External sector vulnerabilities amid uncertainties

It was earlier, in May 2023, pointed out that a significant share of Bangladesh’s on-going macroeconomic challenges originated in the dismal performance of the external sector and the uncertainties faced by the external sector balances, and that a recovery of the economy will need to be triggered, to a large extent, where these problems originated in the first place-the external sector and the external balances. Regrettably, the hoped for recovery from the then prevailing scenario is yet to be visible. Although over the past several months key policymakers engaged with external sector management have been trying to project a bullish stance, with forecasts about getting out of the on-going situation over the subsequent periods of every 2-3 months, these have proved to be rather optimistic. The volatilities and uncertainties have continued to persist and sustain.

Key external sector performance correlates such as the state of exchange rate stability, adequate forex reserves, robust export performance, availability of required forex for L/C openings, remittance flows in view of the outflow of migrant workers, and other relevant indicators, all transmit the signal that the disquieting developments experienced in FY2023 have continued to inform the external sector performance during the early months of FY2024 as well.

True, the Bangladesh Bank has taken a number of measures to improve the balance of payments situation and arrest the falling forex reserves, including the pre-emptive measure of negotiating the US$ 4.7 billion International Monetary Fund (IMF) loan. However, the measures are yet to deliver the expected results. And, also, at times, the very signals transmitted by policymakers have been rather contradictory. Whilst the trade and current account balances have posted some improvements in the early months of FY24, this has primarily been driven by a drastic reduction in imports. This was, however, attained at a cost- Bangladesh Bank’s conscious policy measure to discourage imports of selected items through various restraining measures, dearth of availability of foreign currency to open L/Cs and high price of the scarce dollar. It needs to be kept in mind that the fall in imports is likely to have a knock-on adverse impact on investment, employment, production as also Gross Domestic Product (GDP) growth over the near-term future. This is already evidenced from the lower GDP forecasts for FY2024 by several concerned agencies, including Asian Development Bank (ADB), IMF and the World Bank. A number of targets set out in the IMF support programme, as a condition for the release of the second tranche, could not be met. These included the amount of gross (BPM6) and net forex reserves, and the move to a market-aligned exchange rate management. Energetic steps to forestall capital flight have been missing, with signs of continuing transactions through informal channels and hundi/hawala routes. To add to the uncertainties, the reliability of external sector-related data has emerged as a concern.

While Bangladesh’s external debt situation is within the IMF-World Bank parameters of sustainability and medium-term debt carrying capacity threshold, the debt servicing liabilities of the country over the near and mid-term future are likely to significantly rise in the backdrop of higher interest costs, a larger share of non-concessional loans in the borrowing portfolio, and increasingly stringent terms of loans incurred in recent times. The rising debt servicing liabilities are likely to put further pressure on the country’s falling forex reserves. Unless external balances are stabilised, and external sector performance is put on the rails of the historical trends, it will not be possible to arrest and reverse the sharp drawdown of the forex reserves. Macroeconomic management will remain rather challenging under the prevailing scenario and the economy will continue to face increasing uncertainties and growing risks.

The following sub-sections present some of the major challenges afflicting the external sector performance during July-November, FY2024, and offer some policy measures to address the attendant challenges going forward.

BALANCE OF PAYMENT SCENARIO: A reversal is yet to be seen The BOP scenario has continued to experience serious difficulties during July-October, FY2024 when the corresponding period of 2023 is taken as the comparator. While some improvements are discernible in the current account, this was driven primarily by the sharp decline (of 20.5 per cent) in import payments.

There can be no denying that the falling imports will have adverse consequences on key macroeconomic performance indicators and the growth of the GDP in FY2024. This was already noted above. In view of low FDI and portfolio flows and higher payment of trade credit, the financial account has fallen into negative territory, a reversal of fortune in many years. During July-October, FY2024 period, the financial account witnessed a decline of US$ 5.2 billion. This has contributed significantly to the falling forex reserves.

Overall, foreign exchange reserves (as per BPM6) have come down by about US$7.4 billion, from US$27.5 billion to USD 20.7 billion, between the end of October 2022 and the end of October 2023. The net reserves at present are estimated to be around USD 16.0 billion. Forex reserves are equivalent to 5.1 months of imports, taking the current average monthly import as the reference. If this is estimated by taking the average monthly imports of FY2023 as the reference, the reserves would be equivalent to only 3.5 months. If the net reserves (as noted, about US$16.0 billion) are considered, the purchasing power in terms of import equivalence and debt servicing capacity leaves room for serious concern.

EXPORT PERFORMANCE SCENARIO & CONFLICTING SIGNALS: Exports have been exhibiting quite erratic behaviour in recent months. If in FY23 export growth was primarily driven by the RMG sector (18.8 per cent) growth, in FY24 (July-November), the sector has experienced a significant deceleration in the growth over the corresponding period of FY23 (-2.7 per cent). This, for obvious reasons, has resulted in the low growth of overall export earnings during the first five months of FY24 (1.3 per cent). At a time of falling reserves, this trend is rather discouraging.

The terms of trade (defined here as the import earning capacity of the price of exports of one dozen RMG in terms of the average import price of selected imported commodities) evince a mixed picture. In the cases of palm oil and soyabean oil, the purchasing power (of one dozen RMG) was lower in FY24 (July-November) compared to the corresponding period of FY23. On the other hand, for crude oil, rice and some other commodities, there has been some improvement.

The export performance data reinforces the need to move into the higher value segment of the RMG market to improve the terms of trade. Intra-RMG diversification (focusing on non-cotton items such as MMF, Synthetic and polyester based items), as also extra-RMG diversification (assembling plant, pharmaceutical, leather goods, electronics etc.), along with market diversification must be given highest priority towards this. Attracting investment (both local and FDI) in the Special Economic Zones (SEZz) should be one of the key ways forward. To take advantage of the emerging export opportunities in the markets of the neighbourhood regions, triangulation of investment, multi-modal transport, and trade connectivities will be required.

Export Promotion Bureau (EPB) figures for the first four months of FY24 shows a negative growth of 3.1 per cent in RMG earnings from the US, compared to the corresponding period of FY2023. In contrast, US import figures show a significant decline of (-) 22.5 per cent! Similarly, the EPB figure for the first four months of FY24 shows an increase of 3.1 per cent in RMG earnings from the EU market compared to the corresponding period of FY23. In contrast, the EU import figure shows a decline of (-) 29.6 per cent! To note, the difference in export earnings arising from the conceptual distinction between Free on Board (FoB)  value of the EPB and Cost, Insurance and Freight (CIF) value of the reporting country can hardly explain these significant gaps in export earnings. Neither does the time difference between exports from source countries and import arrivals in destination countries (should cancel out over time).

The anomalies in export earnings figures must be examined very closely. The Bangladesh Bank and the EPB, as also the National Board of Revenue (NBR), should sit together to address this issue and reconcile the figures and come up with actual export earnings figures.

One disconcerting development is the gap between the EPB data and the Bangladesh Bank data on export earnings has also been increasing at an alarming pace in recent past years, from US$2.1 billion in FY15 to US$12.1 billion in FY23 (Figure-1). At a time when every dollar counts, this substantial gap should be a reason for concern on the part of Bangladesh’s policymakers. Evidently, this high difference cannot be explained by discounts asked by brands and buyers or cancellation of orders (or the factors mentioned earlier). The widening gap should be a reason for heightened concern. Is repatriation of Bangladesh’s export earnings being deferred because of anticipated further depreciation of the BDT? Does it reflect capital flight through trade mispricing (under-invoicing)?

In view of the extensive reports as regards the significant capital flight from Bangladesh, primarily through trade mispricing, in the range of US$ 6.0-9.0 billion on average annually over the past ten years, concerned authorities must look into this matter with the urgency that it deserves.

GROWING DEBT SERVICING LIABILITIES: In the backdrop of Bangladesh’s Middle-income graduation, interest rates on the country’s foreign borrowings have experienced a significant rise. Share of non-concessional loans in the loan portfolio has been growing. Terms of borrowings are becoming more stringent (grace period and maturity period are coming down; loans are coming with surcharges and service charges). Principal plus interest payments on Bangladesh’s medium to long terms loans was US$ 5.3 billion in 2021, which rose to US$ 6.2 billion in 2022 (16.9 per cent growth). The corresponding figure was only US$ 3.7 billion in 2020. Also, some of the foreign borrowings of Bangladesh are being incurred in flexible LIBOR/SOFR rates (e.g. loan from Islamic Trade Finance Corporations (ITFC) was incurred at the interest rate of SOFR+2 per cent). As is known, in recent years LIBOR/SOFR rates have seen a significant increase (Table 5.5).

There is every indication that debt servicing liabilities will register a notable rise in the near and medium term future. Major credit rating agencies have downgraded the credit ratings of Bangladesh in the recent past in view of the challenges faced by Bangladesh as regards macroeconomic management and balance of payments situation (Table 5.6). Going forward, this could lead to higher borrowing costs. In all possibility, if and when the situation improves, these ratings will be revisited by the credit agencies.

The above calls for a designing a well-crafted external sector management strategy as also a road map for strategic debt management in moving forward.

REMITTANCE FLOWS - A LOW HANGING FRUIT: Remittance flows could have been a saving grace and salvation for Bangladesh in view of the falling foreign exchange reserves and the consequent woes. However, in spite of about 3.9 million people leaving the country since January 2019 (till November 2023), this is not being reflected in the remittance flows to the country in a corresponding manner (Table 5.7). Over the first five months of FY24 (July-November; 2023), remittance growth was only a lowly 1.1 per cent. Indeed, for the first three months, the growth rate was negative compared to the corresponding period of FY23. To recall, the amount was more than US$ 2.0 billion lower than for the corresponding period of FY21.

Although more than 2.0 million migrant workers went to Saudi Arabia during January 2021 and November 2023, remittance inflows have come down from US$ 2.6 billion in FY2021 (January-November) to US$1.26 billion in FY24 (January-November). Similar pattern also holds for Kuwait and Qatar and, to some extent, Malaysia. This raises a serious question. Why? There are clear indications that significant leakages of remittance are taking place through transfer to informal channels.

True, anecdotal information suggests that an increasingly large number of migrant workers are being issued out passes or facing extradition and returning back home. In spite of this, the fact of the large number of net outflow of migrant workers over the recent period cannot be denied.

There are indications that the significantly high difference between Bangladesh Bank-determined rates and the rates offered in the informal channels has created incentives for large scale move remittance flows from formal to informal channels. This is also reinforced by the fact that when in October 2023, an additional 2.5 per cent incentive for remittances was introduced (to be provided by the receiving banks, over and above the government-provided 2.5 per cent), there was an immediate spurt in remittance flows through formal channels during the months of October and November of 2023. Other measures to incentivise the sending of remittances through formal channels must be put in place (introduction of credit card for workers coming home, savings scheme, speedy transfer, reduced cost of sending, facilitation of transfers of money, recognition of the contribution of remitters to the country’s economy).

Along with market signals, there is a need to strengthen law enforcement and break up the power of hundi/hawala syndicates since no extent of BDT depreciation will dissuade capital flight-related transaction activities carried out by tax dodgers, wilful defaulters and those who want to get their ill-gotten and corruption money outside of the country.

MOVE TOWARD MARKET ALIGNED EXCHANGE RATE: May 2023 analysis carried out by the authors indicated that there was a significant gap between the then prevailing Bangladesh Bank-determined exchange rate (of US$1 = Tk 104.0) and the equilibrium rate (high bound). The estimates showed the need for further depreciation of the Tk in the range of 15 per cent. Since then Tk has depreciated by 8.0 per cent. Our more recent analysis, following our previous estimation method, indicates that there is a further scope for depreciation of Tk, in the range of about 7.0 per cent. As is known, the Bangladesh Bank has been gradually depreciating the Tk over the past several months. Consequently, the difference between NER and REER has come down significantly. There is space for further depreciation and there is a need to unify the prevailing multiple exchange rates. This will not only narrow down the difference between the formal rate and the kerb market rate, but will also dampen the expected pressure surround the exchange rate movement (further depreciation).

One understands why the Bangladesh Bank is pursuing a cautious policy with respect to exchange rate management (the apprehension about higher imported inflation, higher cost of debt servicing of taka denominated repayment of foreign borrowings). On the other hand, depreciation should incentivise remitters and raise the competitiveness of exporters. The trade-offs will need to be carefully weighed in moving towards an optimum equilibrium rate. The BDT exchange rate will need to approximate market determined rate, possibly within a corridor that will need to be supported by the Bangladesh Bank intervention, as and when necessary.

GOING FORWARD:

Some policy initiatives are required in the upcoming days to address the current vulnerabilities of the country’s external sector.  These are:

• A targeted initiative will need to be taken to streamline the discrepancies in the data concerning external sector-related correlates, particularly with respect to export earnings. There is a need to investigate the attendant reasons that are driving the wedge between the Bangladesh Bank data and the EPB data. The reasons being put forward must be thoroughly investigated. As was noted, higher flow of remittances could improve the country’s BoP situation significantly over the short-term future. The incentive to undertake this exercise on the part of policymakers should thus be very high. External sector data should be made more open and more transparent so that anomalies could be identified in an expeditious manner.
• The move towards a market-aligned exchange rate of Tk should be expedited, even if within a band. This will incentivise forex flows on account of exports (thanks to higher competitiveness) and remittances (transfer from informal to formal channels) and also help bring down the demand for foreign exchange via market signals rather than through administrative measures. Monetary policy will need to be well-coordinated with the fiscal policy towards sound exchange rate management and to manage impact of depreciation in view of imported inflation and implications for macro-economic management.
• The multiple exchange rates are creating not only confusion among market players, but this has proved to be difficult to implement as well. Incentivising the remittance flows is also resulting in a rising fiscal burden for the government, as also resulting in additional financial burden on the dealing banks. Both may prove to be unsustainable.
• Bangladesh’s apparel exports are becoming increasingly volume-driven. The need for moving upmarket has thus emerged as an urgent necessity. Incentives need to be recalibrated to encourage intra-RMG diversification and also to stimulate a move towards the growing market segment for non-cotton based exports.
• Sustainable debt servicing is likely to emerge as a challenge for Bangladesh over the near and medium-term, particularly in view of the ongoing drawdown on forex reserves. Government should pursue a cautious policy as regards foreign borrowings: by curtailing hard term borrowings, through proper prioritisation of foreign loan dependent projects and by ensuring good governance in the implementation of foreign-funded public projects. Negotiating capacity to deal with foreign borrowings must be strengthened. A well-thought out strategy concerning external borrowings and debt servicing must be crafted to avoid any future problems. Bangladesh must avoid falling into a debt trap.
• Any disruption in market access will have serious implications for export sector performance and, consequently, the economy. Bangladesh should take the needed steps in view of the concerns voiced by key export destination countries, in areas of labour rights, wages, environment and CO2 emission standards, governance and management of production processes. At the same time a concerted effort on the part of RMG-related business associations will be required to negotiate higher prices with global brands and buyers for Bangladesh’s apparel products. Pressure will need to be exerted so that brands and buyers agree to the establishment of distributive justice along the entire global value chain. Bangladesh’s entrepreneurs and workers should join global movements such as Fair Trade etc., towards this.

Going forward, a lot will depend on how speedily Bangladesh is able to stabilise its external sector balances and correlates. Concerned policymakers will need to pursue evidence-based policies to pull the external balances out of the current conundrum. Institutions such as Bangladesh Bank should be allowed to perform their mandated functions independently by keeping the interests of macroeconomic stability, inflation and interest rate targets, and higher GDP growth at the centre of their attention and activities.

Dr Fahmida Khatun, Executive Director, Centre of Policy Dialogue (CPD); Professor Mustafizur Rahman, Distinguished Fellow, CPD;

Dr Khondaker Golam Moazzem, Research Director, CPD; Mr Towfiqul Islam Khan, Senior Research Fellow, CPD; Mr Muntaseer Kamal, Research Fellow, CPD; and Mr Syed Yusuf Saadat, Research Fellow, CPD. [email protected]; [email protected].

[Research support is given by Mr Tamim Ahmed, Senior Research Associate; Ms Marium Binte Islam, Research Associate; Mr Mahrab Al Rahman, Programme Associate; Ms Anika Ferdous Richi, Programme Associate; Ms Zazeeba Waziha Saleh, Programme Associate; Mr Rushabun Nazrul Yaanamu, Research Intern; and Mr M M Fardeen Kabir, Surveyor, CPD.]