## ADDRESSING CLIMATE CHALLENGES IN BANGLADESH: A SMART CARBON PRICING STRATEGY: A CARBON USER FEE TO MOBILIZE CLIMATE FINANCE

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### Summary
- Climate change poses critical macroeconomic challenges for Bangladesh requiring fiscal, financial, and structural interventions.
- Proposal: gradual adoption of a carbon user fee narrowly on the energy sector, increasing from US$3 per metric ton of CO2 in FY22 to US$25 per metric ton of CO2 in FY30.
- Objectives of the carbon fee:
  - Signal commitment to meeting the 2021 NDC mitigation targets.
  - Help firms plan decarbonization and improve energy efficiency, reducing stranded assets, competitiveness risks, and future job losses.
  - Mobilize revenue that can be recycled to protect the economically vulnerable, support firm decarbonization, and invest in climate projects.
  - Improve negotiating position regarding prospective border carbon adjustments (BCAs) and trade terms ahead of LDC graduation.

### Context and Bangladesh’s climate position
- Exposure and vulnerability:
  - Among the top ten countries most affected by extreme weather events during 1998–2017 (Global Climate Risk Index).
  - Losses linked to extreme events estimated to average 1.8 percent of GDP annually between 1990 and 2008 (IMF 2019b).
  - Notre Dame’s Global Adaptation Initiative Index: 27th most vulnerable and 26th least ready.
- Emissions profile and NDCs:
  - Bangladesh accounts for less than 0.35 percent of global GHG emissions; per capita emissions significantly lower than many regional peers.
  - NDC mitigation commitments:
    - Proposed unconditional aggregate reduction of GHG emissions by 6.73 percent below Business-As-Usual (BAU) levels by 2030.
    - Proposed conditional contribution to reduce GHG emissions by an additional 15.12 percent below BAU levels by 2030.
    - Footnote mapping: BAU emission level expected to be 136 metric tons in 2030 and starting at 97 metric tons in 2021; mapping NDC commitments would mean a 6.73 percent (21.85 percent) unconditional (conditional) reduction from 136 metric ton of emissions.
  - In the Eighth Five Year Plan (8th FYP) Bangladesh proposed a carbon tax of 5 percent of energy prices by 2025.

### Financing needs, gaps, and fiscal constraints
- Climate finance needs and current spending:
  - Estimated adaptation finance requirement: US$5.7 billion per year by 2050 (MOEFCC b).
  - Current expenditure on climate change adaptation: around US$1 billion a year.
  - Total climate-relevant budgetary allocations (mitigation and adaptation) have been less than 1 percent of GDP annually; SDG-aligned need: 3-4 percent of GDP per year.
- Authorities’ cost estimates:
  - Mitigation cost: about US$27 billion (FY2011-30) → about US$1.4 billion per year.
  - Adaptation cost: about US$42 billion (over FY15-30) → about US$2.8 billion annually.
- Fiscal constraints:
  - Tax revenue-to-GDP ratio is less than 10 percent.
  - Depletion of domestic natural gas reserves and rising fuel prices increase energy subsidy spending.
  - Debt vulnerabilities increased post-COVID-19; need for concessional financing and non-debt creating flows (such as FDI).

### Proposed carbon user fee: design, scenarios, and quantitative impacts
- Design:
  - Carbon user fee on energy and IPPU sectors starting at US$3 per mt. ton of CO2 in 2022, rising to US$25 per mt. ton by 2030.
  - Narrow sectoral focus and gradual phasing aimed at implementability and predictability.
- Emissions and global scenario consistency:
  - A US$25 carbon fee by 2030 could reduce CO2 emissions by 12 percent by 2030, exceeding Bangladesh’s 6.73 percent unconditional updated NDC target.
  - To reach the conditional target of an additional 15.12 reduction, Bangladesh would require a carbon fee of US$64.
  - Under IMF global scenario assumptions (Advanced Economies −60 percent, Higher-Income EMs −30 percent, Lower-Income EMs −10 percent), a US$25 fee for Bangladesh would be consistent with keeping warming to 2C.
  - US$25 is IMF’s proposed International carbon price floor (ICPF) for low-income countries (LICs).
- Fiscal revenue impacts:
  - A US$25 carbon fee on the energy sector can provide additional revenue amounting to 0.48 percent of GDP on an annual basis by 2030.
  - This is about a 5 percent increase in the revenue base.
- Welfare and net economic impacts:
  - Gross national monetized welfare benefits (including health and mortality related environmental co-benefits) from a US$25 carbon fee could reach about 0.32 percent of GDP by 2030.
  - Net benefit (after economic costs) could be 0.26 percent of GDP by 2030.
- Methodology and assumptions:
  - Estimates derive from the Carbon Pricing Assessment Tool (CPAT).
  - Assumes linear increase in carbon tax starting in 2022 with no sectoral exemptions; applied to all commercial energy sources including natural gas, petroleum, coal, electricity, kerosene, and gasoline.
  - CPAT incorporates IMF WEO growth assumptions, population growth, authorities’ energy plans, autonomous and endogenous efficiency improvements, and existing fossil fuel subsidies.

### Inflation, competitiveness, and sectoral effects
- Inflationary impacts (assuming full pass-through of a US$3 increase per year):
  - Food-price inflation increase of around 0.2 percent in 2023.
  - Non-food inflation increase of around 1.1 percent in 2023.
  - Resulting overall inflation of around 0.5 percent in 2023.
  - Incomplete pass-through would reduce these inflationary impacts.
- Sectoral cost and employment effects:
  - A US$25 carbon fee can raise input cost of manufacturing of other nonmetallic minerals by 6 percent (highest among downstream sectors).
  - Many export-oriented industries (e.g., textiles and textile products) appear relatively insensitive to carbon taxes.
  - Aggregate jobs at risk in manufacturing estimated at around 1 percent of employment (IMF staff estimate); likely an upper bound as it excludes growth in green sectors, revenue recycling, and endogenous efficiency responses.
- Export competitiveness:
  - Estimated cost increase for apparel and textiles from a US$25 carbon fee is less than 2 percent by 2030.
  - BAU energy projections:
    - Coal share projected to increase from around 3 percent in 2018 to 24 percent in 2025 and slightly decrease to around 23 percent in 2035.
    - Natural gas projected to decline from 85 percent in 2018 to 65 percent in 2025 and 63 percent in 2035.
  - A shift to higher coal usage above the baseline would dilute Bangladesh’s cost and competitive advantage.

### Distributional effects and just transition considerations
- Household impacts (based on 2010 HIES):
  - Electricity and gasoline consumption accounts for 0.4 percent of monthly consumption for the bottom 5 percent of households versus 2.4 percent for the top 5 percent.
  - Average rural household would face less burden than average urban household due to limited commercial energy usage in rural areas.
  - Fully compensating the lowest quartile of households for the burden of a carbon tax (using 2010 HIES) would have required 880 million taka.
- Policy instruments to protect vulnerable groups:
  - Targeted, short-term transition assistance for the poor.
  - Vocational training programs and re-skilling for dislocated workers.
  - Revenue recycling (earmarking carbon revenues for domestic equity and transition to greener economy).
- Equity and labor-market recommendations:
  - Investments in climate-resilient jobs in agriculture and skill development to foster a just transition and create jobs.

### Implementation rationale and complementary policies
- Rationale for narrow, gradual fee:
  - Facilitates implementability; provides predictable long-term signal to firms and investors.
  - Revenue recycling can protect vulnerable households, support firm decarbonization, and finance climate investments.
  - Early carbon pricing signals commitment to donors and investors, potentially improving access to concessional finance and trade terms.
- Complementary fiscal instruments and non-fiscal measures:
  - ETS, feebates, feed-in tariffs, accelerated depreciation, R&D and investment tax credits.
  - Contingency/Reserve Funds, risk insurance, cat bonds, contingency credit lines.
  - Integrate climate risks into financial sector supervision; unify green taxonomy for cross-border financing.
  - Strengthen investment climate, liberalize FX regulations, legal reforms (land registration, contract enforcement), and labor reskilling.
- Financial market and technology support needs:
  - International partner support for technology development, transfer, and industrial-scale deployment is critical.
  - Capital markets are shallow; green instruments limited (example: April 2021 green bond for SAJIDA raising Tk 1.0 billion).
  - Broader reforms needed to address nonperforming loans and improve corporate governance to expand green financing instruments.

### Risks, limitations, and strategic signaling
- Limitations:
  - Carbon pricing alone will not finance Bangladesh’s full adaptation needs.
  - Political economy constraints: plausible increases in production costs and energy prices and practical impediments (e.g., lack of competent energy auditors).
- Strategic role:
  - Carbon user fee can serve as a commitment device to meet NDC targets and to signal to donors, investors, and trading partners.
  - Early adoption could help negotiate favorable terms under prospective BCAs and in the run up to LDC graduation.

### Key numeric facts and projections (selected)
- Carbon fee path proposed: US$3 per mt. CO2 in FY22 → US$25 per mt. CO2 by FY30.
- Emissions and targets:
  - BAU emissions: 136 metric tons in 2030; 97 metric tons in 2021 (footnote mapping).
  - Unconditional NDC reduction: 6.73 percent below BAU by 2030; conditional additional 15.12 percent.
  - A US$25 fee → CO2 reduction of 12 percent by 2030.
  - Fee required to meet conditional target: US$64.
- Fiscal and welfare impacts:
  - Additional revenue from US$25 fee: 0.48 percent of GDP annually by 2030 (about 5 percent increase in revenue base).
  - Gross monetized welfare benefits: about 0.32 percent of GDP by 2030.
  - Net benefit after economic costs: about 0.26 percent of GDP by 2030.
- Climate finance gaps and costs:
  - Adaptation requirement: US$5.7 billion per year by 2050 vs current ~US$1 billion a year.
  - Mitigation cost: US$27 billion (FY2011-30) → about US$1.4 billion per year.
  - Adaptation cost: US$42 billion (over FY15-30) → about US$2.8 billion annually.
- Inflation pass-through (US$3 per year increase, full pass-through):
  - Food-price inflation: around 0.2 percent in 2023.
  - Non-food inflation: around 1.1 percent in 2023.
  - Overall inflation: around 0.5 percent in 2023.
- Employment and sectoral sensitivity:
  - Aggregate jobs at risk in manufacturing: around 1 percent of employment.
  - Manufacturing input cost rise for other nonmetallic minerals: 6 percent.
  - Apparel and textiles cost increase from US$25 fee: less than 2 percent by 2030.
- Distributional compensation benchmark:
  - Fully compensating lowest quartile (2010 HIES) would have required 880 million taka.

### Authorities’ stance and donor perspectives
- Authorities:
  - Operationalized Climate Fiscal Framework and Climate Change Trust Fund; circulated Sustainable Finance Policy for Banks and Financial Institutions (December 2020) with 68 Green Products/Projects/Initiatives.
  - Ten coal-fired power plant projects have been cancelled.
  - Authorities broadly agree a carbon charge/user fee could signal commitment to NDC targets; interest also expressed in exploring an ETS given political feasibility concerns with taxation.
- Donors:
  - Commended a carbon charge/user fee as a good first step but stressed more is needed to translate it into a catalyst for climate financing.
  - Emphasized need to create and identify climate-friendly and viable investment projects; financial sector reforms and corporate governance improvements remain priorities.

*Source: IMF staff analysis as presented in the supplied content unit.*

### References __________________________________________________________________________  18

### ADDRESSING CLIMATE CHALLENGES IN BANGLADESH: A SMART CARBON PRICING STRATEGY: A CARBON USER FEE TO MOBILIZE CLIMATE FINANCE

### Summary
- Climate change poses critical macroeconomic challenges for Bangladesh and requires a mix of fiscal, financial, and structural interventions.
- Proposal: gradual adoption of a carbon user fee falling narrowly on the energy sector, increasing from US$3 per metric ton of CO2 in FY22 to US$25 per metric ton of CO2 in FY30.
- Objectives of the carbon fee:
  - Signal commitment to meeting the 2021 NDC mitigation targets.
  - Help firms plan decarbonization and improve energy efficiency, reducing stranded assets, competitiveness risks, and future job losses.
  - Mobilize revenue that can be recycled to protect the economically vulnerable, support firm decarbonization, and invest in climate projects.
  - Improve negotiating position regarding prospective border carbon adjustments (BCAs) and trade terms ahead of LDC graduation.

### Context and Bangladesh’s Climate Position
- Bangladesh is among the top ten countries most affected by extreme weather events during 1998–2017 (Global Climate Risk Index).
- Losses linked to extreme events estimated to average 1.8 percent of GDP annually between 1990 and 2008 (IMF 2019b).
- Vulnerability/readiness indexes: 27th most vulnerable and 26th least ready (Notre Dame’s Global Adaptation Initiative Index).
- Bangladesh accounts for less than 0.35 percent of global greenhouse gas (GHG) emissions; per capita emissions significantly lower than many regional peers.
- NDC mitigation commitments:
  - Proposed unconditional aggregate reduction of GHG emissions by 6.73 percent below Business-As-Usual (BAU) levels by 2030.
  - Proposed conditional contribution to reduce GHG emissions by an additional 15.12 percent below BAU levels by 2030.
  - Footnote data: BAU emission level expected to be 136 metric tons in 2030 and starting at 97 metric tons in 2021; mapping NDC commitments would mean a 6.73 percent (21.85 percent) unconditional (conditional) reduction from 136 metric ton of emissions.
- In the Eighth Five Year Plan (8th FYP), Bangladesh has proposed a carbon tax of 5 percent of energy prices by 2025.

### Current Preparedness and Policy Tools
- Bangladesh has operationalized a Climate Fiscal Framework (CFF) and adopted climate change budget tagging in 2018; publishes a citizen climate budget annually.
- Identified and costed adaptation pipeline through the Delta Plan 2100; working on the Mujib Climate Prosperity Plan 2030 to mobilize financing.
- Bangladesh Bank (BB) actions: Sustainable Finance Policy for Banks and Financial Institutions and a green taxonomy; policies to promote green financing.
- Suggested policy principle: the simplicity of a price signal is preferable to complex case-by-case climate impact evaluations (OECD 2021 quoted).

### Financing Needs and Constraints
- Estimated adaptation finance requirement: US$5.7 billion per year by 2050 (MOEFCC b), more than 5 times current expenditure of around US$1 billion a year on climate change adaptation.
- Total climate-relevant budgetary allocations (mitigation and adaptation) have been less than 1 percent of GDP annually, below the 3-4 percent of GDP needed per year for climate and biodiversity preservation mandated by SDG goals.
- Mitigation cost estimates (authorities): about US$27 billion (FY2011-30) → about US$1.4 billion per year.
- Adaptation cost estimates (authorities): about US$42 billion (over FY15-30) → about US$2.8 billion annually.
- Financing gap: adaptation investments are significantly higher than mitigation investments; there can be no adaptation without finance.

### Fiscal Space, Macroeconomic Constraints, and Complementary Reforms
- Fiscal constraints:
  - Tax revenue-to-GDP ratio is less than 10 percent, constraining room to increase social, climate, and developmental spending.
  - Depletion of domestic natural gas reserves and rising fuel prices exert upward pressure on energy subsidy spending.
  - Debt vulnerabilities increased post-COVID-19; need to prioritize concessional financing and non-debt creating flows (such as FDI).
- Policy implications:
  - Relax financing constraints and create fiscal space to accelerate adaptation needs.
  - Expand the net-tax base for fiscally sustainable adaptation.
  - Seek concessional finance where possible to ensure macro and fiscal sustainability.

### Technology, Financial Markets, and Investment Needs
- Transition to low-carbon technologies and resilient infrastructure is costly; international partner support for technology development, transfer, and industrial-scale deployment is critical.
- Renewable and nature-based investments cited in updated NDC and plans: wind, biomass, biogas, solar mini-grid, waste-to-electricity, mangroves, coastal protection, waterways — serving both adaptation and mitigation roles.
- Financial market limitations:
  - Capital market remains shallow; green instruments limited (example: April 2021 green bond for SAJIDA raising Tk 1.0 billion).
  - Broader reforms needed to address nonperforming loans and improve corporate governance to develop capital markets and expand instruments like green bonds and catastrophe bonds.

### Distributional Risks and Just Transition Considerations
- Climate change disproportionately affects the poor and exacerbates inequalities.
- Poorly designed climate policies risk amplifying existing inequalities.
- Adaptation policies should ensure equitable allocation of limited resources.
- Mitigation policies should compensate vulnerable populations for higher energy prices and support investment in new skills.
- A just transition needs to create jobs and foster equality; investments in climate-resilient jobs in agriculture and skill development recommended.

### Other Macro-Critical Challenges Linked to Climate Policy
- LDC Graduation:
  - Bangladesh expected to graduate from LDC status in 2024 (now postponed to 2026); graduation may result in loss of preferential tariff status in the EU and reduced access to some concessional climate funds.
  - Imperative to negotiate new international support mechanisms and identify alternative climate finance sources.
- Export Competitiveness:
  - Export demand and capital flows increasingly influenced by environmental standards and greener production processes.
  - Upcoming BCAs (EU expected to introduce BCAs in 2023) could disadvantage Bangladesh’s energy-intensive exports if comparable domestic emissions pricing is absent.
  - Carbon pricing could help mitigate BCAs’ impact and support trade competitiveness.

### Implementation Rationale for a Carbon User Fee
- Narrow energy-sector focus and gradual phase-in (US$3 per metric ton CO2 in FY22 → US$25 per metric ton CO2 in FY30) facilitate implementability and predictability for firms.
- Revenue recycling can protect vulnerable households, support firm decarbonization, and finance climate investments.
- Early carbon pricing signals commitment to donors and investors, potentially improving access to concessional finance and favorable trade terms.

*Prepared by Ritu Basu, Jayendu De, Biying Zhu (all APD), and Vybhavi Balasundharam (FAD).*

### 5.      Bangladesh has already invoked a mix of policy tools but more is needed in moving

### 1bgdea2022002 - 5.      Bangladesh has already invoked a mix of policy tools but more is needed in moving

### Existing climate policy tools and status
- Institutional and planning frameworks already in place:
  - Bangladesh Delta Plan (2018)
  - 8th Five Year Plan (2020)
  - Disaster Management Act (2012)
  - Bangladesh Climate Change Strategy and Action Plan (2009)
  - Mujib Climate Prosperity Plan
- Financial and fiscal instruments implemented or in progress:
  - Sustainable Finance Policy/Green Taxonomy (2020)
  - Securing climate financing
  - Initiating Green Bond issuances (2021)
  - Climate Fiscal Framework (2014)
  - Climate Change Trust Fund (2010)
  - Climate Change Budget Tagging (2018)
- Tools highlighted for consideration (black in table): Carbon fee/ETS/Feebates, Contingency/Reserve Funds, Risk insurance, Cat bonds, Contingency credit lines, Integrating climate risks into financial sector supervision
- Structural reform priorities to mobilize investment and resilience:
  - Improve governance and investment climate, continued liberalization of FX regulations, regulatory adaptation to support trade and outward FDI, legal reforms in land registration and contract enforcement
  - Investments in skill development and reskilling the workforce
  - Strengthen regulations on resilient building codes, vehicle emissions codes, fertilizer use

### Fiscal, financial, and resilience recommendations
- Fiscal:
  - Introduce a dedicated contingency line in the national budget for crisis management and emergency relief for severe flooding or droughts
  - Unused contingency funds could be placed in a natural disaster reserve fund with strict governance and transparency requirements
  - Reduce fossil fuel subsidies and establish a carbon tax as noted in the 8th FYP
  - Complement carbon pricing with non-tax incentives (feebates, ETS) and tax incentives (accelerated depreciation, investment tax credits)
- Financial:
  - Consider risk-sharing instruments: catastrophe bonds, parametric disaster insurances, pre-arranged financing like the CAT DDO
  - National Security Certificate (NSC) pricing reforms to deepen government bond market
  - Promote green financing through integrating environmental risks in financial sector supervision
  - Unify green taxonomy to apply beyond domestic capital markets to cross-border financing

### Carbon pricing: proposed design, scenarios, and key quantitative impacts
- Proposed carbon user fee design:
  - Gradually implement a carbon fee starting at US$3 per mt. ton of CO2 on the energy and IPPU sectors in 2022, increasing to US$25 per mt. ton by 2030
- Emissions impacts:
  - A US$25 carbon fee by 2030 could reduce CO2 emissions by 12 percent by 2030, exceeding Bangladesh’s 6.73 percent unconditional updated NDC target
  - To reach the conditional target of an additional 15.12 reduction, Bangladesh would require a carbon fee of US$64
- Global scenario consistency:
  - Assuming Advanced Economies reduce emissions by 60 percent, Higher-Income Emerging and Developing Countries (EMHIs) by 30 percent, and Lower-Income Emerging and Developing Countries (EMLIs) by 10 percent, a US$25 carbon fee for Bangladesh would be consistent with keeping warming to 2C (IMF global scenario reference)
  - US$25 is IMF’s proposed International carbon price floor (ICPF) for low-income countries (LICs) in consideration of international equity and competitiveness
- Fiscal revenue impacts:
  - A US$25 carbon fee on the energy sector can bring a gradual increase in additional revenue, amounting to 0.48 percent of GDP on an annual basis by 2030
  - This is about a 5 percent increase in the revenue base
- Welfare and economic net impacts:
  - Gross national monetized welfare benefits (including health and mortality related environmental co-benefits) from a US$25 carbon fee could reach about 0.32 percent of GDP by 2030
  - Net benefit (after economic costs) could be 0.26 percent of GDP by 2030
- Assumptions and methodology notes:
  - Estimates derive from the Carbon Pricing Assessment Tool (CPAT)
  - Assumes linear increase in carbon tax starting in 2022 with no sectoral exemptions; applied to all commercial energy sources including natural gas, petroleum, coal, electricity, kerosene, and gasoline
  - CPAT incorporates IMF WEO growth assumptions, population growth, authorities’ energy plans, autonomous and endogenous efficiency improvements, and existing fossil fuel subsidies

### Inflation, competitiveness, and sectoral effects
- Inflation impacts of phased-in carbon fee:
  - A US$3 increase in carbon fee per year would translate (assuming full pass-through) to:
    - Food-price inflation increase of around 0.2 percent in 2023
    - Non-food inflation increase of around 1.1 percent in 2023
    - Resulting overall inflation of around 0.5 percent in 2023
  - Incomplete pass-through would further reduce the inflationary impact
- Manufacturing cost and jobs impacts:
  - A US$25 carbon fee can raise input cost of manufacturing of other nonmetallic minerals by 6 percent (highest among downstream sectors)
  - Many export-oriented industries (e.g., textiles and textile products) appear relatively insensitive to carbon taxes
  - Aggregate jobs at risk in manufacturing estimated at around 1 percent of employment (IMF staff estimate)
  - These estimates likely represent an upper bound as they do not account for growth in green sectors, revenue recycling, and endogenous efficiency responses
- Export competitiveness:
  - Under assumption of low carbon-intensive energy use, Bangladesh can maintain export competitiveness
  - Estimated cost increase for apparel and textiles from a US$25 carbon fee is less than 2 percent by 2030 (lowest among major exporters)
  - Bangladesh’s advantage is driven by primary energy mix: natural gas as primary source (less carbon intensive than coal) and relatively low energy dependence of industries
  - BAU energy projections noted:
    - Coal share projected to increase from around 3 percent in 2018 to 24 percent in 2025 and slightly decrease to around 23 percent in 2035
    - Natural gas projected to decline from 85 percent in 2018 to 65 percent in 2025 and 63 percent in 2035
  - A shift to higher coal usage above the baseline would dilute Bangladesh’s cost and competitive advantage

### Distributional effects and equity considerations
- Progressivity and household impacts:
  - Based on 2010 HIES:
    - Electricity and gasoline consumption accounts for 0.4 percent of monthly consumption for the bottom 5 percent of households versus 2.4 percent for the top 5 percent
    - Average rural household would face less burden than average urban household due to limited commercial energy usage in rural areas
  - Indirect regressive effects via non-energy goods (driven by food spending) are offset by progressive direct impacts of fuel consumption
  - Fully compensating the lowest quartile of households for the burden of a carbon tax (using 2010 HIES) would have required 880 million taka
  - As rural and low-income households gain commercial energy access, more targeted transfers would be required unless expansion uses low-carbon technologies
- Policy instruments for protecting vulnerable groups:
  - Targeted, short-term transition assistance for the poor
  - Vocational training programs and re-skilling for dislocated workers
  - Revenue recycling (earmarking carbon revenues for domestic equity and transition to greener economy)

### Efficiency, signaling, and financing catalysis
- Efficiency and reallocation effects:
  - Carbon pricing can incentivize reallocation from high- to low-carbon sectors and preserve less-energy intensive (generally more productive) firms
  - Enterprise Survey evidence suggests largest allocative efficiency gains for textiles and food manufacturing due to high dispersion in energy intensities
- Signaling and leverage for climate finance:
  - Early adoption of carbon fee could signal commitment to Paris-aligned mitigation and catalyze donor and private investor interest (ESG commitments)
  - Carbon pricing provides a simple price signal preferable to complex case-by-case climate evaluations of projects
  - Early carbon pricing could help prepare for concessions on border carbon adjustments (BCAs) and better tariff arrangements with trading partners in the run up to LDC graduation

*Source: IMF staff analysis as presented in the supplied content unit.*

### Conclusion

### Conclusion

### Climate vulnerability and an early carbon fee
- Bangladesh is highly vulnerable to climate change and faces other economic challenges.
- Early adoption of a small carbon fee as a climate commitment mechanism towards its NDC targets can:
  - help to generate interest and/or catalyze funds and/or technical assistance for adaptation;
  - assist with a just transition.
- Given Bangladesh is a relatively low intensity brown energy user in the region, introduction of an early carbon fee on the energy sector could be an equitable and viable option to reach NDC targets with considerable co-benefits.
- Expected impacts and uses of revenue:
  - The impact on inflation and loss of competitiveness and jobs will be limited.
  - Net revenue gains from a carbon fee can be earmarked to fund a just transition by compensating the most vulnerable while preserving competitiveness and limiting job losses and distributional impacts on workers and households.
- Limitations and signalling role:
  - Carbon pricing alone will not be sufficient to finance the adaptation needs of Bangladesh.
  - An energy related user fee can serve as a commitment device for meeting Bangladesh’s NDC targets and help to signal to donors and investors Bangladesh’s strong climate mitigation commitments to further catalyze funds.
  - This strategy can be considered as a complementary incentive to negotiate better trade deals and prospective border carbon adjustment concessions in lieu of green commitments.

### Donor support, external finance, and trade implications
- Donor support and financial flows for net-zero investments and climate-friendly trade deals are critical for meeting Bangladesh’s climate and developmental aspirations.
- With decarbonization incentives in place, external finance will be less costly as the climate part of environmental impact assessments will be in place.
- Paris-incompatible projects, such as coal-fired power plants, will become less appealing as they will mandate higher rates of carbon fees in line with NDC carbon goals.
- A departure from commitment to green energy supporting growth would imply higher carbon fees to reach NDC emission targets.
- Early commitment to carbon pricing could allow bilateral trading partners like the EU and others to facilitate better terms for prospective border carbon taxes abroad and/or negotiate favorable trade deals in the run up to LDC graduation.

### Complementary policies and enabling environment
- Carbon pricing is not sufficient on its own to catalyze external finance.
- Complementary fiscal policies can accelerate decarbonization, including:
  - ETS, feebates, feed-in tariffs, accelerated depreciation, R&D and investment tax credits.
- Non-fiscal measures to foster an enabling environment include:
  - enhancing the investment climate;
  - strengthening climate-related regulations;
  - promoting diffusion of information and technologies;
  - preservation of natural capital;
  - appropriate labor force skilling;
  - reforms to deepen the financial sector.

### Authorities’ stance and domestic initiatives
- Authorities highlighted their commitment to meeting the climate challenge and noted Bangladesh has been at the forefront of climate action, including:
  - operationalizing the Climate Fiscal Framework;
  - establishing the Climate Change Trust Fund.
- Continued efforts include central bank initiatives to promote solar and other renewable energy sources to reduce emissions.
- Bangladesh Bank (BB) circulated the Sustainable Finance Policy for Banks and Financial Institutions in December 2020 and incorporated lists of 68 Green Products/Projects/Initiatives.
- Ten coal-fired power plant projects have been cancelled.
- Authorities emphasized Bangladesh has largely been a recipient of climate change and concessional climate financing is needed to meet mitigation and adaptation challenges.
- Authorities are strengthening regulations for tapping ESG finance, including BB’s issuance of Environmental and Social Risk Management Guidelines for mainstreaming ESG in overall credit rating methodology.
- On carbon pricing adoption:
  - Authorities broadly agree that a carbon charge or user fee could signal commitment to NDC targets but reiterated carbon pricing should be adopted by other economies as well.
  - Authorities expressed interest in exploring the potential of an Emissions Trading System (ETS) given political feasibility concerns with carbon taxation.
  - Political economy constraints noted include plausible increases in production costs and energy prices and practical impediments such as the lack of competent energy auditors.

### Donors’ perspectives
- Donors commended a carbon charge or user fee as a good first step for meeting Bangladesh’s NDC targets but stressed more was needed to translate it into a catalyst for climate financing.
- Some donors viewed it as a good first step towards mobilizing financing, while others noted the need for greater effort in creating and identifying climate-friendly and viable investment projects.
- Continued reforms in the financial sector and improvements in corporate governance should remain key priorities to attract investments.

*Source: 1bgdea2022002 - Conclusion*

### 9.      In both pandemic scenarios, the COVID-19 crisis will leave medium-term effect on

### 9.      In both pandemic scenarios, the COVID-19 crisis will leave medium-term effect on

### Findings on potential growth
- In the pandemic-baseline scenario, average potential growth rate during FY21-25 is around 1.1 percentage points lower compared to the no-pandemic scenario.
- In the pandemic-optimistic scenario, if the assumptions on real GDP, investment, and employment growth taken from the 8th FYP can be fully realized by FY25, the average potential growth rate during FY21-25 would be only 0.4 percentage point lower than without the pandemic.
- Conclusion: In both pandemic scenarios, the COVID-19 crisis will leave medium-term effect on potential growth; full realization of 8th FYP assumptions by FY25 could largely mitigate the negative effect.

### Decomposition and drivers of potential growth loss
- Most of the decline in average potential output growth rate is due to lower trend TFP growth rate.
- In the pandemic-baseline scenario:
  - TFP is the most significant contributor to potential growth loss.
  - Capital and labor also dragged down potential output growth rate to some extent.
  - Human capital accounts for only a fraction of potential output loss (current estimate 7.1 percent contribution in baseline).
- In the pandemic-optimistic scenario:
  - Fast rebound of capital and labor played a compensating role, reducing the net loss.
- Human capital impacts are likely to be larger in the longer run when students (aged 5-19) affected today enter the labor market during FY26-40.

### Sensitivity analysis on TFP and human capital assumptions
- Alternative TFP derivation using long-run relationship between capital accumulation and balanced growth (Bannister et al. (2020) methodology) produces:
  - Pandemic-baseline: potential growth loss lowered to 0.77 percentage point, with TFP growth loss contributing 0.6 percentage point.
  - Pandemic-optimistic: potential growth loss halved to 0.2 percentage point, with TFP growth loss of 0.4 percentage point.
- Assuming unchanged capital depreciation ratio in both pandemic scenarios has only minor impact on output and TFP growth loss.
- If the effectiveness of remote learning is reduced to 7 percent, human capital’s contribution to potential growth loss rises to 9.5 percent from 7.1 percent in the pandemic-baseline scenario (World Bank (2020b) benchmark for pessimistic scenario with school closure for 7 months).
- Sensitivity checks confirm: (i) the pandemic is likely to have medium-term effect, and (ii) slowdown in TFP growth is a major factor in the decline of medium-term potential growth.

### Multiple reasons for the TFP growth drop
- TFP partly represents technological progress; slower technology growth after a severe pandemic could result from:
  - Less investment in technology due to weakened balance sheets of firms and financial institutions.
  - Loss of management skills and knowhow as viable firms fall into bankruptcy.
- TFP as a residual includes all factors affecting potential output other than capital, labor, and years of schooling; divergence between high capital growth and subdued TFP growth may suggest inefficient use of capital.
- Other contributing factors:
  - Average hours worked per employee (not accounted in labor input) affects skill accumulation.
  - Less efficient allocation of resources due to credit rationing (banks favoring large enterprises during a crisis).
  - Displaced workers moving to different jobs, especially unskilled labor (survey: during June 2020 to March 2021, 41 percent of interviewed workers had to move to another occupation; in skilled labor group, 60 percent maintained skilled job, 15 percent became unemployed, 25 percent ended with unskilled labor; survey of 6,099 households by Power and Participation Research Centre and BRAC Institute of Governance & Development).

### Heading for a Resilient and Inclusive Recovery — Policy recommendations
- Revive private investment to support recovery of growth:
  - Bangladesh’s investment as a share of GDP has been high among peers; capital stock historically contributed to about 2/3 of potential output growth.
  - In the pandemic-optimistic scenario, fast rebound of investment toward the target investment-to-GDP ratio of 36.6 percent by FY25 is a major factor mitigating potential GDP growth loss.
  - Policies to realize this: improve balance sheets of financial institutions; remove distortions in key interest rates to facilitate market-based lending; create a benign investment climate to attract foreign financing; develop capital markets for long-term financing.
  - Public investment should focus on providing key infrastructures efficiently to remove bottlenecks for private sector development.
- Boost productivity (urgent):
  - LDC graduation in 2026 calls for higher productivity amid more intense export competition.
  - Authorities announced skills development programs and planned to implement the Productivity Masterplan in FY22; timely implementation and regular review are key.
  - Increase exposure to foreign technologies through trade and FDI; increase penetration of traditional (energy, transportation) and modern (internet, mobile phone) technologies.
  - Digital platforms and payment methods that flourished during the pandemic can support “Digital Bangladesh” to increase technology penetration with appropriate risk monitoring and supervision.
- Make the recovery human-centered:
  - Unemployment of female and young workers has historically been high and may worsen due to the pandemic.
  - To achieve the 8th FYP’s projection on employment growth, increase labor participation post-pandemic, especially for women and young people.
  - Conduct labor force survey to diagnose COVID-19 legacies and target policy support.
  - Invest in health and skills of workers; diversify the economy to create more decent jobs.
  - Based on UN estimates, working-age population growth will fall below total population growth by around 2036; realize the full potential of the young labor force within the next decade.
- Strengthen human capital:
  - Bangladesh made significant human capital gains in FY1990-2010 but still lags peers; technical and managerial expertise levels are low in most firms (World Bank (2021b)).
  - Prolonged school closure will negatively impact long-run human capital growth with compounding effects; actions needed now to limit impact.
  - Authorities should increase the share of students returning to school, adapt curriculum and teaching methods based on student ability assessments, and continue to increase government education investment as stated in the 8th FYP.
  - Education spending goal: increase public education spending from 2 percent of GDP in FY2019 to 3 percent of GDP in FY25.

### Conclusion
- Bangladesh has been hit hard by the COVID-19 pandemic, likely leaving a medium-term effect on potential output.
- Growth accounting framework and scenario analysis show that both pandemic scenarios result in medium-term potential growth losses; full realization of 8th FYP assumptions by FY25 could largely mitigate these losses.
- To revive growth potential, targeted measures are required that mitigate immediate pandemic impacts while addressing longer-term structural reforms: focus on reviving private investment, boosting productivity, and investing in education and health of the labor force.

*Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1bgdea2022002.pdf*

### 4.      Can digitalization help Bangladesh improve its revenue efficiency that is low by

### 4.      Can digitalization help Bangladesh improve its revenue efficiency that is low by regional and international standards?

### Methodology: empirical approach and variables
- Dependent variables: annual efficiency measures of Value Added Tax (VAT), personal income tax (PIT) and corporate income tax (CIT) (푇푎푥
௜,௧).
- Key explanatory variable: government digitalization proxy (GovTech, 퐺표푣푇푒푐ℎ).
- Country fixed-effects (훼
௜
) used to capture time-invariant country-level heterogeneity.
- Controls (lagged): 
  - GDP per capita;
  - government spending as a share of GDP;
  - agriculture’s share of GDP;
  - trade openness (imports + exports as % of GDP);
  - UN telecommunication index;
  - UN human capital index;
  - WGI control of corruption indicator.
- VAT productivity definitions and other tax productivity measures:
  - VAT productivity = VAT Revenue in percent of GDP / VAT rate.
  - VAT C-efficiency = actual VAT revenues / (standard rate × final consumption expenditure).
  - CIT Productivity = (CIT Revenue as % of GDP) / (CIT Rate).
  - PIT Productivity = PIT Revenue in percent of GDP / [(Lowest PIT Rate×Lowest Threshold)+(Highest PIT rate×Highest PIT threshold)/Lowest PIT Threshold+Highest PIT Threshold)].
- Estimation specifications: panel regressions with country fixed effects (equation (1)); dependent variables of equations (5)-(8) specified in logs due to skewness.

### Tax revenue efficiency: key findings and magnitudes
- Positive association between the e-government index and revenue efficiency measures (Table 1).
- Results remain when control of corruption is included (columns 2, 4, 6, and 8).
- Advanced economies tend to have both higher digitalization indices and higher revenue productivities.
- For Bangladesh, actual VAT revenue productivity is lower than expected given government digitalization efforts, likely due to presence of multiple reduced VAT rates.
- Counterfactual/frontier impact estimates (if Bangladesh reached the GovTech frontier, i.e., government online services index = 1):
  - VAT productivity would increase by about 1 percentage point.
  - VAT C-efficiency would increase by about 1.3 percentage points.
  - PIT productivity would increase by 1.8 percentage points.
  - CIT productivity would increase by 0.2 percentage points.
  - The overall impact on revenue is estimated at about 3 percent of GDP (since numerators of VAT, CIT and PIT productivity ratios measure respective revenue shares to GDP).
- Additional empirical note: digitalization can impact revenue efficiency through improving transparency and reducing corruption vulnerabilities.

### Digitalization and health spending efficiency: method and results
- Method: stochastic frontier analysis where health outcomes (average life expectancy at birth and infant mortality rates, ሺ퐻푒푎푙푡ℎ
௜,௧
ሻ) are regressed on inputs (퐗
풊,풕ିퟏ
) and a compound error term (equations (2)-(5)). The time-varying country-specific technical efficiency (푇퐸
௜,௧
) is obtained and regressed on determinants including GovTech and telecommunication index.
- Main findings:
  - Both government digitalization (GovTech) and telecommunication infrastructure quality are positively correlated with estimated efficiency in health spending (Table 2).
  - Better e-government services are associated with:
    - higher efficiency of health spending in increasing life expectancy;
    - lower inefficiency in reducing infant mortality.
  - Higher GDP per capita and higher health spending are associated with better health outcomes (frontier equation).
  - Health systems tend to be more efficient in countries that are more developed, have less income inequality, or have a greater urban population share.
  - Health spending efficiency is higher where more skilled health staff attend births or where UHC coverage is greater.
- Example coefficient magnitudes reported in Table 2 for GovTech Index (coefficients across specifications, exact reported values):
  - 0.02 ∗∗∗, 0.02 ∗∗∗, 0.01 ∗∗∗, 0.01 ∗∗∗, -0.10 ∗∗∗, -0.09 ∗∗∗, -0.00 ∗∗∗, -0.00 ∗∗∗.
- Example telecommunication index coefficients reported in Table 2 (exact reported values):
  - 0.06 ∗∗∗, 0.06 ∗∗∗, 0.02 ∗∗∗, 0.00, -0.25 ∗∗∗, -0.23 ∗∗∗, -0.00 ∗∗∗, 0.00.
- Model diagnostics shown: Adj. R-squared values in Table 2 include 0.40, 0.42, 0.69, 0.75, 0.42, 0.44, 0.71, 0.76 (as reported).

### Digitalization and education spending efficiency: method and results
- Method: stochastic frontier analysis analogous to health section; inputs include education spending per capita and GDP per capita; outcomes are gross enrollment rates (secondary, upper secondary, tertiary).
- Findings:
  - Countries with stronger e-governments tend to have higher efficiency of education spending in enrolling secondary, upper secondary, and tertiary students (Table 3).
  - Higher education spending and higher GDP per capita are associated with better education outcomes.
  - Advanced government digitalization is correlated with lower inefficiency in education spending, conditional on development and telecommunication infrastructure.
  - Effects are less strong for primary education, where enrollment rates are already higher.
  - More urbanized countries with better access to basic sanitation services tend to have better education spending efficiency.

### Policy implications and recommendations
- Scaling up GovTech in Bangladesh’s public administration offers significant potential for transforming service delivery and mobilizing resources.
- Potential fiscal and service-delivery dividends:
  - Revenue: reaching GovTech frontier could improve VAT, PIT, and CIT productivity and raise overall revenue by about 3 percent of GDP.
  - Health and education: stronger e-government services and better telecommunications infrastructure are associated with higher spending efficiency and better outcomes.
- Important implementation caveats:
  - Institutional frameworks are needed to safeguard against cybersecurity risks, digital exclusion, fraud, and privacy infringement.
  - Digitalization should be accompanied by reforms in governance, transparency, and human capital (digital literacy) to realize its benefits.
  - For monetary policy modernization (related discussion in the chapter), transitions to new regimes (e.g., Inflation Targeting) must be comprehensive and credible; announcement alone is insufficient.

*Source: IMF staff calculations and analysis as presented in the chapter.*

### 6.      The model can explain historical data well and produces high precision of (pseudo)

### 1bgdea2022002 - 6.      The model can explain historical data well and produces high precision of (pseudo)

### Model fit and forecasting performance
- The QPM can explain historical data well and produces high precision of (pseudo) out-of-sample forecasts.
- Model structure reflects the current monetary policy regime where money targeting plays a dominant role.
- Example fit: food inflation dynamics (excluding the effect of partly backward-looking expectations) is predominantly driven by harvest performance and imported inflation, while domestic demand has only marginal impact.
- Table 1 demonstrates that QPM-based historical forecasts outperform random walk (RW) forecasts:
  - QPM-based forecasts outperform RW both in the short term (1-2 quarters ahead; except for nominal interest rates) and over the medium term (3+ quarters ahead).
  - (Values below 1 indicate that the QPM outperforms random walk; the smaller the ratio the better the QPM predicts the variable compared to the random walk.)

### Transitioning to Inflation Targeting (IT): benefits and risks
- Findings on benefits:
  - A well-managed and comprehensive IT regime leads to well-anchored inflation expectations, low and stable inflation, and predictable interest rates, reducing investor uncertainty and volatility of economic output.
  - Comprehensive IT can render shocks more short-lived and smaller in magnitude, requiring less frequent monetary policy reaction.
- Risks and cautions:
  - Eclectic monetary regimes centered on traditional money targeting are often opaque, inconsistent, and poorly understood by market participants.
  - Announcing a switch to IT without parallel modernization of the monetary policy framework, or implementing half measures, could deteriorate economic stability relative to the original regime.
- Required complementary reforms (as cited in footnote):
  - Strengthening of de-facto central bank independence, governance, and transparency.
  - Enhancing analytical and decision-making capacity.
  - Streamlining monetary operations.
  - Developing money markets.
  - Improving policy communications.

### Policy scenarios analyzed
- Two alternative policy scenarios are used to study consequences of policy switch:
  - "Uncommitted Regime Switch" (URS):
    - Monetary authority announces a switch nominally, adopts interest rate as main operational target and allows more exchange rate flexibility, but does not contemporaneously advance related policy reforms (strengthening policy formulation, interest rate transmission, transparency, communications).
    - Economic rigidities remain; expectations stay largely backward looking and not anchored by the inflation target.
  - "Credible Inflation Targeting" (CIT):
    - Central bank successfully transitions to comprehensive IT with a transparent inflation forecast as intermediate target and a forward-looking policy interest rate as operational target; inflation expectations become better anchored over the medium term.

### Model-implied volatility under regimes
- Model-implied standard deviations suggest:
  - URS may increase exchange rate volatility and volatility of other variables (non-food inflation, non-agricultural GDP).
  - CIT leads to lower volatility across variables as expectations become better anchored and forward-looking.
- Interpretation:
  - Under credible IT, market expectations are better anchored, shocks are shorter-lived and smaller, and policymaking requires less frequent reaction.

### Counterfactual simulation of 2011 exchange rate pressures
- Counterfactuals compare policy responses under URS and CIT to actual historical data:
  - Under CIT:
    - Exchange rate would have been allowed to depreciate while the central bank would have reacted strongly to rising inflationary pressures by hiking the policy rate.
    - This reaction would have helped curb domestic demand and stem depreciation; as inflationary pressures dissipated the central bank would have eased.
    - Interbank rate would have remained closely aligned with the policy rate, resulting in a relatively more stable and smoother trajectory compared to actual data.
    - Less volatile GDP growth; cumulative output higher over time (example: by the end of 2014 the level of GDP would have been about 1 percent higher than the realized one).
  - Under URS:
    - Would have required a much more severe policy hike to curb inflationary pressures.
    - Would have led to higher volatility in GDP growth and exchange rate, without stable interbank interest rate.
- Note: Only available annual GDP was input into the model; it was interpolated into quarterly series based on model structure and calibration and informed by available data on other variables.

### Conclusion and policy recommendations
- Modern economic policy consensus: adopting a comprehensive IT framework can be particularly beneficial for small open economies integrated into global markets.
- For Bangladesh specifically:
  - Adopting comprehensive IT would allow higher macroeconomic stability and better capacity to deal with external shocks as Bangladesh graduates from LDC.
  - An ill-managed transition to IT could increase volatility, weaken policy transmission, increase vulnerability to external shocks, and lower growth.
- Recommended preconditions and reforms to underpin a transition to IT:
  - Strengthening the central bank’s independence and governance.
  - Enhancing analytical and forecasting capacity.
  - Streamlining the operational framework.
  - Developing money markets.
  - Improving policy communications.

*Source: IMF staff calculations; Bangladesh Bureau of Statistics; Bangladesh Bank (content excerpt).*

### 1.      Bangladesh became a LMIC in 2015, reaching US$ 1220 GNI per capita.

### 1bgdea2022002 - 1.      Bangladesh became a LMIC in 2015, reaching US$ 1220 GNI per capita.

### Recent Developments
- In FY2001–FY2020, real GDP growth of Bangladesh averaged 6.2 percent per year.
- Poverty declined from 48.9 percent in 2000 to 24.3 percent in 2016.
- Average annual exports-GDP ratio during FY2001–FY2020 was 14.1 percent.
- Average annual remittance-to-GDP ratio during FY2001–FY2020 was 6.9 percent.
- Net FDI inflows averaged 0.8 percent of GDP over the past two decades.
- Growth in FY20 fell to 3.5 percent due to the COVID-19 pandemic.
- In FY21 exports and imports recovered to almost pre-pandemic levels; remittances surpassed expectations.

### Transition Goals and Context
- After expected LDC graduation in 2026, Bangladesh aims to reach UMIC status in 2031 and HIC status in 2041 (GED, 2020).
- Bangladesh reached GNI per capita US$ 1220 (World Bank’s Atlas method) in 2015; Bangladesh reached GNI per capita US$ 2010 in 2020.
- Currently, UMIC GNI per capita threshold ranges from US$ 4,096 to US$ 12,695 (World Bank, 2022a, 2022b).

### Challenges Ahead
- Graduation from LDC status (scheduled 2026) will erode export-related preferential treatments.
- After LDC graduation, the effective tariff for Bangladesh may increase by 7.9 percent (WTO, 2020).
- Estimated reduction of exports to preference-granting countries: US$ 6.19 billion; projected increase in exports to other regions: US$ 0.83 billion (WTO, 2020).
- Bangladesh currently has 71 percent share of its exports using LDC specific preferences (WTO, 2020).
- TRIPS flexibilities helped pharmaceuticals meet about 98 percent of domestic demand and export to more than 100 countries (UNDESA, 2020).
- External public and publicly guaranteed (PPG) debt was around 17.5 percent of GDP; 53.2 percent of outstanding external PPG debt owed to multilateral creditors and 30.3 percent to bilateral creditors (Ministry of Finance, Bangladesh, and IMF Staff calculations).
- Bangladesh borrows on IDA blend terms as GNI per capita is above the IDA operational cutoff (USD 1205 in fiscal year 2022) but has no access to IBRD loans (World Bank, 2022c).
- Bangladesh is currently PRGT eligible; will graduate from PRGT-eligibility if GNI per capita is at least twice the IDA threshold and/or meets market access criterion as defined in PRGT eligibility graduation criteria (IMF, 2020).

### Narrow Export Basket
- More than 80 percent of Bangladesh’s exports comprise Ready-Made Garments (RMG).
- Five-year average (2010–2014) Theil export diversification index for Bangladesh was 4.9; median five-year average index for the LMICs was 3.8.
- Five-year average extensive margin index for Bangladesh was 0.1, compared with median 0.2 for the LMICs.
- Five-year average intensive margin index for Bangladesh was 4.8, compared with median 3.5 for the LMICs.
- Structural impediments to diversification: high domestic market protection, low FDI, poor infrastructure.
- Government’s 8th FYP (FY21–FY25) aims to diversify production and exports to non-RMG sectors including processed food, leather and footwear, light engineering, and pharmaceuticals.
- Planned policy steps: phase out inconsistent cash incentives and subsidies, rationalize tariffs, formulate a ‘National Tariff Policy’ to coordinate tariff rationalization and encourage export diversification.

### Low Tax-to-GDP Ratio
- Five-year average tax-to-GDP ratio for Bangladesh during 2013–2017 was 8.6 percent.
- Median five-year average tax-to-GDP ratio for LMICs that graduated to UMICs after 1990 was 19.4 percent.
- Suggested reforms: automate revenue administration, rationalize tax expenditures, amend tax and customs codes, review and simplify VAT structure, develop and adopt a medium-term revenue strategy.

### High Customs and Other Import Duties
- Customs and other import duties-to-tax ratio for Bangladesh averaged 27.6 percent (2013–2017).
- Recommendation: rationalize high customs and import duties to reduce import-substitution incentives and domestic mark-ups.

### Low FDI Inflows
- During 2013–2017, average FDI-to-GDP ratio of Bangladesh was 1.2 percent; median ratio for LMICs was 2.5 percent.
- Median five-year average FDI-to-GDP ratios for countries transitioning to UMICs and HICs were 4.2 percent and 7 percent, respectively.
- Authorities’ plans: one-stop service platform, investments in supporting infrastructure, skills development, 100 economic zones by 2030, megaprojects, high tech parks, SEZs, modernizing agriculture, encouraging agro-processing.

### Subdued Investment Climate
- Structural reforms needed to improve governance, rule of law, and regulatory quality.
- Bangladesh Investment Development Authority (BIDA)’s One Stop Shop (OSS) aims to consolidate business regulatory requirements.
- Authorities are engaging investors to raise awareness of ongoing business climate improvements.

### Gaps in Selected External Growth Drivers
- Five-year average exports of goods and services-to-GDP ratio for Bangladesh during 2013–2017 was 17.1 percent; median LMIC was 33.0 percent.
- Median five-year average exports-to-GDP ratios of LMICs and UMICs in their transition to UMICs and HICs were 38.5 and 41.3 percent, respectively.
- Five-year average imports of goods and services-to-GDP ratio for Bangladesh during 2013–2017 was 22.9 percent; median for LMICs was 45 percent.
- Five-year average net workers’ remittance income-to-GDP ratio for Bangladesh (2013–2017) was 6.9 percent.
- Median five-year average remittance-to-GDP ratios in transition were 2.3 percent for LMICs and 0.1 percent for UMICs, indicating structural decline with income transition.
- Empirical evidence suggests exports of goods and services increase with increases in FDI inflows.

### Closing the FDI Gap (Summary of Policy Directions)
- Increase gross FDI-to-GDP ratio to 3 percent by FY25 as planned in the 8th FYP; requires:
  - Continued liberalization of FX regulations as conditions allow.
  - Review of regulatory framework to be more supportive of trade and outward FDI.
  - Legal reforms, such as land registrations and contract enforcements.
  - Strengthen governance, supervision and regulation in financial sector to reduce non-performing loans, particularly in state-owned commercial banks.
  - Reform national saving certificate system to deepen capital markets.
  - Automation to increase secondary trading of government securities.
  - Deepen sukuk, municipal, and environment, social and governance (ESG) bond markets.

### Empirical Diagnostics (Exports and FDI Determinants)
- Method: panel fixed-effect estimation for sample period 1992–2017; number of countries varies from 48 to 156; country fixed effects included.
- Key estimated effects on exports of goods and services-to-GDP ratio:
  - REER (in logs): A one percent appreciation of REER could cause an estimated average decline of exports of goods and services by about 0.12–0.16 of a percent of GDP.
    - Bangladesh REER appreciated by 51 percent during 2012 to 2020; NEER appreciated by 11 percent.
  - Trading partners’ growth: A one percent decline in real GDP growth of the rest of the world could cause a decline of exports of goods and services by about 0.7 to 0.8 of a percent of GDP in LMICs.
    - Main export markets for Bangladesh (Europe and USA) comprise about 75 percent of total exports.
  - Real GDP per capita (in logs): A 1 percent increase in per capita GDP could cause an estimated average increase of exports of goods and services by about 0.08–0.16 of a percent of GDP.
  - Revenue mobilization: A one percent increase of tax-to-GDP ratio could cause an estimated average increase of exports of goods and services by about 0.5–0.7 of a percent of GDP in LMICs.

*Source: 1bgdea2022002 - 1.      Bangladesh became a LMIC in 2015, reaching US$ 1220 GNI per capita.*

### 14.      Table 3 shows the results of several fixed-effect panel regression specifications to estimate

### Table 3. Panel Fixed Effect Model: FDI Inflows (Percent of GDP), Sample period: 1992–2017

### Methodology and estimation approach
- Estimations follow the methodologies specified in IMF (2018a).
- Several fixed-effect panel regression specifications are estimated to assess the impact of domestic pull and external push factors on FDI inflows-to-GDP ratio for LMICs and for a group including LMICs, UMICs and HICs.
- Some specifications incorporate variables following Dabla-Norris et al., 2010 (e.g., government consumption-to-GDP and inflation to represent fiscal and monetary policy stances).
- Tax revenue-to-GDP ratio is used to proxy government’s resource mobilization and investment capacity, while controlling for government consumption-to-GDP ratio.
- All domestic explanatory variables are lagged one year to mitigate potential endogeneity.
- Standard errors are clustered at country level.
- Sample period: 1992–2017; number of countries varies from 66 to 112. The value of adjusted R-squared is low and results should be interpreted with this caveat.

### Key empirical findings
- Global Commodity Price
  - An increase in the global commodity price index has an estimated average positive impact on FDI inflows-to-GDP in LMICs.
  - This finding is consistent with IMF (2018a) estimations for Sub-Saharan African countries.
  - IMF (2018a) also found a significant negative impact of tightening global financing conditions (proxied by a rise in US government bond yield rate) on FDI inflows-to-GDP in Sub-Saharan Africa; no such evidence was observed for LMICs in these estimations.

- Trade Openness
  - Trade openness (total exports plus imports as share of GDP) has an estimated positive effect on FDI inflows-to-GDP ratio.
  - Bangladesh’s five-year average total trade-to-GDP ratio during 2013-2017 was 39.9 percent, compared to the median five-year average ratio of 76.8 percent for the LMICs (Table 1).
  - It is observed that in transition to UMICs and HICs, there had been a positive correlation between FDI inflows-to-GDP ratio and exports-to-GDP ratio (Figure 7).

- Capital account Openness
  - A greater degree of capital account openness is estimated to attract more FDI inflows.
  - Chinn Ito index for LMICs in 2017 ranged from -1.9 to 2.3 (higher value represents more openness); Bangladesh had a score of -1.2.
  - The new outward investment policy of Bangladesh is expected to increase capital account openness.

- Macroeconomic Stability and Revenue Mobilization
  - Macroeconomic instability, proxied by high government consumption-to-GDP ratio (mimicking an expansionary fiscal stance), has an estimated negative impact on FDI inflows-to-GDP ratio; this is consistent with Dabla-Norris et al., 2010.
  - Once government consumption-to-GDP ratio is controlled for, higher tax-to-GDP ratio appears to help attract FDI inflows due to spillover impacts from tax-financed capital spending.

### Quantitative correlations and significance
- For LMICs, the coefficient of correlation between the five-year average (2013-2017) export-to-GDP ratio and FDI-to-GDP ratio is 0.5.
- For UMICs that graduated to HICs after 1990, the coefficient of correlation between the five-year average export-to-GDP ratio and FDI-to-GDP ratio during the graduation period is 0.6.
- Both coefficients are significant at 1 percent level of significance.

### Additional methodological notes and caveats
- Capital account openness (Chinn Ito index) is a de jure measure based on binary dummy variables coding restrictions on cross-border financial transactions reported in the IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER).
- The adjusted R-squared values are low; goodness of fit is particularly weak for low-income countries as noted in the literature (Dabla-Norris 2010; IMF (2018a)).
- Table 3 presents multiple fixed-effect specifications; the results should be interpreted in the context of the described controls, lagging strategy, and country-sample variation.

*Source: IMF country chapter — Table 3 and accompanying text (sample period: 1992–2017).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1bgdea2022002.pdf_