Is Bangladesh facing an economic crisis? Not really

The press in Bangladesh has reported over the past few months the economic crisis in Bangladesh. There are endless such statements, meetings, presentations, both in the Bangladeshi media and in the international press. Much of this commentary argues that the Bangladesh economy was building up many problems that the government failed to deal with, and the combination of shocks in the world economy and these underlying weaknesses have together caused this economic crisis.

The government, denying that there was a real crisis, went to the International Monetary Fund and other donors to obtain funds as a safety measure. The International Monetary Fund has come forth with a modest programme plus a lot of vague ideas as to how to “fix” the economy.

There is no crisis. The claim of underlying serious weaknesses is incorrect. The government drawing on International Monetary Fund support was a prudent measure, but really not necessary.

Most of the recommendations from the International Monetary Fund have been suggested by Bangladesh’s leading economists over the past few years, there is never a shortage of suggestions. However, not much has been done by the government in response. Yet, over the past 15 years, there has been strong economic growth. Living standards have definitely improved; the empowerment of women has steadily improved; health is better, as witnessed by the longer life expectancy; education is improving in both quality and quantity delivered.

No one argues things are perfect, but there is definitely substantial progress.

During the past 15 years, we have seen strong economic growth; a stable balance of payments; a low inflation rate; low unemployment levels; the development of an electric power system that has brought great benefits to both households and industry; and the development of the best manufacturing sector in South Asia. A competitive private banking sector has supported this economic development. A private sector, competitive telephone system has developed. Overall there is a competitive economy with moderate government regulation.

What then is this so-called economic crisis?

Due to the extraordinary level of expenditures made in the advanced economies, largely triggered by the response to the Covid-19 disruption, the level of inflation in the advanced economies sharply increased from 2% to 6%-7% [core inflation rate]. This resulted in the Bangladesh balance of payments shifting into deficit. The deficit triggered a depreciation of the Taka that resulted in a rising domestic price level. The onset of the war in Ukraine just made the balance of payments worse and added to the inflationary pressures, largely from disruption of world energy markets. There is a sign of a government-induced excess level of demand. Domestic inflation was a cost push arising from the higher import prices.

External shocks were the cause of the disruption. There was nothing wrong with the behaviour of the Bangladesh economy. To see the economic situation that emerged in financial year 2022 as a crisis is a misunderstanding of what happened.

Of course there are problems, but these were second order issues. The cause of the primary disruption is clear. There are two components of the economy that many refer to as factors responsible for the difficulties: energy and banking. Neither sector has reached a crisis level. The banking sector faces difficult levels of non-performing loans. This is not a new phenomenon and has been made worse by the Covid-19 impact on the economy.

The terms of trade are the ratio of export prices to import prices. If the terms of trade turn in favour of Bangladesh that results in a stronger economy, perhaps more rapid growth, reduced inflation, or stronger employment opportunities. When the terms of trade turn against Bangladesh then the nation gets less goods and services from abroad than would have been obtained without the change in the terms of trade. In financial year 2022 the terms of trade turned against Bangladesh.

The most important policy response to this terms of trade shock is to increase exports to limit the depreciation of the currency and the associated inflation. This also maintains the level and growth of the economy [ as measured by gross domestic product]. Reducing imports may help to limit depreciation and inflation, but will also reduce growth of the economy.

A crisis emerges

The crisis emerged in the first quarter of financial year 2022. The central bank took no action with respect to the exchange rate. The banks indirectly depreciated the Taka without making such change in the rates public. However, no improvement was offered to the exporters, resulting in a large difference between what the banks charged importers and sold Taka to exporters. This resulted in a conflict with the central bank adding to the confusion about the exchange rate.

The increasing dependence of the energy sector on imported fuels led to further pressure on the balance of payments and reduced supply of electricity and gas. Prices of energy increased, but more serious was a short-fall in supply. Whether this was the best solution to the rising energy prices is uncertain. But the real problem is the continuing unwillingness to develop domestic fuel sources.

To cover the deficit in the balance of payments the central bank used its reserves. But there was limited corrective action to limit imports and promote exports. The central bank seemed reluctant to allow the Taka to depreciate. The other action that the central bank could take was to tighten monetary policy by raising interest rates, but this action they deemed ineffective. That is, apparently Bangladesh Bank felt that raising interest rates would have little impact on the level of private investment.

On this the Bangladesh Bank was probably correct. The two key macroeconomic actions to correct the balance of payments – raising interest rates and depreciating the currency were ignored by Bangladesh Bank. The standard actions were repeatedly pointed out by the leading Bangladesh economists but there was neither change or explanation. However, the banks and businesses reacted in their own way.

With the central bank trying to prevent the Taka from depreciating there was a shortage of dollars to meet import demand. This led to increased levels of under invoicing of imports and consequent shifting of remittances into the hundi market.

The Taka depreciated unofficially throughout financial year 2022, but there was confusion and non-uniform treatment among the commercial banks.

Instead of standard macro-economic actions, Bangladesh Bank returned to an approach that goes back 30 years, administrative actions to reduce imports. Rather than depreciate the currency to raise the cost of imports the idea was to introduce various special conditions, making importing more expensive.

However, the currency did depreciate more than 20% without Bangladesh Bank approving this. This of course greatly increased the cost of imports. This price effect was probably more important than the administrative actions in reduction of imports.

Bangladesh Bank reduced the release of reserves to cover the balance of payments deficit. The result was a decline in L/C openings and confusion in the organisation of production.

Restrictions on energy availability contributed to the decline in manufacturing production. The confusion in the foreign exchange market and the restrictions in energy supply had a negative impact on production for export.

Rising demands

Despite all of the confusion in the foreign exchange market, the ready-made garment industry sought and received an increasing volume of orders and export growth was strong. This is the central fact of the so-called crisis, exports responded strongly. If the currency had depreciated more rapidly this export expansion would have been more rapid. A depreciated currency would have increased export competitiveness.

If we look further into the future, the prospects for exports from the ready-made garment sector are disputed. There are all sorts of reports, some optimistic, some pessimistic. One should be optimistic. There are two major factors that will determine the value of ready-made garment exports: the performance of the advanced economies and the manner in which the Chinese exports of garments evolves.

In my view the preponderance of the evidence is that the advanced economies will not fall into recession but will grow slowly, but positively over the next three years. Inflation will not return to its prior low 2% level, but will stabilise at 3%-4% and the major central banks will settle for that. Earlier fears of protracted slow growth seem much less likely.

Another reason one might expect a strong performance of the advanced economies is that fear of continuing war in Eastern Europe or over Taiwan is growing. Defense expenditures will rise in Europe, South Korea, Japan, and the US.

This will be expansionary, raising demand levels.

The position of China is again complicated. Before the pandemic, Chinese wages were rising and industrial competitiveness in the ready-made garment sector was declining. That underlying condition will continue. In addition, the concerns of forced labour in the production of garments and growing cotton are making China a less attractive sourcing site.

In addition, the Chinese economy will begin to grow more rapidly, helping to make the world economy strong.

My conclusion is that the dollar value of Bangladesh garment exports will increase over the next five years at a rate of approximately 15% per annum, doubling in five years. Of this 5%-7% will be an increase in prices and 8%-10% an increase in volume. With an increase in exports of almost 10% in real terms gross domestic product growth will improve and the balance of payments should come into equilibrium at an exchange rate of around 110 Taka-115 Taka/Dollar. Inflation should decline back to 5%-6%.

Such an outcome can be achieved by allowing the exchange rate to float with a narrow spread between the export and import rates.

Need urgent actions

There are other actions urgently needed to accelerate export growth.

The Export Development Fund should be allowed to handle larger orders. The ready-made garment sector is going to grow through larger, higher technology factories not from small, low technology companies.

The adjustment of ready-made garment minimum wages should be determined by the market rejecting both levels imposed by the authorities or unreasonable levels demanded for meaningless concepts such as living wages.

Improving the logistics set up is vital for such an outcome. This can only be achieved by greater privatisation. There needs to be clear recognition that public logistic organisations are inefficient, generally corrupt and are drags on achieving economic growth. Getting piracy on the Chattagram-Dhaka highway under control; ensuring weigh stations function efficiently, limiting side friction from vehicles parking along the road, or buses stopping at unauthorised locations will ease highway delays

Logistics can be greatly improved by good management and disciplined processes. If the costs of reward by corruption are not contained, growth will slow down.

The delivery of quality power and natural gas to the ready-made garment industry should be given first priority.

In conclusion, the Bangladesh economy was hit by a deterioration of the terms of trade. Correcting the exchange rate was handled in a rather awkward way resulting in slow adjustment and an unnecessarily large depreciation. Even now for reasons that are unfathomable the central bank is trying to appreciate the currency and accelerate economic growth the reverse of sound macro-economic practice.

Within this framework, the use of International Monetary Fund and other donor funding is more of a show than a real economic necessity. Accelerating export growth, particularly of ready-made garment is the key to the successful return to stable economic growth. Greater focus on growing exports should be the main direction.

This article first appeared in Dhaka Tribune.