Bangladesh: A call to the IMF to cope with external liquidity pressures

Morgane Salomé – salomem@afd.fr

The Bangladeshi economy, which was resilient to the Covid-19 crisis, has been badly affected by the consequences of the war in Ukraine. The rise in food and energy prices has resulted in an increase in the twin deficits (fiscal and current account deficits at 5.1 and 4.1% of GDP, respectively, in FY2022), which maintains pressure on the taka (-20% against the dollar in 2022). In this context, foreign exchange reserves are shrinking (-$11 billion in a year), to the extent that in July 2022, the country called on the IMF for a $4.5 billion program.

During the Covid-19 crisis, Bangladesh had one of the highest economic growth rates in the world (3.4% in FY2020, i.e. from July to June, and 6.9% in FY2021). This strong performance is mainly due to the recovery in textile exports in late 2020 and a sharp rise in remittances (+50% in two years). Economic growth was even higher in FY2022 (7.2%), but is expected to slow down in FY2023 (6.0%), while inflation weighs on private consumption and power cuts (rationing policy) affect the textile industry.

Inflation stood at 8.9% year-on-year in November 2022, a level that remains higher than the central bank’s target (5.6%), but lower than the peak reached in August (9.5%). Food inflation reached 8.1% in November, following a peak level of 9.9% in August. In March 2022, the authorities responded by launching a food subsidy program (cooking oil, lentils, rice, etc.). The Central Bank has also raised its key interest rate by a total of 100 basis points since May 2022 (to 5.75%). The increase in inflation poses a threat to the social climate, while it is estimated that 15 to 25 million people plunged into poverty and at least 1.6 million into extreme poverty because of the pandemic. Several protests were held in Dhaka in December 2022, demanding the resignation of the Prime Minister, Sheikh Hasina, who is notably accused of failing to contain inflationary pressures.

External position rapidly deteriorating

Bangladesh’s current account balance has been in deficit since 2017, reflecting the sharp rise in equipment imports for large-scale public infrastructure projects. During the Covid-19 crisis, the decline in textile exports was offset by the fall in domestic demand and a surge in migrant remittances, meaning that the current account deficit remained relatively stable in FY2020-FY2021 at just above 1% of GDP. However, it rose to 4.1% of GDP in FY2022 due to the increase in the energy bill. The deterioration in the current account deficit has increased pressure on the taka, which lost 18% against the dollar in 2022, after having remained relatively stable in 2021.

To defend the taka and meet a growing external financing requirement, the Central Bank has drawn on foreign exchange reserves, which lost $11 billion in 12 months and reached $30.1 billion in November 2022, excluding gold and Special Drawing Rights (SDR). However, the government has attempted to halt the fall in reserves by i) restricting imports of non-essential goods (by tightening rules on import letters of credit), ii) rationing energy (including through power cuts), and iii) devaluating the taka twice (in June and September). While the amount of dollar reserves remains relatively high, the amount of reserves expressed in months of imports has fallen significantly to 4.2 months of imports (against 6.4 months of imports at the end of 2021 and 9 months of imports at the end of 2020), a record low since 2013 and a level below the range recommended by the IMF (4.4 to 5.7 months).

In July 2022, external liquidity pressures prompted the Government of Bangladesh to make a precautionary call to the IMF. On 9 November, the authorities and the IMF staff reached an agreement for a program for a total of $4.5 billion, combining a $3.2 billion Extended Credit Facility and a $1.3 billion Resilience and Sustainability Facility, which should catalyze financing from the markets, other official lenders and donors.

External liquidity pressures add to the risk on public finances

With public revenues at only 8.6% of GDP on average for the period 2010-2019, Bangladesh’s tax burden is the lowest in the world. This poor performance is due to the narrow tax base (5 million taxpayers), which mainly results from a very high level of informality (85%) and an extremely complex tax code offering numerous niches and facilitating tax evasion. Public expenditure started to increase in 2018, firstly to support large-scale public infrastructure projects, then to address the health crisis (stimulus of 6.2% of GDP spread over 2020-2022). The stagnation of revenues, coupled with an upward trend in expenditure, has led to a deterioration of the fiscal balance (-4.7% of

GDP on average for FY2018-FY2021). The public deficit widened further in FY2022, as a result of an increase in the cost of subsidies (fuel, electricity, gas and food; +25% in the FY2022 budget). It thereby exceeded the informal threshold of 5% of GDP set by the authorities for FY2022 (-5.1% of GDP according to the IMF) and is likely to remain above this level in the medium term.

Public debt remains moderate at 37.5% of GDP. 60% is held by residents and largely in the form of national savings certificates (47%), investment products benefiting from regulated interest rates which consume over 20% of public revenues. However, a reform of these instruments is ongoing, with the aim of reducing their share in domestic public debt. Furthermore, the government is seeking to develop the domestic bond market, in particular through Islamic finance. Since the end of 2020, three Sukuks[11] have been launched (for the equivalent of $1.5 billion raised) on the local market and largely oversubscribed, a sign of abundant liquidity and of the market’s interest in this type of instrument.

The entire external share of public debt is held by multilateral and bilateral institutions, which limits the external refinancing risk and maintains a high level of concessionality. However, the depreciation of the taka is likely to increase the debt burden in the short-medium term. The payment of debt interest could in particular consume up to 25% of public revenues in FY2023. While foreign exchange reserves are dwindling, the government’s capacity to service its external debt is called into question. In December 2022, Moody’s thereby placed Bangladesh’s sovereign rating (Ba3) under review for a potential downgrade, given the increase in external vulnerabilities.