Extreme poverty to rise in Bangladesh, inflation to hit 9.6% by FY24: WB

Nearly five lakh Bangladeshis are expected to slip into extreme poverty between FY23 and FY24, surviving on less than $2.15 per day, as inflation will reach 9.6%, according to the World Bank's latest Macro Poverty Outlook for Bangladesh, which points to weak private consumption growth and high inflation as key drivers of this concerning trend.

According to the report, the international poverty rate, defined by living on $2.15 per day, is anticipated to climb to 5.1% in the current fiscal year, up from an estimated 4.9% in the preceding year.

Released as part of the South Asia Development Update on Tuesday (2 April), the report also forecasts a marginal increase in moderate poverty defined as living on less than $3.15 per day, from 29.3% in FY23 to 29.4% in FY24, marking an uptick of around 8.4 lakh individuals.

"Weak private consumption growth and high inflation have halted poverty reduction. Higher food prices particularly impacted poor households, which allocate over half of their budget towards food expenditures," says the report.

However, the "Household Income and Expenditure Survey 2022" report by the Bangladesh Bureau of Statistics (BBS) unveiled a noteworthy decrease in poverty rates.

According to the BBS report, Bangladesh's poverty rate dropped to 18.7%, with the extreme poverty rate at 5.6%. Comparatively, the 2016 survey reported a higher poverty rate of 24.3% and an extreme poverty rate of 12.9%.

The World Bank also pointed out that Bangladesh's economy is expected to decelerate to 5.6% in FY24 from 5.8% in FY23 before returning gradually to its long-term trend above 6%, as elevated inflation will weigh on consumption.

At the same time, private investment will remain constrained by forex rationing, the report says.

"Policy reforms can help address these challenges to put Bangladesh back on track for faster growth"

Abdoulaye Seck, country director, World Bank's Bangladesh, and Bhutan office

High inflation will persist in Bangladesh in the current fiscal year as the bank predicted the rate to reach 9.6% in FY24 from 9% in the last fiscal year. The figure was 6.1% in FY22 and 5.6% in FY21.

Inequality is forecasted to remain stagnant. External sector pressure will ease gradually with resilient export growth, the report says.

The current account deficit is expected to narrow further in FY24 as import restrictions persist before widening over the medium term as policies normalise.

Remittance inflows are expected to rise underpinned by a higher outflow of workers and greater exchange rate flexibility.

The fiscal deficit is projected to stay below 5% of GDP over the medium term while nominal revenues will rise with increasing trade, improving domestic activity, and ongoing efforts to strengthen the tax administration.

It is projected that Bangladesh will see an increase in its revenues in the current fiscal year to 8.6% of GDP from 8.2% in FY23.

The report highlighted, "Downside risks to the growth outlook have increased, with a weak global outlook. The pace of monetary and exchange rate reforms may be insufficient, depleting FX reserves. Tighter liquidity could exacerbate banking vulnerabilities."

Fiscal risks include revenue underperformance, realisation of financial sector contingent liabilities, and monetisation of the deficit.

Meanwhile, Abdoulaye Seck, country director of the WB's Bangladesh, and Bhutan office, at the launch of the WB's latest Development Update for Bangladesh, said Bangladesh is facing several interrelated macroeconomic challenges such as persistent inflation, deficit in balance of payments and high interest rates, and tight liquidity conditions have contributed to longstanding vulnerabilities in the banking sector.

"Policy reforms can help address these challenges to put Bangladesh back on track for faster growth," said Abdoulaye Seck adding that this will require coordinated monetary and fiscal policies as well as measures to address financial sector vulnerabilities.

The Bangladesh Development Update also suggests policy adjustments to support a faster recovery. These include a more flexible market-clearing exchange rate that would rapidly attract foreign exchange inflows through the formal channels and help reduce the financial account deficit.

Economy is expected to remain stressed in the near term

Real GDP growth is anticipated to linger at 5.6% in FY24 trailing the 6.6% average seen in the decade prior to the Covid-19 outbreak. Persistent inflation is poised to hinder private consumption growth while energy and input shortages alongside escalating interest rates and financial sector fragilities are set to dampen investor confidence.

The next fiscal year is forecasted to maintain a relatively sluggish growth pace at 5.7% propelled by a modest rebound in private consumption buoyed by moderated inflation. The report emphasises that the resurgence in investment hinges on the effective execution of large-scale public projects.

The WB report sees a deceleration of both industrial and service sector growth. Industrial expansion moderated from 9.9% in FY22 to 8.4% in FY23 due to import constraints and energy shortages with the first half of FY24 witnessing a 3.7% year-on-year contraction in the index of industrial production.

Weak private consumption also slowed services growth from 6.3% in FY22 to 5.4% in FY23. Also, agricultural growth saw a modest rise from 3.1% to 3.4% in FY23, attributed to favourable weather conditions and higher market prices.

The report says even though political uncertainty has diminished with a new cabinet taking oath after the national elections held in January 2024, downside risks to the outlook are significant. Inadequate progress in monetary and exchange rate reforms may result in a further decline in foreign exchange reserves and persistent inflationary pressure.

Observations on the banking sector

Poor asset quality and the weak capital base of the banking system are hampering intermediation and monetary transmission. The gross NPL ratio stood at 9% in December 2023 compared to 8.2% in December 2022. The actual magnitude of the NPL problem is likely to be significantly higher due to the legacy of regulatory forbearance.

Capital adequacy of the banking system stood at just 11.1% in September 2023 with at least a dozen banks severely undercapitalised for years despite capital injections. Inadequate bank capital is a significant factor constraining private credit and investment, the report says.

Continued regulatory forbearance and weak credit risk assessment systems hamper the productive allocation of credit, thereby risking further deterioration in bank asset quality. Impaired bank balance sheets also prevent effective transmission of monetary policy as the incentives for weak banks to conduct intermediation in response to market signals remain limited.

On exchange rate

According to the report, exchange rate reforms are urgently needed to rebuild the external buffers. Gross foreign exchange reserves have declined sharply over the past year, reaching $20.8 billion in February 2024. Implementing a sustainable exchange rate policy is key to stemming the significant depletion of foreign exchange reserves and restoring market confidence.

From January to June 2024, the Bangladesh Bank indicated it is considering adopting a crawling peg system, which would need to be a market-clearing exchange rate mechanism that reduces the gap between the formal and informal exchange rates. This would help rebuild external buffers by attracting remittances through formal channels. The reform would also help ensure sufficient foreign exchange liquidity essential for fulfilling debt service and other external payment commitments.

Other downside risks

Inadequate supply of natural gas during the peak season and inability to import sufficient LNG due to foreign exchange shortages can disrupt industrial production and investment. Unforeseen natural disasters have the potential to disrupt food production and escalate food inflation thus keeping inflation higher than projected in the medium term.

Other fiscal risks include underperformance in revenue collection, realisation of contingent liabilities arising from vulnerabilities in the financial sector, and increased monetisation of the fiscal deficit.

Policy flaws lead to over Tk1 lakh crore VAT shortfall

Bangladesh heavily relies on indirect taxes for tax revenue, with Value Added Tax (VAT) as a significant contributor. However, a VAT gap analysis conducted for FY19 by the World Bank reveals substantial potential for revenue collection if policy and compliance issues are addressed.

The analysis defines the VAT gap as the difference between potential and actual VAT revenue. In FY19, this gap was estimated at over Tk2 lakh crore, more than double the actual VAT revenue. Policy choices are primarily responsible for this gap, accounting for a policy gap of Tk1.30 lakh crore.

These findings were disclosed in the World Bank's "Bangladesh Development Update" report, released on Tuesday. The report, with a particular focus on strengthening domestic resource mobilisation, underscores the need to address policy and compliance shortcomings.

A sectoral breakdown highlights manufacturing and agriculture as major contributors to the policy gap. While exemptions and reduced rates aim to safeguard the interests of the poor, their effectiveness in Bangladesh remains uncertain.

Comparative analysis with other countries suggests that Bangladesh's compliance gap is relatively significant. Only about one-third of tax identification holders pay income taxes, resulting in considerably lower revenue from direct taxes compared to similar nations.

The WB also said Bangladesh's performance in generating income tax revenue relative to GDP, especially in corporate income taxes, falls short. The report states that addressing these challenges is imperative to bolster revenue collection and achieve fiscal stability.