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2010 Bangladesh Economic Update

May 17, 2010

May 17, 2010 - Bangladesh has maintained fiscal discipline despite recurring external economic shocks, natural disasters, and widespread poverty and social needs. Given a highly constrained revenue capacity, Bangladesh has allocated spending well to meet strategic priorities with healthy GDP growth.

" Growth in the next fiscal year hinges on remittances, easing of energy constraints, and pursuit of structural reforms. We expect GDP growth in the range of 5.5-6%. Achieving growth at the higher end of the range will require major efforts to address the country’s energy constraints  "

Sanjay Kathuria

Lead Economist for Bangladesh

Growth still robust in FY10

GDP growth in FY 2010 (July 1, 2009 - June 30, 2010) has been driven by growth in consumption and public development expenditure. Growth throughout FY 2007-09 in Bangladesh was driven mainly by consumption, over 60% of growth in GDP. In FY 2010, private consumption growth is likely to be sustained by remittances, which grew by 17.4% in the first nine months.

In addition, growth in non-rice agriculture appears to have sustained growth in rural incomes and hence private consumption. Public consumption expenditures received a boost from a 52% average increase in public sector pay and an additional stimulus package for the export-oriented sectors.

Energy shortages stifling growth

Energy shortages, however, pose perhaps the biggest threat to Bangladesh’s growth recovery. The present demand for electricity varies between 4,200 MW and 5,500 MW and it is expected to rise to 6,850 MW within the next two years. Maximum generation currently available is between 3,800 MW and 4200 MW. The estimated demand supply gap currently is 2,000 MW in peak hours.

Gas shortages account for at least half of this gap. Power and gas shortages have undermined external competitiveness. According to garment industry leaders, garment orders cannot be fulfilled because of energy constraints. Frequent power cuts and low gas pressure add to shipment time, forcing exporters to airfreight the merchandise at their own cost. Power cuts and gas shortages have reportedly rendered a significant part of the country’s garment capacity idle.

Progress in expanding power generation remains slow. To combat the acute power shortages, the government plans to increase power generation to around 7,000 MW by 2013. However, power plants continue to suffer from gas shortages, despite some recent measures to increase gas supplies for power production. Short-term solutions being floated include diesel - and furnace oil-based rental power plants which can start generation within a short period of time, but these are higher cost routes and will reduce competitiveness of firms. In 2009 and 2010 so far, 586 MW of power were added to the national grid.

Inflationary pressure rising

Inflation rose to 9% in February 2010, from 2.2%in June 2009. This sharp increase was driven by food inflation arising from a shortfall in domestic rice production, rising world food prices, and high food inflation in India. Non-food inflation also rose, from 3.7% in July 2009 to 6.1%in February 2010. While domestic agriculture output and world food prices are likely to have a strong bearing on inflation in the next few months, an incremental tightening of monetary policy, as announced in the Monetary Policy Statement for the second half of FY10, can also help dampen inflationary pressures. An incremental tightening of monetary policy, announced in the Monetary Policy Statement for the second half of FY10, may help dampen inflationary pressures.

Aggregate Fiscal balance sustainable

The fiscal deficit remains sustainable, underpinned by good revenue performance. It is projected to be contained at around 4% of GDP in FY10, well within the sustainable threshold. This is slightly higher than last year’s fiscal deficit of 3.7% of GDP - and derives from the implementation, retrospectively, of the public sector wage increase, higher safety net expenditures, a likely further boost to the Annual Development Program (ADP) this year, and a potential increase in energy and fertilizer subsidies because of rising international prices.

Growth Outlook

FY11 growth outlook is dependent on the easing of domestic supply constraints, particularly energy. Global recovery is off to a stronger start than initially anticipated. Currently, supply issues are more problematic than those of demand; Energy shortages will continue to stifle Bangladesh’s recovery. The estimated demand-supply gap is currently one-third of demand (2,000 MW) in peak hours. Gas shortages account for nearly half of this gap.

Maintaining growth at its recent 6% average over the medium term will thus be a challenge for Bangladesh, given the current infrastructure and energy deficits. Redressing this will require domestic reforms and increasing trade integration with countries in the region and the rest of the world.

The Bangladesh Prime Minister’s visit to New Delhi earlier this year helped to promote Bangladesh-India cooperation in security, power, trade, connectivity, water sharing, and resolution of other long-standing bilateral concerns. If fully implemented, these will lay the basis for higher investment and growth by improving energy security and connectivity.