Bangladesh's Macroeconomic Policy

Bangladesh has been maintaining reasonable macroeconomic stability for the last two decades or so, which served as the basis for higher economic growth trajectories in subsequent years. The economic growth, along with other development interventions, provided a dividend for poverty reduction. However, with higher growth rate, the pace of poverty reduction has slowed down and income inequality is on a rising trend. This chapter provides an overview on the role of macroeconomic policy in attaining macroeconomic stability over time with its implications for growth and poverty reduction, drawing lessons from various chapters of this book.

Inflation in Bangladesh is historically dominated by food inflation. Since food consumption constitutes a major part of the consumption basket of the people, inflation might have detrimental effect on household welfare. This chapter assesses the impact of inflation on different household groups such as day laborers and fixed-salaried households as well as other income groups. For this purpose, group-specific consumer price indexes (CPIs) have been estimated for different groups of households, using respective weights attached to their consumption baskets. Some stylized facts have emerged from the analysis. Relatively poorer households face higher inflation than non-poorer households and day  laborers, and fixed income household groups face higher food inflation than non-food inflation.

This chapter examines the dynamics of inflation and wage adjustments in the labor market of Bangladesh, especially keeping in view the rising food inflation in recent years. The analysis shows that the daily wage laborers in both agriculture and non-agriculture sectors, who constitute the largest poor group in the country, are usually able to protect the level of their daily real wage in the face of rising inflation through upward adjustment in the nominal wage rate without any substantial time lag. A similar behavior is also noticed in the informal labor markets that set the daily wage rates in construction, services, transport (including rickshaw pulling) and other low-paid activities in which the poor are the major participants. The poor day laborers in Bangladesh have some ability to at least partially revise their nominal wage income rather quickly to compensate for the loss in real income due to inflation. On the other hand, the self-employed category and salaried poor households, are more likely to be negatively affected since their real income is eroded by rising inflation while they pay higher prices for purchased goods. The remaining major poor group comprising nearly 10 percent of the poor households in both rural and urban areas belongs to unemployed/not working category households and these households, no doubt, become extremely disadvantaged with rising inflation.

This chapter aims to assess the impact of energy price adjustments under a macro-econometric modeling framework at the backdrop of the government’s efforts of energy price reforms in recent times. The effect of energy price changes on macroeconomic outcomes has been predicted with alternative scenarios of deregulations of domestic energy prices, particularly to the outcomes for growth, inflation, fiscal balances and external balances. The prediction has been done for the period FY2015 to FY2021 in line with the Seventh Five Year Plan period (2015–2019) and the Perspective Plan, 2021. Overall, the out of sample performance of the model seems quite good. The model initially analyzes macroeconomic data for the period 1980–2011. The sample validation and out of sample prediction imply that the model fit is good and it can be used for policy simulations through assumed shocks. The results suggest that an upward revision of energy prices will be slightly inflationary and as a result, the real gross domestic product (GDP) growth rate will fall slightly during the predicted period. However, the GDP growth and inflationary situation might improve if changes in other macroeconomic indicators take place along with energy price adjustments.

This chapter attempts to analyze the effectiveness of monetary policy in Bangladesh by identifying various transmission channels. Structural Vector Autoregressive (SVAR) model has been applied to the monthly data between 1989 M1 and 2018 M12. Positive innovation in broad money supply causes an increase in price level and bank credit, but only in the short run. Expansionary monetary policy also influences nominal exchange rate of Taka. However, the study suggests that structural weaknesses of the financial system and lack of dynamic adjustments of policy rates be the key reasons for which monetary policy appears to be less effective in Bangladesh.

Fiscal discipline has been a strength in Bangladesh’s macroeconomic management. Budget deficits have been consistently maintained at prudent levels over time. Consequently, public debt is low, and Bangladesh is assessed to be at low risk of debt distress over the medium to long term. This assumes sustained economic growth at 6.5–7 percent every year for the next 20 years. However, contingent liabilities, particularly those from state-owned financial and non-financial enterprises, risk putting pressure on the fiscal stance. Low revenue mobilization and weak public investment management have limited the growth and equity impact of fiscal policy. Tax revenues and expenditures also appear to be procyclical, implying that fiscal policy does not act as an automatic stabilizer, thus complicating the management of macroeconomic stability challenges.

The effectiveness of fiscal policy in stimulating the economic activity and maintaining macroeconomic stability of a country has received considerable policy and research interests. This chapter aims to explore the effects of key fiscal policy instruments on economic growth in the context of Bangladesh economy. The study conducts time series analysis using data of real gross domestic product (GDP), government current consumption and tax revenue of Bangladesh for the period 1980–2017. Using the vector error correction model (VECM) and Johansen cointegration technique, the chapter analyzes both short-run and long-run effects of fiscal policy instruments on economic growth. The findings of the study suggest that there is a positive and significant long-run causal relationship between real GDP growth and government consumption as well as between real GDP growth and tax revenue. The study also investigates nature of the impulse response functions (IRFs) resulting from vector autoregression (VAR). Finally, the study attempts to provide relevant policy insights based on the research findings.

In the context of growing demand for infrastructure investment in Asian countries including Bangladesh to support higher growth, this chapter discusses various alternative approaches of financing investments. This chapter particularly focuses on the use of spillover tax revenue to attract more private investments in infrastructure. Sharing spillover revenue with private investors will raise the rate of return of the private investors and improve infrastructures to a great extent with less burden on the government’s fiscal budget. Therefore, this approach is expected to create a win-win situation for both the government and private investors. Solving land acquisition related disputes is another key aspect for successful implementation of infrastructure investment projects. Therefore, we propose to use land trust method for acquisition rather than direct acquisition from landowners in order to reduce the cost and minimize the delay in implementation of infrastructure projects. Some innovative financing aspects practiced in Japan and other countries are also discussed.

This chapter analyzes various trade liberalization policies implemented in Bangladesh in phases and examines how the policies have contributed to overall trade performances. As part of liberalization, customs duty rate was reduced from 350 percent in 1990 to 25 percent in 2011. The number of operative tariff slabs was reduced from 24 in the 1980s to 5 in 2010. Trade liberalization policies contributed positively to the enhancement of country’s overall trade—the share of which is increased from 12 percent of gross domestic product (GDP) in 1990 to about 50 percent of GDP in 2015. However, still there are scopes of improvement of trade regime by further liberalizing the sector through eliminating all sorts of biases and rationalizing supplementary import duties and non-tariff barriers.

This chapter analyzes trade pattern, evolving markets and trade potential in Bangladesh. The estimated revealed comparative advantage (RCA) and specialized Balassa Indexes (SBIs) suggest that Bangladesh has been enjoying high revealed comparative advantage in knitted garments, woven garments, jute and jute goods, other textile articles, frozen fish, leather, footwear, headgear and parts. The analysis indicates that attention needs to be given not only on revealed comparative advantage of products for specialization, but also on diversification of export items and market destinations. Since RCA cannot tell about future potentials of exports, a trade potential index (TPI) has been estimated, which indicates that Bangladeshi products have huge potential in some countries for which Bangladesh needs to comply with sanitary and phytosanitary standards of those countries.

This chapter analyzes determinants and persistency of capital flows (foreign direct investment, debt and official aid) to least developed countries (LDCs) for the period 1990–2012. The results indicate that capital flows to LDCs, particularly foreign direct investment (FDI) and external debt, are associated with various factors, such as macroeconomic stability, financial sector development, trade openness, natural resource abundance and political environment. However, the determinants of capital flows vary significantly across regions. While FDIs are of natural resource seeking type in Africa, it is mostly efficiency-seeking in Asia. The results suggest for appropriate policies aimed at improving macroeconomic and financial environment along with political stability in order to ensure more capital flows.

This chapter assesses the role of aid in macroeconomic stability and economic development in Bangladesh. Beginning with high aid dependency since independence in 1971, the country sharply reduced the dependence by the late 1990s. Aid played a critically important role during this period, in supporting the external and internal balances and sustaining macroeconomic stability, as well as in laying the foundations for the shift to a higher, more inclusive growth trajectory with faster poverty reduction, which were to follow after 2000. Since then, along with the share of aid, donor priorities also shifted as the country’s capacity to finance an increasing part of the development plans improved. Aid allocation to health and education increased, and the access to low-cost foreign exchange resources provided by aid enabled allocation to longer gestation infrastructure projects, thus ensuring sustainable debt levels. By 2015, Bangladesh became one of the better performing low-income countries in achieving the core Millennium Development Goal targets. While the aid-GDP ratio declined to 1 percent by 2015, it will continue to be important for infrastructure development, especially transport and energy. Involvement of the multilateral donors will also remain important in enabling access to external financing—both public and private. However, still there are some key challenges in the aid-development nexus in Bangladesh. Greater attention by donors to the local context, government ownership, more implementable institutional reforms in the rapidly changing economic context, effective monitoring and evaluation to improve aid disbursement and achieve stronger results, etc., are needed, while Bangladesh remains on track to graduating from aid over the next decade.

Workers’ remittances are one of the main sources of foreign exchange in developing countries. Therefore, understanding how macroeconomic factors influence the flows of workers’ remittances is important for macroeconomic policy formulation in developing economies. Using a panel data of remittance flows from 12 major host countries to Bangladesh over the 2005–2017 period, this chapter examines the role of macroeconomic factors and financial sector development in Bangladesh in determining the flows of remittances. We found that the effect of income differential between the host countries and Bangladesh is statistically insignificant, indicating that altruistic motive was not the main factor for remittances during this period. On the other hand, financial sector development played a positive role in increasing remittance flows through improving access to financial services in Bangladesh. Using time series data on workers’ remittances from 1981 to 2017, we also found that there is a positive long-run relationship between remittances and gross domestic product, which highlights the importance of remittances for macroeconomic development in Bangladesh.

This chapter reviews the process of financial liberalization that has taken place over time and assesses its impact on the financial sector development and economic growth. Financial liberalization in the 1990s improves all the indicators of financial development, and as a result the financial system of Bangladesh has widened and deepened. The average credit, deposit and broad money to GDP ratios increased substantially from 6.6 percent, 14.9 percent and 19.0 percent, respectively, during 1976–1980 to 38.05 percent, 41.84 percent and 50.8 percent in 2012. Investment and per capita income also display a similar increasing pattern reflecting a close association with financial development. However, analysis casts doubt on the positive role of financial liberalization on the efficiency and competitiveness of the financial sector.

The chapter addresses the role of microfinance in sustainable development and economic growth in Bangladesh. In Bangladesh, microfinance institutions (MFIs) have played a key role in financial inclusion. Due to the expanded outreach of the MFIs, around 43 percent of households have access to financial services. The credit market is uniquely divided between banks and MFIs. Banks are largely concentrated in the urban credit market, and MFIs are mostly concentrated in the rural credit market. Increase in microfinance outreach and loan size is expected to have an impact on poverty reduction and food security as well as economic growth. Analysis of the longitudinal Programmed Initiatives for Monga Eradication (PRIME) data from the north-western region of Bangladesh shows that microfinance complimented by non-financial services has contributed greatly toward increase in financial inclusion, improvement in food security and reduction in multi-dimensional poverty. In comparison to control households, multi-dimensional poverty decreased by 15 percentage points for the program participants. On the other hand, based on literature review and recent estimates of the macro impact of microfinance, it was shown that microfinance had contributed to GDP growth and even largely to real rural GDP growth in Bangladesh. Such macroeconomic impacts are results of the penetration of microfinance, increase in loans for micro enterprises, productive use of microcredit and increase in total factor productivity. However, it is concluded that, in future, macroeconomic impacts will increase further with the current growth of investment in micro and small enterprises and human capital development.

This chapter highlights various aspects of the capital market in Bangladesh, which now consists of two stock exchanges—Dhaka and Chittagong stock exchanges. After a crash in 2010, various policy reforms helped the market return to its normal behavior. Lack of institutional investors and underdeveloped secondary bond market are key impediments of the capital market to meet the financing needs of the country in the backdrop of its graduation from the least developed country (LDC) status, which is likely to be achieved in 2024. Therefore, a set of recommendations is made in this chapter for further development of the capital market in Bangladesh.