Accelerating specific reforms to avoid export shock after LDC graduation
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If the export losses are not countered with timely measures, the estimated socioeconomic impact can be substantial. Simulation results show that the direct and multiplier effects of the export shock can cause an average GDP loss of 1 per cent per year. This will have adverse effects on employment and poverty reduction. Importantly, Bangladesh will go off-track on the PP2041 development path. It will not be able to reach Upper Middle Income Country (UMIC) target by FY2030 and High Income Country (HIC) target by FY2041. The goals of eliminating extreme poverty by FY2030 and reducing moderate poverty to 5 per cent or less by FY2041 will not be possible. Hence, acceleration of policy reforms to counter the potential export losses from LDC graduation is essential.
THE WAY FORWARD: Graduation from LDC is a major milestone and Bangladesh should be justifiably proud of the achievement. The march towards the development goals of PP2041 must continue. The loss of LDC benefits will create important challenges in terms of potential loss of exports and the end of special treatment under WTO that could affect export subsidies, agriculture sector, pharmaceuticals and the services sector. These shocks to the external sector will need to be managed starting from now in order to be well prepared for a smooth transition to post LDC Bangladesh. The PP2041 development strategy and the associated macroeconomic framework and the Delta Plan 2100 are both well-thought out and balanced development strategies. Their solid implementation can help overcome the challenges posed by LDC graduation.
The specific reforms that need to be accelerated to avoid the export shock from LDC graduation include the following:
* Strengthen the implementation of a prudent macroeconomic framework: Bangladesh has generally followed a prudent macroeconomic framework that has served the country well in terms of low inflation, low interest rates, stable balance of payments and exchange rate and comfortable public debt situation. The macro-economy has come under stress recently owing to weak public resource mobilisation, over-valuation of the real exchange rate, and growing non-performing loans (NPLs) of the banking sector. These imbalances must be addressed and removed quickly to put the macro-economy on track as envisaged under the 7th Plan and PP2041. Addressing the public resource mobilisation challenge to sharply increase the tax to GDP ratio from the present 8.7 per cent to at least 10 per cent by FY21 and undertaking banking reforms to lower NPLs in a sustainable manner by addressing the root causes are the two top most macroeconomic priorities for the immediate future. Once the immediate macroeconomic imbalances are reduced, the macroeconomic management must be aligned to the PP2041 macroeconomic framework in order to support the acceleration of the GDP growth rate to 8-9 per cent. Fiscal reforms, especially the tax reforms, will be the most critical challenge.
* Reform trade and exchange rate policies: The best way to counter the export losses from LDC graduation is to increase the rate of growth of exports by diversifying the export base. Diversification of the exports base requires a host of measures, but the two most important reforms are: reducing trade protection and avoiding the over-valuation of the real exchange rate. Exports growth has slowed down considerably in the past 5 years as compared to the growth between FY2000-FY2014. Export concentration on RMG products has also increased. The lack of export diversification has contributed to the slowdown of export growth.
Research shows that export diversification has not happened mainly because the trade regime is biased against exports. Large trade protection through tariffs and para tariffs has provided strong incentives to production for domestic market where rates of return are much higher than exports owing to protection. Additionally, the over-valuation of the real exchange rate since 2008 has hurt exports. The RMG sector has been sheltered through a range of support measures like duty-free imports of inputs through bonded warehouse, export subsidies and income tax break that is not generally available to all exports. A sharp reduction in trade protection along with a supportive real exchange rate will be very important to help export diversification. Moreover, trade protection and export subsidy issues will need to be addressed comprehensively in any case to comply with the WTO rules once the special treatment provisions are eliminated in a post LDC graduation world.
* Address behind-the-border issues: The private sector is the engine of growth for Bangladesh. It has come a long way since the 1990s based on a series of trade and investment deregulation measures. The private investment rate surged from less than 10 per cent of GDP in FY1990 to 22 per cent in FY2010. Since then, however, the private investment rate has stagnated at around 22-23 per cent of GDP. Productivity improvement of private investment has helped boost growth in the interim period along with better capacity utilisation. But export growth of 12 per cent based on diversification and GDP growth in the 9 per cent range as envisaged in PP2041 will not be possible without an increase in the private investment rate to the 27-32 per cent of GDP range over the next 10-12 years. Despite solid progress with development Bangladesh, has not attracted adequate foreign direct investment (FDI).Overall FDI in Bangladesh reached a mere $2.2 billion in 2017, as compared with $134 billion in China, $40 billion in India and $14 billion in Vietnam. Moreover, most FDI investments are outside manufacturing.
A range of behind the border issues will need to be addressed to spur the growth of FDI and domestic private investment. These include: strengthening electricity and transport infrastructure; improving trade logistics focused on enhancing the efficiency and timeliness of port clearances; improving the investment climate by reducing the cost of doing business related to licensing and clearances, access to serviced land, property registration, ease of foreign currency transactions, ease of tax payments, ease of contract enforcements, and bankruptcy laws; improving technology transfer, skills and market access through partnership and joint ventures with FDI; investment in research and development to support innovation and adoption of new production technologies; strengthening labour productivity through investments in human capital; fostering trade facilitation and competitiveness with customs modernisation; and strengthening institutions for trade and industry. Reforms in these areas will also strengthen export competitiveness that is essential to penetrate markets in the post-LDC world.
* Adapt to the world of the Fourth Industrial Revolution (4IR): As Bangladesh is set to graduate out of the LDC status, a global scale fourth industrial revolution powered by cutting-edge technology is also on the horizon. As 21st century world prepares for a new age economic transformation, mechanisation or automation has arrived as a credible problem for job creation that requires preparation. In order to remain competitive in the global market, Bangladesh will also need to adapt to the new production technologies in all spheres of production, especially in manufacturing and modern services. Bangladesh economy is already showing signs of first stage automation. Modernisation of the RMG industry over past several years has increased the capital intensity of production and raised productivity but it has slowed down employment growth.
Despite this employment challenge, automation is inevitable, and there should be no policy hesitancy about promoting competitiveness by supporting technological up-gradation, particularly for export sectors. In some cases, technological advancement can lead to improvements in product quality with prospects for export expansion. Non-export and import-competing sectors also need to embrace more capital-intensive production techniques. Investment in machinery and equipment, as measured by import data, per unit of labour is much lower in Bangladesh, compared to Cambodia, Viet Nam or China. To balance this automation and capital intensity of production trend with job creation, the best response is to promote export growth and diversification that will create more jobs through the scale effects.
Additionally, backward linkages to export-led manufacturing will help create jobs in modern services. This will have to be supported by strong effort to raise labour force education and skills.
Automation will eliminate many jobs now done manually with low skills, but it will also create new jobs that are technical in nature and are skill intensive.
* Trade agreements with regional communities: Bangladesh has been a beneficiary of the multilateral trading system under the auspices of the WTO. While using the special dispensation of LDCs for the remaining few years, it must not lose sight of a long-term strategy of deepening its competitiveness as it prepares to graduate out of its LDC status. At the same time, it should also prepare to follow the new global trend and continue seeking market access under the various bilateral and regional trade and investment arrangements. What is notable is that it might be easier to sign on to South-South regional arrangements, but the greatest gains will come from North-South regional communities. In future, apart from emerging market economies, Bangladesh should be looking forward and preparing to reach trading arrangements with CPTPP, and RCEP (ASEAN+), where the bulk of the country's future export markets lie. However, to access those communities through potential FTAs will require fulfilment of stringent tariff and non-tariff standards. Unless rationalized, the Bangladesh tariff regime will become the first significant hindrance to such FTAs.
The Government of Bangladesh has received proposals for potential bilateral trade arrangements from several countries including China, Malaysia and Thailand in recent years. Some analysts suggest that under current unorthodox protectionist approaches by US and some European governments to trade negotiations, Bangladesh would be an attractive country for a potential bilateral deal. Post-LDC Bangladesh may have to negotiate a trading arrangement with the EU along with the possibility of an FTA with the post-Brexit United Kingdom. But as it stands today, Bangladesh neither has the adequate capacities or experiences for strong trade negotiations and signing comprehensive FTAs. Urgent attention should be given to enhancing trade policy capacity including negotiating FTAs.
* Preparing the transition strategy for post-LDC full WTO compliance: There are a range of restrictive WTO rules and agreements that have been temporarily waived for LDCs as a special concession. These include: Agreement of Subsidies and Countervailing Measures (SCMs); Agreement on Agriculture (AoA); General Agreement on Trade in Services (GATS); Agreement on Trade Related Investment Measures (TRIMS); and Trade Related Intellectual Property Rights (TRIPS) phase out. Compliance with these agreements will all be obligatory on Bangladesh after the LDC graduation. In particular, compliance with SCMs, AoA, and the TRIPS phase out can be challenging for Bangladesh. Hence, clear understanding of the implications of these agreements and how they might affect Bangladesh is necessary. Early preparation can help phase in compliance with these agreements over a period of time along with implementation of required policy reforms to counter any negative impact on Bangladesh. Of particular importance is to focus on how to deal with export subsidies as an instrument for export promotion in the post LDC graduation world, and on the readiness for the TRIPS phase-out in order to continue to support the growth of the pharmaceutical industry.
[The first of the two-part series, titled LDC graduation: Progress brings its own challenges, was published on Thursday, May 30, 2019]
Dr. Shamsul Alam is Member (Senior Secretary), General Economics Division, Bangladesh Planning Commission. This is adapted from the study GED has undertaken titled 'Impact Assessment and Coping up Strategies of Graduation from LDC Status for Bangladesh'. The study is under the process of finalization.