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Macro analysis: Growth number eclipses reality

Sharjil Haque | Published: May 08, 2016 17:49:21 | Updated: October 25, 2017 02:52:20


The annual ritual of GDP-growth debate has resumed with an all too familiar flavour: the government swatting away less optimistic growth figures coming from every direction. That the economy reportedly grew by 7.0 per cent adds a little spice to an otherwise mundane debate but says little about the underlying economic realities. True, in a subdued global environment, anything above 6.5 per cent growth is exceptional. On top of that, domestic inflation slid below 6.0 per cent, exports grew by11+ per cent (July-April FY 16), terms of trade improved from lower import prices, external debt stock as well as its servicing cost remained low, foreign reserves continued to rise, lending rates came down and government officials received long overdue pay hikes. 
This is still the only side of the story. Economic stimulus through pay hike of government employees is a temporary shot in the arm, and is unlikely to sustain higher growth rate. Reserve build-up from persistent current account surplus, reflects the economy's state of under-investment. By extension, banks have been drowning in excess cash to the point where call money rate collapsed to historic lows. Their profitability is hit from falling yields on government bonds and central bank bills and scarce investment opportunities in the real sector. Firms have not really come forward to capitalise on falling lending rates. On the other hand, corporate (and individual) savers are earning lower returns from deposits, and almost nothing in inflation-adjusted terms. Lower income in the real and financial sector has obvious implications for revenue collection and critical public expenditure. So, the net effect of lower interest rates on the economy seems ambiguous at best and detrimental at worst. 
It should not be surprising that lower borrowing cost has not yet catalysed private investment. Local and foreign entrepreneurs shy away from investing in an economy where getting electricity and land, minimising transport costs, enforcing contracts, trading across borders and accessing affordable capital are all uphill battles. Undoubtedly, infrastructure spending would ramp up private investment; but that is a lot easier said than done. A lot depends on the government's ability to operationalise Special Economic Zones and implement the proposed 'capital budget' consisting of mega infrastructure projects (nuclear power plants, major bridges, deep sea port, elevated expressways etc). That said, big projects have long gestation periods, so priority must also be given to Annual Development Programmes (ADP). But if past record is any guide, one must wonder if the necessary resources can be generated for such ambitious capital spending? 
The less said about tax collection the better. Fundamental challenges such as narrow tax base, lack of automation, tax evasion by the super-rich and illicit outflow of funds undeniably hold back Bangladesh's infrastructure financing potential. Assuming the new VAT law boosts revenue growth to a certain extent, authorities would still have to finance fiscal deficit around 4-5 per cent of GDP (gross domestic product) if they want to kick-start infrastructure development. 
Here lies the need for directing a portion of Bangladesh's growing stock of foreign exchange reserves for productive public expenditure. No doubt, return on investment would be far higher than the paltry interest that reserves generally earn in foreign government bonds (as a matter of fact, reinvesting now in short-term European debt will earn negative interest). Introducing a dynamic strategy where reserves in excess of 5-6 months of import cover are allocated for infrastructure financing is the logical way forward. 
Collecting resources is only one side of the coin. Better spending is the other. A recent study by the IMF revealed that countries with the most efficient public investment get "twice the growth bang for their public investment buck" than the least efficient. No points for guessing Bangladesh's rank in this efficiency spectrum. That public investment worth a non-trivial 7.0 per cent of GDP has hardly eased infrastructure constraints is evidence of low spending quality. Higher accountability and transparency in cash management, government procurement process, project management, monitoring and evaluation are steps long overdue. Consulting specialists to boost resource-absorption or implementation capacity may also be considered. Such reforms will also accelerate disbursement of concessional loans from development partners.
Strengthening public finance needs to be complemented by efficient financial markets. A banking sector plagued by bad assets and a bond market lacking depth does not help business expansion. Only time will tell if the recently appointed 'observers' to public banks can put a dent on non-performing loans. In the meantime, deepening the bond market will enable the government to finance fiscal deficits and provide retail, SME (small and medium-sized enterprises) and large corporates a new channel for investing and borrowing. Strong bond markets also strengthen monetary policy's interest-rate transmission and compel banks to be more efficient. With national savings rate rising this year, it is high time to deepen the debt market. 
This will require an enabling regulatory environment with incentives such as tax exemptions, issuing benchmark bonds, establishing robust trading platforms with effective clearing and settlement systems, stimulating liquidity in secondary market by simplifying trading procedures and encouraging institutions to trade bonds, developing various corporate debt instruments and finally, establishing market with instruments of long maturities to hedge against interest rate, exchange rate and default risks. 
To be sure, a period of sustained manufacturing boom requires both domestic as well as foreign demand. For all the hypes around Bangladesh becoming increasingly integrated with the global economy, trade policy still suggests the opposite. Be it rolling back trade restrictions to diversify exports, exploring higher value-added products or striking free-trade agreements, Bangladesh is rapidly falling behind global trends. 
The matter does not end there: optimising trade flows requires careful exchange rate management. A number of commentaries in this financial daily have pointed out the appreciation of Bangladesh's (trade-weighted) real effective exchange rate (REER) due to high inflation-differential with major trading partners. Another factor which contributed to this unwelcome development is rapid appreciation of the Taka-Euro nominal exchange rate. Pegging the Taka implicitly to the Dollar means the former will appreciate with respect to the Euro whenever the Dollar does the same. For instance, in the 12 months ending in April 2015, the Dollar appreciated by around 20 per cent against the Euro. Small wonder that Bangladesh's REER also shot up during the same period. 
On a positive note for Bangladesh, the Euro recently started gaining value thanks to a more dovish outlook from the U.S. Federal Reserve (Fed) on future policy rate hikes. However, this scenario could reverse if and when the Fed feels more confident of raising rates. So what can be done? Authorities could consider adopting a basket of trading partners' currencies as benchmark for foreign exchange intervention instead of keeping the Taka roped only to the U.S. Dollar. Considering the need for trade competitiveness in Euro terms, this strategy could be a stronger guide to exchange rate management.
Sadly, even an endless list of reforms will not sustain higher investment and more inclusive growth if political condition takes a turn for the worse. Be that as it may, authorities can no longer delay reforms which will raise confidence of private investors - domestic and foreign. Decisive action is essential. 
Sharjil Haque currently works as a macro-economic research analyst for an organisation in Washington, D.C. 
sharjilmuktafi.haque@gmail.com

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