LDC graduation: Improving economic competitiveness

Total net official development assistance to Bangladesh is worth around US$2.57 billion (in 2015). The largest bilateral donor is Japan who provided $8.93 million as grant aid, $34.4 million as technical cooperation assistance and $422 million as loans (2015). USAID and other US agencies provided a total of $239.14 million in 2016 - primarily spent on the health sector. The remaining aid flow originated mainly from multilateral sources, EU and UK. To put this in perspective, total ODA represents 1.32 per cent of GDP and 7.37 per cent of exports of goods and services. Technical cooperation grants amount to 0.92 per cent of GDP (2015). In other words, aid dependence is low but remains useful at the 'margin'. However, the bulk of ODA is unrelated to LDC status while some of the technical cooperation and grants are possibly related to LDC membership. Graduation will not therefore substantially affect aid flows to Bangladesh.

Bangladesh benefits from a variety of preferential market access arrangements, and many of these are in fact attributable to its LDC status. The most important of these is its access to the EU market under the "Everything but Arms" (EBA) initiative, which provides DFQF treatment to its RMG exports. Under EBA all exports from Bangladesh are eligible for duty free treatment, subject to compliance with product-specific ROO. Inclusion of Turkey in the EU Customs Union also means that Bangladesh has similar access to the Turkish market as well. Access to the EU market has played a crucial role in the continued and sustained success of the sector.

Other countries also provide access under various Generalised System of Preference (GSP) measures including Canada, Japan and the US - although the US has withdrawn GSP privileges citing labour standard issues including the right to forming trade unions.

The Canadian GSP scheme for the LDCs was revised in 2002 when almost all tradable items were made eligible for DFQF treatment. Four excluded items were eggs, poultry, dairy and refined sugar. Bangladesh does not export these items save limited poultry exports to the Middle East.

About 84 per cent of US tariff lines are covered under the US GSP scheme for LDCs. As far as Bangladesh is concerned, US GSP is the most restrictive scheme amongst those provided by developed countries as it excludes the majority of its tariff lines relating to the apparels and textiles category.

Other countries that have provided GSP privileges to Bangladesh are China, India, Pakistan, Republic of Korea, Sri Lanka and Thailand under various RTAs (e.g. SAFTA, APTA and BIMSTEC).

Bangladesh is poised for graduation and fully expects to cross the initial review in 2018 and the final review in 2021. The main worry for Bangladesh is the increased duty its exports will face in EU, and to an extent in other less important trade destinations. The Bangladesh government is worried although the private sector seems confident it can weather the change. Estimates of 'loss' available seem to indicate a drop in exports of 6.5-7.0 per cent (UCTAD 2016).

Bangladesh's graduation strategy should be to improve its trade competitiveness and remove many of the inefficiencies and costs that still plague manufacturing and exports, including port congestion, poor roads, bottlenecks with energy supplies, improving labour skills etc. At the same time it needs to aggressively begin negotiations with existing partners as well as to seek out new export destinations including China, South Africa, Latin America while making more effort to diversify into new, higher value exports. Bangladesh's advantage is that it has a strong private sector, which is able to respond to global opportunities. However, as the success of RMG has shown, this requires policy innovation and government support, including export incentives and pro-private sector regulatory framework. The most invaluable policy innovation for the RMG sector was the 'back to back' Letter of Credit (L/C) which allowed exporters to use their contracts to gain import finance from banks. Such innovations need to be extended to other sectors and new ones encouraged.

Another potential area of worry is the likely withdrawal of Trade Related Intellectual Property Rights (TRIPS) of which Bangladesh is a beneficiary. Its highly successful pharmaceutical sector enjoys a relaxation of Intellectual Property Rights rules as an LDC, that allows it to produce generic drugs. Loss of this privilege may impart a huge blow to this promising sector unless cushioned somehow. The country will need to enter into negotiations for further relaxation of TRIPS but at the same time start to establish a world-class Research and Development (R&D) programme for the sector in order to survive the challenge.

NEPAL: AHEAD OF US? Nepal received ODA worth $1.2 billion and technical cooperation grants worth $133.9 million in 2015 - this is equivalent to 54.20 per cent of its exports or 5.70 per cent of GDP for ODA, and 0.63 per cent of GDP for technical assistance grants. Its top five development partners are World Bank Group, ADB, UN Country Team, EU and the Global Fund. The top five bilateral donors are UK, India, Japan, Norway and Germany. Its dependence on aid is high in a context of relatively low per capita income. It is poised to move out of the LDC status based on its good performance with regard to HAI and EVI. However, Nepal's aid portfolio is well diversified, and it seems unlikely that graduation will affect total flows adversely although in some instances the costs of borrowing may rise. Nepal's tax-GDP ratio is good by regional standards and this will also be helpful in adjusting to graduation.

Nepal enjoys trade preferences in two ways. One is through bilateral trade negotiations with India, which goes deeper than any other preferential treatment scheme available, and the other relates to privileges given by the quad countries (USA, EU, Canada and Japan) under the GSP.

There is a marked difference between the two despite both being non-reciprocal schemes. There is less predictability to the Indian market as access is regulated by time bound agreements, which may or may not be renewed or may be subject to revision. The QUAD agreements are not time bound but differ amongst them with respect to product coverage and rules of origin.

The US has excluded Nepalese apparels from the scheme while Nepalese manufacturers are frequently unable to comply with rules of origin due to ignorance or inexperience.

The main risk or advantage faced by Nepal relates to its land-locked location as well as its utter dependence on India for trade, aid and technology - somewhat akin to the situation of Bhutan. Nepal's superior performance in HAI and EVI should allow it to build further on this to generate competitive advantage in manufacturing to fully exploit access to Indian and Chinese markets, along with those in the QUAD countries. This should also translate to improved growth. A smooth transition for Nepal would require continued macro stability, fiscal discipline, revenue generation and addressing energy and infrastructure gaps.

It needs to be restated however, that Nepal has not exploited its market access benefits very well for different reasons, and therefore additional restrictions will not harm it very much. At the same time, it does mean that it will need to build its capacity to generate manufactured exports over time. In terms of concessional finance, it is relatively more dependent than its peers, and this does have the potential to cause hardship. Current India-Nepal tensions introduce some additional risk factors into this equation.

In other words, while Nepal did get approved by CDP for graduation in 2015 and will come up for confirmation in 2018 (and in this sense they are ahead), it faces a number of downside risks that could affect confirmation or post-graduation difficulties. Given that Bangladesh is set to achieve graduation on the strength of all three indicators, its journey ahead promises to be that much smoother.

CONCLUDING OBSERVATIONS: As far as 'other ISMs' are concerned, these constitute rather minor opportunities for the LDCs save perhaps for the smallest ones. Even then, access is constrained by poor information, complex bureaucratic mechanisms and inadequate preparation on the part of most LDCs. If these are to be made more meaningful, it is important to introduce simplicity, transparency and better information to countries.

In the context of concessional finance, it is not the case that it will completely disappear but only that the degree of concession will decline. Seen in conjunction with a parallel move to LMIC or middle-income status, the drop in concessional finance could hurt. The way forward is to generate more domestic resources and encourage FDI and other forms of financing, including Public-Private Partnership (PPP). Tax-GDP ratios in most countries are low, and therefore provide considerable opportunities to expand. This however, will require fiscal and institutional reforms in these countries. The presence of new donors in the neighbourhood is a positive sign suggesting supply of finance is less of a problem than good investments. Thus, LDCs must improve capacity for better management of large-scale projects in sectors like energy, infrastructure, health, education and skills. Graduation will also lead to lower risk ratings by e.g. Standard and Poor, which in turn will help to cut interest rates on loans.

For the larger countries, market access is crucial for structural transformation via industrialisation. In fact, preferential market access could be thought of as the the most important factor for export-led, labour-intensive manufactures that have played such a key role in in Asian industrialisation. Therefore, LDC graduation does pose a threat here, which needs to be carefully managed. There is some time available to enable a smooth transition but this time must be fruitfully utilised. Negotiations need to be started with key trade partners while on the supply side, every effort needs to be made to raise productivity and reduce costs. There is considerable potential as well as opportunities to enable gains in these areas, which however, will require investment, technical assistance, technology and political will. LDCs will also need to take R&D seriously, especially in areas like pharmaceuticals and higher-value apparels and leather goods.

Ultimately, the key factor is to improve economic competitiveness to ensure smooth, sustainable graduation. Becoming a 'developing country' is just a small step forward on this journey. Given that only five small countries have so far made this transition (Botswana, Cape Verde, Maldives, Samoa and Equatorial Guinea) even this small step does not appear easy.

The writer is Director General of Bangladesh Institute of Development Studies (BIDS). [email protected]