Dr. Zahid Hussain, Former Lead Economist, The World Bank

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Matters of Macroeconomy

In conversation with Marjiya Baktyer Ahmed, Dr. Zahid Hussain, former lead economist at the World Bank advises on how to overcome the pitfalls of our projected numbers for FY20.

What is the state of the economy in terms of growth?
We are the fastest growing economy in the world depicted by the official estimate. The problem with the official estimate is its inconsistency with the other growth-related indicators. In order to explain where this growth is coming from, we have to break it up and look at the drivers of growth – the official numbers on the expenditure side. But you see it is private consumption and investment. Usually, the contribution of foreign trade is negative as we have a deficit since imports are greater than exports. But last year imports were depressed and exports recovered so there was a turnaround, but that is not enough to explain 8+ growth.

Investment to GDP ratio has been flat as evident from the credit growth and capital machinery import numbers, which are supposed to be correlated with growth. However, you don’t get to see such strong momentum in the economy. BBS is the ‘only’ source of national accounts data. So, we cannot outright reject it, but we cannot unquestionably accept it either. There may have been healthy growth. 6+ is a very healthy growth when we compare with other South Asian countries. Exports and remittances were good, and our agriculture production was struck with the good fortune of two bumper crops. Public investments in some projects are visible, like the Metrorail, Padma Bridge, which may have supported the growth.

Can you talk us through the state of inflation in the country?
On the inflation front, it was within the targeted 5.5%. The 2018-2019 inflation outcome was exactly 5.5%. Food inflation was down which was the main reason why inflation was within the target, but non-food inflations were creeping up. The rice price collapse story was the result of a bumper crop causing rice prices to fall significantly. International commodity prices are very stable, so inflation in Bangladesh is largely determined by supply-side factors, the cost of imports, domestic production. Fiscal year-wise, FY19, inflation did okay, but later we have seen some reversal both in food-inflation and non-food inflation. It now stands at 6.05%. One reason is the infamous onion price hike, although onion in the proportion of total expenditure is not that big – it is 1.6% of typical household expenditure.

But the price increase was so high, like 400-500% so even though the weight is low, but the growth is so high, that it has a visible impact. There were other knock-on effects like other spice prices being increased, alongside rice prices have crept up a little bit. Then in the non-food, the house rents and several other consumer prices (clothing, footwear) went up. We have the same target of 5.5% in FY20, but now inflation is above that. Depending on the boro production, I think it will still be possible to bring it back down to 5.5%. We still have six months left, and the international commodity price outlook is fairly stable. The most important price for us is oil prices. All our major imports like diesel, furnace oil, petroleum, fertilizers and many of the food products we import, they are all linked with oil prices. The projection I have seen, oil prices remaining between 65-70 dollars a barrel, which is fairly standard, but of course, if we have problems like the onion price hike, that kind of a bubble, then it is a different story. So far so good.

The one concern on the inflation front from the demand side is that public borrowing is growing very rapidly and if that leads to monetary growth beyond the monetary policy target, then there could be some demand-pull factors coming in. There is also a demand-pull from the remittances which are doing really well, which is the only indicator that is strongly positive, while the remaining are strongly negative.

Bottom line: external stability is comfortable, but export decline is a worry. Reserves are okay but Bangladesh Bank’s intervention in the foreign exchange market is a worry. We need to let go of the exchange rate. Fiscal debt is okay, but revenue is slipping and expenditure is getting out of control. If the financial sector becomes unstable, people lose confidence in banks, so they start withdrawing their deposits, but we are not there yet.

What’s your take on the unemployment rate? How do we improve the numbers?
On the unemployment front, we don’t have recent numbers. The last survey was done was in 2017. The other numbers that you see that comes from General Economics Division are projections based on growth numbers. We have not gone to enterprises and done a labor force survey, because unemployment is not something that we regularly measure. For unemployment, we need regular surveys, a kind of system we have not developed yet. We have anecdotal evidence. Now, most of our employment is in the informal sector – 85% plus of our labor force. The employment level in the informal sector does not really change that much, what changes is the hours worked. Open unemployment rate in Bangladesh is always very low. If you compare it with the developed countries, it would be below the natural rate, which doesn’t really mean much. People can’t afford to not do anything in a country like Bangladesh. They may work in a tea stall, or as a rickshaw puller, it doesn’t mean they are working full time. Even if they are working full time, it doesn’t mean they are productive in that work.

The concept of unemployment in the textbook applies more to the formal sector, where we have the manufacturing sector in a large or medium scale. Then we have some of the service sector, e.g. banking, telecommunication. Even wholesale and retail trade, apart from the departmental stores and supermarkets, is largely an informal sector, where some of them aren’t even registered. In the formal sector, the employment picture does not look that good. The biggest employer is garments, in recent news from BGMEA, 200-250 factories have been closed down laying off 20,000-30,000 workers. The 2017 labor force survey shows an absolute decline. Exports have been doing poorly this fiscal year; there are some serious concerns about joblessness in the formal sector employment, particularly for females since garments labor force is largely comprised of women workers. A part of the reason for this labor shedding is automation, moving onto more 4IR technologies. The amount of work previously done by four people is being handled by one since new machineries are coming in. However, automation is not the only reason; there is also a competitiveness problem.

The unemployment rate among the educated youth is the highest among Bangladesh. There is also a big category outside the labor force. They are the NEET, people who are neither employed, nor educated, nor in training, but these are young people who are working age people. 9 out of 10 are women between the ages of 25-40 who are educated and capable, but not in the labor market. The number is around a staggering 4 million. When you are not finding jobs in the labor market, then you get frustrated and stop looking for jobs. Once that happens, you are not considered unemployed. The definition of unemployment is not having a job but seeking one. This is known as the discouraged worker hypothesis. Most of the women in the NEET category are perhaps young married women who are maybe mothers. Since we don’t have proper daycare facilities, child rearing becomes a full time responsibility.

We don’t have employment growth in the formal sector. The main problem is private investment, it is almost stagnant as a percentage of the GDP. If existing employers are not expanding their operations or new firms are not coming into business then where will the jobs come from? It’s not like investment is not happening at all, but investment proportion of GDP is not moving. We have like 22-23% private investment rate, and for a country like Bangladesh if you want a sustained 7% growth rate, then it has to be around 28-30% of GDP. It’s a rule of thumb calculation. If you look at the countries that have done really well on generating jobs in numbers and quality, you realize that our problem is not just that we don’t have enough employment opportunities, but the jobs available are not worth much. The income is not that great. You want both employment growth and wage growth. Wage growth in Bangladesh has barely kept up with inflation and the growth in nominal wages has been below the inflation rate in some sectors such as fisheries and construction. In the manufacturing sector, wage growth has stayed ahead of the inflation rates, so there have been 1%-2% real growth in wages. For a country like Bangladesh, you expect a lot more, but if you don’t have investments and the formal sector is not expanding then you cannot have good job creation.

Most of the women in the NEET category are perhaps young married women who are maybe mothers. Since we don’t have proper daycare facilities, child rearing becomes a full time responsibility.

How do we evaluate the macroeconomic balance of external policy?
When we talk about external policies, bottom line we are doing fine. The total amount of reserves that we have is still comfortable; they can finance 5 and a half months of imports. But comfort and complacency are two different things. There is no reason for complacency from this comfort. In two years we got rid of $9 billion, so if there is any big shock to the economy like the one we are having now with exports being down 7.6% in the first five months, trade deficit has expanded, the current account deficit has declined as remittances have boomed by 22%. That has been the savior. On the financial account, the foreign aid disbursement has slowed, but it is still good. We have declining exports and depressed imports which means the economy is not doing well which is why people are not buying and investing so current machinery imports are down. From a balance point of view it is a positive, because it is reducing pressure for payments, but if we want economic growth to pick up and investment to be higher, then imports will rise creating pressure on BOP. The main issue on the external balance front is what do we want to stabilize? We have so far chosen the stability of the exchange rate, so when we think there is an excess demand for dollars in the foreign exchange market and if the Bangladesh Bank doesn’t do anything then the taka will depreciate so we start selling dollars to keep taka stable. However, when you start doing that you start destabilizing the reserves, because how long can you sell off dollars with persistent excess demand? We have to decide whether we want exchange rate stability or reserve stability. If you want exchange rate stability then you have to make sure you have adequate reserves all the time so you can intervene in the foreign exchange market.

Bangladesh Bank is still very adamant about keeping the foreign exchange rate stable and not devaluing the taka too much. Our official policy is that it is a floating exchange rate system and we will allow market demand-supply to do the work. Bangladesh Bank should only intervene when exchange rates become extremely volatile like 85 today, 90 tomorrow and 80 the day after. There are certain positive factors which give us a sense of comfort and these are remittances, the reserve we already have and the amount of committed aid money in the pipeline. If we utilize them properly, then we will not face an external balance problem.

Can you shed some light on fiscal and monetary policies?
The other side of macroeconomics is fiscal and monetary policies. On the fiscal front, we have a very low debt to GDP ratio. All the analyses that the IMF does, all the projections that we do suggest that the risk of public debt distress for Bangladesh is low. Debt distress means you are not able to service your debt. That becomes a major worry if governments start defaulting then the whole financial market will collapse. We don’t have that problem yet. But recently, the revenue mobilization has been poor, fiscal deficit has gone up and government borrowing from domestic sources has also been increasing. This is a concern from a financial point of view because the government is taking money away from the savers and there isn’t much left for the private sector to borrow. This puts pressure on the interest rates which could become a problem. Revenue performance has been very poor and recurrent expenditures have boomed recently because of the wage hike, rising interest payment burden and the subsidy budget which has expanded where we have added new subsidies. Since the procurement of LNG, the power sector has been selling it below the cost price. Rental power plants, even if they don’t produce anything, they are paying a capacity charge which is 60% of their production capacity. Even if there is no output, they pay.

This is the reason the Power Development Board alone, the budget subsidy provision is about Tk 95 billion BPDB. Then you have an export subsidy, then we introduced the remittance subsidy, subsidy on diesel, fertilizer and add to that the social protection payments, transfer payments – the recurring budget have risen. That is why the deficit is rising now. Our deficit target has always been 5% of GDP. Typically what happens is you have shortfalls in both revenue relative to the budget and also shortfall in expenditure relative to the budget. But the shortfall in expenditures used to exceed the revenue shortfall. This is getting reversed now. The revenue shortfall will go up, and the expenditure shortfall will shrink, so that buffer is disappearing. There is no crisis, but there are some red flags we need to pay attention to both on the revenue side and the expenditure side. We should prioritize and try to identify areas of wasteful expenditures.

The monetary program that is announced every year is fairly prudent. Monetary growth is almost in the single-digit last fiscal year. There we don’t see any source of instability from monetary policy. The issues are in financial regulation, that’s where our main source of macro instability is.

Bottom line: external stability is comfortable, but the export decline is a worry. Reserves are okay but Bangladesh Bank’s intervention in the foreign exchange market is a worry. We need to let go of the exchange rate. Fiscal debt is okay, but revenue is slipping and expenditure is getting out of control. If the financial sector becomes unstable, people lose confidence in banks, so they start withdrawing their deposits, but we are not there yet. Financial stability means the ability to finance production and trade. Our external trade needs bank financing; the foreign supplier will look at your LC. They don’t accept any Bangladeshi LC anymore without a guarantee from HSBC, Standard Chartered or some foreign correspondent bank. To get a confirmation of your LC, you need to pay a fee and cost of trade financing rises. They look at NPL ratio, interest income, return on equity and when they see they are beyond industry standards, then they raise their fees. There is a deficit in confidence elephant in the room are the NPLs, and if we don’t address this now then the weakness in the banking sector will continue. Private credit growth is at a historic low at around 10% with most of it going to trade financing. That’s where the macro stability concerns are in banking.

What is your assessment of the outlook?
Global outlook has improved significantly in the last month. Two things have happened. One is the uncertainty relating to Brexit. We still don’t know whether it’ll be a No-Deal Brexit, or whether they will work out an alternative arrangement. Secondly, the trade war between the United States and China has not gone away, but there has been a ceasefire. The escalation of tariff war was the biggest worry and that has stopped. Even though you won’t see it in the numbers, the global outlook has improved, because global economic prospects and world economic outlook were published before these things happened. My expectation is that when you see the next round of international forecast, it will be upgraded not downgraded like it was the last time. That’s good news for us because we have a big presence in the E.U., U.S, Canada and several other advanced markets.

The outlook for us will depend a lot on what is happening in the domestic economy, particularly on the policy front. Based on the indicators related to growth like tax revenue, export, credit, import of machinery, I would be inclined to revise it downwards, because these are all in a very depressed state. There are some concerns on the macro stability outlook, it is slipping a little bit, but if they tighten and take a few actions like allowing the exchange rate to be more flexible, revenue mobilization if they try to improve particularly if they can reduce the evasion in VAT for example. If they are able to supply the Electronic Fiscal Device, then they can monitor the collection better so the revenue effort can start showing some results in the second half of the year. If they prioritize on the expenditure side, this booming public borrowing would be contained. This is the main source of worry on the macro outlook.

We need to address long term structural reforms, and the investment environment , the regulatory complexities and the unpredictability. These are the long term policy challenges.

What are the key external and domestic risks we need to be wary of? And how do we overcome them?
Downside risks are primarily domestic. High NPLs and stock market volatility pose financial stability and credit intermediation risks. Liquidity pressures may be exacerbated by additional government borrowing from domestic banks. A further deterioration in the financial health of state-owned banks could undermine the fiscal balance. Reform reversals such as easing of loan classification standards, ceilings on lending rates, reduced the autonomy of BB and the state-owned non-financial corporates, increases in untargeted subsidies and ad hoc changes in taxes and fees through nontransparent processes pose additional risks. Loss of competitiveness from the real exchange rate appreciation could further hinder Bangladesh’s limited integration in global supply chains. Higher inflation remains a risk in the context of growing domestic demand and rising public expenditures. Managing risks will require prudent macroeconomic management. The monetary policy announced in July 2019 seeks to contain inflation while achieving growth objectives. BB maintained the repo and reverse repo rates at 6.0 and 4.75 percent respectively. Broad money growth is targeted at 12.5 percent, with domestic credit growth of 15.9 percent. The medium-term fiscal stance is sustainable if taxation, expenditure and deficit financing policies are prudent. The FY20 budget maintains an overall deficit target of 5 percent of GDP. Domestic financing is projected to reach 2.7 percent of GDP with the balance from foreign sources. Given a low public debt-to-GDP ratio and access to concessional external finance, this does not increase the risk of debt distress.

What are the key short and medium-term policy challenges?
The short term policy challenge is first will they be able to let go of the exchange rate? Second, serious actions need to be taken in the banking sector regarding the NPLs. Efforts to direct the banking sector to provide loans at 9% rates don’t work. You cannot force people to do business that they find unprofitable. Then we said forget about 6%, you can charge whatever deposit rate you want, but if you want to lend to the productive sectors, you cannot exceed 9%. This was the latest policy until they decided to go back to directed interest rates of 6% on deposits and 9% on credit, except on credit cards. Implementing such a policy demands a lot on the administrative machinery. Then there is the problem of poor governance. If you have weak institutions, and public officials who are easily corruptible then these kind of directives are very difficult to implement. Some serious actions need to be taken on the legal front to enforce the law against the defaulters. There are other problems, for example, why do we have such a high NPL problem? One is our policy encourage default and defaulters are rewarded, but also there is a problem on the supply side as in we have too many banks.

Now because there is a limited market with lots of institutions competing, they take excessive risks. They are forced to do aggressive banking. The biggest challenge is structural reform. Are we going to allow consolidation in the banking sector? If banks were to merge, is there an adequate legal framework that will enable it? Are the Financial Institution Division and BB, capable of overseeing mergers and consolidation. We need to address long term structural reforms, and the investment environment, the regulatory complexities and the unpredictability. These are the long term policy challenges.
If you are looking at the economic growth as the headline number, we need to have sustained high growth to achieve our objective of SDGs, and upper-middle-income country status and all these aspirations that we have.

To achieve those we need investments and innovations, that’s the mechanics of it. For people to enter and exit business, the environment has to be friendly, which would mean structural reform. One, you have to ensure macro stability. Second, regulations to start a business, to operate a business or to close a business need to be simplified. Third, your infrastructure, particularly trade logistics like roads and ports need to function a lot better. Fourth is your human capital without whom you cannot face the challenges of the Fourth Industrial Revolution. We need to focus on STEM (Science, Technology, Engineering Mathematics).


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