Private equity in Bangladesh: A road yet not traversed

Wednesday, 16 November 2016

Bangladesh Securities and Exchange Commission (BSEC) passed the “Bangladesh Securities and Exchange Commission (Alternative Investment) Rules, 2015” in mid-2015. The registration and regulation of fund, fund managers, trustee, investors etc. of the private equity and venture capital firms of Bangladesh are regulated by BSEC under these rules. A broad definition of private equity will cover the gamut of alternative investments. The unexplored market of private equity now needs a formal presentation to the investors in Bangladesh and abroad.
The area is uncharted. A good guesstimate is nevertheless possible by assessing the size, growth and the patronisation of government for sustainable economic advancement of the economy. The data on SME sector can be a good basis for estimation.
Bangladesh has been on the radar of the cross-border investors since its economy was included in the lists of frontier markets – “the Frontier 5” and “Next 11 nations”. Nevertheless, investors’ activities are insignificant in this country which in geo size is smaller than the US state of Iowa and in terms of population is about half the size of USA. 
Bangladesh has not been able to attract many cross-border extra-large investors, because of its sub-optimum size. The gross domestic product (GDP) of the country is US$ 202.3 billion which is one-third of the market capitalisation of Apple Inc. The economic growth rate is amazing though – 6.0 per cent sustained over last seven years. Bangladesh aspires to earn a demographic dividend with 25 per cent of population under the age of 25 years, while most of the world population is ageing. 
Inadequate rules, regulations and governance have been in questions too.  The situation improved significantly in the last five years or so.  Regulations are getting structured and large scale cases of corruption are being detected.
The government recognises the private sector as the growth engine. The capital market is under massive reform and remodelling. Stock exchanges are in the fast process of demutualisation under the weight of the donors. There are 292 companies listed on the Dhaka Stock Exchange vis-à-vis 39,000 non-listed limited companies who are under the income tax net. The market has to accommodate the growth companies.  The stock exchange has a scanty debt segment US$ 7.8 billion vis-à-vis US$ 6.7 billion of equity. Corporate bond on the other hand is ridiculously low at 81 million. Rest amount of debt are governmental. 
The total size is, however, lean, having a market capitalisation of US$ 42 billion, that is 20 per cent of the GDP (October 2016). The currently shallow capital market is expected to widen following the improvement in governance standard.
The statistics of the small and medium-sized enterprises (SME) segment of the economy may be the most significant instrument in fathoming the depth and width of the uncharted private equity market in Bangladesh. The small and medium enterprises, as well as the smaller ones categorised as micro enterprises, have a good standing in Bangladesh. So far these ventures are loan based. The success rate is moderate but the loan repayment (with high interest) is extremely good. These projects deserve the fuel of private equity, venture capital and impact funds.
SMEs account for 25 per cent of the GDP of Bangladesh. SMEs contribute about 40 per cent in the manufacturing sector. There are almost 16 thousand units of small and more than six thousand units of medium-sized manufacturing ventures.
Micro units are outside this account and the micros are taken care of by the micro finance organisations with spectacular success.  It is the small and medium enterprises who are in need of private equity. About 7.35 million people are employed in the SME sector which is 30 per cent of the country’s total labour force (excluding agriculture) while 14 per cent of the labour force is employed by the large manufacturing sector.
SMEs are currently absorbing an investment of US$ 12.9 billion in the form of loan although the number of borrowers has decreased over the last five years and the amount lent to the sector is on the rise. This is significant as it represents the number of unsuccessful projects. Any new project can hardly receive loan because most of them fail to place collateral. Between 2013 and 2014, number of SME projects receiving loans from banks and non-bank financial institutions decreased from 746 thousands to 541thousands. The amount advanced rose by US$ 2 billion in one year.
A report of Asian Development Bank (ADB) estimates that demand for SME loan is US$ 23.78 billion and supply is US$16.97 billion. There is a gap of US$ 6.8 billion. The supply consists of high interest debt only given against collateral. In case of unsecured risk capital, that is venture capital – private equity is almost absent in the finance system. Only 8.3 per cent loans are without collateral. Private Equity is required which can create a demand far more than the gap.
SME encompasses the most basic sectors. In terms of sales volume, food and beverages tops the list followed by pharmaceuticals, textiles, polymer materials, and light engineering. 
Information Technology and IT Enabled Services (ITeS) sector is a thrust sector receiving all appropriate encouragement of the government but venture capital. The result of governmental campaign for Digital Bangladesh has started bearing fruits. Gartner listed Bangladesh among the top 30 outsourcing destinations. Freelance software developers billed US$7 million in 2012 which rose to a staggering figure of US$132 million in 2015. This growth requires structured development to reach the best possible height.  Private equity is absolutely required for the IT and IT Enabled Services (ITeS) sectors to the next level by utilising the vigours of the young tech savvy population. Bangladesh is a place targeted for Business Process Outsourcing (BPOs) and Knowledge Process Outsourcing (KPOs). 250,000 jobs were created recently in IT and ITeS sectors. The green-shoots need venture capital.
The pharmaceutical industry has another story. The TRIPS agreement allows LDCs, including Bangladesh, to choose whether or not to protect pharmaceutical patents and clinical trial data before 2033. The TRIPS agreement also keeps the option open for further extensions beyond that date. It signifies that Bangladesh can manufacture pharmaceutical products and their ingredients without much regard to patent laws. 
ADB has taken up a few unique projects with its private sector operations in 1989. At the end of 2012, ADB cumulatively approved 12 projects worth US$297.2 million. ADB’s largest private sector initiative for infrastructure was the 450 MW gas fired combined cycle Meghna Ghat power project.   ADB has also lent money to a commercial bank to finance environmentally sustainable project in the RMG sector.
In the backdrop of a lesser political governance, private sector is now more important for the international investors–donors, and institutional and private investment from the high net worth individual (HNWI) or family offices.
The writer is a co-founder of Maslin Capital Limited. [email protected]