IMF Executive Board Concludes 2009 Article IV Consultation with BangladeshPublic Information Notice (PIN) No. 10/28
February 23, 2010
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 January 5, 2010, the Executive Board of the International Monetary Fund (IMF) concluded the 2009 Article IV consultation with Bangladesh.1
Bangladesh’s economy has held up remarkably well despite the global recession. Financial contagion was contained by low levels of financial integration. Growth, estimated at 5.9 percent for FY2009 (July 2008-June 2009), decelerated only modestly from the pace recorded in recent years and remained broad-based. The limited impact of the global downturn on Bangladesh’s growth partly reflects the relatively low overall trade openness, and the large share of basic textiles and garments in total exports, which fared relatively well. The resilience of Bangladesh’s exports contrasts with the experience in other countries in Asia where exports are still substantially below the pre-crisis peak.
The external position strengthened considerably in FY2009 and the first four months of FY2010. Strong remittances, resilient exports and weak imports caused the current account of the balance of payments to record a surplus of almost 3 percent of GDP in FY2009, up from less than 1 percent of GDP in FY2008. With the capital and financial account of the balance of payments broadly in balance, the improvement in the current account caused a major rise in gross international reserves during FY09. Reflecting also an SDR allocation from the IMF (US$0.7 billion) and Asian Development Bank disbursements (US$0.6 billion), gross international reserves exceeded US$10 billion in November, almost double the level in November 2008. This is equivalent to 4.8 months of prospective imports, a 15-year high.
The strength of the external position put pressure on Bangladesh Bank (BB)’s monetary policy framework. The improvement in the current account put upward pressure on the taka which BB countered through unsterilized foreign exchange purchases. This caused banks’ excess reserves to rise sharply, sending short-term interest rates below 1 percent. Over the summer, with no measures taken to absorb liquidity, the monetary policy framework was rendered virtually inoperative.
The accommodative monetary policy pushed up asset price inflation. A decline in international food and commodity prices contributed to a fall in inflation to 2.2 percent in June 2009. But with the accommodative monetary policy, upward pressures on real estate prices have became visible and stock market prices have risen by 40 percent since end-March. As international food and commodity prices began to rise again, inflation rose to 6.7 percent in October.
The FY2009 budget deficit remained below the budget target, despite revenue shortfalls, owing to continued problems in implementing the Annual Development Program (ADP). Held back by lower imports, customs revenue fell short of the target. As a result, the ratio of tax revenue to GDP declined by 0.2 percent of GDP to 8.6 percent of GDP, falling short of the original budget target by 0.6 percent of GDP. ADP spending fell short of the original budget by 1 percent of GDP reflecting implementation bottlenecks. The overall fiscal deficit (including grants) amounted to 3 percent of GDP, almost 1 percentage point of GDP smaller than envisaged in the original budget. The counterpart to the lower deficit was mostly in lower than budgeted disbursements of foreign loans.
In the area of structural reforms progress was mixed. Comprehensive plans to address infrastructure bottlenecks, such as the power and gas shortages which are holding back growth, remain under discussion. Progress in Public Private Partnerships (PPP) has been slow. The reintroduction of interest rate ceilings on important categories of bank lending was a setback to financial market development. The recent appointments made at the Boards of Directors of three state-owned commercial banks (SCBs) were not fully in line with established regulations. The FY2010 budget’s extension of para-tariffs and the introduction of a regulatory duty to a large number of consumer goods raised nominal protection and is second-best to comprehensive tax policy reform.
Amid continued uncertainty about the strength of the global recovery, Bangladesh’s growth momentum is likely to remain somewhat subdued in the near term yet inflation seems set to increase. Accordingly, growth could decelerate in FY2010 as economic activity is likely to be held back by weak imports, particularly of capital machinery, sluggish exports and private sector credit, and subdued hiring of Bangladeshi workers by employers abroad. The strong performance of the agricultural sector in FY2009 will also be hard to exceed substantially. The ample availability of liquidity along with adverse base effects related to last year’s unprecedented decline in international food and commodity prices is likely to drive up inflation throughout FY2010, possibly to double digits by the summer. As strong inflows of remittances are expected to continue, the external position should remain strong and gross international reserves should remain above a relatively comfortable 4 months of prospective imports.
Over the medium term, as global growth and trade recover, Bangladesh’s growth should edge up as well, to around 6 percent per annum, building on increasing trade integration with countries in the region and the rest of the world, and growth momentum in the agriculture, services, and construction sectors. The current account can be expected to remain in surplus with the import coverage of reserves remaining robust.
Executive Board Assessment
Executive Directors commended the authorities for the strong performance of Bangladesh’s economy, despite the global recession. They noted that growth has been supported by buoyant domestic activity, including in agriculture and services. Directors considered that resilience in exports as well as continued strong inflows of remittances also played an important role. They noted that fiscal conservatism of the government has paid large dividends. Going forward, Directors expected these trends to continue with medium-term growth in the baseline scenario projected at a respectable 6 percent. However, they identified two policy issues.
First, Directors considered preventing an increase in inflation to be the immediate policy concern. They observed that by stabilizing the exchange rate of the taka in the face of strong remittance inflows, monetary policy has been too accommodative for the domestic conditions. Directors welcomed the commitment made by BB to employ all available instruments to contain inflation if and when there are clear signs of a pickup in prices. However, they saw a need for preemptive and bold action by BB. Directors considered that the resulting higher market interest rates would be a small price to pay to prevent a harmful acceleration of inflation, which hurts the poor most severely.
Directors noted that greater flexibility in the exchange rate would support monetary policy objectives. They were of the view that the authorities should move towards greater flexibility in the exchange rate to lessen the constraints on macroeconomic policies. Directors observed that the export sector should be able to sustain such a move, since they believed that the taka is somewhat undervalued, though not far out of line with fundamentals. In Directors’ view, increased day-to-day movements in the exchange rate would also help deepen the foreign exchange market.
Second, for the medium term, Directors noted that measures should be taken to unleash Bangladesh’s potential, while maintaining fiscal prudence and sustainability. Directors observed that Bangladesh seems stuck in a low revenue-low capital spending equilibrium and infrastructure bottlenecks are holding back growth. They agreed that higher growth could be achieved through higher revenue and higher capital spending. Therefore, Directors strongly encouraged the authorities to push through the plans for Value-Added Tax (VAT) reforms.
Directors noted that further financial deepening is needed to allow Bangladesh to achieve its growth potential. In light of this, they observed that ceilings on lending rates and other non-prudential interventions should be removed as soon as possible. They considered that increased flexibility of interest rates, including for National Savings Certificates (NSCs), would make the auction process for government paper more efficient and give impetus to an active secondary market. Directors noted this would also help offset the government’s higher interest costs related to the needed monetary tightening. Directors encouraged the authorities to accelerate the restructuring of SCBs.
Directors noted that continued improvement in the quality and timeliness of statistics would improve policy making. They considered improvements in national account statistics to be particularly urgent.
Directors encouraged the authorities to adopt a timetable for the removal of the remaining exchange restriction subject to approval under Article VIII, on the transferability of funds in nonresident taka accounts.