Trade reform can help Bangladesh strengthen its competitiveness and diversify exports to attain its vision of becoming an upper middle-income country by 2031, said a new World Bank report, The Bangladesh Development Update April 2023, Trade Reform: An Urgent Agenda.
Bangladesh navigated the pandemic shock with prudent macroeconomic policies and real GDP growth rebounded to 7.1 percent in FY22. This recovery was supported by the containment of the COVID-19 pandemic, the resurgence of external and domestic demand, and government stimulus packages and policy support.
The economy faces rising inflationary pressure. Inflation increased up to 9.5 percent in August 2022, as commodity prices continued to rise, and the taka depreciated. Significant administered price adjustments of energy and electricity coupled with exchange rate depreciation contributed to rising inflation in the second half of FY22.
The Balance of Payments (BoP) has widened. The BoP deficit reached $5.3 Billion in FY22 following a surge in imports and a decline in remittance inflows. While imports declined in the first half of FY23, the BoP deficit widened to $ 7.2 billion as a sharp contraction in trade credit and lower medium- and long-term borrowing contributed to a financial account deficit.
A complex multiple exchange rate regime has distorted market incentives. Foreign exchange reserves came under pressure in FY22 as the BoP deficit widened. A multiple exchange rate introduced in September 2022 has disincentivized export and official remittance inflows while contributing to economic uncertainty, worsening BoP pressure.
Monetary policy was tightened, while financial sector vulnerabilities deepened. An accommodative monetary policy was tightened towards the end of FY22 and in the first half of FY23. However, the transmission of higher policy rates was impaired by a cap on lending rates. Tight liquidity conditions and narrow net interest margins weighed on private sector credit growth. Financial sector vulnerabilities deepened, with a rise in non-performing loans, weak capital buffers, and bank governance challenges.
The fiscal deficit widened, although Bangladesh remains at a low risk of debt distress. The fiscal deficit widened to an estimated 4.3 percent of GDP in FY22, from 3.7 percent in FY21. External debt rose to 33.6 percent of GDP in FY22, from 32.4 percent in FY21, excluding guarantees. The January 2023 joint World Bank-IMF Debt Sustainability Analysis (DSA) assessed that Bangladesh remained at low risk of debt distress.
Real GDP growth is expected to be 5.2 percent in FY23, weighed down by elevated inflation, tighter financial conditions, disruptive import restrictions, and global economic uncertainty. Growth is expected to accelerate in FY24 and converge to around 6.5 percent over the medium term, as inflationary pressure eases, external conditions improve, and reform implementation gains momentum. The fiscal deficit is expected to widen in FY23 as subsidy expenditures rise, moderating over the medium term. Downside risks include slowing demand in Bangladesh’s major export markets and unresolved financial sector vulnerabilities.
Priorities for sustained growth momentum amid global uncertainty
- The report highlights Bangladesh’s difficult policy tradeoffs, pointing to market-based monetary, fiscal, and structural policy instruments to sustain growth, rather than price and quantitative controls.
- Monetary policy would be enhanced by adoption of market-based lending interest rates, and inflation targeting.
- Incorporating international good practices in banking legislation can help reduce financial sector vulnerabilities.
- Adoption of a single, flexible exchange rate would reduce distortions and strengthen the external position.
- Fiscal policy can be adjusted to support macroeconomic stabilization, supported by external borrowing.
- Trade reform can accelerate economic growth by reducing tariff and non-tariff barriers, lowering trade costs, and easing bottlenecks to trade in services.