Key economic reform priorities

Despite welcome progress in stabilising the balance of payments based on growing earnings from RMG exports and remittances, Bangladesh economy is traversing a turbulent sea. Inflation remains stubbornly high, hovering around 10% per year, GDP and manufacturing sector growth have plunged to an annual rate of 4%, public and private investment rates are down, and tertiary educated youth unemployment rate has reached an alarming 28% . While much of the blame for this dire economic situation lies with economic and financial mismanagement of the immediate past regime, the responsibility for turning around the situation rests with the current government.

The reform agenda is long and tough. The interim government is also handicapped by the deteriorating law and order situation and the current political uncertainty. Yet, there is little option but to try to steer the buffeted economic ship as best as possible away from the turbulent sea into calmer ones. Given limited time and administrative capacities, reform priorities will have to be set. The reform agenda cannot be comprehensive and all inclusive. It should be focused on a few critical areas and designed so that positive outcomes are achieved quickly, making a tangible difference in people's lives. 

The reforms should aim to achieve the following three core objectives: (a) reduce inflation by stabilising the macroeconomy, increasing imports, and boosting manufacturing production; (b) increase GDP growth to improve job prospects, focusing on manufacturing sector production by diversifying exports, enhancing financial sector stability, and strengthening the climate for private investment; and (c) protect the incomes of the poor through increased public spending on human development and water management.

The top five economic reforms that best serve these objectives include: (1) tax reforms; (2) reform of state owned enterprises (SoEs); (3) trade policy reforms; (4) reform of public banks; and (5) greater public spending on social protection, health, education and training, and water management.

Tax reforms: Tax reforms are critical for all three objectives. Monetary tightening and interest rate hikes have reached their limits, and further progress with stabilisation requires fiscal policy actions to reduce inflation. Government bank borrowing to finance fiscal deficits is still much higher than desirable, putting undue pressure on interest rates and crowding out private borrowing. The focus of tax reforms should be to increase the tax to GDP ratio while increasing reliance on income taxes and reducing reliance on trade taxes. Much has been written on the subject, including my contributions, and shared with the government.  Key reforms include separating tax policy from tax collection, digitising tax filing and payments, simplifying tax forms by eliminating income expenditure reconciliation, conducting selective and productive audits, rationalising tax exemptions, managing tax policy and tax collection departments professionally, significantly reducing trade taxes, and transforming wealth tax into a well-designed property tax system.

SoE reforms: Bangladesh has invested over 17% of GDP in SoE assets that reported negative earnings in FY2024. The country also provides a net fiscal transfer of 2% of GDP annually to support these enterprises. With proper corporate governance and pricing policies, it is possible to achieve a rate of return of 8-10% on these assets, which could significantly impact the fiscal landscape. A detailed report on SoE reforms was shared with the government in 2023, but no action has been taken so far. 

Trade policy reforms: Manufacturing sector growth and exports benefited tremendously from the success of the labour-intensive RMG sector, which supported the expansion of private investment, financed critical imports, accelerated GDP growth and created jobs. Two most important policies were a flexible exchange rate and access to duty free imports through the bonded warehouse system. Sharp appreciation of the real exchange rate between 2011 and 2022 hurt both RMG and non-RMG exports. Non-RMG exports were further hurt by heavy trade protection, imparted through a combination of custom duties, supplementary duties and regulatory duties, which makes domestic production more profitable than exports since non-RMG exporters do not have duty-free access to imported inputs. The combination of real exchange rate appreciation and anti-export bias of trade policy stymied the growth of non-RMG exports. Lack of export diversification is a major constraint to the growth of total exports, the manufacturing sector value added, private investment  and job creation.   

The recent correction of the exchange rate policy since May 2024 is a strong positive development and has already shown its power by boosting RMG exports and remittances in recent months.  But trade policy reforms remain hostage to revenue mobilisation. So trade and tax reforms have to go hand-in-hand with proper coordination. 

Reform of public banks:  Banking reforms of 1998-2011 brought in a sea change in the Bangladeshi banking sector whereby the dominance of corrupt and inefficient public banks was replaced by a competitive private sector led banking system. The resultant deregulated banking sector contributed handsomely to the expansion of private investment, exports, GDP growth and employment. Between 2012 and July 2024, the banking sector slowly became poisoned with corrupt practices that have damaged the health of the banking sector and threaten to create a roadblock to the expansion of economic activities in Bangladesh.  

Some solid actions since mid-August have stopped the bleeding of corruption-affected private banks, and efforts are underway to stabilise the private sector banking enterprises. But reforms are necessary in the public banks that are heavily infested with a much larger share of non-performing loans than the private banks. Perceived government guarantees of deposits in these public banks has prevented a run on these banks but in reality the government has little fiscal space to protect the deposits of these banks. Urgent attention needs to be given to improving the portfolio quality of these banks through corporate reforms, professional management, establishing full accountability of bank management for performance, adopting Basel 3 prudential norms, and requiring Bangladesh Bank oversight for these banks. Continuing with a dual banking system with Ministry of Finance oversight of these public banks is not a desirable situation.  

Reform of public expenditure management: Shortage of revenues is constraining public spending on critical areas that support GDP growth and poverty reduction. So revenue mobilisation is essential to achieve key development objectives. Yet some immediate increases are needed in a few areas to protect the poor who are suffering from the burden of high inflation and natural disasters. These increases will need to come from a careful review of public expenditure priorities. The interim government has already taken a decision to cut ADP spending on large infrastructure projects, which is a sound decision. Some further scrutiny is necessary to reallocate spending. Public spending on social protection, health and education, and water management has taken much of the brunt on expenditure cutbacks over the past several years.  This is most unfortunate. On the other hand subsidies and transfers to support SoEs have grown. Wages, pensions and interest costs have also grown. 

In the short term, a quick review of all ongoing programs should be done with a view to rephasing some of these spending to conserve some 0.75-1% of GDP equivalent of spending and reallocated to social protection and water management.  Spending on health and education can be increased once the tax and SoE reforms begin to yield results.  Extra-ordinary budget financing from development partners like the ADB and the World Bank can be sought to help increase funding of social protection and water management. I have reason to believe development partners will be eager to respond to this request when combined with some reforms relating to these two areas.

Sadiq Ahmed is Vice Chairman of the Policy Research Institute of Bangladesh.  He can be reached at sadiqahmed1952@gmail.com