Economic impact of $202m US-Bangladesh development agreement: Key reform priorities

During the US delegation's visit in Bangladesh, the United States Agency for International Development (USAID) signed a development agreement worth $202 million with the interim government on 15 September 2024.

Through this collaboration, Bangladesh aims to promote good governance, social, human and economic opportunity and resilience, and expand international trade between the countries for a better, prosperous future. The officials discussed ways to support inclusive economic development for the people of Bangladesh, ensure financial stability, and strengthen democratic governance.

The assistance grant is provided under the Development Objective Grant Agreement (DOAG) signed between the GOB and USAID on 27 September, 2021. USAID will provide a total of 954 million USD grant to Bangladesh for the period 2021-26. USAID has provided $425 million through the first five amendments. Under the 6th amendment, USAID will grant an additional $202.25 million, focusing on three key areas: good governance, social and economic opportunity, and resilience.

The U.S. embassy reaffirmed its commitment to collaborating with Bangladesh on expanding economic opportunities, building institutional capacity, upholding human rights and addressing climate risks. This article aims to present a macroeconomic analysis of how this US grant can be best utilized by Bangladesh to fulfill its development agenda that include inclusive development, youth empowerment, strengthening democracy and governance.

The context under which we are seeking the US support is not unusual. From a macroeconomic point of view, the ongoing economic situation must not be termed as a catastrophe, Bangladesh is not in a crisis situation; however, the country certainly is going through some volatility. High inflation, rise in energy and food prices, exchange rate fluctuation and depleting forex reserves have put the economy through a difficult time. Bangladesh faces several long-standing challenges, which include a low tax-to-GDP ratio, a high percentage of non-performing loans, poor banking sector governance, low foreign direct investment (FDI), exchange rate misalignment that hinders export promotion and diversification, slow employment growth, sluggish private sector investment, and a significant amount of illicit outward money transfers. Amidst these challenges, this grant will help Bangladesh to carry out a series of badly needed policy reforms. Using the grants from USAID and multiple more loans from similar multilateral and bilateral development partners including the IMF, JICA, ADB, Bangladesh can address its long-term structural issues to build better economic foundation for the future. Major reform areas that should get the highest priority are discussed below.

Betterment of foreign exchange reserve, narrowing trade deficit, greater international trade:

Despite a narrowing current account and trade deficit, pressure on the foreign exchange reserves remains high as the financial account deficits keep widening. According to the latest data of Bangladesh Bank, the current foreign exchange reserve stands at USD 24.30 billion, the reserves are close to USD 20 billion under the International Monetary Fund's (IMF) BPM-6 methodology. We have a large trade deficit since our import expenses exceed our export earnings; in FY2023-24, the negative trade balance reached over USD 22 billion. Although the workers remittance inflow has increased in the current fiscal year, the overall balance in the current account shows a deficit of US$ 6.5 billion in FY 2023-24 (July-June). The negative balance of payment is also attributed to the decline in financial account receipts, which indicates declines in foreign direct investments, medium and long-term loans, assets and portfolio investments.

The primary cause of the trade deficit is simply because we import more products and services than we export. So, in order to manage the current account imbalances, our imports will need to grow lesser than the exports in the next few years. However, import reduction is not a good prescription for the economy because most of the imports of Bangladesh are production driven. Besides, the other drivers behind the high external deficits have been the spike in energy, fertilizer, food, and edible oil import prices – which are external factors and depend on global economic circumstances.
We must bring in internal reforms to address the long-holding structural weaknesses in international trade such as less diversified export destination, less diversifies export basket, an undertrained labor force, a difficult investment environment, a stressed financial sector burdened by non-performing loans, poor governance; weakness in infrastructure, energy and urban development planning – all of which lower our economy's export competitiveness.

US's assistance sends a positive signal to the market and other multilateral lenders in regard to our external economy. This will boost the foreign direct investment, medium and long-term asset investments in Bangladesh. 

Strengthen governance and institutional capacity

Bangladesh will be using this assistance to strengthen governance and institutional capacity. Sadly, Bangladesh has failed to establish its institutions in a way that they deliver the best possible economic outcomes. Our financial sector is troubled with a large number of non-performing loans (NPLs). Default loans in Bangladesh's banking sector reached a record high of BDT 211,391 crore at the end of June 2024, this is about 12.56% of the total loans disbursed. The banking sector has remained a matter of concern for us for over a decade. And a major reason behind that is the politicization of the banking industry, which has allowed powerful borrowers with ties to the ruling party to take out hefty loans – violating rules and regulations of the banking sector.

Reforms for greater revenue mobilization, better tax-GDP ratio 

Despite Bangladesh achieving impressive GDP growth rate over years, domestic resource mobilization efforts have remained stubbornly slow. The tax-GDP ratio is only 7.6 percent at present, which is the lowest in South Asia. In fact, Bangladesh's Revenue-GDP ratio has come down in recent past years – from 10.99% in FY 2010 to 10.36% in FY 2021 to 8.26% in FY 2023. If no reforms are made, this rate will decrease further in the coming years. And it is not possible to reach high-income countries with less than 10% tax-GDP ratio. Therefore, the need to improve tax revenues is urgent. The support from development partners including USAID, IMF, JICA is designed to help Bangladesh destabilize the fiscal situation, but without increasing revenue, Bangladesh's ability to pay its debts will not improve. Therefore, reforms should include: increasing the portion of direct tax revenue, establishment of a dedicated tax policy division in the Ministry of Finance, VAT reform, automation of tax administration, efficient implementation of property and wealth taxes. If greater domestic revenue mobilization is achieved through these reforms, this will positively impact the economy to ensure more equal income distribution, less reliance on domestic and foreign borrowings and a reducing debt servicing obligations.

Tackling money laundering 

In regard to the issue of money laundering, the government and the associated government institutions have remained incompetent in enforcing strong laws and making use of international cooperation. Most of these illegal transfers land in developed countries. There are many ways through which money laundering takes place, trade-based illicit financial outflows, various forms of illicit investments and transactions for residencies and other acquisitions in the places such as Canada's Begumpara, Malaysia's second homes, and facilities in Middle Easten locations. Bangladesh has an Anti-Money Laundering Act of 2012, enforcement of which must be ensured. Bangladesh has the opportunity and, in fact, a national obligation, to take its nearly non-existent anti-money laundering initiatives to a new level. Bangladesh can amply benefit from the US's centuries old rich experience in this regard. For instance, in getting back the money siphoned off from the country to the US, Canada and different European destinations, the US support can play a critical role.

Greater social spending on health, education and social protection.

Any sort of institutional reform should put public interests first, that is, people's well-being should be at the center of planning. In the past years, the middle class and the poorer segments of society have become the primary victims of macroeconomic challenges of Bangladesh. Income inequality has increased, poor became poorer. Government spending on the social sector is crucial to ensure that a larger section of the population has access to basic health care, education and social safety nets. Once the reformed policies are implemented, it is expected to bring in better social, human and economic opportunities for all citizens. Continued assistance from the development partners will allow the government to invest in key public services provision, employment generation and infrastructure development. 

In summary, the analysis presented in this article demonstrates that through proper utilization of the assistance received from USAID and other development partners, Bangladesh can bring in the much needed structural, institutional and policy level reforms in the following vital aspects:  

• Improve governance of the financial sector 
• Reduction of Non-Performing Loans (NPLs)
• Improve corporate governance
• Modernization of revenue administration
• Expansion of tax net and increment of tax-GDP ratio
• Trade liberalization, export promotion and export diversification
• Narrowing trade and BOP deficits
• Increased foreign direct investment, foreign portfolio investments
• Greater spending on public service, employment generation and infrastructure development
• Reduction of illicit outward money transfer

Given the relevance and importance of the reform measures, Bangladesh should have taken these initiatives long ago. Economists have been proposing these measures for years, we hope the government keeps up the political will to address these recommendations. A transparent and accountable system will be key to the successful outcome of the assistance support. The government must constantly monitor the fund's flow and utilization. The government must make sure the money is used in a way that the economic conditions are improved, the living standard of ordinary people are improved, and the country is remaining on track to keep the commitments on which the assistance is provided.

Nipun Naureen, Lecturer, Department of Economics, BUP