Bangladesh had a good run of robust economic growth since the early years of this century. It was rudely interrupted by the Covid-19 pandemic that swept across the world with amazing speed in 2019-20. Fortunately, Bangladesh bounced back to its high growth trajectory in 2020-21, and improved performance further during the next year. Impressive social index values, praised profusely by Professor A K Sen and multilateral agencies, added to the lustre. Not many seriously doubted the finance minister when he claimed impressive achievements in the budget speech of this year. Bangladesh had become the poster child of economic progress of the relatively low-income countries with a good international image and press coverage.
This widely held perception of Bangladesh as a model developing country took a hit with the onset of the Ukraine war, which severely affected the international gas and LNG market because of sanctions imposed by the collective West on Russia. The sky rocketing cost of international transportation added to the severity of the problem. The supply dried up and the prices, especially that of LNG, increased several fold.
Unable to import LNG at these high prices Bangladesh had to ration the limited supply. The hardest-hit were the gas or LNG driven power plants and some industries, especially garments. Suddenly load shedding returned with a vengeance, and the ordinary people of Bangladesh again experienced multiple electricity outages every day. The much-hyped development of the last decade lost its sheen as many power plants and industries either shuttered, or reduced their operation very considerably. The possibility of a recession cannot be dismissed outright.
Some authors, who wrote op-eds in national newspapers, wondered if Bangladesh could soon walk the Sri Lankan way. Several well-known international news media such as DW, Al Jazeera, the Guardian and the Times of India also carried reports that expressed a similar concern. The well-publicised visit of a team of Bangladesh Bank officials, led by its governor to seek 'pre-emptive loans' from the International Monetary Fund (IMF), only deepened the suspicion. [IMF on Wednesday agreed to lend Bangladesh US$4.5 billion in a package that includes wide-scale reforms.] The local conventional media as well as the social media were abuzz with all types of discussions and conclusions. Government leaders also made obligatory rejoinders, but these had little impact on the public perception of doom and gloom.
The immediate past and the current governors of Bangladesh Bank had identified exchange rate, foreign exchange reserves and inflation as the most serious problems facing the Bank (and the economy). One could perhaps add external debt to the list. However, the important point in this regard is that all these are determined to a greater or lesser extent by the current account (CA) of the balance of payments of the country. CA is a macroeconomic expression for the excess of the country's spending over its income, or equivalently, the excess of foreign exchange payments made to foreign entities for current transactions over the receipt of such foreign exchange.
When the spending is more than income the current account will be in deficit (CAD = Spending - Income), and it will be in surplus when the reverse is the case. The only way a nation can run a CAD, i.e., spend more than it has produced, is if it can borrow from overseas, or it has sufficient international reserves to run down. In the event the spending is less than the income, the excess is either loaned out overseas or added to the international reserves. (A similar role is also played by foreign direct investment or FDI, but for this analysis it is subsumed under foreign borrowing without affecting the conclusions.) It is easy to see that a major determinant of international reserves is the balance of the current account. The current account is also a major determinant of foreign borrowing, and consequently also of foreign debt, which is the sum of the net foreign borrowings of the past.
When the CA is in deficit (CA<0) it sends a signal to the exchange market that the country has an excess demand for foreign currency. When this is the case the price of the foreign currency may go up as reserves start falling. Sometimes it may be possible to cover the deficit with foreign borrowing or FDI, in which case it may be possible to avoid the fall in reserves or the depreciation of the domestic currency.
Bangladesh has been in persistent CA deficit since 2016-17. But there was only a small depreciation of the taka until recently. The main reason was that the substantial deficits in each of the years 2016-17 to 2020-21 were matched by even more substantial capital inflows (borrowing and FDI) such that the reserves increased substantially instead of falling. A substantial part of the reserves thus originated from borrowed funds. But when CAD went through the roof in 2021-22 peaking at US$18.7 billion, it could not be matched by net foreign capital inflow. Hence, the reserves had to be used to cover the excess deficit. The reserves fell to less than US$36 billion by October from $46 billion in February this year. (IMF estimates the reserves at US$8 billion less than this amount.) The exchange market reacted sharply to this large depletion of the reserves. The exchange rate declined by a massive 20 per cent and a large kerb market differential opened up. It has been reported recently that many banks have failed to settle LCs because of scarcity of dollar. If this situation persists foreign borrowing will become increasingly more difficult as lenders become more cautious.
By causing a depreciation of the domestic currency, CAD directly raised the landed cost of imported commodities. The exchange rate pass-through is high and occurs quickly in Bangladesh such that a depreciation of the taka raises the market prices of imported goods proportionately and quickly as the consumers have found out recently to their dismay. Since many of the essential products are imported, the consumer price index (CPI) increased similarly leading to higher inflation. This could be exacerbated by a synchronous response of other prices to import price increases.
The foregoing discussion makes is abundantly clear that the principal factor causing the difficult problems mentioned by the governors is the large and persistent deficit in the current account. The question then is what caused this gaping deficit? It is actually embedded in the very strategy of economic development adopted by this government. The strategy is based on an old economic model which suggests development is driven by investment, mainly infrastructure or fixed capital (including human capital) investment. Several East Asian countries including China based their economic growth policies on this model with spectacular success. The government of Bangladesh also predicated the development of the economy on large-scale infrastructure investment with mixed results.
Two important differences between Bangladesh and the East Asian countries was that the latter paid for their investment from mostly their own resources. It was possible since they had high saving propensity. They also invested heavily in human capital. But Bangladesh wanted to emulate them with only modest saving and very little investment in human capital. The paucity of saving meant that the only way to execute the strategy was to borrow heavily overseas to invest in the so-called mega projects.
Many respectable economists have judged these projects to be not always sufficiently productive. There are two reasons for this conclusion. First, runaway costs of these projects made their contribution to productivity as a proportion of the high cost relatively low and lower than that required to comfortably service the debt liabilities. This implies that many of these expensive projects will not generate sufficient income to pay-off the debt servicing liabilities and associated costs. This will progressively increase the debt burden in future. Short term borrowing on a large scale has also exacerbated the problem.
Second, the failure to invest adequately in human capital development over a long time has created a labour force that is mostly unskilled or semi-skilled. The productivity of such a labour force is low. It is difficult to raise the overall productivity with investment in just physical capital. Another consequence has been that any work requiring high skill cannot be performed by the domestic workers. Thus, despite being a labour-abundant country Bangladesh is paradoxically importing a large amount of foreign labour, which is causing a large drain on its modest resources especially international reserves. By not investing adequately in human capital Bangladesh has also let the golden opportunity for demographic dividend largely slip through its fingers.
It should be obvious that if Bangladesh wants to avoid a debt crisis it must quickly balance the current account, or better still, move it to a surplus. This will require balancing the government budget, which is a major source of the CAD. In fact, an important macroeconomic identity is CAD = BD + (I-S), i.e., CAD is identically equal to budget deficit (BD) and the private sector investment-saving (I&S) balance. No amount of tinkering with import will improve the current account unless the right side of the identity can be changed appropriately. Herein lies the problem: BB has absolutely no say over the budget being a sub-ordinate institution of the government; and it has contributed its share in this emerging payments crisis by letting the deposit rate become negative and keeping the taka exchange rate overvalued for a prolonged period.
The government will obviously find it difficult to reduce the BD which essentially implies a reversal of its strategy of development. The lavish development projects have been propagandised as its principal success; and a climb down now could be seen as a failure. Furthermore, government investment also serves as a major mechanism to distribute favours to maintain its support base. Hence, it will be even more difficult to substantially reduce public investment now when it is facing a restless public and staring at a difficult election next year.
The situation in Bangladesh is difficult, but not an impossible one. There is still an opportunity for the government to adopt appropriate policies that will veer Bangladesh away from the abyss. Much will depend on the ambition and the sagacity of the government in dealing with the situation.
The write is Professor of Economics, Independent University of Bangladesh (IUB).
