Exports, cheap foreign loans to take a hit for LDC graduation

Bangladesh's export earnings and the flow of concessional foreign financing and grants will decline once it becomes a developing country, according to a government study.

The projected loss of exports and grants and higher debt service costs would lead to higher current account deficit, said the study styled "Impact assessment and coping up strategies of graduation from LDC status for Bangladesh" prepared by the General Economics Division (GED), a wing under the planning ministry.

The study was prepared before the coronavirus pandemic hit the country.

In August, it was sent to all ministries to come up with strategies to make up for the losses caused by the crisis, said Prof M Shamsul Alam, a member of the GED.

The ministries will incorporate the risk factors in their strategies. For example, the commerce ministry has taken steps to sign trade agreements with various countries as Bangladesh would lose duty-free market access following the graduation, he said.

The biggest blow will emerge in the form of the loss of duty-free market access. The projected export loss from garment products in the European Union and non-EU markets estimated to be about 5 per cent of the total exports in the fiscal year of 2017-18, the study said.

This amounts to a loss of $7 billion in FY27, which would steadily increase to $13 billion by FY31.

"Policy actions will be necessary to counter these projected losses," the study said.

The proportion of concessional assistance will continue to fall while the proportions of non-concessional loans will increase in the coming years.

This is not the direct result of the LDC graduation, but a continuation of the ongoing trend owing to the increase in per capita income.

The concessional debt is already declining: the ratio came down to 51.3 per cent of the total external debt in FY16. Bangladesh has accessed a significant amount of non-concessional financing in recent years.

Under the hypothetical scenario, where Bangladesh had remained an LDC in the foreseeable future, the proportion of concessional external debt would have remained high at more than 65 per cent.

The loss of concessional loans will lead to increased debt servicing costs, the study said.

Since the level of foreign currency reserves is assumed to be kept unchanged, the gap will be filled up by the accumulation of external debt.

The LDC graduation will open up the door for market-based borrowing by both the public and private sectors. And Bangladesh will become more dependent on borrowing from relatively higher-cost sources. The private sector external debt will also see an increase.

The third important factor will be the loss of foreign grants, currently received by the public and private sectors.

Bangladesh's dependence on foreign grants has come down significantly over the last several decades. In recent years, grants received by the public sector are estimated to be about 0.1 per cent of GDP, or less than $300 million per annum.

There are no definitive estimates for grants from the foreign private sector to the domestic private sector.

However, based on the data on private transfers as reported in the balance of payments, the amount could be up to $400 million.

The total grant amount of about $700 million may disappear over time as Bangladesh graduates from the LDC group and firmly moves towards an upper-middle-income country status.

The combined impact of the three types of losses will directly affect the BoP, and the current account deficit may swell to 0.9-1.4 per cent of GDP in FY27.

Most of the losses are on account of export loss in both EU and non-EU markets. The widening of the current account deficit from garment market loss in the EU alone contributes a 0.9 per cent increase in the current deficit.

If the export losses from the non-EU readymade garment, other exports and the loss of grants are considered, these add another 0.5 per cent to the current account deficit in FY27.

The higher debt-servicing costs and higher borrowing to finance the increased current account deficits will reduce the economy's capacity to invest, build up reserves or consume by the same amount under unchanged policies, according to the study.

The loss of grants will be primarily reflected through adjustments in budgetary outlays and private NGO activities.

The study also suggested ways to offset the losses accrued from graduation.

The first approach could be to cover the full amount of BoP financing requirement by external borrowing. In this case, external debt will increase by the full amount of the shortfall, and there will be no need for import compression, also known as import reduction.

There will be no need to adjust the exchange rate and other policies, including monetary.

This may be a short-term and politically quite attractive solution but not a very desirable outcome from a medium and long-term perspective, the study said.

The adverse effects on GDP could be substantial, and associated negative implications for employment and poverty will create social problems.

Importantly, Bangladesh will deviate from its long-term development objectives associated with the Perspective Plan 2041.

Furthermore, the debt sustainability situation may be compromised over time. The debt accumulation will increase rapidly that could jeopardise debt sustainability and debt servicing owing to reliance on high-cost commercial debt in market prices.

The second approach could be to allow the market mechanism to initiate the necessary adjustment process, including trade reforms and other policies to diversify exports and adjustments (depreciation) in the exchange rate to contain imports and provide incentives for exports.

Under this scenario, exports will be more competitive, and the consequent boost in exports, along with the containment of imports due to the exchange rate adjustment, will offset the impact of the loss in overseas sales.

In order to minimise the export loss, the authorities should engage in economic diplomacy, including initiatives for continued market access in the post-LDC period regionally, bilaterally or multilaterally.

The study suggested for reforms in the tax administration, macro-economic management strategy and stability in the BoP to offset the impacts of the LDC graduation in the economy.

Bangladesh was recommended for LDC graduation by the Committee for Development Policy (CDP), a United Nations panel that analyses the status of LDCs, in its triennial review in 2018 as the country met the graduation criteria in Gross National Income (GNI) per capita, Human Assets Index (HAI), and Economic Vulnerability Index (EVI).

The CDP will review the country's performance later this month. If Bangladesh can meet the requirements, it will be recommended for graduation.