Over the last two decades, Bangladesh has achieved significant economic progress, epitomised by the fact that the country's GDP, according to the World Bank, grew more than six-fold in real terms from $53.37 billion in 2000 to $324.24 billion in 2020.

This has been supported by a structural transformation in trade and financial markets, harnessing the combined effects of capital deepening and cross-sectoral labour reallocation.

From an economic perspective, Bangladesh's transformation thus far has been underpinned by two key elements: (1) trade concentration: the preponderance of textiles and clothing as a share of exports, and (2) persistent trade and current account deficits since 2016, supported by volatile remittances and unrequited transfers entailing offsetting capital account surpluses, foreign direct investment (FDI), foreign exchange reserves, and net external debt.

In the last few years, FDI inflow into Bangladesh has been modest. Net FDI inflow into the country during 2018-2020 was $8.91 billion. During this period, Pakistan recorded a net FDI inflow of $9.17 billion, and India $154.51 billion.

I believe that Bangladesh has the capacity to attract $25-30 billion in FDI annually with enhancements in its business climate indicators and continued reform in its regulatory environment. As such, DelMorgan plans to channel about $13 billion into key growth sectors in Bangladesh during 2022-23, including RMG, pharmaceuticals, financial services, infrastructure, real estate, and diversified manufacturing.

I was pleased to meet Faruque Hassan, president of the Bangladesh Garment Manufacturers and Exporters Association (BGMEA), as we discussed the growth potential of the country, going forward. According to BGMEA, Bangladesh has 3,500 active clothing factories, 827 textile mills, and 433 spinning mills. It has 40 out of the world's top 100 garments factories.

However, the challenges of the prevailing specialisation pattern are corroborated by the analysis of trade in value-added and related indicators of participation in global value chains.

According to a recent report by the UNCTAD, Bangladesh's vulnerability profile highlights that, although the country is approaching LDC graduation on the back of sustained progress and with strong political will, there is no time for complacency.

The UNCTAD Productive Capacities Index (PCI) shows that while Bangladesh has delivered steady improvements in the index during 2000-2018, it has consistently underperformed the LDC average productivity growth. In particular, out of the eight elements of the PCI, Bangladesh underperformed in seven components: ICT, transport, energy, institutions, private sector, structural change, and human capital.

The only component in which it was at par with the LDC average was natural capital.

Furthermore, the UNCTAD highlights four lingering sources of vulnerability which will continue to shape the trajectory of Bangladesh towards LDC graduation and beyond: (1) Heightened reliance on LDC-specific international support measures (most notably in terms of preferential market-access); (2) Lack of export diversification and over-reliance on low-technology textile and clothing products; (3) Dependence on external development finance, predominantly in the form of migrant remittances, to support capital accumulation; and (4) Exposure to the far-reaching effects of climate change.

Bangladesh plans a GDP growth of 7.2 per cent in 2022, which should come out at the high end of what other developing countries are projecting. As expected, developing countries will outpace the global average GDP growth rates, but inflation and exchange rate management challenges remain.

Based on the UN Global Policy Model, UNCTAD's Trade and Development report calculates overall global nominal GDP growth for 2022 at 3.6 per cent, driven by developing countries delivering 4.7 per cent nominal growth.

Compounded by rising commodity prices and ensuing inflation pressures, real income growth has been negative in much of the eurozone. According to UNCTAD's Global Investment Trend Monitor, global FDI rebounded strongly in 2021, but recovery was highly uneven across regions and sectors. Infrastructure finance increased due to stimulus and greenfield projects in industry were still weak.

Global FDI flows showed a strong rebound in 2021, up 77 per cent to an estimated $1.65 trillion, from $929 billion in 2020, surpassing their pre-Covid-19 level. Developed economies saw the biggest rise by far, with FDI reaching an estimated $777 billion in 2021 – three times the exceptionally low level in 2020.

According to the UNCTAD, FDI flows to developing economies increased by 30 per cent to nearly $870 billion, with a growth acceleration in East and South-East Asia (20 per cent), a recovery to near pre-pandemic levels in Latin America and the Caribbean, and an uptick in West Asia.

Net portfolio flows to developing countries are largely driven by non-resident investment in debt and equity. Of the total increase in global FDI flows in 2021 ($718 billion), more than $500 billion, or almost three quarters, was recorded in developed economies.

On the economic front, the dramatic collapse of output, as countries locked down to contain the spread of the virus, was so dramatic as to trigger unprecedented responses. Massive central bank action in rich countries stabilised financial markets and aggressive government spending cushioned firms and households against the worst of the downturn.

The liquidity risk associated with an expansionary fiscal policy is higher. For Bangladesh, progressive stages of economic development are associated with typical liquidity risk configurations. Non-investment grade countries such as Bangladesh have trouble accessing international credit markets, while exports and remittances are often the only sources of foreign currency.

With impending LDC graduation, Bangladesh can expect declines in international commitments related to official development assistance. The recent decision of the government of Bangladesh to utilise $313 million from its foreign currency reserves for the purpose of investing in capital projects is likely to emasculate the foreign investor community's confidence in its monetary policy discipline and might serve as a precursor to a sovereign rating downgrade.

The reality is that Bangladesh is highly dependent on global finance to support its balance of payments. The regime change in its interest rate environment resulting in a downward shift in its yield curve positioning is likely to further constrain both short and long-term debt inflows.

While speculative capital inflows can overwhelm the domestic financial and credit markets, sustained above-average risk-adjusted returns can ensure sustained portfolio flows into the capital markets. From this point of view, it is market discipline, or being exposed to liquidity risk, that will prevent the country's policy-makers from spending their way to a structurally supportable path of debt sustainability.

If mitigating liquidity risks is a national policy target, addressed, for example, by price and capital controls, it is mainly coordination between fiscal and monetary policies that will provide the needed policy space for the government of Bangladesh to ensure sustainable growth and development.

While the independence of Bangladesh Bank is clearly inhibited by the mere existence of the banking division within the finance ministry, achieving the required degrees of policy coordination around a pro-development revamp of the national financial architecture is not trivial.

The expansion of Bangladesh's external balance sheet can gain momentum with the participation of direct investors (i.e., FDI) and asset managers from advanced economies, in addition to targeting foreign currency-denominated corporate bond markets, increasing their participation in the country's domestic bond markets.

While government bonds dominate Bangladesh's fairly underdeveloped secondary bond market, greater reliance on domestic-currency denominated public debt mitigates the currency mismatch in its balance sheet and creates duration mismatches arising from the prohibitive costs of issuing long-term government securities and weak governance of asset-liability immunisation risk. With limited access to non-deliverable forwards or active swap markets, it also shifts the currency risk to prospective global lenders, thus heightening exposure to speculative, non-resident investor behaviour.

As a result of these vulnerabilities, strongly net negative, if fluctuating, portfolio flows to Bangladesh can translate into a vicious cycle of currency depreciation, weakening debt sustainability, and reduced fiscal spaces.

Long-term FDI is thus a lower risk approach in support of Bangladesh's structural transformation, triggering reductions in sovereign credit spreads and driving up the value of foreign currency-denominated debt, thus also affecting private borrowers' balance sheets and refinancing risks.

The author is a global managing director at DelMorgan & Co. Investment Bank, USA.