III. ECONOMIC TRENDS AND OUTLOOK Major Trends and Outlook Lying between the eastern arm of India and the Bay of Bengal, Bangladesh is a semitropical riverine nation with fertile soil and high vulnerability to floods. Once the main source of jute and other agricultural raw materials for the British Indian city of Calcutta, the land of what is now Bangladesh continues to be farmed extensively, and most Bangladeshis still make their living from agriculture. With its 120.5 million people crowded into an area the size of Wisconsin, Bangladesh has the highest population density of any country, excepting city-states like Singapore. Present-day Bangladesh became part of Pakistan when the British withdrew from the Indian subcontinent in 1947. Disputes with the West Pakistanis led to a bloody war of independence in 1971 and to the creation of the new nation of Bangladesh. Since 1971, Bangladesh has remained one of the world's poorest countries, although agricultural output has increased steadily over the nation's 23-year history. During that time, Bangladesh's difficult circumstances have drawn significant assistance from developed nations. Bangladesh receives annually the equivalent of 6-8 percent of GDP in foreign assistance, and would get even more were it not for local bottlenecks that cause projects to back up in the aid "pipeline." Given a respite from natural disasters and major political unrest, Bangladesh's democratically elected government was able to take some additional steps towards economic reform, a process begun in the mid-1980s, in Bangladeshi fiscal year 1993. (Bangladesh's fiscal year (FY) runs from July 1 to June 30.) Major changes in Bangladesh's fiscal and trade regimes and the liberalization of the foreign exchange regime have helped open markets. Although these changes, along with reforms in industrial, agricultural, and financial regulations, have not yet produced dramatic increases in investment, some observers believe it is only a matter of time and the important thing is for reform to continue. The macroeconomy appears healthy, with record low inflation, a declining fiscal deficit, substantial foreign exchange reserves, and a reduced current account deficit. Stable growth in rice production and garment exports are expected to keep economic growth this year roughly equal to last year's 4.46 percent growth rate. The overall microeconomic picture, however, is less encouraging. The government made little progress in privatizing inefficient state-owned industries or reducing the public payroll. Bureaucratic bottlenecks, labor strife and a deteriorating law and order situation continue to discourage most domestic and foreign investors, keeping Bangladesh from reaching the 6-7 percent sustained annual economic growth rate necessary to lift it out of poverty. The Bangladesh government (BDG) hopes to boost GDP growth to an ambitious 6 percent in the coming year. This will require another good crop, a rise in foreign aid utilization, and significant progress in expanding the role of the private sector. A looming cloud on the horizon, the country's population is expected to double to over 200 million in the next 30 years. This is despite the significant achievement of a family planning program that has reduced the population growth rate from 3.0 percent at the country's birth in 1972 to 2.1 percent in 1994. Without accelerated industrialization and greater private sector involvement, population pressure therefore continues to undermine future economic stability. Import Trade: (Note: All trade figures are calculated in nominal dollar terms.) Official imports rose dramatically in FY93, up 15 percent after a 0.4 percent decrease in FY92 and an even larger decrease (7.7 percent) in FY91. This appears mainly due to a surge in the global price of raw cotton and a shortage of cotton aggravated by Pakistan's recent ban on raw cotton exports. The price of yarn imports has risen by 20-30 percent, caused by the poor quality of government yarn stockpiles and by a yarn shortage in India which has reduced smuggling into Bangladesh. Tariff liberalization, the continued growth in garment production (which uses more than 70 percent imported inputs), and a slight rise in industrial production have also spurred imports. By all accounts, unofficial imports, basically border trade with India, have increased sharply over the past year because of a 35 percent depreciation of the rupee to the taka. Export Trade: Exports increased by 12.4 percent in FY93 down from 13.8 percent growth observed in FY92. The growth in garment exports, still by far the most dynamic performer in Bangladesh's economy, continued to taper in FY93, up only 18 percent compared to growth rates exceeding 30 percent in the previous three years. At over $1.2 billion in FY93, garments now make up roughly half the value of Bangladesh's total exports. However, because most of the trade consists of assembling imported cloth for re-export, the total value added to garments in Bangladesh is only about one fourth of the exported value. Bangladesh began exporting garments only in the early 1980s, but growth in the industry since that time has been phenomenal, partly due to the imposition under the Multi-Fiber Arrangement (MFA) of U.S. textile import quotas on Bangladesh's Asian competitors. Sharing credit for the success of garment exports is the Bangladesh government, which permitted garment manufacturers to skip customs formalities by providing access to bonded warehouses and to back-to-back letters of credit (which enabled foreign banks to finance operations) and otherwise leaving the manufacturers alone. However, Ministry of Commerce regulations require garment exporters to have 25-30 percent domestic value added in the case of most garments. Since this requirement is achieved normally through labor costs, the government has created incentives to encourage the use of locally produced fabric. While the aim of creating backward linkages with another domestic industry makes sense, most local textile manufacturers, particularly in the public sector, are not able to supply export quality cloth. Bangladesh's non-garment exports did well in FY93, although the base remains small. Frozen food exports (mostly shrimp) rose by 26 percent in FY93 to $165 million. Tea and leather exports increased slightly. The export of jute manufactured goods increased, but exports of jute specialty products were hard hit. A World Bank-financed jute restructuring program may breathe new life into the jute sector. For the short term, Bangladesh jute exports seem likely to continue to suffer from stagnant world demand and a shift in competitors' exchange rates. The 2.6 percent depreciation of the taka in FY93 over the average exchange rate prevailing in FY92 may have helped exports. Given Bangladesh's low domestic demand, hopes for accelerated economic growth must rest with exporters. To promote exports, the Bangladesh government will need to follow the pattern it established with the garment industry in granting relatively easy letter of credit facilities and bonded warehousing. Further arbitrary interventions such as the ban on wet-blue leather exports, or the 30 percent domestic value added requirement for garments, will short circuit export promotion efforts. Assuming that the growth in garment industry exports continues at current levels, that frozen food exports continue to rise with the introduction of semi-intensive shrimp farming, and that the government steers clear of major policy mistakes, export growth in FY94 should be in the area of 15-20 percent. Export growth may slump over the long-term as the phaseout of the MFA forces Bangladesh's garment industry to compete on the world stage without the benefit of quotas. U.S.-Bangladesh Trade: With slowing growth of Bangladesh's garment exports and a rise in imports from the United States, the U.S. trade deficit with Bangladesh dropped slightly from $644 million in calendar year 1992 (double the previous year's figure) to $641 million in calendar year 1993. The United States imported $886 million worth of goods from Bangladesh in calendar year 1993, mostly ready-made garments. U.S. exports to Bangladesh totaled $245 million in 1993, up 30 percent over 1992. Half of the 1993 performance is accounted for by a $111 million lease of McDonnell Douglas DC-10 aircraft and $7 million in parts and spares. However, traditional U.S. exports of wheat and fertilizer dropped dramatically in 1993. Telephone equipment and soybean oil are relative newcomers to the U.S. export market, although trade was still relatively small. More than half of all non-aviation U.S. exports to Bangladesh were financed by U.S. foreign assistance. Bangladesh is shifting a larger share of its garment exports towards the European Union, and U.S. garment imports from Bangladesh dropped slightly to $668 million in calendar year 1993. U.S. and Bangladeshi negotiators meet every year to review garment quotas under the MFA and establish quotas for new items as they come into production in Bangladesh. Recent years have seen some challenges to Bangladeshi garment exporters from U.S. labor groups protesting child labor practices, and from U.S. garment producers alleging that some products are being dumped or covertly subsidized. U.S. imports of hats and headgear rose significantly, to over $40 million in calendar year 1993, while frozen food imports continued to increase. Most other imports have risen over the past year, including imports of jute and jute products. The year 1994 may bring additional U.S. aviation leases or sales. Unless this happens, garment imports will likely push the U.S.-Bangladesh trade deficit to over $1 billion in calendar year 1994. Principal Growth Sectors Agriculture: Bangladesh maintained rice production at near commercial self-sufficiency in FY93, producing 18.3 million metric tons (mt). The Bangladesh fiscal year runs from June July 1 to June 30. Strong supply and the government's withdrawal of rice price subsidies propelled rice prices down by 20-30 percent, although prices have begun to rebound slightly with the depletion of large government stocks. Many farmers switched to wheat, resulting in a 10.4 percent increase in wheat production (1.2 mt) in FY93. The gains in crop production resulted from greater use of fertilizer, irrigation, and high yield varieties of rice. The private sector now handles all commercial wheat sales and distribution. Wheat imports are predicted to rise to meet the needs of a large and growing population. In FY93, Bangladesh imported 1.14 million mt of wheat, of which 716,000 mt was provided through various food aid programs. The donated portion of the country's wheat supply has dropped dramatically. In FY93, the U.S. government committed 243,000 mt of food aid to Bangladesh under the Title II and Title III PL-480 programs. Bangladesh also imported 427,000 mt of wheat on commercial terms, 70 percent of which came from the United States. Private imports accounted for about 80 percent of the country's commercial wheat imports. Under pressure from wheat millers and distributors, the Bangladesh government lifted restrictions on private sector wheat imports in July 1992 and waived duties charged to private importers. Taking advantage of the opening, the private sector imported 334,000 mt of wheat in FY93. However, the government reversed its policy in November 1992 by reimposing a 7.5 percent duty on wheat imports, while maintaining support for unrestricted imports. In July 1993, duties were raised to 15 percent. Private sector imports have since slowed. In FY93, the U.S. Export Enhancement Program (EEP) supported sales of 198,000 mt of wheat to the private sector, and a larger share of U.S. foodgrain exports to Bangladesh will be on commercial terms in the future. With the increase in private wheat imports and a slight shift from rice to wheat production, the government's reserve grain stocks at the end of April 1994 dropped to as low as 520,00 mt, the lowest level of stocks in recent years. Jute, the traditional "golden fiber" of Bengal, is Bangladesh's main cash crop, cultivated in rotation with rice on the country's wet, fertile fields. Industry advocates contend that millions of people in Bangladesh rely on jute for their livelihood. Although Bangladesh is still the world's leading jute exporter, the fiber's prominence has slipped in recent years as world demand for such jute products as carpet-backing and burlap bags has stagnated or fallen. Heavy government involvement in procurement and processing has also contributed to jute's decline. Exports of jute and jute goods decreased slightly, from 927,000 mt in FY92 to 824,000 mt in FY93, bringing in $366 million in FY93. Jute exports to the United States increased from $17 million to $18.6 million. Cotton production in FY92 rose by 72 percent to 110,000 bales, a record harvest. Sugar constitutes a large domestic agroindustry, but production is still not adequate to satisfy domestic demand. Growth in the industry is impeded by a high level of state involvement that tends to force up production costs, allowing smuggled Indian sugar to infiltrate the market. Industry: Growth increased moderately in the production of jute goods and significantly in the production of urea and petroleum products, as well as in garments. Despite improved project aid disbursements and liberalized tariffs and duties, manufacturing industries continue to contribute only about 10 percent of GDP. If construction, power, and utilities are added, the contribution of industry to real GDP was 18.1 percent in FY93. Overall, the industrial growth rate increased slightly from 7.1 percent in FY92 to 7.4 percent in FY93. The slow pace of industrial growth can be partly attributed to a lack of policy implementation and coordination, as well as business frustrations with bureaucracy, labor strife, and a deteriorating law and order situation. Without significant changes in the public sector and increases in private and foreign investment, no dramatic upsurge in the country's industrial growth rate is likely. The government describes privatization of public sector industry as a major priority and recently formed a Privatization Board to facilitate the process. However, little progress has been made in selling off or shutting down parastatal enterprises. As of December 1993, the government had privatized only two of the 42 public enterprises which it slated for privatization in 1991. Power and telecommunications have been opened up to private investment. While a few private contracts have been negotiated in the telecommunications sector, none has yet come forward in the power sector given the absence of a clear-cut government policy with respect to the future role of the Power Development Board and pricing and subsidy issues. The World Bank has negotiated a jute restructuring package which is geared to accelerate the privatization of public sector jute mills. Assuming that some further reforms will be made but that the public sector remains largely intact, overall industrial growth should continue at 7.5 percent in FY94. Overall real GDP growth could be as high as 5.5 percent, but will probably remain around 4.5 percent in FY95. Government Role in the Economy Bangladesh's industrial development has been hampered by a strong government commitment, common in South Asia, to intervention in trade and industry. Some privatization and liberalization measures followed an initial burst of nationalization at independence, but the government's uneven efforts in this area have generally yielded unimpressive results. Efforts at reform often run afoul of vested interest groups, such as public sector labor unions or domestic producers in import-competing industries. The public sector accounts for only about one-fourth of Bangladesh's industrial output, but exercises a dominant influence on industry and the economy. Most public sector industries, including textiles, jute processing, and sugar processing, are perennial money losers, draining the treasury and setting high wages that their private sector counterparts often feel compelled to meet out of fear of union action. Moreover, the fact that crucial infrastructure--power, telecommunications, railroads, and the national airline--is in the public sector tends to limit private sector productivity. Balance of Payments Situation The current account deficit, having fallen dramatically from $1,541 million in FY90 to $516 million in FY92, increased marginally to $535 million in FY93. A drop in the pace of export growth, a rise in imports, and falling net investment income acted to increase the current account deficit in FY93, though it still remained low because of an 11 percent surge in wage remittances from overseas workers. Despite a slight drop in aid disbursements, Bangladesh ran a substantial balance of payments surplus of about $518 million. This surplus in turn generated continued growth in the Bangladesh Bank's (central bank's) foreign reserves, from $1.6 billion (end-FY92) to $2.1 billion (end-FY93), equivalent to over six months of imports. While the increase in reserves is intrinsically desirable, it also reflects the low demand for imported capital goods and low rate of economic growth for FY94. Hard currency remittances from Bangladeshi workers abroad, many in the Middle East, are expected to continue increasing, promising to offset further the balance of payments deficit in FY94. At almost $1 billion, remittances made through the Bangladesh Bank were up over FY92, thanks in part to reconstruction projects following the Gulf War. The exchange rate depreciated by two percent during FY93 to 39.8 taka to the dollar at end-FY93. The Bangladesh Bank follows a semi-flexible exchange rate policy of revaluing the currency on the basis of a weighted basket of economic indicators. Although the high level of reserves suggest the taka is overvalued, with a black market rate close to the official rate, the exchange rate has been stable. The taka's market value, however, is bolstered by the large sums of foreign exchange Bangladesh receives every year through aid transfers. Noting that the real exchange rate for the taka has risen vis-a-vis exchange rates for the currencies of export competitors such as India and China, some economists and exporters now argue for further devaluation. The government recently declared the taka fully convertible on the current account. It also has taken steps to liberalize further the foreign exchange regime. However, various limitations still continue to be placed on foreign exchange transactions. Assessed on the basis of outstanding principal, Bangladesh's national debt was $13.5 billion as of June 1993, up 11 percent from the June 1992 debt of $12.2 billion. Because virtually all of the country's outstanding external debt has been granted on highly concessional terms (e.g., 1 or 2 percent interest, 30-year maturity, and a 20-year grace period) by donor nations and multilateral lending institutions, the net present value of the debt is far lower than the face value. In addition to the national debt, Bangladesh owes about $1.19 billion to the United States as an obligation incurred through PL-480 Title II and Title III food disbursements. Trade and Investment Barriers Officially, private industrial investment is completely deregulated and the government has significantly reduced the time and hassle to register investments. However, while registration has been simplified, domestic and foreign investors typically must obtain a series of approvals from various government agencies in order to implement their projects. Bureaucratic red tape, compounded by rent-seeking activity, slows decision-making. The lack of effective commercial laws makes it difficult to enforce business contracts. Barriers to investment also include the country's low labor productivity, poor infrastructure, and an uncertain law and order situation. The government has been liberalizing one of the most restrictive trade regimes in Asia. Tariff reform was accelerated significantly in FY93 by the compression of customs duty rates into a range of 7.5-100 percent for most products. In July 1992, the government replaced an import sales tax with a trade neutral VAT, leaving only the 2.5 percent "advance income tax" to be removed to make customs duty the only protective instrument for most imports. The number of products subject to an import ban or restriction was cut in half between FY92 and FY93, and import procedures have been streamlined. The cumbersome procedure for opening letters of credit also has been liberalized. Labor Force The formal sector in Bangladesh has an estimated 4.8 million workers, with 1.4 million (30 percent) employed in public enterprises. Total underemployment and unemployment in Bangladesh is loosely estimated at 30 percent. Real wages have not increased appreciably in the past decade, labor productivity continues to be low, resulting from poor management and inefficient infrastructure and machinery. Over the past 17 years, more than 1.2 million Bangladeshis have worked overseas, officially bringing in over six billion dollars in foreign exchange. Although labor unions in public enterprises represent only three percent of the work force, most are aligned with political parties and wield significant influence. They have a reputation for militancy, especially in the jute, textile, and transportation sectors. Local and Third Country Competitors in Principal Sectors Bangladesh's top ten trading partners, in descending order of value traded, are: Japan, the United States, Hong Kong, India, China, Singapore, Saudi Arabia, Canada, Germany, and Indonesia. Among its major export items, the United States faces competition in telecommunications from Japan and France, in cotton from Pakistan and the Commonwealth of Independent States, in wheat from Australia and Canada, and in aircraft from Europe. Competition for procurement contracts comes mainly from Japan, France, the United Kingdom, and South Korea. On the investment scene, Hong Kong, the United Kingdom, and Japan are the major foreign players. Hong Kong, South Korean, and local investments dominate the garment industry, in which individual investments tend to be small. Infrastructure Most observers give the transport sector mixed marks. The 6,600 kilometer primary road network is in relatively good shape and seems to be effective, giving rise to a reasonably good private trucking industry. Inland waterways are extensive and boat transport is pervasive in much of the country, despite some siltation and inadequate port facilities. Bangladesh's two major seaports, Chittagong and Mongla, handled 9.7 million metric tons of cargo in 1990-91. Chittagong (by far the largest port) has two container terminals and is generally viewed as effective, although expensive and corruption- riddled. Bangladesh's 2,800 kilometer railway system suffers from two different gauges, widespread ticketless travel, and old equipment. Bangladesh's power sector is inadequate and rife with corruption. Overloading and a lack of maintenance cause frequent trippings and outages. Damaged equipment, investments in standby generators, and wasted production time caused by power failures have reportedly cost some firms up to 30 percent of their value of production. The country's telecommunications services are also inadequate. The government- controlled telephone service provides less than two telephones per 1,000 people. Most lines are analog, and the quality of service is poor, undermined by widespread petty corruption and a lack of equipment. Major Infrastructure Projects Underway Several infrastructure projects are just beginning. These include a $770 million project to build a bridge over the Jamuna river, the World Bank's Rural Road Maintenance Project-II (which will rehabilitate roads in the Northwest), and an Asian Development Bank program to rehabilitate railway cars. Chittagong is expanding its airport and has recently added 130,000 digital telephone lines. Bangladesh Biman Airlines is in the process of procuring additional medium-haul aircraft and may seek to lease or purchase more long-haul aircraft in the near future.