## 1. External Sector Assessment ## Source details **Canonical URL:** [1. External Sector Assessment](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1627.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1627.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1627.pdf.json) --- ### Context and recent developments - The Bangladesh economy has undergone a major transformation over the past two decades: GDP growth average 5.8 percent since the mid-1990s; real per capita income doubled. - Structural shifts: shares of manufacturing and services in GDP rose, led by the garment industry; poverty declined while inequality remained broadly stable. - Policy backdrop since last Article IV: prudent policies and an Extended Credit Facility (ECF) arrangement supported robust real GDP growth, easing headline inflation, rising international reserves, and a stable public debt-to-GDP ratio. Tax revenues underperformed and economic activity weakened recently. - Political environment: calm returned after early-2015 but lingering uncertainty remains from disputes over the January 2014 elections and war crimes tribunal convictions. ### Macroeconomic developments and growth prospects - Activity: - Domestic demand and activity weakened; private consumption share of GDP steadily declined since FY11; private investment share largely unchanged since FY12. - Activity indicators weakened markedly in the second half of FY15; exports performed poorly in FY15. - Preliminary official growth estimate for FY15: 6½ percent (FY14: 6.1 percent); staff notes this appears somewhat high. - Indicators suggest a slow start in FY16 (exports, imports, remittances, tax revenue, public investment). - Headline and nonfood inflation: - Headline inflation eased from 7.4 percent (y/y) in December 2013 to 6 percent (y/y) in November 2015. - Nonfood inflation rose to 6.6 percent (y/y) in this period due to higher minimum wages in the garment industry and electricity and gas tariff hikes. - Fiscal developments: - Tax collections underperformed; tax-to-GDP ratio fell in FY14 and FY15. - Nontax revenues declined significantly in FY15. - Fiscal deficit (excluding grants) estimated to have risen to 4.2 percent of GDP in FY15 (FY14: 3.5 percent of GDP). Authorities’ preliminary estimate: 3.8 percent of GDP; staff expects an upward revision based on historical revisions. ### External sector—main findings - Overall assessment: external position broadly consistent with fundamentals and desirable policies. - Current account: - After two years of surpluses, CAB swung into a moderate deficit of 0.8 percent of GDP in FY15; CAB returned to a surplus in Q1 FY16 as imports fell. - Box 1 figures: - Actual CA: -0.9 - Cyclically adjusted CA: -1.0 - CA norm (EBA-lite): -4.4 - Adjusted CA norm: -1.0 - Cyclical contribution from the model: 0.1 - Adjustment for structural country-specific factors: -3.5 - CA gap: 0.0 - o/w global fiscal policy gap: -0.5 - Staff’s EBA-lite CA norm -4.4 percent of GDP; country-specific adjustments raise the adjusted CA norm to -1.0 percent of GDP. Staff assesses the current account gap between -1 percent and +1 percent of GDP; reported CA gap is 0.0. - NIIP and external positions: - NIIP: -11 percent of GDP in 2014 (2013: -13 percent of GDP). - Foreign assets: 16 percent of GDP; foreign liabilities: 27 percent of GDP. - About 80 percent of assets are Bangladesh Bank’s gross international reserves; over half of liabilities stem from public sector debt obligations. - Commercial banking system’s net foreign asset position is positive. - Assessment: structure dominated by low-risk liquid assets and public sector liabilities implies low vulnerabilities. - Real exchange rate (REER): - REER appreciated by about 24 percent since the last Article IV consultation, driven about equally by nominal effective appreciation and relatively higher domestic inflation. - Staff finds no clear evidence of misalignment; REER gap assessed at -3 percent to +3 percent. - Capital and financial accounts: - Capital and financial accounts recorded surpluses, reaching 2½ percent of GDP in 2014; inflows dominated by official development assistance and medium-term public sector loans. - Private sector inflows (FDI and portfolio) small (around 1 percent of GDP) and largely offset by private outflows. - International reserves: close to 6 months of prospective imports — assessed as adequate. - Structural external weaknesses: export concentration in garments; FDI inflows as a share of GDP much lower than in most low-income countries. ### Financial sector and credit - Financial system: better than peers on a broad financial development measure, but facing deteriorating bank asset quality, profitability, and capital adequacy since end-2012, particularly in state-owned banks (SBs). - Key weaknesses and implications: - High NPLs and governance problems reduce lending capacity, crowd out productive investment, and can lead to fiscal recapitalization costs for SBs. - High rates on national savings certificates (NSCs) raise funding costs and put upward pressure on interest rates. - Corporate external borrowing rising modestly, reducing reliance on domestic credit. - Past stock market crash and real estate effects depressed private demand and affected banks exposed to the market. - Slower bank credit contributed to high banking system liquidity; inter-bank (call) rates fell steeply, more than deposit and lending rates; broad money growth weakened. ### Reserve adequacy and FX intervention (Box 1 concluded) - Exchange rate regime: de jure float; BB intervenes to keep exchange rate relatively stable against the US$. - Gross international reserves increased from 4.7 months of imports end-2013 to 5.8 months at end-November 2015. - Staff reserve adequacy framework: optimum reserves range from 2.6 to 8.4 months of imports (net cost of holding reserves assumed 5 percent); de facto stabilized regime suggests a figure closer to top of range. - Traditional rules of thumb imply a lower range of 1 to 4.5 months of import cover. - Staff considers current reserves adequate. - Net cost of holding reserves for Bangladesh estimated at about 5 percent (using marginal cost on sterilization instruments and cost of short-term external borrowing for oil imports). ### Medium-term outlook and staff projections (selected) - Near-term: real GDP growth projected at 6.3 percent in FY16 (supported by higher public sector wages and public investment). - Medium-term assumptions and projections: - Growth accelerates to 7 percent by FY20; converges to about 6.5 percent beyond FY20. - Inflation edges up in FY16–18 from higher public wages and a one-off from the new VAT; headline inflation should fall toward 6 percent by FY20 under prudent monetary policy and eased supply bottlenecks. - Private sector credit growth expected to average around 15½ percent over the medium term; share in GDP rising by 2 percentage points to 40 percent by FY20. - Current account deficit projected to widen to about 2 percent of GDP over the medium term; international reserves remain adequate. - Staff projection table (selected series; fiscal-year basis): - Real GDP (annual percent change): FY15 6.5; FY16 6.3; FY17 6.8; FY18 7.0; FY19 7.0; FY20 7.0 - CPI inflation (annual average): FY15 6.4; FY16 6.5; FY17 7.0; FY18 6.7; FY19 6.4; FY20 6.1 - Credit to private sector (end of period): FY15 13.2; FY16 14.7; FY17 15.9; FY18 15.7; FY19 15.3; FY20 15.4 - Current account balance (percent of GDP): FY15 -0.8; FY16 -1.3; FY17 -1.4; FY18 -1.6; FY19 -1.8; FY20 -2.0 - Overall fiscal balance (excluding grants, percent of GDP): FY15 -4.2; FY16 -4.7; FY17 -4.6; FY18 -4.5; FY19 -4.4; FY20 -4.3 - Central government debt (percent of GDP): FY15 34.0; FY16 34.3; FY17 34.2; FY18 34.0; FY19 33.9; FY20 33.6 ### Risks and vulnerabilities - Main risks: - Political shocks and financial-fiscal shocks. - External: protracted slowdown in the EU; potential competitiveness loss from TPP implementation. - Remittances uncertainty due to low oil prices and labor market conditions in host countries. - Natural disasters and climate change. - TPP-specific risk: - TPP could erode competitiveness in TPP markets (around one-fourth of Bangladesh’s exports); US is 20 percent of garment exports; current tariff to US: 15.6 percent for Bangladesh vs 8.4 percent for Vietnam (which falls to zero under TPP). - Mitigants: Bangladesh’s larger population, favorable demographics, and duty-free access to the EU (61 percent of garment exports; 55 percent of total exports). - Banking sector vulnerabilities: - Credit shocks main risk; poor lending decisions at SBs and some private banks. - Main exposures to services sectors and large single borrowers. - Under a conservative scenario (full write-off of existing NPLs and rescheduled loans), SB recapitalization needs above provisions estimated at about 2¼ percent of GDP (as of June). ### Policy implications and priorities (summarized) - Improve investment climate to attract larger FDI inflows and diversify exports. - Address financial sector weaknesses: asset quality, governance, capitalization of SBs; strengthen supervision and avoid regulatory forbearance. - Strengthen tax policy and administration to raise the tax-to-GDP ratio and reduce fiscal vulnerabilities. - Remove infrastructure bottlenecks, especially in energy and transport, to support private investment and diversification. - Consider fiscal measures to contain subsidies and align energy prices with international benchmarks over the medium term. *Source: _cr1627 - 1. External Sector Assessment (IMF mission document).* ### 1. External Sector Assessment ______________________________________________________________________ 9 ### 1. External Sector Assessment ### Context - The Bangladesh economy has undergone a major transformation in the past two decades. GDP growth has been strong and largely stable since the mid-1990s (average: 5.8 percent), allowing real per capita income to double. - Shares of manufacturing and services in GDP rose, led by the garment industry. Poverty has declined steadily, while inequality has remained broadly stable. - Bangladesh compares favorably to other low-income countries on several social indicators. - In the two years since the last Article IV consultation, prudent policies and an Extended Credit Facility (ECF) arrangement supported generally strong macroeconomic performance: robust real GDP growth, easing headline inflation, rising international reserves, and a stable public debt-to-GDP ratio. Tax revenues underperformed and economic activity weakened recently. - Political calm has returned but tensions remain; disputes over the January 2014 general elections and convictions by a war crimes tribunal led to episodes of violence that subsided after early 2015 but create lingering uncertainty. ### Macroeconomic developments - Domestic demand and activity weakened against global headwinds and domestic unrest. Private consumption share of GDP has steadily declined since FY11; private investment share has remained largely unchanged since FY12 after increasing since the mid-1990s. - Activity indicators weakened markedly in the second half of FY15. Exports performed poorly in FY15 due to garment industry restructuring and subdued external demand. - Preliminary official growth estimate for FY15: 6½ percent (FY14: 6.1 percent); staff notes this appears somewhat high given other indicators. - Indicators (exports, imports, remittances, tax revenue, public investment) suggest a slow start in FY16. Factors weighing on private investment and growth: - Crippling regulations and bottlenecks in critical infrastructure, particularly energy and transport; constraints partly stem from low public investment and inadequate infrastructure maintenance. - Political turmoil and uncertainty affecting activity directly and via uncertainty. - Subdued private sector credit growth: credit slowed since mid-2013, with the private credit-to-GDP ratio below trend (a negative credit gap); the slowdown is partly a correction after a credit boom in FY09–12. ### Financial sector and credit - Financial sector weaknesses hamper credit, investment, and growth. Bangladesh performs better than other low-income countries on a broad financial development measure but faces deteriorating bank asset quality, profitability, and capital adequacy since end-2012, particularly in state-owned banks (SBs) due to poor governance and scams. - Weak bank balance sheets and governance issues: - Reduce lending capacity and crowd out productive investment. - In the case of SBs, can lead to fiscal recapitalization costs. - High non-performing loans (NPLs) and high rates on national savings certificates (NSCs) increase banks’ operating and funding costs, putting upward pressure on interest rates. - Corporate borrowing from abroad has risen (albeit still small), reducing reliance on domestic credit. - The 2010–12 stock market crash, accompanied by anecdotal real estate declines, affected private demand and banks exposed to the stock market. - Slower bank credit to public and private sectors contributed to high banking system liquidity; inter-bank (call) rates fell steeply, more than deposit and lending rates, and slower credit led to weaker broad money growth. ### Prices, fiscal, and public finances - Headline inflation eased from 7.4 percent (y/y) in December 2013 to 6 percent (y/y) in November 2015, helped by a good rice harvest in 2014 and declining global prices. Nonfood inflation rose by nearly 2 percentage points in this period to 6.6 percent (y/y), reflecting one-off factors such as higher minimum wages in the garment industry and electricity and gas tariff hikes. Domestic retail fuel prices have not been reduced despite lower global oil prices. - Tax collections significantly underperformed in the past two years. Revenues grew more slowly than output, causing the tax-to-GDP ratio to fall in FY14 and FY15. Nontax revenues declined significantly in FY15, partly due to lower profit transfers from public sector agencies. - Current expenditures remained restrained; capital budget was under-executed, but weak revenue performance led to a larger fiscal deficit. - Fiscal deficit (excluding grants) is estimated to have risen to 4.2 percent of GDP in FY15 (FY14: 3.5 percent of GDP). The authorities’ preliminary estimate of the FY15 deficit is 3.8 percent of GDP, but staff expects an upward revision; staff’s higher estimate is based on average historical revisions to preliminary data. ### External sector: main findings - Overall assessment: The external position is broadly consistent with fundamentals and desirable policies. Staff assesses the external position as broadly in line with fundamentals and desirable policies. - Current account: - After two years of surpluses, the current account balance (CAB) swung into a moderate deficit of 0.8 percent of GDP in FY15 on subdued exports; CAB returned to a surplus in Q1 FY16 as imports fell. - Staff’s extended External Balance Assessment (EBA-lite) suggests a CA norm of -4.4 percent of GDP, but adjustments for country-specific factors (domestic natural gas substitution for oil imports; large, non-capital-intensive garment exports with significant profit margins; credit constraints; relatively lower FDI inflows; high propensity to save out of remittances) raise the adjusted CA norm to -1.0 percent of GDP. The cyclically adjusted CA (removing all temporary factors) is -1.0 percent of GDP. Staff assesses the current account gap ranges between -1 percent and +1 percent of GDP; the reported CA gap in the box is 0.0. - Specific figures from Box 1: - Actual CA: -0.9 - Cyclically adjusted CA (removing all temporary factors): -1.0 - CA norm (from EBA-lite model): -4.4 - Adjusted CA norm: -1.0 - Of which: cyclical contribution from the model: 0.1 - Of which: adjustment for structural country-specific factors: -3.5 - CA gap: 0.0 - o/w global fiscal policy gap: -0.5 - Foreign asset and liability position: - NIIP: -11 percent of GDP in 2014 (2013: -13 percent of GDP). - Foreign assets: 16 percent of GDP; foreign liabilities: 27 percent of GDP. - About 80 percent of assets are Bangladesh Bank’s gross international reserves; over half of liabilities stem from public sector debt obligations. - The commercial banking system’s net foreign asset position is positive. - Assessment: Structure dominated by low-risk liquid assets and public sector liabilities implies low vulnerabilities. - Real exchange rate (REER): - REER appreciated by about 24 percent since the last Article IV consultation. Nominal effective appreciation and relatively higher domestic inflation contributed about equally. - Despite appreciation, staff finds no clear evidence of misalignment or loss of competitiveness: export market shares have remained strong and there is no import boom. The REER gap is assessed at -3 percent to +3 percent. - Capital and financial accounts: - Capital and financial accounts recorded strong surpluses, reaching 2½ percent of GDP in 2014. Inflows dominated by official development assistance and medium-term public sector loans. - Private sector inflows (FDI and portfolio) are small (around 1 percent of GDP) and largely offset by private sector outflows. - Assessment: Capital and financial accounts are relatively stable; vulnerabilities limited by concessional inflows and high reserve buffers. - International reserves: Adequate at close to 6 months of prospective imports. - Structural external weaknesses: Exports remain concentrated in garments; FDI inflows as a share of GDP remain much lower than in most low-income countries, mainly due to investment constraints (infrastructure, regulations, governance). ### Policy implications and priorities (implied from assessment) - External sector policies should seek to improve the investment climate to attract larger FDI inflows and diversify export supply. - Address financial sector weaknesses (asset quality, governance, capitalization of SBs) to restore bank lending capacity and reduce fiscal risks from potential recapitalization. - Strengthen tax policy and administration to raise the tax-to-GDP ratio and reduce fiscal vulnerabilities. - Remove infrastructure bottlenecks, especially in energy and transport, to support private investment and diversification. *Source: _cr1627 - 1. External Sector Assessment (IMF mission document).* ### Box 1. Bangladesh: External Sector Assessment (Concluded) ### Box 1. Bangladesh: External Sector Assessment (Concluded) ### FX intervention and reserve adequacy - Background: - The de jure exchange rate arrangement is classified as floating, but BB intervenes in the foreign exchange market to keep the exchange rate relatively stable against the US dollar. - Gross international reserves increased from 4.7 months of imports as of end-2013 to 5.8 months at end-November 2015. - Staff assessment: - Staff’s reserve adequacy framework suggests that the optimum level of reserves for Bangladesh would range from 2.6 (for a flexible exchange rate regime) to 8.4 months of imports (for a fixed exchange rate regime), assuming a net cost of holding reserves of 5 percent. - Since Bangladesh has a de facto stabilized exchange rate regime, a reserve adequacy figure closer to the top of this range would seem appropriate. - Traditional rules of thumb for gauging reserve adequacy (3 months of imports, 20 percent of broad money, or 100 percent of short-term debt) imply reserve adequacy in a lower range of 1 to 4.5 months of import cover. - Against these estimates, staff considers that the current level of reserves in Bangladesh is adequate. - Notes on cost assumption: - For Bangladesh, the net cost of holding reserves is estimated at about 5 percent, using: (i) the marginal cost on sterilization instruments; and (ii) the cost of short-term external borrowing for oil imports. ### Medium-term outlook and key projections - Near-term: - Staff projects real GDP growth at 6.3 percent in FY16, supported by higher public sector wages and public investment. - Medium-term (staff projections and assumptions): - Growth: - Growth is projected to accelerate to 7 percent by FY20 on the back of: (i) a ramp-up in public investment, which assumes tax revenues will be boosted by the launch of the new value added tax (VAT) in July 2016; and (ii) a recovery in private investment as regulatory and infrastructure bottlenecks are eased and the financial sector strengthens. - Beyond FY20, once the demand-side impact from increased investment subsides, growth is expected to converge back to a potential rate of about 6.5 percent. - Inflation: - Inflation is expected to edge up in FY16–18 on account of higher public sector wages and a one-off effect from the introduction of the new VAT. - Headline inflation should fall gradually toward 6 percent by FY20 assuming monetary policy remains prudent and supply bottlenecks are eased. - Credit and financial deepening: - Private sector credit growth is expected to average around 15½ percent over the medium term, with its share in GDP increasing by 2 percentage points to 40 percent by FY20. - External sector: - On the back of investment-led growth, the current account deficit is projected to widen to about 2 percent of GDP over the medium term, with international reserves remaining adequate. - Staff projection table (selected series; fiscal-year basis): - Real GDP (annual percent change): FY15 6.5; FY16 6.3; FY17 6.8; FY18 7.0; FY19 7.0; FY20 7.0 - CPI inflation (annual average): FY15 6.4; FY16 6.5; FY17 7.0; FY18 6.7; FY19 6.4; FY20 6.1 - Credit to private sector (end of period): FY15 13.2; FY16 14.7; FY17 15.9; FY18 15.7; FY19 15.3; FY20 15.4 - Current account balance (in percent of GDP): FY15 -0.8; FY16 -1.3; FY17 -1.4; FY18 -1.6; FY19 -1.8; FY20 -2.0 - Overall fiscal balance (excluding grants, in percent of GDP): FY15 -4.2; FY16 -4.7; FY17 -4.6; FY18 -4.5; FY19 -4.4; FY20 -4.3 - Central government debt (in percent of GDP): FY15 34.0; FY16 34.3; FY17 34.2; FY18 34.0; FY19 33.9; FY20 33.6 ### Risks and key vulnerabilities - Main risk categories: - Political and financial-fiscal shocks are highlighted as the main risks to the outlook. - External risks include a protracted slowdown in the European Union and potential competitiveness erosion from implementation of the Trans-Pacific Partnership (TPP). - Uncertainty over remittances given low oil prices and labor market conditions in key host countries. - Natural disasters and global climate change pose major risks. - Specific risk notes: - TPP impact: TPP could erode competitiveness of exports to TPP member countries (around one-fourth of Bangladesh’s exports), with the main impact likely on garment exports to the United States (20 percent of Bangladesh’s garment exports). Bangladesh’s garment exports to the US are currently subject to a 15.6 percent tariff; Vietnam’s are subject to an 8.4 percent duty, which will go down to zero after full implementation of TPP. Mitigating factors include Bangladesh’s larger population and favorable demographics and duty-free access to the European Union (61 percent of garment exports and 55 percent of total exports). - Remittances: Remittances are about four times larger than oil imports; persistent low oil prices could weaken job prospects for Bangladeshi workers in Gulf countries (source of about two-thirds of remittances), potentially outweighing the positive income shock from lower oil prices. - Banking sector vulnerability: - Credit shocks are the main risk for the banking system. - Poor lending decisions are a major concern in the state-owned banks (SBs) and some private banks. - Main credit exposures are to services sectors and to large single borrowers; exposures to households and real estate are small. - Rising external borrowing by corporations poses an indirect currency risk. - Under a conservative scenario that assumes full write-off of existing NPLs and rescheduled loans, the SB recapitalization needs above recapitalization provisions already in staff’s baseline are estimated to be about 2¼ percent of GDP (as of June). ### Authorities’ views (summary) - Outlook: - Authorities agreed on drivers of FY16 growth but viewed staff’s projections as conservative; expected FY16 growth in the 6.5–6.8 percent range and FY16 inflation at 6.2 percent. - Under the Seventh Five Year Plan (FY16–20), authorities expected growth to reach 8 percent. - Risks: - Authorities believed political violence is highly unlikely and does not pose a risk to the outlook. - Authorities noted revenues had continued to grow in nominal terms and stressed efforts to boost collections. - Authorities agreed with staff’s external sector assessment. ### Policy discussions — Safeguarding stability and strengthening resilience (A) - Macroeconomic policy framework: - With GDP growth broadly stable, near-term macro policies should focus on safeguarding stability. - In the event of large temporary shocks: counter-cyclical fiscal easing (including automatic stabilizers and increased transfers to the poor) and use of reserve buffers are appropriate. - If shocks are protracted: allow exchange rate depreciation and adjust fiscal policy to keep it broadly in line with the fiscal anchor. - Fiscal policy stance and debt sustainability: - Overall fiscal deficit (excluding grants) is expected to widen to 4.7 percent of GDP in FY16 due to a public sector pay hike. - Over the medium term, staff projects the increase in pay (1 percent of GDP) and in public investment (2 percent of GDP) to be partly offset by lower energy-related subsidies and higher revenue from the new VAT. - Debt-to-GDP ratio would remain broadly stable as a share of GDP but is highly vulnerable to revenue shocks given the low revenue base and high debt service burden. - Debt remains sustainable on the key assumption that the new VAT is implemented as planned. - Deficit financing recommendations: - Authorities should reconsider the need to use NSCs as a financing vehicle: NSCs compete with bank deposits, potentially leading to disintermediation, set an artificial floor on bank rates, and reduce fiscal space. - If NSCs are kept, their rates should be systematically aligned with market rates. - Over the medium term, domestic financing of the fiscal deficit should be gradually reduced to lower banks’ exposure to the sovereign and avoid crowding out private investment. - Forced subscription of treasuries by banks (“devolvement”) should be eliminated. - There is scope to switch to more external financing given the relatively low level of external debt, strong reserve position, and manageable currency risks. - Monetary policy stance: - With upside risks to nonfood inflation from higher public wages, reserve money growth in FY16 should remain at about the current pace. - Over the medium term, bringing reserve money growth below the baseline projection, while protecting private sector credit by shifting deficit financing to more external sources, would help inflation ease faster than projected. - Looser policy could stoke inflation and stock prices, risking instability. - Exchange rate policy: - Given considerable REER appreciation in recent years and uncertainty about its impact on export competitiveness, continued sterilized FX intervention is warranted in the near term. - Further nominal appreciation against the US$ should be resisted in the near term; if consistent with the inflation outlook, monetary policy should be eased. - If appreciation pressures prolong into the medium term, the exchange rate should be allowed to adjust. - Authorities should consider using a basket of trading partners’ currencies as a benchmark for FX intervention, instead of implicitly pegging to the U.S. dollar, given the importance of the euro area as an export market. - Financial sector policies and priorities: - Enhance financial sector regulation and supervision by strictly enforcing existing rules and avoiding regulatory forbearance; complete implementation of risk-based supervision, contingency planning, and lender of last resort policies. - Revise loan rescheduling and restructuring policies to reflect costs on bank balance sheets. - Consider adoption of a coherent macro-prudential framework; explore instruments such as counter-cyclical capital buffers and debt-to-income ratio caps; loan-to-value ratio limits exist for home and auto loans. - Address risks from concentration and macro-fiscal linkages by reducing banks’ exposure to: (i) the sovereign (and reform the NSCs); (ii) the capital market (in line with the legal limit by the July 2016 deadline); and (iii) large single borrowers. - Strengthen SBs via the three-pillar agenda adopted during the ECF arrangement: - (i) improve governance (appoint independent, accountable boards and enhance internal control and compliance under strict BB oversight); - (ii) shore up SB balance sheets through recapitalization, improved loan recovery, and temporary credit growth limits; and - (iii) complete branch automation by 2016 to strengthen financial reporting and efficiency. - Improve the legal and financial framework for loan recovery by promoting simpler court procedures, alternative dispute resolution procedures, and asset management companies. _Italic: Source: IMF staff estimates and staff report content._ ### 24. Addressing long-term vulnerabilities: climate change. Bangladesh is one of the world’s ### 24. Addressing long-term vulnerabilities: climate change ### Climate change resilience — findings and policy recommendations - Bangladesh is one of the world’s most vulnerable countries to the impact of climate change, particularly in the form of flooding from rising sea levels and tropical cyclones, with potentially devastating effects on the most vulnerable. - To build resilience, the authorities should: - Identify, and cost, priority projects for adaptation, including protection against flooding. - Strengthen the fiscal framework for climate change, ensuring that spending plans are adequately financed and reflected in the annual budget and medium-term fiscal plans. - Strengthen coordination of climate change initiatives by centralizing policymaking under one agency and allowing all spending and financing to be reflected in the budget. - Contain greenhouse gas emissions, including through: - (i) carbon taxation and further energy subsidy reforms; and - (ii) a review of natural gas pricing policies: the financial terms in production sharing contracts (PSCs) are deemed unattractive by prospective investors, discouraging exploration and production of this cleaner energy source. Also, low prices for end users, while encouraging consumption, induce waste. ### Authorities’ views on climate change and related policies - The authorities broadly shared staff’s views and concurred on the need for coordinated action to adapt to the challenges from climate change. - The authorities did not support eliminating NSCs, viewing them as providing a safety net to women and the elderly, but were open to reviewing NSC rates regularly to reduce the gap with market rates. - The authorities viewed the financial terms for exploration and production of natural gas as sufficiently attractive (contrasting staff’s recommendation to review PSC terms). ### Promoting inclusive growth — boosting private investment and diversification - To sustain high growth with weakening external demand and to raise productivity, private investment (including foreign) needs to increase and exports should be diversified into new, higher value-added goods and services. - Policy measures recommended: - Better public infrastructure: focus increased public investment on high-priority and cost-effective projects in power and transport infrastructure and foster private participation through public-private partnerships (PPP), taking advantage of the PPP Act passed in September 2015. - Easier investment climate: continue liberalization of FX regulations, reform to increase land availability, enhance transparency, and simplify tax and customs procedures. Reviewing the financial terms for natural gas PSCs and allowing international firms to bid for onshore gas wells would boost investment in the gas sector. - More supportive financial system: continue improvements in financial regulation and supervision, strengthen state banks (SBs), contain bank financing of the fiscal deficit, and align NSC rates with market rates to make more credit available for productive investment. ### Strengthening inclusion — social spending and taxation - Recent trends: poverty has declined and income inequality has remained relatively low and stable over the last two decades. - To raise the poverty-reducing impact of growth: - Improve the progressivity of public spending by containing expenditure on regressive universal subsidies and unfunded pension systems for civil servants, and increase spending on well-targeted social safety nets. - Improve the progressivity of the tax system by implementing the new VAT with its regressivity-reducing features, broadening income tax bases, and strengthening property taxation. - Continue to promote financial inclusion: expand successful schemes using mobile phones for domestic remittances or facilitating women’s access to finance. ### Financial inclusion — stocktaking (Box 3) — findings - Policies adopted include promoting mobile financial services; requiring banks to open at least fifty percent of their branches in rural areas; agent-based banking; credit floors for agricultural and rural sectors; prioritizing support to small businesses and women; schemes for slum dwellers; and no frill accounts (including the 10 Taka accounts). - Progress over time: - The ratio of bank deposit accounts in the adult population has steadily increased. - Mobile money accounts, bank branches, and ATMs have increased. - Bank credit to women has risen as a share of total credit, while the share of credit to agriculture has declined. - Cross-country analysis: - Bangladesh compares favorably with other low-income developing countries (LIDCs) on accounts at and credit from formal financial institutions across vulnerable groups. - Use of credit and debit cards is minimal, and prevalence of informal finance remains high. - Bank branches and ATMs per 100,000 adults are lower due to high population density, but access is better when measured per 1,000 sq. km. ### Creating fiscal space for growth-enhancing and inclusive spending - Case for additional fiscal space: - Staff’s baseline assumes that capital spending under ADP will increase by 2 percentage points of GDP between FY15 and FY20, with social spending remaining stable as a share of GDP. - To accommodate this additional spending within a fiscally sustainable envelope, the authorities need to strengthen tax revenue and improve the allocation of spending. ### Boosting tax revenue — priorities and timelines - VAT implementation: - The new VAT is the authorities’ main reform to expand revenue. - Initially scheduled to be completed in July 2015, the implementation process suffered setbacks and delays in 2014. - Progress has been made and the authorities are working towards full implementation in July 2016. The timeline is tight. - Priority actions: complete necessary procurements; develop refund procedures; finalize VAT rules and regulations and prescribe exempt items; develop a transition strategy from the existing to the new VAT. - The VAT is designed to protect the poor and small businesses, and to reduce taxpayer harassment and compliance costs; an effective communication campaign is critical. - Direct tax reforms: - Finalize the draft for a modern Direct Tax Code. - Broaden the bases for corporate and personal income taxes and expand property taxation. - Administrative reforms: - Enhance transparency, reduce discretion, simplify compliance, and continue automation. ### Improving spending allocation and public financial management - Spending allocation: - Increase spending on infrastructure, infrastructure maintenance (which has stagnated), and social spending targeted to the poor. - Gradually reduce subsidy costs (noting subsidies remain significant despite recent price hikes), renegotiate contracts with costly rental power plants, and build new plants operated by cheaper fuels. - Over the medium term, align domestic fuel prices with international prices through a formula mechanism. - Reform civil servants’ unfunded pension system to reduce future liabilities. - Public financial management — recommendations: - Strengthen budget planning, formulation, and execution; address unrealistic revenue assumptions and reliance on budget revisions; further calibrate treasury cash flow forecasting. - Use nonconcessional external borrowing strictly for growth-critical, cost-efficient projects following rigorous cost-benefit analysis. - Strengthen financial reporting in state-owned enterprises, particularly Bangladesh Petroleum Corporation (BPC), with priority on pressing ahead with an external audit by a reputed global firm. ### Other issues and authorities’ views on fiscal management - The World Bank’s 2015 Public Expenditure Review (PER) Update main findings summarized: - Bangladesh has among the world’s lowest ratios of central government expenditure to GDP (about 14 per cent). - Health spending per capita around US$95 in 2013; infrastructure ranked 130th out of 144 countries in the Global Competitiveness Report 2014–15. - Remuneration has declined as a share of noninterest current expenditure (to 30 percent) in FY14. - Subsidies are sizeable (over 1 per cent of GDP for fertilizer and electricity in FY14) and not well targeted or efficient. - Interest costs account for around one quarter of current expenditure in FY14 and have almost doubled since FY11. - Development (capital) spending accounted for around 40 per cent of total central government spending in FY14, but delayed execution and cost overruns are common. - Authorities’ views: - Reaffirmed commitment to launching the new VAT by July 2016 and agreed on the need for an effective communication strategy. - Welcomed staff views on improving budget formulation, prioritization of government spending, and monitoring of nonconcessional external borrowing. - Agreed on the need for improving financial management in BPC and noted parliamentary consideration of amendments to BPC’s charter, including one on allowing external audit by international firms. - Preferred domestic fuel price stability over an automatic adjustment formula. - Safeguards and institutional governance: - Outstanding safeguards recommendations include strengthening Bangladesh Bank’s internal audit function and legal framework, and regularly appointing globally-reputed firms to audit Bangladesh Bank’s annual financial statements. - Two globally-affiliated local firms audited Bangladesh Bank’s FY15 financial statements and issued unqualified opinions. - Exchange rate regime: - The de jure exchange rate regime is a float. - Effective February 2013, the de facto regime was reclassified from “other managed” to a “stabilized arrangement”. - Bangladesh is an Article VIII member and maintains an unapproved exchange restriction on the convertibility and transferability of proceeds of current international transactions in non-resident taka accounts; the restriction has been relaxed to allow certain debits for outward remittances but no timetable exists for complete removal. *Source: International Monetary Fund.* ### 36. Overview. Macroeconomic performance has been strong over the past two years, ### _cr1627 - 36. Overview. Macroeconomic performance has been strong over the past two years, ### Overview - Macroeconomic performance has been strong over the past two years, underpinned by prudent policies. - Concerns: private domestic demand has weakened; nonfood inflation has edged up; and tax collections have underperformed. ### Outlook and risks - Real GDP growth: - Expected to remain flat in FY16. - Should accelerate gradually over the medium term, conditional on: prudent policies, strengthened tax collections, and maintained calm. - Inflation: - Headline inflation will likely go up in FY17 on higher wages and as the new VAT comes into effect. - Expected to fall thereafter on prudent policies and eased supply bottlenecks. - External position: - The current account deficit should widen slightly as investment takes off. ### Macroeconomic policy stance - Overarching objective: safeguard stability and strengthen resilience in the near term. - Room exists for a counter-cyclical response to temporary growth shocks. ### Monetary policy - Given upside risks to nonfood inflation: - Reserve money growth in FY16 should be maintained around 13 percent. - Medium term: - Bringing down reserve money growth slightly would help inflation fall faster. - Protect private sector credit by shifting to greater external financing of the fiscal deficit. ### Exchange rate policy - The REER has steadily appreciated over the past three years, but is broadly in line with fundamentals. - Bangladesh still maintains its labor cost advantage. - Near term: continued sterilized FX intervention is warranted. - Recommendation: consider using a basket of trading partners’ currencies as a benchmark for FX intervention, instead of keeping a close link to the U.S. dollar. ### Fiscal policy - The fiscal deficit (excluding grants) is expected to widen in FY16 as a public sector pay increase comes into effect. - Medium-term anchor: keep the public debt-to-GDP ratio broadly stable around its current level. - This will require an increase in the tax revenue-to-GDP ratio as public pay and investment rise. - To contain government interest expenses and reduce financial disintermediation: - Discontinue the NSCs or align their rates with market rates on a permanent basis. - Over the medium term, consider a moderate shift toward more external financing. ### Mobilizing domestic revenue - Under current spending plans, full and timely implementation of the new VAT is critical for fiscal sustainability. - The timeline is tight and requires focused, concerted efforts by all stakeholders. - A well-designed communications strategy is essential to highlight the tax’s features and benefits. - Other measures: broaden the tax base and expand property taxation. - Expedite administrative reforms. ### Improving spending allocation - Public expenditure should prioritize: - Growth-critical infrastructure. - Well-targeted social safety net programs. - Complementary action: reduce regressive energy subsidies. ### Strengthening public financial management - Important priorities: - Improve budget formulation, including more realistic revenue forecasts, and execution. - Subject nonconcessional external borrowing to rigorous cost-benefit analyses. - Strengthen financial management and reporting at state-owned enterprises, including through an external audit of BPC by a globally-reputed firm. ### Promoting further inclusion - Improved spending allocation, a more progressive tax system, and further gains in financial inclusion should: - Boost growth. - Make growth more inclusive and allow poverty to fall faster. ### Financial sector reforms - Continue to strengthen risk-based supervision and avoid regulatory forbearance. - Banks should comply with the legal limit on their exposure to the stock market by the July 2016 deadline. - Further progress needed in improving governance, capital position, and asset quality in SBs. - Staff recommends developing a strong macro-prudential framework and adopting reforms to facilitate loan recovery. ### Promoting private investment and diversification - Achieving higher growth requires policies to: - Boost private investment, including foreign direct investment. - Diversify exports to higher value-added goods and services. - Complementary measures: better public infrastructure; an easier investment climate (including for gas exploration and production); a more supportive financial system. ### Adapting to climate change - To minimize climate change impact: - Identify top priority projects for adaptation and include their costs in the medium-term fiscal framework. - Improve coordination and oversight of climate change-related spending. - Additional considerations: tax carbon and review the pricing of natural gas. ### Staff recommendations - Given the absence of a specific timetable for its removal, staff does not recommend approval of the existing exchange restriction. - Recommendation for consultation timing: the next Article IV consultation with Bangladesh should take place on the standard 12-month cycle. *Source: _cr1627 - 36. Overview. Macroeconomic performance has been strong over the past two years,* ### introduction of stricter NPL accounting standards at the end ### _cr1627 - introduction of stricter NPL accounting standards at the end ### Banking sector: asset quality, profitability, and capitalization - Introduction of stricter NPL accounting standards at the end of 2012. - Most NPLs are long overdue and concentrated in a handful of state-owned banks. - By sector, industrial loans (including garments and textiles) account for the majority of NPLs. - Poor asset quality has led to a worsening of banks’ profitability, but private and foreign banks are considerably more profitable than state banks. - As a result, banks’ capital adequacy has worsened, with all the state-owned banks below the regulatory minimum. - Key indicators presented (exact figures in source charts and tables): - Banking Sector Assets (In percent of GDP): series for 2009–2014 showing composition: Cash and cash equivalent; Investments; Loans and advances; Fixed and other assets. - Concentration of Banking Sector Assets (Share of top 10 banks in percent of total banking sector assets): Dec. 2010–Jun. 2015 with series for State-owned commercial banks and Other banks. - Banks' Asset Quality (Nonperforming loans in percent of gross loans): Jun-12 to Jun-15 with series for Banking sector, State-owned banks, Private banks, Foreign banks. - Concentration of Banking Sector Nonperforming Loans (In percent of total outstanding nonperforming loans): overdue categories and sectoral breakdown (e.g., Commercial loans, Garments and textiles, Agriculture, Housing and consumer credit) as of Jun. 2015 and Dec. 2014. - Banks' Return on Assets (In percent; annualized; net of taxes and provisions): Jun-12 to Jun-15 with adjusted and unadjusted series. - Banks' Capital Adequacy (In percent of risk-weighted assets) 1/: series through Jun-15. - Note on adjustment: 1/ Adjusted for intangible "goodwill" assets and relaxation in loan rescheduling rules in December 2013. ### Nonbank financial sector (NBFIs and licensed MFIs) - Nonbank financial institutions (NBFIs, 31 in total) and licensed microfinance institutions (MFIs, about 700 in total) are much smaller as a whole than the banking sector. - NPLs in the nonbank sector are lower than for banks, but rose in the first quarter of 2015 for the NBFIs. - NBFIs are adequately capitalized, but their profitability has been on a down trend. - Financing through equity and capital market debt has tapered off recently and remains small compared to the size of bank credit. - Market capitalization is lower than that in other South Asian countries and some of the large low-income economies. - The penetration of the insurance industry is low compared with countries at a similar stage of development. - Key indicators presented: - Loans by NBFIs and Licensed MFIs (In percent of GDP), 2010–2015. - Nonperforming Loans: NBFIs and Licensed MFIs (in percent of gross loans), 2010–2015. - NBFIs: Selected Financial Soundness Indicators (Return on assets; Return on equity; Capital to risk-weighted assets), 2010–2015. - Dhaka Stock Exchange: Issued Equity and Debt (IPOs/private placements; Issued equity and debt as percent of GDP), FY05–FY14. - Stock Market Capitalization (In percent of GDP): cross-country comparison including Bangladesh 2014. - Insurance Premia Written (In percent of GDP): cross-country comparison. ### Banking sector liquidity and money conditions - Weak credit growth has contributed to a decline in banks’ loan/deposit ratio, resulting in comfortable liquidity and lower demand for liquidity support from the central bank. - Lower market rates have been observed, with somewhat lower bank deposit and lending rates. - Slower credit expansion has led to slower growth in broad money. - On the back of falling bank deposit rates, subscriptions to national savings certificates have risen. - Key indicators and series (exact temporal series in source): - Loan-to-Deposit Ratio, Jan. 2011–Sep. 2015 (Incl. and excl. government deposits). - Bangladesh Bank's Liquidity Support to Deposit Money Banks: Net Repurchase (Repo) Transactions (in billions of taka; end of month; positive = liquidity injection). - Interest Rates, Jan. 2011–Nov. 2015 (Call rate; BB repo rate; 5-year T-bond rate; 91-day T bill rate). - Commercial Banks' Lending and Deposit Rates, Jan. 2011–Oct. 2015. - Contributions to Broad Money (M2) Growth Jan. 2011–Sep. 2015 (Other domestic assets; Private sector credit; Net claims on government; Net foreign assets). - National Savings Certificates, Jan. 2011–Sep. 2015 (Net sales in billions of taka; Mid-range of NSC rates; Difference with bank deposit rates). ### External sector developments - Export growth has slowed, reflecting in part adjustments in the garment industry; exports also weakened in regional competitors, suggesting slower external demand played a role. - Bangladesh garment exports’ share in the European Union and U.S. markets remained strong. - Imports recovered strongly after the January 2014 elections, but weakened since early 2015 in part reflecting slower activity and the decline in global oil prices. - Inbound remittances recovered in FY15, but have weakened in the first five months of FY16. - The current account balance was in a moderate deficit in FY15, but the overall balance of payments remained in surplus, backed by medium- and long-term inflows. - Key indicators and series: - Exports by Main Commodities, Sep. 2011–Oct. 2015 (Year-on-year percent change, 3mma): Raw jute and products; Frozen food; Readymade garments; Leather and products (excl. shoes); Total exports. - Selected Asia: Exports of Goods (Year-on-year percent change) Oct. 2013–Sep. 2014 vs Oct. 2014–Sep. 2015. - Shares in Garments Markets, Jan. 2007–Oct. 2015 (in United States; in European Union). - Imports by Selected Categories, Sep. 2011–Sep. 2015 (Total imports; Inputs for readymade garments industry; Oil imports; Capital machinery). - Workers' Remittances, Sep. 2011–Nov. 2015 (Year-on-year percent change; remittances and HP-filtered trend). - Current and Financial Account Balances (In percent of GDP): FY11–FY15 (Other financial flows; Medium- and long-term loans; Portfolio investment; Direct investment; Financial account balance; Current account balance). ### Alternative scenario: Slower money growth (policy scenario and projected impacts) - Scenario description: - If the authorities targeted slower reserve money growth than currently projected... - ...and the government shifted to slightly higher external financing for a given deficit... - Projected outcomes relative to baseline (FY15–FY20 projections shown in source charts): - This would allow keeping private sector credit’s share to GDP in line with the baseline while helping bring down broad money growth. - Headline inflation would come down faster over the medium term. - The change in the deficit financing mix could help the central government reduce interest expenses. - Key projected series (Baseline vs Alternative scenario): - Reserve Money (y/y percent change), FY15–FY20. - Net Credit to the Central Government (In percent of GDP), FY15–FY20. - Credit to Private Sector (In percent of GDP), FY15–FY20. - Broad Money (y/y percent change), FY15–FY20. - Consumer Price Index (y/y percent change), FY15–FY20. - Central Government's Interest Expenses (In percent of GDP), FY15–FY20. - Source for scenario: IMF staff estimates. ### Macro projections and selected fiscal and external statistics (exact values preserved) - Selected macro and fiscal projections (Staff projections and table series; FY2013–20): - Real GDP: FY14 6.0; FY15 6.1; FY16 6.5; FY17 6.3; FY18 6.8; FY19 7.0; FY20 7.0 (annual percent change, various tables show series). - CPI inflation (annual average): FY14 6.8; FY15 7.3; FY16 6.4; FY17 6.5; FY18 7.0; FY19 6.7; FY20 6.4 (table formats in source). - Credit to private sector by the banking system (end of fiscal year; percent change): FY14 10.8; FY15 12.3; FY16 13.2; FY17 14.7; FY18 15.9. - Current account balance (percent of GDP): FY14 1.6; FY15 0.8; FY16 -0.8; FY17 -1.3; FY18 -1.4; FY19 -1.6; FY20 -1.8 (Table 3 and Table 4 memo items). - Gross official reserves (billions of U.S. dollars): FY14 15.1; FY15 21.4; FY16 24.9; FY17 27.2; FY18 29.2; FY19 31.2; FY20 33.4 (Table 4). - Exports (f.o.b., billions of U.S. dollars): FY14 26.6; FY15 29.8; FY16 30.8; FY17 32.6; FY18 35.7; FY19 39.1; FY20 42.8 (Table 4). - Imports (f.o.b., billions of U.S. dollars): FY14 -33.6; FY15 -36.6; FY16 -40.7; FY17 -43.3; FY18 -47.2; FY19 -51.6; FY20 -56.3 (Table 4). - Current account balance (in dollars): FY14 2,388; FY15 1,406; FY16 -1,645; FY17 -2,707; FY18 -3,395; FY19 -4,195; FY20 -5,091 (Table 4). - Central government operations (selected ratios and levels): - Total revenue and grants (percent of GDP): FY14 11.2; FY15 10.9; FY16 9.9; FY17 10.5; FY18 11.6 (Table 5a). - Total expenditure (percent of GDP): FY14 14.6; FY15 14.0; FY16 13.8; FY17 14.9; FY18 15.8. - Overall balance (including grants, percent of GDP): FY14 -3.4; FY15 -3.1; FY16 -3.9; FY17 -4.4; FY18 -4.3. - Annual Development Program (ADP) (percent of GDP): FY14 4.2; FY15 4.1; FY16 4.3; FY17 4.8; FY18 5.2. - Balance of Payments highlights (Table 4, FY14–FY20 projections): - Ready-made garment sector exports (f.o.b., billions of U.S. dollars): FY14 21,516; FY15 24,492; FY16 25,491; FY17 27,359; FY18 29,926; FY19 32,704; FY20 35,708. - Workers' remittances (part of private transfers): FY14 14,338; FY15 14,116; FY16 15,170; FY17 15,630; FY18 16,568; FY19 17,562; FY20 18,616. - Foreign direct investment (billions of U.S. dollars): FY14 1,726; FY15 1,432; FY16 1,700; FY17 1,908; FY18 2,356; FY19 2,574; FY20 3,092. ### Development indicators and Millennium Development Goals (summary) - Millennium Development Goals, 1990–2013: progress varies across goals; selected entries include: - Poverty headcount ratio: 1990 = 57; 2005–10 = 32; 2011–13 = 29; 2015 target status indicated. - Prevalence of child malnutrition (percent of children under 5): 1990 = 58; 2005–10 = 41; 2011–13 = 37; 2015 = 33; status: On track. - Net enrollment ratio in primary education: 1990 = 61; 2005–10 = 96; 2011–13 = 97; 2015 target = 100; status: On track. - Under 5 mortality rate (per 1,000): 1990 = 114; 2005–10 = 49; 2011–13 = 44; 2015 target = 48; status: Achieved. - Maternal mortality ratio (modeled estimate, per 100,000 live births): 1990 = 440; 2005–10 = 200; 2011–13 = 170; 2015 = 143; status: Needs attention. - Selected general indicators: - Population (in millions) 2015 = 157. - GDP per capita (FY14, U.S. dollars) = 1,110. - Life expectancy at birth (years) 2012 = 70. - Poverty headcount ratio (2010, percent) = 32. - Sources for these indicators: Bangladesh authorities; United Nations Development Program; World Bank, World Development Indicators. *Sources: Bangladesh authorities; and IMF staff calculations and estimates (content drawn from the supplied IMF staff report material).* ### 1. Central government accounts ### 1. Central government accounts ### Revenue and expenditure (table values preserved verbatim) - Revenue: 1,346 1,467 1,892 1,504 2,142 1,808 2,284 - Taxes: 1,075 1,160 1,553 1,288 1,822 1,503 1,883 - Grants: 586 462 445 843 61 - Other revenue: 214 243 277 172 262 262 339 - Expenditure: 1,162 1,186 1,381 1,301 1,726 1,594 1,942 - Compensation of employees: 217 263 287 288 452 444 582 - Purchases of goods and services: 131 151 164 165 178 172 187 - Interest: 240 282 310 310 351 354 453 - Subsidies 2/: 322 211 263 215 235 180 208 - Grants: 193 219 250 227 368 313 359 - Other payments: 596 0 108 96 142 132 153 ### Balances and net transactions - Gross operating balance: 184 281 510 202 416 214 343 - Net acquisition of nonfinancial assets: 589 695 1,124 790 1,225 972 1,181 - Fixed assets: 500 552 803 651 970 821 1,024 - Nonproduced assets: 89 143 321 201 392 551 511 57 - Net lending (+)/net borrowing (-) 3/: -405 -413 -613 -588 -809 -758 -838 - Net financial transactions: -358 -372 -613 -475 -809 -758 -838 - Net acquisition of financial assets (+ increase): 224 1 ... -13 ......... - Domestic: 224 1 ... -13 ......... - Deposits: 224 1 ... -13 ......... - Net incurrence of liabilities (+ increase): 380 372 613 475 809 758 838 - Domestic: 283 283 433 359 566 590 651 - Debt securities and loans and advances: 283 283 433 359 566 590 651 - Other accounts payable: 0 0 0 0 0 0 0 - Foreign: 979 0 18 11 1624 316 8187 - Statistical discrepancy (net borrowing less net financial transaction): -47 -41 0 -1 13 0 0 0 ### Net financial worth and stocks - Net financial worth — Stock of financial assets: 150 190 ... 178 ......... - Domestic: 150 190 ... 178 ......... - Deposits 4/: 150 190 ... 178 ......... - Foreign: 0 0 ... 0 ... 0 0 - Stock of liabilities: 4,132 4,551 ... 5,139 ... 5,897 6,735 - Domestic: 2,395 2,725 ... 3,197 ... 3,787 4,438 - Debt securities and loans and advances: 2,395 2,725 ... 3,197 ... 3,787 4,438 - Foreign: 1,737 1,826 ... 1,942 ... 2,109 2,297 ### Notes and sources - Sources: Bangladesh authorities; and IMF staff estimates and projections. - Footnotes preserved exactly: - 1/ Fiscal year begins July 1. - 2/ Includes transfers to Bangladesh Petroleum Corporation and Bangladesh Power Development Board. - 3/ Includes statistical discrepancy. - 4/ Excludes deposits of autonomous and semi-autonomous bodies. *Source: _cr1627 - 1. Central government accounts (IMF staff tables and notes).* ### 1. The IMF and World Bank Group (both International Development Association (IDA) and ### 1. The IMF and World Bank Group (both International Development Association (IDA) and ### Collaboration overview - IMF and World Bank Group (IDA and IFC teams) work together to promote policies and critical reforms essential for maintaining macroeconomic and financial stability and for sustained high growth and poverty reduction in Bangladesh. - Collaboration is strong at headquarters and in the field (through the IMF Resident Representative’s Office and the World Bank’s Country Office). - Modes of interaction: - Frequent formal and informal exchanges of information on each other’s activities and on assessments of developments, the outlook, and key policy issues. - Mutual invitations to participate in critical internal discussions, sharing of key documents, and soliciting comments. - Staffs invited to relevant Board meetings. - Regular discussions on division of labor and collaboration on the Debt Sustainability Analysis (DSA). ### Achievements and priorities under the Extended Credit Facility (ECF) - The ECF arrangement: approved in April 2012 and completed in October 2015. - Under the ECF, authorities restored macroeconomic stability and undertook reforms in: - Domestic revenue mobilization, notably enacting a new Value Added Tax Act in 2012. - Tax revenue administration. - Fiscal expenditure allocation, including the reduction in regressive energy subsidies and strengthening of social safety nets. - Public financial management, including strengthening external debt management. - Banking supervision and regulation, including amending the Banking Companies Act in 2013. - Addressing weaknesses in the state-owned commercial banks. - Improving central bank operations. - Liberalizing foreign exchange regulations. - The priorities for macroeconomic policies and reforms going forward are identified in the main text of this report. ### World Bank Group strategy and Systematic Country Diagnostic (SCD) - The Bank’s strategy is reflected in the forthcoming Country Partnership Framework (CPF) for FY16-20, to be delivered in 2016. - CPF alignment: Government’s Seventh Five Year Plan; anchored in the Bangladesh Systematic Country Diagnostic (SCD), completed in 2015. - The SCD identifies five transformational investments needed to create more and better jobs and accelerate poverty reduction: - energy; - inland connectivity and logistics; - regional and global integration; - urbanization; - adaptive delta management. - The SCD identifies three foundational priorities as prerequisites for growth where policy attention must be sustained: - macroeconomic stability; - human development; - institutions and business environment. ### Agreed reform areas and division of labor - Tax policy and administration - Bangladesh has one of the lowest tax-to-GDP ratios in the world. - New VAT Act, 2012, being implemented for a launch in July 2016; the new VAT is the authorities’ main tool to boost tax collections over the medium term. - Ongoing efforts: boost capacity of the National Board of Revenue and modernize the Direct Tax Code. - Division of labor: IMF provides TA on the new VAT law and VAT implementation plan; a resident advisor was in place until late 2014 to help with VAT implementation. IDA will provide financial support for implementation aspects, including designing organizational reforms and new administrative processes. Both institutions currently provide TA to the implementation process. - Public financial management (PFM) - Importance: maintain fiscal discipline and improve quality of public expenditure. - Division of labor: IDA provided assistance through Strengthening Public Expenditure Management Program (SPEMP), supported by a multi-donor trust fund; SPEMP focused on core PFM issues in the executive branch and strengthened public expenditure oversight in parliament and audit institutions. IDA leads on public procurement reform and capacity building. IMF provides TA missions on cash flow forecasting and management, budget and accounting classification, and budget formulation. - Debt management - Significant progress under the ECF, but more to do. - Division of labor: IMF and IDA will continue joint work, including on the DSA. IMF coordinates macroeconomic assumptions and outlook and supports structural reforms on debt management through Article-IV consultations. IDA provides technical support through Public Expenditure and Revenue Analysis (PERA), Analytical Support Activity on PFM reforms, and a Debt Management Performance Assessment (DeMPA). - Monetary and exchange rate policies - IMF takes the lead. - IDA complementary role: operations to strengthen payments systems at Bangladesh Bank (BB). - Financial sector reforms - IMF provided TA on banking supervision, including through a resident advisor until late 2014, and on strengthening state-owned commercial banks (SOCBs). - IMF will continue support through Article-IV consultations. - IDA will support regulatory and oversight capacity of BB, strengthen SOCBs through automation/improved management systems and business process reengineering, including potential governance reforms, and help lay the foundation for a well-functioning insurance and pension sector. - Energy sector reform - Over the last three years, spending on subsidies, particularly on energy, has come down as a share of GDP, initially through domestic price adjustments and more recently with help from a decline in the international oil prices. - Further price adjustments needed, including systematic adjustments to domestic fuel prices in line with international price movements. - Need to reduce financial and operational inefficiencies in state-owned enterprises in the energy sector. - Bangladesh ranks poorly among the low-income countries in terms of availability of electricity. - Power generation should rely less on expensive liquid fuel; proper incentives needed for increased private investment; institutionalization of transparent and competitive procurement processes recommended. - Division of labor: IDA will lead on policy dialogue and investment; IMF focuses on policies to address fiscal implications. - Social protection - Under the ECF social spending as a share of GDP was protected. - Further improvement needed via improved targeting and consolidation of a large number of programs. - Rationalization of regressive fuel subsidies would free resources for enhanced social safety programs. - Division of labor: IDA leads through support to development of the National Household Database for objective beneficiary selection and improved management and administration of SSNs. - Trade and investment climate reform - Objective: boost productivity and investment by creating a level playing field and reducing cost of doing business. - Division of labor: IDA led a Diagnostic Trade Integration Study (completed); IFC targets incremental reforms to improve legal and administrative procedures. Trade & Competitiveness global practice (joint IDA-IFC unit) will address institutional and policy reforms, and provide IDA financing for special economic zones. IMF supported review of foreign exchange regulations. - Statistical policy - Improvements in statistics are critical for policy formulation and monitoring. - Division of labor: IDA on poverty, social, development statistics, and statistical infrastructure including IT needs; IMF on macroeconomic and financial statistics. - Other structural policies - World Bank informs IMF about work on governance and anti-corruption, local government and decentralization, and private sector development to allow upstream IMF comment. ### Coordination commitments - Teams agree to continue informing each other of respective activities, coordinating financial and technical support, and sharing key documents. *Source: _cr1627 - 1. The IMF and World Bank Group (both International Development Association (IDA) and* ### 10. Each year, the AsDB publishes its Asian Development Outlook and Asian Development ### _cr1627 - 10. Each year, the AsDB publishes its Asian Development Outlook and Asian Development ### Statistical issues and data adequacy - General: "Data provision has some shortcomings, but is broadly adequate for surveillance." Most affected areas: national accounts, fiscal, and external sector statistics. - National accounts: - Annual GDP time series base year: "2005/06". - Comprehensive benchmark compiled and published by Bangladesh Bureau of Statistics (BBS) in "2013". - Material statistical discrepancy in subsequent periods due to minimal source data; estimates predominantly derived from a biennial census of manufacturing establishments or extrapolations from the "2005/06" benchmark. - BBS technical assistance to use VAT data from National Board of Revenue (NBR) to compile contemporary estimates and construct a contemporary statistical business register. - Quarterly GDP: "currently not compiled." - Price statistics: - New CPI series base year: "2005/06", introduced "July 2012". - CPI undergoing further improvements, including incorporation of recent household survey and COICOP; IMF provided TA. - Producer price index base year: "1988/89" (outdated; requires urgent attention). - Government finance statistics: - Ministry of Finance revising Budget and Accounting Classification System (BACS) to follow "GFSM 2014"; new BACS expected to be incorporated into the "FY18 Budget". - Coverage of units outside central government: "inadequate". - No data published on assets and liabilities of the general government. - Monetary and financial statistics: - Bangladesh Bank compiles monetary data using SRFs; consistent SRF-based time series available from "December 2001". - Survey of Other Financial Corporations (OFCs): "not yet available." - Financial Soundness Indicators: - Reporting since "August 2014": "10 core and 9 encouraged FSIs." - External sector statistics: - Quarterly BPM6 compliant time series covering "2005 to 2014" published by Bangladesh Bank. - Inconsistencies remain between BOP, IIP, and other macro statistics; published IIP estimates "remain weak." - Data standards and quality: - Bangladesh participation in GDDS since "March 2001". - Data Module of the ROSC published "December 2005". *Data adequacy assessment: broadly adequate for surveillance with important gaps in national accounts, fiscal coverage outside central government, producer prices, OFC coverage, and IIP robustness.* --- ### DSA overview and main conclusions - This DSA Update: "updates the joint IMF/IDA full DSA from October 5, 2015." - Risk assessment: "Bangladesh remains at a low risk of external public debt distress." - Total public debt: on a sustainable path assuming the new VAT "comes into effect in full." - Without a permanent boost to revenues, "the public debt trajectory would become unsustainable." - Public sector composition and stocks as of end-FY15: - Total public sector and public sector-guaranteed external nominal debt: "US$26 billion (13 percent of GDP or 77 percent of exports of goods and services)." - Largest creditors: World Bank "US$12 billion"; Asian Development Bank "US$7 billion"; largest bilateral creditor Japan "US$2 billion." - Total public sector domestic debt as of end-FY15: "20 percent of GDP (or 208 percent of central government revenues, including grants)." - Domestic debt composition: mainly commercial banks’ holdings of treasury instruments and non-banks’ holdings of national savings certificates; includes net credit by Bangladesh Bank and outstanding liabilities of state-owned enterprises to the banking system. --- ### Underlying macro assumptions (changes vs. October 2015 full DSA) - Growth in "FY16 and FY17" marked down by "0.2 percentage points of GDP." - Average annual export and import growth in "FY16-FY20" marked down by "0.7" and "0.3 percentage points" respectively. - Real bilateral taka-dollar exchange rate: assumed to "appreciate by 3 percent in FY16" instead of remaining constant. --- ### External DSA (baseline and stress test findings) - Baseline projection: - PPG external debt to GDP ratio: increases from "13 percent of GDP in FY15" to "15 percent in FY21", peaks at "approximately 17 percent in the late 2020s", then trends down to "15 percent of GDP by FY36." - Associated PPG indicators: trend up initially but "remain well within the respective policy-dependent solvency thresholds" under baseline and standard stress tests. - Stress tests with larger impact: "large nominal depreciation" or "borrowing on less favorable terms." - Selected numerical indicators (at end-June 2015): - Multilateral debt: "20,507" (millions of U.S. dollars) — "78.5 percent of total external debt." - World Bank: "11,596" (44.4%) - ADB: "7,402" (28.3%) - IMF: "705" (2.7%) - Bilateral debt: "3,993" (15.3%) - Japan: "2,066" (7.9%) - China: "917" (3.5%) - Guarantees to external borrowing by SOEs: "94" (3.6%) - Short-term debt: "69" (2.6%) - Total external debt: "26,131" (100.0) = "13.4 percent of GDP." --- ### Public DSA (baseline, trajectory, and fiscal caveats) - PV of public debt to GDP: - Projected increase from "29½ per cent in FY15" to "34 per cent in FY21." - Long-term rise to "about 41 percent of GDP by FY36" (compared with "35 percent of GDP in FY15"). - Drivers: - Higher public investment raises debt; expected increase in tax revenue from new VAT mostly offsets impact through FY21. - Gradual increase in real interest rates assumed as concessionality of debt declines. - Sensitivity: - If primary deficits remain fixed at projected peak in "FY16", debt indicators drift upwards. - Stress test with largest impact on public debt indicators: materialization of contingent liabilities; debt indicators increase medium-term then stabilize. - Conclusion: Public debt indicators remain within benchmark under baseline and standard stress tests, conditional on implementation of VAT and fiscal consolidation where needed. --- ### Alternative scenario: failure to introduce the new VAT - Tax revenue to GDP ratio: lower by "about 2 percentage points" relative to baseline. - With "no consolidation in expenditure assumed," fiscal deficit widens and domestic borrowing costs rise. - Result: "significant deterioration in all standard public debt sustainability indicators," and "debt trajectory would become clearly unsustainable." - Policy implication: In absence of VAT-induced revenue boost, a "significant cut in public expenditure would eventually be needed" with negative knock-on effects on growth and poverty reduction. - Modeling note: alternative scenario assumes same public investment and external financing profile as baseline and domestic financing used to meet revenue shortfall. --- ### Key projected macro and fiscal variables (selected from Table 1) - Nominal GDP (in billions of U.S. dollars): - 2013: "150" - 2014: "173" - 2015: "195" - 2016: "216" - 2017: "236" - 2018: "257" - 2019: "281" - 2020: "307" - 2021: "333" - 2036: "1,153" - Real GDP (percentage change): - 2013: "6.0" - 2014: "6.1" - 2015: "6.5" - 2016: "6.3" - 2017–2021: "6.8", "7.0", "7.0", "7.0", "6.5" (as shown in table) - Long-run: "6.5" - GDP deflator (percentage change): - 2013: "7.2" - 2014: "5.7" - 2015: "5.8" - 2016: "6.8" - Long-run figures include "4.7" and "4.7" entries in later years as shown. - Total revenue and grants (percent of GDP): ranges shown in projections include "10.5" (2016), "11.6" (2017), "12.2" (2018), and consistent "12.9" in several subsequent years. - Overall balance (percent of GDP): projections show deficits such as "-4.4" (2016), "-4.3" (2017), with long-run around "-3.8" to "-3.9". - Current account, including official transfers (percent of GDP): "1.6" (2013), "0.8" (2014), "-0.8" (2015), projected "-1.3" (2016) and trending to "-2.6" by "2036". - Gross official reserves (months of prospective imports of goods and services): "4.1" (2013), "5.3" (2014), "5.8" (2015), projected "5.8" (2016) down to "5.0" by "2036". --- ### Sensitivity and stress-test highlights (selected) - External DSA sensitivity (Table 3): - Baseline PV of debt-to-GDP+remittances ratio displayed values: "8" (2016), "8" (2017), "8" (2018), "9" (2019), "10" (2020), "12" (2021), "12" (2026), "12" (2036). - Alternative A2 (new public sector loans on less favorable terms) shows larger increases (e.g., "17", "19" in later years). - Bound test B6 (one-time 30 percent nominal depreciation relative to baseline in 2017) yields elevated ratios (e.g., "13", "16", "17" in some indicators). - Public DSA sensitivity (Table 5): - Baseline PV of Debt-to-GDP Ratio: "31" (2016), "31" (2017), "32" (2018), "33" (2019), "34" (2020), "38" (2021), "39" (2036). - Alternative A2 (primary balance unchanged from 2016) pushes PV Debt-to-GDP to "44" and "52" in long-run projections. - Bound test B4 (one-time 30 percent real depreciation in 2017) increases PV Debt-to-GDP to "44" (2036) in the scenarios shown. --- ### Policy recommendations and implications (as presented) - Implement the new VAT in full to realize the projected increase in tax revenue (about "2 percentage points of GDP" in the counterfactual). - Maintain fiscal consolidation consistent with scaling up public investment to avoid unsustainable public debt trajectories. - Address data shortcomings to strengthen surveillance: - Update national accounts (compile quarterly GDP; use VAT and business register to reduce discrepancies). - Update producer price index base year ("1988/89" is outdated). - Expand fiscal coverage beyond central government and publish general government assets and liabilities. - Improve IIP estimates and reconcile BOP/IIP/macroeconomic statistics. - Develop survey coverage of OFCs. --- *Source: IMF staff report excerpts and associated tables and figures (December 2015 — January 5, 2016), Bangladesh: Staff Report for the 2015 Article IV Consultation — Debt Sustainability Analysis Update.* ### 7. Staff’s recommendations on direct tax reforms, strengthening tax administration, ### 7. Staff’s recommendations on direct tax reforms, strengthening tax administration, improving the budget formulation process, prioritization of spending and rigorous monitoring of non-concessional external borrowing ### Fiscal policy, tax administration, and NSCs - Staff’s recommendations on direct tax reforms, strengthening tax administration, improving the budget formulation process, prioritization of spending and rigorous monitoring of non-concessional external borrowing have been carefully noted and efforts will be made for graded improvements in these areas. - The authorities have also taken note of the concerns staff has expressed about the use of NSCs for financing government expenditure. - The authorities do not view NSCs simply as a means to borrow, but also as a means to support the underprivileged and disadvantageous sections of society; therefore, they do not consider the elimination of NSCs advisable. - The NSC rates were reduced by up to 2 percentage points in May 2015 to reduce the gap with market rates. - The authorities also point out that devolvement has not been resorted to in the last two years. ### External competitiveness and exports - Our authorities recognize the possible adverse impacts of further REER appreciation and will carefully monitor developments in this regard. - Bangladesh continues to enjoy significant cost advantage vis-à-vis other countries in garment exports and the authorities are confident of an improved export performance going forward. ### Banking sector reform and supervision - In our Buff statement at the time of Board consideration in October 2015 of the combined fifth and sixth reviews under the ECF arrangement, we had mentioned that the authorities were committed to enhancing banking supervision and taking strict action in cases of financial misconduct in banks. - We had also mentioned that Basel III would be implemented by 2019. - Reform of the state-owned banks continues to be a priority for the government. These banks are being recapitalized in a phased manner. - The progress in automation of their branches in 2015 has been encouraging. - The compliance of state-owned banks with their MOUs with Bangladesh bank is being closely monitored. ### Private investment, infrastructure, and inclusion - To boost private investment and potential growth over the medium term and make the growth processes more inclusive, Bangladesh needs wide-ranging structural reforms, including reducing the deficit in public infrastructure and improving the business-climate. - The PPP Act passed in September 2015 should enable private participation in public infrastructure projects, particularly in the power and transport sectors. - The authorities have noted staff’s recommendations for enhancing private investment and diversification and will take action to ease the business and investment climate. - Bangladesh’s record in financial inclusion compares favorably with peers; however the authorities recognize that more needs to be done and will continue making efforts for greater financial inclusion. - As mentioned in our October Buff statement, the government’s oil subsidy bill has reduced, electricity and gas prices were raised a few months back, and labor safety standards are being improved. ### Climate change policy and institutional architecture - Our authorities are fully cognizant of the fact that dealing with the impact of climate challenge poses a serious challenge for Bangladesh. - Staff’s Selected Issues paper acknowledges the early action that Bangladesh has taken to be able to meet this challenge. - A comprehensive institutional architecture has been put in place, including the Bangladesh Climate Change Strategy and Action Plan (BCCSAP) of 2009, Climate Change Trust Act of 2010, BCCTF and BCCRF, for concerted efforts in this area. - In addition, several routine programs focus on measures to tackle the challenge. - The authorities recognize that it is necessary to significantly add to the steps that have already been taken, particularly for ensuring the availability of the required funds and building institutional capacity in managing climate change related projects. - Staff’s recommendations will be kept in view as further progress is made in this area. *Source: _cr1627 - 7. Staff’s recommendations on direct tax reforms, strengthening tax administration,* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1627.pdf_