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Powering investments needs power

Zahid Hussain
In a recent CPD discussion on FY10 budget implementation, the finance minister rightly nailed investment as the key challenge facing the Bangladesh economy today. At 24.2 percent of GDP in FY09, investment rate in Bangladesh is low relative to emerging economies like India and China where it hovers around 40 percent of GDP. It has also been declining since FY06, reflecting primarily decline in the rate of public investment
The good news is that the rate of private investment has maintained an increasing trend in recent years, albeit at a slow pace, rising from 17.8 percent of GDP in FY04 to 19.6 percent in FY09. The other good news is the increase in foreign direct investment from $385 million (0.7 percent of GDP) in FY04 to nearly $1 billion (1.1 percent of GDP) in FY09. A survey on FD1 just released by the Bangladesh Bank shows that FDI inflows in the last half of 2008 doubled in the telecommunication sector compared to the first half of 2008. It also increased significantly in textiles, banking, food and agriculture. These FDIs came mostly from Egypt, Malaysia, UK, Japan, Norway, Hong Kong, South Korea, US and the Netherlands. Total stock of FDI has increased from $3 billion (5.3 percent of GDP) at the end of December 2004 to $4.8 billion (6 percent of GDP) at the end of December 2008.
Unfortunately, the ongoing global recession together with weaknesses in the domestic investment climate provide a little confidence that the recent increases in domestic and foreign private investments can be sustained in the near-term. Bangladesh needs to raise the total investment rate to at least 34 percent of GDP in the next three to five years in order to accelerate the economic growth rate to the 8.5 to 9 percent range for becoming a middle-income country in a decade and a half. The country also needs to enhance the efficiency of investment to get the maximum return from its extremely scarce capital resources. With declining GDP growth rate in the last four years, the efficiency of investment, as measured by the Incremental Output Capital Ratio (1OCR), has declined. An additional taka of investment yielded Tk 0.24 worth of output in FY09, compared with TkO.27inFYO4.
The relatively low investment rate, its slow pace of increase, and declining efficiency are closely related to the quality of the domes-tic investment climate in Bangladesh. The lesson from Bangladesh's experience in the last two decades is that broadbased market friendly reforms together with macroeconomic stability propelled both private investment and technological development. No doubt the exter-
nal constraints on animal spirits to invest in Bangladesh have hardened due to the severity and persistence of the ongoing global financial crisis. While there is a little Bangladeshi policymakers can do to help global recovery, there is a lot they can do to ease the internal constraints.
The most bindings of these internal constraints are energy and the quality of public administration, as emphasised by the finance minister. With pressure for expansion of access to electricity even in the face of limited supply, there is a sharp decline in the quality of service, reflected in vastly increased power outages as the same or even at times much reduced quantity of power (due to tripping) is rationed to a growing pool of users. Business firms report supply disruptions all the time that cause significant losses of production and sales and great frustration with corruption in the sector.
A very conservative estimate is
that Bangladesh needs an additional 4,000 MW of reliable power supply in the next four years. The cost of construction of thermal power plant is about $0.8 to $1 million per MW. This implies an additional investment of $3.2 to $4 billion in power generation, something that the government alone cannot entirely afford. The government has therefore rightly opened the sector to Public-Private Partnership (PPP) to attract investors who will build, own and operate generation plants and/or offer short-term rentals of their small privately owned generation capacity. Private investors, however, may be reluctant because of uncertainty of reaping returns from selling power into a system that is currently not financially sustainable. Bangladesh is thus trapped in a vicious cycle. Financial sustainability requires cost-effective tariffs. But how do you explain to the public why they should pay higher tariffs in an environment of rapidly deteriorating supply? Improved power supply appears to have become a political pre-requisite to promoting financial sustainability, but without cost-effective tariffs it i^ difficult to attract private investors to improve power supply.
This unfortunately is not the only vicious cycle. Competent administrative machinery is needed to deliver power and other essential public services such as telephone and gas connections to boost the country's investment rate. Markets are generally investment shy in an environment characterised by heavy and complex red tape as well as weak administration. These breed opportunities for hassle to the point that graft and malfeasance do not even serve to speed up the provision of needed services, as in a typical “speed-money” model of corruption.
Successive governments have attempted to reform Bangladesh’s administrative system to make it more efficient and dynamic, but to no avail. The key lesson from the past administrative reform efforts appear to be that excessive politicisation in public recruit ment, and posting and promotion system create a vicious cycle of incompetence. Competent individuals do not enter the civil service because of politicisation. With fewer competent members, the scope for politicisation gets a fillip, which further discourages the most able candidates from entering the service. This turns politicisation into a deeply embedded administrative culture, which only a powerful political leadership can hope to change.
Boosting investment in Bangladesh thus requires power, both literally and figuratively, to break the vicious cycles.
The author is senior economist at the World Bank Dhaka office. Views expressed m the article are stnctly his own.