A good record of implementing first generation reforms - macro stability and domestic deregulation in particular - has facilitated good economic growth. The Government recognises the need to now deepen the structural reforms programme to sustain and accelerate growth performance; in particular by deepening trade liberalisation and further strengthening the sectoral and cross-sectoral underpinnings of the investment climate.
Ensuring continued macroeconomic stability: The Government's medium-term macroeconomic framework commits to fiscal and monetary prudence and deepening structural reforms. The framework envisages acceleration in gross domestic product (GDP) growth from 5.4 per cent in FY05 to 6.5 per cent in FY06 and 7.0 per cent in FY08. Such faster growth would require a significantly higher level of investment and more efficient investment decisions than in the past. Achievement of these, in turn, assumes acceleration in the pace of structural reforms to tackle supply-side bottlenecks.
Fiscal policy aims to finance social development and key public investment while containing the deficit and maintaining debt sustainability. The Government's success in containing the central government deficit at around 3.5 per cent of GDP partly through curbs on wasteful expenditures, coupled with greater reliance on concessional external financing, has improved the prospects for fiscal sustainability. A relatively high 60 per cent of total expenditure is on infrastructure, education, health, social safety nets and rural development. In contrast, defence expenditure remains lower than most of the region. Interest payments on government debt have stabilized at less than 2.0 per cent of GDP. The level of public expenditure, however, at nearly 14 per cent of GDP, remains low by global standards, reflecting weak revenues and low implementation capacity (tax and revenue collection rates remain among the lowest in the world, at 8.0 and 10 per cent of GDP respectively). The quality of expenditures at the project level remains a concern.
Public debt is currently sustainable although concerns are emerging. Public sector debt, including contingent liabilities, is manageable at about 60 per cent of GDP, more than half of it on concessional terms from external official creditors. Longer-term risks to sustainability, however, arise mainly from weak revenues and escalating energy SOE losses.
Reducing opportunities for corruption by reducing and streamlining trade restrictions: Trade liberalisation has been advanced, with a reduction in customs duties and near-elimination of trade-related quantitative restrictions, although expanded use of para tariffs partly offset this. The average rate of customs duty was lowered from 21 per cent in FY01 to 15.4 per cent in the FY06 budget, and the top rate was lowered from 37.5 per cent to 25 per cent. The number of non-zero customs tariff rates was reduced from four to three. This progress, however, was partly offset by an increase in the protective incidence of para tariffs which now account for about 40 per cent of total protection, compared to only 12 per cent in the mid-1990s. The net result has been a reduction in average nominal protection from 29.4 per cent in FY02 to 26.5 per cent in FY05. Substantial progress has been made with removing quantitative restrictions (QRs). The number of items subject to QRs was reduced from 122 in FY01 to 15 in the FY06 budget, and all but three trade-related QRs were eliminated. Removal of longstanding ban on a wide range of textile imports has been particularly important.
The remaining trade liberalization agenda is substantial. Despite significant trade liberalization in the 1990s, Bangladesh still has the highest level of trade protection in South Asia and among the highest amongst developing countries as a whole. High tariffs and duties on imported inputs discourage export diversification and constrain growth. A cumbersome and inefficient duty drawback system for non-garment manufacturers seeking to reclaim duties paid on imported inputs for export hinders their competitiveness. So, stronger efforts to accelerate liberalization of the economy are essential to achieve the government's growth goals set out in the PRSP. A pre-announced programme of reductions in customs duties and, especially, para-tariffs to bring Bangladesh in line with the developing country average within five years would give industry a clear signal and allow companies to plan their investments.
Streamlining and reducing scope for discretion in the regulatory environment: A number of measures have been initiated to streamline the domestic regulatory environment and reduce the scope for corruption arising from it. Regulatory reforms have involved streamlining of process related to customs and port clearance, investment facilitation, land registration, utility regulation, and the financial sector. Specifically:
l Customs and port clearance: A noteworthy step has been the introduction of the ASYCUDA++ system, involving electronic processing and tracking of files. Further, a one-stop service was recently introduced at the Chittagong port to facilitate port and customs related paperwork, thereby shortening the time taken for clearing and also improving the turn around time for ships.
l Investment facilitation: The Board of Investment has introduced e-government processes that allow on-line tracking of various approval requests. Business registration process has been streamlined and further progress would come from automation at the Registrar of Joint Stock Companies, work on which has already started with support from International Finance Corporation's (IFC's) South Asia Enterprise Development Facility (SEDF) and AusAID.
l Land registration. A Land Registration Act came into force from July 01, 2005. This will help reduce the scope for false and multiple registration of land. A pilot project to computerize land records has been initiated in the Demra thana of Dhaka district. This project aims at simplifying the title deed requirements, putting the title, the location of the land, and map on a single page with all other documents in a back-up data base. This follows the completion of the survey of greater Dhaka by the Land Department.
l Utility regulation. The Bangladesh Telecom Regulatory Commission (BTRC) has been set up, leading to rapid growth in the private telephone sector. The Energy Regulatory Commission was recently been set up and has now starting to become functional.
Improving financial sector accountability, transparency, and performance: Improved governance of the financial sector, including continued restraints on lending, strengthened loan recovery efforts and tighter supervision have reduced the market share of nationalised commercial banks (NCBs) and given a greater role to private banks. Memoranda of Understandings (MOUs) between Bangladesh Bank and the four NCBs have set a ceiling of 5.0 per cent on annual growth in lending, put a limit on single borrower exposure to 5.0 per cent of paid-up capital of each bank, and set monitorable targets on cash recoveries and cost reductions. The MOUs are to be extended beyond 2005 for Agrani and Janata banks and until divestment for Sonali bank. The net result has been a reduction in the NCBs' share of total bank assets from 54 per cent in 1998 to 40 per cent by FY04. Their non-performing loans, net of provisions and collateral, fell from 27 per cent in FY98 to 18 per cent by end - FY04. Private banks have strengthened considerably their financial positions and are steadily increasing their share of the market. Net non-performing loans (NPLs) of private banks fell from 16 per cent in 1998 to less than 3.0 per cent by end-FY04. Indeed, NPLs nearly halved as a per centage of GDP from 2000 to 2004.
Bangladesh Bank's regulatory powers have been further strengthened. Bangladesh Bank has continued to align its prudential norms more closely with international standards and enforce these more strictly. Its capacity to carry out its regulatory authority is being strengthened under the Bank's Central Bank Strengthening project. NCBs and development banks were brought under Bangladesh Bank supervision in FY03. The minimum risk-weighted capital adequacy requirement for banks was increased from 8.0 per cent to 9.0 per cent and the minimum capital requirement increased from Tk 400 million to Tk 1.0 billion (US$17 million). At the same time, limitations on dividend payout were tightened and special audits based on IAS were conducted for all NCBs. In March 2005, Bangladesh Bank tightened loan classification with the introduction of a "Special Mention" category for loans overdue by 90 days or more but less than 180 days. Banks will not be allowed to accrue interest into their income on such loans and will have to make general provisions against them. The exposure limit for private banks for a single borrower has been reduced from 50 per cent of a bank's capital to 35 per cent.
Bangladesh Bank has also introduced measures to improve banks' corporate governance. These include: (i) tightening "Fit and Proper" tests for bank Chief Executive Officers (CEOs) and introducing these for bank directors; (ii) making it mandatory for banks to have independent directors represent the interests of depositors; (iii) limiting the maximum number of directors for a bank to 13; (iv) limiting directorship of banks to two consecutive terms of three years each; (v) allowing only one director from each shareholding family; (vi) requiring the establishment of an independent Audit Committee of each bank's board to assist in financial reporting, audit, and internal control; and (vii) requiring significantly enhanced annual financial disclosures including publication of audited financial statements in newspapers and ensuring their availability for public view in bank branches. Risk management guidelines covering credit, market and operational risks have been introduced.
Bangladesh Bank has enforced its prudential regulations more strictly. Some 65 bank directors and chairmen have lost their directorships for loan default, insider lending and other violations. Five managing directors of banks have been removed since 2000 for allowing their banks to be engaged in irregular or illegal transactions. The guidelines on early warning system and problem bank categories have been strengthened, followed by the institutionalization of a Systems Audit of banks with a risk rating (viz., core risk areas) after completion of an inspection. Bangladesh Bank has also initiated audit of IT transactions and IT security for banks, and 25 banks have been audited so far.
The government is in the process of strengthening the NCBs' management with the aim of improving their operational performance, and preparing them for divestment. Management team and experts funded under the World Bank's Enterprise Growth and Bank Modernization project are supporting the restructuring and corporatization of three NCBs - Agrani, Janata and Sonali - before they are divested. Rupali Bank has been brought to the point of divestment. A key part of the strategy for resolving NCBs is that they should restructure their operations, including credit allocation, cost controls, branch closures and staff rationalization. Progress on these fronts has been slow. (This is the fifth instalment of a report -- Bangladesh Poverty Reduction Strategy Paper Forum Economic Update: Recent Developments and Future Perspectives -- prepared by the World Bank that the FE is publishing in a serialised form. The fourth instalment of the report was published on January 22)