(The interview was conducted in April 2024)

Elections introduce a period of economic uncertainty, navigating through existing shocks while potentially raising new challenges. Prolonged and elevated protection measures alter the incentive framework, leading to distortions over time with stability, often as price. Harnessing hope becomes a strategic imperative to propel us forward during challenging times.

Post-election, Dr. Mohammad Abdur Razzaque, Chairman of Research and Policy Integration for Development (RAPID), sat down with Tazrian Iqbal from Industry Insider to discuss the contemporary economy and the challenges to tackle. 

Dr. Razzaque is also director of the Policy Research Institute of Bangladesh (PRI) and editor-in-chief of Policy Insights. He also has vast experience in policy research and capacity-building projects in Bangladesh, sub-Saharan Africa, South Asian, Caribbean, and Pacific economies. He offers feasible strategies and guidance within the interview and beyond.

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Industry Insider: As the election is over now, how can the government’s policies be modified to maximize efficiency and ensure positive economic output? What avenues should be prioritized?

Dr. Abdur Razzaque: With the easing of political uncertainties, we’re looking at a golden chance to shake up our policies to tackle our challenges. We need a well-rounded strategy that touches on several interconnected areas.

There’s a solid consensus on the need to fight inflation, deal with our shrinking foreign reserves with appropriate exchange rate policies, boost our fiscal capacity by collecting more domestic revenue, and ensure our public spending is wise and high-quality. We can’t forget about strengthening how our banks are run, either. That’s just as crucial as getting ready for LDC graduation by boosting and diversifying our exports. Getting these things right is key to keeping our economy growing, cutting down poverty and inequality, creating jobs, pushing human development forward, and making progress towards the Sustainable Development Goals.

These measures are well-known and line up with the IMF program, which helps Bangladesh with its balance of payments issues. They’re also reflected in our long-standing five-yearly plans that aim to beef up our economic management and efficiency.

Historically, the reluctance to implement reforms has significantly impaired economic performance and resilience. Critical areas like banking sector governance and tax reforms have not been given adequate attention. Additionally, policies governing the interest and foreign exchange rates have been flawed.

Now that the elections are over, we’ve got this perfect window to tackle policy stagnation head-on. If we get moving on these tough reforms quickly, we can reduce the time it takes for our economy to adjust. The first 2-3 years after an election are usually the best time to get these reforms rolling because public opinion starts to make things tricky later on. 

Of course, reforms are inherently challenging and can incite opposition from groups benefiting from the status quo. The government’s got a tightrope to walk—pushing through these reforms while trying not to step on the toes of the more vulnerable groups. Maybe expanding social protection measures could help soften the blow for them. It’s all about finding that balance.  

II: Privatized state-owned enterprises (SOE) are another channel that previously worked for many governments in reducing operational costs, which would help the fiscal budget. For example, Brazil, Malaysia, and Peru have utilized it. Can our economic structure adopt this? What criteria should the government consider while determining which state-owned enterprises to privatize? Do you think the cons will outweigh the pros? 

AR: It’s not always a one-size-fits-all situation when discussing adopting policies from other countries. Every country is different, right? So, just copying what others have done might not work out for us. We need to look at what’s worked elsewhere, learn from those experiences, and then think about how we can tweak those ideas to fit our own situation here in Bangladesh.

Regarding state-owned enterprises (SOEs) in Bangladesh, it’s clear that we need to shake things up. While a few SOEs are doing alright, most are struggling and leaning heavily on government support. This is a profound problem because our government spending, about 14% of our GDP, is already among the lowest globally. With the tax income being around 8% of GDP, which is also amongst the lowest compared to other countries, the government is borrowing a lot to cover the expenses. So, pouring money into these SOEs means we have less for important sectors like health, education, and social protection.

It has been found that since 2016, the money that is being lost on SOEs has jumped from 1.5% to 3.1% of our GDP by 2020. Compared with countries like India, Malaysia, China, and Vietnam, our SOEs aren’t doing as well.

Research suggests that if we could get our SOEs more efficient, like improving their return on assets to about 10-12%, we could boost our revenue by up to 2% of GDP. The government’s trying to do something about it. They’ve got a Monitoring Cell in the Ministry of Finance and a plan to make SOEs more profitable, aiming for 2% of GDP by 2025. But it’s tough, with budget limits and energy subsidies that don’t make sense.

The issue with SOEs is often how they’re run and their pricing policies. In a recent study, the Policy Research Institute (PRI) suggests we need a clear plan for what we want our SOEs to achieve, better management with professional boards and external audits, and a solid system to monitor their performance. That study also says we should be stricter with budgets, set better prices for what they sell, and maybe consider privatizing some, especially in manufacturing.

But here’s the thing – making these changes isn’t going to be easy. We need to take it step by step, be politically savvy, make sure we’ve got good data, and talk to everyone involved. If we plan this right and get people on board, reforming our SOEs could free up some money for the government and help improve public services. It’s a big task but doable with the right approach.

In terms of Inflation

II: Antoinette Sayeh, Deputy Managing Director and Acting Chair of the IMF executive board, said, “Raising tax revenues and rationalizing expenditures will allow increasing social, developmental, and climate-related spending in Bangladesh.” Given the current inflation rate of approx. 10%, what should the fiscal policy in the second half of FY24 look like to generate growth while simultaneously trying to lower the inflation rate? 

AR: The inflation rate’s been high for a while now, and it’s not going anywhere anytime soon. At first, there was a bit of hesitation about what to do, with wishful thinking that it would sort itself out without much intervention. Part of the reason for this reluctance is that taking steps to tackle inflation isn’t always popular, especially with the groups who benefit from low-interest policies, like businesses. Keeping a 6% interest rate on savings and 9% on loans didn’t line up with basic economic sense.

A clear picture of the policy issues can help us get back on track. The interest rate caps were lifted, but our central bank’s been pretty conservative about steering the rate adjustments and keeping a tight rein on the money supply. This has slowed down the impact of policies meant to control rising prices. Just recently, there’s been a genuine move limiting government borrowing from the central bank, which is smart. However, adjusting interest rates has been a slow process.

It’s important to remember that controlling imports when foreign reserves are under pressure can push domestic prices up. Imports play a big role in keeping domestic prices under check. Right now, the effectiveness of imports is limited. If we have to control imports to save our reserves, cutting import tariffs might help make the most of our limited import capacity to fight inflation. But the government is under pressure to collect more revenue, so there’s this tricky balance between reducing tariffs and mobilizing more domestic resources. However, relying on imports for domestic revenue is a bad idea. A good solution could be to widen the tax net. Millions of individuals and businesses aren’t paying their fair share of taxes.

Managing public spending is a major fiscal policy instrument to ease inflation. Sure, our public spending isn’t huge, but there’s still a lot of room to use what we have more effectively. When inflation sticks around, running a big fiscal deficit isn’t wise. So, prioritizing how we spend public money is crucial. Where spending isn’t doing much good or is just wasteful, cutting back can help the government depend less on deficit financing, which is expensive—about 12% of our public spending goes just to paying interest on government debt.

When thinking about how to spend public money more wisely, we must ensure the poor and vulnerable don’t suffer. Inflation is already hitting them hard, and the last thing we want is to make things worse for them. Ideally, we should restructure public spending so the total amount might be lower, but the portion for the poor and vulnerable goes up. That’s not just fair; it’s the right thing to do. Hence, tackling inflation isn’t just about the nuts and bolts of fiscal and monetary policy; it’s also about making smart, compassionate choices.

The government will soon face a trade-off between growth and stabilization. With the reduced levels of imports and investment, growth has to suffer. But if that comes with lower inflation rates, things will get better soon. For a country like ours, even a 4-5% growth will be quite solid in the backdrop of the currently sustained inflationary pressure. However, there is a tendency to put growth above other policy objectives. 

II: Bangladesh Bank recently withdrew the interest-rate cap, thus making the interest regime market-based. Additionally, another contractionary monetary policy is being considered by BB to be implemented for six months, allegedly starting Jan 15. With high IRs and reduced money supply, will inflation be truly contained using simple textbook solutions? How can the economy recover well from these shocks? 

AR: What you’re calling ‘simple textbook solutions’ have actually been quite a challenge for Bangladesh to implement for quite some time. With persistent inflation, we have no option but to go for a contractionary monetary policy.

But here’s the thing – it’s crucial to understand the difference between the direction we take with our policies and how deep we go with them. Deciding to raise interest rates or cut down the money supply is about setting a course, but the extent to which we do this – that’s about depth. And this is where skillful handling of policy tools comes into play. How we move these policy levers can also shape market expectations, influencing outcomes.

One big hurdle for the Bangladesh Bank in dealing with inflation is the impact of shrinking reserves on managing the exchange rate. If we find ourselves in a spot where a significant devaluation is unavoidable, it could throw a spanner in our efforts to keep inflation in check.

II: To tame the rising inflation rate, if current policies persist, what market distortions should we watch out for in our current post-election economy and in the long run?

AR: I feel we’re about to see some significant policy shifts. If they’re done right, they could help us get a handle on the economic challenges we’re facing. It’s always a kind of a toss-up between good luck and good policy, isn’t it? But in our current situation, we’re definitely going to need a bit of both if we want to come out of this sooner rather than later.

Now, about the policies for tackling rising inflation, there are a few things we need to keep an eye on. Let’s say interest rates are kept low. What happens then? Well, people might start using cheap credit for speculative investments instead of putting it into things that help the economy grow. This can lead to a misallocation of resources, and before you know it, you’ve got asset bubbles popping up, especially in real estate and land. And with inflation on the rise, 

those with cash are likely to move their resources around to maintain their purchasing power in the future.

On the flip side, if we go too hard with contractionary monetary policies for too long, we might slow down consumer spending and business investment. That’s not great because it can lead to higher unemployment and put the brakes on economic growth.

Then there’s the whole exchange rate situation. A tight grip on the exchange rate will lead to misalignments with the market reality, affecting export competitiveness, and the current pressure on foreign exchange reserves could be maintained for a long time. On the other hand, if the taka starts to drop too quickly, it will add more fuel to the inflation fire.

It’s like we’re walking a tightrope with these policy tools—they’re a double-edged sword. We’ve got to be careful how we use them, or we might end up doing more harm than good.

Most importantly, if we cannot restore macroeconomic stability, consumer and investor confidence could be lost, with the underlying structural issues remaining fragile. One major success of the Bangladesh economy has been solid macroeconomic stability over the past three decades. The quicker we can get back to that stability, the better it will be for our economic future.

Depleting Reserve

II: Bangladesh received $1.31 billion combined from IMF and ADB in December last year as a stopgap relief till the polls for the country’s depleting foreign exchange reserves. While it’s a temporary relief on a large economic scale, it is still a band-aid on a much larger issue. From a macroeconomic standpoint, are there any potential long-term solutions ahead of us?

AR: The IMF package might look like just some additional foreign aid to boost our reserves, but it’s a lot more than that. Before the IMF program came into the picture, there was quite a bit of confusion about the actual state of our reserves. That uncertainty wasn’t great for confidence among local and foreign investors and other economic players. When the IMF stepped in with their assessment as part of the lending program, it reassured everyone that we still had enough reserves to cover our import needs for 3-5 months, which is considered a rule of thumb bare minimum reserves that the country must maintain. In the process, the IMF also recommended amending the reserve estimates by the Bangladesh Bank and undertaking a host of reforms in exchange and interest rates management to address the structural issues affecting the balance of payments crisis. Therefore, this IMF package lent some credibility to the policy changes the Bangladesh Bank is now trying to implement.

Of course, we need to find long-term solutions. This crisis shows us that we need to up our game in earning foreign exchange. Despite all the talk about our export success, our exports, in absolute terms, remain quite small compared to most Southeast Asian countries. For Bangladesh’s large population of 170 million, its current merchandise export volume of $55 billion is much smaller compared to, for instance, Vietnam, with a population of 91 million, boasting an export volume of over $360 billion; Indonesia, with 218 million people, exports $240 billion; and the Philippines, with a population of 101 million, earns around $80 billion from its goods exports. Even much smaller Southeast Asian countries like Malaysia (33 million inhabitants) and Singapore (just 5.5 million residents) are among the most successful exporting nations in the global economies, exporting $350 billion and $460 billion, respectively,

Our remittance inflows through the formal channel are also quite modest compared to countries like Nepal and the Philippines. Just 3.5 million Nepalese migrant workers send home nearly $10 billion in remittances, while 2.1 million Filipinos remit more than $35 billion. In comparison, 10 million Bangladeshi migrant workers send only about $25 billion.

Estimates suggest that 25-50% of the remittance inflows into Bangladesh come through the informal channel, which does not contribute to boosting foreign reserves. The huge demand for goods and services through the informal channel and the illegal transfer of money are the main reasons for a sizeable portion of the remittances sent through the Hundi network. This situation has been further exacerbated by maintaining an overvalued exchange rate for a prolonged period. Furthermore, almost three-quarters of Bangladeshi migrant workers are in the less-skilled category, earning much less than their potential in semi-skilled or skilled categories.

On the export side, an overvalued exchange rate has certainly hurt export competitiveness, particularly in non-garment sectors. Bangladesh has also been pursuing a highly protectionist trade policy stance with high tariffs and other import duties. The domestic economy has been growing quickly, and the heavy protection given to the import-competing sectors has made investments targeting local sales much more attractive than those targeting external markets. It is often not recognized in policy circles that high import tariffs are a disincentive for exports. Therefore, tariff rationalization is critical for promoting exports. Rationalization does not mean tariffs should be dismantled altogether; rather, it should aim to make the incentive structure fairer so that more investment can be channeled into the export sector. The government has adopted the National Tariff Policy, and we will have to wait and see its effective implementation. Furthermore, we have also failed to attract foreign direct investment (FDI), which is often a precondition for rapidly expanding exports.

Thus, several things must be done to find long-term solutions to the current reserve crisis. The flawed policies of the past many years now must be addressed to boost export response. 

II: Post-elections, several economic reforms are coming now, including a market-based exchange rate system. Considering the role of exchange rate policy as a development strategy, the evidence of a high degree of exchange rate pass-through to consumer prices would likely constrain a long-run expansionary effect. For Bangladesh, maintaining external competitiveness and promoting growth remains a delicate task. What consistent macroeconomic policies can be adopted in conjunction with the market-based exchange rate system? 

AR: Policy reforms can generate shocks and adjustment needs. That is why reforms should ideally be undertaken in good economic times. Unfortunately, we will have to embrace adjustments under difficult circumstances. Indeed, as I have said earlier, a major fall in the value of the taka through exchange rate adjustments will certainly cause price levels to rise. On the positive side, we expect exports and remittances to pick up.

Going ahead, reforms will have to cover wider areas to produce the desired results. Furthermore, consistent macroeconomic policies are crucial to balance external competitiveness and growth. Firstly, fiscal discipline is key; this involves prudent public spending and efficient tax collection to reduce reliance on deficit financing.

Secondly, monetary policy should be carefully calibrated to manage inflation through interest rate adjustments and liquidity management. Thirdly, trade policy reform is important for improving export incentives and helping promote export diversification. Finally, developing a robust financial sector with effective regulation will be essential to support the new exchange rate system and foster economic resilience. When cohesively implemented, these policies can help navigate the complexities of a market-based exchange rate while promoting stable and inclusive economic growth.

II: The general public has lost confidence in keeping money at the bank on an aggregate scale, leading to an uprise in mattress money. What does this trust deficit and loss in consumer confidence in the banking system entail for the current economy and domino-ing into the long term?

AR: Saying that people have completely lost faith in banks might be stretching it a bit. Actually, with interest rates on the rise, we’ve seen a boost in deposit growth, particularly in savings accounts. The previously fixed deposit rates weren’t doing savers any favors, especially with inflation being what it is.

But there’s a trust issue with the banking sector as a whole. Many banks are sitting on a mountain of bad loans, and there’s been plenty of talk about the need for serious reforms to tackle the problem. If this lack of trust keeps up, it could shake things up in the long run. Central banks might find it tougher to manage the money supply and interest rates if too much cash is being stashed under mattresses instead of in bank accounts. And let’s not forget about financial inclusion – if people aren’t using banks, they’re missing out on loans, savings options, and safer ways to handle their money.

So, what do we do about it? Well, the government and financial institutions need to roll up their sleeves and work on rebuilding trust. This means making banks more transparent, protecting depositors, and being clear with the public about how their money is being looked after.

Another thing to think about is the size of our informal economy. If people are making money on the down-low or through corruption or not paying taxes on it, a big chunk of that cash isn’t going to see the inside of a bank. Tackling this isn’t going to be easy, but we’ve got a chance to make a dent in the problem by widening the tax net and getting better at collecting revenue. It’s all about bringing more informal activities into the light and making the system work for everyone.

II: An uncapped interest system leads to a rise in deposit rates, attracting potential depositors to come back into the banking channel, especially when the window for investment continues to shrink. Will this strategy be enough to derive the desired outcomes, especially since investment instruments for general people on the country’s money market are very limited?

AR: One issue is that deposit growth will have a dampening effect on inflation, and this could be quite a positive outcome in the short term. It’s true that limited investment opportunities in the money market mean that interest rate rises are important for absorbing liquidity, providing some respite to rising prices. But beyond inflation, what the banks do with those deposits is a crucial question. However, I don’t believe the scope for productive investment is shrinking. With low interest rates, capital might have been misallocated, and the rise in interest rates can compel a more efficient allocation of resources. If the Bangladesh Bank isn’t lending to the government through money creation, the government is likely to borrow from the banking system. This method of deficit financing is much preferable when there’s inflationary pressure. However, with rising interest rates, the government will incur a greater cost for such borrowing.

II: We have seen delayed responses regarding lifting the interest rate cap on lending, stopping the printing and lending of the taka, and deciding to opt for a market-driven exchange rate. How can a more proactive approach be implemented to control mechanisms reflecting the ground reality?

AR: To get a grip on the mechanisms that mirror what’s happening on the ground, we must focus on beefing up our institutions, especially the independence of key players like the central bank. You see, there’s often this hesitation or delay in changing policies – we call it policy inertia. It’s often a result of pressure from vested interests who benefit from maintaining the status quo.

Now, building up institutional capacity isn’t just about training the officials who work there to be top-notch at what they do. It’s also about ensuring these institutions can stand on their own two feet, free from outside pressures and influences. 

And then there’s the whole accountability thing. We need a solid system where checks and balances are in place, making sure decisions are transparent and based on solid economic thinking. This kind of accountability builds trust and credibility, which, let’s face it, is what makes people believe in these institutions and the decisions they make.

If we don’t focus on making our institutions stronger, more independent, and more accountable, getting past this policy inertia will be a tough nut to crack. We need a framework where institutions are robust, stand independently, and are answerable for their actions. That’s the bedrock for proactive and effective economic policies. With this kind of setup, we can respond to economic challenges in a timely, relevant way and in tune with what’s happening in the real world.

II: Bangladesh’s average nominal tariffs are currently higher than the average of low, middle, and high-income countries, including most competitors. Are high tariffs a critical requirement for sustaining infant industries without regard to their efficiency implications of long-term protection?

AR: The argument about infant industry protection is valid. It makes sense, but keeping tariffs high forever? That’s not going to do us any favor. See, a tariff basically hikes up the domestic price of a product over its international price, at least by the tariff amount. It’s like a tax on the consumer and a bit of a lifeline for the producer. Without it, the producer would have to sell at the international price, usually lower. What happens is that producers pass this tax burden onto consumers with higher prices because of the tariff, and they often add a markup, too.

Economist Dr. Zaidi Sattar has estimated that during the 5-year period, FY2013-17, the total protection cost to consumers was a staggering $70.6 billion. For FY2017, it amounted to 5.7% of GDP. Then, this analysis by Research and Policy Integration for Development, RAPID for short, makes you think. They found that when the government uses import tariffs and other indirect taxes to rake in revenue, the poorest groups end up getting hit the hardest. Moreover, the higher tariff-ridden prices contribute to restraining imports and limiting the consumers’ choices.

I also mentioned earlier that sustained high protection has distorted the incentive structure. It has made investing in domestic production more attractive than exporting. This is part of the reason why we’re finding it so tough to diversify our exports.

The trouble is that domestic industries seem not to be growing up and continuing to demand protection. And on top of that, as product quality and standards are not effectively enforced, consumers often end up paying more for lower-quality goods. 

What we need is a way to support our domestic industries that’s time-bound. Give them protection, sure, but only for a while, so they have to get competitive eventually. And we’ve got to get our tariff regime sorted out so that the protection rates aren’t through the roof. The National Tariff Policy adopted last year is supposed to address this. But, as with so many other policies, ensuring they’re put into practice properly is always tricky.

II: To reduce trade deficits, should import restrictions continue in addition to domestic decelerators, will our consumer market be able to sustain this sluggishness? 

AR: Import restrictions have become necessary given the pressure on our reserves, but this isn’t a long-term fix. Over the past decade, our economy has grown quite fast, but our capacity to earn from exports hasn’t kept up. You can see how our export-GDP ratio dropped from 20% in 2012 to about 13% in 2022. Imports are crucial for keeping the wheels turning – we’re talking about machinery, raw materials, and even food items. Sure, we can try cutting down on importing those so-called luxury items, but that won’t be enough to sort out our current reserve crunch.

Now, as we’ve been seeing recently, cutting back on imports can have a knock-on effect on our economic activities. And as I mentioned before, restricting imports can drive domestic prices higher. We’re in a period of adjustment for the Bangladesh economy. It’s a bit like recalibrating things. If we can get our policy measures spot on, I’m confident we’ll see economic dynamism bounce back. It’s all about finding the right balance and steering the ship through these choppy waters.

tazrianiqbal@gmail.com