The Economy Needs Credibility, Not Optimism

A spectre is haunting the Bangladesh economy -- the spectre of the crisis of confidence.

The legacy issues in the banking sector and corporate balance sheets mean there is a dearth of private investment. 

After its latest mission in July, the IMF revised down the FY2027 growth forecast to 3.5%, a far-cry from the government forecast of 6.5 percent. And that was before the gas shortages hit.

Policy-makers are facing a set of genuinely difficult trade-offs. The temptation, understandable in any political system, is to manage the narrative by talking up the resilience of the economy, to treat each piece of bad news as an isolated shock, and to promise that better days are just around the corner once the current crisis passes.

That temptation must be resisted. The data, even before the full effects of the energy crisis are visible, point to an economy that was already losing momentum on several fronts at once.

What the country needs now is not reassurance but candour: a clear-eyed account of legacy issues it is dealing with, a coherent framework for what the authorities intend to do about it, and credible statements about the trade-offs and costs involved.

Stagflationary Quagmire

Let’s start with economic growth. Real GDP growth slowed to just 2.2% in the year to the March quarter, and worryingly, the industry sector's contribution turned negative. More worryingly, partial indicators of activities and demand suggest that economic growth in the June quarter was also weak, perhaps even weaker.

Industrial production in manufacturing remained sluggish through the year to June (Chart 1), suggesting industry may well have made a second quarter of consecutive negative contribution to GDP growth.

Export growth, which had been a source of strength in recent years, screeched to a halt over the same period (Chart 2). Two of the most direct gauges of formal-sector economic activity were therefore already flashing close to recession territory before the energy shock had been fully felt.

Chart 1: Industrial Production Growth (percent through the year)  Chart 2: Export Growth (percent through the year)

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Source: Bangladesh Bureau of Statistics. 12 month moving average     Source: Bangladesh Bank 12 month moving average

Demand-side indicators reinforce the picture. Import growth has also stalled, which implies weak domestic demand (Chart 3). At the same time, private sector credit growth continues to weaken (Chart 4), implying that whatever recovery in investment policy-makers might be hoping for is not yet visible in the data -- and is unlikely to arrive quickly given the legacy issues in the banking and corporate sectors.

Chart 3: Import Growth  (percent through the year)                                                               

Source: Bangladesh Bank 12 month moving average

Chart 4: Private Sector Credit

  Source: Bangladesh Bank 3 month moving average.

The picture is equally grim when we turn to the indicators of prices and income. Nominal wage growth has been reasonably strong (Chart 5), but it has not kept pace with inflation (Chart 6). Non-food inflation has been stuck above 9% for a sustained period, and while the headline inflation rate has eased somewhat recently, that improvement is being driven entirely by a decline in food inflation -- which, even after falling, remains higher than pre-pandemic norms.

In other words, ordinary households are experiencing a real income squeeze: prices, especially non-food prices, are rising faster than pay packets, and the recent easing in the headline number flatters the true picture facing most families.

Chart 5: Wage Growth (percent through the year)

Source: Bangladesh Bureau of Statistics

Chart 6: Inflation (percent through the year)

Source: Bangladesh Bureau of Statistics

If there has been a genuine bright spot in the economy last couple of years, it is remittances. Remittance growth has remained strong, buoying up the domestic services sector and household consumption through this period of weakness. But this bright spot comes with an asterisk.

The number of workers going overseas has fallen sharply since the outbreak of the Iran war (Chart 7), and while remittance growth is still robust, its pace has begun to moderate (Chart 8).

A pipeline of new overseas workers that has narrowed today is a pipeline of remittance inflows that may narrow tomorrow. This is a trend worth watching closely, particularly considering the monetary policy trilemma that bedevils the central bank.

Chart 7: Number of Workers Going Overseas 

Source: Bangladesh Bank 3 month moving average 

 Chart 8: Remittance Growth (percent through the year)

Source: Bangladesh Bank 12 month moving average.

Limited Policy Space

Monetary policy trilemma is a well-recognized concept in international finance and macro-economics that holds that a central bank can, at any given time, pursue only two of the three objectives: Affect domestic interest rates, unfettered international capital mobility, and exchange rate stability.

To understand what this means in the current Bangladeshi context, let us consider the monetary policy settings as they stand: interest rates have risen after the so-called nine-six caps were abandoned after the July uprising (Chart 9) and the central bank’s stock of convertible reserves appear sufficient (Chart 10).

Chart 9: Interest Rates

Source: Bangladesh Bank

Chart 10: Stock of Convertible Reserves (months of imports)

Source: Bangladesh Bank. 3 month moving average

But the pictures don’t necessarily tell the full story. The central bank has started cutting policy rates and has been pushing several credit schemes to stimulate the economy, seemingly to little effect, while inflation clearly remains sticky.

Meanwhile, the stock of reserves is being measured against historically weak import volumes. If inflation is expected to remain higher than our trading partners, taka faces a risk of depreciation, or the central bank faces a risk of reserve depletion.

There is a further, less obvious danger here: If expectations of future depreciation take hold, remittances could shift from formal into informal channels, doing simultaneous damage to both the balance of payments and to inflation. 

The central bank's room to manoeuvre here is genuinely and dangerously limited, something not appreciated in our policy discourse.

Meanwhile, fiscal policy offers no easy escape route either, and is exacerbating the central bank’s tasks. Tax revenue growth did rebound in the year to June (Chart 11), but credit to government kept accelerating through the summer months (Chart 12), implying that there is no fiscal space to spend the economy out of this slowdown.

Chart 11: Tax Revenue Growth

Source: NBR. 12 month moving average

 Chart 12: Growth in Credit to Government (percent through the year)

Source: Bangladesh Bank 12 month moving average

A Credible, Coherent, Consistent Framework to Boost Confidence and Avoid Arisis

Given all of this, what should the policy-makers do? Five things, and each requiring candour and uncomfortable truths and unpalatable trade-offs.

Firstly, Bangladesh Bank needs to articulate a credible and internally consistent monetary policy framework.

Right now, it is not clear what really is the central bank’s priority. It may well be the case that interest rate cuts are giving support to heavily leveraged businesses, and thus avoid a worse economic slowdown. However, this is coming at a cost of higher inflation.

And it is not clear at all whether the central bank has factored in the implications for the external sector. The Monetary Policy Statement that was released in June is no longer a tenable document. Pretending that it is only detracts from confidence. A reset is needed.

Second, announce a supplementary budget by the end of October.

It is a sign of our sorry state of economic commentary that a genuinely novel development in this year’s budget was largely ignored. The budget papers contained a detailed scenario analysis of the macro-fiscal implications of a prolonged conflict in the Middle East.

Well, the conflict continues, and the macro-economic assumptions underpinning the budget are no longer tenable. The fiscal year has been in principle moved to begin from April, therefore an October supplementary budget is entirely appropriate.

This supplementary budget should be a strictly austerity one, identifying the government’s core functionalities and deferring all development and aspirational programs to next fiscal year.

That is, the government should use the next six months as the baseline to build its recovery program on.

Third, be honest about the difficult choices in the banking sector and form a commission to resolve them.

There is no straightforward, low-cost way out of the problems in the banking sector, and pretending there is one only defers the reckoning.

Policy-makers should spell out bluntly what the costs of different reform options will be -- to depositors, to shareholders, to the budget, to growth in the near term -- rather than dithering. 

Having been honest about the costs, they should then form a commission tasked with a clear mandate and time-frame to deliver. Ambiguity here is not a source of stability; it is a source of the very uncertainty that keeps credit growth weak and investment on hold.

Fourth, pass a functioning bankruptcy law.

Bangladesh's corporate sector includes large, heavily indebted entities that cannot restructure their obligations under the current legal framework, which leaves both good and bad debt frozen in place rather than resolved.

Until an orderly bankruptcy and restructuring regime exists, investment will remain hobbled -- not because entrepreneurs lack ambition, but because capital cannot be redeployed away from failing enterprises and toward productive ones.

This is one of the more immediately solvable problems on this list, in the sense that it is a matter of legislative will rather than macro-economic trade-offs, and it should be treated with the urgency that implies.

Fifth, put in place a coherent energy policy framework.

Bangladesh’s energy problems reflect not a shortage of plants but of gas and money. Solutions involve fixing the payment chain first by netting the arrears, publishing every contract, and setting a three-year tariff and subsidy path. These will not switch on the lights. But they will boost confidence because they will show that the government is serious.

Of Candour and Credibility

None of this is a comfortable message to deliver publicly, which is exactly why it needs to be delivered clearly rather than obscured. An economy that slowed to 2.2% growth with a negative industrial contribution, sticky non-food inflation eating into real wages, a narrowing pipeline of overseas workers, and no meaningful fiscal or monetary space to spare, is not an economy that can be talked back into health through optimistic soundbites.

What it can be helped by are policy-makers willing to say plainly what the problem is, what they intend to do about it, what it will cost, and what range of outcomes people should realistically expect.

There is a common thread running through all five recommendations above, and it is worth stating explicitly: none of them ask policy-makers to perform a miracle.

They ask for a framework instead of ad hoc responses, a realistic budget instead of an aspirational one, candour about costs instead of comforting silence, a legal fix that has been overdue for years, and patience with a long-gestation energy policy that has no shortcut. 

These are, in other words, achievable steps. What has been missing is not the capacity to take them, but the willingness to say clearly, in advance, what is being done and why -- and to let the public judge the results against a standard the government itself has set.

That kind of honesty carries its own short-term political costs. Admitting that inflation, the exchange rate, and business support cannot all be prioritized at once invites criticism from whichever constituency feels shortchanged.

Publishing a supplementary budget built on realistic rather than aspirational numbers will, almost by construction, show a smaller and less flattering picture than the one presented in June. 

Spelling out the costs of banking reform will alarm exactly the depositors and investors policymakers most want to reassure. But the alternative -- vague reassurance followed by the same difficult decisions arriving later, and under worse conditions, with less room to manoeuvre and less public trust to draw on -- costs considerably more.

Bangladesh's economy does not need a better story. It needs a straighter one.

Opinion polls show that the people are still hopeful about the future, and the Prime Minister retains strong approval rating. The Minister for Finance and Planning has been forthcoming in his recent remarks about economic difficulties.

The government deserves credit for pushing out its electoral promises at the soonest, without being bogged down by the bureaucratic miasma. It deserves credit for providing a long-term aspirational strategy.

However, the government must now pivot to confront the crisis of confidence that is imminent.

Jyoti Rahman is the Executive Editor of the weekly Counterpoint.