Challenges that could persist in the coming days

External pressure is expected to remain elevated, high inflation is likely to weigh on aggregate demand, consumer spending growth could slow, and protracted global and domestic uncertainties are expected to put pressure on investment growth in Bangladesh in the coming days.

Similarly, the rising risk of a global growth recession would exert downward pressure on exports, while official remittance flows remain vulnerable to administered exchange rate policies and illicit capital outflows.

These were the some of the stresses that were highlighted by the World Bank in its latest Bangladesh Development Update, which was published last week.

INFLATION PAINS CONTINUE UNABATED

High inflation relative to Bangladesh's own history and the current global average is likely to weigh on aggregate demand in the near term.

Inflation in Bangladesh jumped to a seven-month high of 9.33 per cent in March as food prices rose and the adjustment of oil, gas, and electricity prices took hold, highlighting the pains low-income households are going through, official figures showed.

This means the spike in the Consumer Price Index was just behind the 10-year high of 9.52 per cent seen in August last year.

Consumer spending growth appears to have passed the post-pandemic peak, and growth would be expected to slow due to falling real wages and declining household savings, particularly for low- and middle-income households.

"Fragile demand across many sectors combined with global uncertainties and higher prices of capital goods have dampened investment growth. Protracted global and domestic uncertainties are expected to weigh on investment growth, although the completion of the Padma Bridge offers high potential opportunities," said the WB report.

Private investment had been stagnant at around 23 to 24 per cent of GDP for about a decade before the pandemic, as a shortage of skilled labour, opaque regulations, and limited credit availability outweighed discretionary government incentives.

"The incentive to defer investment has increased with rising global uncertainty, higher capital goods prices, an unpredictable domestic foreign exchange regime, energy shortages, and political uncertainty ahead of upcoming elections," said the WB.

Higher inflation puts poverty gains at risk.

Lower income households, already impacted by the two years of the pandemic, are struggling to make ends meet, as evident from the long queues formed when the Open Market Sales trucks are on the street to distribute low-priced essentials.

Inflation momentum may ease with favourable base effects from the first half of FY24 and some cooling in international commodity prices with slower growth in advanced economies.

"The rising risk of a global growth recession would exert downward pressure on Bangladesh's exports."

— World Bank

EXPORT CONTINUES TO FACE PRESSURE

The export boom of the last two years has benefited from pent-up demand globally as countries eased Covid-19 policy restrictions. However, the global economy is slowing, particularly with challenging financial sector conditions in Europe and the United States, the two largest markets for Bangladesh.

"The rising risk of a global growth recession would exert downward pressure on Bangladesh's exports," said the WB.

Earnings from merchandise export fell by 2.49 per cent year-on-year to $4.64 billion in March as demand from key markets in the West declined amid high inflation and a slowdown in the economies, according to the Export Promotion Bureau.

However, overall earnings grew 8 per cent year-on-year to $41.72 billion in the July-March period of the current fiscal year 2022-23.

The WB said Bangladesh benefited from a diversion of export orders from China, particularly in the European market.

"Going forward, upsides are contingent on Bangladesh's ability to maintain export market share and take advantage of recession-induced shifts in preferences in advanced economies towards low-value apparels, electronics, and light engineering products."

VULNERABILITY OF REMITTANCE FLOWS

Official remittance flows are vulnerable to administered exchange rate policies and illicit capital outflows. A surge in labour migration and a substantial depreciation of the taka have so far not made a visible impact on the monthly size and variability in formal remittance inflows.

The WB said formal remittances suffered a setback with the introduction of the complex multiple exchange rate regime in mid-September 2022. A persistent gap between official and parallel market rates has disincentivized the use of official channels.

"On the other hand, demand for dollars in the informal markets has regained momentum. Capital flight can result in higher demand for informal remittance flows, in the context of formal sector capital restrictions."

EXTERNAL PRESSURE TO REMAIN ELEVATED

The current account deficit is expected to narrow to 2.1 per cent of GDP in FY23 from 4 per cent of GDP in FY22, as imports normalise with the moderation of commodity prices and exports grow modestly.

Short-term financing flows have contracted. Together with delays in the repatriation of export earnings and lower medium- and long-term government borrowing, this has limited financial account inflows, although disbursements are expected to rise in the last quarter of FY23 with budget support from development partners.

FISCAL DEFICIT PROJECTED TO RISE

The fiscal deficit is projected to rise to 4.4 per cent of GDP in FY23, narrowing over the medium term.

In the near-term, revenue growth is expected to remain tepid as a result of declining imports. Over the medium term, revenues will rise with increasing trade, improving domestic economic activity, higher incomes, and ongoing efforts to strengthen tax administration.

Public expenditure is expected to match the rapid pace of GDP growth. The GDP growth is projected to decelerate to 5.3 per cent in the current financial year.

Subsidy expenditure is expected to rise in the near term, modestly widening the deficit in FY23. Over the medium term, growth in subsidy expenditures will be contained by pricing reforms.

Capital expenditure on infrastructure megaprojects is expected to keep pace with GDP growth. Over the longer term, rising public expenditure requirements to meet infrastructure needs, mitigate climate vulnerabilities, and accelerate human capital will require additional domestic revenues.

The multilateral lender said Bangladesh is facing near-term risks in sustaining economic growth, reining in inflation, and reducing the current account deficit without being disruptive to the supply side.

"Relatively low external indebtedness and vaccination success enabled the economy to restart swiftly. However, the policy responses to mitigate external imbalances have so far been inadequate."

The uncertain availability of foreign currencies is an impediment to business development, as much as the price of foreign currencies and the level of interest rates. These may compound the effect of costlier imports and weaken the taka further.

Contingent liabilities from high non-performing loans and insufficient capital in state-owned banks, as well as any recapitalisation of or facilitation of resolution processes for privately-owned financial institutions, could result in higher domestic debt.

"Finally, the fiscal deficit could rise unexpectedly in the run-up to the general election in January 2024 if additional spending measures are adopted or policy reform implementation is deferred."

WHAT SHOULD BANGLADESH DO

The demand and supply side austerity measures introduced in response to a widening balance of payments (BoP) deficit slowed growth in attempts to relieve pressure on forex reserves and the exchange rate. Tariff hikes and import controls are blunt instruments with costly unintended consequences for investments, exports, and GDP growth.

"A better approach would be to minimise reliance on price and quantitative controls and instead use market-based monetary, fiscal, and structural policy instruments. An orderly approach is a prerequisite to avoid unnecessary adjustment costs that risk continuity along the long-term growth path," said the WB.

"Enhancing monetary policy would enable inflation targeting and support financial stability. Monetary policy needs to be fully dedicated to reining in inflation through interest rate channels."

Addressing banking sector vulnerabilities could strengthen financial intermediation and adoption of a market determined single, flexible exchange rate would reduce distortions and strengthen the external position, according to the report.

It said adherence to fiscal austerity measures announced in July 2022 has waned, and the fiscal deficit in the first half of FY23 has widened. Domestic financing of the deficit has increasingly been monetised, which is incompatible with inflation reduction objectives.

The foreign financing target has been revised down in an effort to limit external borrowing at higher interest rates. A reduced foreign financing target is contributing to the financial account deficit and putting pressure on demand for dollars.

"In this context, there is an opportunity to adjust fiscal policy to support macroeconomic stabilisation objectives, while protecting social protection expenditures for low-income households."