IMF Executive Board Concludes 2007 Article IV Consultation with BangladeshPublic Information Notice (PIN) No. 07/75
June 29, 2007
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On June 22, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Bangladesh.1
Bangladesh's growth outlook and external position remain robust, but inflation has picked up. The economy continued to grow at over 6½ percent in the fiscal year ending June 2006 (FY06) spurred by strong exports and investment. GDP growth is expected to continue at around 6½ percent in FY07 despite some supply-related disruptions, with lower agricultural growth offset by strong manufacturing and service activities. Inflation has recently picked up to over 7 percent reflecting increases in both food and nonfood prices.
The exchange rate has been relatively stable and international reserves have increased throughout the period of political upheaval. Reserves have reached beyond US$4 billion (approaching three months of imports) on the back of continued strong remittances and exports, which are growing at 25 and 21 percent, respectively.
Overall macroeconomic stability has been maintained, but fiscal performance continues to suffer from structural weaknesses. Revenue performance has consistently been below budget targets. In addition, spending accelerated early in FY07 causing a surge in domestic financing of the government while delays in external disbursements further aggravated the situation. This forced expenditure cuts later in the year to contain the overall deficit and domestic financing. As a result, development expenditure was significantly underexecuted.
The growth in monetary and credit aggregates increased considerably in FY07. Broad money growth reached a high of 22 percent in December and private credit growth has been close to 20 percent for much of the year. Reflecting better control of government finances since January 2007, the growth in monetary aggregates has declined somewhat, but still remains above targeted levels. With ample liquidity, bank lending and deposit interest rates have seen only modest increases.
Petroleum prices have not kept pace with international prices leading to a deterioration of finances of state-owned enterprises. After the April fuel price adjustments, domestic prices of diesel and kerosene are around 80 percent of their breakeven level and below prices in neighboring countries. The losses accumulated in the past have been financed through loans from the nationalized commercial banks, and about two-thirds of these loans are overdue contributing to the weak financial health of these banks.
The Bangladesh Bank has further advanced reforms aimed at deepening financial markets. The regulatory framework has been strengthened, off-site and on-site supervision has been enhanced and steps taken to restructure, corporatize, and privatize the large nationalized commercial banks. These reforms have contributed to reducing the share of the large nationalized banks and strengthening the banking system. However, interest rate spreads are high and point to inefficiencies in the domestic banking system that detract from efficient financial intermediation.
The current transitional government has moved to address several areas where reforms had stalled. These include adjustments in fuel and electricity prices, introduction of a Financial Intelligence Unit, reconstituting the Anti-Corruption Commission, and separating the judiciary from the executive branch.
Executive Board Assessment
Executive Directors welcomed that macroeconomic stability with strong growth has been maintained for several years, and that most of the objectives of the Poverty Reduction and Growth Facility-supported program were achieved. Inflation was largely contained, poverty has been reduced, and good progress has been made toward achieving the Millennium Development Goals. The shift to a flexible exchange rate strengthened the external sector, helping to support double-digit growth in exports and remittances and a significant improvement in international reserves. Although fiscal discipline was maintained, revenues fell short. Looking forward, growth is expected to remain healthy, underpinned by buoyant exports, strong remittance flows, and continued reform efforts. At the same time, weak revenue collections, poor infrastructure, low skill levels, and governance issues remain important impediments to sustained growth and further poverty reduction.
Directors observed that revenue collections are insufficient to meet development needs or to support the desired reductions in tariffs and supplementary duties. They called for a fundamental reform of the tax system by broadening the tax base, separating the responsibility for tax policy and collection, simplifying VAT and income tax legislation, and consolidating and strengthening the institutional structure of tax administration. Directors welcomed the recent steps to consolidate import taxes, but observed that the rate of effective protection remains high.
Directors welcomed the planned reforms in the area of public financial management and the adoption by major ministries of the medium-term budget framework, but drew attention to the underexecution of development spending. They hoped that the adoption of a regulatory framework for the Public Procurement Act would raise the efficiency of project implementation.
Directors supported the authorities' efforts to stem state-owned enterprise losses and ease infrastructure bottlenecks. They welcomed the fuel price adjustments by the state-owned petroleum company, but called for more timely adjustments through an automatic pricing formula. Directors recommended adjusting the price of domestically produced natural gas to encourage efficient gas usage and raise government revenue.
Directors commended the authorities for their progress in strengthening central bank operations and improving the institutional framework for monetary policy, and the steps taken to develop a secondary market for government securities. They recommended further monetary tightening in the face of strong inflows and higher inflation, and with money and credit aggregates above targeted levels. The recent pickup in inflation could become entrenched in the absence of corrective policies.
Directors considered that the flexible exchange rate regime has helped maintain competitiveness, and remains appropriate. With reserves now at a more comfortable level, exchange market intervention should be confined to alleviating disorderly conditions, and thus allowing greater flexibility in the nominal rate to support stabilization objectives. Directors urged the authorities to remove the remaining exchange restriction on the transferability of funds in nonresident taka accounts.
Directors commended the authorities for improving financial sector surveillance, and recommended that they build on recent financial sector reforms. They welcomed the corporatization of the remaining state-owned banks, hoped for a successful privatization of Rupali Bank, and encouraged the authorities to prepare the other state banks for eventual divestment. Directors called on the authorities to bring banking sector prudential guidelines more in line with international standards and strengthen monitoring, particularly in the context of rapid credit growth. Directors commended the authorities for implementing many of the recommendations of the 2003 Financial Sector Assessment Program (FSAP), and welcomed the authorities' request for an FSAP update.
Directors supported the recent reforms to promote transparency, good governance in public administration, fair elections, and the prevention of money laundering and terrorist financing. These reforms, if sustained, will improve overall efficiency and boost the investment climate.
Directors noted that data are broadly adequate for surveillance purposes, but called for continued efforts to improve data quality, including banking soundness indicators, and national accounts, fiscal and debt statistics.
Directors looked forward to continued close cooperation and dialogue between the authorities and the staff in support of Bangladesh's reform objectives, possibly in the context of a Fund-supported program.