size of the Annual Development Programme (ADP) for FY05 has been fixed at Tk crores, which is percent higher than that the revised ADP of FY04 and about higher than the actual implemented ADP of FY04. While only 83 percent of the original size of the ADP i.e. 89 percent of the revised size was implemented during the FY04, questions were raised regarding rationale of fixing such an ambitious target. However, CPD in its post-budget reflection pointed out that this so-called ambitious ADP target needs to be seen from the perspective that Bangladesh remains an under invested economy and as such a large ADP target is worth chasing for. Thus, implementation of a fuller ADP became the major challenge, than targeting a bigger ADP. The second aspect, which needs to be underscored in this respect, is that the issue of quality is no less important than the question of size of the ADP. The ADP for FY05 took some steps decrease the number of projects, which has been slashed down from 1163 in FY04 to 869 in FY05 including about 150 new projects. CPD: IRBD FY05 (First Interim) 15

27 Figure 12 Taka Release and Expenditure of ADP During the 1st Quarter of FY Taka Release Expenditure percent FY02 FY03 FY04 FY05 Latest available figure indicates that during the first quarter of the FY05, only Tk 2212 crore were spent for ADP implementation, of which Tk 1493 crores (67.5%) were funded from internal resources (Taka) and Tk 720 crores (32.5%) were underwritten by project aid. This indicates only a 10 percent realization of the target ADP during the first three months of FY05. While the performance of ADP implementation during the first quarter of the current fiscal year remains comparable with the experience of previous years, it also suggests that the much anticipated big push necessary to achieve the aggregate target in general and augment the domestic demand in post flood situation was not forthcoming. One interesting point to be noted is that the implementation of ADP in FY04 as percentage of Taka release has increased significantly as the release of Taka declined sharply, keeping the implementation situation same. To be precise, while about 46 percent, 53 percent and 60 percent of targeted domestic resources (Taka) for ADP were released during the first quarters of FY02, FY03 and FY04 respectively, only about Tk 2985 crore or 20 percent of the total allocation of domestic resources (Taka) target of ADP were released during the first three months of FY05. CPD: IRBD FY05 (First Interim) 16

28 Figure 13 Target ADP and Actual Implementation During FY02-05 (1st Quarter) crore Tk Actual During 1st Quarter (P.A.) Actual During 1st Quarter (Taka) Target ADP for the Full Fiscal FY02 FY03 FY04 FY05 A closer look at the ADP implementation reveals that among the ministries/divisions which received the highest allocation in the target ADP, the Ministry of Health and Family Welfare implemented the least spending, only 2 percent of its allocation during the first quarter of the FY05. Others performed moderately during this period: Power Division 15 percent, M/O Education 15 percent, Local Government Division 18 percent and M/O Communication 10 percent. Figure 14 Performance of Major Ministries (in terms of ADP Allocation) percent Pow er Division Education Local Government Communication Health and Family Welfare CPD: IRBD FY05 (First Interim) 17

29 It was perceived that the government will use the ADP resources for the post-flood rehabilitation programme. CPD s Rapid Flood Assessment 2004 pointed out that the government could utilise Tk crore from its development budget which were kept as sectoral and unallocated block allocation. CPD also mentioned that ministries/divisions of some selected sectors, 4 which can be closely involved in the postflood rehabilitation programme, have a block allocation of Tk crores or 3.0% in their ADP budget. Surprisingly many line ministries of this group showed very low ADP realisation that involved Ministry of Industries (6 percent), Ministry of Agriculture (13 percent), Ministry of Fisheries and Livestock (9 percent) and Ministry of Water Resources only (3 percent). More surprisingly, unallocated block allocation of Tk 295 crore and sector-wise block allocation of Tk crore remained untouched during the first three months of FY05. One needs to take a closer look at the financing of government s post-flood rehabilitation programme in the context of this low ADP implementation and even lower foreign aid flow. 4 Sectors which CPD thought would be involved more directly in the post-flood rehabilitation programme are: Agriculture, Rural Development, Water Resources, Industry, Transport, Communication, Infrastructure & Water Supply and Health, Population & Family Planning. CPD: IRBD FY05 (First Interim) 18

30 IV. STATE OF THE MONETARY SECTOR 4.1 Domestic Credit Expansion The outstanding amount of domestic credit at the end of October 2004 stood at Tk crore of which Tk crores was in the private sector and rest percent in the public sector. Total domestic credit during the first four months of the current fiscal year registered a perceptible 15 percent growth over its matching figure for FY04. Government s expansionary approach following the Flood 2004 was reflected by this upward trend in domestic credit expansion. But it needs to be pointed out that though borrowing in the public sector increased on a point to point basis by crores (i.e. by percent) in October 2004 against the decline of Tk crores (i.e. (-) 3.64 percent) during the comparable period of the preceding year (2002); the high growth rate largely resulted from an increase of Tk crores (i.e percent) in credit to the Other Public Sector. Net credit expansion to government sector was percent more than that of the matching figure of the previous year Figure 15 Domestic Credit Expansion During Jul-Oct FY01 to FY Tk in Crore Government Other Public Private Sector CPD: IRBD FY05 (First Interim) 19

31 The 15 percent growth of private sector during the first four months of FY05 seems quite low, when compared with the growth rate of 22 percent during the same period of previous year. It may be noted that the correlation of credit growths between public and private sector often appears to be negative 5. When government borrows excessively from the banking sector, it usually squeezes banks private sector lending capacity. As shown in figure 16, growth of credit expansion in the private sector increased from percent in October 2002 to percent in October 2003, while the growth of credit expansion in the government sector declined from 0.40 percent to (-) 6.70 percent during the same period. As the economy observed a high growth in the public sector (government percent, and other public percent) in October 2004, the growth in the private sector declined to 15 percent Figure 16 Growths in Domestic Credit During Jul-Oct FY01 to FY05 percent Government Other Public Private Total However, excess liquidity in the banks provides enough room for government sector borrowing to expand without crowding out the share of private sector. As seen during the first four months of FY05, credit to private sector increased both in terms of absolute volume and in terms of share corroborating the expansionary approach of the government after the post-flood situation. 5 For example, on a point-to-point basis, growths during the first four months of FY01 to FY04 indicate a negative correlation of -0.4 percent. CPD: IRBD FY05 (First Interim) 20

32 Figure 17 Private Sector Share in Domestic Credit During Jul-Oct FY01 to FY05 percent Share of private investment marginally increased from percent during October 2003 to percent during October This is quite high when compared to the average share of 72 percent as was observed during the past five years. 4.2 Government Borrowing and Public Debt During the first four months of FY05, the government borrowing experienced a major shift as regard to its source by way of moving away from non-bank sources to banking sources. This process has been underpinned by a drastic fall in net the sale of National Savings Deposits (NSD). Total public borrowing during the July-October period of FY05 stood at Tk crore registering a growth rate of about 7 percent over the corresponding period of the previous fiscal year. Share of government borrowing from the non-bank sources during this period decreased from 8.35 percent in FY04 to 3.77 percent in FY05. While net borrowing from the banking sector increased by about percent, net borrowing of government from the non-bank sources decreased by (-) percent during the period under report. CPD: IRBD FY05 (First Interim) 21

33 Figure 18 Growth of Net Government Borrowing During Jul-Oct FY05 (point-to-point) Borrowing from Bank Borrowing from Non- Bank Total Government Borrowing percent Government borrowing through sale of NSD certificates during the first four months of FY05 stood at Tk crore registering a (-) 6.50 percent negative growth, while the repayment of principal increased by percent, registering a (-) percent negative growth in the net sale. This decline in the sale of savings certificate is a response to the government s decision of lowering the interest rate of NSD certificates to reduce the cost of borrowing and to encourage people to invest in the economy. The recent upward movements in the capital market can be correlated with the declining trend of NSD sale. Though the second aim of the government was somewhat achieved, the lowering of interest rate however backfired with a sharp decline in NSD sale, putting the government at a risk to face financing crisis to fulfil the budget deficit with borrowing. In that case, the government will have to increase its borrowing from the banking sector, which will then create a negative impact on the private sector investment by squeezing the private sector s share of borrowing from the bank. CPD: IRBD FY05 (First Interim) 22

34 Figure 19 Sale and Repayment of NSD Certificate Net Sale Crore Tk Repayment Sale Jul-Oct FY04 Jul-Oct FY05 In the context of this dilemma, recently the government has taken some decisions to increase the sale of NSD certificates with the same lowered interest rate. The government has increased the limit of investment in NSD certificates, for single owner from Tk 20 lakh to Tk 25 lakh and in dual name, from Tk 40 lakh to Tk 50 lakh, which is equally applicable for re-investment. Besides one can also reinvest his/her interest with the principal. The commission of banks and post-offices has also been increased from Tk 20 to 5 percent for each transaction to encourage their selling effort. 4.3 Agricultural Credit It was expected that the post-flood rehabilitation programme of the government will be reflected by an increase in the agricultural credit. However agricultural credit expansion during the first four months of FY05 shows a mixed picture with improved disbursement rate which remains low in terms of target achievement. Credit disbursement to the agricultural sector stood at Tk crore at the end of October 2004 which is about 58 percent higher than the disbursement of the matching period of the previous year. However this extraordinarily high growth rate can be explained by its lower benchmark during the previous year. During the first four months of FY04 only Tk core were disbursed as against Tk crore of recovery. This out-flowed an amount of Tk 121 crore from the rural economy. CPD: IRBD FY05 (First Interim) 23

35 Figure 20 Growths in Agricultural Credit Expansion During Jul-Oct FY Jul-Oct FY04 Jul-Oct FY taka in crore Disbursement Recovery Netflow In this context, a moderately high credit expansion during the agricultural sector could take a breath following the devastating flood. However, notwithstanding the agricultural credit growth of FY03, the post-flood disbursement of agricultural credit during the FY05 falls short of the target as only percent of the total target (Tk crore) was disbursed during the first four months of FY05. It may be recalled that CPD in its Flood 2004 report suggested for disbursement of Tk crore as agricultural credit in FY Industrial Credit In the backdrop of the slowdown in growth of industrial term loans in the recent years (since FY01), the disbursement record for FY04 was quite impressive Tk crores, i.e percent growth. After a recovery of Tk crores in FY04, the net flow to the sector is Tk crores which compares favourably with the outflow of (-) Tk crores during the comparable period in FY03. The expansionary trends in the disbursements of industrial term loan continued in the first quarter of FY05 (61.5 per cent growth). But in the absence of the data on recovery of the loans, it is hard to get a complete picture of the term loan situations. CPD: IRBD FY05 (First Interim) 24

36 However, one interesting feature is that loan disbursement by NCBs declined by 60 percent, though the loan sanctioned was 257 per cent higher than the first quarter of the FY04. Loan disbursement from PCB (domestic) shows a growth rate of 154 per cent, which has also emerged decisively as the largest contributor (almost 65 per cent) to total industrial loan disbursement. Figure 21 Term Loan for the FY04 and FY NBFI Crore Tk PCB(F) PCB(D) DFI 0.00 FY04 (July-Sep.) FY05 (July-Sep.) NCB Figure 22 Working Capital for the FY04 and FY NBFI Crore Tk PCB(F) PCB(D) DFI 0.00 FY04 (July-Sep.) FY05 (July-Sep.) NCB CPD: IRBD FY05 (First Interim) 25

37 The disbursement of working capital grew at 46 per cent in FY05 (July-Sept). Similar to the term loan, PCB (domestic) has the largest share (almost 65 per cent) in total disbursement of working capital. 4.5 Price and Wage Inflation Trend in Inflation The rising trend in inflation is another concerning issue of the last few months. The general inflation in October 2004 rose to 7.92 on point-to-point basis while inflation in October 2003 was 6.16 per cent. Three major features of the recent rise in the price level is: (i) inflation is higher in the rural areas, (ii) food inflation is higher in both rural and urban areas; and (iii) non-food inflation showing a declining trend since October The 12-month moving average inflation rate also shows an increasing trend, reaching as high as 6.21 per cent in October The major factor behind this trend is the increase in food price, which increased to 7.57 per cent (10.46 per cent on point to point basis). However, the weakening of Taka against dollar and the rising import prices also added fuel to the rising trend of inflation. Figure Inflation (Moving Average) Per cent Jul-01 Sep-01 Nov-01 Jan-02 Mar-02 May-02 Jul-02 Sep-02 Nov-02 Jan-03 Mar-03 May-03 Jul-03 Sep-03 Nov-03 Jan-04 Mar-04 May-04 Jul-04 Sep-04 General Food Non Food CPD: IRBD FY05 (First Interim) 26

38 4.5.2 Trend in Food Inflation The recent flood may be the most influencing factor in the rise in the food price, although the upturn started back in January, The food inflation in FY04 was 6.64 per cent (on point to point basis), the food inflation then started accelerating and on October 2004, it reached per cent (on point to point basis), a record high since FY99. Figure Food Inflation (Point to Point) Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Per cent National Rural Urban Wage Inflation The general wage index grew by 5.38 per cent in October 2004, on a point to point basis. The general wage inflation in October 2002 and 2003 was and 6.83 per cent, respectively. The crucial point here was that CPI inflation is increasing on the one hand while the wage index was falling on the other hand in FY04. However, wage inflation in FY04 was 3.93 per cent and since then it started increasing. Agricultural wage index also started increasing since July 2004, following a decreasing trend over the previous 12 months. CPD: IRBD FY05 (First Interim) 27

39 Figure Wage Inflation (Point to Point) Jan-02 Mar-02 May-02 Jul-02 Sep-02 Nov-02 Jan-03 Mar-03 May-03 Jul-03 Sep-03 Nov-03 Jan-04 Mar-04 May-04 Jul-04 Sep-04 Per cent General Manufacturing Construction Agriculture Fishery Inflation Trend in South Asia Inflation in India (on a point to point basis) in July 2004 was 6.16 per cent, which was inclined by an increase of the oil price in the international market. WPI inflation reached at 8.3 per cent in August 2004; and then gradually decreased to 7.1 per cent in October The CPI inflation in Pakistan was also quite high, but it shows a declining trend in contrast to Bangladesh. TABLE 2 COMPARISON OF INFLATION IN INDIA, PAKISTAN AND BANGLADESH Bangladesh (CPI) India (WPI) Pakistan (CPI) Jul Aug Sep Oct CPD: IRBD FY05 (First Interim) 28