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Done well, but can be better

Zahid Hussain and Johannes Zutt
SINCE 2010, when the last household survey to assess poverty was done, Bangladesh maintained progress towards reducing poverty by sustaining growth at 6% or more and by holding inflation at moderate single digits. In all likelihood, Bangladesh in 2013 surpassed the MDG target of halving extreme poverty by 2015, two years ahead of schedule. Although progress on poverty reduction may have slowed somewhat in FYI4 due to a slower pace of economic expansion, significant poverty reduction continued. Below, we provide an overall assessment of Bangladesh's economic performance in the current fiscal year, the near- and medium-term outlook, and the development challenges.
Resilient growth and macroeconomic stability
Economic activities recovered in the second half of FY14, driven by resilient exports and domestic demand, following setbacks suffered in the first half due to political uncertainty and turmoil: A recovery in export growth and increases in public expenditure are likely to help achieve 5.4% GDP growth in FYI 4, slightly higher than the average for developing countries but lower than last year's 6%. The political turmoil in the last quarter of 2013 inflicted a value-added loss of about $1.4 billion, of which 86% was in services, 11% in industry and the remaining 3% in agriculture. Business and consumer confidence in general suffered through declines in rate of return on investment perceived by domestic and foreign investors, remittances and demand for labour.
Sound macroeconomic management helped contain inflation at a moderate single-digit level: Inflation has increased somewhat in recent months due to cost push from supply disruptions and wage increases. The political disturbances obstructed food distribution channels, resulting in constrained supplies and higher food prices. Stability in international commodity prices, weak domestic demand, and some
appreciation of the nominal exchange rate combined with a restrained monetary policy to moderate the recent increase in inflation.
Foreign exchange reserves have increased to adequate levels, with a sustained large surplus in the overall balance of payments: The external current account surplus has remained comfortable due to good export growth and weak imports which more than offset the decline in the level of workers' remittances. A large surplus in the overall balance of payments, underpinned primarily by surplus in the current account, and Bangladesh Bank's frequent intervention to prevent an appreciation of the nominal exchange rate led to further accumulation of official reserves to over 5 months of GNFS import cover.
The financial sector is stressed: Deteriorating fundamentals of the banking sector were exacerbated by a rise in default risk across the board due to losses inflicted by a prolonged disruption in production and trade. The state-owned banks were already negatively impacted by the earlier financial scams. The growing nonperforming loans of private commercial banks are also a matter of concern. Capital market turnover has been increasing in the post-election period, but it will be important not to get swamped by another bout of irrational exuberance.
The well-established tradition of prudent macroeconomic management continues: Monetary policy pursued a restrained path, achieving broadly the targets for the first half of FY14. Implementation of monetary policy benefited from slowdown in private credit growth. This contributed to an increase in excess liquidity; despite stepped up sterilisation operations by BB in response to overshooting of the target for growth of net foreign assets.
The fiscal deficit and public borrowing have remained within sustainable limits: Fiscal management this year is facing challenges because of a large and growing shortfall in NBR tax revenue, demand for fiscal support from sectors adversely affected by the political turmoil and slower utilisation of ADP. Tax revenue growth in the first seven
months of FY14 was barely 10%. Usual shortfalls in public investment spending may not be enough to keep deviation from the FYI 4 budget deficit target within a reasonable limit. Government bank borrowing so far has been contained, while net nonbank borrowing has increased.
Near and medium-term challenges
Key near-term challenges need prioritised attention: The momentum of GDP growth acceleration has been deflated in the last three years as a result of lingering uncertainties around the modality of political transition, the slow pace of structural reforms and the inability to get started on building transformative infrastructure. In the immediate future, Bangladesh faces three sets of formidable challenges: (i) maintaining stability and resolving the remaining political uncertainties while boosting investment in power and roads; (ii) managing well the transition in the readymade garment (RMG) industry; and (iii) stemming the decline in remittances.
The medium-term challenge is to boost productivity: The medium-term development challenges include re-invigorating structural reforms that boost supply capacity and productivity by investing in transformative infrastructure, energy and streamlining trade and investment regulations. Growth in Bangladesh may rise to a potential 6.5% within a couple of years if stability prevails. But it is unlikely to accelerate much further without hitting capacity constraints and generating overheating pressures in the absence of continuing structural reforms and upgraded infrastructure.
The external balance cannot be taken for granted: The sustainability of the external balance will depend on addressing garments and remittance related challenges. As the RMG industry upgrades both factory and labour standards, export growth will likely recover after moderating in FYI 5. Remittances are expected to normalise from FYI 5, assuming improved demand for Bangladeshi labour with the relaxation of restrictions in Saudi Arabia, UAE and Kuwait, made possible by inten-
sified economic diplomacy. Failure to act in time on RMG standards and the legal status of Bangladeshi labour in GCC countries combined with a pick-up in import growth due to a recovery in private investment demand may quickly dissipate the reserve comfort currently in place.
What would it take to raise the growth rate to 8 percent?
Macroeconomic stability must continue and investment-oriented reforms need a new lease of life: Confidence and economic activity will improve in the near- and mediumterm if stability is sustained. Supported by the demand and supply effects of enhanced public investment in infrastructure, harnessing of the demographic dividend, fostering human capital accumulation, and structural reforms to revamp the climate for domestic as well as foreign private investment, the pace of poverty reduction will rise with growth acceleration regaining momentum. Continuation of prudent macroeconomic management will contribute to reducing inflation to around 6%, below the threshold where it begins to hurt growth.
The growth rate can be raised to 8 percent quickly: Overall, the Bangladesh economy did well in the outgoing fiscal year, considering the large costs of political turmoil. The near- and medium-term outlook is favourable because of the recovery in Bangladesh's key trading partners and the restoration of internal stability. A rise in public investment in transformative infrastructure will be critical to boosting private investment and capacity creation. Other things being equal, increasing the growth rate to a new normal of about 8% from the current rate of 6.5% could be achieved by a combination of annua) average 14% export growth, 13% remittance growth and 15% growth in public investment, compared respectively with 11.6%, 13.3% and 8.5% average growth rates achieved in last ten years. Bangladesh's own experience suggests this is doable. The authors are respectively Lead Economist and Country Director (Bangladesh and Nepal), the World Bank.