The news of LDC graduation has often been accompanied by warnings as economists urged the government to prepare for a seamless transition into a developing economy. Bangladesh first met the criteria for graduation back in 2015 and since then LDC graduation had become a mainstay of public discourse.
Many hoped that by this point, Bangladesh would have been well on its way to shock-proofing its economy against preference erosion in the international market and increased competition from other developing economies like Vietnam.
As it stands, however, Bangladesh appears to be one of the worst-performing graduating economies in terms of revenue collection, foreign direct investment, and exports of goods and services, a recent report from the International Monetary Funds states.
According to the report, exports in Bangladesh remain highly concentrated – 80% of which come from the Ready-Made Garments (RMG) industry. The inflow of remittances – one of the major sources of foreign currency in Bangladesh – will also likely dwindle in the coming years as Bangladesh morphs into a developing economy.
The Business Standard spoke to Dr Ahsan H Mansur, the Executive Director of Policy Research Institute, to explore the bottlenecks preventing sustainable development and how we can ensure a smooth transition of Bangladesh into a developing economy.
Bangladesh's tax to GDP ratio remains very low, and many experts, including you, have warned that such low rates will create significant problems in the future. Could you elaborate on the kind of problems, especially keeping the coming LDC graduation in view?
The tax-to-GDP ratio in Bangladesh is one of the lowest in the world. No country can sustain economic growth for long with such a low tax-to-GDP ratio. Even when you include non-tax revenue, the ratio jumps only up to 10-11%.
As a result, the Government of Bangladesh is unable to increase in size. The current condition of the healthcare system, especially the public healthcare system, as well as the education system in Bangladesh, is far from satisfactory.
Unfortunately, the current size of the government is too small to adequately invest in social security, universal pension fund, education, health care and infrastructure development - all of which would be required for the country to become an upper-middle-income country.
Secondly, as the economy grows, so do the aggregate demand and expectations of the consumers. The government is also working towards fulfilling those expectations. Their expenses are rising as they are undertaking massive development projects. But most of these are financed by taking out loans. Consequently, the interest rates payable on these loans are also increasing at a faster rate.
Another unavoidable aspect of running a government is incurring administrative costs, i.e., the cost of running offices, paying the salaries of government employees, paying for conveyances etc. These costs are increasing over time as well. An increasing number of government employees are retiring, and this number will only rise in the future with more employees retiring.
Then comes the pressure of subsidies. Although currently, the government provides approximately Tk50,000-60,000 crores in subsidies, it will increase in the coming days and may even reach up to Tk100,000 crores. Financing these expenses might become quite difficult for the government.
The amount of funds left after paying for essential expenses like the salary of government employees, interest payments etc., is usually allotted to the annual development programme (ADP).
In the last budget, the size of ADP was Tk2,06,000 crores, while the budget deficit was Tk2,18,000, implying that the government had to fund all of its development projects through loans. These are alarming signs as the government has no savings. This also raises questions regarding the sustainability of Bangladesh's economic development, and the government must consider the reformation of its fiscal management and tax collection system.
We have known about LDC graduation since 2015. Given that, why does the tax collection remain so poor in Bangladesh? Is this a sign of institutional failure? Are there discretionary forces at work?
As of now, the government is yet to make any visible effort to introduce economic reforms in the country and revenue collection is no different. In the context of LDC graduation, the protection level on trade has to be decreased to encourage increased exports. But this will further decrease revenues for the government.
To counteract this, the GOB will have to increase its earnings from internal revenue. For example, at present, Bangladesh is heavily dependent on trade for revenue compared to other countries. The average protection rate for Bangladesh at this moment is approximately 27%. For developed countries, this rate is only 1-1.5%. For India and China, the average protection rate is 9%, while for the ASEAN countries, it is only 4.5%.
Now without lifting protections, it is unlikely that exports will rise significantly. But decreasing the protection rate will decrease revenue. The government seems to have no plan to undertake policies that would increase domestic revenue collection and counteract this potential dip in revenue.
Then we are also supposed to have signed trade deals with other countries. Although there have been discussions regarding this, no significant progress has been made. One reason behind this is the domestic business leaders who enjoy protection from foreign competition. Naturally, they lobby against the relaxation of tariff protection.
But potential trade partners will also expect Bangladesh to ease all tariff and non-tariff barriers so that their products can enter the Bangladesh market with ease. However, if Bangladesh maintains such high tariff rates, no country will be interested in signing treaties with Bangladesh. I doubt whether Bangladesh will even be able to stay in the WTO for long if we continue down this road.
The trade to GDP ratio (except for 2018) has been declining for the past decade. It's been 5-7 years since we learned about LDC graduation. Why is Bangladesh still lagging? Can it all be blamed on Covid-19, or are there other factors at play?
No, only a fraction of it can be explained by Covid-19. Over the past decade, both exports to GDP ratio as well as remittances to GDP ratio have been steadily declining. The Covid-19 pandemic only made it worse. Most of it has to do with our internal policies. If we want to become an export-oriented economy, exports must rise at a rate higher than that of GDP. Still, we do not see necessary steps being taken to increase exports of goods and services substantially.
Exports in Bangladesh remain highly centralised. Why are we still unable to decentralise and diversify our exports?
Except for resource-rich countries like Saudi Arabia, no other developed or developing nations have such a highly concentrated export basket. We should have been able to diversify our exports by this point. Unfortunately, we have failed to do so. Looking forward, I would mainly recommend expanding the benefits provided to the RMG industry to other export-oriented industries as well. Central warehouse facilities should be provided, especially for smaller exporters unable to get back-to-back LC (Letter of Credit).
The Foreign Direct Investment (FDI) inflow (% of GDP) has been declining for the past decade. Despite building high-tech parks and special economic zones, the FDI inflow to Bangladesh remains low. Why is this happening, and what would be your recommendation?
The bureaucratic system is primarily responsible for the low FDI inflow. Investors - local or foreign - are harassed by the bureaucrats. Even though the senior bureaucrats display an investment-friendly attitude, they are rarely the ones operating on the field.
The ones in the field do not understand client relationships. To them, a new client is merely a new opportunity for corruption and extortion. The existing tax administration has also failed to create a hospitable environment for investors. Bangladesh has a serious perception problem, which is the reason behind the low FDI inflow that is even lower than Pakistan.
Could Bangladesh fall into a debt trap like Sri Lanka or a middle-income trap like Argentina?
I would say we have to be cautious and selective in choosing development projects. We cannot finance each and every one of our projects through loans. We need to prioritise projects that yield higher returns and postpone low-priority projects with potentially low returns on investment. The choice of development projects should be driven by data analysis and evidence as well as consultation with relevant stakeholders.
Although undertaking arbitrary development projects may be eye-catching, their exposure to corruption is also higher. And high exposure to corruption is often accompanied by inadequate returns. For instance, the return on investment for setting up rail lines on the Padma Bridge is low compared to building roads that connect two disjointed parts of the country. Most development projects are undertaken without considering the potential return, and continuing on this path may expose the economy to external shocks.
Do you have any particular policy recommendations for improving the tax-to-GDP ratio?
Firstly, tax policy should be separated from tax collection. That is, the National Board of Revenue (NBR) should no longer be in charge of tax policy. Instead, another division should be created under the Ministry of Finance. Those in charge of tax policy should be the ones actually informed in tax policy literature and their potential impact on the economy.
They should base their decisions on the movements of macroeconomic indicators over the year and adjust the tax policy accordingly. The NBR is mainly a tax administrator. They should not be in charge of formulating tax policy. The NBR should only be in charge of tax collection in the new framework.
Secondly, the automation process in tax collection remains half-baked. You can only submit the form online, but then you have to physically go to the tax office for the remainder of the procedure. Either way, you still have to go through the hassle of paying your taxes. They are not allowing the entire system to be automated for some reason.
Finally, the tax office and the organisations paying taxes should not be situated in the same place. There should be some distance between the organisations. That is, the tax administrator and taxpayers should never meet in person because it exposes both of them to corruption. If someone pays taxes in Dhaka, it should be processed somewhere like Khulna and vice-versa.