pri quarterly policy briefs on bangladesh economy · pri quarterly policy briefs on bangladesh...

PRI Quarterly Policy Briefs onBangladesh Economy

September 2012

Policy Research Institute of Bangladesh (PRI) Department for International Development (DFID)

Volume II

ii

PRI Quarterly Policy Briefs on Bangladesh Economy September 2012

Foreword

Bangladesh seeks to achieve middle-income status by 2021. The Sixth-Five Year Plan hasbeen formulated as a stepping stone for accomplishing this goal. The macroeconomic objectivesof the Plan include considerable acceleration of economic growth, significant reduction ofinflation and substantial decline of the incidence of poverty.

It is widely recognized that achieving the above-mentioned objectives would requireconcerted governmental action on many fronts. Most importantly, the country has to implementappropriate policy measures to mobilize both domestic and external resources with a view toraising public investment well beyond the present level. This is of crucial importance foralleviating infrastructural bottlenecks which stifle private investment.

The country is already in the third year of the Plan period. This is an opportune time toundertake an objective assessment of where the country stands in relation to implementation ofthe Plan as the basis for identifying needed policy actions. The present volume brought out byPolicy Research Institute competently accomplishes this task. The topics are appropriately chosen.These deal with macroeconomic framework of the Plan, sustaining the recent success in taxrevenue collection, strategy for foreign resource mobilization and revamping the power sector.The authors deserve acclaim for undertaking objective analysis of the current status and offeringconcrete, implementable suggestions for action in each of these areas. The volume should beimmensely useful to academicians, researchers as well as policy makers.

Mirza Azizul IslamFormer Adviser to the Caretaker Government,

Ministries of Finance and Planning,Visiting Professor, BRAC University;

Member, PRI Advisory Panel

iii


Contents

Summary ................................................................................................................................... v

I. Implementation of the Sixth Plan Macroeconomic Framework ................................. 1

Introduction........................................................................................................................1

Assessment of the Implementation Record ......................................................................1

Implications for Policy Reforms .........................................................................................5

II. Implementation of the Sixth Plan Strategy for Foreign Resource Mobilization........ 7

GDP Growth and Saving-Investment Balances in the Sixth Plan ......................................7

Strategy for External Resource Mobilization in the Sixth Plan ..........................................7

Implementation Record of the Sixth Plan’s External Resource Strategy ..........................8

The Way Forward..............................................................................................................12

III. Tax Revenue Mobilization—Sustaining the Recent Success .................................... 13

Background and Introduction..........................................................................................13

Revenue Potentials and the Sources of Recent Revenue Growth ..................................13

How to Realize the Revenue Targets for the SFYP in the Coming Years? .......................16

On the Income Tax Front..................................................................................................16

On the VAT Front ..............................................................................................................17

IV. Revamping of the Power Sector: Where do We Stand Now?..................................... 18

Background and Introduction..........................................................................................18

Where Do We Stand in Terms of the Road Map?.............................................................19

Key Findings and Recommendations ..............................................................................21

iv


List of Tables

Table 1.1: Summary of Key Macroeconomic Targets ............................................................. 1

Table 1.2: Sectoral Growth Performances .............................................................................. 1

Table 1.3: Bangladesh Current Account Balance Situation (US$ millions)........................... 3

Table 1.4: Monetary Policy and Outcome (growth rates %) .................................................. 5

Table 2.1: Saving and Investment, FY10 – FY12..................................................................... 7

Table 2.2: Bangladesh Current Account Balance Situation ................................................... 9

Table 3.1: Selected Components of Income Tax- Deducted at Source ............................... 15

Table 3.2: Productivity of Tax Revenues among Asian Countries....................................... 15

Table 3.3: Selected Countries Payroll Tax withholdings ..................................................... 16

Table 4.1: Electricity Generation by Fuel Type..................................................................... 21

List of Figures

Figure 1.1: Net Capital Account Balance................................................................................. 3

Figure 1.2: Tax Performance ................................................................................................... 3

Figure 1.3: Composition of Deficit Financing, FY10-FY13B (% of GDP)................................ 4

Figure 1.4: Trends in Inflation ................................................................................................. 4

Figure 1.5: Monthly CPI Inflation Rate (%) ............................................................................. 4

Figure 2.1: Bangladesh: Debt Dynamics during FY01-FY10.................................................. 7

Figure 2.2: Bangladesh: Debt Services Ratio during FY01-FY10........................................... 8

Figure 2.3: Bangladesh: External Debt Dynamics for SFYP ................................................... 8

Figure 2.4: Net Capital Account Balance................................................................................. 9

Figure 2.5: Foreign Direct Investment (Million USD) ........................................................... 10

Figure 2.6: Net Commitment of Foreign Resources as percent of GDP .............................. 10

Figure 2.7: Disbursement/Commitment Ratio (Percent) ..................................................... 11

Figure 2.8: Net Official Foreign Financing Disbursement ................................................... 11

Figure 3.1: NBR Tax Revenue................................................................................................. 13

Figure 3.2: Trend in VAT and Direct Taxes............................................................................ 13

Figure 3.3: Growth in VAT vs VAT base................................................................................. 13

Figure 3.4: Consumption and VAT Pattern........................................................................... 14

Figure 3.5: Growth in Income Tax- Its Components and Base............................................. 14

Figure 3.6: Income Tax & Tax deducted at source................................................................ 14

Figure 3.7: Bangladesh: VAT Efforts and VAT Productivity................................................. 15

Figure 4.1: Plan Vs Actual Supply (MW) ................................................................................ 18

Figure 4.2: Demand and Supply of Electricity ...................................................................... 18

Figure 4.3: Avg. Load Shedding as % of Peak Gen............................................................... 19

Figure 4.4: Plan Vs Actual Supply (MW) ................................................................................ 19

Figure 4.5: % of Electricity Generated by Oil........................................................................ 19

Figure 4.6: Electricity Tariff for Industrial Users and Top Tariff Rate for Domestic Users . 20


v

Summary

I. Implementation of the Sixth PlanMacroeconomic Framework

The outcomes for the first two years of the SixthPlan suggest a mixed record of performance. TheGDP growth was on target in FY11 but is lower thanplanned in FY12. The current account and fiscalbalances are broadly on target, but there issubstantial shortfall in the targets for theinvestment rate, growth of exports and the inflationrate. Slower GDP growth and higher inflationrelative to the Plan targets, unless tackled forcefully,will likely have adverse implications foremployment and poverty reduction targets of theSixth Plan.

The Sixth Plan adopted a sound macroeconomicframework where the targeted higher GDP growthwas planned to be supported by a substantialincrease in investment rate, a strong agriculture, adiversified and fast growing export base, andimprovement in productivity. The higherinvestment rate would largely be financed bynational saving rate along with a modestlyimproving role for foreign saving. Public savingwas projected to increase by keeping currentexpenditures under control and through higherrevenue mobilization. Budget borrowing from thebanking sector would be limited and madeconsistent with the monetary growth target toreduce inflation.

During the first two years, GDP growth was goodbut the performance in FY12 was below the target.Manufacturing sector and services have done wellbut there have been substantial shortfall inagricultural growth rate and export growth rate inFY12. Export performance slipped mainly due tothe Euro-Debt crisis, but it is also symptomatic ofinadequate progress with export diversification

On the growth front, the biggest shortfall is inincreasing the investment rate that remainsstagnant at around 24% of GDP. The nationalsaving rate fell significantly during the first twoyears of the Sixth Plan. The tax performance wasgood but subsidies soared. Foreign aiddisbursement also was lack luster. As a result, therewas a substantial fall in public investment.

The SFYP targeted a substantial reduction inpoverty from 32.5% in FY10 to 22.9% in FY15. Thistarget was underpinned by average GDP growthrate of 7.3% for the plan period and the assumptionthat there will be no worsening of incomedistribution. So, the shortfall in GDP growth in FY12is a source of concern for poverty reduction.Similarly, slippages from the Sixth Plan growth pathin the coming years will hurt poverty reduction.

It is clear that the poverty reduction targets for theSixth Plan face serious downside risks that requirecareful monitoring and policy actions.Strengthening agricultural diversification, sharplyreducing the rate of inflation and improving thelevel and quality of social safety net spending are ofparticular significance for securing the povertyreduction goals of the Sixth Plan.

On the growth front, the highest priority is toincrease the investment rate. Additionally, exportgrowth should be bolstered by reducing tradeprotection.

The financing constraint could be addressed byreducing energy subsidies, strengthening incometaxes, attracting foreign private investment andmobilizing more resources from developmentpartners. Additional resources thus mobilizedshould be used for infrastructure, humandevelopment and social protection. Publicinvestment programs should be protected frombudgetary cutbacks and implementation capacitystrengthened by recruiting professional staff fromoutside the civil service.

Acute governance problems continue to impingeon higher GDP growth and delivery of publicservices. In terms of immediate priority, institutionalreforms to strengthen the urban management,local governments and public administration needto be bolstered.

II. Implementation of the Sixth Plan Externalresource Mobilization

Bangladesh is lagging behind in capitalaccumulation since investment as a percentage ofGDP remains stagnant over the past few years andmuch below Sixth Plan target. A new challenge thatwas unanticipated during the Sixth Plan is theemergence of a resource constraint. Saving rate


vi

declined dramatically in the first two years of thePlan. The financing constraint has reduced publicsector investment and renewed efforts are neededto mobilize both foreign and domestic resources.

Regarding foreign financing, the Sixth Plan adopteda strategy of continued prudent debt managementbut support the financing needs of substantiallyhigher investment by mobilizing additional foreignresources through public-private-partnerships(PPP) in infrastructure, by mobilizing more foreigndirect investment (FDI), by diversifying the sourcesof foreign funding including access to internationalbond markets and by much better use of the largepipeline of committed foreign aid.

The actual implementation of this strategy in thefirst two years of the Plan shows serious gaps. ThePPP initiative did not take off as expected; FDI flowscontinue to show lack-luster performance; thebond initiative is yet to be implemented and the aiddisbursements remain low.

Sixth Plan adopted a sound external resourcestrategy that has met with significantimplementation shortfalls. Efforts now need tofocus to address those implementation constraints.

Need to jump start the stalled PPP strategy througha more thoughtful and realistic approach thatinvolves the participation of internationallycompetent staff that have a track record formanaging PPP programs. The relocation of PPP cellas an autonomous body would allow it to attract across-sectoral pool of expertise to supplementcapacities in the line agencies that contract forPPPs. These experts could also play a substantiverole in developing PPP projects and attractingforeign financing.

The biggest potential is to mobilize much more FDI.Hospitable investment climate can makeBangladesh a major destination of FDI. Theconstraints to the investment climate include issuessuch as inadequate power supply, transportbottlenecks, complex land procurement, andsimplification of business procedures. The foreignexchange regulatory regime also needs furthersimplification to allow smooth private internationalfinancial transactions.

Pursue an aggressive approach to much betterutilization of the large pipeline of undisbursed ODApipeline. The most important constraint here is

procurement. The government may need to thinkout of the box here and adopt options includingturn-key type procurement involving theconcerned donor agencies and invitinginternationally reputed procurement agencies.

Based on good ratings from Moodys’ and Standardand Poors’, Bangladesh can now implement thestrategy to diversify sources of aid including bondfinancing by floating its bond to a tune of $500million. The experience will establish a benchmarkand provide a reality check on international marketperception about the strength of the Bangladeshieconomy.

The government should resolve all disputes withthe donor agencies and manage aid coordination inan atmosphere of mutual trust and respect.

III. Tax Revenue Mobilization

NBR has been extremely successful in Tax RevenueMobilization in recent years with target beingexceeded for three (3) successive budget years. Thisremarkable feat has been achieved despitechallenges like global economic crisis and increasedvolatility in imports. Buoyant performance indomestic-based taxes helped realize the targets.

Direct Taxes and VAT-Domestic have been the maindrivers in the revenue growth. There is greaterpotential to make gains on both the VAT and DirectTax fronts in the near to longer term. Both VAT andincome tax revenue collection exceededsignificantly their respective base expansions,which need to be sustained in the coming years.

Increase in VAT-Domestic indicates that domesticconsumption has been tilting towards domesticproduction and rendering of goods and services.Broadening of the domestic VAT base (imports,wholesale, retail and service sectors), moreorganized production and distribution structure(corporatization) helped sustain the growth.

Growth in withholding of income tax at source hasbeen slow with its relative share declining whichindicates a fundamental weakness in direct taxadministration. Withholding from contractors onaccount of government supplies/projects, financialinstitutions and advanced tax on importers are thetop three sources of withholding. Payrollwithholding which accounts for a very large part of


vii

income tax collection in most countries, stillremains very low in Bangladesh.

Despite the recent success in tax revenuemobilization, achieving the domestic revenuemobilization target envisaged under the SFYP willremain challenging. After taking into account theenvisaged nominal economic growth, the averagenominal growth in NBR tax revenue would need tobe 26.2% per annum in order to achieve the SFYPtargets in the upcoming years.

While continuing with the revenue structuralreforms envisaged under the Modernization Plan ofthe NBR, achieving the revenue targets under SFYPwill require measures in a number of areas: On thedirect tax side the focus should be on:

Simplifying the tax filing process and making itmore taxpayer friendly by simplifying the forms, notfocusing on expenditure accounts andaccumulation of wealth; automatic acceptance oftax returns.

Payroll monitoring through broadening of thewithholding base is very poor and there istremendous scope for improvements in this areawith very high payoff. In most developed taxsystems, much of the personal income tax comesfrom payroll withholding systems. Thus to improvethis, all employers must be registered under payrolland withholding of payroll system and necessarymechanisms must be put into place expeditiously.

On the VAT side the primary focus should be onstrengthening the administration of the tax systemthrough exchange of information between the VAT,Direct Tax and Customs Wings. In particular, payrollinformation would be very useful in assessing VATliability since much of the value addition is donethrough payroll. NBR needs to develop urgently acentral IT network covering all 3 major wings andenabling information sharing andstatistical/research analysis.

IV. Revamping the Power Sector

At the time the current government came to powerin early 2009, power sector was already in a state ofdisarray and was considered to be the number oneconstraint to sustain higher levels of economicgrowth and faster rate of poverty reduction. Thegovernment in its political manifesto and the

accompanying Vision 2021 document committedto ensure energy security for Bangladesh andelectricity for all citizens by 2021.

Government opted for installation of small sizedquick rental liquid fuel based power plants as ashort term solution along with lager sized Powerplants for medium and long term. As new rentalpower plants came into operation, electricitygeneration in terms of actual (maximum) level hascertainly increased steadily (43 percent) during2010 through July 2012. Although load sheddingdid not decrease in absolute terms due to growingdemand and other factors, it certainly came downin relative terms by mid-2012.

Due to high fuel costs associate with powergeneration through rental power plants, a largeportion of the installed capacity has remainedunutilized. Although there is room for further tariffincrease in the near term, sustainability over thelonger run will require reducing dependence onrental power plants, change in the primary fuel mixand generation through more efficient larger sizedplants.

As a medium term strategy government shouldwork with the private power producers foraccelerating the pace of implementation of thelarger projects, which are facing financingproblems, by helping them to access varioussources/options for foreign financing. Anotherelement of the medium term strategy will be to:import power from the more efficient Indian privatepower producers; and start work on developing theinfrastructure for a strong South Asian power gridand the regulatory framework for cross-bordertrade in electricity among the private sectorproducers and users of power.

For long run sustainability, a major shift in the fuelmix will be absolutely essential. Bangladesh cannotrely on gas at the current level of more than 80% ofelectricity feedstock given the low level of provengas reserves. Shifting to coal will be a priority. Coalpolicy should be finalized and definitive measureneed to be taken for joint venture projects for coalbased projects with India. Securing electricity fromuntapped potential hydroelectricity in Nepal andBhutan through joint venture investment with Indiacan be a cheap source in the long run.


1

I. Implementation of the Sixth PlanMacroeconomic Framework

Sadiq Ahmed

Introduction

The Sixth Plan set fairly realistic macroeconomic targetssupported by a well-rounded and consistentmacroeconomic framework. The outcomes for the first twoyears of the Plan suggest a mixed record of performance.The GDP growth was on target in FY11 but was lower thanplanned in FY12. The current account and fiscal balancesare broadly on target, but there is substantial shortfall in thetargets for the investment rate, growth of exports and theinflation rate. Slower GDP growth and higher inflationrelative to the Plan targets, unless tackled forcefully, willlikely have adverse implications for securing theemployment and poverty reduction targets of the SixthPlan.

Assessment of the Implementation Record

Sixth Plan Macroeconomic Framework: The SFYP targetsan average GDP growth rate of 7.3 percent for the planperiod. The associated yearly time path entails acceleratingreal GDP growth from 6.1 percent in FY10 (base year) to 8percent in FY15. To achieve this growth, the investment rateis targeted to rise from 24.4 percent in FY10 to 32.5 percentin FY15 (end year of the SFYP). The key macroeconomictargets and indicators of the Sixth Plan are presented inTable 1.1.

Table 1.1: Summary of Key Macroeconomic TargetsBenchmarkFY10

FY11P FY12ESFYP Target

FY12 FY13 FY14 FY15

Real GDPGrowth Rate

6.1 6.7 6.3 7.0 7.2 7.6 8

Investment Rate(% of GDP)

24.4 24.7 24.9 26.8 29.6 31.0 32.5

Savings Rate (%of GDP)

28.1 25.7 25.2 26.7 29.4 30.7 32.1

Export Growth(US $)

4.2 38 6.0 14.5 14.5 14.5 15

Import Growth(US $)

5.4 45 7.0 14 14 14.5 14.5

Current AccountBalance (% ofGDP)

3.7 1.0 0.3 -0.1 -0.2 -0.3 -0.4

Fiscal Balance(excludinggrants) (% ofGDP)

-3.7 -4.4 -5.1 -5 -5 -5 -5

Inflation(average)

7.3 8.8 10.6 7 7 6.5 6

Source: SFYP and PRI estimates

P= provisional; E=estimated

Savings rate is projected to rise gradually during the SFYPfrom 28.1 percent in FY10 to 32.1 percent in FY15. A growthrate of 14-15% per year in exports has been set over theseyears. To support GDP growth, exports and investment, the

Sixth Plan anticipates a steady increase in the growth ofimports to around 14-15% per year. Some scope for fiscalexpansion is also allowed in the Sixth Plan, although thefiscal deficit target is set prudently not to exceed 5 percentof GDP. The Sixth Plan recognized the need to stabilize themacroeconomy and curb inflationary pressure. Accordingly,inflation was targeted to slow down steadily from 7.3percent rate in FY10 to 6 percent in FY15. Although thecurrent account balance in the benchmark year was insurplus, the SFYP recognized that such large surpluses arenot sustainable or necessary. Higher growth would entailrising imports as well as foreign financing of investment. Assuch, the Sixth Plan targeted a slowly rising current accountdeficit that is aligned to available foreign financing.

External Environment: In an open economy, the externaldevelopments can have positive or unanticipated negativeimplications for development efforts. The exportperformance in FY 11 benefitted from the recovery of worlddemand from the global financial crisis. But the exportperformance in FY12 was adversely affected by theEuropean debt crisis. The positive external environmentbenefitted exports and GDP growth in the first year of theSixth Plan, but negative developments in FY12 have hurtexports and GDP growth in the second year of the Sixth Plan(FY12). On the financing side, the positive outcome on theremittance front has helped counter the adverse effects ofslowdown in growth of exports.

GDP Growth Outcome: The GDP growth is estimated at 6.7percent for FY11, which is in line with the Sixth Planprojected growth path. Agriculture and services sectoractivities continued to follow the benchmark year’s growthrate performance while an impressive surge was achieved inindustrial sector growth (Table 1.2).

Table 1.2: Sectoral Growth Performances

ComponentsFY10 FY11P FY12Target FY12E

Share Growth Share Growth Share Growth Share Growth

Agriculture 18.6 5.2 18.4 5.0 17.7 4.5 17.5 2.53

Industry 28.5 6.5 28.6 8.2 29.4 9.6 28.5 9.47

Services 53.0 6.5 53.0 6.6 52.9 6.8 53.9 6.06

Real GDP 100.0 6.1 100.0 6.7 100.0 7.0 100.0 6.32

Source: Bangladesh Bureau of Statistics and PRI estimate

Agricultural sector achieved 5 percent annual growth in thelast two fiscal years (FY10 and FY11) reflecting thegovernment’s continuous effort to boost the performance ofthis sector. Government has taken various support initiativesincluding better distribution of seeds, fertilizer, and othernecessary inputs which have contributed to these positiveresults. Uninterrupted electricity supply for irrigation at asubsidized rate and higher prices of farm produce includinggovernment procurement prices also contributed toagricultural growth.


2

Strong rebound in export-oriented manufacturing andbetter performance of domestic market based industriessupported higher growth in industrial sector in FY11.Though growth in small scale industries declined, owing topower shortage and high raw material prices, an impressivegrowth in large and medium scale manufacturing supportedby a huge 40% growth in exports, especially ready-madegarments (RMG) provided the impetus. As a result thegrowth of manufacturing sector increased to 9.5% inFY2011, as compared with 6.5% in FY10.

Supported by vibrant agriculture and manufacturing, theservices sector flourished, registering a healthy growth of6.7% per year. All service components- transport, trade,financial sector, government and private services-contributed to this, responding to demand fed by risingincomes from agriculture, manufacturing and remittances.

The estimate for GDP growth for the FY12 suggests that itwill remain strong but will fall short of the Sixth Plan targetof 7%. While the long-term prospects for agricultureremains solid, agricultural growth in FY12 has fallensubstantially short of the Sixth Plan target. The growth ofvalue-added from crop production, which is dominated byrice, has slowed down owing to sharply falling rice prices inreal terms that has lowered farm incentives. Furthermore,progress towards diversification appears limited as reflectedin sharply rising prices of livestock and fishery productssuggesting that supply constraints remain strong. On thewhole the estimated growth of the agricultural sector inFY12 (2.5%) is much below the Sixth Plan target (4.5%). Forthe future, inadequate crop diversification and lowerproductivity are two major challenges of this sector thatmust be addressed to sustain a 4% plus growth as envisagedin the Sixth Plan. Sustaining a 4-5% real growth inagriculture on the basis of food crops for domestic marketalone with demand growing at around only 2% per year isnot a viable proposition. The options for food exports anddiversification to other higher value-added farm production(fish, meat, fruits, vegetables, processed food, etc) must beexplored to sustain agriculture GDP growth at 4% plus.

Regarding manufacturing, the slowdown for RMG exports inEurope owing to the ongoing Debt Crisis will hurtBangladeshi exports and value-added in manufacturing. Inrecent years the manufacturing outturn is substantiallydetermined by RMG and other exports. As such, thereduction in export growth from 40% in FY11 to only 6%estimated for FY12 has tended to lower the growth ofmanufacturing. This adverse effect of the external sector onmanufacturing production in FY12, however, was offset by astronger performance of small enterprises. So, the overallmanufacturing sector growth is expected to reach 9.4% inFY12 as compared with 9.8% target for FY12 in the SixthPlan. Additionally, the strong performance of constructionsector will boost industrial sector performance. On thewhole, in FY12 the industrial sector is expected to grow by9.5%, which is close to the Sixth Plan target of 9.6%.

Supported by strong inflows of remittances and the growthin industrial production, the services growth, which isdemand driven, will continue to grow at a healthy pace of6.1%. These sectoral growth outturns imply a total GDPgrowth of 6.3% in FY12, which is a solid performance in theinternational context but slower than targeted in the SixthPlan. The shortfall in GDP growth over the target in FY12 islargely the result of the unexpected slowdown in thegrowth of the agriculture sector, although the Euro-Debtcrisis also affected the growth of exports. Agricultural sectorgrowth, which is also substantially below target, will likelyrecover with policies to help diversification. However, fromthe longer-term perspective, the bigger concern for thesustainability of the Sixth Plan growth target is thesubstantial shortfall on the investment front. It is wellrecognized that the inadequacy of infrastructure,particularly power, has emerged as a binding constraint tothe expansion of economic activities, especiallymanufacturing. Unless the challenges of infrastructure andthe expansion of the investment rate needed to finance thehigher GDP growth are tackled upfront, there is a substantialrisk that the Sixth Plan growth targets will not be achievable.

Emerging Resource Constraint: A major unanticipatedfactor underlying the shortfall in the investment rate is theemergence of a resource constraint. In recent yearsBangladesh was fortunate in experiencing a rapidlyexpanding national saving. This made it possible to financea growing domestic investment even in the absence of abuoyant foreign direct investment and dwindling officialassistance. The financing environment has changed overthe past 2 years. Compared to a saving rate of 28.1% of GDPin FY10, it declined dramatically in FY11, sliding to 25.7%,and further declining to 25.2% in FY12. This change in thesaving outcome is a negative development that requiresattention.

Public investment mainly has suffered from the resourceconstraint. In addition to the implementation capacityconstraints in the public sector, the inability to achieve thetargeted increase in the public investment rate is also due toa serious shortage of financing. The projected increases inpublic saving during the first two years of the Plan did notmaterialize as growing energy and food subsidies increasedpublic consumption. As well, the expected financing ofpublic investments from foreign sources, both official andthrough PPP channels, did not materialize to the extentprojected in the FY11 and FY12 budgets.

Balance of Payments Outturn: In the foreign account,despite satisfactory trend in export growth in recent years,trade deficit has been widening due to persistently highimports of fuel, food and capital goods (Table 1.3). The tradegap widened from US$ 4.7 billion in FY09 to $7.3 billion inFY11 and to $8.5 billion in FY12. Along with the gap on theservices and other income accounts, the total financing gapon the trade and services account widened from $$7.7billion in FY09 to $13.3 billion in FY12.


3

Fortunately for Bangladesh, these financing gaps in thetrade and services account are financed by the large inflowof remittance income. Remittance inflows are still largeenough to finance such gaps and even allow a surplus in thecurrent account. Monthly flows now exceed a billion dollars.For FY12, total remittance is expected to reach $12.9 billion,which is an all time high for Bangladesh.

Table 1.3: Bangladesh Current Account BalanceSituation (US$ millions)1

FY09 FY10 FY11 FY12P

ComponentsTrade balance -4708 -5149 -7318 -8472Export f.o.b.(including

EPZ) 15583 16237 23009 23992

Import f.o.b (includingEPZ) -20291 -21387 -30326 32464

Services -1621 -1240 -2399 -3279Income -1361 -1484 -1354 -1508Current transfers 10226 11610 12068 13699Official transfers 72 122 120 105Private transfers 10154 11488 11948 13594Of which : Workers'

remittances 9689 10987 11536 12843

Current Account Balance 2536 3737 998 440Source: Bangladesh Bank

Nevertheless, the widening gaps in trade and servicesaccount of the balance of payments are becoming a sourceof concern. While these gaps are still lower than total inflowof remittances, the current account surplus is narrowing.Thus, the current account surplus narrowed from 3.4% ofGDP in FY10 to 1% in FY11 and further narrowed to 0.3% ofGDP in FY12. Although this remains a positive developmentand more generally a current account deficit rather than asurplus is a normal result for a low income developingcountry like Bangladesh, the main problem is the lack ofadequate foreign funding in the capital account.

Unlike other developing countries, Bangladesh has beenexperiencing mostly a negative capital account balance overthe past 4 years (FY08-FY12) owing to declining net officialaid and stagnant foreign direct investment (Figure 1.1).There have also been large private capital outflows in FY11and FY12 due to a variety of factors including outwardremittances. The outflows were particularly large in FY11,contributing to a substantial net deficit in the capitalaccount. For FY12, it is estimated that the capital accountwill virtually be in balance, thereby allowing a small overallsurplus in the balance of payments. However valuation

1 There are unresolved issues regarding the FY12 import data. Theimport figure based on payments recorded in BB is $1.4 billion lowerthan the import figure from NBR sources. The IMF has used anestimate that lies between these two figures, which is also used in thisTable. Once a full reconciliation is done, the true import figure mightchange.

losses in foreign reserves will absorb this surplus, leavingreserves unchanged at $10.4 billion2.

Acute shortage of foreign capital including official foreignaid and foreign direct investments are a major constraint tothe Sixth Plan macroeconomic framework. To achieve thegrowth rate targeted in the Sixth Plan Bangladesh needs tomobilize substantial higher inflows of official aid and foreigndirect investment as an important element of financingrequired investments during the Sixth Plan.

Figure 1.1: Net Capital Account Balance

Source: Bangladesh Bank

Fiscal Outturn: The fiscal stance in FY11 was moderatelyexpansionary with overall deficit (including grants)estimated at 4.4 percent of GDP. This deficit was below thebudget target of 5 percent but higher than the budgetdeficit in FY10 (3.7% of GDP). Revenue performance wasgood, exceeding the budget estimates and registering animpressive 27.8 percent growth (figure 1.2). As a result thetax to GDP ratio reached the double digit mark in FY11 forthe first time in Bangladesh.

Figure 1.2: Tax Performance

2 The reported reserves of $10.9 billion in FY11 overstate the truereserves that were $10.4 billion once foreign exchange overdrafts ofcommercial banks are taken into account

-3-2-101234

(As %

of G

DP)

Current Account Balance Overall Balance Net Capital Account

9.2% 9.2%

9.7%

10.5%

9.0% 9.0%

10.1%10.5%

8.0%

8.5%

9.0%

9.5%

10.0%

10.5%

11.0%

FY09 FY10 FY11 FY12 (B/RB)

As %

of G

DP

2(a): Tax revenue (Budget vs Estimates)

Budgeted Actual/RB


4

Source: Ministry of Finance.

On the spending front, increase in subsidies to agriculture,power, fuel, foods and exports contributed to a surge innon-development expenditures. Subsides and currenttransfers including grants and pensions increased as well,amounting to 3.7 percent of GDP in FY11. However, despiteincreasing pressure of current spending, total publicexpenditures in FY11 remained below the budgetary targetdue to underutilization of Annual Development Program(ADP) allocations.

On the financing front, foreign aid disbursement has beenslowing down. The declining trend in external financingover the last few years has intensified reliance domesticborrowing to finance the budget deficit. A particularlyworrisome development was the increase in net borrowingfrom banking sources, which jumped to 2.6 percent of GDPin FY11 from (-) 0.3 percent of GDP in FY10 (figure 1.3).

Figure 1.3: Composition of Deficit Financing, FY10-FY13B (% of GDP)

Source: Ministry of Finance, Bangladesh and GED estimates

The progress with improved tax performance has beenmaintained in FY12. The outlook is that the tax to GDP targetof 10.4% of GDP for FY12 will be achieved. But continuedpressure on account of food, fuel and electricity subsidiescoupled with a further slowdown in the availability offoreign funding has challenged fiscal policy management inFY12. In the first four months of FY12 the Governmentborrowed TK 150 billion from the domestic banking system,which is 80 percent of the target for the entire fiscal year.Since then the borrowing rate has declined somewhat. ForFY12 as a whole, the bank financing is estimated at 3.2% ofGDP, which is substantially higher than the 2% of GDP target

in the FY12 national budget. ADP implementation has alsobeen slow and a combination of capacity and financingconstraints has reduced the ability to implement theplanned ADP expenditure in FY12.

On the whole, while the tax target for FY12 has beenachieved, the investment target for FY12 has been missed.The fiscal deficit is contained at around the stated target of5% of GDP, but much of the deficit financing has come fromborrowings from the Bangladesh Bank with adverseconsequences for the growth of credit to the private sector.

Inflation Outturn and Monetary Policy: Inflation:Bangladesh has been facing growing inflationary pressuressince FY01 (figure 1.4). The average yearly rate of inflationclimbed from a low of 2% in FY01 to a peak of 10.6% in FY12.

Figure 1.4: Trends in Inflation

Source: Bangladesh Bureau of Statistics

More recently, the rate of inflation on a point-to-point basiscrept up steadily since July 2009, rising from a low of 2.3% inJune 2009 to a peak of 12% in September 2011. The inflationrate declined slowly after that and stood at 8.6 % in June2012 (Figure 1.5). Increase in the overall CPI was initiallydriven by high food prices, but non-food prices have beensoaring in recent month.

Figure 1.5: Monthly CPI Inflation Rate (%)


-515355575

In b

illio

n BD

T

2(b): NBR Revenue Shortfall/Surplus

FY11

FY10 FY11 FY12(RB) FY13B

1.43%0.60% 1.30%

-0.30%

3.20%3.18%2.59%

0.63%0.59%

Non-bank Financing Bank Financing


4















2(b): NBR Revenue Shortfall/Surplus

FY12

FY13B

1.78%

2.21%

1.01%

Bank Financing

8.66

0

2

4

6

8

10

12

14

1994

/95

1995

/96

1996

/97

1997

/98

1998

/99

1999

/00

2000

/01

2001

/02

2002

/03

%Annual Average Inflation

General Food, beverage & tobacco

02468

10121416

Jan-

11

Feb-

11

Mar

-11

Apr

-11

May

-11

Jun-

11

Jul-

11

Aug

-11

Sep

-11

General


4















9.9410.62

2002

/03

2003

/04

2004

/05

2005

/06

2006

/07

2007

/08

2008

/09

2009

/10

2010

/11

2011

/12

Annual Average InflationFood, beverage & tobacco Non-food

Oct

-11

Nov

-11

Dec

-11

Jan-

12

Feb-

12

Mar

-12

Apr

-12

May

-12

Jun-

12

Jul-

12

Aug

-12

Food Non Food


5

Increases in food prices reached a peak at 14.4 percent inApril 2011, but declined after that, falling to 8.0 percent inJune 2012. Non-food prices fell during the first half of FY11reaching a low of 3.3 percent in December, but thenincreased rapidly climbing 14.0 percent in March 2012. Itthen declined to 12% in June 2012.

Inflation in Bangladesh can be explained through bothsupply and demand side factors. Soaring internationalcommodity prices was the main source of food inflation.Meanwhile an accommodating monetary policy boosteddomestic demand, creating serious upward pressure onnon-food prices. Larger-than-planned budgetaryborrowings in FY11 and FY12 also contributed to monetaryexpansion and inflation.

Despite the intention to restrain monetary growth, duringFY10 and FY11 Bangladesh Bank’s monetary targets wereexceeded in practice due to growth in credit to public andprivate sector (Table 1.4). In FY11, monetary growth washigh partly because of the monetization of the fiscal deficitthrough government borrowing from Bangladesh Bank. Thestock of government borrowing from BB at end-June, 2011was 43.6 percent higher than that at end-June, 2010.

Table 1.4: Monetary Policy and Outcome (growth rates%)

MonetaryComponents:

FY10 FY11 FY12Target Actual Target Actual Target Actual

Net ForeignAssets

27.9 41.3 -1.5 5.2 -1.6 11.6

Net DomesticAssets

13.1 18.8 20.0 25.0 22.1 18.5

Domestic Credit 15.6 17.6 18.8 27.4 20.0 19.5Public sector 11.9 -5.2 29.2 33.6 28.1 18.8Private sector 16.7 24.2 16.5 25.8 18.0 19.7Broad money 15.5 22.4 16.0 21.3 18.5 17.4

Reserve money 7.0 18.1 15.0 21.1 16.0 9.0

Macroeconomic Outcomes

Inflation(CPI) 6.5 7.3 6.3 8.8 7.5 10.6Real GDP growth 5.5 6.1 6.7 6.7 7.0 6.3 (E)

Nominal GDPgrowth

12.0 12.9 13.0 13.4 14.5 14.8 (E)

Source: Based on BBS and BB data

The FY12 monetary policy statement (MPS) for the first halfaimed to restrain domestic credit growth by selectivelycontaining the growth of credit for wasteful, unproductiveand speculative uses. The MPS also sought to ensureadequate credit flows for all productive pursuits inmanufacturing, agriculture, trade and other services.However, achieving this balance required coordinated fiscalpolicy management that keeps borrowing from BangladeshBank to a minimal level. In the event, this has proven difficultowing to larger-than-budgeted energy subsidies.

Controlling inflation has, therefore, been a major challengein the first two years of the Sixth Plan. The good newshowever is that efforts since the second half of FY12 to

tighten domestic credit and money supply has yieldedpositive results. Building on the success of theimplementation of the MPS for the second half of FY12, theMPS for the first half of FY13 aims to continue and build onthe progress made in the second half of FY12. In summary,the estimated average inflation rate for FY12 is 10.6%, muchhigher than the Sixth Plan target of 7.5%. For the future,monetary and fiscal policies need to be coordinated so thatthe Treasury borrowing from Bangladesh Bank is restrainedand the monetary growth rate is consistent with the SixthPlan’s inflation target. Proper implementation of the MPS forFY13 is of critical importance for achieving lower inflation.

Poverty and Inequality: The SFYP targeted a substantialreduction in poverty from 32.5% in FY10 to 22.9% in FY15.This target was underpinned by average growth rate of 7.3%for the plan period and the assumption that there will be nofurther worsening of income distribution. The shortfall inGDP growth in FY12 is a source of concern for povertyreduction.

The assumption of no worsening of income/consumptiondistribution is a predicated on proper implementation of allthe Sixth Plan programs related to the poor and vulnerablepopulation including higher funding for social securityprograms. The target to increase social security spending to2% of GDP in FY11 was not achieved and the prospect forincreasing this spending to 3% of GDP by FY15 ischallenging. Additionally, available M&E of a number ofsocial protection spending suggest a mixed record ofachievement. Similarly, while the FY11 and FY12 budgetshave emphasized spending on education, health, and ruralinfrastructure, the volume of spendings are below the levelsneeded for sustained improvement in these services. Theother key development that could seriously hurtincome/consumption distribution is inflation. There isconsiderable empirical evidence that inflation hurts thepoor relatively more than the rich. So, higher inflation since2009 is of serious concern. The recent reduction in inflationis a welcome development. Sustained efforts to furtherreduce inflation to 4-5% rate will be important for povertyreduction.

Implications for Policy Reforms

It is obvious that the poverty reduction targets for the SixthPlan face serious downside risks that require carefulmonitoring and policy actions. Corrective policy measuresto increase the investment rate focused on infrastructure,strengthening agricultural diversification, sharply reducingthe rate of inflation and improving the level and quality ofsocial safety net spending are of particular significance forsecuring the poverty reduction goals of the Sixth Plan.


6

On the growth front, the highest priority is to increase theinvestment rate. The financing constraint could beaddressed by reducing energy subsidies, strengtheningincome taxes ( eliminating the exemptions on capital gains,introducing a broad-based property tax system), attractingforeign private investment and mobilizing more resourcesfrom development partners. The PPP initiative forinfrastructure financing could be revitalized by assigningthis responsibility to an autonomous entity staffed byproper technical specialists. Public investment programsshould be protected from budgetary cutbacks andimplementation capacity strengthened by recruitingprofessional staff from outside the civil service. Strongerpartnership with development partners in projectdevelopment and implementation will also help.

Exports could be boosted by reducing trade protection,reducing trade logistic costs by improving transport andport services. The potential for agricultural exports includingexports of foodgrain may also be explored. Bangladesh hasalready made some headway in exporting food-products.The lessons of that experience might be reviewed for policysupport. Agricultural export, including foodgrain, is possiblythe best strategy for supporting production and income inthe agricultural sector. Diversification of manufacturingexports and options for entering the services exports marketmay also be explored. Services exports in India provide agood example of how this might be promoted inBangladesh.

In addition to strengthening growth, the social sectorprograms need more attention. The priority given to health,education and social protection is appropriate butbudgetary resources allocated to these programs is lowerthan needed to achieve the poverty reduction targets of theSixth Plan. A part of the additional resources mobilized bycutting energy subsidies and increasing income taxes mightbe reallocated to these programs. In the area of socialprotection, corrective policy actions to improve programdesign, reduce the multiplicity of programs, and improvetargeting are also needed. In environmental managementattention could be given to fiscal and pricing policy aspects.In energy resolving the primary fuel shortage requiresurgent policy attention.

Acute governance problems continue to impinge on higherGDP growth and delivery of public services. In terms ofimmediate priority, institutional reforms to strengthen theurban management, local governments and publicadministration need to be bolstered. The strategies andpolicies for these reforms are well identified in the SixthPlan. The implementation of these strategies and policiesrequire urgent attention.


7

II. Implementation of the Sixth Plan Strategyfor Foreign Resource Mobilization

Sadiq Ahmed

GDP Growth and Saving-Investment Balances in theSixth Plan

Capital accumulation along with increase in average laborproductivity is the mainstay of long run economic growth.Bangladesh is lagging behind in capital accumulation sinceinvestment as a percentage of GDP remains stagnant overthe past few years (Table 2.1). To achieve the Sixth Plan’starget of 8 percent real GDP growth by FY15, a boost in theinvestment rate is essential (from 24% of GDP in FY10 to32% by FY15). Increasing investment to the desired levelappears to be a formidable challenge and requires majoreffort to improve the investment climate, especially toattract more foreign direct investment (FDI). Reviewssuggest that there is considerable scope for improving theinvestment climate, by strengthening the availability ofpower and transport services, by simplifying land acquisitionand registration, and by reducing the corporate tax rate.

Table 2.1: Saving and Investment, FY10 – FY12FY10 FY11 FY12P FY12E

(In Percent of GDP)Investment Rate 24.4 24.7 26.8 24.9

of which:Public Investment 4.1 4.5 6.6 5.0Private Investment 20.3 20.2 20.2 19.9Incremental capitaloutput ratio(ICOR)

3.7 3.8 3.8 3.9

Financed by:National Savings Rate3 28.1 25.7 26.7 25.2

Public Saving4 0.5 0.1 1.6 0.1Private Saving 27.6 25.6 25.1 25.1Foreign Saving (-)3.7 (-)1.0 0.1 (-) 0.3

Source: Sixth Five Year Plan, 2012 and PRI estimates 2012

P=planned; E=estimated

A new challenge that was unanticipated by the Sixth Plan isthe emergence of a resource constraint. In recent yearsBangladesh has been fortunate in rapidly expandingnational saving. This made it possible to finance a growingdomestic investment even in an environment of low FDI anddwindling official assistance. The financing environment forinvestment has been changing rapidly over the past 2 years(Table 2.1). Compared to an estimated saving rate of 28.1%in FY10, the saving rate declined dramatically in the first twoyears of the Plan, falling to 25.7% in FY11 and further sliding

3 Consistent with standard accounting practice, national saving isderived as the difference between total investment less foreigncurrent account deficit (foreign savings)4 Consistent with standard accounting practice, public saving isdefined as public investment minus fiscal deficit.

to 25.2% in FY12. This is a major negative development thatrequires urgent attention.

The financing constraint appeared primarily in the publicsector. In the private sector buoyant demand,accommodating monetary policy, low real interest rates andacceleration of housing prices that built up windfall untaxedwealth pushed the growth of private consumption.Nevertheless total private saving rate still substantiallyexceeded private investment. In the public sector theprojected increases in public saving during the first twoyears of the Plan did not materialize as growing energy andfood subsidies increased public consumption. As well, thefinancing of public investments from foreign sources, bothofficial and through public-private-partnership (PPP)channels, did not materialize to the extent projected in theFY11 and FY12 budgets.

A range of policies could be taken to offset this patternincluding higher public saving through cutback in subsidiesand increase in tax revenues, and through greatermobilization of private financial savings by offering moreattractive real rate of return. Importantly, the Governmentneeds to focus serious attention to mobilizing FDI,reactivating the PPP infrastructure financing initiative,greater mobilization of official assistance and faster use ofavailable foreign aid pipeline.

Strategy for External Resource Mobilization in the SixthPlan

Traditionally, Bangladesh has managed its externalborrowing prudently by securing low current accountdeficits and relying on mostly concessional sources ofofficial assistance. This has served Bangladesh well. Externaldebt to GDP ratio has been declining (Figure 2.1) andexternal debt servicing burden has been very low and alsodeclining. The management of domestic debt has beensimilarly conservative over the longer-term (Figure 2.1) butthe cost of domestic borrowing has been growing in recentyears (Figure 2.2).

Figure 2.1: Bangladesh: Debt Dynamics during FY01-FY10

Source: Ministry of Finance


8

Figure 2.2: Bangladesh: Debt Services Ratio during FY01-FY10


The external financing strategy under the Sixth Planessentially sought to maintain the current strategy ofprudent external borrowing on best possible terms. It wasexpected that donor supports for various majorinfrastructure projects (like the Padma Bridge, deep sea portin Chittagong, power plants, expressways etc) shouldincrease as the pace of project initiation andimplementation gains momentum under the Plan.Bangladesh also planned to implement numerous projectsfor mitigating the adverse impacts of climate change duringthe Plan period and much of them were to be financed inthe form of grants and soft loans from the internationalcommunity under multilateral initiatives.

The external financing of the Plan also sought to rely ongreater inflows of FDI and a broadening of the sources offinancing, creating greater scope for private investors tosecure external financing on better terms through reducedcountry/sovereign risk. Bangladesh received favorableratings from the international rating agencies like Moody’sand Standard and Poor’s (S&P). The positive ratings arereflections of Bangladesh’s good track record inmacroeconomic management, prudent debt managementand its positive external outlook. The favorable rating thusopened up a new channel for potential borrowing from theinternational capital market at reasonable terms by issuingsovereign debt instruments. Although the Sixth Plan didnot anticipate the need to issue sovereign debt forbudgetary or balance of payments financing, it recognizedthat such an issue would establish a benchmark.

Projections based on this broad strategy entailed continuedreduction of government and government guaranteedexternal debt in relation to GDP and reduction of externaldebt service payments in relation to exports of goods andservices (Figure 2.3). Sustaining this strategy was expectedto help broaden access to international capital markets bydomestic private borrowers and also help reduce financingcost for domestic borrowers.

Figure 2.3: Bangladesh: External Debt Dynamics forSFYP

Source: Ministry of Finance and SFYP Projections

The domestic debt management strategy was madecommensurate with the above external resourcemobilization strategy. Maintaining the past momentum, thereliance on external financing was projected to go downwhile reliance on domestic financing will continue toincrease. Since domestic financing is relatively costly andexcessive borrowing by the public sector could crowd outthe financing of the private sector, the domestic financing ofthe Plan was made consistent with the borrowing needs ofthe rapidly growing private sector. By limiting the overallfiscal deficit (including grants) within the targets set underthe Plan (4-4.5 percent of GDP) and by securing a sizablepart of that from the external sources, the Plan expected toalleviate this concern.

The domestic financing of the Plan took into account thesustainability of the public debt burden. Domestic debtaccounts for about one third of the total public debt, butinterest payments on account of domestic debt accounts forabout two third of the total debt servicing payments.Although high costs of domestic debt servicing was notexpected to pose any debt sustainability issue over themedium term, still it limits the size of budgetarydiscretionary spending and the fiscal space for undertakingpriority programs in the public sector. Therefore, the SixthPlan assumed that debt management reforms will beundertaken to make public borrowing cheaper and also tohelp domestic debt market development.

Based on the above external and internal borrowingstrategy, the Sixth Plan’s resource requirements forfinancing investment and growth was made fully consistentwith a prudent national debt strategy and soundmacroeconomic management.

Implementation Record of the Sixth Plan’s ExternalResource Strategy

Balance of Payments Developments: Despite satisfactorytrend in export growth in recent years, trade deficit has been


8













7.2 6.2 5.2

36.5

0

10

20

30

40

(Sha

re a

s % o

f GDP

)

External Debt Services as % Exports& Remittance

External Debt TO GDP


8













3.4 2.8 2.5 2.8 2.6

18.3

External Debt Services as % Exports& Remittance

External Debt TO GDP


9

widening due to persistently high imports of fuel, food andcapital goods (Table 2.2). The trade gap widened from US$4.7 billion in FY09 to $7.3 billion in FY11 and to $8.5 billion inFY12. Along with the gap on the services and other incomeaccounts, the total financing gap on the trade and servicesaccount widened from $$7.7 billion in FY09 to $13.3 billionin FY12.

Table 2.2: Bangladesh Current Account BalanceSituation5

FY09 FY10 FY11 FY12P

Components

Trade balance -4708 -5149 -7318 -8472

Export f.o.b.(including EPZ) 15583 16237 23009 23992

Import f.o.b (including EPZ) -20291 -21387 -30326 32464

Services -1621 -1240 -2399 -3279

Income -1361 -1484 -1354 -1508

Current transfers 10226 11610 12068 13699

Official transfers 72 122 120 105

Private transfers 10154 11488 11948 13594

Of which : Workers' remittances 9689 10987 11536 12843

Current Account Balance 2536 3737 998 440


Fortunately for Bangladesh, these financing gaps in thetrade and services account are financed by the large inflowof remittance income. Remittance inflows are still largeenough to finance such gaps and allow a surplus in thecurrent account. Monthly flows now exceed a billion dollars.For FY12, total remittance is expected to reach $12.9 billion,which is an all time high for Bangladesh.

Nevertheless, the widening gaps in trade and servicesaccount of the balance of payments are becoming a sourceof concern. While these gaps are still lower than total inflowof remittances, the current account surplus is narrowingsharply. This is a huge swing in the macroeconomicenvironment, with the current account surplus narrowingfrom 3.4% of GDP in FY10 to less than 1% in FY11 andfurther narrowing to 0.3% of GDP in FY12. Although thisremains a positive development and more generally acurrent account deficit rather than a surplus is a normalresult for a low income developing country like Bangladesh,the main problem is the lack of adequate foreign funding inthe capital account. To achieve the GDP growth targets ofthe Sixth Plan, Bangladesh needs to mobilize substantialhigher inflows of official aid and foreign direct investment asan important element of financing required investmentsduring the Sixth Plan.

5 There are unresolved issues regarding the FY12 import data. Theimport figure based on payments recorded in BB is $1.4 billion lowerthan the import figure from NBR sources. The IMF has used anestimate that lies between these two figures, which is also used in thisTable. Once a full reconciliation is done, the true import figure mightchange.

Net Capital Account: Unlike other developing countries,Bangladesh in recent years has been experiencing mostly anegative capital account balance owing to inadequate FDIand declining net official aid (Figure 2.4). It was expectedthat the implementation of the Sixth Plan’s externalresource mobilization strategy from both official and privatesources will over-turn the past experience with net capitalaccount and even allow the room for financing a deficit inthe current account that might become necessary to financethe growing investment needs of the Sixth Plan. As notedabove, while the surplus in the current account hasnarrowed from the level in FY10, there was still a surplus inthe current account. This is partly owing to the slower –than-projected implementation of large infrastructureprojects including the Padma Bridge. Importantly, the netpositive capital flows projected in the Sixth Plan did notmaterialize. In addition to declining net official aid therehave also been substantial private capital outflows in FY11and FY12 due to a variety of factors including outwardremittances. In FY12 the capital account outturn wasslightly better, approaching a zero balance, therebyallowing a small surplus in the balance of payments in FY12.

Figure 2.4: Net Capital Account Balance

Source: Bangladesh BankForeign direct investment: Inflow of FDI has historicallybeen low in Bangladesh. Data from Bangladesh Banksuggests that the inflow of FDI virtually remained stuckbetween $600 million and $900 million during FY05-FY11suggesting that foreign investors do not find Bangladesh asan attractive destination for their investments (Figure 2.5).There were somewhat higher inflows in FY12, approachingthe $1.0 billion mark for the first time in the history ofBangladesh.

During the same period average annual inflow of FDI inVietnam, Pakistan, India and China were respectively $4.2billion, $2.5 billion, $18 billion and $75 billion. These figuressuggest that despite the good intentions of the Sixth Plan,Bangladesh has not yet succeeded in attracting FDI inrelation to competitors.

-3-2-101234

(As %

of G

DP)

Current Account Balance Overall BalanceNet Capital Account


10

A part of the impetus to FDI was expected to come from thegovernment’s much-heralded public private partnership(PPP) strategy for financing infrastructure. The Sixth Planexpected that the share of PPP financing in total investmentwill grow from the 0.5% of GDP level in FY10 to 2.5% of GDPby the end of the plan period (FY15). In practice, there hasbeen hardly much dent in implementing this initiative.

Figure 2.5: Foreign Direct Investment (Million USD)


More specifically, although, the Government allocated fundsin FY2010 - FY2012 budgets and established a PPP cell in theBoard of Investment (BOI) to operationalize the PPPinitiative, little progress has been achieved so far due toseveral implementation challenges. These include pricingand financing aspects, regulatory and legal frameworks,competitiveness in the bidding process and a careful matchbetween assets, liabilities and cash flow. Additionally, lack ofleadership and technical staff has constrained progress. Thegovernment review of the financial and economic viabilityof PPP projects is crucial because success depends largelyon costing and pricing issues, as well as generation of therevenue stream. The legal framework must lay downobligations of the government to private sector partners,keep provisions for cost recovery and address issues ofcompensation and redress mechanisms. Imminent actionsare required to establish a comprehensive policy andregulatory framework to ensure competitive andtransparent bidding, sharing of risks and rewards anddispute settlement mechanisms.

The inability to attract much larger FDI and the lack ofprogress with the PPP strategy are missed opportunities thatneed to be corrected quickly to support higher growth,investment and exports.

Floating of Bangladesh Bond: Buoyed by relativelyfavorable rating by international credit rating agencies(Standard and Poor’s and Moody’s), Bangladesh is preparingto float a sovereign bond to the initial tune of $500 million.This is consistent with the Sixth Plan strategy to diversify thesources of foreign resources within the framework of aprudent debt management. The borrowing environment

for Bangladesh is relatively comfortable and competitivewith countries like Sri Lanka and Pakistan that already have amarket presence. However, the actual outturn onceBangladesh goes to the market will provide more insightson the prospects of this source of external financing. So theimplementation remains incomplete.

Foreign Aid: In spite of its status as a member of the leastdeveloped country group, Bangladesh’s dependence onforeign assistance (ODA) has declined very significantlysince independence. The country was heavily dependent onaid during the first two decades of independence. Evenduring 1980-90 new net commitment of ODA was around8% of GDP. Since then, ODA as a share of GDP has declinedrapidly, falling to around 4% of GDP at around thebeginning of the millennium. The role of official aid furtherdeclined over the past 12 years with new net inflowsapproaching 2-3% of GDP (Figure 2.6).

Figure 2.6: Net Commitment of Foreign Resources aspercent of GDP

Source: External Relations Division, Ministry of Finance

ODA – Persistent Story of Mismatch betweenCommitment and Disbursement: In addition to dwindlingaid inflows, a major problem is the consistently wide gapbetween disbursements and commitments/plannedspending of Development Partners. In just six of the 18 yearsunder consideration have disbursements exceeded plannedspending (Figure 2.7). Since FY2003, disbursements as ashare of commitments have consistently been well below100 percent. As a result of this persistent gap the pipeline offoreign aid increased to a record high level of about $12.4billion in 2012. Such prolonged under- disbursement ofcommitted aid is indicative of several issues that have beena deterrent to higher disbursement of planned assistance.

The explanations of the observed mismatch are to be foundin the discussion on aid effectiveness that has now takencentre stage. According to an independent EvaluationGroup Survey carried out in mid 2008, DevelopmentPartners are critical of the way in which aid is spent inBangladesh and consider governance and weak quality ofcountry systems, especially

564

391 376276

800 743 793650

961 913768

995

0

200

400

600

800

1000

1200

00.5

11.5

22.5

33.5

44.5

Net Commitment of Foreign Assistance as % of GDP


11

Figure 2.7: Disbursement/Commitment Ratio (Percent)

Source: Data from External Relations Division (ERD), Ministry of Finance

procurement, as main impediments to realizingdevelopment potential6. This is corroborated by anOperations Evaluation Department Survey also carried outat the same time that pins the blame squarely ongovernment related problems such as “…delays, policies ordecisions delaying or obstructing the projects, difficultgovernment systems and procedures, lack of coordinationwith other agencies, and lack of (qualified) governmentstaff”7. Weaknesses also emanate from the developmentpartner (DP) side. Delays caused by DPs, difficult forms,procedures and paperwork and enforcement of the donoragenda also contribute to lower disbursement of ODA thanplanned.

In spite of reduced reliance on aid, Bangladesh hasparticipated in all initiatives to enhance aid effectivenessand has endorsed the joint commitments contained in theParis Declaration (PD) of 2005. The PD “…stipulates that newpartnership relationships and ways of working betweendeveloped countries and partner countries are essential ifdevelopment results are to be assured, aid well spent andaid volumes maintained”8. Since then the government hastaken significant steps to promote all the Paris Principles –ownership, alignment, harmonization, managing for resultsand mutual accountability. In fact, the 2008 DAC evaluationof the PD assessed the country’s progress against these 5principles of the PD. Although, the evaluation report 9 notedsome improvements in above five areas, there is room forimprovement.

Furthermore, the value and effectiveness of foreignassistance is also frequently undermined by a high degree ofaid fragmentation. The ODA environment is becoming evermore complex due to the growing importance and role ofnon-DAC emerging Development Partners. These pose

6 Development Partners 2009. Donor Coordination andHarmonisation in Bangladesh: A Joint Evaluation Paper. Dhaka:ADB, DFID, JICA, World Bank.7 Development Partners 2009. Above cited.8 DAC 2010. Evaluation of the Implementation of the ParisDeclaration: Phase II. PD Evaluation Secretariat.9 NRP 2008. Evaluation of the Implementation of the ParisDeclaration: Case Study at Country Level Bangladesh. Dhaka:Natural Resources Planners Ltd.

challenges to harmonizing and aligning aid, increasingtransaction costs for both Development Partners andrecipients and creating duplication in delivery that iswasteful. Increasing fragmentation in sectors could also leadto rising competition between DPs that could lead togreater focus on results of own projects rather than onbroader national priorities, posing coordinationchallenges10.

Use of Official Foreign Financing in the Sixth Plan: Theimplementation of the Sixth Plan official aid strategy doesnot show an encouraging progress. Total aid disbursed (netof amortization) in FY11 and FY12 is below the amountsprojected in the Sixth Plan (Figure 2.8)11. The outturn inFY11 was particularly worrisome. Disbursement of grossofficial assistance including grants amounted to a mere $1.7billion in FY11. After allowing for repayment of $0.7

Figure 2.8: Net Official Foreign Financing Disbursement

Source: External Resources Division, Ministry of Finance

billion, net assistance was a meager $1.0 billion. Thesituation improved somewhat in FY12, with grossdisbursement rising to $2.2 billion (2.0% of GDP) while netdisbursement grew to $1.4 billion (1.2% of GDP). Yet, theseresources remain inadequate compared to the developmentneeds of Bangladesh. The shortage of foreign fundingreduced the ability to implement major infrastructureinvestments including the Padma Bridge. This alsocontributed to higher-than-planned use of domestic bankborrowing to finance the budget deficit, which contributedto inflationary pressure as well as to a rising cost ofgovernment borrowing.

A range of issues contributed to this unhappy situation.These include primarily procurement disputes, which led tothe cancellation of the Padma Bridge (subsequently restored

10 Nadoll, J. and N. Hussain 2008. Fragmentation and Proliferationin the Delivery of Foreign Assistance to Pakistan. Discussion Paper,Islamabad: UNDP Pakistan.11 ODA Figures for disbursement provided by the External RelationsDivision (ERD) do not match the figures recorded by the BangladeshBank in the balance of payments (BOP). The gap is particularly largefor grants. The BOP figures show a much lower gross disbursementof grants and loans/credits than recorded by the ERD. This is aserious anomaly that ought to be investigated and corrected.


11














00.5

11.5

22.5

3Net Disbursement of Foreign Assistance as % of GDP


11














Net Disbursement of Foreign Assistance as % of GDP


12

in September 2012) and also contributed to slower-than-planned use of the aid pipeline, and a lack luster approachof the government to mobilize foreign aid. A part of thegovernment has a negative view of foreign assistance thatmight have weakened the overall effort of the FinanceMinistry and the Bangladesh Bank to procure official foreignassistance.

The Way Forward

With $750 per capita income and a head count povertyincidence of 31 plus percent Bangladesh remains a poordeveloping country. The government of Bangladeshthrough its Vision 2021 aspires to attain middle incomestatus by 2021. This requires a lifting of the GDP growtheffort from 6 percent per annum to 8 percent per year onaverage. Achieving this growth rate will require a majoreffort to increase both public and private investment. Thefinancing of this investment will largely come from domesticresources; yet foreign financing will need to play acomplementary role. This strategic view was clearlyrecognized in the Sixth Plan and the underlying resourcemobilization strategy was built around this. Two years ofimplementation record show that there have been shortfallsin both domestic and foreign financing front that hasconstrained the ability to increase domestic investment. Inparticular, shortfalls in mobilizing foreign financingincluding the implementation of the public-private-partnership (ppp) strategy has constrained the ability of thegovernment to implement its ambitious infrastructureupgrading strategy. Shortage of infrastructure services inpower and transport continue to hamper the ability toincrease the growth rate to 7% and above. Policy actionsneed to be taken immediately to reverse this pattern andincrease the domestic and foreign financing of investment.

On the foreign financing front, the Sixth Plan adopted asound external resource strategy that has met with seriousimplementation shortfalls. Efforts now need to focus toaddress those implementation constraints. In summary,these actions are:

Need to jump start the stalled ppp strategy through amore thoughtful and realistic approach that involvesthe participation of internationally competent staff witha proven track record for managing ppp programimplementation. Most countries engaged in a broad-based PPP program have felt the need to develop across sectoral pool of expertise in a dedicated PPP unitto supplement capacities in the line agencies thatcontract for PPPs. These fulfill different roles dependingon the needs of the situation. In some cases their role islimited to disseminating information on PPPs andproviding broad guidance on good practices. In othersthey have an active role in helping line agencies andministries successfully contract for PPPs, and in yet

others they play a role in approving PPPs developed byother government agencies. In the case of Bangladesh,the relocation of PPP cell as an autonomous bodywould allow it to attract a cross sectoral pool ofexpertise to supplement capacities in the line agenciesthat contract for PPPs. These experts could also play asubstantive role in developing PPP projects andattracting foreign financing.

The biggest potential is to mobilize much more FDI. Thesize of the FDI global market is large and the examplesof China, India and Vietnam show that a hospitableinvestment climate can make Bangladesh a majordestination of FDI. The constraints to the investmentclimate have been well researched and well known andinclude such issues as power supply, transportbottlenecks, land procurement, corporate taxes andsimplification of business procedures. A serious andconcerted effort to address these long-standing issues isnow essential. The absence of even- handed and non-discretionary implementation of FDI policies are also ofconcern and must be ensured. Furthermore, the foreignexchange regulatory regime needs furthersimplification to allow smooth international financialtransactions for the private investors.

Adopt an aggressive approach to much betterutilization of the large pipeline of undisbursed ODApipeline. The most important constraint here isprocurement. The government may need to think outof the box here and adopt options including turn-keytype procurement involving the concerned donoragencies and inviting internationally reputedprocurement agencies.

Implement the strategy to diversify sources of foreignresources including bond financing. The preparatorywork has been done and the government should takesteps to float its bond within the framework of securingall prudential norms of external debt management.

The government should resolve all disputes with thedonor agencies and manage aid coordination in anatmosphere of mutual trust and respect.


13

III. Tax Revenue Mobilization—Sustaining theRecent Success

Ahsan Mansur

Background and Introduction

Bangladesh government has been most successful in taxrevenue mobilization in recent years. For the first time in thehistory of Bangladesh, the National Board of Revenue (NBR)has exceeded the tax revenue targets specified in thebudget for three successive years. This remarkableperformance in revenue mobilization has been recordeddespite significant challenges in the form of decliningdependence on import-based taxes and increased volatilityin imports. Buoyant performance in domestic based taxes—VAT and direct taxes in particular—helped reducedependence on import based taxes and better anchored therevenue performance to developments in domesticeconomic activity.

Figure 3.1: NBR Tax Revenue

Source: National Board of Revenue, Bangladesh

The purpose of this policy brief is to identify the sources ofthe revenue gains, the tasks ahead in terms of achieving thetax revenue targets under the Sixth Five Year Plan (SFYP)and what lesson we derive for sustaining the gains in future.The brief argues that despite the recent gains, achieving theSFYP tax revenue targets remains challenging. It also findsthat enormous potentials remain on both VAT and direct taxfronts, which can be reaped through sustained structuralreforms in tax policy and in the administration of the taxsystem. It also outlines a number of specific measures whichwould help NBR achieving the SFYP targets while continuingwith the medium-term reforms in the context of itsModernization Plan. It also argues that, while efforts shouldcontinue on both VAT and income tax fronts, greaterpotential can be realized through information sharingbetween the two important wings of the NBR.

Figure 3.2: Trend in VAT and Direct Taxes


Revenue Potentials and the Sources of Recent RevenueGrowth

Both VAT and income tax performance exceeded theirrespective targets during the last 3 years, despite the targetsbeing quite ambitious.

Figure 3.3: Growth in VAT vs VAT base

Source: National Board of Revenue, Bangladesh, Bangladesh Bank.

A closer review of the strong NBR performance indicatesthat, in case of both VAT and income tax, revenue collectionexceeded their respective base expansion. In the case ofVAT, which is a consumption type tax, the average rate ofgrowth of consumption in nominal terms over the last 3years was 13.3% compared with a much rapid growth intotal VAT collection (19.6%). Much of the VAT revenuegrowth came from domestic sources, which accounts for62% of revenues from VAT. Growth in domestic VAT surgedto an average of 25% during the same 3-year period, almostdouble the pace of expansion in domestic consumption.The higher growth performance of domestic VAT is not arecent phenomenon, and it has been happening since theintroduction of VAT in FY92, when import stage VATaccounted for more than 73% of total VAT revenue.However, it certainly gained momentum in recent years.

050

100150200250300350400

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10VA

T-To

tal a

nd D

irect

Tax

es-B

DT in

bill

ions

VAT-import VAT-DomesticDirect Taxes VAT-Actual


13


Ahsan Mansur













0

50

100

150

200

250

FY10

FY11

FY12

VAT-Import &

VAT-Domestic BDT in billions

VAT-DomesticVAT-Actual

0100200300400500600700800900

1000

FY01

FY02

FY03

FY04

FY05

BDT

in b

illio

ns

Budgeted

3%8%

13%18%23%28%33%

FY07 FY08 FY09

Gro

wth

in %

Growth in VAT


13


Ahsan Mansur













FY06

FY07

FY08

FY09

FY10

FY11

FY12

610.0

725.9

918.7

620.4

794.0

939.5

Budgeted Actual

FY09 FY10 FY11 FY12Growth in VAT Growth in VAT base

Avg. Growth17.5%

Avg. Growth11.3%


14

This shift in the composition of VAT revenue is a positivedevelopment. It shows that domestic consumption hasbeen tilting towards domestic production and rendering ofgoods and services. Certainly, the steady expansion ofdomestic based VAT to wholesale, retail and service sectorshave played important roles. The strong growth of keysectors like the newly emerged cell phone basedtelecommunications and the formal construction sector(real estate/housing industry), travel and transport, and theorganized service sector (large hotels and restaurants).Another interesting phenomenon is the marked shift inconsumption towards the private sector over the last twodecades. Private consumption which accounted for 85.4%of total consumption in FY92 increased further to almost93% of domestic consumption by FY12. Since governmentconsumption—mostly in the form of payroll—andgovernment delivery of services (which constitute bulk ofpublic services) are not subject to VAT, this shift in favor ofprivate consumption has also worked in enhancingbuoyancy in domestic VAT.

Figure 3.4: Consumption and VAT Pattern


On the income tax side also gains have been certainly madein relation to the tax base. Total income tax collectionincreased by 26.6% during FY07-FY12, while the expansionof the tax base during the corresponding period was 12.7%While the corporate side of the income tax was impacted(negatively and positively) by developments inmacroeconomic environment like the global economic crisisand the phenomenal surge in stock market prices inducingstrong fluctuations in the performance of this component,personal income tax maintained its higher growth ratesalmost unhindered by market/external developments.Growth in corporate income tax slowed down to 11% inFY09 with the slowing of global and domestic economicactivity, but performed very strongly in FY11 influenced inpart by the stock market boom.

Figure 3.5: Growth in Income Tax- Its Components andBase

Source: National Board of Revenue

An examination of income tax collection process indicatesthat although income tax from source deduction hasremained important, revenue from income tax returns hasgained more importance over time. Income tax deducted atsource declined from 61.5% in FY04 to 48.2% in FY10.

Figure 3.6: Income Tax & Tax deducted at source


While the increase in tax payments through submission ofreturns is a welcome development, the slower growth inwithholding at source indicates a fundamental weakness indirect tax administration and the current focus andinadequacies of the withholding measures. The structure oftax withholding in Bangladesh is very old-fashioned anddoes not indicate proactive management of tax withholdingagents.

In most cases the captive sources—using public offices (forcontracts and supplies), financial institutions (withholding of

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

FY92

FY93

FY94

FY95

FY96

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

Priv

ate

and

Gov

t. Co

nsum

ptio

n as

a %

of T

otal

Private Consumption Government ConsumptionVAT-Domestic VAT-import


14












0%

10%

20%

30%

40%

50%

60%

70%

80%

FY08

FY09

FY10

FY11

FY12

VAT-

Dom

estic

& V

AT-Im

port

as %

of T

otal

VAT

Government ConsumptionVAT-import

28.09%

0%

10%

20%

30%

40%

50%

60%

FY 07 FY 08 FY 09

Gro

wth

in C

orpo

rate

and

Per

sona

l Inc

ome

Tax

(%)

Growth in Corporate Income TaxGrowth in Personal Income TaxGrowth in Income Tax Base (%)Growth in Income Tax

47.1 55.871.6

87.2

61.5%60.1%56.0%

59.1%

0

50

100

150

200

250

FY04 FY05 FY06 FY07

Inco

me

Tax

and

Com

pone

nts-

BDT

in b

illio

ns

Total-Income Tax Deducted at SourceTotal- Income Tax from ReturnsTotal Income TaxTotal-Income Tax Deducted at Source as % of Total


14












28.09%

12.6%13.7%

17.99%

35.00%

0%

5%

10%

15%

20%

25%

30%

35%

40%

FY 09 FY 10 FY 11 Gro

wth

in In

com

e Ta

x an

d In

com

e Ta

x Ba

se (%

)

Growth in Corporate Income TaxGrowth in Personal Income TaxGrowth in Income Tax Base (%)Growth in Income Tax

87.2

117.5138.6

170.4

230.1

56.0%59.1%

52.6%49.6%48.2%

53.2%

0%

10%

20%

30%

40%

50%

60%

70%

FY07 FY08 FY09 FY10 FY11

Inco

me

Tax

dedu

cted

at s

ourc

e as

% o

f Tot

al

Total-Income Tax Deducted at SourceTotal- Income Tax from Returns

Total-Income Tax Deducted at Source as % of Total


15

interest and dividend income) and customs points (advanceincome tax from importers)--have been relied upon forcollection of withholding tax. A careful review indicates thatdespite a decline in dependence in recent years,withholding from contractors on account of governmentsupplies/projects accounts for more than 30% of totalwithholding in FY10. Withholdings from financialinstitutions on account of interest on savings, term deposits,security and treasury bonds accounts for the second highestsource of withholding (21%), followed by advanced tax onimporters (17.4%) in FY10.

Table 3.1: Selected Components of Income Tax-Deducted at Source

FY07 FY08 FY09 FY10 FY11

Contractor/Supplier 12.91 16.32 18.3 24.69 31.96

Import of goods 7.91 10.44 12.27 14.25 28.42

Withholding fromFinancial Institutions: 18.5957 16.2594 16.5967 17.2774 19.5077

Interest on Saving orTerm Deposits 9.18 11.13 14.21 15.74 18.15

Interest onSecurity/Treasury Bond 9.1 4.37 1.89 1.4 0.8671

Interest on BankDeposit 0.1724 0.7303 0.091 0 0

Interest on treasurybond 0.1433 0.0291 0.4057 0.1374 0.4906

Salary Income 2.49 2.8 3.61 4.82 6.53

Total-Income TaxDeducted at Source

51.55 61.76 68.67 82.13 122.34

As % of Total Income Tax Deducted at Source

Contractor/Supplier 25.04% 26.42% 26.65% 30.06% 26.12%

Import of goods 15.34% 16.90% 17.87% 17.35% 23.23%

Withholding fromFinancial Institutions:

36.07% 26.33% 24.17% 21.04% 15.95%

Salary Income 4.83% 4.53% 5.26% 5.87% 5.34%


The unpleasant fact is that despite significant gains in recentyears, withholding from salary income accounts for less than6% of total withholding. Although this component hasregistered the fastest growth (29 % during FY06-FY10), atonly Tk. 5.3 billion it is relatively insignificant and falls wellshort of its potential. It is even more disturbing that out ofthis total Tk. 2.7 billion (56%) was withheld by the very fewenterprises under the Large Taxpayers Unit (LTU) of theDirect Tax Department. None of the commissioneratesreported any withholding on income from Doctors’ fees(which may be easily doable through hospitals and clinics)despite clear legal provision in this regard.Reflecting these administrative deficiencies, some of whichmay also originate from inadequacies in the tax laws, taxefficiency in Bangladesh has remained very low comparedwith its regional comparators. Given the 15% basic VAT taxrate, Bangladesh’s current tax efficiency in VAT was only 0.24in FY11, compared with much higher levels for itscomparator countries. The story in terms of Bangladesh’s

direct tax efficiency is also similar. Although the gainsrecorded in recent years is encouraging, Bangladesh has along way to go.

Table 3.2: Productivity of Tax Revenues among AsianCountries

Country CIT Rate PIT Rate VAT rate

VATProductivity(GDP Based)

PITproducti

vity

VATProductivity(Consumption based)

Bangladesh 27.5 10 – 30 15 0.21 0.08 0.24LIC Average 0.4 0.19 0.43Nepal 25 15-35 13 0.46 0.12 0.39India 30 10-- 30 10 0.67 0.25 0.99China 30 5--45 17 0.58 0.33 1.16Thailand 30 10--37 7 0.7 0.26 1.63Indonesia 30 5--20 10 0.45 0.19 0.67Philippines 30 5--32 12 0.49 0.2 0.59Korea 22 6--35 10 0.61 0.34 0.61Sri Lanka 20 5--35 15 0.46 0.15 0.36Data Sources: PRI Estimates based on WEO (Data of 2011) of the IMF.

Note: Revenue productivities ratio of revenue collections aspercent of GDP (or consumption, in the case of VAT) overthe respective tax rate. Standard corporate tax rate used forincome tax)

Figure 3.7: Bangladesh: VAT Efforts and VATProductivity

Source: Author’s own estimates

Note: VAT efforts are simply the ratio of actual taxcollections to the predicted value, underlying theassumptions of vat tax base and others economic variablesrelated to the tax efforts, such as institutional reforms, taxpolicies, tax rates, and so on. To calculate the tax efforts, ithas been attempted to formulate the regression as VATrevenue collections on VAT base and others economic andtax policy variables. If the value of the efforts ratio lies belowone, country’s tax performance points below its potentialperformance. That means, such a country has a potentialityto enhance tax efforts through adopting effectual reforms inthe tax system.

Figure1. Bangladesh: VAT Efforts and VAT Productivity

0.00

0.10

0.20

0.30

0.40

0.50

0.60

FY92

FY94

FY96

FY98

FY00

FY02

FY04

FY06

FY08

FY10

FY12(es

t.)

VAT Productivity VAT efforts


16

How to Realize the Revenue Targets for the SFYP in theComing Years?

The SFYP envisages a steady increase in NBR tax revenue by0.6 percentage points in relation to GDP every year onaverage. After taking into account the envisaged nominaleconomic growth, the average nominal growth in NBR taxrevenue would need to be 26.2% per annum. Despite amodest shortfall in NBR revenue in relation to GDPcompared with the target of 10.32 % percent set for FY12,the gains made in recent years gives us the confidence thatPlan targets for NBR revenue may still be attainable if thereform agenda is sustained. The NBR RevenueModernization Plan should still remain the basic frameworkfor achieving the medium- and long-term objectives and theprocess needs to be accelerated and sustained. At the sametime, achieving the revenue targets under the SFYP wouldrequire series of measures which will generate enoughrevenue in the near term to meet the Plan targets and alsohelp sustain the reform agenda.

On the Income Tax Front

1. Broader tax base should be the primary focus of incometax administration. The ongoing campaign in the formof tax fairs is a welcome initiative in this direction and iscreating much greater awareness among the potentialtaxpayers. While creating awareness and interestamong taxpayers, efforts need to be made to make taxfiling easy and friendly. This can be achieved in severalways: Self assessed tax returns submitted by taxpayers

should be considered accepted automatically withthe submission whether it is done physically orelectronically. There should not be any requirementfor approval of returns by the tax officials.

Income tax form should be simplified. The focusshould be on income earned during the fiscal yearand not on wealth and expenditure statements.Only thing that may be asked is a reporting of theassets owned by the taxpayer although suchinformation may be collected over time throughdifferent sources and financial transactions once acomprehensive IT system is operational.

For the newcomers who are submitting themselvesthere should be a policy of no questions asked andno audit or inspection in the first 3 years ofsubmissions, except for some generalinconsistencies (if any) found during review of thereturns.

2. Payroll monitoring through broadening of thewithholding base is very poor and there is tremendousscope for improvements in this area with very highpayoff. As noted above, withholding from payrollaccounts was less than Tk. 500 crore in FY10 and morethan half of that is coming from a handful of companiesadministered by the LTU. In most developed tax

systems, much of the personal income tax comes frompayroll withholding systems.

Table 3.3: Selected Countries Payroll Tax withholdings

Countries Year

TotalDirect

Tax

TotalPayroll

Tax

TotalPersonalIncome

Tax

TotalPayroll

Tax as %of

IncomeTax

TotalPayrollas % ofDirect

Tax

UK 2009-10(£in millions) 382,331 122,584 144,881 84.6% 32.1%

AUS2009-

10(AUS $in millions)

177,788 119,966 115,270 104.1% 67.5%

Bangladesh

2009-10(BDT in

millions)17,428 482 7,556 6.4% 2.8%

Source: HM Revenue and Customs, Australian Taxation Office, NationalBoard of Revenue Bangladesh

It is always relatively easy to manage thewithholding agencies compared with managingthe huge pool of salaried income earners. InBangladesh, there is virtually no effectivemechanism in place for registering all employers aswithholding agents and administering theiractivities through reconciliation of payrollstatements and tax deducted with the actualreceipts of the amount withheld. A number ofsteps can be considered in this regard:

Register all employers for payroll managementpurpose. All business enterprises in all sectors mustregister themselves with the tax department asemployers and withholding agents. This, inprinciple, should apply to all employers although atthe first phase every firm employing 5 or morepeople should be required to register as anemployer for withholding purpose and should begiven an employer registration number if they arenot already registered with a TIN or BIN.

Every registered employer must submit PayrollStatements and amounts withheld to the taxdepartment within 7 days after the end of themonth along with a copy of the withholding taxdeposit receipt or treasury chalan.

The registered employers should include allfactories, financial institutions, hospitals, clinics,diagnostic centers, legal firms, consulting firms,NGOs, and all other types of service providers.

Instead of using 10% withholding NBR shouldsteadily move to an estimated/projected incomebase and withholding rate should be in line withthe applicable marginal rate with some allowancefor exemptions/thresholds. Thus high incomeemployees, managers or Directors of organizationswould need to pay withholding taxes at higherrates commensurate with their income. At presentmany taxpayers consider the 10% withholding asthe final tax and there is virtually no follow up onthe additional tax liabilities.


17

Exemptions in the form of housing or medicalallowances essentially create a discriminatory andhigher exemption levels and should be abolishedon equity and tax efficiency grounds.

On the VAT Front

1. Since the new VAT law is ready to be enacted byParliament and it will come into effect 3 years after itsenactment, some key elements of the new VAT law maybe incorporated in the current VAT law (of1991)through Finance Bills in phases. In particular,changes may be introduced in phases with regard to:market-based valuation (by moving away from theprocess of price approval for manufacturers); gradualphasing out of the Account Current and truncated baseVAT systems; and conducting massive educationcampaigns about the benefits of invoiced basedtransactions and the VAT input credit mechanism.

2. The primary focus in the mean time however should beon administration, administration and administration ofthe VAT system. Shifting VAT administration from thecurrent geographical to a functional based system willbe a major medium-term undertaking. While continuingwith that, a number of critical linkages with otherwings/directorates of the NBR will be beneficial forstrengthening tax administration. Some of theseinclude:

Exchange of information between the direct tax,VAT and customs wings. In particular, theinformation on payroll which accounts for about70-80 percent of value addition of a typical firm isvery useful for assessing VAT liabilities on producersand service renderers.

The very weak state of NBR IT system is a majorimpediment against effective tax administration.Progress on customs front is better than in theother two wings (income tax and VAT). NBR needsto develop urgently a central IT network coveringall 3 major wings and enabling information sharingand statistical/research analysis.

Strengthening of Research and StatisticalDepartment of the NBR to identify areas ofweakness or greater tax potentials for targetedintervention by the tax wings.

3. Cleaning up the VAT registration database should be apriority task. In the current database, the number ofinoperative accounts far exceeded the number of trulyactive accounts. This needs to be done systematically sothat non-filing and other standard notices could begenerated automatically through the computer system.


18

IV. Revamping of the Power Sector: Where do We StandNow?

Ahsan Mansur


At the time the Awami League government came to powerin early 2009, power sector was already in a state of disarrayand was considered to be the number one constraint tosustain higher levels of economic growth and faster rate ofpoverty reduction. Inadequate investment, inappropriatepower tariff policy, excessive reliance on domestic gassupply, and a lack of strong political commitment with alonger-term vision contributed to a widening gap betweenthe rapidly growing demand for power and a much slowergrowth in generation capacity. The shortfall in power supplyand the consequent load shedding increased to – percent ofactual power generation by 2010.

The Awami League government in its political manifestoand the accompanying Vision 2021 document, whichoutlined the long-term socio-economic targets of the Party,committed to ensure energy security for Bangladesh andelectricity for all citizens by 2021. Bangladesh’s energysecurity has been threatened by its continued excessivedependence on gas-based electricity generation in anenvironment of virtual stagnation of gas supplies and nonew major discoveries of gas fields during more than twodecades. Ensuring universal uninterrupted access toelectricity, from the prevailing situation where only 47percent of households had access to electricity, wascertainly a major undertaking. Consistent with theseobjectives, after careful deliberations, the government hadannounced its power and energy sector road map in June201012.

The purpose of this Brief is to take stock of the power sectorsituation more than two years after the announcement ofthe Power and Energy Sector Road Map and in the fourthyear of the Government’s tenure. Certainly gains have beenmade, but how they compare with the targets set under theRoad Map. Questions also remain about the sustainability ofthe gains achieved in recent years in terms of generationcapacity over the medium term, and the fiscal burdenarising from a sharp rise in budgetary subsidies for thepower sector. The Brief also aims to take stock of longerterm power sector sustainability issues like: achieving theoptimal primary fuel mix for electricity generation;diversification of sources of power; and developing areliable regulatory (including pricing) framework for activeprivate sector participation in power generation, tradingand distribution.

12 Towards Revamping Power and Energy Sector: A Road Map, June2010, Finance Division, Ministry of Finance, Government of thePeople's Republic of Bangladesh.

Current Power Supply Situation: Power supply in terms ofactual (maximum) generation has certainly increasedsteadily (43 percent) during 2010 through July 2012.Currently the peak generation stands at 6,330 MW,compared with 4,002 MW in 2009. Despite the markedincrease in generation, actual generation however fell wellshort of the target of 8633 MW for 2012 set under the RoadMap.

Figure 4.1: Plan Vs Actual Supply (MW)

Source: Bangladesh power development board; Towards RevampingPower and Energy Sector: A Road Map, June 2010.

Demand and supply imbalance however remained quitesizable up to June 2012, except for the winter months(November through January) when electricity demandgenerally falls. Accordingly, electricity load shedding whichdeclined to around 250 MW during the winter months, onceagain increased to about 1000 MW by June 2012. Aselectricity demand resumed its normal growth after thewinter months, the gap between demand and supply ofelectricity once again increase to about 1000 MW by June2012.

Figure 4.2: Demand and Supply of Electricity

Source: Bangladesh power development board.

As the generation capacity and actual generation increasedin recent months, primarily due to installation of rentalpower plants, average load shedding as percentage of peakgeneration declined. In the months of November-January2012, the average load shedding as percent of peakgeneration declined to the lowest level of less than 1percent. However since February 2012, the average loadshedding as percent of peak generation increased andreached a peak of 12 percent in May 2012, which wasslightly higher than the level of the preceding year.Thereafter the load shedding situation has improvedmarkedly and by June at more than 6 percent it was almost

5,10

9

6,36

3 8,68

3

9,76

4

10,5

27 12,6

01

4,43

2

5,13

8

6,33

0

2010 2011 2012 2013 2014 2015Supply Projection Maximum Generation (Actual)

0

500

1000

1500

3000

4000

5000

6000

7000

Load

She

ddin

g (M

W)

Dem

and

and

Supp

ly (M

W)

Peak Generation Peak Demand


19

half the level of load shedding of the preceding year. Loadshedding further decreased during Ramadan in July-August(figures are not available). In general, electricity situation hasimproved during most of the period this year, whencompared with the same period of the previous year.

Figure 4.3: Avg. Load Shedding as % of Peak Gen.

Source: Bangladesh Power Development Board.

Much of the initial improvements in power generation camefrom quick rental power plants. Generation of power fromrental plants increase in both actual units produced (from400 MKWH in January 2011 to 1000 MKWH in July 2011) andin relation to total power generation. Actual capacityexpansion by the rental power plants was however muchhigher than their total production. During May 2009through March 2012, work orders have been issued forgenerating 5906 MW of electricity, out of which 3100 MW ofelectricity was added to the power grid through 29 powerprojects. At present electricity generation ranges between5200-6000 MW, which is however well below the installedand actual generation capacities of 8819 MW and 8159 MW,respectively. It is noteworthy that, because of the muchhigher generation cost for the liquid fuel based powerplants, PDB’s capacity to pay has been severely constraineddespite a marked increase in subsidies from the budget,causing shutdown of power plants with 800 MW - 1200 MWof capacity.

Where Do We Stand in Terms of the Road Map?

In terms of increased generation, despite the significantaddition of new capacity, maximum generation (actual) fellwell short of the supply projection envisaged in the RoadMap.

Figure 4.4: Plan Vs Actual Supply (MW)


Although 3100 MW has been added to the national grid,due to closure of some old and inefficient generation unitsand inability to run the new additions because of fuelshortage, net additions to actual power generation wasmuch lower. At the time the Awami League governmentcame to power, the derated capacity was 5166 MW of which50 percent of plants were more than 20-40 year old.Effective capacity essentially declined by about 25% to 3874MW. Actual power generation however declined to only3100-3200 MW in early 2009 as power plants with totalcapacity in the range of 600-800 MW were not in operationfor some time due to shortage of natural gas. As a result, theincreased addition to capacity did not lead to acorresponding increase in actual power generation.

Nevertheless, to meet the growing power demand, becauseof the new installed capacity, the government was able toexpand the electricity network by 2.1 million new powerconnections. The visible decline in load shedding alsohelped sustain economic growth and expansion of themanufacturing base and the cropping area under irrigation.The short-term positive impact of rental power plants on theoverall economic activity thus cannot be overlooked,despite delays in coming into operation of many rentalpower projects due to various reasons.

PDB’s weakened financial position, due to addition of highgeneration cost liquid fuel based plants and its inability topass on the higher costs to the consumers, also contributedto a much lower actual generation of electricity. Thisphenomenon has been clearly reflected in the lowerpercentage of electricity generated through liquid fuelduring April-June 2012.

Figure 4.5: % of Electricity Generated by Oil


The maximum load shedding increased to more than 1000MW by June 2012, close to its recent peaks, primarily due toPDB’s inability to settle the power bills of the oil-basedrental power companies.

The sharp increase in the average fuel cost per KWH, due tocoming into operation of increasing number of liquid fuelbased rental power plants, contributed to a sharp increase inelectricity subsidy from the budget. Average fuel cost perKWH of electricity increased almost four fold from less than

8.6

12.2

18.6

12.4

11.5

12.1

11.1

9.5

9.4

12.7

0.2 1.0

0.9

5.4 6.

911

.212

.06.

6

0

5

10

15

20

5,10

9

6,36

3 8,68

3

9,76

4

10,5

27 12,6

01

4,43

2

5,13

8

6,33

0

2010 2011 2012 2013 2014 2015

Supply Projection Maximum Generation (Actual)

23.4

12.2

0

5

10

15

20

25

FY 0

6FY

07

FY 0

9FY

10

Jan-

11Fe

b-11

Mar

-11

Apr-

11M

ay-1

1Ju

n-11

Jul-1

1Au

g-11

Sep-

11O

ct-1

1N

ov-1

1De

c-11

Jan-

12Fe

b-12

Mar

-12

Apr-

12M

ay-1

2Ju

n-12


20

Tk. 0.75 in June 2011 to almost Tk 3 per KWH by October2011 as new fuel-based plans came into operation.Combined with very slow response of the government toauthorize upward adjustments in electricity tariff, budgetarysubsidy for electricity increased sharply (to TK. 131 billion)and the overall government borrowing from the domesticbanking system crossed the annual target for the wholefiscal year (ending on June 30, 2012). As the government puta brake on subsidy payments due to fiscal management,arrears built up rapidly and PDB was not in a position toutilize fully the available generation capacity for the benefitof the economy. Thus capacity expansion while necessary isnot sufficient to ensure increased supply of electricity: it isnot uncommon to observe that many countries/states passthrough severe power crunch despite idle generationcapacity as happened in Pakistan and many states in India.Fuel mix and power tariff structure are generally blamed forsuch an outcome.

Efficiency in power generation and the level of power tariffcharged to the customers are directly related for the long-term viability of the sector. If generation costs arereasonable it becomes politically easy to pass on to theconsumers. Bangladesh’s power tariff structure has beenbased on cheap domestic gas supply would certainly not becompatible with the shift to liquid fuel for new power plants.Despite continued dependence on cheap domestic naturalgas, the required increase in power tariff is much higherthan the increases implemented so far. Deliberations arenow complete for a further significant increase in the powertariff to contain PDB’s losses and the consequent budgetarysubsidies. The required increases should be implementedsoon in order to utilize the capacity expansion already madein recent years.

Question may arise if power tariff increases would hurtBangladesh’s export competitiveness. Certainly, the days ofcheap power will not last very long and Bangladeshimanufacturers’ and exporters would need to depend onlabor productivity to maintain their competitiveness. Acomparison of the power tariff structures of a number ofcomparator countries indicates that given the relativelylower power tariff rates in Bangladesh, there is scope forfurther tariff increases without undermining exportcompetiveness.

Figure 4.6: Electricity Tariff for Industrial Users and TopTariff Rate for Domestic Users

Source: Bangladesh Energy Regulatory Commission; World EnergyOutlook, U.S Energy Information Administration; Ministry of Power,India; Ceylon Electricity Board, Sri Lanka and Pakistan Economic Survey2010-11

While in the next 2-3 years Bangladesh may rely on the highcost liquid fuel based small rental power plants, theGovernment has to find ways to reduce marginal costs ofnew power plants. Given the limited prospects for increasedgas supplies for power generation, the optimal mix mustentail much greater use of coal as the primary fuel; import ofpower from India and Bhutan through regional power grid;nuclear power; hydropower from neighboring countries likeNepal, Bhutan, Myanmar and India; and renewable sourcesof power. In this brief we will focus on the first two sourcesgiven their potential in the next few years.

The Power Sector Road Map has rightly focused on the needto reduce dependence on gas and move toward a muchgreater reliance on coal based power generation. Itappropriately aims at increasing the share of coal basedpower generation to 5313 percent of total power generationby 2021 from only 3.77 percent in 2010. Such a target isconsistent with the strategies adopted by other countries in

13 Perspective Plan of Bangladesh 2010-2021, Planning Commission,Government of Peoples Republic of Bangladesh

11.3

10.3

6.85 8.

00

10.9

7

6.95

02468

1012

India(2011)

Pakistan(2011)

BD(Current)

BD (Prop.) Sri Lanka(2012)

USA(2012)*

Electricity Tariff for Industrial Users (Cent/KWH)

10.4

15.4

9.6 11

.6

27.2

0

5

10

15

20

25

30

India (2011) Pakistan(2011)

BD (Current) BD (Prop.) Sri Lanka(2012)

Top Tariff Rate for Domestic Users (Cent/KWH)

*Average Tariff


21

Asia. India and China has long been using coal as a majorbasic fuel for electricity generation.

Table 4.1: Electricity Generation by Fuel Type

USA(2011)

World(2008) BD (FY 12) India

Non-OECD Asia

(2008)Coal 42.2 40.2 2.9 68.8 67.9Hydro 7.9 N/A 2.2 14.5 N/aNeuclear 19.2 13.6 0.0 3.6 2.4Gas 25.0 21.7 79.0 8.5 9.9LiquidPetrolium

0.4 5.3 16.0 0.3 3.3

Others* 5.2 19.1 0.0 4.3 16.5* Figures for world and Non-OECD Asia includes hydro in others categorySource: Power Grid Company of Bangladesh; World Energy Outlook, U.SEnergy Information Administration; Ministry of Power, India.

As part of this strategy, the Government is in negotiationwith the Indian Government to construct two large coal-based power plants with total capacity of more than 2600MW by [2015]. However, progress on this front is laggingbehind and may be wrongly placed. Delays in finalizing anddeveloping the sites for construction and negotiations withIndia on the Joint Venture initiative have already put thisinitiative much behind its target date. Furthermore, due togovernment’s inability to finalize and start implementingthe draft Coal Policy due to political considerations, the coalbased power plants are envisaged to be powered byimported coal increasing the cost of power from suchprojects. While it would be difficult for the currentgovernment to finalize the Coal Policy in its current tenure,after the next parliamentary elections the Policy should beadopted and implemented by the next government in thegreater interest of the country. Without a well articulatedCoal Policy it would not be possible for Bangladesh toincrease coal-based power generation to the target level of53 percent.

Progress is being made in getting electricity supplies fromIndia from both government and private sector sources.Indian Government has agreed to provide 250 MW ofelectricity from public sources to the PDB once inter-connection between the Bangladesh and Indian grids iscompleted in 2013 under an ADB supported regionalproject. Based on current understandings, Bangladeshwould also be able to import 250 MW of electricity from theprivate sector of India. This is an initiative which has hugepotential for future expansion if proper forum for regionalelectricity trade and regulatory and payments mechanismsare put in place. Indian produces with better access tointernational and domestic capital market and with thecapacity to construct and maintain large power plants,would generally be able to generate electricity al lower coststhan its regional competitors.

Another important area where progress has not beensatisfactory is construction of larger size duel fuel powerplants as part of the medium-term plan under the RoadMap. A sizable number of projects, generally ranging

between 300-450 MW, were awarded to a number ofnational and international firms during 2010-11. However,most of these firms are facing difficulties in securingfinancial closure for these projects leading to significantdelays and in some cases potential cancellation of contracts.Government needs to engage more actively with themultilateral IFIs like the World Bank/MIGA and ADB andfollow transparent competitive process to secureguarantees for financing the projects. Without a fasterresolution of this financing issue the medium and long termelements of the Road Map will remain unattainable, therebyjeopardizing the objectives of energy security and electricityfor all Bangladeshi citizens by 2021.

Key Findings and Recommendations

As part of its short-run plan under the Road Map, despitesome delays, Bangladesh has constructed enoughgeneration capacity through smaller Quick Rental PowerPlants (QRP). More capacity expansion is also underwaythrough QRP plants. Proper utilization of the increasedgeneration capacity will require increased resourceavailability to the PDB through internal revenue generationat a fast pace. It is most important that necessary tariffadjustments are put in place without further delays toprevent a reemergence of extensive load shedding in thesummer months.

Generation costs with the QRP plants based on liquid fuelare very high and a speedy transition to the medium-termphase based on larger power plants would be mostimportant for the viability of the strategy outlined in theRoad Map. Two areas which need to be focused in thiscontext are:

Ensure rapid financial closure of the larger powerprojects which have been contracted out. If theprivate sector power companies cannot securefinancing, either the Government should help themin securing external financing or cancel theircontracts and go for fresh bidding with greaterfocus on financially stronger companies.

Negotiate with India for getting larger supplies ofelectricity from the Indian private sector powerproduces. Also work towards developing a regionalmarket for electricity and the associated legal andinstitutional framework and infrastructureinvestment.

Long run sustainability of the power sector strategy willcritically depend on increased reliance on coal-based powerplants using domestic coal. For this process to start:

Finalization of the Coal Policy will be important.However, given the political cycle, it may onlyhappen after the next election in early 2014.Whichever government comes to power, it wouldbe most important for the next government to


22

finalize the Coal Policy in the first six months of itstenure.

Accelerate the process to complete all necessaryformalities associated with the joint venture coalbased projects with India so that the constructionof the plants starts very soon. Significant delayshave already happened and high level attentionneeds to be given to these projects to overcomethe remaining hurdles.

More proactive engagement between the EnergyRegulatory Authority and the power sector entities/playerswill be the key for development of the sector. Despiteseparation of power generation and distribution as separatecompanies, not much progress has been made indeveloping a competitive private sector focused market-based power sector. Market based pricing of electricity andmoving away from the monopoly role of public sectorentities will be keys to the development of the sector alongwith Bangladesh’s integration with the potential futureregional power market.

pri quarterly policy briefs on bangladesh economy · pri quarterly policy briefs on bangladesh...

Documents