World Bank sees U-shaped recovery for Bangladesh's economy

Bangladesh's economy may make a U-shaped recovery if the government spends proactively and can tap into international resources even though output is set to fall drastically in the next two fiscal years because of the prolonged coronavirus pandemic, World Bank said yesterday.

U-shaped recoveries happen when a recession occurs and the economy does not immediately bounce back but tumbles along the bottom for a few quarters.

In its twice-a-year regional update, the WB maintained its GDP forecast for Bangladesh at 1.6 per cent for the current fiscal year and 3.4 per cent for the next fiscal year, assuming that the impact of the Covid-19 crisis would extend.

"Bangladesh would experience a fall but would recover quickly (a 'U-shaped' recovery)," said the latest South Asia Economic Focus.

Speaking on the report, Mercy Tembon, World Bank's country director for Bangladesh, said the global economic downturn will impact Bangladesh's economy like all the economies in South Asia.

However, the policies that the government has undertaken to mitigate the impacts are in the right course, she said.

"For resilient recovery, the government needs to continue to save lives, protect the poor and vulnerable, save its debt and fiscal positions, build financial sector health and create a conducive environment for private sector development and job creation."

The WB forecast came as South Asia is set to plunge into its worst-ever recession as the devastating impacts of the Covid-19 on the region's economies linger on, taking a disproportionate toll on informal workers and pushing millions of South Asians into extreme poverty.

It forecasts a sharper than expected economic slump across the region, with regional growth expected to contract by 7.7 per cent in 2020.

"The collapse of South Asian economies during the Covid-19 has been more brutal than anticipated, worst of all for small businesses and informal workers who suffer sudden job losses and vanishing wages," said Hartwig Schafer, World Bank vice president for the South Asia Region, in a press release.

In Bangladesh, private consumption growth is likely to remain subdued with depressed wage income and a decline in remittance inflows, while anemic private investment is projected due to heightened uncertainty.

Investment and exports will suffer amid major uncertainty about the resumption of demand for ready-made garments. Demand in Europe and the United States is stabilising but the recovery is fragile.

Moreover, while remittance inflows have surged over the past three months, this may be the result of repatriated savings by returning overseas workers. Remittances are forecast to decline in FY21 with weaker demand from migrant-receiving countries such as the oil-producing Gulf states.

Weaker demand and financing constraints may further reduce industrial production, while flooding in early FY21 may hamper agriculture production. However, GDP growth is projected to recover to 3.4 per cent in FY22, supported by a rebound in export demand, remittance inflows and public investment.

Inflation is projected to remain above target due to expansionary monetary and fiscal policies and higher food prices. The current account deficit is expected to widen with a decline in exports, due to continued low external demand, and a decline in remittances, due to the return of workers from overseas.

The fiscal deficit is likely to rise as recurrent expenditure on social protection measures remains elevated in the near term and capital expenditure increases in the post-Covid-19 recovery phase.

Poverty is expected to increase substantially in the short term, with the highest impact on daily and self-employed workers in the non-agricultural sector and salaried workers in the manufacturing sector.

Urban areas will continue to be disproportionately affected, with an estimated 68 per cent of directly affected workers located in Dhaka and Chattogram.

Downside risks to the outlook are substantial, the WB said.

Domestic risks include additional waves of the Covid-19 that may require renewed restrictions. In the government's Covid-19 response programme, risks include ineffective implementation of infection prevention measures and limited operationalisation of credit programmes.

In the context of Covid-19 disruptions, fiscal risks may arise, particularly if tax reforms are delayed or infrastructure projects face cost overruns.

"Increased deficit financing from domestic banks may put upward pressure on interest rates and may further constrain credit to the private sector."

In the financial sector, challenges include deviations from international regulatory and supervisory standards, the absence of a bank resolution framework and weak governance in state-owned banks.

"Financial sector challenges are particularly severe in Bangladesh due to deviations from international regulatory and supervisory standards, the absence of a bank resolution framework, the introduction of interest rate caps, and weak governance in state-owned banks."

The resolution of rising non-performing loans (NPLs) will require substantial policy dialogue to reduce credit risks, limit moral hazard and manage fiscal risks.

"While growth is expected to recover over the medium term, downside risks include a prolonged Covid-19 pandemic and financial sector fragility."

External risks also remain elevated, the WB said.

While external demand for garment products is stabilising, the recovery is fragile. Lower oil prices may limit demand for Bangladesh's overseas workforce in the Gulf region, impairing remittance inflows.

"Also, the continued appreciation of Bangladesh's real exchange rate would adversely impact export demand and remittances."

Going forward, the report said the government's Covid-19 response would remain a paramount priority, including testing, quarantining and treating patients and providing economic relief to the poor and vulnerable.

"Other ongoing priorities include strengthening fragile banks, diversifying exports, accelerating reforms in business regulation, and deepening fiscal reforms."

The WB said for any country with projected new average daily coronavirus cases of 5 per 100,000 people or less on or before the last quarter of 2020 are assumed to see economic activities go back to normal levels by end-October due to lifting of restrictions, necessity or both.

"Within the region, Afghanistan, Bhutan, Pakistan and Sri Lanka had already reached that milestone by September 2020, while Bangladesh is forecasted to reach it as well."

Early, proactive spending by governments combined with the possibility of full access to international markets at reasonable rates could catalyse a faster recovery, the WB said.

This scenario assumes that governments undertake a faster expenditure switch from current transfers and supporting consumption to activities that can help revive the economy, such as temporary work programmes.

Moreover, it assumes that external financing will be forthcoming at historical rates and terms. Under these assumptions, the recession would be much more muted than in the baseline scenario for all countries.

The simulations suggest that prudent fiscal and financial policies are important, but the availability of external financing makes a critical difference in the rate of economic recovery in the region and in minimising the income loss.

Even if a buildup in external debt does not materialise, many countries with low debt-to-GDP levels have domestic vulnerabilities that could transform into a public debt problem in the form of contingent liabilities.

"Bangladesh, Pakistan and Sri Lanka are expected to see a rise in domestic debt in the baseline forecast. Moreover, rising non-performing loans in the domestic sector have been cited as an issue in Bangladesh, Bhutan, India and Pakistan."

The report said the Covid-19 impact is biased against informality. Informal sector workers have suffered the largest declines in employment, and most of the households who have fallen into poverty during the pandemic are dependent on informal workers, largely daily casual wage workers from the middle of the income distribution.

Almost all the workers in the bottom 50 per cent of the earnings distribution in Bangladesh are informal.

"Informal workers and women are losing livelihoods, and considerable uncertainty remains."

A large share of Bangladeshi workers is engaged in sectors directly impacted by the Covid-19. Compounded with pre-existing vulnerabilities and the absence of formal safety nets, households tend to manage income shocks with their own resources.

Relief measures should, for example, consider the high vulnerability of casual and temporary wage workers. Expanding income assistance in the form of transfers linked to a poverty threshold may be sufficient to protect some of these workers, the WB said.

And other forms of support, such as in-kind transfers or public works, may also be effective.

"However, since a large group of affected informal workers may not qualify for poverty-tested transfers, there may be a need to loosen the conditions for eligibility."

"Immediate relief has dulled the impacts of the pandemic, but governments need to address the deep-seated vulnerabilities of their informal sectors through smart policies, and allocate their scarce resources wisely."