Growth projections must reflect the latest evidence
The remittance boom and dominance of services in GDP do no provide an adequate basis for keeping the growth projection unchanged in the revised monetary program.
Defending the 8.2 percent growth projection for the current fiscal year despite decline in exports, import of capital machinery and intermediate inputs and weak private credit growth, the Bangladesh Bank (BB) provided two justifications: (i) a surge in remittances and (ii) high share of services in the GDP.
Remittances can surely boost growth. The transmission mechanism goes from remittance to aggregate demand growth to GDP growth. The income of the recipient households increases because of remittances. Domestic production benefits as domestic demand is stimulated. This in turn helps increase utilization of the existing production capacity and incentives investment in capacity expansion. How much additional GDP is created as a result is an empirical question because the increase in aggregate demand could also increase prices.
There is no consensus on the magnitude and direction of the impact of remittances on growth. However, the weight of evidence appears to favor a positive impact of remittances on growth, according to many different studies at the national and international levels. Evidence based on an international panel data set is that the impact of remittances on per capita GDP growth can range between 0.12 to 0.74 percentage points. An increase of 1 percentage point in the remittance share of GDP increases GDP growth by 0.12 percentage point at the lower end and 0.74 percentage point at the higher end depending on the political and economic environment.
Using these findings, let's try to get a sense of the best possible impact of the remittance boom on growth. "Best possible" means we take the upper bound (0.74) of the growth impact and assume that the 25.4 percent remittance growth achieved in the first half will continue the rest of the year, increasing the share of remittances in GDP by 1.4 percentage points. The GDP growth impact is thus likely to be about 1 percentage point (1.4 multiplied by 0.74). That is the maximum we can expect based on currently available hard evidence on the remittance-GDP growth nexus.
Even this upper bound estimate is subject to the following caveats:
- Several disincentive effects have been left out. Remittance may induce the recipients to consume more than they otherwise would, thus decreasing the propensity to save. The recipients may choose to work less than they otherwise would have in the absence of remittance income, thus decreasing labor supply. The likelihood of such behavioral responses is higher when the remittance inflow is perceived to last long.
- By increasing the supply of foreign currency, remittance strengthens the value of taka than would be the case in the absence of remittances. This crowds out exports, by making it more expensive to foreigners, and production of domestic import substitutes by making imports cheaper. It is known as the Dutch Disease effect.
- Insufficient aggregate demand is unlikely to be the most binding constraint on GDP growth in Bangladesh. The ones that bite most are on the supply side: infrastructure, private investment, human capital accumulation, barriers to resource mobility between sectors and constraints on technological upgradation at the microeconomic level. None of these depend, to any significant extent, on remittances. Of course, to the extent remittances boost bank deposits as well as household expenditure on housing, family business assets, education and health, both physical and human capital accumulation can get some stimulus. However, most survey evidence suggests, the impact on physical capital accumulation is fairly small while the impact on human capital accumulation takes a long time to work its way through the economy.
High share of services cannot be a sufficient reason for not considering downward revision of the growth projection. The share of services in our total GDP was 55.5 percent in FY19, about the same as in India (54.4 percent). The projected GDP growth for India has been downgraded by 1.2 percentage points to 5.8 percent in FY20 by the IMF in the just released World Economic Outlook, relative to their projection made in October 2019.
High share of services does not guarantee high GDP growth either. Growth in services depends to a very large extent on growth in production, trade and finance. Agriculture appears to be the only sector on track to maintaining its recent good performance. Industrial production growth has weakened considerably not just because of export decline but also because of weak domestic sales. Production of cement, steel, agricultural equipment, footwear and leather products, aromatic soap, furniture, and motor cycles were all reportedly seeing negative growth in July-September 2019.
When manufacturing growth is weak, trade is declining (negative export and import growth), and financial intermediation is in a mess, sustaining the 6-7 percent growth in services seen recently is itself a huge challenge. Within services, the real estate sector is likely to have been stimulated this year because of the concessional tax treatment allowed in the FY20 Finance Act for disclosure of undeclared money if invested in real estate. Growth in public administration and education has already tapered off while the rest of the services sector are not large enough to outweigh the slowdown in retail and wholesale trade, transport and financial intermediation.
Thus, the remittance boom and dominance of services in GDP do no provide an adequate basis for keeping the growth projection unchanged in the revised monetary program. BB missed an opportunity to update their growth forecast reflecting the information from new data.
The author is an economist.