Lecture-10

Domestic and Foreign Resources in Bangladesh

Since independence Bangladesh has been experiencing a steady increase in the growth rate
of real GDP, accelerating from an average of less than 4% per year during 1974-1990 to 6.4%
in 2010-13. This is a remarkable performance, even after allowing for the low initial base.
Importantly, this performance is still below true potential, which gives hope that with a stronger
performance Bangladesh can expect to attain middle income status by the year 2021 as
envisioned in the Government’s Vision 2021 and the 20 year Perspective Plan (Government of
Bangladesh, 2011a). Indeed, the ongoing Sixth Five Year Plan (Government of Bangladesh
2011b) aimed at achieving an 8% annual rate of GDP growth by 2015 and the Perspective
Plan projected to further accelerate this growth to 10% by 2021.

In the early years since independence (1974-1990) the expansion of investment was facilitated
by foreign saving mostly in the form of official aid. Since the early 1990s much of the investment
has been financed by national saving. This is a remarkable result and somewhat different from
the experience of many developing countries that have faced a saving constraint for a fairly long
time. Indeed, the expansion of national saving in recent years has exceeded the investment rate
thereby contributing to current account surpluses, which is very unusual for a developing
country. What this means is that there are other constraints on investment which if removed
would allow a greater pace of capital accumulation.

While the long term track record for the role of capital accumulation in driving growth is
generally very good, the recent results are worrisome. In the past two years, the investment
rate seems to have stagnated, especially the private investment effort (Figure 3). Importantly,
the investment rates are much lower than what were projected in the Sixth Plan (Figure 4). It is
clear that additional efforts will be necessary during the Seventh Plan to substantially increase
the investment rate to the 34-36% of GDP range to achieve 8% and higher average growth
rate that is envisaged in the Perspective Plan and Vision 2021. Although the favorable national
saving effort is a big plus for policy making, Bangladesh will also need to explore opportunities
for attracting foreign financing to meet its growing investment requirements. This will be
particularly relevant to meet the massive investment requirements in the area of infrastructure
(power, energy, transport). Such investments are not only large and complex they involve
highly capital intensive and technology intensive projects that are best done with foreign
assistance in terms of both financing and technical assistance.

Discussions on post-2015 international development agenda are gaining increasing momentum

as we are approaching 2015 fast. While debates on setting the goals and targets have more or
less narrowed, the focus is now increasingly shifting towards the means of implementation
(MoI). Interestingly, in view of the limited success of the goal on global partnership in the
Millennium Development Goal (MDG 8), the emphasis on MoI that includes financing as an
important component in the post-2015 agenda is noticeable. The MoI takes a distinct position in
the agenda of the Open Working Group (OWG) of the United Nations which is working towards
shaping the post-2015 agenda. Thus goal 17 of the OWG spells out various MoI including
finance in general and sources of finance in particular. Needless to say that domestic resource
mobilisation has taken the centre stage of the current discussion. To be more specific, taxation
has featured more prominently in the ongoing discussion on efforts towards domestic resource
mobilisation.
This is not only due to the declined flow of foreign aid to low income countries, but also for a
more stable source of resources. As opposed to an unsustainable development path through
reliance on resource from external sources, domestic resource mobilisation can lead towards a
self-sustaining development. A number of reasons can be put forward in favour of this logic.
First, domestic resources provide a predictability of resource flow to make allocations for the
medium term fiscal planning in a country. As poor countries tend to rely on foreign aid they also
have to face the impact of volatility and uncertainty in aid flows which creates difficulty in their
budget management. Even countries which have graduated themselves from aid dependent to
trade dependent countries may also face such volatility and unpredictability. Second, adequate
domestic resources create fiscal space for the country to prioritise its spending in line with the
policy priorities and political commitments. It thus gives more flexibility as opposed to
conditionality’s of aid.

Third, the need for broadening tax base as a source of domestic resource mobilisation in the
country is important also because of the fact that in order to attract foreign investment, countries
have to provide generous tax incentives to foreign investors to be competitive in the global
market. In order to make up for the reduction in corporate tax, resource generation through the
broadening of tax net becomes necessary. Fourth, domestic resource mobilisation through
taxation is crucial for creating the sense of participation among people in the development
process of the country. This can in turn act as a mechanism to create pressure on the public
representatives to be accountable and transparent on the use of resources.

Bangladesh has remarkably reduced its dependency on foreign aid since its independence. In
FY2013 the share of overseas development assistance (ODA) in Gross Domestic Product
(GDP) has declined to 2.2 percent in FY2013from 5.8 percent in 1981. When compared with the
Annual Development Programme (ADP), the share of ODA is 42.9 percent in FY2013 compared
to 53.2 percent in FY2000. Notwithstanding a better economic growth compared to other least
developed countries, Bangladesh suffers from an imbalance between the public expenditure
and revenue. Such imbalance has led the country to rely on borrowing from both internal and
external sources to meet up its public expenditure requirements.

Figure 1: Trend of revenue as percentage of GDP during 2003-2013

Source: Various issues of Bangladesh Economic Review, Ministry of Finance.

Despite various initiatives in the area of tax policy and administration, tax mobilisation remained
low. Tax performance in Bangladesh is constrained by a number of structural factors. These
include low per capita income and narrow tax base. A gradual move towards expanding the
income tax base is being observed recently. Albeit slow, the growth of revenue collection during
the last few years can be attributed to a number of factors. Measures such as simplification of
value added tax (VAT) system, increased coverage of VAT and imposition of supplementary tax
have contributed to revenue growth. With a view to improve collection of VAT, a new VAT act
has been approved in the national parliament. This will be in place from July 2015.

The National Board of Revenue (NBR) is also undertaking a modernisation plan that started in
2011 and be completed in 2016. It is expected that proper implementation of these initiatives will
bring some fruition in terms of higher revenue generation. Another concern is the increased
capital flight from the country which has been quite significant, according to the report on ‘Illicit
Financial Flows from the Least Developed Countries’ by UNDP. Given the importance of the
issue the newly set up Transfer Pricing Cell within the NBR needs to be more vigilant on such
outflow of domestic resources. Such effort has to be backed by human resources and
infrastructure.

In order to mobilise resources effectively and allocate them to the most productive investment
opportunities a well-functioning financial system is an important requirement. Though
Bangladesh has a relatively sound and profitable financial system, its financial intermediation is
low. The financial system in Bangladesh is dominated by the banking sector with a small non-
bank financial sector. In terms of outreach and access to financial services to its population
Bangladesh has made good progress. However, there are still gaps between the demand and
provision of financial services to rural areas and in financing small and medium enterprises,
agriculture and infrastructure. Moreover, interest rate spread which is the difference between
the weighted average lending rate and the weighted average deposit rates is high in the banking
sector by international standards. This is because of high overhead costs, credit risk, and weak
competition within the sector and can be discouraging for savers.

In addition to banks and other financial institutions, the development of capital market is
necessary to achieve efficiency of capital allocation. In contrast to banks which finance only
well-established and safe borrowers, stock markets can finance risky and innovative investment
projects. Unfortunately, capital market in Bangladesh could not take off due to various
regulatory and policy failures. The capital market is not a matured one and market capitalisation
is low. Moreover, the capital market experiences volatility due to both economic and non-
economic factors. The depth of the market is shallow as it lacks sectoral diversification and has
a concentration of the financial sector which again is represented mainly by the banking sector.
Hence the opportunity to finance large infrastructural projects through raising funds from foreign
portfolio investment, off-loading of shares of the state owned enterprises and various equity and
bonds from the capital market is very limited.

Given the resource constraint of the government the private sector can play an important role to
bridge the gap between resource requirement and availability. The public private partnership
(PPP) could be a useful mode of domestic resource mobilisation for undertaking large
investment in power, port and infrastructure projects. An amount of Tk. 2,500 crore was
allocated by the government in the budget of FY2010. However, there is very little enthusiasm
on PPP projects. Thus the achievement in the area PPP has been frustrating till today.
In addition to reform measures and policies, the improvement in the revenue scenario is
contingent upon several factors including sound public spending management. Domestic
resource can become the driver of economic development only if public spending is managed
efficiently and prudently.

Ironically, domestic resource mobilisation effort in Bangladesh is constrained also by low level of
public expenditure and investment, among many other factors. Thus the country is posed with
dual challenges of generating domestic resources and utilizing that resource efficiently for
increased productivity and economic development. The lack of capacity to spend by the
government is also reflected through the gaps between national savings and domestic
investment rates. The shares of gross national savings and gross investment as a percentage of
GDP were 29.5 percent and 26.8 percent respectively in FY2013 suggesting that there was
investible surplus in the economy. This surplus is also manifested through under implementation
of the ADP.

While addressing the issue of domestic resource mobilisation both policy and institutional
aspects have to be considered. The implementation of new measures requires a transparent
and accountable tax administration which should be supported by efficient and honest human
resources. They should also be able to work independently and impartially without any external
influence. Finally, enhancement of resource mobilisation also depends on the utilisation of
resources. If taxpayers are not convinced and confident of the proper utilisation of their hard
earned money, the generation of resources becomes difficult. Therefore, there has to be clarity
and transparency on the purpose of resource allocation for investment so that the responsible
authority can be made accountable in case they fail to perform. This is also required for
improving the quality of expenditures so that resources spent by the public representatives can
contribute to employment generation and poverty reduction which are part of the post-2015
development agenda. The achievement of post-2015 agenda is thus, to a large extent,
contingent upon domestic resource mobilistion.

It is apparent that, the solid platform of sound macroeconomic management and the
comfortable debt, bop and foreign reserve situation will be very helpful to help Bangladesh
move forward. Nevertheless, the increased requirements of foreign resources will present a
challenge for Bangladesh during the Seventh Plan and beyond. It is therefore important to take
early measures to prepare for this challenge. The foreign resource strategy proposed here calls
for strong efforts to improve the utilization of the large unused aid pipeline while also taking
policy actions to mobilize additional debt and equity foreign financing. In view of the changed
global sources of supply of foreign resources, the reliance on concessional ODA will need to fall
and a larger share of additional funding will need to come from private creditors at market based
costs. The required strategy calls for a judicious mix of debt and equity.

The opportunities for equity financing are substantial and strong efforts will be needed to sharply
increase equity financing, especially based on FDI. The revamping of the PPP initiative can be
especially useful in attracting additional FDI, particularly for financing infrastructure. Greater use
of non-guaranteed private borrowing by creditworthy private enterprises will also provide
flexibility in mobilizing foreign funding for private investment. In this regard, the launching of the
proposed Bangladesh Sovereign Bond can be instrumental in supporting bond-financing by
private enterprises.
While the average cost of debt will likely increase, overall debt service should remain
manageable and will not present a debt sustainability issue. The Bangladesh debt indicators are
highly favorable and modest increases in external debt along with higher GDP growth and
exports should continue to keep Bangladesh in a comfortable situation. The credit rating for
private borrowings is also favorable at present owing to good GDP growth and sound
macroeconomic management. Mobilization of private debt from the international market will
likely increase the interest cost from the present 1% average to 3-4%. Yet, this will keep debt
servicing comfortable provided additional borrowings are used to finance productive
investments.

The institutional arrangements for foreign borrowing are generally solid, but further efforts are
needed to improve inter-agency coordination, especially in the area of equity resource
mobilization. Along with consolidated debt and equity data and constant monitoring, efforts are
needed to improve debt research and analysis on a regular basis to inform the debt strategy
and improve its implementation.