Report No. 2^9i-BD AUv 2 bIif \A

issues ancd Prospects for industriai Development(in Two Volumes)

v ' :ji.I I IM i. Ii c lail I IXC:[JJI L

December 5,1978

Inuustrial Development anu Financ:e DivbIUIo

South Asia Projects

FOR OFFICIAL USE ONILY

EDocument of the World Bank

This document has a restricted distribution and may be used by recipientson!y in the performance of their official duties. Its contents may nototherwise be disclosed without World Bank authorization.

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

CURRENCY EQUIVALENTS

Prior to 1972

US$ = Pakistan Rs 4.762Rsl = US$0.21Rs 1,000,000 = US$210,000

Average 1972 - May 1975

US$1 = Tk 8.0

Tk 1 = US$0.125Tk 1,000,000 = US$125,000

The Bangladesh Taka is officially valued at 29.525 to the

Pound Sterling. The Pound now floats relative to the US Dollarand consequently the Taka/US Dollar rate is subject to change

(as of November 30, 1978, US$1 = Tk 15.1). The rate below hasbeen eidaa f-hvrnougchot tih isi rpnnrt.

US$1 = Tk 15.0

Tk 1 = US$0.067Tk 1,000n000 = USS66-667

FISCA.T YE.AR (FwV

July 1 through June 30

(e.g. FY78 = July 1, 1977 through June 30, 1978)

This report was prepared by a mission consisting of David Williams (Chief),

Bernard Decaux (Consultant), Nissim Ezekiel, Fred King, Walter Oettinger

(Consultant) and Sang Mok Suh. The mission visited Bangladesh from March 15

to April 5, 1978.

FOR OFFICIAL USE ONLY

LIST OF PRINCIPAL ACRONYMS

BBSC BangladAesh Bureau of StatisticsA"U A.ULQU- L J.. A. &UA J ULV L £ L&*~a

BCIC Bangladesh Chemical Industries Corporationn 1DLLL1 LI LI FLLLL1UL1 1U £1DOWC Bang'ladesh S;tee'l and Engineer,ng.L1 CorLporationV

BFIDC Bangladesh Forest Industries Development CorporationBJMC Bangladesh Jute Mills CorporationBMDC Bangladesh Management Development CenterBMEDC Bangladesh Mineral Expioration and Development CorporationBSFIC Bangladesh Sugar and Food Industries CorporationBTM4C Bangladesh Textile Mil1s uorporationBSB Bangladesh Shilpa BankBSCIC Bangladesh Small and Cottage Industries CorporationBSRS Bangladesh Shilpa Rin SangsthaCFTC Commonwealth Fund for Technical CooperationCMI Census of Manufacturing IndustriesDRC Domestic Resource CostsECNEC Economic Committee of the National Economic CouncilECU Export Coordination UnitEPAC Export Promotion Advisory CommitteesEPB Export Promotion BureauEPC Export Promotion CouncilEPIDC East Pakistan Industrial Development CorporationEPZ Export Processing ZoneGOB Government of BangladeshIACB Investment Advisory Center of BangladeshIBA Institute of Buasiness AdministrationICB Investment Corporation of BangladeshIDA International 'Development AssociationITC International Trade CenterSBC Sadharan Bima CorporationUNDP United Nations Development ProgrammeUNIDO United Nations Industrial Development OrganizationXPL Export Performance License

This document has a restricted distribution and may be used by recipients only in the performanceof their omcial duties. Its contents may not otherwise be disclosed without World Bank authorization. |

RANrjT.Anrg: TFIWllS ANTI PROSPECTS FOR INDUSTRTAL DEVELOPMENT

VOLUME 1: THE MAIN REPORT

'1' AnTT V i Ar. CAMT'CMKTC

Page No.

PREFACL ....... - ii

CHAPTER 1: INDUSTRIAL STRUCTURE AND GROWTH ................. i

Industrial Growth ...... .........................Investment and Capital ....... .................... 2Employment and Labor Productivity .... ........... 3Capacity Utilization ..... ....................... 4Structural Change ...... ......................... 4Small and Cottage Industries .................... 6

CHAPTER 2: THE INDIJSTRIAL POLICY FRAMEWORK .... .............. 7

A. The Evolution of Industrial Policy ... ...... 7B. The Present Climate ..... ................... 8C. Improving the Present Policy Framework ..... 12

(a) Controls .............................. 13

Import Controls ....................... 13The Investment Schedule .... ........... 14Limit on Investment .... ............... 15Allocation of Public and Private

Sector Activity .... ................. 16Investment Approval Procedures ... ..... 17

(b,} Instruments ........................... 18

Customs Duties ........................ 18Taxes and Tncenti ---- 19

Foreign Investment Policy .20Industrial Financing .9.2............ . . . 2

wuAn'rr:n 'I. TUt' OTTUTTO TUNnTTCTPTAI 1CT1P 31tuALZIL .LLiXx v. *LLLJ it' JvvJfv . ) .__

A. Background and PEbrformance ................. Z 31Background .31Physical Perform,,ance .32Financial Performance .33Eooi - E -C IflCUIIUliC Dii LLtL........... 35

-2-

TABLE OF CONTENTS (Cont'd)

Page No.

B. Major Issues ....... ........................ 39

Performance Criteria .... .............. 39Organization ..... ..................... 39Management ...... ...................... 41Labor ................................. 42Training ...... ........................ 43Pricingy Policies and Financial

Structure ...... ..................... 46niscinuvestment- .=a azztze - - - - -. ..................... 47Rehabilitation of Existing Equipment 48Conclusions ........................... 49

r'UIADTIiD A. . YVDADT nlIl71;T ADM5'r;NT R1VX L ~X . LI- =\s /v S ss^ .. .. .. ................. .................. .

A. Export, Stlructure and Rvecent Trends ..... 51B. Present Export Incentives and

Tnstitutional Framework 53LL L.LUt-L.UJA. L rL .. .. W... .. ..

Export Incentives .53nstLtutLonLaL r1ramewor.. 'orExport Promotion .58

C. Dimensions of a Naew XportL SLraLegy .6

The Role of Exports .60Pre-conditions for Success .6Export Incentives .62Institutional Framework .63Technical Assistance by IDA .64

CHAPTER 5: CONCLUSIONS AND RECOMMENDATIONS .76

Introduction and Summary .76Towards an Industrial Strategy .79

PREIFACE

i. GOB is redefining its approach to industrial development in orderto obtain a greater contribution from industry to general development. Acentral objective of the new .approach is to increase participation in industryby private investors. Important changes have been introduced in policiesand institutions affecting both the private and public sectors. The responsefrom private investors has been positive, but somewhat less rapid than washoped; the response of the public sector has been limited by its burden ofstructural problems. So far, general industrial objectives have been identi-fied, the new direction of desirable development has been indicated, and someprogress is evident; but there are both long and short term problems to betackled.

ii. Many choices in industrial development are pre-empted by the limitedresources of Bangladesh and by the tangible and intangible legacies of pastpolicies. The industrial sector is dominated by, and the country is dependenton, the production and axport of jute goods by an industry which has yet torealize its potential comparative advantage. Other state enterprises, estab-lished for the purpose of sunnlving a larger internal market, are strugglingwith excess capacity and low efficiency. Bureaucratic controls, policies andattitudes aimed at restricting the private sector still shape part of thepolicy framework. Ongoing projects - some of them 10 years old -. still makeun a large fraction of planned industrial investment. Industrial an' mana-gerial skills are scarce; and knowledge and information necessary to diversifyand develop the indu-strial sector are not widely available.

This does not mean that there are no choices in industrial develop-ment. It means that choices are difficult to identify and must be consideredcarefully. Greater reliance on private investment and market rorces indetermining industrial efficiency alone will not be sufficient to transformhe industria' sector oi- Barngladeshi. "ere is too much uncertainty among

businessmen; there is a lack of knowledge of alternatives and opportunities;there is a lack of appr ciation of the nature of some of the current problemsin the public sector and a consequent unreality in formulating policies andplanning.

iv. Inew approac[ to industrial policy making is needed. GOB hasacknowledged this need by preparing a Two-Year Plan which, in effect, is aperiod of preparation for the Five-Year Plan, i980-85. This pause gives timefor the work of determining development options in general and for consideringspecific strategies in industry. if this opportunity is exploited GOB couldmove towards an industrialization program, together with a policy framework,which directs industrial activity into a pattern more consistent with achiev-ing national goals within the constraints confronting Bangladesh.

v. While formulation of a specific industrial strategy is important,it is clear that industrial development in Bangladesh must be based on a morediverse and more efficient industrial sector. There are three areas in whichproblems affecting efficiency and diversification can be attacked immediately:

policy towards private industry; policy towards public enterprises; and export

development policy. Much of this report is devoted to analysis and recommend-

ation in these areas. Chapter I contains a brief examination of industrial

structure and growth, Chapters 2, 3 and 4 address issues in the areas of

private industry, public enterprises and exports, respectively. Chapter 5

combines a summary of the conclusions and recommendations of preceding

chapters with a brief examination of the issue of formulating an industrial

strategy for Bangladesh.

CHAPTER 1: INDUSTRIAL STRUCTURE AND GROWTH

Industr,ial Growth 1/

1.01 Before the partition of India, East Bengal was an agriculturai areasupplying first indigo and then jute and rice for the industries and people ofCalcutta. At artitioa, on-ly 4% of' East Pakistan's GDP came from industry andonly 1/2% from medium and large scale industry. After partition, when Indiareceived most of the inidustrialized areas, Pakistan undertook a strong programof industrialization. From 1950 to 1970 large and medium scale industrialoutput for all rakistani grew by almost 15% a year, compared to an overall GDPgrowth of about 3.5% per annum. However, this growth was concentrated in thewestern wing and few industries developed in the East. During the war thatled to Bangladesh's independence, many of the physical assets of the industriesin East Pakistan 2/ were damaged or destroyed and many managers and owners whowere West Pakistanis left the country. Despite erratic fluctuations duringthe six years since independence, production has slowly returned to pre-warlevels. Industry now produces around 8% of GDP (Annex Table 1.1).

Table 1.1: INDEX OF INDUSTRIAL VALUE ADDED(FY70 = 100)

FY63 FY66 FY70 FY73 FY74 FY75 FY76 FY77

58 76 100 81 95 86 94 100

Source: Annex I, Table I.2.

1.02 Industrial production grew at a rate of 8% Der annum in East Pakistanduring the 1960s, but fell sharply immediately after independence due to thesevere shortage of foreign exchange to import raw materials, as well as phy-sical disruptions caused during the war and the loss of managers, owners and

1/ Despite the efforts of the Government and especiallv the Butreau ofStatistics, the data base in Bangladesh is weak and this is especiallytrue for investment and capital figures in the industrial sector. Themain source of information for this sector is the annual Census of Manu-facturing Industries (CMI). The Census is mailed for self-enumerationto all registered Eactories, employing more than 10 persons on any dayduring the precedlnag vear, and engaged in a manufacturing process. Thisleads to differences in the quality of response received and also hasled to a resnonse ratio onf only 50-60% of those questionnaires sentout. However, most: of the medium and larger factories respond and itis believed that the census probably covers 80-90% of industrial output.The Bureau of Statistics has adjusted the values for the years since1974/75 to account for non-response, but has not yet done so for previousyears.

2/ GOB estimates that industrial assets worth more than Tk 290 millionwere dLestroyedu during thle war.

West Pakistan markets. The index of overall industrial production in FY73 waslower than the FY70 level by 19%, and has only recently returned to the pre-warlevel. During this post-independence stagnation in industrial production,population increased from 70 million to 83 million.

1.03 Table 1.2 sets out a summary of the major industrial variables forthe years FY60, FY70 and FY76 (the most recent year for which detailed dataare available). Generally speaking, the 1960s were a period of impressivegrowth in the industrial sector with capital, labor and output all expanding.In contrast, the 1970's have seen virtual stagnation in output despite in-creases in the capital and labor stocks with a resulting decline in produc-tivity of the factors of production. More detailed data are given in thetables in Annex I, and the difierent variables are discussed in detail below.

Table 1.2: SUMMARY OF TRENDS IN MANUFACTURING

FY60 FY70 Ratio FY76 RatioFY70/FY60 FY76/FY70

Value Added (Constant FY70 Prices: 548 1,534 2.80 1,436 .94Tk million)

Employment (Thousands) 139 204 1.47 374 1.85

Capital (Constant FY70 Prices: 605 1,875 3.10 2,902 1.55Tk million)

Capital/Output 1.1 1.2 1.09 2.1 1.75Capital/Labor (Tk) 4,353 9,164 2.11 7,760 .85Output/Worker (Constant FY70 Prices: Tk) 3,934 7,486 1.90 3,830 .51Labor Cost as Share of Value Added .38 .24 .63 .345 1.44Average Real Wage (FY70 Tk/yr) 1,480 1,798 1.21 1,320 .73Return on Investment (ConstantPrices) 57% 62% 1.09 32% .52

Index of Total Productivity 100 114 1.14 65.7 .576

Source: Annexes I.4 - I.8.

Investment and Capital 1/

1.04 A relatively high level of investment in manufacturing has beena continuous feature of policy by Government since partition, though aggregateinvestment was very low in East Pakistan and lower in Bangladesh. The manu-facturing sector has received about 25% of the total investment in the economyin both East Pakistan and Bangladesh, a much higher percentage than its share

1/ The CMI does not give a capital stock series, but rather a "value offixed assets" is given which is the book value of land, machinery,equipment and buildings. Since this value ignores price changes itwas necessary to derive a current and constant price series for capitalstock. The methodology used is described in Annex 1.14.

- 3-

of outDut. Capital formation was encouraged with abundan.t Government finance,low interest rates and an overvalued exchange rate. Duties on capital goodswere traditionallv lower than on other goods= After independence, industrykept its share of total investment, but the real value fell to less than 70%of the value of the late 19 6 0's.

Table 1.3: FIXED CAPITAL INVESTMENT IN MAAMUUFACTURING

(FY70 Constant prices)

FY64 FY66 FY68 FY73 FY74 FY75 FY76 FY77

Tk million 383 418 718 358 375 259 363 394I of Tr otal ITnves tment) 22L IC 28 26 25 23 26 n.a.

)ource: Annex Tdale I 3.

1.0V The proportionately high levels of investment in manufacturingraised the capital stock rapidly, especially in the first half of the 1960's(Annex Table I.4). Nonetheless, the capital output ratio remained very steadythroughout this decade at between 1.[ and 1.6, a level that compares favorablywith other nations. 1/ The capital-labor ratio increased in real terms byover 100% in the 19 6 0's. After independence, the capital-output ratio in-creased greatly reflecting shortages of raw materials and other inputs andincreased inefficiency in the industrial sector rather than any decrease inthe marginal output of capital due to increased capital intensity. 2/ Simi-larly, the large drops in the gross rate of return on capital are probablydue more to inefficiency and lack of needed inputs than to capital saturation.Still, the sharp drop in the rate of return may have reduced the rate of in-vestment from retained earnings, and discouraged new investors in the indus-trial sector.

Employment and Labor Productivity

1.06 The number of workers in industries covered by the CMI was increasingthroughout the 1960's. At the same time the value added per worker increasedby more than 90%. Labor costs as a percentage of value added fell from 38%in 1960 to only 24% by the end of the decade, and the average real wage perworker increased by over 20%. The picture changed completely after independ-ence with a sharp rise in the percentage of value-added going to labor, aslight drop in the average real wage and a sharp decline of value added Derworker to the level of 1960. Since the real capital-labor ratio does not seemto have fallen greatly during the 1970's, it appears that decreased laborefficiency and foreign exchange shortages led to the lower productivity oflabor: many of the pubLic sector corporations apDear to be overstaffed withworkers hired more for social than productive reasons.

1/ For example, in the 19 6 0's Tanzania's ratio ranged from 1.6-2.0, andIndia's 3.0-3.7 wh:ile Sri Lanka's in 1974 was more than 2.0.

2/ This is borne out by attempts to calculate incremental capital-outputratios (ICOR) for the years 1973 through 1976 which yield very lowvalues of 1.0 and 1.1 suggesting that capital is not the major con-straint to output.

- 4 -

1.07 This fall in overall industrial productivity is one of the importantproblems facing Bangladesh. While employment and capital have both increasedby more than 80% and 50%, respectively, value added is less than it was inFY70. There has been a large increase in the capital-output ratio and a sharpfall in the output per worker. As a result both the average real wage and therate of return on capital have fallen and an index of total productivity 1!(value added per unit of capital and labor) after remaining constant throughthe 1960's has fallen by almost 50%, an enormous drop. Similarly, value addedas a share of total output in the industrial sector (Annex Table 1.8) hasfallen from 44% to 32%. This is due to increased inefficiency in the sectorand could also reflect the inability of many industries to pass on raw mate-rial cost increases due to Government price controls. 2/

Capacity Utilization

1.08 Government policies (discussed in Chapter 2) of the 1950's and1960's encouraged the creation of excess capacity. After independence, theWest Pakistan market was lost and some industries faced the problem of evenmore excess capacity. As a result, capacity utilization has always been lowin many industries (Annex Table I.9). After being at a level of 70% in FY70,the average capacity utilization in major industrial sectors fell to 49% inFY73 and then rose slowly to reach 61% by FY77. It has consistently been aGovernment goal to increase the rate of capacity utilization and it seems tohave been successful in slowly bringing the country back towards the pre-independence levels.

Structural Change

1.09 After partition, there was almost no large or medium scale industryin East Pakistan except for some cotton textile mills. During the 1950's and1960's, there was a large shift within the sector towards large scale produc-tion and growth was concentrated on the textile (jute and cotton) and the food,beverage and tobacco subsector;. By FY70 they accounted for over two-thirdsof industrial production. The jute industry grew to process the raw jute whichwas the major crop of the region and the consumer goods industries grew underthe Government's policy of favoring import substitution. Before partition,the jute of East Bengal was processed in Calcutta. After partition when tradewith India declined, East Pakistan developed its own processing industry whileIndia began to cultivate its own jute.

1/ This is calculated by comparing the weighted average of the increasesin capital and labor with the increase in production. The weights arethe shares of labor and capital in output in the base yeear, here FY70.

2/ Preliminary data for FY77 and FY78 suggest that the situation is now

improving in some firms in the public sector.

- 5 -

Table 1.4: STRUCTURE OF VALUE ADDED, EMPLOYMENT AND GROSS OUTPUT /a(percentage)

Value Added Employment Gross OutputFY70 FY76 FY70 FY76 FY70 FY76

A. Consumer Goods 33.8 39.0 19.4 18.0 34.7 26.2

B. Intermediate Goods 57.6 50.7 75.0 73.3 52.6 60.5Textile (jute and

cotton) 44.4 32.1 64.0 60.6 38.1 31.2

C. Canital Goods 6.n 9.5 4a5 7.9 7-7 19.1

D= Others A. 0 .9 1. 0.9 ZL. 1Q.

Total 100.0 1000 100.0 100.0 100.0 100.0

/a Data on the split: between public and private enterprise is not avail-au le forL Lth LWLo years e xAamlineIU HIUWeVeL, thiIe sIfIti LtoU pUUbi.L UWII=L-

ship is the single most important change in the period.

Source: Annex Tables I.10 and I.11.

1.10 The jute and cotton textiLe industries were the first to be developedin the then East Pakistan and even by FY70 they still produced more than 44%of the value-added in the organized industrial sector. By FY76 they accountedfor less than one-third of total output and capital goods had increased theirshare by more than 5074 from 6% of the total to more than 9%. However, some ofthis change may also be due to relative price changes, particularly since manyprices were directly controlled by the Government. The picture for employmentis similar with the percentage of people employed in textiles decreasing from64.0% of the total labor force covered in the Census of Manufacturing Indus-tries in FY70, to 60.6% in FY76. The proportion of other intermediate workersin capital goods has increased in proportion to their share of output. Consumergoods showed an increase in proportion to value added with a decrease in employ-ment, but this is due to an increase in the share of value added in total outputas explained below.

1.11 In contrast to value added, the structure of gross output over thissame period shows a decrease in the share of consumer and capital goods, andan increase in the share of intermediate goods (although textiles do show adecline). The reason for the switching of consumer and intermediate goods isthat while the former has increased the ratio of value added to gross outputfrom 42.5% to 47.1% from FY70 to FY76, the ratio for intermediate goods hasfallen from 47.9% to only 26.4% with textiles going from 51% to 32.5%.

- 6 -

Table 1.5: IMPORT SUBSTITUTION IN MANUFACTURING(percentage)

FY70 FY76

A. Domestic Production/Total Supply

Total Manufacture 50 62

Consumer Goods 60 64Intermediate Goods 58 65Canital Gnncl 24 51

RB Total Dnmestic Pr-dicrton 100 100

For export market 21For domestic market (consumer goods) 28 24Fo._ r doesicmarlr ket (pnroducer -AO)A 3455

Source: Annex Tables 1.12 and I.13.

1.12 The proportion of total supply of manufactured goods coming from--- A.-._ : -- A)'l C- VV7 .. : ro- rnl r-_o FY70.

IJITCO X L CJL VULL- IVLL WOO --- O 1VL LL U '.' OIUW -116 OIL t LL -OOC .L L VIU SUb 1VU 1 X I

The increase came from all subsectors, but most dramatic was the capitalgoolUs whIich went furom 'less thLan 25%. 'Lo more thLladn 5 .n'J * -nile the -- L----- L-L

of manufactured goods in total exports has increased from 56% to 70%, only21% ofL mranufactureu goods were exported in FrY76 comiipareu L JOi FY70.

However, this is largely a result of the loss of the captive West Pakistanmarket which has forced the economy to become more self-reliant (Chapter 4).

Small and Cottage Industries

1.13 Data on the small and cottage industry subsector are even rarerthan for the medium and large subsector. It is estimated that at the time ofpartition, seven-eights of East Pakistan's industrial production was in thesmall and cottage area, but since then the subsector has virtually stagnatedwhile the medium and large area has grown at an impressive rate. Thus, smallindustries are now estimated to contribute only about one-third of the valueadded in the sector. There are an estimated 50,000 small scale firms (thosewith fixed assets of less than Tk 2.5 million) and 500,000 cottage units(those where the activities are wholly or primarily the activity of a family).

1.14 The data that are available come from the Census of ManufacturingIndustries and Sample Survey of Unregistered Industries, 1976-77. It isestimated that about 1.6 million people are employed in this small and cot-tage (SCI) subsector, and estimates of the key indicators are given below.Unfortunately, there is no set of data for an earlier period to compare whathas happened over time.

7 _

Table i.6: SELECTED INDICATORS LN THE SMALL AND COTTAGE INDUSTRIES

Cottage Industries Small Scale Industries(sample 60,681 firms) (FY76 CMI-1,334 firms)

Value Added 294,543 28,577(FY70 Prices Tk '000)Employment 250,827 13,030Capital (FY Prices Tk '000) 240,000 46,600Capital/Output .81 1.63Capital/Labor (Tk) 956 3,585Output/Worker 1,172 2.190Labor cost as share of .67 /a .33value addedAverage real wage (FY70 Tk/yr) 783 /a 711Return on investment 40% /a 41%(constant prices)

/a Adjusted for non-paid labor.

1.15 Comparison of Tables 1.2 and 1.6 suggests that, compared to largescale industry in Bangladesh, cottage industries are more labor intensive,have lower output per worker, lower capital-output and capital-labor ratiosand a higher share of Labor in value added. The rate of return on capitalis almost the same for cottaae and small industries, both being higher thanin the large and medium subsector. The average real wage is slightly lowerin the small-scale industries with cottage next lowest and medium and largebeing the highest. However, this gross comparison does not take into accountsuch important factors as produCt differences between large and small industry,and the potential improvement in efficiency possible in all sectors, butespecially i-n the state enterprises.

CHAPTER 2: THE INDUSTRIAL POLICY FRAMEWORK

A ±Ihe Evolution of Industrial Policy

2.01 When Bangladesh became,independent, its industrial policy frame-work = the instruments, institutions, attitudes, rules and procedures whichaffect industry - reflected the molding of the past governments of Pakistanand India. Tne basic approach to industry was one of bureaucratic control ofa largely private industrial sector, with stress on import substitution andnear exclusion of foreign investment. The focus of control was on foreignexchange, and the main tool was quantitative restriction of imports of goodsand materials. Around this central control grew a complex licensing systemwhich affected almost every aspect of the behavior of industrial firms. Pro-fits became as much a function of skill in manipulating the license system asof skill in production and marketing. Entry to an industry became a function

-8-

of the ability to obtain licenses. investment in industry was largely deter-

mined by the issue of licenses and the tendency was to award licenses to new

producers in an allocative pattern which was not necessarily related to

existing capacity.

2.02 The industrial sector, to which these policies applied, was dominated

before independence by West Pakistani entrepreneurs. Moreover, West Pakistan

was the principal market for many of the industries. At independence, both

these factors changed. The Pakistani entrepreneurs left the new country and

the Pakistan market was closed. The new government changed the structure of

ownership dramatically. The assets of the departing Pakistani industrialists

were nationalized along with some private Bangladeshi enterprises. In partic-

ular, the jute, cotton textile and sugar industries were totally nationalized.

The new enlarged public sector comprised some 400 firms and included about 85%

of the assets of medium and large scale industry. Thus, the new government

undertook the task of not only controlling but operating an industrial sector

which had been drained of its managers and deprived of some of its principal

markets.

2.03 For some time, the role of the private sector remained unclear.

In 1973, an industrial policy statement established limits to private invest-

ment of Tk 2.5 million initial investment (including land), with freedom to

expand, through reinvested profit, to Tk 3.5 million. In addition, a 10-year

moratorium on nationalization was proclaimed. 1/ Despite these drastic changes

in the industrial sector, the pattern of industrial policy towards the private

sector retained similarities to that of the past. There was a mixture of

restriction and attraction. New investors were offered a 5-year tax holiday,

although 60% of the tax exempted Drofits were to be ploughed back or invested

in government bonds. Customs duties on imported machinery were deferred for

up to 6 years, and a 5% duty rebate on capital equipment up to Tk 1 million

was offered. In 1973, firms exporting the whole of their output were exempted

Lror,ttmost duties and sales tax on machineryj spares and imported raw materials.

Further incentives were offered to firms locating in less developed areas of

the country. 2/ The overall policy was clearly aimed at fostering and main-

taining public enterprises in large and medium scale industry, and encouraging

limited private activity in smaller industries.

B. The Present Climate

2.04 Since 1973, GOB's general policy on industry has shifted towards

encouraging private sector activity and reducing, through disinvestment, the

1/ The moratorium ensured 10 years of freedom from nationalization from

January 1973 fcr existing firms, and 10 years from the date of estab-

lishment for new firms.

2/ Firms locating outside of Dacca, Narayanganj, Chittagong and Khulna

were given extended grace on loans; were required to plough back only

30% of tax exempt profits and were permitted higher debt-equity ratios.

-9-

dominant role of the public sector in order to develop a mixed econommy. In1974, the limit on private investment was raised to Tk 30 million (US$2 mil-lion) and the morator-iumJ on nationalization was increased to 15* years. 'IThleInvestment Policy Statement was revised in December 1975, increasing the in-vestment ceiling to T1k 100 million (UJ$6.7 millio n). This nominal limit hasjust been removed, though projects above this size will have to be approvedby the ECNEC. Private investment was permitted in an additional 10 sectorspreviously reserved to public firms (Annex II.1). In these sectors, preferencewas to be given to joint public/ private firms, though proposals for pure pri-vate sector investment were also to be considered. Investment in all otherareas was open for private investors, subject to the limits. However, inthese open areas, public firms are still free to invest. The assurance of amoratorium on nationalization was deleted because it was felt that any discus-sion of nationalization would deter private investors, however, this may bereconsidered (see para 2.50).

2.05 GOB maintains general control over industrial investment through thepublic sector corporations, and by limits on both size and area of activityfor private investment. An Investment Schedule is published by the Departmentof Industries listing projects which the Government regards as desirable andserving as the central control on private investment.

2.06 The allocation of resources in the Two-Year Plan indicates the in-creasing importance given to private investment in Bangladesh. For the period1978-80, Tk 8,160 million 1/ were allocated for investment in industries, ofwhich about Tk 2,460 million or 30% of the total is to be private. This isroughly twice the share of the private sector in the First Plan period 1973-78.

2.07 Disinvestment of public enterprises, especially the smaller ones,has been proceeding. So far, 77 public sector enterprises have been dis-invested in the past two years, with a total value of Tk 330 million (US$22million). The firms dlisinvested were in the chemical, food, leather process-ing and engineering irndustries and had an average sale price of $285,000.Another 11 units of similar size remain to be disinvested. Though all Dublicfirms outside the reserved list of 8 sectors are eligible for disinvestmentunder the policy announced in 1976, GOB has not, as yet, announced firm Dlansfor this process. Further, GOB does not intend to disinvest major sectors ofthe jute, textile and sugar industries (Annex II.2).

2.08 The net impact of these policy changes is reflected in a risingvolume of private investment approvals granted in the past 2-1/2 years.Composite data maintained by the Department of Industrips show the followingtrends:

1/ This represents 22% of the total outlay for all sectors and is secondto agriculture with 2_57..

- 10 -

Table 2.1 INVESTMENT SANCTIONED(Tk Millions) /a

Per Local Currency Foreign Exchange Total Index(FY74=100)

FY74 47.80 39.60 87.40 100

FY75 86.90 63.60 150.50 172

FY76 136.60 564.50 701.10 802

FY77 427.70 382.20 809.90 927

FY78 1,213.10 878.30 2,091.40 2,392

Total 1,912.10 1,928.20 3,840.30

/a Approximately 80% of the above figures represent the value of new

investments being approved by the Investment Board, while 20% is

accounted for by existing companies whose capacity is being "recognized"

for the first time by the Investment Board for import control purposes.

Source: Department of Industries, Dacca, 1978.

2.09 In Bangladesh, national accounts do not have expenditure data. In

the absence of any consiqtpnt data on actual nrivate investment, either with

the Department of Industries or the Planning Commission, 1/ it is difficult to

determine accurately the trends in private investment over the last five years

and to show whether investment has kept pace with the sharp increase in

approvals. The Department of Industries is cu,rrpntlv attempting to evaluate

progress of individual projects in order to compare actual investments with

approvals. It has also made an estimate o--f act-unal nrivat- sector indtustrial

investment in the last five years, which, if accurate, indicates an upturn in

actual investment in the private sector (see Table and Annex IT.6).

1/ The Planning Commission has established total private sector irvestment

at Tk 1,570 million in FY77 and projected a level of Tk 1,920 million

for FY78. Details are lacking, however, and the figures include large

amounts invested in agriculture, transport, construction, trade and other

service sectors. The Bank estimates that private sector investment

averages around 2% of GNP, and represents nearly 20-25% of total fixed

capital formation in the economy. It is obviously a low proportion,

particularly in comparison with other developing countries.

Table 2.2 INVESTMENT IN PRIVATE SECTOR MANUFACTURING INFY77 and FY78(Tk Million)

Total No. Total Investment MadePeriod of Units Internal External Total Index FY74 = 100

FY74 295 44.80 37.60 82.40 100FY75 276 78.10 55.10 133.20 162FY76 265 108.80 89.20 198.00 240FY77 439 307a=0 142.90 450.00 546FY78 552 495.60 254.40 750.00 910

TOTAL: 1)827 1,034.40 579.20 1,613.60

Source: Department oi- Industries.

Despite this apparentl.y rapid growth in private industrial investment, theresponse seems to have been less than was hoped for by GOB. 1/ The causes forthis lack of response may be divided into general and policy-related. At thegeneral level, an important problem is uncertainty due to two factors. Thefirst is the suspiciorn by many businessmen that the Government does not intendto give its "full support" to private industry. For example, the retentionin the public sector cf the jute and textile industries, the backbone of theindustrial sector, is claimed by sorne private businessmen to be inconsistentwith the avowed policy on private industry; businessmen believe that theycould operate the jute and textile indistries profitably. Further, as thepublic sector will continue extensive activity in some areas (such as steel)now open to private investment, some businessmen are afraid of unfair competi-tion from Government-assisted public enterprise and are not clear on the rolethe private sector will play. Another aspect of this first factor is generalpolitical uncertainty, although the recent presidential election results haveprobably reduced this significantly, and the forthcoming gpneral electionscould disperse more uncertainty.

2.10 The second factor is that neither businessmen nor the Governmentare clear on which industrial activities should be encouraged. and which wouldbe profitable. There is a knowledge gap on industrial opportunities. Thus,alternative activities such as trading and real estate sneculation are seen asquicker, easier ways of turning profits, as well as less risky than industrialmanufacturing--especially outside the two traditional industries. Many poten-tial entrepreneurs lackc the knowledge and experience to put an investment pro-ject together. These effects can be seen, for example, in the minor rush of

1/ For example: "There has been a favorable change in the investment climateand government no]icies have been streamlined keeping in view the need forproviding additional support to the private sector. There seems to be someresnonse to these Government moves; but the response could and should havebeen better." Excerpted from a speech by a senior GOB official to theseminar on the draft Two-Year fian, Narayangan; Chamber of Commerce andIndustry, Dacca, June 1978.

- 12 -

investment applications in jute carpeting. The earliest investors appearedto believe they had special information on markets and processes and that, bybeing first, they could not lose anyway. Nonetheless, several applicationsfollowed by investors who were not as conversant with either markets or pro-cesses as were the leaders. 1/ Clearly, a number of investors have resourcesbut lack information and know-how on establishing industrial projects. Theseproblems are related to the task of developing GOB's industrial strategy,and are discussed in Chapter 5.

2.11 At the policy level, businessmen complain about several aspects ofthe present framework. These include overlegislation and overcontrol; slow-ness and complexity of procedures for establishing new industries; price con-trols and their use as a device to place excessive restrictions on returns;lack of supporting infrastructure; muddled incentives for regional dispersionof industry; and inadequate export incentives. Many of these complaints arenrobablv excuses for not investing in an environment of general uncertaintv.Nonetheless, there are several areas in which the effects of policies andincentivs ae aTnhmbiiiuos GOPB has recognizpd that qnmp of the rrittricims

are justified and has taken action to correct anomalies in several areas.

C_ Tmnrnv-inQ thp Prpsont P1 i iv FrnmPwnvrk

2.12 The purpose of this section is to examine the array of policiesanA ntttostlog hW1h_1 CI-OB _nfluences thIe 4ndustrial sector,4 tonu -LOC.L . LLO C. JI

6LW!L1 JJ kiLtICfL..O U IL L & UO IL Oat I UL. C L.

analyze their various functions, and to consider ways in which their operationcouId b-e A.L.pLuve.

L.1 I hiere are two bas ic c lasses of] relationshiLps withLin the presentpolicy framework; these may be labelled controls and instruments. The con-trols tend to have a negative or preventive intent; are applied case-by-caseto individual firms; usually nave a once-for-all application; and are oftennot applied to public enterprises. Many of the controls are continuations ofpast practices, or are based on similar practices in neighboring countries.The instruments are usually more universal in application and cover all firmsunless specific exceptions are granted; they are usually continuous in opera-tion, although they may be varied in effect from time to time; some of theinstruments have dual purposes (e.g., tariffs). In general, controls havebureaucratic, administrative origins, and instruments tend to have economicorigins. Though both have a role in managing the industrial sector, the morepolicy is focussed on efficiency, the more will instruments tend to be used asthe main tool of management, with controls applied for specific and usuallysocial functions (such as safety, worker protection, national security andlimitation of monopoly). Conversely, the more controls are used as the maintools of managing the sector, the less will firms tend to focus on efficiencyand competition among themselves, since rewards are obtained from "beating"the system, rather than competing in productivity terms.

1/ Subsequent analysis of an early jute carpet project suggests that theleaders were not very well informed in any case.

- 13 -

2.14 GOB's policies do not differentiate between small and large indus-tries, except for special financing facilities (para. 2.71). Consequently,the following discussion of controls and instru mpnf applies to all firms,except where special exceptions are noted.

(a) Controls

Import Controls

2.15 Foreign exchange is allocated to industry groups on a six-monthlybasis. Firms must obtain the approval of the Ministry o' Corrnierce (importlicense), open a letter of credit through a designated bank, and the lettermust finally be approved by the Ce;tral Bank. 'Lo obtain an import license,individual units need the recommendation of the Department of Industries.For a new company, a preliminary license is issued to cover the trial produc-tion period. Using the Department's recommendation, the firm applies to the0ffi"ce of Cief Conitroller of Imports and Exports for an import license whichis valid for six months. The allottment of raw materials is based on thepriority list of industries. Firms in Priority List I (164 sectors) are atpresent entitled to 100% of licensed capacity. Priority List II firms areentitled to import 75% of capacity.

Applications are automatically valid for the second iind third yearsunless a larger allocation is required. Firms exhausting their one-shiftentitlement may request a supplementary license. Beginning in FY79, importlicenses are valid for 12 months instead of six months.

2.17 Supplementary imports can also be arranged through the Wage Earner'sScheme and Export PerFormance Licenses. The Wage Earner's Scheme permitsimports on some goods using remittances made by Bangladesh nationals abroad.Under the Export Performance License scheme, registered exporters are issuedwith "bonus" import licenses up to a specified proportion_of their actualexports. GOB has recently expanded the list of products eligible for importunder these schemes. In addition, GOB is experimenting with a scheme of OpenGeneral Licenses under which liberal quantities of specified items 1/ could beimported without individual licenses.

2.18 Recent changes in import control procedures have improved the system.However, further improvements are possible despite the limited foreign exchangeresources of the country. In particular, new licenses should be usable forlonger than one year as is already the case for the public sector. This shouldbe accomplished easily because the Department of Industries has stepped up itsinspection procedure to identify "bogus units" which hold import licenses but

1/ In an earlier attempt in 1977, importers were given the concession toimport, in addition to normal entitlements, any of the following items:(i) cotton yarn, (ii) salt, (iii) lentils, (iv) coconut oil, (v) con-densed milk and patent food, (vi) dyes, chemicals and pigments, and(vii) tires and tubes for motor vehicles and spares for aut:omotivevehicles, marine diesel engines and bicycles. At the first attempt, thedemand for OGL exceeded the foreign exchange allotted to it: and the schemewas suspended in Dctober 1977, but was revived in the second half of FY78.

- 14 -

are not in production or have closed down. Successful weeding out of a largernumber of such units would mean that genuine users of imported raw materialswould constitute a major proportion of import license holders. A longer termlicense would enable firms to improve their production planning and inventorycontrol. More important, the chance of production slowdowns because issue ofimport licenses is delayed would be reduced. Giving public and private sectorunits more equal access to raw materials would also improve the confidence ofthe private sector. More generally, the licensing system should be geared topromoting the use of multiple shift operations by existing firms. The use ofOGL should be expanded as much as possible within the constraints of foreignexchange availability and pricing.

The Investment Schedule

2.19 Related to import controls, the Investment Schedule is a controlon the use of foreign exchange in investment. The Department of Industriesestimates the demand-supply balance for various products, sets this againstexisting capacities and computes the increases in capacity which would beneeded to meet projected demandl. Once an aggregate list of products iscompiled and investment requirements for additional capacity have been esti-mated, these are compared with the expected supply of foreign exchange and apriority list of projects is prepared.

2.20 While the basic approach used in compiling the schedule is soundin theory, it is not clear that there are sufficient data and skilled manpowerin the Depnartment to annlv what are essentiallv longer term nlanning methodsto a short-term bureaucratic process. In effect, the Schedule is prepared byapplving a nronortionate rate of girowth to the slinnlv and demand figures and

relating these to capacity sanctioned at the beginning of the period. Actualrnnraitv and sanctiorned pern,Aritv Are rarelv re-ronri1ed anda as the tAble

(para. 2.09) shows, there is so little data on actual investment that it isceortai,n the ScheduAile is no.t based onf real buit on esiate crntapacnr i,y

2.21 The Schedule is also seen by GOB and the Department of Industries

as a promotional device; a means of informing the potential investor of areaswn whchivsmn woull le welcrldb O. I rcie oee,tepoin WLLL.L Lii L iUV-_L.U_L L.. LU U~ Li ~LkIiLLU L)' '.i'. L %J L d~LtLL-, LLiJW CL, L.LL" F U

motional function of the Schedule appears to be secondary. If investorsexpress interest in implemelting projects outside the Schedule, the initialreaction from the financial institutions and the Department of Industries islikely to be negative. For example, a factory making readymade garments forexport was denied approval for approximately a year because readymade garmentswere not mentioned in the Investment Schedule. indeed, this example callsinto question the utility of the Schedule for planning, controlling, or pro-moting. W-hy were readymade garments not on the Schedule? There is no clearerexample of a small scale, export oriented, labor-intensive industry, and yetit took a year to approve it.

2.22 The Schedule does not, and in its present form cannot, perform thefunction of relating national objectives to industrial investment decisions.In some cases, however, progress is being made in reducing controls. Forexample, the Department itself has simplified annual clearance procedures

- 15 -

for licenses inI the Lcase of establisned industries. Nonetheless, the Depart-ment needs assistance from the planners who must provide a strategy and guide-lines for industriai activities within which controls can be clearly seen tobe of less importance than promotion and assistance.

2.23 At the moment, there is no attempt to define the economic efficiencyof production in terms of domestic resource costs or economic rates of return.Given the large number of subsectors and products (136) for which such esti-mates are derived, the focus is mainly on expansion of output in existing in-dustries. There is little room for evaluation (and inclusion in the Schedule)of new items, the production of which may be economically justified on thebasis of supplying the domestic market or meeting a potential export demand.Yet the absence of su:h an item from the Schedule presents a potential investorwith severe problems. Recognizing some of the deficiencies in the Schedule,the Government has int:roduced more flexibility in its application. Exportoriented projects are now automatically considered for approval even if thevare not originally identified in the Schedule. In most other cases, however,investment applications for items outside the Schedule are turned down and.in the rare cases that: they are approved, such approval is only granted afterspecial requests are riade directly to the Director General, Industries or theMinistry of Industry.

2.24 In general, GOB should examine carefully the function and objec-tives of the Schedule and its attendant bureaucratic structure. Its controlfunctions are, in most cases, a repetition of preventive power which isapplied at other points anyway (financial intermediaries, issue of importlicenses). Moreover, they are based on shaky data and inadequate analysis.Its promotional functions are diluted by its "control" image and by itsbureaucratic procedurEs, structure and powers. Controls tend to breed andDroliferate; this one should be examined (as should all others) to establishprecisely what probleml it is supposed to be solving, and to determine whetherthe net benefits of thbi9 tyne of solution are adequate.

Limit on Investment

2.25 The former ceilina of Tk 100 million ($6.7 million) on investmentin fixed assets for new private projects had been exceeded on occasion whereannroved by the Investment Board and the President's Council of Advisors.For example, in recent months four private projects for the manufacture ofiut- carpets for export, with investment costs of approximately Tk 140 millioneach, were approved and: are now seeking finance from the development banks.This has tended to increase the amount of tirue required for an investment topass through the approval process. In addition, public corporations involvedin the industry were aLso required to give approval before investment couldproceed. Since the lilnit also applied to projects with foreign participation,Loreign in-vestors tended to be deterred by the low limits and the alternative

of slower processing of applications in cases where the limit is waived.

2.26 Even before l-he ceiling was lifted, GOB had indicated that, generallyfor export projects, this limit would continue to be waived. While this wascommendable in the sense that, whenever possible, less control is better, it

- 1 6 -

is not export projects per se which are desirable, it is pibjects which areefficient users of resources, including iport-substitution rojects whichBangladesh needs. The present system contains sufficient checks to permitthe potential net benef4ts Lo a p- e to be etLih on LL the one hand, I/

and for socially undesirable projects to be rejected, on the other. In viewof the variety of oltiler contr;ls thr ough wh ich GOB0L 'I) couldiu influence th'Le ch o i c e

of projects in the private sector, the use of a financial size limit on pri-vate beuLutr ilnvestuient appeared tU e reaunuant. wnile Ete limiLt has now beenwaived, large projects will continue to require the special scrutiny of ECNEC.LI the lifting oLE thle limit i to be an efrective stimulant to private invest-ment care should be taken that: approval by ECNEC does not substantially in-crease the time taken by a iarge project to clear the approval process, andthat all such approval is dependent solely on the economic justification forsuch projects.

Allocation of Public and Private Sector Activity

2.27 There is some confusion over controls in industries where both pub-lic and private firms are permitted to operate, either as competitors or incollaboration. All private proposals received by the Bangladesh Shilpa Bank(BSB) and Bangladesh Shilpa Rin Sangstha (BSRS) for investment in any of these10 areas are referred to the Director General, Industries as well as theMinistry of Industries in case public sector corporations have potential in-vestment proposals. 2/ This causes delays and, in effect, gives corporationsveto power over private projects in these sectors. This could lead to mono-polization by public corporations and makes private investors suspicious.There are no proposals for joint collaboration by public or private firms inthe current list of industries. GOB has waived its former requirement thatpublic sector units hold 51% of equity in any joint venture with private in-vestors (local or foreign). This liberalization may stimulate more jointventures in the future.

2.28 Regardless of the exact mix of public-private sector activity whichthe Government desires, a clearer delineation could result from reversing theprocedure for permitting private sector investments in all except the eightreserved industries. Private projects should normally be allowed to proceed,except in cases where public enterprises are already implementing similarprojects and additional capacity is not necessary. That is to say, the pro-posed Droiect would not be economic, given the existence of an ongoing ntiblicproject. In general, new public investment in industries should be comple-mentarv to private investment by pithpr (a) collanhloratiinc, with -ixate- f4rmc

or (b) undertaking projects in which social benefits exceed costs but private

1/ In the case of the jute carpet proposals, for which the limit was waived,serious questions on the adequacy of preparation of these projects arebeing raised downstreaml- in +-I ap-r-o-v process - the absence of a limlit

had no effect.

2/ Recently, the DGI and the Banks have agreed to simply "exchange informa-LionUL on a lltHoIIL ly db Las so that no [ aU neeCL- [ b-C Ue cause' y the

Department.

lir[iIs will not undertake the investment because the financial benefits aretoo low. For exampLe, under such a policy, the public sector would not beinvolved in the production of jute carpets, which has attracted several pri-vate investors, unless there is a supply gap which the private sector cannotfill. Combined withl deletion of the financial limit on private investment,this approach would lead to a clearer distinction between areas of publicand private activity; and should generally assist in stimulating industrialactivity.

Investment Approval Procedures

2.29 Investment in Bangladesh is often slowed by relatively cumbersomeand intricate proceelures for approving private investment applications. Delayscan occur in three ways: (i) obtaining the preliminary clearance required fromthe Department of Industries; (ii) obtaining the final approval required fromthe Investment Board; and (iii) during the internal processing bv the financialinstitutions.

2.30 One source of delay is the need to refer to the Department of Indus-tries, the Investment Board and very occasionally ECNEC. A desire to controltightly the investment approval process for all but the smallest of projectsis the main reason for the existence of this multi-lavyred procedure. Therequirement that all projects submitted to financial institutions be referredto the Department of Industries for nreliminary approval, even if they areincluded in the Investment Schedule, can only be explained in this context.The rules regarding size of proipcts and need for imported raw materials causea minority of projects flowing through the financial institutions to needapproval by the investment Board. In the April 1978 meeting of the Board,for example, about 70 projects were discussed and approved, including 30 spon-sored b … financial institutions. It seeu,s unlikely tat suiiicient competentanalysis of this number of projects could have been applied in one session.This raises the question of whether all the steps in t-e system do in factcontribute to ensuring that there is an efficient use of resources in indus-trial investment.

2.31 The processing capacity of the financial institutions is in partdetermined by the availability and competence of the staff and the number ofinvestment applications flowing into the institutions. The recent increasesin applications have resulted in some backlog build-up although the develop-ment banks are taking; steps to improve both the speed and quality of process-ing. 1/ Once projects are being considered, the time taken to completeevaluatiLon is again a function or the capacity of the appraising officer andthe completeness of the investment application. The lack of adequate indus-trial information in Bangladesh and the relative inexperience of many newBangladeshi entrepreneurs in preparing feasibility studies often slows downevaluations.

2.32 The involvement of the concerned financial institution, the Depart-ment of Industries -and the Investment Board in the approval process represents

1/ Both BSB and BSRS are receiving technical assistance in this area.

- 18 -

unnecessary duplication of effort. Thus, evenL without delays within the sys-tem, the process can be time-consuming. This could be avoided by delegating

greater powers to the financial institutions to sanction projects withoutfurther reference to the Department of Industries or the Investment Board.

Both the requirements on proportion of raw materials and atount ol loan could

be raised so as to require only large or otherwise exceptional projects to be

considered by the investment Board.

2.33 Finally, it cannot be over-emphasized that controls should be exa-

mined in terms of their cost-effectiveness. For example, is it worth includ-

ing a taxation clearance in the investment procedures? An investor with

"unaccounted resources" may choose to invest in real estate or trading rather

than face investigation in order to invest in industry. The use of illicit

funds for legitimate investment should not attract more attention than mere

possession of those funds. This kind of control may simply achieve results

opposite to the objectives of GOB. This is not to say that GOB should not

investigate tax evasion - it is simply that the investment controls should

not trigger investigation more than would be the case in alternative uses of

the funds.

(b) Instruments

Custom Duties

2.34 After independence, the existing structure of import duties became

outdated because the structure and origin of imports changed substantially and

because the realignment of the Taka in January 1972, together with the aboli-

tion of the bonus voucher scheme, modified the level and structure of import

prices. In the context of the FY73 budget, import duties were adjusted for

many items. but these changes corrected onlv some of the most obvious anom-

alies. Thereafter, the growing exchange rate overvaluation of the Taka led

to the introduction; with effect from July 1974. of a eeneral 20% import

license tax, which remained in existence until the devaluation of the Takatook effect in May 197S. Since thenj nartial aRdiustments in the imDort tariff

were made from time to time to reduce the effects of the devaluation on domestic

prices. Also, some reduction was made in the multinlicit" nf tariffs and thp

preferential tariffs applicable to the U.K. and some commonwealth countrieswere abolished. On th1e other hand, aAA4itional concessione:y duti-swr in-

W ctC CUtJ I. .5.0 LUCIA. .J Ut L~~~~~~~~~~~~~~~~~6. ti J L. OL' , _ aL'. LL *.La %.JSE a .. -j .. o.

troduced, such as for imports under the Wage Earners' Scheme.

2.35 The existing customs tariff reflects a structure under which dutiesare generally higher as a product comes closer to the final production stage.

Protection is thus roughly aligned with value-added in the finished product;

however, rates are numerous. Most goods fall within the 30-125% range, -where-

as luxury and non-essential goods are taxed at higher rates (up to 300%). An

average rate of 25L/ applied till recently to numerous types of machinery and

machinery parts. The basic rate has just been reduced to 15% with further

concessions available for projects in less developed areas, or those that are

"export-oriented". A number of essential goods, including industrial raw

materials, coarse fabrics, pharmaceuticals and medicines, are also taxed at

relatively low rates, whereas essential items such as rice, wheat, fertilizer

and seed are imported duty-free.

- 19 -

2 36 The rate structure is complex and GOB has recognized t:hat it needssimplification. To this end, the Taxation Enquiry Commission,'in its InterimReport has recommended a comprehensive revised customs tariffL aimed at simpli-fication and rationalization. The number of ad valorem rates is intended tobe reduced from 36 t-6*o only 7. The normai rates would range from 0-125%,except for a few highe,v rates on luxury items or for protective reasons.

2.37 However, the Taxation Enquiry Commission, while simplifying andratLionaliizing thLe struc:ture in administrative terms, has based most of itsrecommendations on revenue criteria. It appears that no serious attempt wasmade to consider effeci:ive protection as a basis for rationalizing tariffsaffecting industry. Thus, even if its recommendations are accepted it isunlikely that the resu:Lt will be a tariff structure which encourages thelocal production of products in which Bangladesh has a comparative advantageand discourages production in cases where continuing imports may be preferable.

2.38 The Tariff Commission is charged with providing protection "wherejustified." Its functi.on is to review, case by case, the need for adjustingtariffs to provide justifiable protection for local production. The TariffCommission uses relatively crude criteria in its decision-making. Among otherfactors it takes into account: demand, ability to produce (i.e., plant),quality, size of investment, saving of foreign exchange, costs (which areacceptable at c.i.f. + 15%), and "other advantages." Again, however, nomeasure of efficiency in resource use appears to be applied. In particular,the Commission did not appear to use such concepts as DRC as a guide to whichproducts deserved additional protection. 1/ The Commission should be upgradedand equipped for the task of applying the principles of effective protectionto the rationalized tariffs in preparation for the Five-Year Plan. 1980-85.Further consideration should be given to the possibility of Technical Assist-ance to the Tariff Commission to upgrade its capacity for economir analis.

Taxes and Incentives

2.39 Company taxation is relatively high comnared to levels in mostother countries in South and Southeast Asia. Provisions for depreciation,loss carry-forward, etc. and other allowances are also less generous (AnnexII.3). Currently, the aggregate corporate tax rate is 60% on pr:ivate limitedcompanies and 55% on public limited companies; wifth an additional 20 tax oncash dividends and 15% on stock dividends. The normal depreciation allowanceis 7% on nlant and machinery and provision is made for carry-rforward of lossesonly in the tax holiday period for eligible companies; otherwise, there is noprovision for rarry-forward of losses. Superimposed on this is a complexstructure of incentives, including provisions for accelerated depreciation,tax holidays for new projects, reduced rates of taxes on exports and new pro-jects in less developed areas (Annex II.4), which makes it difficult to arrive

1/ Mission estirmates of one Commission case in which a consumer product wasafforded more protection suggested a DRC of approximately 5 times the

o ca' exchange rate, i.e. the use or approximately Tk 75 in localresources being needed to effect a saving of US$1 in foreign exchange.

- 20 -

at any accurate judgment on the effective level of taxation on the corporatesector. Overall comnanv taxatinn accou,nts for about 22 , of rovernment reve-

nues and 2.9% of tax revenues. This is equivalent to about 0.3% of GDP.

2.40 Since 1975, expansion projects have been denied many of the incen-tives which are available to new companies; for example, they are denied accessto the tax holiday provision. Expansion projects are eligible for the initialdepreciation allowance whichl is allo-wed 'Lo non-tax holiday concerns. ' ome

incentives to new companies, such as the tax holiday provision, exist side byLI LI J.L~I4 iLH L _ iiVb Ulft o partsidewithrestrictive clauses, such as the onLe requiring re-nvestmentofpr

of such "tax holiday" profits or investment of the same fraction in Governmentborld, s.

2.41 To improve the impact of Lhe tax system, expansion projects shouidbe treated equally with new projects. In many cases expansion of existinglines of production would be a more rapid way to increase output, and wouldobviously require less capital. The taxation system should not bias invest-ment in favor of new plants. If relief is to be offered, it should rewardefficient expansion of output, not simply expansion of capacity.

2.42 The requirement on investment or bond-purchase for tax-holidayprofits seems to take away much of the incentive of the tax holiday. Theattraction of a tax-holiday is that it offers the businessman a more rapidpayback. To require him to defer using these funds or to expand the samebusiness simply removes the rapid recovery of liquidity, which is the rewardthe tax-holiday offers. Moreover, this requirement creates a control problemin ensuring compliance. While the recent reduction of the reinvestment pro-vision to 30% in developed areas and 15% in less developed areas (from 60%and 30%, respectively) is a step in the right direction, it would be prefer-able to eliminate these restrictive elements completely - even if the lengthof the tax holiday were reduced--making the incentive easier to understandfor the businessman, and much easier to administer.

2.43 The impact of high capital gains taxes on the attractiveness ofownership of company shares needs to be examined, particularly because thesehigh tax rates counter the liberal tax exemptions and allowances designed toencourage equity investment. Gains resulting from sale of company sharesshould be taxed at a substantially lower rate in recognition of the risksinherent in such investments.

Foreign Investment Policv

2.44 Foreign investment is nermitted in crllAhnrAtion with hnth (ovnun-

ment and local entrepreneurs. [n the private sector, foreign equity partici-pation ic limited ft thosp indusltries where technical know-how is not locallyavailable; technology involved is very complicated; capital outlay is high;and to industries based entirely on local raw materials or export products.Technical collaboration without equity participation is allowed in all types0of 4ndustries. In the case of new inve.st-ments, foreign collaborators are

expected to provide the entire foreign exchange portion of the investment asequLty. The terms and con-iti deL e-Y .iLiCg e Fqui participatiUn an -heprecise nature of association, including management contracts in individual

- 21 -

cases are, however, subject to negotiation. All foreign investment projectsrequire the approval of the Investment Board.

2.45 There are no stated limits on the share of foreign investmentin individual projects, dividend remittances are freely allowed after paymentof tax and even companlies with foreign majority ownership are treated asdomestic companies for incentive eligibility. Just and fair compensation inthe currency of the country of origin is also promised in the event of anynationalization necessitated by an emergency.

2.46 There is liitle comprehensive information available on the aggregateamount of foreign investment currently in the country, but it appears to be asmail proportion of total industrial investment. The limited amount of invest-ment is concentrated :in pharmaceuticals, electrical goods and cables, thetelephone equipment industry and to a marginal extent in chemicals, engineer-ing and tobacco. Since July 1976, a major part of the new foreign investmentproposals sanctioned have been in the fishing and fish processing sectors,mainly for shrimp and frog legs. Some investment has also been approved inreadymade garments for export, marine diesel engines and pharmaceuticals. Aproject utilizing natuiral gas to produce carbon black for export and costing$27 million has also teen approved, as has a $4 million joint venture involv-ing fish processing and the building of trawlers. (Joint venture possibilitiesin the leather tanning sector are aLso being considered.) Except for pharma-ceuticals and carbon black, most of the investments are by firms from Japan,Korea, and Thailand. Others seem to be adopting a wait-and-see attitude inBangladesh for reasons discussed below.

2.47 While it is clear that some foreign investors are already attractedto Bangladesh, discussions with potential investors, banks and other informedsources would suggest that many more foreign investors could be attracterdFirst, GOB has to determine for itself the long-term role it wishes foreigninvestment to play in the industrial sector. The selection and cimnlpmentationnof a medium-term induptrial strategy will facilitate this clarification.Given the desired role, the foreign investors must then be attracted- Whilpincentives may.be useful to some extent, the greatest attraction for foreigninvestors is a high level of certainty. Political instability. fear of nation-alization, civil unrest and other disruptions can more than counteract lavishincentives. GOB is already considering a Foreign Tnvestment Protection Act.Properly framed, this could be an important stimulant (para 2.50). The recentrelaxation of the Tk 10 Crore limit n ivestment (which was also applicableto foreign investment and joint ventures) will also help in improving theattractiveness of Bangladesh for foreign inuet-ors particularly if approvalby ECNEC is granted expeditiously.

2.48 Immediate act:ion should be taken on repatriation rights. Althoughearned profits paid out: in casih d4Vidends-c§n be repatriate in full, sub-ject to the appropriate tax, present regulations stipulate that capital,capit-al gain_s and reinvrest.^ment's fromu profits m,a Ae Auring th-e fPirst10) years

L.L"~UhLCLU ~ j~~Jt.L lflLI LUL11 LIAC L L L LuyV L

of operation must be repatriated over a 10-year period. This clause comparesunfavorably wil- the r;ules in practi, ally aL'L other Asian anu 'outhL Edast Asiancountries, where either there are minimal restrictions on such repatriation orwhLlere full repatriaton is perruiLtteu over a maximum of seven years.

- 22 -

2.49 - L The J.ec of thi- cluems e examlie --- oge-ther with another

regulation which requires foreign collaborators in new investments to providethe entire amount of the foreign exchange component of tne project as equitycapital. In cases where the foreign exchange cost of the project is greaterthan the foreign partner's snare of the jolnt venture, tne Dalance amounc canbe provided in the form of a loan. This loan is normally treated as initialcapital and is subject to the repatriation ruies unless a special agreementis made with the Bangladesh Bank. Regardless of the timing of repatriation,other considerations are important when repatriation rights are being granted.Loans may not be repaid out of sale of assets, only from profits. A companyis required to have an adequate cash balance before repatriation is permitted.Current liabilities and short-term bank borrowings are taken into account whenmaking this determination. While it is necessary to have adequate safeguardsagainst malpractice by multinationals, it is also necessary both to set outthe rules clearly and ensure that the disincentive is not excessive. A simpleblunt statement of what is offered and what is expected, what is permitted andwhat is forbidden is much more effective in attracting foreign investment thanseemingly attractive incentives with hidden controls.

2.50 All the foregoing issues should be covered in the forthcomingForeign Investment Protection Act. In this context, GOB could consider re-introducing an individual 15 year guarantee against nationalization (para 2.04).In general, the Act should set out the General Provisions of GOB's attitude toforeign investors; the purpose, scope, criteria and general authority underwhich the Act will function. In addition the rules for authorization, regis-tration and the treatment of remittances, repatriation restrictions exemptionsand imposition of taxes and benefits should be stated. Terms of loans andagreements on technology transfer should be specified as well as nominationof the committees, bodies and institutions empowered to administer the Act.Finally, the Act should incorporate the decrees or regulations which willgovern the procedures to be followed by foreign investors under the Act. 1/Consideration should be given to the use of Technical Assistance in the formof a consultant to draft and advise on the alternative forms for an Act.

Industrial Financing

2.51 The industrial sector in Bangladesh is well supported by financialinstitutions. Nine commercial banks (six of which are local and national4zed)with deposits totalling about Tk 13.5 billion as of December 1977, concentratedainlon te - -r - - -si -on of workin g capital a.-thoug byl- th r o of Vunds,

long term funds are also made available. The Bangladesh Shilpa Bank (BSB) andthIe langladesh Sh.ipaia Rin 'angsLa (BSRSD5) are the industrLial sector's mainsource of long term loans. Capital market activities in the form of debentureissues are unuerLaken primarily by the Investment Corporation of Bangladesn(ICB), a Government-owned institution. Loans to small scale industries areprovided by the commercial banks, tnougn in tne past tne Bangladesn Smaii andCottage Industries Corporation (BSCIC) and BSB were active in providing someterm financing. WGO, througn the Department or industries, the Ministry of

1/ An example of such an Act is the "Foreign Capital Inducement Act" ofthe Economic Planning Board of Korea - 1973.

-- 23 -

Jute and the Ministry of Textiles, also provides lone-term financing in theform of equity in state enterprises and allocations through the annual devel-opment program. Although the Dacca Stock Exchange was recommissioned in 1976;there is almost no trading in shares. Thus, for the private sector, institu-tional finance comprises BSB and BSRS for long-tprm finanr- t-hp TCR to alimited extent for equity investment and underwriting and the commercial banksfor short-term working eapital funds.

2.52 Demand and Sunnlv- There are qlmnQt- no stfati-icis on private sectorindustrial investment and financing. Rough figures for FY77 and FY78 from theDpnart-m-nt- of T1nAiit-ries show tontal ir.vestmeotsa of Tk- 529 million and Tk 3million for the two years respectively. These estimates, however, are crudeand are not broken up .y type of investment (i.e., into land, plant andmachinery, working capital). For FY77, an analysis of sources of funds

indicates ~ Llabe theLnIA. LL pattern:

T.L.L ') 2 D TUAT't QL~IV LX f r t.T,U1 1%1'.rL1r

(Tk million)

(a) BSB and BSRS /a 84(b) C.%ommercial DanKs /D 275(c) Others /c 170

m . I ^Iotal 529

/a Actual disbursemernts in FY77./b Increase in outstandings to the private sector. Much of this represents

increases in working capital by firms not making investments.Ic Including cash gerneration, own funds, etc.

Source: Department of Industries.

These figures indicate that financial institutions may have accounted forapproximately 68% of the additional financial needs of the private sectorin FY77. However, the Department of Industries estimate only includes newprojects and expansion of existing enterprises. A major part of commercialbank financing consists of increased working capital financing for existingcompanies. The amount of financing from other sources could be substantiallylarger than indicated in the above table.

2.53 Future trends are difficult to predict. The Investment Schedulefor 1978-80 estimates industrial approvals during the two years at Tk 4,190million or about 38% more than the Tk 2,900 million approved in 1976-78. Ifactual investments were assumed to increase in line with approvals, from therough base estimates for 1976-78, investment in 1978-80 would be around Tk2,000 million in addition to the increased working capital requirements ofexisting enterprises. This could be financed from the following sources:

- 24 -

Table 2.4 PRIVATE SECTOR FINANCING: 1978-80 /a(Tk million)

BSB/BSRS 500ICR 125Commercial Banks 675Others 700

2,000

/a Also, since these estimates depend on an assumed relation between sanc-tion -an actual -investr,,ents -C1 the flo ma be -Iower than predicted.L 1i d[IU 4L L I. .LLL V teb. LLtmentb LL LE t:- LOLW LILaLY U C LtJWC LItLI U

Dource. tuedLparLtmeLL UL LdLUUtLI. tf .

2*54 in the past, about lOY OL lon1g teLm U Ltance Lrom 01)± IJOABO Lhd as ueenl

in the form of foreign exchange funds. Of the Tk 500 million of long termfunds which the above assumptions suggest should be expected from these in-stitutions in FY78-80, about Tk 350 million (US$23.3 million) would be inforeign exchange and this amount should be easily availabie given tneir exist-ing resources and the new US$25 million loan recently negotiated between ADBand BSB.

2.55 Short Term Financing. The commercial banks supply the bulk ofshort term financing in Bangladesh and within this group the nationalizedcommercial banks provide the major portion, about 94%. The minor role playedby the foreign banks is partly the result of the low levels of direct privateforeign investment and international trade in Bangladesh.

2.56 Over the last two years, the commercial banking system as a wholehas increased its support of the private sector, including manufacturing,while holding steady the level of advances to the public sector (see Table 2.5).At the end of 1975, the public sector accounted for 66% of loans from all com-mercial banks; this share had fallen to 56% by June 1977. Loans to privatemanufacturing as a proportion of loans to the entire industrial sector hadrisen from 12% in December 1975 to 20% in June 1977. While exact figures arenot yet available, the share of the private manufacturing sector is expectedto have grown further to about 25% in FY78. While the share of the privatesector is increasing, it is still far short of the share of the private sectorin manufacturing value added which is estimated at about 45% of manufacturingvalue added. Small-scale and cottage units are themselves estimated to accountfor about 35% of industrial value added and it is this sector which is likelyto have only limited access to the commercial banking system under presentcircumstances. Cottage industries, in particular, need regular access to moneylenders whose rates vary although the effective rate is generally above 25%.As the commercial banks increase their financing of the private sector, greaterattentinn shnuilri be npid tn the needs of small and cottage industries.

- 25 -

Table 2.5 COMMERCIAL BANK ADVANCES CLASSIFIEDBY SECTORS

(rk millinsc)

Dpepmhpr 1975 Decembhr 1976 Jline 1977Amount % Amount Amount %

Public Sector 6030.9 65.6 6406.7 59.6 6394.0 55.3Sector Cor-poratons 4LCkg r758.5 51. 7 S .1k 5006. '7 A46 .6 1.1.7 A41 . 4

Others 1272.4 13.8 1400.0 13.0 1601.3 13.9

Private Sector 3163.0 34.4 4348.1 40.4 5145.3 44.5A__:_ rn. __ ono I -,nr 1) 4 A 0 0 oAgrculture U776.3 X.6u iv7.2 6.6 70J. O.J

Manufacturing 663.5 7.2 906.0 8.4 1180.6 10.2Commerce 932.1 0lC.1 1486.0 13.8 1:318.9 11.4Others 868.1 9.4 1250.9 11.6 1662.0 14.4

TOTAL 9194 100 10755 100 11539 100

Source: Bangladesh Bank

2.57 Interest Rate Structure. The level of nominal and real interestrates on medium to lonag term industrial lending since independence is shownin Table 2.6. Except for a two-year period in FY76 and FY77 when the rateof inflation dropped sharply, real interest rates have been negative in theperiod FY72-FY78. However, while no detailed study has been carried out, therate of interest does not appear to be a major determinant of industrialinvestment in Bangladesh. Of far greater importance is the state of Govern-ment policies and the investment climate in general. The increase in thelevel of investment s:ince FY76 can in fact be related directly to the changingeconomic policies of l:he Government in that year, and is in no way related tothe level of interest rates - which in fact were sharply positive in thatperiod (Annex II.5).

Table 2.6: REAL INTEREST RATES IN BANGLADESH: FY72-FY78

Rate of Nominal Interest Real InterestInflation /a Rate /b Rate

FY72 15.2% 8.0% -6.7%FY73 50.4% 8.0% -39.3%FY74 39.0% 8.0% -28.7%FY75 61.2% 12%-13% --43.4%-42.6%FY76 -6.9% 11.5%-13% 16.5%-17.6%TFY77 08% 11=5%-]2% 9.6%-10-0%FY78 13.8% 11.5%-12% -2.1%-1.6%

/a Dacca Cost of Living Index.H Range for local and -- eign currency lending.

SJource: langladesh Baak; Mission *sLim,ales.

- 26 -

2.58 The above table relates the rate of inflation in a given period tothe long term lending rate, a procedure which is not strictly accurate. None-theless, in many cases, investors' long term perception of inflation arestrongly influenced by the rate of inflation prevailing at the time the invest-ment is made. For the future. inflation which was about 14% in FY78 can beexpected to be about 10% which is a reasonable assumption given GOB's policies.Thus the real rate of interest for local currencv loans would be about 1.4%.For foreign currency loans, the potential deterioration of the exchange ratehas also tn ha tanken int-o, account, since the foreign exchange risk is horne hv

the sub-borrower. If the rate of international inflation in the period FY78-FY79 is assumed to be 7.1% (as projected by the Bank) the real rate of intereston foreign exchange loans would be about 4.3%, which is a reasonable level.Short-term interest rates for local currency loans fluctuate between 11.5%and 13%. This implies a real short-term rate of about 3%.

2.59 From the point of view of the development banks there may be somescope inL rais iLr. LLthe rate of itterebst L l cL1l CurrLen.cy loaInUs to produuc a

higher real rate of interest and also to improve the profitability of theinstitutions, arid also to IncLeae saVinLgb. In FY77, howrvtL, the interestrate on local currency funds was lowered from 12% to 11.5%. While thefiLanaLial structure of tle BSB 1/ and BSJR is LULL:tLy satLisacULUL y, soml-e

improvement in profitability would enable the institutions gradually to playa greater promotional role in the private sector, and perhaps to develop tnecapacity for making some direct equity investment in new companies.

2.60 Terms and Conditions of Lending. With notable exceptions, long termloans from tne BSB and BSKS are available on terms and conditions which arebasically similar to those on which long term finance is available from devel-opment banks in most other developing countries. The normal maximum lengthof a loan is 15 years though shorter maturities are used in individual caseswhere appropriate. Grace periods also vary in individual cases though thenormal practice in the case of new projects is for the first installment tobe due in the second year of production. Interest rates have been discussedearlier but it should be noted that interest on local currency loans is fixedin relation to the Bank rate, i.e. 3.5% above the rate subject to a minimumof 11.5%, payable half-yearly. This formula leaves the borrower liable tosome upward fluctuation in debt servicing costs over the life of the loan butany such increase is unlikely to be large enough to cause serious financialhardship to borrowers. Since the foreign exchange risk on foreign currencydenominated borrowing is borne by the sub-borrowers (para 2.58), this leavesthe borrowers exposed to occasional sharp increases in repayment obligations,as was the case in 1975. Potential investors may still be concerned aboutthis risk and GOB could consider setting up a scheme to bear part of thisexchange risk in the short run, as part of a series of measures to stimulateprivate sector investment.

2.61 The basic security required for most loans is a first charge on thetangible fixed assets of the borrowing company. In addition, the personal

1/ The BSB interest spread is currently about 3.5% and profitability is,dprn,ilnto nt 1 -97L ani nvr tot inl nqqpt .

- 27 -

guarantee of all the clirectors of the company is also required before dishurse-ment of any part of a loan. This requirement is unusual, particularly in thecase of public limited companies, and it is difficult to comprehend its use-fulness in the event of default. Directors cannot be generally held liablefor the debts of a limited company in the course of normal operations. Theapplication of this requirement couLd, however, discourage qualified personsfrom serving on the Bcards of companies.

2.62 Two other controversial conditions attached to all long term lendingin Bangladesh could, in the future, lead to unnecessary disputes between thelending institution and borrowing companies. The first condition gives BSB/BSRS the option of participating in any future share capital increase of bor-rowing companies, at par value, up to 20% of the loan sanctioned. The secondcondition gives the financial institution the option to convert its loan intoequity of the company at any time during the currency of the BSB loan. Boththese conditions appear to be arbitrary and are not linked to the company'smeeting its repayment obligations. Given the high debt:equity ratios underwhich many new companies are beginning operations, it is conceivable thatBSB/BSRS could claim a major part of a capital increase planned by successfulnew companies in the future; this possibility, in turn, may discourage com-panies from future exp;ansions involving share capital 4ncreases until longterm loans are paid off. In particular, the requirement that such optionsbe converted at nar valtue appears unjustified. The second option gives thefinancial institutions the possibility of becoming major shareholders ofindividu,al companies for no particular reason. This is not consistent withrecent Government moves to increase the role of the private sector and torestrir^t public owneershin to- particular industries.

2=63 Both these conditions are ruore in line wtLtihI thiie policy of a Govern-ment which intends to restrict the role of the private sector and increasepublic ownership of industry. Given the stated policies of the current admin-istration, it may be useful to modify or eliminate some of the above conditionsso as to remove the implicit threat which hangs over all companies borrowingfrom BSB/BSRS. Such a change could also improve the relations between thefinanciall institutions andi thiLe privaie sector.

2.64 Equity Finance and the ICB. The present industrial financing struc-ture in Bangladesh appears to be generally meeting the requirements of loanfinance for viable projects, though the time required for arranging suchfinancing can be considerable in view of the backlog of projects with the BSBand BSRS. A major problem however is with the availability of equity finan-cing. Under current guidelines being followed by the financial institutions,projects are normally allowed a debt equity ratio of 60:40 (70:30 in specialcases and in underdeveloped areas). In the case of public limited companies,the promoters are required to contribute 50% of the equity portion (i.e., 15%-20% of project cost) while the balance comes from a public issue, which can beunderwritten by the Investment Corporation of Bangladesh. The present re-sources of the Corporation consist of its paid-up capital of the Tk 50 millionand an interest free loan of Tk 27.5 million from the Government. The Cor-poration is also authorized to borrow from other agencies including interna-tional agencies, both in local and foreign currencies. The authorized capital

- 28 -

of the Corporation is Tk 200 million divided into 2 million ordinary shares of

Tk 100 each. Since its establishment in October 1976 the Corporation (till

June 1978) had made commitments of Tk 180 million to 58 projects for providing

underwriting/debenture financing.

2.65 In order to diversify its portfolio, spread risk among a group of

institutions andi boost its limited resources, the ICB has constituted a con-

sortium of 6 nationalized banks, 2 financial institutions and the Sadharan

Bima Corporation (General Tnsurance Corporation) to undertake joint under-

writing operations. During the first year of its operation, the Group under-

wrote Tk 102 million in private sect-or shares and debentures of which 55% was

provided by ICB, 37% by commercial banks and 8% by BSB and BSRS. Due to a

tight liquidity position and the lack of marketabilitv (or adequate return) of

company shares in Bangladesh, the commercial banks have shown a reluctance to

mitaintain tLiLr siLare during FY78 and of the Tk 205 m nllinn committed by the

consortium in the year the share of ICB rose to 62% (Tk 126 million). The ICB

disbursements at the end of June 1978 amounted to Tk 25 million and have been

slower than anticipated as projects have taken an extended amount of time to

complete the procedures r.ecessary to start operations.

2.6 Th aicpolm ihte structure that has culrrently been set Lip

to provide equity support to the private sector is that in view of the under-

developed nature of the capital market, companies can only expect to make pub-

lic issues after production and profitability have been established which in

some cases can be 5 years after company flotation. In the interim period,

bridging finance is made available against the underwriting commitment. This

results in debt:equity ratios of as much as 85:15 in the initial years of a

project. In addition, promoters tend to borrow directly from commercial banks

the resources required to make the promoter's equity contribution, thus in

fact raising the project's debt burden even higher. While such high debt:

equity ratios can on occasion be acceptable, in Banglauesh where shortage of

imported raw materials in particular often leads to low utilization of capac-

ity, companies are likely to have difficulty in servicing their debt, let

alone declaring a satisfactory level of dividends.

2.67 A partial solution to this problem would be for the BSB and BSRS

to take equity in certain projects, as opposed to underwriting commitments.

More fundamentally, a long-term solution needs to be found to the financing

structure of ICB. Currently, the Government is making ad hoc loans to !CB in

anticipati'on 1 lurure 1,,;bursement requirements. The tentative Investment

Schedule for 1978-80 estimates investment approvals of Tk 4,190 million for

the two years (para 2.53). Assuming that total equity component is typically

35% of project cost, this suggests an equity requirement of about Tk 1,450

million. If 50% of this has to come from institutional support, there would

be a requirement of over Tk 725 million in two years. However, commitments

bv ICB alone are already three times the level of available resources and as

commercial banks lower their participation in the ICB consortium, ICB itself

is being required to increase! its share while keeping its level of annual

commitments the same. Thus, in FY79, the total level of commitments by the

consortium could be less than the Tk 205 million in FY78.

- 29 -

2.68 Another step towards alleviating this problem would be to havegreater participation by the Sadharan Bima Corporation (SBC) in the under-writing consortium oE ICB, and by making direct equity contributions toselected public limited companies. Before the recent involvement of the SBC(to the extent of 7%) in the !GB underwriting consortium, the t:wo insurancecompanies in Bangladesh (general and life) were not very active in industrialfinancing. Both compalnies, in particular, the Life Insurance Corporation(LIC) labored under the handicap of the financial structure which they inher-ited following independence. A major part of the assets of the LIC were inPakistan and hence the company was left servicing its old policies basicallyfrom revenue generated from sale of new policies rather than income from priorinvestments. While Governmental budget allocations have assisted LIC inmeetin8 its obligations, the company has not been able to undertake industriallending of any kind.

2.69 The SBC on the other hand fared generally better and though auditedaccounts for the past thLiree years are still not available, pre-tax profits in1977 were about Tk 100 million. Annual premium income has risen from Tk 120Million in 1973 to Tk .. million in 1977 and is expected to reach Tk 350 mil-lion in 1978. The corporation has indicated that it is looking for investmentopportunities anrd, apart from a direct equity investment in ICB, it also hasa commitment to take up 10% of the equity of a joint-sector tea company whichthe Government expects to set up from the more profitable tea gardens whichit currently manages. The Corporation should be similarly encouraged to sub-scribe directly to the equity of selected private sector companies.

2.70 Greater amounts of promoters' equity contributions might also beforthcoming if the income tax clearance procedure (para 2.42) were eliminatedor modified. Individuals might then be willing to invest resources whichotherwise would flow into real estate speculation or consumption which ismore difficult to track down for tax, purposes.

2.71 Small Scale Industry Lending. Apart from BSB, the main source oflong-term finance for SSIs has been BSCIC in a consortium with the commercialbanks. This arrangemenit has not worked well. BSCIC was responsible forappraisal of the technical, organizational, economic, financial and marketaspects of the project; and for providing extension services and follow-upas well as project promotion. The commercial bank's role was limited toappraisal of creditworthiness of clients and handling disbursements andcollections. This split of responsibility in areas that are interrelated(such as follow-up and collections), and the fact that different institutionsmade decisions on different aspects of a project during appraisaL, resultedin the institutions blaming each other for mistakes without taking responsi-bility for failures. Under the provisions of a recent IDA credit, BSCIC willcease to have a direct involvement in lending operation but will focus onpromotion and extensiorn work. The term lending requirements of SC! will bemet by the commercial banks and for 'Larger SSI by BSB.

2.72 Investment Promotion. There appears to be in Bangladesh today aneed for improved investment promotion activities to assist the private sectorin preparing, formulating and implementing new investments. This would include

- 30 -

the preparation of fpastihilitv studies and nroject proposals and provision ofmanagement advisory services. The lack of such services is particularly im-port-nt given the background of the priuvte spctnr in the country today - most

of its expertise has been in the jute and cotton textile industries which arenow in the public sector. With very limited baic information on other in-dustrial opportunities being available, prospective investors seem to lackthe ability to identifyviable investment prospects.

2. 73 The existing financial institutions and the Department of Industries

do not have the capability to carry out sustained and basic promotion activity.ThLe fCnancial 4ia si4ns are 4 ttemptn - - improve their capaability in this

area, but are currently preoccupied with improving appraisal standards and

follow-up procedures. Their present efforts are rmainly concentrated, however,

in alerting prospective investors to opportunities. These opportunities aregenerally identified on the basis of information available in the InvestmentSchedule. Assuming that such opportunities do represent good investment pros-pects, however, the financial inbstitutioLLns cannot bU expeLctedLU Ut bLsLaLCU LU

provide suitable assistance such as for preparation of feasibility studies.

2.74 The Department of Industries also has the basic function of promoting

private investment though, as discussed earlier, its controi runctions ortentend to swamp its promotional role. The present Director General, Industriesis in the process of revamping the operations or tne Department to enaDie itto play a more effective promotional role. Plans are under way to set up aninvestment Promotion Center (as a free service) which would have the role ofassisting private investors to identify basic investment opportunities andgive general guidelines on the procedure involved in setting up new industrialunits in the country. The emphasis in this case is on assisting people withideas through the bureaucratic structure of investment approval, provide helpin filling out forms, etc. While such a function would be useful in speedingup the investment approval process for some investors, it would not fill thegap caused by a lack of investment ideas and the inability to formulateprojects. There are also plans to revitalize the Investment Advisory Centerof Bangladesh (IACB) to provide the more basic kinds of assistance such asfeasibility study preparation. Successful operation of such a center wouldrequire the recruitment of highly qualified staff independent of the bureau-cracy and paid well enough to prevent excessive turnover of staff to the pri-vate sector. It is unlikely that such a structure could be evolved withinthe framework of the Department of Industries.

2.75 A possible solution to the shortage of investment promotion serviceswould be to set up an institution in the private sector (with the support of

the Government) with a capability of promoting projects, making equity invest-ments on its own as well as independent projects, and providinR a range ofindependent managerial, technical and economic consultancy services. If via-hlp siiuch an institution could fill part of the gap in equity financing aswell as provide a structure for improved investment promotion services in thecountrv. Surh an institution may also Drovide a very limited amount of loan

finance to selected projects. At this time, a group of international develop-ment instituitions inrliiding the IFG, CDC (UK). DEG (West Germanv). and IPS;

- 31 -

Geneva (the internationaal investment arm of the Aga Khan) is studying thepossiilit ofetndustri 1a promotion company, with participation

by GOB as a partner to assist the private sector in Bangladesh. Discussionson the sLructure of - -Uthe------ -- ini u are stll in prUgress.

L L L fE. L ia... L. at ~LLO LU. LU . UU L ) L L � Li.t U L L. LLuc it UrCL I=b iC tiy U L CL L2.76 Th.,e financial institutions in Bangladesh ----, general] tomet-h

long term loan financing needs of the private sector, both in terms of localcurrency and foreign _urrency funds, and they should face little difficultyin meeting demand in the immediate future. Their ability to meet demand ispartly the result or the iow level of private sector investment during a majorpart of the post-independence period. As investment begins to accelerate inresponse to policy changes, however, the administrative capacity of the BSB;BSRS is being challenged and their ability to process applications could be-come another possible bottleneck in the investment cycle, in addition to thevarious other delays which have been discussed earlier. The commercial banksare increasing their support of the private sector and in the future will needto pay particular attention to the needs of smaller and cottage industries.The availability of eqluity finance is also a problem and though the activitiesof the ICB offer a parl:ial solution, additional steps need to be taken ifshortage of equity funds is not to become a serious hurdle to the growth ofprivate investment. Finally, the absence of an institution capable of carry-ing on genuine promotional activity is hindering the growth of the privatesector. The setting up of such an institution, preferably in the privatesector itself, would be an important step in accelerating investment andbolstering the confidenlce of the private sector in Government policies.

CHAPTER 3: THE PUBLIC INDUSTRIAL SECTOR 1/

A. Background and Performance

Background

3.01 The success of industrial development in general as well as exnortdevelopment depends on the performance of the public enterprises which domi-nate industrial outDut.. The Dublic industrial sector in Banvladpsh at nrpRPnt

accounts for about 50% of the value added in industry, 25% of industrial laborforce. and 85% of Tnanufasturpd exports.

3.02 The nihlic ge-tor played a leading role in the development of indus-tries in Bangladesh. From its inception in 1952 until 1971, the East PakistanTndutiitrial Development Corporation (FPT) established 74 manufacturing s

in East Pakistan. The intention was for EPIDC to set up manufacturing unitswhen the private sector was hesitant to enter anrd then to disinvest its hold-ings as soon as investors came forward. However, actual disinvestment waslimitedA to 10 -ute mil].s, 7h4ich were joint- --Aues and one pae r,il.Thus- t.- -U --' JU UILL .0 I I -.L.t -an. a U - U-L V CL-. UJ O , aiLLu ULiC F.F~ . tILti .. LIt * t

at independence, EPIDC controlled about 40% of the modern industrial fixedassetas.

1/ Details on individlual sector corporations are in Volume II, Part I.

- 32 -

3.03 Private manufacturing activities had been dominated by West

Pakistanis. As a result of their exodus at independence, the new Government

was left with many abandoned units. The Government nationalized all abandoned

industrial units with fixed assets of more than Tk 1.5 million and decided to

disinverst the remainder. It also nationalized the jute, cotton textile and

sugar industries irrespective of ownership. By 1973, the public industrial

sector consisted of about 350 units organized under eleven corporations. In

1976, in an attempt to improve management control, GOB decided to disinvest

relatively small units to the private sector. At nresent, the industrial

public sector consists of 275 units organized under seven corporations. 1/

Physical Performance

3.04 Physical production, after reaching the FY70 level in FY74, slowed

down in the next two years dUue to slackeniU,g dom0estiC Aemand. By FY77, it had

increased significantly over the production of FY73 and, in some cases, ex-

ceeded the FY70 level as the overall production itndex (FY74 = 100) reached

105 in FY77. The production index is expected to show a further increase of

10% in FY78. The main reasons for this improved trend in production are pro-

bably the improved availability of foreign exchange to import raw materials

and spare parts as well as the higher domestic demand for manufactured pro-

ducts due to the good harvests in recent years.

Table 3.1: PRODUCTION INDEX FOR THE PUBLIC SECTOR

(FY74 = 100)

Industry (Corporation) Weight /a FY/70 FY/73 FY/75 FY/76 FY/77

Jute (BJMC) 34 112 89 89 96 98

Textile (BTMC) /b 26 100 81 107 95 85

Chemicals (BCICY7/c 15 95 86 69 94 91

Steel & Engineering (BSEC) hd 10 65 82 92 81 105

Food (BSFIC) /e 14 109 60 99 100 138

Cement (BME DCY I 10O 60 270 302 581

Total 100 101 82 94 97 105

/a Based on value added in FY74./b Ratio between cotton yarn anA cloth production assumed at 70:30.

/c Ratios among major products assumed at 30% for paper and newsprint,

Jul' 0or fertilizers, 21o for soaps, 50% for footwear, and 8% for matches.

/d Ratios among major products assumed at 53% for steel ingots, 37% for

vehicies, and 11% for vessels./e Ratios among major products assumed at 46% for sugar, 34% for edible oil,

iI% for cigarettes and 9% for biscuits and bread.

SOnirce: Mission estimates.

1/ The Bangladesh Jute Mills Corporation (BJMC) under the Ministry of Jute;

the Bangladesh Textile Mills Corporation (BTMC) under the Ministry of

Textiles; the Bangladesh Sugar and Food Industries Corporation (BSFIC),

the Bangladesh Steel and Engineering Corporation (BSEC), and the

Bangladesh Chemical Industries Corporation (BCIC) under the Ministry

of Industry; the Bangladesh Mineral Exploration and Development Corpora-

tion (BMEDC) under the Ministry of Petroleum and Mineral Resources; and

the Bangladesh Forest Industries Development Corporation (BFIDnu under

the Ministry of Agriculture and Forestry.

- 33 -

3.05 Despite the recent improvement in production trends, many publicenterprises sufier liroin low capaCit-y Utilization. W[Lile average capacityutilization in the inclustrial public sector was about 60% in FY77, capacityutilization was part icularly low for tne matcn (38%), steel k4vZ0), engineering(15-50%), paper and newsprint (30-50%), and edible oil (40%) industries. 1/However, preliminary figures for FY78 suggest improved capacity utilizationin some firms (see Vol. II, Studies 2, 3 and 4).

3.06 Reasons for low capacity utilization vary not only across subsectors,but also from plant tc, plant. Nevertheless, a number of common factors under-lying the problem are identifiable. In order of importance they are: (i)irregular and insufficient raw materials supply; (ii) lack of demand; (iii)equipment breakdown and poor maintenance; (iv) insufficient labor trainingand migration to the Middle East; (v) administrative delays linked to excessivecentralization; (vi) frequent power cuts; (vii) inadequate transportation;(viii) lack of spare parts and components linked to foreign exchange short-age; and (ix) lack of working capital which prevents procurement of sufficientspares and components and even, in some cases, raw materials to operate atcapacity. Low capacity utilization is only a symptom of many serious problemsaffecting production efficiency. Remedies are discussed in the later sectionsof this chapter.

3.07 Employment in the public industrial sector amounted to 331,000 in1977, where the jute industry accounted for 59% follovred by the textile in-dustry (20%), the chemical industries (8%) and the steel and engineeringindustries (8%). The public enterprises, with the major exception of jutegoods, are mainly concerned with meeting local demand; the share of exDortsin total sales (excluding jute goods) amounted to only 6% in FY77, consistingmostly of frozen shrimns. leather and newsDrint.

Financial Performance

3_nA WfNet nrnfits hpfnrp tax nf the 9iX CGrnnrAtinnQ for FY73-FY77

are shown below:

1/ It should be noted that several definitions of "capacity" are possible,mission estimates are based on the concept or !!attainable" capacityunder normal operating conditions for the industry (see Studies 2through 5, Vol. !I).

- 34 -

Table 3.2: NET PROFITS OF SECTOR CORPORATIONS /a(Tk million)

Corporation FY73 FY74 FY75 FY76 FY77

BJMC -325 -332 -239 -285 -525(-18.5) (-20.0) (-11.6) (-9.6) (-17.8)

BTMC 100 163 123 27 -132(13.0) (12.6) (8.3) (1.4) (-7.5)

BCIC -42 3 -327 -233 149(-8.5) (0.4) (-37.2) (-17.1) (8.1)

BSEC -19 48 121 118 76(-5.4) (8.2) (13.3) (9.7) (5.3)

BSFIC -6 105 93 7 51(-1.9) (17.8) (9.6) (0.5) (3.6)

BFIDC 44 26 20 -12 -4(44.2) (26.3) (19.9) (-11.7) (-3.6)

Total -249 13 -207 -377 -385(-7.1) (0.3) (-2.2) (-4.3) (-4.1)

Total (excluding BJMC) 76 345 32 -93 140(3.9) (10.5) (0.7) (-1.6) (2.1)

/a Figures in parentheses are net profits as percentages of sales.

Source: Sector Corporations.

3.09 Several general conclusions emerge from these results:

(i) Public sector corporations have incurred heavy lossesO IL. L* L IUCCL 1sUULLC .LL AL. IL L---L-al Laxes OLand LILAL A- i

collected by Government have exceeded total losses,th[ e corporations hLIave bUeen a net dUraLin on the tBudget-in that the cost of capital has not been fully covered.

(ii) There is considerable variation in the financial performanceamong these corporations. Tne jute induscry (DJMC) sufferedthe largest losses to the extent that the average ratio ofnet profits over sales in FY77 increased from -4.1%7 to +2.1%7by excluding BJMC from the total. Financial difficulties ofBJMC (as well as BTMC) were analyzed in detail in recent Bankreports. 1/ Export prices of jute goods had to be maintainedat relatively low levels in view of stiff competition from

1/ (i) Bangladesh: Survey of the Jute and Cotton Textile Industries(World Bank Report No. 883-BD, September 25, 1975)

(ii) President's Report on the Sixth Imports Program Credit to Bangladesh(World Bank Report No. P-2155-BD, November 8, 1977)

(iii) President's Report on the Seventh Imports Program Credit toBangladesh(World Bank Report No. P-2373-BD).

- 35 -

synthetic substitute and other jute goods manufacturers, whilecosts of production remained rather high due to poor maintenanceof machinery and inefficient management particularly in rawjute purchasing;

(iii) Financial performance is not a sufficient indicator for mea-suring the efficiency of a given corporation or enterprise,not only because prices of a number of commodities producedby public sector corporations have been strictly controlledby the Government, but also because many public enterprisesserving the domestic market enjoy a virtual monopoly position.For example, the steel and engineering industries (BSEC) hasbeen able to generate sizeable profits in spite of ttheir lowproduction efficiency (as discussed in Annex III.3) due to themonopoly position of BSEC in many products and price increasesin 1976 and 1978. On the other hand, financial losses by thechemical sector (BCIC)(as discussed in Annex III.1) and, recentlv.the textile sector (BTMC) were largely due to the Government'sreluctance to grant nricp increases for fertilizers, newsnrintand textile products. 1/

Economic Efficiency

3.10 Since financial indicators can provide ambiguous indicators ofeconomic efficiency particularly for public enterprises, the dcmestic resourcecost (DRC) of foreign exchange must be estimated in order to measure economicefficiency of the pro;luction process in selected firms and indut-stries in the~... I UL~ JC LI ~IL L~ £ .L LLL dU LILUL LL L L i tlLI

public sector.

3.11 To this end, data have been collected by questionnaire supplied tothe public sector cororations. TILese dLata are useuL to estimate thllree uifier-ent DRCs: (i) the financial DRC; (ii) the economic DRC; and (iii) the incre-mental DRC. The firsi: value comes from using directly the financial costs ofthe firms and is mereLy the total domestic cost (net of taxes and duties)divided by the net foreign exchange earned or saved. It uses actual pricespaid ignoring distortions, shadow costs, etc. Capital costs were assumed tole covered by the depLeciation plus interest charges divided between foreignand domestic costs. The economic DRC measures this ratio using economic orreal rather than financial costs. rhe methodology used to estimate these isgiven in Annex III.6. The incremental DRC ignores fixed costs (i.e., capital)and calculates the DRC using the other economic variables. The results aregiven in Table 3.3. Economic and incremental methodology and assumptions usedin estimating DRC are shown in Annex !II.! and the results are summarized inTable 3.3.

1/ Profits earned inI FY78 have increased in BSEC (Tk 65.6 million aftertax), BCIC (Tk 7$.9 million after tax) and BSFIC (Tk 50.97 millionafter tax).

- Jo -

TABLE 3.3 - DOMESTIC RESOURCE COSTS /aI ~ ~

(as of FY77)

Financial DRC Economic DRC Incremental DRCIndustry (Tk/$) (Tk/$) (Tk/$)

COTTON TEXTILES1. Grey Cloth

(a) Industry Average 15.8 15.3 14.6(b) Good Mill 11.0 18.7 10.3(c) Bad Mill 15.2 12.6 12.3

2. Cotton Yarn(a) Industry Average 12.2 14.4 9.4(b) Good Mill 7.4 8.1 6.5(c) Bad Mill 17.9 21.3 11.1

,-

JUTE/' TEXTILES1. Hessian

(a) Industry Average 27.0 53.2 16.6(b) Good Mill 14.8 12.7 11.1(c) Bad Mill 66.4 45.0 25.5

2. Sacking(a) Industry Average 22.7 39.2 15.8(b) Good Mill 13.0 11.6 10.4(r) Bad Mill 25.0 20.9 14.9

3. Carnpt BAcking

(a) Industry Average 30.8 397.0 14.3(b') good Mill 23.7 108 . 19 1

(c) Bad Mill 123.1 NEG 14.5

STEEL1. Hneav-j Plate NEG NEG- 63.7

2. Steel Billet 74.6 53.6 36.2

CEMENT1 T .- ~~~~~~~~~ -7 A c71. Limestone 5.7 5.9

2. Clinker 7.0 8.6 6.2

/a DRC is the ratio between the domestic resources used in each unit ofproduction and the foreign exchange saved by producing that unit inBangladesh, rather than importing it. The ratios are expressed in lakaper dollar saved. Any ratio below 15 means that the domestic value ofresources used is less than the value of foreign exchange saved orearned at current exchange rates.

/b These are, of course, marginal values valid for small changes in outputwhere marginal costs and revenue are equal to price. Because Bangladeshdoes not face infinitely elastic demand curves for either raw jute orjute goods, major shifts in production would produce different DRCs.

- 37 -

Financial DRC Economic DRC Incremental DRCIndustry (Tk/$) (Tk/$) (Tk/$)

FOOD & ALLIED1. Sugar

(a) Industry Average 17.4 20.9 15.3(b) Good Mill 14.9 15.3 13.1(c) Bad Mill 35.3 86.6 22.2

2. Frozen Shrimp 14.4 14.5 14.23. Cigarettes :3.7 3.7 3.54. Edible Oil NFG NEG NEG

FERTILIZER1. Urea-Fenchugan; 2.6 3.7 2.92. Urea-Ghorasal :3.5 4.8 3.63. TSP 26.9 NEG 9.8

PAPER & BORRD

1. Newsprint 15.0 28.3 7.22. Particle Board 631 .8 NEG 72.23. Rayon Yarn 77.5 159.0 16.24. Paper (Karnafuli) 57.9 20.2 16.4

rUV?,AT r AT

1. Caustic Soda 279.8 NEG 41.9

/c A "negative" DRC may be caused by foreign exchange costs of productionexceeding the c.i.f. cost of the equivalent imported product. The ratiothus has a negative denominator, reflecting an absolute loss of foreignexchange from local productioII.

Source: Mission estimates based orn the questionaire supplied to sectorcorporations.

3.12 These results should be interpreted in the light of the followingqualifications. First, the questionnaire used here was simplified to a signi-ficant extent (as compared with those used in other full-fledged research onDRC) so as to minimize the data requirement from the sector corporations. Asa result, many simplifying assumptions had to be made. Second, previouslyestimated shadow prices for labor and capital were used. 1/ These estimates,derived by Kahn 2/ may turn out to be somewhat outdated for FY77. Finally,the estimates of DRC in this report are based on the price structure andefficiencies and availabilities of FY77 and these may well change in thefuture.

1/ A new study by Boston University on the estimation of shadow prices andDRCs of major industries is being financed by the Bank. The resultswill be ready by December 1979.

2/ A.R. Khan, The Economy of Bangladesh (St. Martin's Press, 1972).

- 38

3.13 Yet, several tentative general conclusions can be drawn from thesefindings:

(i) Overall economic efficiency of public enterprises appears tobe rather low as indicated by the fact that 13 out of 21products show higher economic DRCs than the average officialexchange rate of Tk 15.5 per US$ in FY77. As a matter offact DRCs for all of these 13 products exceed Tk 20 per US$.Four products, namely, heavy plate, edible oil, particleboard and caustic soda show negative DRCs;

(ii) The incremental DRC is a measure of whether the firms areable to earn or save foreign exchange efficiently if pastinvestment is ignored. Here most firms fall below a cutoff of, say, Tk 20 per dollar except for steel billet,heavy plate, particle board and the "bad" sugar mill andthe "bad" hessian miLl. The steel industry appears toneed help, 1/ as do paper and board, which are also quiteinefficient. While the jute industry shows acceptableincremental DRCs, the very high economic DRCs imply thatoperations must be made much more efficient. 2/

(iii) Finaneial nprformancp is often a very nnor indicatnr nfeconomic efficiency for an industry or a plant. The textileindustry shows a rpnsnnAhlv c-rpntahle DRC althou1gh itincurred heavy losses in FY77, while the steel industryshows a rlatively hingh DRGC when it genearated sizable profits.Furthermore, the economic DRC for a "good" cloth mill washigher th,an that for a "bad" cloth m.,1.1, while their f4nan-cial performance showed an opposite result.

(iv) These results give some indication of the industriesor firms which may require major efforts to improveproduction efficiency. Whether a given plant should beclosed or not, however, depends on the likely cost andbenefit of such efforts to improve production efficiency.Furthermore, actual investment decisions to expand produc-tion capacity for those industries with favorable DRCsshould be re-examined in view of the expected market trendsas well as investment costs. The type of analysis shown

1/ UNDP is planning to finanice a comprehensive study for: (i) estimatingdemand for steel products in Bangladesh; (ii) examining the most econo-mical means of meeting the projected demand for steel products; and(iii) finding appropriate ways to improve production efficiency of theBangladesh steel industry in the context of (i) and (ii). IBRD willparticipate in the monitoring committee for this study.

2/ Both the paper and jute industries have been studied by IDA in connec-tion with its program lending operation and action programs towardgreater production efficiency formulated.

- 39 -

here can provide only a starting point in identifyinginvestment poss4bilities, although It 'is ofL immediateassistance in separating apparent inefficiencies due toprice policy frou more fundamental causes.

B. Major Issues

Performance Criteria

3.14 Like public corporations in many countries, the public industrialsector in Bangladesh is confronted with multiple objectives and must performmultiple roles. While expected to be efficient in operating their productiveprocesses they are also required to go beyond the requirements of a privatefirm in contributing to redistribution of income by maintaining sometimesexcessive levels of employment, and by being used as channels for consumersubsidies. Under these conditions normal industrial performance criteria havelittle meaning. Profits, losses, costs, sales etc. are flows which representnot only the financial, transactions of production, but of welfare adjustmentsas well. In so far as it is possible, GOB should attempt to separate theseobjectives and roles. Where GOB requires actions and expenditures of stateenterprises which would not be normal for a private firm, these should berecognized and taken into account in assessing performance. On the otherhand, additional support afforded to state enterprises (such as monopolyrights or subsidized costs) should also be recognized in assessing performance.

3.15 Ideally, assessment of cost effectiveness in state enterprisesshould be based on economic opportunity costs and prices and the basis forsuch an assessment system should be included in industrial policies forthe public sector in the industrial strategy.

OrRanization

3.16 Each corporation is managed by a Board of Directors consisting ofa Chairman, who is the Chief Executive, and usually five directors with lineresponsibilities for the following functions: finance, nroduction, marketing,planning, research and quality control. The Board is appointed by the Govern-ment with no fixed term although, in practire, the chairm.an has been changedrather frequently, while the directors tend to remain in their posts for alonger period of timme. The Government should establish a policy that nor-mally, chairmen of the sector corporations remain in their posts for at leastthree years, so as to allow them time to play a more effective leadership role.

3A17 Tn most cases, each plant is directly controlled by the corporation.In the case of the Forest Industries Corporation and the Jute and TextilesCorporations, apart from functional departmerLts under each director, thereare zonal offices. l/ The main activity of these zonal offices is datacollection and serving as a contact point between tne mill and Corporation's

1/ Usually Dacca, Chittagong and Khulna.

- 40 -

head office. Decision-making responsibility rests with the head office,particularly with the individual directors. Clearly, it is difficult for afew directors at the head office concentrating on administrative problems ofdozens of mills to set policy, monitor the plants' performance and coordinate

their activities.

3.18 To solve this problem, the Chemical Industries Corporation andthe Jute Mills Corporation recently decided to establish a Board of Directorsfor each of the plants (Enterprise Boards). These Boards are composed of theplant manager (secretary), 1 or 2 representatives from the Corporation anda representative from the financial institutions/Banks. In addition (atleast in the case of BCIC), a number of smaller plants have been grouped atthe Board level. 1/ As most of the problems facing individual plants (e.g.,matches, rubber products, pharmaceuticals, etc.) are common, it should beDossible for these Boards to supervise closely the affairs of a smaller groupof plants. The closer and more organized supervision will also allow moredelegation of authoritv to the nlant mana2er. Further, it is easier for theCorporation's Directors 2/ to monitor the activities of a few Boards, rather

than a Board fnr each inAiviAil naint-. This allows Cnrnoration managementtime to concentrate on the supervision of plant performance, control, coordi-nation and licv-mnking- Such a system should be introduced in other corno-

rations.

3.19 In May 1976, the Government issued guidelines on "The Relationship

b(e-ween G-overn.m.ent and the Autonomous RBodies' Gorp-or ati- ns A Enterpri sesunder Them." These guidelines state that the Government's functions willbIe confiJ neA Uo poilcy-m.ak4I, nyA..Ai.L ofUI-IU-II and auditosand approval of the budget. The corporations, as the shareholder of indi-vidLuual. compiFanies , w guide ~Uand a--A 0 e4.U tIem Uo achieve the overall Governm.entindustrial objectives. The plants will act with maximum commercial autonomy.fn addILlon, thle sector cOrpULrdtilOS WtLer bUPjJjU:U LU PLtjJPaLv LXUL%:D UL Ubuiness

to define their relationship with the plants in more detail. These rules havebeen prepared by the Jute and the Textiles Corporations and iLL pLrir,cple givegreater autonomy to management. However, such powers as hiring and firing andtransferring remain with senior personnel of the corporations. Also, plantmanagers have limited power to incur local currency expenditures, but priorpermission must be obtained from the corporations for tne import or cnemicaisand spare parts. However, this latter constraint must be viewed in the lightof the need to utilize aid facilities, of which unit managers may have noknowledge.

3.20 Significant progress towards autonomy has been made in recent years.There is a tendency to allow managers to run plants with increased freedom.The relationship between the corporations and the plants has been more clearlydefined and rules of business have emerged in some areas, clarifying the

1/ Corporation Directors are Chairmen of the Boards in BCIC.

2/ This avoids the problems of Corporation Directors being Chairman of toomany Enterprise Boards in addition to their functional responsibilities.

respective roles of the corporations and of the plant management. However,progress is still needed in two areas: personnel management and power toincur local expenditures (including purchase of raw materials) to a largerextent. Specific Rules of Business emphasizing autonomy, accountability forperformance and enhancing incentives should be prepared by each corporationin consultation with plant management.

Management

3.21 At independence, most of the top level management, administrativeand technical staff of public firms were non-Bengali 1/ and left the country.in addition, when the remaining plants under Bengali ownership were nationalized.many management personnel in those enterprises gave up their posts. Thus oneof the major problems facing the Government was to identify and recruit seniorstaff to operate the plants. On the other hand, it would appear that a numberof qualified personnel were not permitted to remain in their posts or wereignored as a result of political considerations. Moreover, inadequate sala-ries and lack of financial incentives for management discouraged some com-petent executives and technicians from continuing in or taking up responsibleposts in industry. IMany of current management level staff have rather extensiveexperience in production but limited experience in other aspects related toplant management. These difficulties were compounded by the excessive degreeof centralization adopted by the sector cornorations which hindered day-to-dayoperation of the plants. Recognition of this has led to the decentralizationintroduced in recent years.

3.22 It would appear that under the present system, the performance ofplant managers is still being judged mainly on the basis of volume of output;hence, the incent_ve to nroduce at all costs. 2/ The only constraint tomaintaining output is often the availability of credit to finance production.It should be possible in the future to develop a more rational system of mea-suring performance based on making management more responsible for directingthe nroduction schedule of plants to maximize profit and efficiency.

3.23 On the other hand, plant management should be permitLed as muchauthority as possible for every day operations at plant level. Among theseare selection of personnel for all but the uost senior positions ('for thelatter, managers should have responsibility for recommending their choices),spare parts purchases, locaL raw materials purchases, financial matters with-in guidelines set by corporations and, for the larger plants, sales and cus-tomer relations. For sales, -while basic price guideiines should be set by thecorporations, plant managers should be permitted to provide special quantitydiscounts, allowances for product defects as well as price adjustments fordeviations from standard specifications, in order to maximize profits. Sale

1/ An exception is 'he textile industry.

2/ The target achievement bonus system is also an incentive for managementand workers to maximize output in order to receive the largest possiblebonus.

- 42 -

on credit 1/ should also be allowed, particularly in order to compete withthe private sector which frequently extends credit to customers.

3.24 There is an urgent need to develop an incentive system for seniorplant management. Corporations should be given maximum flexibility in develop-ing incentive criteria. Salaries received by plant managers are relativelymodest. i.e. around Tk 2,500 per month. Real income has deteriorated sincethe late sixties. Fringe benefits include housing and transportation butthere is no snecial incentive based on Derformance. Managers get the same

bonuses as the rest of the staff, festival bonus (one month salary) andproduction hnnns. 2/

' 95I Plant mnnnaers ArP asking fnr Rnpriql inrprntiv$s qurh aq thc)egranted to them before independence. The system was usually based on nettncome earned and the managers were aivun a nprcentagp of nrofits when thecompany had been profitable in a given year. A bonus was also paid when theowners were generall- satisfied with the manager's performance Qualitative

factors were thus taken into account.

3.26 Returning to this practice would seem desirable in order to reducethe gap between salaries in the public and private sectors. With the recent

growth of the private sector and also increased demand in the Middle East fortrained personnel, tlhl1e corporations are havAir,g f- -dficty 4n rai co . -- -.,--

petent managers. The Governmernt should consider carefully the provision ofspecial bonuses for managers. nowever, suchi an incentive sybLteu would pre=suppose that input and output price controls, subsidies and taxes were alltaken into account in estimating performance.

Labor

3.27 Bangladesh uses the traditional system found in the South Asiaregion of permanent workers supplemented by occasional laborers (or badlies 3/)who fill in when the former are absent. Base salaries are set by the Govern-ment within the overall wage policy. Several bonuses are granted to allworkers (festival bonus, target achievement bonus, capacity utilization bonus).They are in fact just a supplement to wages and do not act as incentives forindividual workers. Prior to independence, labor incentives, tied to produc-tion performance comprised a considerable portion of labor benefits. 4/Absenteeism is a serious problem in many enterprises, 5/ particularly during

1/ Cash sales are compulsory for public sector undertakings.

2/ The bonus is calculated according to capacity utilization and production

targets fixed annually. If targets are fully reached, bonus can amountto about two months salary.

3/ There are 42,000 temporaries in the jute industry alone.

4/ The Jute Mills Corporation has established a Committee to review thefeasibility of having an adequate incentive system for the mills.

5/ As high as 25-30% of the labor force in jute mills and 15-20% in textilemills.

-- 43 -

planting and harvesting seasons when many permanent workers as well as badliesleave to work on farms where they are able to earn as much as twice what themills can pay. At such times, some plants have had to reduce the number ofmachines in operation. An adequate incentive system would help to amelioratethe absenteeism probleim.

3.28 It is essential that production standards, used as the- basis forapplying the productio11 bonus system at the level of the individual plant,reflect not the average output for the industry but rather the technicalcharacteristics of the particular types of machines determining their potentialoutput. This will require more detailed surveys of the machines in use to fixthe standards according to types.

3.29 While labor unrest was a source of considerable disruption inproduction in the first: years after independence, these difficulties haveeased in recent years. The political changes of 1975 and the passing of theIndustrial Relations (RLegulations) Ordinance in December l975 have broughtsome improvement in latbor relations. One exception is the textile sectorwhere labor problems continue to cause disruptions, 1/ reducing efficiencyin mills to about 30%.

3.30 There are six main nationaL labor federations, all linked to poli-tical! parties. Some of th-ese national federations nave sectoral branches suchas jute and textiles. National Federations are also represented in industrialareas, through local branches. Finally, enterprise unions (there are oftentwo unions in each enterprise) are attached to the local or the sectoraltrade union brancles. It appears tLat most trade union activities takeplace at the enterprise level and that the influence of politically linkednational federations has been declini:ng.

3.31 Coliective bargaining is widely practiced. Since wage scales aredetermined at the national level, the elected collective bargaining agentsact as a link between management and workers for discussing bonuses, socialbenefits and other matters. Incentive schemes and training programs are alsodiscussed with management. There seems to be growing communication betweenlabor and management.

Training

3.32 When viewed in the context of the effect upon the industrial publicsector operations and eEficiency, the lack of suitable trained staff and theabsence of a structured program of staff training is one of the major issuescurrently facing the co:rporations. In part, the textile and the chemicalscorporations have recognized the need for an ongoing training program. BTMCis not only training surplus unskilled workers prior to their redeployment tonew mills but has now a five-year program which sets out by category the staffand workers to be trained. Training programs have been or are being estab-lished in the fertilizer and paper industry. However, such training is far

1/ This may be due to the political connections of labor leaders in thetextile sector.

- 44 -

from satisfactory and all corporations should start developing a corporation-wide training program indicating clearly: (i) the purpose of training; (ii)the content and structure of t:he program; (iii) the number, qualfications andmethod of selection of officers for training as well as the method of adminis-tering and staffing the program; and (iv) the teaching facilities and methodsto be used. Production units should prepare regular training plans to fulfillmanpower requirements and communicate these training plans to the relevantcorporation. The corporations should consult production units when preparingtechnical training programs.

3.33 Special attention should be paid to the training of temporary,

casual workers (badli). Some formal training should be given to the largestpossible number of badli workers who may be expected to be required for vary-ing periods of time. Training these workers on the job only, as is the cur-rent custom, can lead to unnecessary disruptions in production flows. Successin this type of orientation has been achieved in the Adamjee Jute Mill by theU-K. tprhnicn1 assistance mission and this experience can serve as a model,particularly for larger mills in various sectors.

3.34 Training seems to be related more to the needs of individuals thanto organizational reouirements. For example. training abroad for engineers

and technicians has come to be expected as a right or reward, with littlerelevance to actual works needs, Trainees sometimesQ coTne back from abroad andare then transferred to other activities. Training abroad should be carefullyplanned, not only because it is expensive, but also because it is essential, inparticular for small firms specialized in the production of specific products,to be able to send staff abroad in order to be kept informed of technologicalchanges in the industry.

3.35 Management training is provided by the Bangladesh Management Devel-opmr.et Center (BC)VU% under the Min`ster of Tndustry an' Ile Tns-iule of4

OpitleilL ~~~~~~~~LIL ~~~L \UL'W'~~~~~.J ULIU~~~~L Lii~~~~ LL.LII.L~~~~~ L~~L 01. ~~~~- iIUU~~~~ Li y ~~~~iiu LL1'~~~~~ ~~ LL L L LL. L.ULuU L IJL

Business Administration (IBA) of the University of Dacca.

Table 3.4 CHARACTERISTICS OF THE MANAGEMENT TRAINING INSTITUTIONS

(per annum)

BM"wC IBA

Clientele --- 16,000 ----Staff 20 10

Capacity ia NA 100Enrollment /a 52 70Output 52 35-40

/a Regular training only; does not include specialshort-term courses.

Source: BMDC; IBA.

The extent to which training institutions have failed to fulfill their purpose

is seen in two statistics: only 2% of managers have relevant professionalqualifications, and 86% of senior managers have had no in-service training.

- 45 -

The Government and othier employers have assumed that the conventional degreesrequisite to appointment as managers would provide management and leadershipskills. The current weakness of management in cornorations shows the errorin this assumption. The number of able managers is also limited by the shortperiod since independence and historical factors which prevented Bengalis fromgaining experience during the colonial and Pakistan periods. Finally, thesetting in which managers operate also contributed to the present problem:even fully competent managers could fail under the organizational and pro-cedural handicaps now imposed. Therefore, attacks on this problem must becarried simultaneously in two directions: (i) to increase the quantity andquality of management training while (ii) examining and rationalizing theadministrative structure itself. It: is clear that the existing institutionsdo not serve their potential clientele adequately. The capacity in BMDC andIBA is underutilized. Intensive training programs should be expanded to pro-vide senior mi- l management opportunilies Lo familiarize themselves withmodern management techniques to supplement their existing knowledge.

3.36 Technical and vocational education and training programs are pro-vided mostly by two Ministries: Education and Labor. The former consistsof (i) engineering education, (ii) technician and commercial education, and(iii) vocational and' s7is1 training. The Ministry of Labor program ispresently limited to the operation of Technical Training Centers (TTCs) fortraining skilled workers. There are also a few small private vocationaltraining schools. There is no non-formal skill training to serve the needsof the populaLion wno have not attained the minimum entrance education(Grade 8) for the formal training programs. 1/

3.37 The technicaL and vocational subsector suffers from an absence of(i) accurate knowledge of employment prospects for graduates, and (ii) coor-dination of the initiatives of the several ministries concerned. Shortlyafter independence, 80%, of graduates of polytechnics were unemployed. Atpresent, officials maintain that graduates promptly gain industrial employmentrelated to their training; however, some employers are reluctant to hiregraduates who are not experienced in specific jobs or with specific equipment.The annual estimated supply of nearly 700 engineers and 2,100 technicians isobviously out of proportion to the annual supply of only 1,400 skilled workers.Supply of technical and vocational teachers is provided by two institutesoperated by the Ministries of Education and Labor. Both are unattractive toprospective students because of poor quality of training and available train-ing spaces are unfilled. There is no systematic provision for teacher trainingfor vocational training: institutes. Curricula are largely based on instruc-tion in industrially developed countries. Some changes have occurred in pastyears but the following problems remain: (i) curricula have not been adjustedto the socio-economic conditions of the country; (ii) teachinz is far tootheoretical; (iii) links to industries are weak; and (iv) practical work isnot considered in student evaluation. Clearly, for the needs of industry, andto meet the demand for technicians in the Middle East, a complete revision andupgrading of the technical education system is needed. Increased technicalassistance would be advisable in this area.

1/ Only 10% of the school age population finishes Grade 8.

- 46 -

Pricing Policiesa and Financial Stwruture

3.38 Government pricing policies have a lar impact on rofi tabh ili

of the mills. An example is textiles. The latter are considered "essentialcommodities' by the overnment so the Textiles Corporation (BTMr) can onlyraise prices on approval by a Price Advisory Board. From early 1975 throughMiay 1976U, iLn spilte o cost inCrlceases, BTMIC uaintaiLned itL pLricLs inI the Lfcel

of its large inventories and the depressed demand conditions. In fact, millswere authorized LU permit 0ume price UL IuUIIts as a IUe II to proUIoLe aIeI.

At that time, in view of the previous period of profits, BTMC was sufficiently-- I - fI C - f lf-flt

iiquid to absorb the cost increase. With the recovery of aemana in 176i, DIT'IM

obtained approval for a price increase averaging about 8%. As its raw materialcosts continued to rise, BTMC sought further price increases but the PriceAdvisory Board has not permitted major changes; in January 1977, selectiveprice rises were permitted of the order of 3% only. 1/ Thus, Government pricepolicies directly influenced the profitability of the Textiles Corporation.

3.39 Another case is the edible oil industry which has suffered lossesin recent years due to the fact that refined oil is considered an essentialcommodity and is subjected to tight Governmental price control. Productioncosts have risen faster than selling prices with resulting large losses forthe industry in FY76 and FY77. A third example of pricing policies affectingprofitability of the industry is paper. The paper mills have been operatingat a loss for several years. This is largely due to the fact that domesticprices of newsprint and paper have been kept at an artificially low level bythe Government. Such low prices are in effect a subsidy to the newspaperpublishers and readers. Should the Government wish to keep reading materialat a low cost (e.g. for educational purposes) direct subsidies could beprovided but the mills should not be allowed to suffer from it.

3.40 Pricing policies in public sector enterprises should be revised inorder to separate consumer subsidies and "social" pricing from considerationsof productive efficiency. The Government considers it necessary to supply"essential" commodities such as textiles, edible oil, paper and pharmaceuticalsat particularly low prices for social reasons. Such prices are often setwithout due regard to factors affecting costs in the plants with resultingheavy losses for the latter. The problem is thus to separate subsidies whichhave to be borne by the Government and true costs of the enterprises.

3.41 Public enternrises should be allowed to realize Drofits indpnend-ently of the subsidization policies of the Government. Profitability canonly hp mpasu1rpd hy making a drastir and rlear division hbtwepn nublic enter-prises as firms, and public enterprises as welfare institutions. To makethis division effective, the Government would have to apply som.ething like themanagerial methods of a private firm. Salaries, wages, staffing and operatingmethods must all be directed at the single objective - profits. Tn additi4-,

subsidies should be applied as close to their point of impact as possibleanA not loaAed ontothef the cs ofthe last firm handling the product.

1/ Prices were finally increased by 25% in October 1977.

-- 47 -

3.42 Some of the enterprises may never be profitable, even if the abovemethods were adopted. In this case, the basic approach is simiLar, but, ratherthan distribution of surplus, the question is one of justifiable subsidy to theproducer. This would require careful analysis of the social costs and benefitsof continued operation so that the Government takes into account the true eco-nomic cost of whatever approach it uses. Such an analysis is important whetheror not the Government is really serious about creating efficient public enter-prises on an autonomous basis.

3.43 Apart from an improvement in profitabiity, there is need to reestab-lish the capital structure of many firms. It must be recognized that a betterfinancial structure must be accompanied by improved production efficiency, inorder to ensure that there is no further erosion of capital. Provided effortsare made to improve ef:"iciency, the Government should endeavour to reduceexcessive financial charges now burdening public enterprises. This should bedone not only by converting long term liabilities (to commercial banks and tothe Government) into eqiuity but by strengthening the capital structure of in-dustrial undertakings t:hrough increases in share capital. However, it must beremembered that equity is not a free good. It may indeed have a higher costthan borrowing; it is, however, more management since dividends can be post-poned.

Disinvestment

3.44 It is the Government's policy to disinvest small companies wn ichwere nationalized or taken over as abandoned firms. A Disinvestment Boardhas been set up, chaired by the Advis-er for Industries. Members include theSecretary of the Ministry of Industries and Chairmen of the Corporations.Disinvested firms aze sold by auction to interested parties. Terms of pay-ment are very favorable since the buyer does not take over any uncoveredliabilities, 1! and 20% down payment is required only. The remaining 80% ispayable over a seven to nine-year period.

3.45 Since buyers can usually acquire disinvested firms at relativelylow prices, 2/ it is not surprising that corporations have been able to dis-invest quickly. However, it seems that in many cases the disinvested firmshave been put back into operation only after some delay or not at all. Inaddition, the entire staff is usually fired by the new buyer who is then freeto close the piLant for as much time as needed and recruit new staff beforestarting up again. It appears also that some buyers are not interested inoperatLing thle firms (which they are not qualified to do in some cases) butrather in waiting until the value of land and buildings increase sufficientlyto sell them at a profit. Rapid purchase of firms earmarked for disinvestmentmay be as much the result of real estate speculation as eagerness to turngovernment firms into private ones.

1/ Liabilities to Banks and Corporations are paid back by the DisinvestmentBoard through payments made by the buyers.

2/ The book value of fixed investment is multiplied by 2.25 and land isestimated at the current market value.

- 48Q -

3.46 A number of small firms have been disinvested so far, including10 by the Steel and Engineering Corporation, 28 by the Chemical IndustriesCorporation, and 25 by the Sugar and Food Corporation. However, their contri-bution to total corporation sales was on the average about 5% only. The mUaineffect of disinvestment is to relieve the Corporations of the burden of admin-istering smail, often unprofirabie companies. This is itsell a beneficialresult and it is recommended that the Government pursue its present disinvest-ment policy to the maximum feasible extent. Four match factories have beendisinvested but three others remain under BCIC control and it is difficultto understand why these factories are still in the public sector. The sameapplies to five rubber products industries which are also still in the publicsector whereas five others have been disinvested. Soap and detergents couldbe disinvested (one soap plant has already been disinvested) and the threepaper packing and converting plants, which are relatively small, mightalso be sold to the private sector.

Rehabilitation of Existing Equipment

3.47 One of the main causes for the low level of production efficiencyin many enterprises is the poor state of the equipment resulting from negligentmaintenance practices as well as the lack of investment for rehabilitation,balancing and modernization in the past. The absence of adequate maintenanceof spare parts facilities should also be recognized as a critical problem.

3.48 Balancing and modernization programs have been established for jute,textiles, and paper. However, rehabilitation of existing equipment is alsoneeded in fertilizers, steel, sugar, and cement, and to a lesser extent inrubber products, matches, pharmaceuticals, construction materials, and woodproducts. For these subsectors, production is usually well below nominalcapacity. Among the principal factors are the poor state of the equipment,which has suffered from both inadequate supplies of spare parts and a virtuallack of appropriate maintenance programs, and the shortages of skilled laborand management.

3.49 There is therefore a need to obtain more efficient use of the equip-

ment combined with a general rationalization of available capacity. Emphasisshould be placedDA o.aasemepnt nf the overall condition of the equipmentof each plant taking into account the expenditure required to bring capacityup to an acceptable level of output and efficiency. For example, there areplants which have a very large proportion of technologically obsolete machinery;p _ fo. . 1 _ 1 . . Ar the smaller o would apear m rational to eaicL L , - , - I L 1 -I 7XV L L *olk, - _ _ - V-t - - - - - - -;.w._ =z__

operations than to replace this equipment. There are also some plants whichLlave beern poor'Ly constructed or hLLave notlJ Ilad a-equate structural foundationsgiven the soil conditions at the site, these difficulties have adverselyaiLecteu machine opLeratioLs and rake m fficient u-liQzatlon all but impossibAle.

3.50 For tne plants where the muajor problem is the poor condition of theequipment (i.e., without obsolete machinery) it will be necessary to determinethe costs of overhauling and the expected increase in output in order to estab=-lish cost/benefit relationships. On the basis of the estimates prepared byeach firm, the Corporations shoulid be abie tO estimate total expected outputand equipment requirements to meet the expected future demand levels.

- 49 -

3.51 The objective of a rehabilitation program for the main subsectorswould be to reduce production costs. To achieve this objective, it isnecessary to consider::

(i) rehabilitation of worn out equipment where technicallypossible; 1,'

(ii) programs for improved plant productvity through adequatemaintenance and spare parts facilities; and

(iii) closure of units which cannot be brought to efficientoperation. For example, closure of a plant with a veryhigh or negative DRC would result in an economic gainto Bangladesh.

Corporation Planning Departments should prepare an overall long-term rehabili-tation program, taking into account all these factors and based on expecteddemand as well as foreign exchange requirements of the industry. The programshould include the setting of-quantitative targets to improve productionefficiency and also profitability.

3.52 More small workshops could be installed in plants to repair andproduce spare parts. This is particularly necessary in plants where themachinery is obsolete and the particular equipment and spare parts are nolonger produced. 21 An alternative wouldU ue to set up large workshops whichwould repair and/or manufacture spar-e parts and supply them to individualmills. However, the number and kind oL spares to be produced is very largeand there is a wide variety of small plants in many different subsectorswith quite A,versified types OL machinery. Because of the scattered natureof the industry, it would probably be difficult to manage efficiently largecentralized workshops. Moreover, excess capacity in large-scale engineeringis likely to increase in the near future (Vol. II, part 1). However, it isoften necessary to repair rapidly and produce spare parts on the spot toprevent stoppage in operations. Communications and transportation are also aproblem, particularly Eor mills located in remote areas. For these reasons,it seems more appropriate to encourage setting up small workshops in plantswhich would maintain o:r produce simple spares to meet urgent requirements.

Conclusions

3.53 GOB has three broad options in managing the public sector. Thefirst, disinvestment, has been used in the case of about 80 firms. Planned

1/ In some instances when the machinery is obsolete and the particularequipment and spare parts are no longer being produced, cannibalizationof some of this eqjuipment would allow for some rehabilitation of thebetter maintained units. However, this is likely to be limited ineffect since the worn parts will be the same in all machines.

2/ Examples can be fc,und in severaL subsectors (jute mills, match factories,rubber processing plants, etc.).

- 50 -

disinvestment is almost comDleted. Some of the disinvested firms are operat-ing profitably, some are making losses, and in some cases have been closeddown by the new owners.

3.54 In those firms which it has decided to retain. GOB is attemDtingto apply the second option, of creating efficient public enterprises. Somesteps are being taken to establish the firTn on a mnrp autonomous basis.But this is only a beginning. Unfortunately, there is a danger, given thedifficulty of taking the full measures necessary to create efficient opera-tions, that GOB will have to adopt option three in many cases, that is tocontinue with the firms as -rtual extensions of the Government machinery.

3.55 Two problems are evident. First, true profitability can only be

measured by making a drastic and clear division between public enterprisesas firmsUO, and.... public.L etLLrprLisL LOs es as welfare inst itu t iLOns. LTo make tliso

division effective, GOB would have to adopt something close to the managerialstyle of' private firm. Lalaries, w .ondituions, -tfing -d_ operatin-g

methods must all be directed at the single objective - profits. The questionis whether GOB is willing and able to implement the difficult decisionsneeded to achieve this objective (in such areas as pricing, salary scales,hiring-firing, closure) for its public enterprises.

3.56 The second problem is that some of the enterprises may neverbe profitable, even if the above methods were adopted. In this case, thebasic approach is similar, but, rather than distribution of surplus, thequestion is one of justifiable subsidy or of closure. This would requirecareful analysis of the social costs and benefits of continued operation.Thus, in analyzing the public sector firms in the context of any industrialstrategy, special attention must be paid to analyzing social efficiency.The public enterprises cannot be judged by a simplistic "bottom line"criterion. Their contribution should be estimated in social opportunitycost terms and not purely on their ability to mobilize domestic resourcesin purely financial terms.

3.57 During the Two-Year Plan period, the Bank could assist GOB in itsattempt to move towards a solution to the public enterprise problem by con-sidering technical assistance for: (i) participating in the programs andstudies necessary to rehabilitate some sectors (such assistance is alreadybeing provided for the jute and textile industries and work on other sectors,such as paper, could be expanded). However, the Bank could also assist inways not requiring extensive manpower. For example, the Bank will participatein the Monitoring Committee for the steel study and rehabilitation project nowbeing approved by UNDP), (ii) assisting the Government to pursue disinvestment,especially of some smaller plants which cannot run efficiently in the presentstructure, but which have good potential for single unit operation; (iii)helping organize and provide assistance in training in view of the current"brain drain"; (iv) assisting GOB to rationalize the problems of managerialtenure. incentives and generallv develop a stronger relation between Droduct-ivity, rewards, and sanctions; and (v) assisting in the revision of pricingpoliries hb wav of sparating consiumer sibsidips from ronsidpration of

productive efficiency.

- 51 -

CHAkPTER 4: EXPORT DEVELOPMENT 1/

A. Ejxort Structure and Recent Trends

4.01 Whatever the 3hape and nature of the industrial strategy that isevolved for the Five Year Plan 1980-85, GOB has already indicated that manu-factured exports should and will be seen as an important means of attemptingto improve industry's contribution to national development. This is espe-cially important through the imnact of exporting on productive efficiencyand foreign exchange earnings. Manufactured exports are already important butthe level of Bangladesh's exnorts has been low. Between FY73 and FY77, totalexports averaged about US$370 million per annum, equal to about 35% of totalimport paymenats in this period. As the export sector accounts for roughly 8%of the value added in agriculture and industry, it plays a relatively minorrole within the Bangladesh econoy

Table 4.1: E-YPORTS

(million US$)

Annual Increase inAverage Average sti'mate Growth Rate FY78 over

Commodities FY66-FY70 FY73-FY77 FY78 FY73-FY77 FY77

Jute 331.0 302.0 340.0 -1.6% 18.5%(304.0) Ia

Others 145.8 65.5 150.0 35.7% 28.0%(28.9%) /a

Total 476.8 367.5 490.0 4.4% 21.3%(332.9) /a

/a Excluding exports to West Pakistan.

Source: BBS, EPB and Mission Estimates.

4.02 The export sector is dominated by jute as jute exports have consti-tuted about 80% of total exports and Bangladesh is the major exporter ofraw jute and jute goods in world markets. The export earnings from raw juteand jute goods averaged about US$116 million and US$186 million, respectivelyduring the period of FY73-FY77. Production of raw jute accounted for 6% ofthe value added in agriculture and the jute industry for 15% of the valueadded in industry. Non-jute exports, consisting mostly of tea, semi-tannedleather and frozen shrimp, amounted to only US$66 million during this period.

1/ Problems and prospects for major manufactured exports are discussedin Annex IV.1.

- 52 -

4.03 Export earnings increased in nominal terms at a rate of only 4.4%per annum between FY73 and FY77 and total exports in FY77 were 15% lower thanthe average level of exports (including exports to West Pakistan) during thepre-independence period of FY66-FY70. There are two major reasons for such apoor record. First, exports to West Pakistan, which constituted about 30% oftotal exports from East Pakistan, ceased at the time of independence. Withthe exceptions of tea and jute, Bangladesh experienced considerable difficultyin finding alternative export markets, particularly for newsprint, paper andmatches. Second, iute exports were stagnant in this period (actually showinga decline of 1.6% per annum) dlue to a number of factors, particularly, increas-ing competition from synthetic substitutes. Non-jute exports grew by 36% perannum in this period, but from a low level so that the overall export trend wasnot much affected. Between FY73 and FY77, tea exports increased from US$9.4million to US$36.0 million, frozen shrimp from US$3.0 million to US$16.9 mil-lion; and semi-tanned leather from USS15_8 million to USS37.9 million

4.04 The export nirttirp durina FY78 is much imprnuoed- Fxnp-rt- earningsfrom jute are likely to grow by 19% over the FY77 level, as the export pricesof both raw Jute ann3d Jute goods have incresed r_apidly though thi wass largelydue to the low level of raw jute production during the last three seasons.Non-jute exports are also expected to maintain recent growth rates so thattotal exports in FY78 are likely to be about US$490 million, recording an4-.rase of 21% over the FY77 level.

4.05 AJ L. Bt e F aInu FY77 I I anuLactured exports a-uou[.tedU L US$22L0

million per annum, representing about 60% of total exports. Jute goods wereby far the most important item, constituting 85% of all manufactured exportsin this period. Semi-tanned leather was the second largest item with an 11%share in manufactured exports.

Table 4.2: MANUFACTURED EXPORTS

Value (Million US$) Percentage DistributionAverage Estimate Average Estimate

Commodities FY73-FY77 FY78 FY73-FY77 FY78

Jute Goods 186.1 227.5 84.7 76.3Leather 25.0 40.0 11.4 13.4Forest Products 3.2 8.2 1.5 2.7Special Jute Products 0.5 1.3 0.2 0.4Handicrafts 0.4 1.3 0.2 0.4Petroleum Products 3.7 16.0 1.7 5.4Others 0.8 4.0 0.4 1.3

Total 219.7 298.3 100.0 100.0

Source: EPB and Mission Estimates; Annexes IV.7 and IV.8.

Various products such as newsprint, paper, naphta, furnace oil, handicraftsand jute carpets made up the rest of manufactured exports.

- 53 -

4.06 The overall structure of the manufactured export sector may besummarized as follows:

(i) At present, jute-related products are clearly the mostimportant exports for Bangladesh. They have lost somemarkets as a result of technical change and competitionfrom synthetics. Nonetheless. Bangladesh Droducers stillhave a potenw:ial comparative advantage in jute goods,because of their high qualitv iute and low wage costs-Furthermore, the competitive superiority of syntheticsubstitutes has hben rediuircti lightly hv rpepnt inrcrasesin oil prices and high capital costs fcr new syntheticsnlaqnts. Exrport- develorpment, of ju,te produc,ts aie atmaintaining as much as possible of these existing marketsand developing new markets through active research andmarketing efforts must be a central objective for the-mmediate fut:ure.

(ii) The public slctor accounts Lor more tha 8% o EL allmanufactured exports in Bangladesh. Exports of mostof these products, particularly Jute goods, newsprintand paper products, result in large financial lossesdue to the low level of erriciency in the public enter-prises which produce them. Thus, improvement in themanagement oij these public enterprises is an importantaspect of export development.

(iii) Manufactured exports by the private sector consistlargely of semi-tanned leather and handicrafts. Mostof these prirate exporters are small businessmen withlimited financial resources and little experience inexport market:ing. A medium and long term exportdevelopment strategy designed to broaden the presentnarrow export: base would necessarily involve the Gov-ernment's active support to potential exporters interms of not only financial resources but also tech-nical knowhow in marketing and product development.

B. Present Export Incentives and Institutional Framework

Export Incentives

4.07 Export Performance License (XPL). Under the XPL scheme, exportersreceive additional import licenses for specific products over their normalpercentage allocation cf the f.o.b. value of their exports, within six monthsof realization of export proceeds. If the value of import license is lessthan Tk 5,000, the exporter can wait until such time as his entitlementunder XPL reaches Tk 5,000. Eligible industries and their respective ratesof entitlement are specified in the Import Policy, which is published by

- 54 -

the Government semi-annually. At present, the scheme covers 63 commoditieswith the rate of entitlement varying from 10% to 40% of the f.o.b. valueof exports (Annex IV.2). Items may be added if they are recommended by theExport Promotion Bureau and approved by the Government. Major traditionalexnorts such as raw iute. ;ute aoods and tea are excluded from the scheme.Import licenses under XPL may be transferred one time to a recognized indus-trial unit or a registered commercial imnorter. A wide range of rommodities.as specified in the import policy, may be imported under this scheme.

4.08 Before the devaluation of the Taka in May 1975, import licenseswere sold at a substantial premium (about 100%) and this as. important indetermining the profitability of the beneficiary export industries. As theofficial exchange rate has become more realistic and the availability of for-eign exchange has improved recently, the financial premium of XPL has beenreAuceA. At present, XPT has a ---- 4um. of about 28% abve th.e- oiL4c4al ex-change rate and probably about 10% of all XPL's issued are being traded.

4.09 The primary objective of XPL is to provide exporters with sufficientImpULLs o. raw matLrt!LLts, sp ariLU 1UrLtsa d a 1Lh L LUL foricreased export activ=ities. By allowing XPL to be transferred, exporters are also offered a finan-cia. iLnceLtive since X4I may e tradUeU at a premiuUL. Ab iLLpULL LcULIL s LU hLUave

been quite restrictive in Bangladesh due to the shortage of foreign exchange,thfe XLL system has proved to be a powerful incentive for some exporters, par-ticularly leather exporters. Unfortunately, the rates of entitlement for dif-ferent commodities are determined arbitrarily and changed frequently, creatinguncertainty for exporters as well as inequity among export products. Veryoften the rate is increased for slow moving items ana reaucea for rast movingitems, resulting in financial rewards for bad performance and penalties forgood pertormance. Rationalization ot the entitlement structure (say, a uni-form rate applicable to the net value added content of all exports) needs tobe considered.

4.10 Rebates of Indirect Taxes. Import duties paid on raw materials andpacking materials used for export goods, and sales taxes and excise dutiespaid on finished goods, which are exported, are refundable. Total export re-bates under this provision amounted to Tk 2.4 million in FY74, Tk 2.9 millionin FY75, Tk 19.1 million in FY76, and Tk 15.8 million in FY77. Recently, theGovernment has established a bonded warehouse at the premises of a garmentexporter so that customs duties on imported raw materials are avoided. Asthe demand for such facilities increases, this firm-specific approach mustbe replaced by a processing zone.

4.11 Tax Reduction on Export Income. Income from non-traditional exports(i.e. products other than raw jute, jute goods and tea) qualify for incometax reductions of upto 50% of the income tax attributable to export sales,depending on the proportion of export sales to total sales (Annex 4.3). Theactual financial benefits for exporters under this arrangement cannot be esti-mated; since this exercise is done as a Dart of the normal income-tax assess-ment process.

Table 4.3. EFFECTIVE EXCHANGE RATES FOR EXPORTS(annual averages, Taka per US$)

Nominal Effective Exchange Rates adjusted Real Effective Exchange Rate adjustedl forfor Export Subsidies, Export Taxes and XE'L Purchasing Power Parity (1972/73 prices)

Period Rate (Nominal) ____ ___

Raw Juite Jute Goods Tea Others Aver Raw Jute Jute Goods Tea Others Average1972/73 8.0 7.7 9.2 9.2 8.4 8.6 7.7 '9.2 9.2 8 8.6

1973/74 8.2 8.2 9.4 9.8 8.9 9.0 7.0 8.1 8.4 7.6, 7.7

1974/75 8.5 8.5 9.1 8.5 9.8 9.0 6.2 6.7 6.2 7.2' 6.6

1975/76 14. 8 13.7 15.6 14.8 15.4 14.9 122.2 13.9 13.2 13.El 13.3

1976/77 15.'5 14.1 17.3 13.9 16.2 15.9 ]L3.0 116.0 12.8 15.Ci 14.7

1977/78 15.C) 13.'6 17.4 13.7 15.8 16.0 1L2.4 15.9 12.5 14.4 14.,6

Ln_n

Source: Mission estimates.

- 56 -

4.12 Export Subsidies and Taxes. In view of the deteriorating financial

position of the jute industry as a result of its accumulated losses since

indenpndpnne; explicit export subsidies are now provided to the jute industry

at 10% of the f.o.b. value for sacking, 15% for carpet backing and 20% for

hessian, resulting in a weighted average subsidy of about 16% for all jute

goods exports. For the purpose of maintaining the domestic price of raw jute

at a reasonably low level for the jute industry; an export tax on raw jute has

also been introduced at 10% ad valorem for long jute and 8.5% for cuttings.

To encourage exports of processed leather, an export tax is imposed on wet blue

leather at 10% ad valorem. In order to ensure an adequate supply of tea for

the domestic market and reduce windfall gains in tea exports due to the recent

favorable trend in export prices, an export tax of Tk 1 per lb. is levied on

tea exports. The main objectives of imposing these export taxes seem to have

been met without serious adverse effects on overall export performance. How-

ever, since an export tax is a response tLo short-term changes in fe demand

and supply situation, it should be flexibly adjusted to any new situation

that may develop in the future; and the basis for its calculation and applica-

tion stated clearly for the benefit of producers.

4.13 Export Financing. Commercial banks offer exporters preshipment and

packing loans at 10.5% interest (instead of the conventionaal rate of 13%0) for

upto 90% of the Letters of Credit or confirmed export orders. In an attempt

to strengthen export financing, these banks initiated training programus and

designated selected bank branches as "export branches" specializing in export

financing. An Export Credit Guarantee Scheme, designed to provide insurance

to banks/exporters against losses arising from risks in export financing, has

also been introduced. The Scheme, administered by the Sadharan Bima Corpora-

tion, covers 85% of the loss caused by commercial risks and 95% of the loss

caused by political risks at a premium of 0.075% to bankers for preshipment

financing and 0.25%-0.75% to exporters for post-shipment financing.

4.14 . Immediately after independence in December

1971, Bangladesh devalued the Taka by 53%, while abolishing the "Bonus Voucher

System" which was instituted to promote manufactured exports. The value of

the Taka had since deteriorated considerably due to high rates of inflation;

by May 1975 the cost of living index in Dacca had increased by some 120% over

the FY73 level. The profitability of the export sector deteriorated as the

exchange rate (which stayed at about Tk 8 per US$ until May, 1975) became

increasingly unfavorable to exports. In November 1973, the Government intro-

duced the export cash subsidy scheme and the subsidy rates were then gradually

increased to 30% of the f.o.b. value, covering about 90 commodities, other

than raw jute, jute goods and tea, with a few minor exceptions. 1/ In May

1975, the Taka was devalued with respect to the Pound Sterling by 85%. At

the time of the 1975 devaluation, all export subsidies were abolished. Since

then there have been several minor adjustments and the official exchange rate

i6, a' present, about Tk 15 per US$_

1/ Subsidy rates were higher for certain products such as spices,

handicrafts (40%), silk yarn (50%) and silk fabric (75%) and lower

for frozen shrimp, prawns and frog legs (10%).

- 57 -

4.15 Effective Exchange Rate. In order to estimate the combined eftectof the official exchar,ge rate and various types of export subsidies and taxes,"effective" exchange rates were calculated for major export products; name -,raw jute, jute goods and tea and other exports. 1/ Export subsidies includedirect cash subsidies, benefits under the XPL scheme and ad hoc subsidies tothe jute industries (which are assumed to be equal to the cash deficits in-curred by the jute industry in a given year, except in FY78 when subsidiesbecame pre-specified in terms of actual export earnings). Other types of ex-port subsidies such as lower interest rates and income tax reduction are nottaken into consideration in these calculations. These effective exchangerates (Table 4.3) are then adjusted for purchasing power parity hased on therelative trends of the GNP deflator in Bangladesh and the United States.Several observations can be drawn from these results:

(i) The real effective exchange rate for exports declinedgradually during the period FY73 to FY75 due tothe high rate of inflation in Bangladesh. Exportcash subsidies introduced in November 1973 failed tooffset this trend. The Taka devaluat4on in May 1975resulted in doubling the real effective exchangerate, which has improved slightly in susequentyears as a result of the stable price level inBangladesh in this period.

(ii) As the existing export incentive schernes are commodity-specific, there are sizable variations in the level ofthe effective exchange rate among products. For example,the effective exchange rate for jute goods, the highestat the morm.ent, is 28% higher than that for raw juteand tea.

(iii) The average effective exchange rate for the exportsector after export subsidies, XPL, and export taxesis at present only 7% higher than the official exchangerate. Thus, the significance of the various exportincentive measures and export taxes appear to be theirdifferential effects on specific commodities.

(iv) The real effective exchange rate is obviously a cri-tical factor in determining the profitability of theexport sector. The Taka devaluation in 1975 resultedin a higher Taka value of exports and much higher profitsfor most export products, with the notable exceptionof the jute industry, which had to pay much higherprices for raw jute due to the devaluation as well asthe fact thal: the export trade of raw jute was also

1/ Export subsidies lend to increase the effective rate for an industryby making foreign exchange "cheaper" than the nominal rate. Taxeshave the reverse effect.

- 58 -

transferred to the private sector. The improved pro-fitability resulted in more exports in many cases,although the resulting increase in export volumeappears to have been moderate as compared with that inthe real effective exchange rate. For example, averageexport volume during the period of FY76-FY78 showedan increase of only 9% over the period of FY73-FY75,while the increase in the real effective exchange ratewas 87% between these two Deriods. The reasons weremanifold: (a) the public sector which accounted forthe maioritv of exnort earnings. tended to be lessresponsive to price signals (e.g. jute goods and papernrnducts&); (h) ranid inrrease in the sunnlv available

for export was constrained by the inability of manysmall prnoduicrs to inrreRae thepir nroduction due to

structural deficiencies (e.g. handicraft, wet blueleather, and frozen shrimp), and (c) development ofnew export products was hampered by the lack of know-how on export marketing .- A -roduct developmen o as

well as the uncertain investment climate. Clearly,whle devaluation is a policyn option opnin to. GOB, itsWIL .L ',~ VOXLUL *ILL C 0 jJ l -A . .tL. *J L tL - -~J

application should be preceded by careful analysis ofthe current sLtat e eLoL'L t L kLe i ndUbs o ILactUors i- t hLIe

industrial and other sectors.

Institutional Framework for Export Promotion

4.16 The Export Promotion Bureau (EPB), a specialized government agency

under the Ministry of Commerce, piays a central role in various activitiesrelated to export promotion. EPB, which was established in 1963 as a branchof the Pakistan Export Promotion Bureau, has a head office in Dacca and threeregional offices in Chittagong, Khulna and Rajshahi. Recently, the Bureaubecame a semi-autonomous body and its structure has been changed and expanded.It is, at present, governed by a Board of Management, consisting of theMinister/Adviser in charge of the Ministry of Commerce (the ex-officio chair-man), the Vice Chairman (the chief executive of the Bureau), the DirectorGeneral of the Bureau, two part-time members representing the private sectorand six part-time members representing various Government Ministries. Themain functions of EPB are defined as:

(i) "to suggest to thLe Governmuent measures des6ignedU LU

provide efficient, adequate, economic and coordinatedplanis andu poUIIiczes LUL pLUmiULLUL Ut expUorts fLroru the

country by both private and public sectors;"1

(ii) "to explore and examine the potentials of export-orientedproducts within the country and help ensure quality con-trol of all exporters;" and

(iiij "to co-ordinate the export efforts of various private andpublic sector organizations within the country and providenecessary advice, information and assistance to such orga-nization so as to enable them to participate in, or increasetheir exports to, other countries."

- 59 -

4.17 The Bureau is, at present, funded entirely through the GovernmentBudget, although the Bureau has the authority to raise funds from othersources with the prior approval of the Government. The head office(Annex IV.4) has five functional directorates, dealing with (i) planning,(ii) trade information, (iii) facilities, fairs and displays, (iv) marketdevelopment, and (v) commodity development. As of March/April 1978, about60% of 46 professional positions of the Bureau were vacant. The Bureauplans to establish foui new regional offices at Bogra, Comilla, Sylhet andBarisal. In view of the present severe shortage of staff, the EPB shouldconcentrate on filling existing positions adequately rather than on creatingnew positions.

4.18 The Bureau is receiving technical assistance from external agencies.The International Trade Center (ITC) initiated a technical assistance projectin the areas of trade information and market studies in early 1977. Progressunder this project has been rather slow up to now, although a beginning hasbeen made in the area of trade information. The Commonwealth Fund forTechnical Co-operation (CFTC) undertook a study of the organizational struc-ture of EPB in 1976 and identified the main shortcomings as: (i) the lackof functional autonomy due to its departmental status; (ii) acute shortageof staff both at the professional and supporting levels; (iii) structuraldeficiencies due to inadequate organizational set-up and lack of precisedefinition of functions for the various directorates; and (iv) absence ofcoordinating and review machinery. Most of these shortcomings, with theimportant exception of the second point, are being remedied to a significantextent as a result of the recent measures such as the designation of EPB as asemi-autonomous body, the appointment of the Board of Management and the re-organization of EPB strujcture. Recruitment for vacant posts has also started.

4.19 The Export Promotion Council (EPC) is a high level advisory bodyon export promotion. The Council is chaired by the Minister/Adviser in chargeof the Ministry of Commerce and has a large number of members and participants(at present 44 members and 35-40 additional participants), representing varioustrade groups, sector corporations and Government agencies. The only functionof the Council has, up i:o now, been its annual meeting in June to review thedraft annual export polijcy, prepared by EPB in consultation with relevantsector corporations, business groups and Government agencies. The annualexport policy endorsed by the Council is, then, submitted to the Cabinet(the Council of Advisers) for final approval. The Council should meet morefrequently to provide arn effective foczal point for the view of the variousparties involved in expcrting.

4.20 The Export Coordination Unil (ECU), consisting of the Secretariesof various Ministries (at present, Coimnerce, Finance, Industries, Agricul-ture, Planning, Railway, External Resources, Forest and Fishery, and Portsand Shipping) and the Governor, Bangladesh Bank and the Vice Chairman, EPB.The Unit is chaired by the Secretary, Commerce and usually holds bi-monthlymeetings for the purpose of coordinating export promotion activities among thevarious Government Ministries and agencies. The Vice Chairman, EPB is theMember Secretary for ECU. The Unit has been focussing on settling variousshort-term issues related to export activities.

- 60 -

4.21 The Export Promotion Advisory Committees (EPAC) are specializedgroups on specific export commodities and various export-related issues.A typical EPAC consists of experts and EPB officials, who act as Secretariatfor the Committee. The main funtion of EPAC is to recommend specific sug-gestions for incorporation into the draft annual export policy as well as forconsideration by ECU. At present there are about 19 such committees(Annex IV.5). However, the effectiveness of these committees is seriously

hampered by shortage of staff- and lack of product studies on which to baserecommendations.

C. Dimensions of a New Export Strategy

Tho Rnlc, rof F.vmnnrtC

4.22 The export sector, at present, plays only a limited role inBangladesh: export earnings finance less than a half of import payments and

,he expor- sector 4i h-ardly a mjor sourc of growth i the eonomy as it

accounts for a small portion of GDP and its growth rate has not been anyhigh0er than the C-DP growth rate. H owevr - h sucssu -evelo.---f-1of adynamic and growing export sector could have important implications for thefuture of tLe langladesh economy. In adti LU on Co beieng a valuable source

of foreign exchange, it could also become a major catalyst for economic ex-pansion. Beneficial spin-f tteffec's suchL as tUh deIvelpmen' oU toulwar

looking" manufacturing and trading sectors and rapid employment may also befostered as the promising export activities for Bangladesh are likely to belabor-intensive.

Pre-conditions for Success

4.23 Recent experiences of other developing countries suggest that

rapid growth of manufactured exports was achieved by export promotion activelysought by the Government through formulating appropriate export incentiveschemes and establishing an effective institutional framework. However, therewere several "pre-conditions" for this kind of success such as: (i) the pre-sence of a "reasonably developed" industrial base; (ii) the availability ofa "well disciplined" labor force at relatively low costs; (iii) the existenceof a "fairly experienced" entrepreneurial community and (iv) the use of arelatively liberal import regime for raw materials, intermediate goods andcapital.

4.24 These necessary conditions appear to exist in Bangladesh with

several important qualifications. First, there are various medium and large-

scale industries, ranging from the intermediate and capital goods industriessuch as steel, fertilizer, paper, shipbuilding, cement and engineering to theconsumer goods industries such as jute and cotton textiles, pharmaceuticals,leather and sugar refining. In addition, there is a wide range of smallscale and cottage industries. The main discouraging factor is that produc-tion efficiency is low in many industries for various reasons including thefact that most industries serve only the domestic markets, well protected

-- 61 -

from competition through rigid imnort controls. Emphasis on exnort promotionwith gradual liberalization of imports could lead to much improved productionefficipncv in the mannfartllring sector.

4.25 Second. Banstadesh haR a larop lahor forrp. eRtimated at about30 million. Although no reliable statistics are available, there is a highlevel of unemployment and underemploymenuntly, the wage levelremains very low. Ave:rage daily wages in the manufacturing sector in FY76were about US$0.53 for skilled workers and US$0.43 for unskilled workers.These wages were very Low, by comparison with the other countries 1/ whichhave recently succeeded -p-r-o-,-o labor-intensive manufactured -

As wages in these countries are increasing at a high rate, labor-surpluseconom.ies such as Bang]adesh should be able to take advantage of the situationby actively promoting the labor-intensive and low-skill-intensive manufacturedexports currenitly dominated by these developing countries. The importantissue is whether labor productivity would be sufficiently high so that pros-pective exporL industri.es can take advantage or tne iow ievei or wages inBangladesh. In this respect, it wouLd be essential to formulate and applyappropriate labor policies, designed to avoid frequent labor unrest, whileprotecting the basic rights of workers.

4.26 The fact that Bangladesh has a reasonably well developed industrialbase, implies that there is a pool oi. businessmen and managers experienced inrunning industrial enterprises. Although many of the medium and large scaleenterprises were run by West Pakistanis before independence, most of the smallscale enterprises, and even a good portion of medium and large scale enterpriseparticularly in the jute as well as cotton textile industries, were operatedby East Pakistanis. The present managers of public enterprises, many of whominitially had little business experience, have gained valuable experience inrunning fairly large scale enterprises during the last seven years since in-dependence. However, the performance of public enterprises has been hamperedby factors such as the lack of appropriate incentives, autonomy and performance-monitoring mechanisms. Furthermore, there is a pool of Bangladeshi formerowners of jute and textile mills, and although many are currently engaged invarious types of import and domestic trading activities, they could, withappropriate policy initiatives by the Government, be brought back into manu-facturing activities in new export industries. Besides taking the necessarysteps to ensure that these essential pre-conditions can be met in Bangladesh,a successful export development program needs to be accompanied by formulatingeffective incentive schemes and establishing an efficient institutional frame-work for this purpose.

1/ Accordine to the UN Statistical Yearbook, average wages in the manu-facturing sector were as follows:

Country US$/day

Hone Kong 4.67Korea 3.16Philinnines 1.84Singapore 4.88

4.24Mexico 10.96

- 62 -

Export Incentives

4.27 Financial incentives through the Government's exchange rate, creditand taxation policies are an important necessary condition for promotingexports, as shown by the recent experience of other countries which havesucceeded in this field. It was encouraging to note that the real effectiveexchange rate improved substantially due to the Taka devaluation in 1975 andthe subsequent stabilization measures. However, more recently there has beena re-emergence of inflationary pressures resulting in stable domestic prices.Yet, the present export incentives need further improvements from the follow-ing aspects: (i) rationalization of the incentive structure; (ii) higherexport incentives in relation to those for alternative activities; and (iii)simplification of procedures. Finally, the development of a more liberalimport regime appears to have begun, but has not yet progressed very rapidly.This is discussed further in Chapter 5.

4.28 Rationalization. The most notable feature in the present exportincentive structure is that the level of effective exchange rate varies con-siderably among products since most export incentives (or disincentives) areproduct-specific. Moreover, the basis for differential treatment among pro-ducts is highly arbitrary. Very often, poor performance has been the mainrationale for giving high export subsidies (e.g., jute goods and paper products).In the case of XPL, it is particularly desirable to set a uniform rate appli-cable to all export products based on their net value added in order toequ1aipze t-ihe leuvl nf "effective protectinn" nrovided iinder this scrheme=Exceptions to this general rule can then be granted on the basis of (i) theinfAnt inchiltrv nrailmpT1t (i-eA Q hichor rqt-o rnn ho uon tn new Povnmrt nr(o-ducts for the initial period of product and market development) and (ii) in-elasic deiman annd ciuplynn sitin (f.e., lnwer rnt car nbh ,ivun t-o nrimarny

products, e.g. raw jute, and tea where export demand may be inelastic to ex-port price nand domestic supply also inelastic to sales -r----- -FI,n.-.n,-.

frequent changes in export incentives need to be avoided, as much as possible,in order to reduce the- uhncrtainty of -ivesmlent decisions in exp ort-oriented

industries.

4.29 Level of Export Inc:entives. Some export incentives do not offermuch support to exporters. Due to the low import content of major exportproducts and the cumbersome rebate procedures, total rebates of indirecttaxes amount to less than 1% or total export earnings. Although no reliablestatistics are available, tax reductions on export income are likely to bealso insignificant due to the present state or poor coliection of income taxin the country 1/. The interest subsidy of 2.5% on export financing amountsto an export subsidy of only 0.5% on the assumption that about 80% of exportearnings are financed at this subsidized interest rate for three months. Eventhe XPL scheme implies an export subsidy of 5-6/ for nontraditional exportsand only 1% for the whole export sector. Thus, the combined effect of thevarious export incentives and export taxes amounts to an export subsidy ofabout 8-9% over the official exchange rate.

1/ Collection of company income tax was Tk 233 million in FY77. Theexport sector is likely to have contributed much less than 5% of th4-

amount since the major export industry (jute goods) incurred heavylosses in tiat year.

=. 63=

4.30 Export incentives must be judged in terms of their effectivenessin encouraging investment into the export sector as against possible alter-natives in import and domestic trading or manufacturing activities for thelocal markets. At present, export activities seem to offer lower financialreturns, than importing,, domestic trading, real estate, and even import-substitution industries. This issue needs to be examined further in detailparticularly since measures such as the exchange rate adjustment necessaryto correct this situation have other implications on the economy. Exportincentives will be studied in detail as a part of the proposed technicalassistance program on export development, as outlined in para 4.37.

4.31 Simplification of Procedures. One important point in formulatingappropriate export incentive measures for Bangladesh is that the proceduresinvolved need to be as simple as possible in order to make them effective.For example, establishment of product-specific standard rates for rebateof indirect taxes would facilitate the rebate procedures significantly.Conversion of the XPL scheme into a straight-forward export cash subsidyscheme also deserves serious consideration.

Institutional Framework

4.32 At the early stage of export development, export incentives alonecannot zenerate ranid expansion of exnort earninps. This nnint i ouidePnt

by the poor response of the export sector to the 1975 devaluation. An ex-nort development nrograrn invoulvp almost Pupry nprt of the econnmmy: both

public and private sectors. It is thus essential to develop a mechanismwhich would plan, coord-inate, and direct activities of various governmentministries and agencies, the banking and business communities, and, even,

reserch nsttutins. Significant progress has b-een mtaAe -recently-in this.LL.tLuI-I. %JLt o Ia LJ CI iia. - . CL -L.U LY LLI £0

important area by estab:Lishing various institutions as described earlier.However, the effectiveness of these 4nstuio isu serUi ou 0--ly hamperd,

particularly by deficient staffing. The most urgent task at this stage isto strengtL-te thI..- txi 2- .I - CI I I-f- -I Cto strenIgthenII theC exis;iLng i,st itut ional Lramkework in the fol Lowing areas:

(i) formulation and imp]ementation of the export policy; (ii) strengtheningof VPBU; (i improved climate 'or private ardt foreign i-vesment, and (.iv)

careful consideration of special export promotion schemes such as EPZ.

4.33 Export Policy. As the export policy is formulated on an annualbasis, its recommendaticins tend to rely heavily on short-term trends andimpressions instead of in-depth analysis of the major issues. In order tostrengthen the content cf the annual export policy, there is an urgent needto formulate a medium-term strategy on export development based on detailedanalysis of export market and product development possibilities. Detailsnecessary for this purpcse and external technical assistance requirementare discussed in para 4.37. The present monitoring mechanism of the exportpolicy needs to be strengthened. In this respect, EPC and ECU should holdmore frequent meetings (say, monthly meetings for ECU and quarterly meetingsfor EPC).

4.34 EPB. The bureau has a very important role to play particularly inareas of export marketing and trade information, since the lack of knowledgeand experience by most existing exporters is a major factor constraining

- 64 -

development of new export markets and products. As already noted, the mosturgent task for EPB is to strengthen the quality of its staff by recruitingnew personnel as well as providing the existing staff with necessary in-service training. In order to perform its assigned duties, the Bureau shouldbroaden its source of financial resources. One way of achieving this wouldbe to impose a small fee on commercial and industrial imports, from whichadditional financial requirements by the Bureau and other institutionsprimarily engaged in export promotion can be met.

4.35 Investment Climate and Controls. As exporting is hiRhly comDeti-tive, private enterprise tends to perform better than public enterprise whosedpcision-making ability is often constrained by bureaucratic rigidities.One of the major reasons for the poor performance of the export sector inBangladesh is that this sector is dominated bv nublic enternrises and most

private exporters (with some exceptions in raw jute) are relatively smallbusinessmen with limited financial resources and overseas contacts. In this

respect, the Government's measures towards an improved investment climate,

as discussed in Chapter 2, would be a necessary element in the export devel-

opment program. Foreign investment could play a catalytic role in export

d. evelopment in Bangladesh, -- as foreig n investors c-an c-ontribute expertisein

export marketing and product development.

4.36 Export Processing Zone (EPZ). Establishment of an EPZ deserves

carefu'l consideration. EPZ canb Ue an effective means oUf attracting floreign

investment and promoting industrial exports, provided it is planned care-

fully and implemented eflectively. As tLere hIas bUeen nio feasibility study

undertaken for this purpose, 1/ it is not possible to formulate a firm view

on this subject at this stage. in any case, an EPZ should be considered as

an element of a much broader export development program, rather than a panacea

for export promotion.

Technical Assistance by IDA

4.37 Although the Government's recent measures clearly reflect its aware-

ness of the importance of export development and its willingness to take the

necessary steps, Bangladesh lacks the experience and expertise required for

developing integrated and detaiLed plans on export development. The existing

technical assistance programs from the external agencies (summarized in AnnexIV.6) have often been too piecemeal in approach and slow in implementation. In

view of the importance of export development for the long-run viability of the

Bangladesh economy and the comprehensive nature of any effective export devel-

opment program, it would be very useful for IDA to fill any gaps in the exist-

ing technical assistance programs and to assist the Government in formulatinga comprehensive medium-term strategy on export development within the frame-

work of overall economic planning for the economy. This medium-term strategy

would be based on a series of in-depth studies on export possibilities andpriority issues relevant to the export sector, as summarized in Table 4.4. 2/

I/ For the purpose of undertaking a feasibility study, a two man teamfinanced by UNIDO visited Bangladesh in April/May 1978.

2/ The Bank sponsored Boston University study of shadow prices, domesticresource costs and trade and development policy will be a major con-tribution in support of the development or an export strategy.

- 65 -

Table 4.4: BANGLADESH EXPORT PROMOTION BUREAUDEVELOPMENT PROG.RAM FY79-FY80

(Containing perspectives for Five-Year Plan FY81-FY85)

Implementa- StatusTec.hni,^al tinec'e'ule as atL L L. L.~a L. LULL 0L IU UI s a

Activities Support FY79 - FY80 Oct. 1978

I. Strengthening the EE'B EPB Ordinance

(a) Establishment of ) No. XLVI estab-Legal Status as ) lishing semi-semi-autonomous ) autonomousorganization; ) status promul-further review ) gated in Oct. 77and change )in light of )experience j(i) Recruitment (Positions advertised

(ii) Staffing of ( Aug 78posts (recruitment ongoing

(placement Dec 78

(iii) Training of Inservice trainingstaff program start Jan. 79.

ITC Training Adviser(12 m/m) availablefrom Nov. 78.

(b) Improve capability Establish and implementof EPB to monitor progress control systemexport program and Jarn-Mar 79facilitate implemen-tation of activitiesto achieve annualexport targets.

II. National export policyand Strategy Development

(a) Review existing Govern- ITC. PA Assnciatpe hbinament policies, regula- Comm recruited throughtions, Drocedure:3 and Spc Comm Sec an ronn8l-

restrictions peri:aining tants for Stage I:to Ppnnrt related I Nov 78 - April 79.activities, with a viewto a coorated exprt For actions in Technical inputspolicy and development specialized areas, in specializedprogram., especia-jy in also see Section. -ns- ar eas a- - pro-production, marketing, VI and VII. vided for in-iVestmllent, financing, o-her pa--ts or

transport and pricing. this ActionProgram.

- 66 -

Implementa- StatusTechnical tion Schedule as at

Artivities Sunport FY79 - FY80 Oct. 1978

(b) Grry- out studiesi ITTGj Snpecialist ro.^siul-

and establish the UNCTAD tant from Jan-net foreign exhange Junp 79: work will

earnings delivered be coordinated withby each major export rationali7ntion of

product export rebate andXPL schemes (seealso Section VI)

(c) Establish coordinated PA associates (fromide lines for deriving Nov. 78) will make

product-specfic targers initial proposals.to be incorporated in Work of SpecialistSecond Five Year Plan, Consultant underand prepare targets llD() (Jan-June '9)

will also providedata. Guidelineswill be published byAug. 79, and targetswill be prepared byDec. 79

III. Products

(a) Carry out export ITC, Product specificpotential and mar- EEC, activities willketing studies: Comm be implemented

Sec during period

(1) Marine products Stage I. ITCSpecialist Adviser'srecommendationsNov./Dec. 78. EECreport (Dec 77)available.Stage II. Implemen-tation of specificdevelopment and mar-keting plans -Mar. - Aug. 79.

(9) Leather and Exnprts being recruited

Leather products

(3) Handicrafts Stage I. Specialist AdviserMay-Tune 78Stage II. Implementation ofrecom-mendat4ons Feb 79-June 79.

- 67 -

Implementa- StatusTechnical tion Schedule as at

Activities Support FY79 - FY80 Oct. 1978

(4) Tea Specialist AdviserAug-Dec 77. Reportawaited.

(5) Spices (Stage I. ITC Marketingof Spices Seminar inOct 1978.(Stage II. EEC study tohc nmmi s nned=

(6) Knockpd-down FE(' report received May 1978

furniture

(7) Processed and EEC report received Sept. 1978nrc.cor--c-A F...; -

(8) Plywood and veneer EEC report reeie May 1978particle board

(9) Natural gas and EEC report received May 1978by-products

(10) Forest products CFIC repo received Sept. 1978.

(paper, newsprint Comm. Sec. marketing study torayon, timber) be commissioned.

(ii) Ready-made garments EEC report awaited, study compietedAug. 1977

(12) Electric wires and Comm Sec study to be commissionedcables

(13) Safety matches Comm Sec study to be commissioned

(14) Molasses EEC study to be commissioned

(15) Potatoes EEC study to be commissioned

(16) Coir products Comm Sec study to be commissioned

(17) Jute rugs and carpets EEC study to be commissioned

(18) Jute waLl materials EEC study to be commissionedand fur-nishings

(19) Fresh fruits andvegetables

Implementa- StatusTechnlcal L LUS1 OLLLdUUle as aL

Activities Support FY79 - FY80 Oct. 1978

(20) Specializedtextiles.

V. Markets ITC, EECComm Sec

(a) Initiate and carry Stage I - In-depth review of Studiesout, for non-trad- markets, existing studies and availableitional products, identification of new markets, in EPBmarket development using ITC systems such as ITS - and TISprogrammes includ- June 79.ing market research,product development Stage II - Established comr-and adaptation, test prehensive plans on productmarketing and promo- and market specific basistional programs. - Dec. 79

Stage III - Implementation

Jan-Dec. 80 and during FiveYear Plan period

(b) Provide marketing and A detailed plan will be pre-

promotional support for pared Oct 79-Mar 80 forachieving the export implementation during Fivetargets that will be Year Plan period.incorporated in theSecond Five Year Plan1980-85

V. Trade Attaches ITC,Comm. Sec-

(a Establish procedure ) St~age T - implementation Stmag T

for briefing and serv- ) Jan-Feb 79 proposals

ic ng trade attacbes )und

in regard to EPB activi-) Stage II - July 79-June 80 consider-tes and export deve' ) ation

opment work.

(b) Establishing regular )reporting and foiow- v

up system.

(c) Organize and implement Two special ITC training Design ofspecial training courses will be held in coursesprograms for Trade Jan. & Apr. 79. under pre-attaches.

- 69 -

Implementa- StatusTechnical tion Schedule as at

Activities Support FY79 - FY80 Oct. 1978

VI. Incentives

(a) Examine existing Comprehensive proposalsfinancial incentives will be made after resultswith a view to mea- of actions being takensuring their adequacy under Section II a and band rationalising are available Mar-Oct. 79them, and proposenew measures asrequired. Inparticular:

(i) review of export ) Announcement of revised EPB Dre-rebate scheme, ) schemes planned for liminaryrationalizing of ) xynort Pnlicv Stntempnt proposalsduty drawback ) 79/80 to be made on submittedsystem, and estab- ) July 1, 1979lishing procedures )for the duaty free a

use of raw materials )

(ii) establishment of )ratLioal bass for )export performance )li1cences (APLp )

(b) ExamLne and propose Comprehensive proposals EPB VCthe foreign and local will be made July-Dec 79 leadsincentive measures inter-necessary for the Ministryestablishment of ex- body re-port industries in sponsiblethe proposed Chittagong for over-Export Processing Zone all pro-

posals

UNID() study on physicalinfrastructure completedApril. 78

VII. Strengthening ExportInfrastructure

(a) Review present export ITC, Stage I - PA Associatesadministrative formal- UNCTAD, Nov-April 79ities and regulations, Comm Stage II - specializedwith a view to their Sec technical inputs willrationalization, sim- be provided fromplification and July 79-June 80 toimprovement implement proposals.

- 70 -

Implementa- StatusTechnical tion Schedule as at

Activities Support FY79 - FY80 Oct. 1978

(b) Institute trade ITC, Establish nationalfacilitation by UNCTAD trade facilitationstreamlining (FALPRO) Committee - June 79existing exportprocedures anddocuments

(c) Improve export Review needs and Schemefinancing facil- propose comprehensive presentlyities and expand plan July-Dec. 79 operatedexDort credit by Sadharanguarantee and Bima Corp.insuirance scee

VIII. National ExportTraining ITC Training AdviserProgram (NETP) TTC for 12 m/m from Nov. 78

(a) Identificaio of

national trainingneeds 4n relationto export promotionandu developm.ent.-

_L U UV LIJU.LLLCLVM

survey July 77 bylIu a fal-l

(ii) In-depth Evaluation and pro- Reportevaluation posals by Training availableand action Adviser Mar-June 79plans

(b) Designing of train-ing programs/activitiesand implementationaccording to priorities

(i) Coordinated series Special ITC training Preparationsof courses under team will implement completed.NETP 8 courses mid Oct- EPB under

mid Dec 78 NETP has(ii) Design and provide conducted

in-service train- In-service programs 6 nationaling courses for start Jan 79 trainingEPB staff events Jan-

Sept 78 and14 more areplanned untilJuly 79

- 71 -

Implementa- StatusTechnical tion Schedule as at

Activities Support FY79 - FY80 Oct. 1978

(iii) Provide train-ing coursesabroad, fellow-ships, studyhours on-going

(c) Development/uograding ) StaRe I will be imDle- Activitiesof national training ) mented Nov 78-Oct 79 by start incapability ) SDecialist Training Oct 78 with

) Adviser, who will also series of(i) Provide :echnical ) make proposals for ITC rciorses

inputs to enhance ) Stage II, i.e., in-export training ) dpnth programs with acapabilil:y of ) few selected organiza-Universiltip. ) tions to be implementedInstitutes, etc. ) Jan-Dec. 80

)(ii) Train a cadre of )

loaPl intuctorrs )in export: promotion )and devel,opm.mentn)

:. Trade in.orm.aIon S ervice ITde- Iiormaion on-going

and Documentationadviser fzor 10 m/mfrom Jan 78

(a) Reorganize TradeL[nLor m atiofn 'ervice,install administra-tive procedures in-cluding Manual. ofProcedures, arnd up-grade presentfacilities

(i) Staffing See Section I (c) in progress

(ii) accommodation Renovations complete start Oct 78by Dec 78

(iii) equipment and Installation complete Some avail-furniture by Jan 79 able, others

on order.

(iv) Library - pro- Arrangements and in progressvision of source access complete by from Jan 78material and Jan 79cataloging

- 72 -

Implementa- Status

Technical tion Schedule as atActivities Support FY79 - FY80 Oct. 1978

(v) staff training Intensive in-service Manual ofprogram Jan-Mar 79 Procedures

ready

(vi) extension of Systems implementation Preliminaryservices to methods and proposals arrange-

ready by Jan 79; ments intelex link to Chittagong handoffice Dec 79

(b) Establish procedures Implementation of Discussionsfor disspminating Dronosals by Mar 79. with TCB,

information to target Training events in Handicraftusers andr assist i'n ius of Trnde Informa- exporters,

utilization tion (under NETP) etc. inTwill bea hoeld Mar~-Apr. ?9 progressc

(c) Upgrade existing

publications andintroduce new pub-lications to dis-sem,inate information

(L IE Lxporters DirJectory W978/79 Directry wiLLh pLinLteL

publication Dec. 78.Work on 79/80 Directorystarts Mar 79.

(ii) Export News and New format and contents Proposals sub-Trade Information from Jan 79 mitted May 78

(iii) Series of export First issue available Preparatoryguides Nov. 78 work for first

few in seriesin hand

(d) Acquire and exhibit Implementation proposalsforeign competitive ready by Jan 79; firstadvertising and sales display planned formaterial, packaging April 79material, brochurescatalogues, etc., forinformation ofexporters

- 73 -

Implementa- StatusTechnical tion Schedule as at

Activities Support FY79 - FY80 Oct. 1978

(e) Establish and maintain Forms will be dispatched FormsCompany and product progressively; completed readyprofiles on all ex- profiles ready for useporters and their by Mar 79products

(f) Provide import related Specialist Import Procure- Jobinformation (prices, ment Information Adviser descrip-sources, standards, for 3 m/m from Nov. 78 tionetc.) to importers and approvedGovernmental agencies and nost

requestedby Govt.price ands- upl i er

informa-

tiallyava lal e.

- 74 -

BANGLADESHSeyenth lmports Pro2ram CreditProjection of Export Earnings

(FY79-FYRn)

Actuals TargetsFY77 FY78 FY79 FY80

A: PRIMARY GOODS (Tk frore)

1, Jute raw 176e54 144.90 228.00 245.00

- Non-jute items

2. Tea 55.87 69.28 65.50 70.003 0 F.~ro zen foodJ(shrip,

fish and froglegs) 26.22 31.06 60.00 80.00.L*l, * U. CZ±. , ' , S > fr,4 v . S n 'o

5. Prccessed fish -- :50 0.50

6. Sharkfins & fishmaws 0.62 1.08 1.50 3.007. Spices 1.96 2.06 3.00 3.00o, Tamarind 0.11 0.04 0.10 0.209, Fresh fruit &

vegetables 0.34 1.24 3.00 3.0010. Betel leaves 0.30 0.58 1.00 1.00

.1 Pptato ouY- O.' 4,00 4.0012. Raw cotton & kopak 0.61 1a84 2.00 2.0013, Tobacoo 0.13 0.09 0.40 0.4014. Animal f°.°l (oilcake

wheat rice 'braX)2e0196250215, Crude fertilizer(crush

bDone & bnme ) oO3 oo75 140 016. Animal cas:ings 0.40 0.17 0,50 0.50

17.~ 0.08n. tr>e OO 7.50 '7.5018. Other primary products 1.73 2.45 5.00 5.00

non-jute items 91,31 112,84 160.00 188.00

Total primary goods Z67.85 257,74 388.00 433.00

B: M'ANUFACTURED GOODS

1, Jute goods 267.75 371.65 360.co 390.002. Jute carpet & screen

cloth 0.86 0.93 2.00 5,003, Tanned semi-tanned

leather 5o8,72 68.83 70.00 75004. Leather goods &

f oo twear 0.01 0U11 0.25 0.50'Furflaceoi

6. NMaptha V 22,10 230C8 19.00 20.007, Newsprint 2.24 8.78 8.50 10.00U. raper CL 0J 201 I I 7aOO

9. Rayon 0,60 0.75 1.40 2.00

Hardboard 0C,08 0.09 0.20 0,501 2. Pcarticle Bo_-d 0.01 0s0 n,4 05n13, Safety matchs 0.)3 0,01 0.25 0.2514. Sug< __ 8=88 oo -.100015, Mol asses 0.21 o069 1,90 3,0016, Ccttm f6hricns2 0.(0 1,00

',7. lectric .wires & cablesO.70 0.24 3.00 3.0018. Super enamel copper.wire - 0.50 0.50

_ 75 =

Actuals TargetsFY77 FY78 FY79 FY80

CTk CrQre)

19. Telephone cablsz - 1,00 1.0020. G.I.Pipe 1.00 1.0021. M.S.Plates - - 1.00 1.0022. Glycerine 0.15 0.25 1.00 1,00O23. Medicine o.o6 0.09 1.50 1.5024. Paper pulp 0.03 0.99 2.00 3.0025. Handicrafts 1.40 2.65 4.00 7.0026. Specialised toxtiles .' 0.08 3.00 3.0027. Readymade garments - 0.02 1.00 5.0028. StCnless s'-e! cutlery - 1.00 1.0029. ether manufactured

products 1.09 0.54 10.57 11.00

Total manufactures(non-jute) 103.68 117.62 150.00 172.00

Tot-al manufactures 357.64 489.27 512.00 561.C0

.A: Jute items

i. Jute raw 176.54 144.90 228.0CC 245.00ii. Jute manufacturem 267.75 371.65 360=oo 390,00ii) Jute car7et & zcreen

cloth o.86 0.93 2XO 5X0i Total 44515 517.48 590.00 640.00B: N>on=j,te -ie.msi. Primary products 91.31 112.2R 160o00 188.00

l f Mar.ufactures 189.193 1 /0 1.50 0 (r7 uuTotal 18 .50 230.75 310.00 360.00

Grand total: 625.50 747. Z 900.00 1000.00

E2)ORT PROMOTION BUREAU3 October 1978

- 76 -

CHAPTER 5: CONCLUSIONS AND RECOMMENDATIONS

Introduction and Summary

5.01 The preceding chapters of this report have focussed on the issuesnf iivprRificatinn and Pffirienrv in three rplatpd areas: nnlirv towards

private industry; policy towards public enterprises; and export developmentnnlicru The npirnnpp ef this rhan,pr iq firstj_ to summarize the fineingrq of

the earlier chapters into a more concise statement of immediate recommenda-toson -he t-hree issue rpra 5.02 thrug 517), -an second, to consider

U. t'.LLO UJ I I * .LA .c .o tl- .\ 'a a- - '. S. -- -. U.flA5- -' . I / I~ 0 S..- _L.4 ~ U. ~U.UL LUC

the question of developing an industrial strategy for Bangladesh in the lightof th,ese findings.

LAS. LILC C J.A.L LA . L J.A60

5.02 ' IEndustrLial 'tructure an' 'rowth. After a period of L imp-essiveindustrial growth in the 19 60s in the region that is now Bangladesh, the 1970sbrought virtual stagnation in output despite increased capital and employment.The manufacturing sector has continued to receive about 25% of total invest-ment -- a much higher percentage than its share of output. Throughout the1960s, employment and the value added per worker increased by more than 50%while average real wages remained almost constant. After 1970, productivityfell while employment and capital stock both increased. Although capacityutilization has always been low, loss of the West Pakistan market caused itto fall to 49% in FY73. Utilization had risen slowly to 61% by FY77. How-ever, import controls and other aspects of industrial policy still encouragecreation of excess capacity.

5.03 From almost no industry at partition, industrial activity in EastPakistan expanded up to 1960 with concentration on jute and cotton textiles,food, beverages and tobacco. While other sectors have increased their shares,jute and cotton are still the most important industries with about one-thirdof both total output and value added. Import substitution increased in allareas with an increasing proportion of total supply coming from domestic pro-duction. In capital goods, the percentage of total supply coming from domesticproduction rose from 24% in FY70 to 51% in FY76. The share of total domesticmanufacturing going to exports fell from 38% to 21% in the same period becauseof the loss of the West Pakistan market.

5.04 The Industrial Policy Framework: Evolution and Present Climate.At independence, Bangladesh inherited an industrial policy framework focussedon controls, licensing and bureaucratic allocation. The structure of owner-ship in industry changed dramatically, when the jute, cotton textile and sugarindustries were nationalized together with firms abandoned by West Pakistanientrenreneurs. The role of the nrivate sector was restricted bv the 1973policy statement that set low limits on permissible investment. Despite this,and t-hp change in ownershin structure. nolicies. incentives and controls

remained very similar to those of the past.

5.05 Since 1975, objectives have shifted, private activity in industry isencouraged, and the dominant role of public enterprises ismbeing so.hat re-duced by disinvestment. The ceiling on private investment was removed recently;

- 77 -

10 sectors previously reserved for public enterprise were opened. Investmentapprovals have increased, but the response has been less than GOB hoped. Theslow response appears to be caused by uncertainty, lack of knowledge of oppor-tunities, and problems with present policies. UIncertainty and awareness ofalternatives can be addressed by developing an industrial strategy for inclu-sion in the Five-Year Plan, 1980-85. In the meantime, present policies shouldbe examined and revised.

5.06 Improving the Present Policy Framework. GOB uses both controls(direct regulatory policies) and instruments (indirect policies of economicorigin) in shaping industrial development. The main controls are: importlicensing; the investmient schedule; limits on investment; allocation of areasof activities for pubLic and private investment; investment approval proce-dures. The main instruments are: customs duties; taxes and incentives;policy on foreign investment; the mechanisms and institutions for industrialfinance.

5.07 In pursuing its objective of increasing private industrial activity,GOB will need to place more emphasis on instruments than controls in thefuture. Where controls are unavoidable, some effort must be made to give themmore of the qualitv of instruments by emphasizing the economic rationale ofthe control. On the other hand, the tendency to load instruments with controlelements should be minimized.

5.Q8 Particrular controls would be improved_ by: lengthen.ing the periodof import licenses in the light of more careful checks on licensed firms;expanding the use of cpen general licenses wherever possible; allocatinglicenses to promote multiple shift operations; reviewing the functions of theinvestment schedule in the `ligh Uo improved i`nustrial planning; permittingprivate investment in all cases except where public enterprises are alreadydominant and efficient and no extra capacity is therefore required, however,in taking these decisions the trade-off between potential excess capacity andpossible large increases in erficiency should be considered; simplifying pro-cedures for approval of projects. Improvements in instruments should include:ratLionalLzatiool of Lhe tariLL structure, after upgrading the Tariff Commissionand an analysis of effective protection. Taxation concessions and relatedincentives should be granted to expanding firms as well as new firms as thesystem should reward expansion of output, not simply expansion of capacity.A loss carry-forward provision should be introduced; restrictive requirementson use of tax-holiday profits should be removed and capital-gains tax onshare-trading profits should be lowered.

5.09 The flow of foreign investment should be improved by: early en-actment of a Foreign Investment Protection Act; removing investment limits;permitting full repatriation of profits and capital within seven years; anda clear statement of aLl the terms and conditions for foreign investment inBangladesh.

5.10 GOB's industrial policies do not differentiate between small andcottage industries (SCls) and larger units. Hence, the main policy problemsfor SCIs are treated by GOB as similar to the problems of industry in general.

- 78 -

Special, and quite appropriate, arrangements for providing financial andtechnical assistance to small industry do exist, however, and have recentlybeen strengthened.

5.11 The structure of industrial financing institutions in Bangladeshis generally adequate but there is an institutional gap in the field of pro-motion involving equity investment, preparation of sound feasibility studiesand generally assisting investors, although GOB is considering participationin such a company with a group of international development institutions(para 2.75). The share of private manufacturing in total manufacturing ad-vances from commercial banks rose from 12% at end 1976 to 20% by June 1977.The share of the private sector is expected to rise to approximately 25% inFY78 -- still short of the private share of industrial value added of 45%.Real rates of interest have been negative in all years except FY76 and FY77,and there is little indication that interest rates have been a major deter-minant of investment.

5.12 The Public Industrial Sector: Performance and Efficiency. Whileoverall production has been restored to pre-war levels, low canacity utili-zation persists in many firms. Though some sectors are profitable, financialperformance does not always reflect economic efficiencv sinrce CGfB controlsmost prices. Estimates of domestic resource costs (DRCs) were made forselected public enterprises. While the resul ts must be treated with caution,since data were collected hurriedly and several simplifying assumptions weremade, some tentative concluisinns can be drawn from the analysis. First,economic efficiency of public enterprises is low, 13 out of 19 products haveDRCs exceeding Tk 20/US$1.00. Four products show negative DRCs indicatingan absolute loss of foreign exchange in their production. Disparity betweenfinancial and economic performance is highlighted by comparing the textileindustry, which has acceptable DRCs but heavy financial losses, and the steelindustruy which has negativ-e DRCs but makes profits. Wt ile the analysis iscrude, it may serve as a starting point for identifying both problem areasand -nete. possibl-ities.

5.13 Th.e Tndustrial Public SDector: Major issues. Organization of publicenterprises would be improved by wider use of Enterprise Boards, recentlyintroduced in chemicals and Jute, and by completing the rules of business forall firms. Under the enterprise boards, and within the rules of business,managers should be given more autonomy and offered specific efficiency-relatedincentives. Management and technical training must be upgraded by adjustingcurricula to conditions in Bangladesh; and introducing more practical andless theoretical teaching, especially by creating closer links between train-ing institutions and industry.

5.14 Pricing policies in the public sector should be revised to separatesocial factors from productive efficiency. This requires clear delineation ofany subsidy element in a price or cost. Wherever possible, direct subsidiesat the point of intended impact should be used in preference to loading allsocial costs onto the last firm handling the product. In addition, balancingand modernization programs are needed urgently in fertilizers, steel, sugarand cement and to a lesser extent in rubber products, matches, pharmaceuticals,

-- 79 -

construction materials and wood products. At both management and technicallevel, the public enterprises are losing their better qualified persoinel.Many of these are leaving for jobs in the Middle East. The basic causes ofthe exodus are (a) low salaries relat,ive to the level available abroad, and(b) generally low morale. There are no short-run solutions to this problem;the only imi ediate response is to improve the quantity and quality of train-ing and to try to upgrade the quality of those who stay.

5.15 Export Development. The export sector is dominated by jute and jutegoods which account for about 70% of the value of exports. However, despitethe shift from raw jute to manufactured products, total exports account foronly some 8% of the value added in industry and agriculture. Present incen-tives include: export performance licenses, rebate of indirect taxes; incometax reduction on export earnings; direct subsidies to the jute industry; re-duced financial charges for exporters. An important factor in export behavioris the combined effect of exchange rate movements and the incent:ive package.Estimates show that effective exchange rates for exports average only 7% higherthan the official rate in spite of the various export incentives. The analysissuggests that relatively large increases in real effective rates are requiredto elicit a response in growth of exports and that constraints are: lack ofresponse to financial incentives by the public sector; structural problemsamong small private exporters; lack of know-how and poor knowledge of productalternatives as well aS an uncertain investment climate.

5.16 The institutional structure for export development is in place, butrequires strengthening and assistance in several areas such as: more adequatestaffing; definition of objectives, functions and activities; development ofadequate coordinating machinery.

5.17 Although GOB is obviously aware of the importance of export devel-opment, it lacks some of the experience and expertise to develop an integratedstrategy for exports. IDA could assist by filling gaps in the existingtechnical assistance program and assisting GOB in the formulation of thestrategy for inclusion in the Five-Year Plan, 1980-85.

Towards an Industrial Strategy

5.18 The remainder of the chapter will consider development of an in-dustrial strategy in Bangladesh in the light of the findings of the earlierchapters.

5.19 GOB has achieved much in the industrial sector since its policy ofencouraging private investment was announced in 1975 Output has recoveredand a transition to greater private industrial activity has begun. But,desnite some improvements, many problems remain. In fact, in its presentcondition, industry is probably more of a development cost than a benefit.Canital stock in industry has risen by 54% since 1970 and average employmenthas risen by about 47%. At the same time, surplus creation has fallen by 19%,and output per worker has f/allen to 64 of 1970 levels. If industry were Lo

make the contribution to growth that it was making in 1970, the rate of returnon capital would be 2 to I.' times what i n ow is, and overall productivity

- 80 -

would have to be increased by some 63%. In other words, a steady flow of

national resources into industry has resulted in lower production, lower re-wardsA tn the factorg; and a lower contribution to GDP. The public sector

is run inefficiently and supported by subsidies; the private sector is also

ineffirient due to r0wercontrol and over-protection.

5.20 GOB~ t has stnted diffprpnt occasions a number of objectives which

it would like industry to achieve, such as: industrial growth; employment

creation; more self reliance; more equal distribution nf induistry, incomesand employment among people and regions; greater agriculture-industry link-ages and higher export earnings from industry. 1/ Nonetheless, GOB is notclear on what are the tradeoffs and what are the policies, programs, incen-

tvsan' controls it should use to appro-ch optima aheemn-f hsL L V~ dIL ~u IJL~ IL ~LLJI O

goals, given the new direction of its general economic policy, and the con-straints it faces.

.L21 Examination OL Li.e iwU- Iear f Idlt WUUlL Su gg6eSDt LLtdt L-L[:: gadp UeLw:-II

objectives and policies is partly the result of the approach to planning. 2/The Plan purports to relate objectives to action in in dustrial development.However, despite extensive elaboration of the objectives, 88% of availableresources had to be devoted to ogoing projects. In effect, the objectives

simply cannot be achieved with the resources available and within the con-straints imposed by present conditions.

5.22 GOB issued a Five Year Plan in 1973 and intends to issue one in

1980. However, its decision to provide a two-year interim plan, as a period

for preparing a Five-Year Plan, shows that GOB is aware of the need to con-

sider new approaches. Analysis and constructive criticism of the weaknessesof present planning methods are quite widespread. 3/ One of the main points

made by the critics is that there is very little relation between plan objec-

tives and plan programs. The Panel Report (see footnote 3/) observes: "Many

lofty statements are made in the chapter on objectives. (The) general readerhas no way of ever finding out how the details given in the sectoral chapters

really add up to accomplish all the nice things said in the chapter on objec-

tives. This gives the planner plenty of latitude to make impressive pro-nouncements by way of enunciating plan objectives, which may not be fullywarranted by the sectoral plans which follow."

1/ For example, a recent (March) statement on industrial strategy (policy)by GOB said: "Our industrial policy is based upon four important consid-

erations. These are: (1) development of agro-based industry; (2) de-vplonmTnt of exnort-oriented industrv; (3) development of industry in

the rural areas; and (4) development of labor-intensive industry."

2/ For a brief review of previous plans, see Annexes Vl - V3.

3/ Perhaps the best exaraple of this constructive criticism is the "Report

of the Panel o-f Fonnomist on thp Preliminarv Draft of the Two-Year

Plan (1978-80)," Dacca, March 1978.

- 81 -

5.23 Unfortunately, while enunciating goals is relatively easy, assign-ing weights to the goals, before the planning work is done, is almost impos-sible. How much is rural development worth relative to overall growth ofGDP? Is there a trade-off? How consistent are the two goals? Because manymay have opinions, a national consensus is difficult to nuantify. Because ofthis sort of difficuLty, the burden falls on planners to assume weights andpriorities implicitly in order to compLete their job. The result is a planners'strategy -- open to the kind of criticisms of inconsistency raised by the Panelof Economists.

5.24 The discussion of the previous Chapters has illustrated the needfor integrating GOB's objectives into a coherent program. Despite the nume-rous changes in policy made by GOB,, private investors are responding slowlybecause they are sti]l uncertain of Government intentions; Government policiesand bureaucratic interpretation of ther.m are sometimes equivocal, creatingdelays where rapid processing is desired and deterrents where incentives areintended. Moreover, there are some conflicts between policies, between in-stitutions, and between departments. Public enterprises manifest a wide arrayof problems and a wide vartety of performance levels. Many of them are notoperated as productive enterprises but often more as welfare institutions.In both public and private sectors, many import substituting industries usedomestic resources inefficiently, even though some may be profitable. Non-traditional exports are growing and a sound start has been made on the machi-nery for export development, but exports, like import substitutes, are onlydesirable if they represent an efficient use of national resources, and thebulk of Bangladesh's exports are still earning foreign exchange at an exces-sive domestic resource cost.

5.25 It is clear from the multiple objectives of GOB and the variety ofproblems and constraints facing Bangladesh, that no simple single answer islikely to be found to the problem of industrial development. The issues tobe faced in meeting multiple goals are complex: which industries would givethe mix of agro-based:, export-oriented, rurally located and labor-intensivefactors that Government objectives describe? What resources would be neededto create that mix? What resources will be available? How much of the mixcan be reasonably achieved by 1985? In Bangladesh, however, the answers tomany of these questiorns depend on how some of the problems in the industrialsector are solved. For example, small-scale, rurally-located, labor-intensiveengineering industries might be an ideal mode for improving agro-industrylinks and meeting GOB's objectives. But the possibilities for developingthe engineering subsector in this way are limited. Among the legacies ofBangladesh's past are four engineering complexes which, when completed, willrepresent a vast excess capacity for engineering services unless they areput to productive use. Putting these plants to use will mean creating solu-tions for problems of inappropriate scale, technology, and products -- sincesome of the markets for which the plants were designed no longer exist -- andmay well pre-empt the introduction of some small industries. Moreover, thealternative of developing "in-house" engineering spare narts manufacturing bystate firms is also prejudiced. 1/ While the problems of the engineering sector

1/ A detailed analvsis of mainr issues in the engineering industry is inVolume II, Part I.

- 82 -

are special in some ways they are not unique. Thus, it is important that the

industrial strategy for Bangladesh include a focus on existing problems and

subsector realities, rather than exclusively on abstract slogans such as

"small-scale," "rural," and "agro-industry," or any other set of objectives.

The industrial sector is inefficient and has built-in problems, and these two

issues spell out two important strategic objectives: improve efficiency in

operations and find ways of turning past mistakes into gainful projects, or

of cutting their future losses.

5.26 Another important strategic objective, on which GOB is already

acting. is the development of industrial exports. To the extent that this

represents a shift in attitude by GOB - from thinking about controls as a

means of controlling foreign exchange scarcity, to thinking about a more

liberal trade regime--it provides a central focus for the kind of indus-

trial strategy that could evolve. The rationale of this objective is clear,

and is supported by comparative analysis of the performance of other devel-

oping countries. Moreover, the implications of pursuing an export-oriented

industrial development are sufficiently evident to provide some building-

blocks for implementation. The relative Derformance of countries using a

liberal trade approach together with export promotion (Korea, Taiwan, Hong-

Kong and others) and countries maintaining an inward-looking, controlled and

protective system (India, Ghana, Bangladesh, Tanzania and others) are widely

known. The liberal, export-oriented economies grew faster, weathered reces-

sions better, were clearly more self-reliant and, obviously, had more effi-

cient industrial sect ors than the economies with widesoread controls on

imports and foreign exchange.

5.27 The function of a strategy should be to create a link, in the form

of a program of actions, between the present situation and the industrial

objectives of GOB. The preparation of an industrial stategy for Bangladesh

should not be an abstracL planning exerc4se. The basic com.ponents of GOR's

strategy are already explicit: increasing private activity in industry,

increased orientation toward export industries. Both of these imply much

more liberal and market-related policies toward industry; both imply an

increased emphasis on efficiency. Examination of the major problems in the

industrial sector suggests that their solutions lie in the same directions:

increased efficiency and a more dynamic approach to the management of indus-

trial activities, especially in the public sector. What is required is an

overall program which addresses the particular problerms of both the public

and the private sector and includes the development of exports in both

sectors within a framework for implementing the necessary liberalization

policies. It is highly probable that an increased focus on attacking indus-

trial problems and generating industrial growth on the basis of efficiency

would, in Bangladesh, tend to be more effective in bringing about agro-

based, export-oriented rurally-located and labor-intensive industry than

any attempt to create rules and sanctioning procedures aimed directly at

these objectives.

5.28 The question of evolving an industrial strategy for Bangladesh is

thus basically one of implementation. In what ways and at what speed should

the current process of liberalization and export development continue? The

-- 83 -

direction of change required is easier to identify than the speed at which itshould take place. An ideal strategy for trade and industry liberalizationwould be aimed at achieving a system of resource allocation which optimizedthe social profitability of all productive activities, both exporting andimport substituting. In addition the strategy should include steps to safe-guard against retaliation against export incentives by importing countries,and should provide certainty and stabilitv to exporters and imDnort sub-stitutors, both local and foreign, without offering excessive protectionto anyone 1/.

5.29 The basic consideration of social nrofitabilitv is the provisionof equal incentives to exports and to import substitution. Foreign exchangesaved efficipntlv is a valuable as foreign exchanged earned efficiently.Equality of incentives to production enables economies of scale and tech-niral progress to be used effectively throughout the industrial sector.With the central objective of setting tariffs and export subsidies atequal rates on all products, (i.e., a "free-trade" reg4L men) Ile necessarydeviations from this should be undertaken directly and openly by using sub-sidies and excise taxes and not by offering protection through distortedtariffs or complex quantitative restrictions. For example, temporary addi-tional protection may be given to infant industries in both exporting andimport substituting activities, but the onus for demonstrating the need forprotection, for proving that ultimat,e eeficiency is achievable, should be onthe applicant. Moreover, the assistance, if awarded, should be as directas possible (subsidies or bounties rather than special tariffs), strictlylimited in its duration, and declining in force over that period. In otherwords, tne objective should be to depart from the "economic" use of aninstrument only when necessary, beneEicial and in a limited fashion so asto minimize the proliferation of cont:rols.

5.30 GOB's stated objectives imply an approach toward this "ideal"trade and industry strategy. However, the speed and degree of this approachcan only be decided by GOB in the light of the political circumstances. None-theless certain steps may be taken immediately in both the public and privatesectors in addition to those already taken by GOB. The basic public industriesin Bangladesh have been studied extensively over recent years. Studies onjute goods, textiles, steel, paper and leather were compiled with IDA assist-ance. 2/ A start has been made on the engineering industry in this report(see Volume II, Part I). Within the public sector, GOB faces many alterna-tives both within subsectors and across the whole public manufacturing sector.Management, costly operation, maintenance, closure, disinvestment, marketsand pricing represent problems in almost all cases. A first step in applyingsome consistent criteria to public manufacturing would be to pull togetherall this information, update it where necessary, and map out a program ofproduction, pricing, sales and investment targets. The efficiency, present

1/ For a comprehensive discussion of these issues see "Export Incentivesand Export Performance in Developing Countries," World Bank StaffWorking Paper No. 248, Jan. 1977.

2/ References Chapter 3. para 3,09.

- 84 -

and notential. of each firm should be estimated. and the return expected fromany incremental investment calculated. This should not entail extensive workby niot-idP crnsu,ltants, I/ t-hp information i8 alreadv at hand; the analvsis

is relatively straightforward; and the criteria must be derived by GOB in anycase. Responsiibility for the prearation of thsQe npbli I e-nte,-rnri s nrnoduictio n

and investment possibilities could rest with the Department of Industries andthe corporations. Above all, thhe possibility sumarie6 shoul be ralistic

without being too elaborate. For example, repetition of the original programt pr A de . ar num'r. o C oA; h fsc t ed F; J maine _ ols Ai e ni ne A Ar. A

sector would not be a constructive approach. Much more useful would be a com-prelensiLve p'lan f'or thie eCf--ie. ,mnuacu. oE1 _ pu-s, --lmnt n eup~1L~L1L V ~ £GLL . LJL LL~ _ L.LLL ~_LLL. ILiau ILC..C L-U L -_ V L pUIUJC) , L UIj L =UZ Li L Z, alIU r L

ment for the agricultural sector and the jute and textile industries as wellas some MachinLe tools. ALternati ve prudiictioa patteLrLn, eLLtat to Bangladueshsi

needs, should be prepared together with a program for attacking the managerialproblems created by the new production profile. It may be necessary to createtask-forces for some industries, to ensure that preparation of the summary ofpossibilities is sufficiently thorough.

5.31 After putting together the summaries for all public industries GOBmust decide on the flow of resources it expects from the public sector; whatoveraii return it may expect; now much inefficiency it can tolerate, and inwhat areas, and at what cost.

5.32 In the private sector, the main inhibiting factor appears to be alack of market information and a lack of data on existing industry. These

two problems should be attacked simultaneously. The development banks couldcontribute by preparing demand studies where obvious gaps exist in areas ofgrowing interest to investors (e.g., jute carpets). Too many subproject pro-posals have inadequate market analysis. (Further technical assistance to thebanks may be necessary to produce results rapidly). At the same time, theDepartment of Industries must move quickly to establish some realistic esti-mates of the relationships between industrial firms sanctioned and actualfirms in operation. This should be carried out in cooperation with the Bureauof Statistics, which must take steps to establish a firm estimate of existingcapacity in at least the large and medium private sector. Without betterestimates of existing firms and their capacity, and improved demand studies,the Investment Schedule, the Tariff Commission, and the whole apparatus ofmonitoring investment can be meaningless and often counterproductive. Theemphasis in this exercise, which has already been started by the Department,should be on gathering information rather thani on controlling investment.

5-33 Taking the steps outlined above would place GOB in a position to

obtain both better performance from industry and to revise its own controlsystem into a less direct and restrirtivp format. This will only happen,however, if the information compiled is used as a means of designing policiesbased on increasing the efficient use of resources. This means giving muchmore weight to measures of real efficiency (ERR, DRC) than in the past; andauapting planning to the new objectives a to te n o.

1/ In some cases, however, consultant studies are essential (e.g., theproposed study of steel) already plianned.

industrial sector may be regarded as having two major components: (i) mediumand large industry, oF which a great proportion is currently public, and(ii) the small, cottage, traditional and rural industries. The planning needsof the medium and large pUDiic industries are for detailed production possi-bility planning as discussed above. The small scale and traditional sectorneeds planning of inst:itutional support during its early development. Theprivate sector requires an indicative approach in which policies are designedto provide incentives for investment and expansion in appropriate areas.

5.34 A serious at:tempt by GOB to achieve its stated objectives throughexport-led industrial development implies a massive shift only in industrialplanning but in established attitudes, methods, criteria and policies towardmanufacturing. While the change need not take place overnight, it must takeplace with certainty, and in the forseeable future. Only when the new rulesare clear, and local and foreign investors are convinced that GOB is committedto a shift from contrcols to a market system, can a rapid response be expected.As indicated in the preceding chapters (and in paras 5.06 to 5.17) a systemof controls provides too many opportunities to profit by beating the system -transferring public resources to private use - for the entrepreneurs to be toointerested in earning profits by efficient competition. On the other hand, agradual approach may be the only way to avoid the risk of massive disruptionof the economy, since the changes are so fundamental. The key to the change-and this is, of course, more than simply an industrial issue - is foreignexchange management. The controls were developed because of a foreignexchange shortage and the speed of liberalization may have to be tied toprogress in reducing the foreign exchange problem. However, whatever thespeed of change, useful first steps for GOB, outlined above, are to raiseefficiency in the public enterprises and to generate more industrial infor-mation for the private sector. At the same time. GOB must accelerate itsdrive to develop exports. In this r-egard the Bank and GOB are cooperating onan Export DeveloDment Program as part of the Seventh Tmports Program Credit.The Bank is also assisting GOB to prepare for the presentation of a revisedpolicv structure. The work on Trade Policy and Development (involving a studyof DRC, shadow price and policy alternatives) is being carried out by BostonUniversity and the Bangladesh Bank with Bank fiinding and is expected to becompleted by December 1979. The results of this work should be used for aneconomic revision of the tariff structure, and to provide a context in whichdomestic policy measures (interest rates, tax policy, exchange rate policy,etc) can be brought into line with the emerging strategy. By the time ofpublication of the Five Year Plan, GOB should be prepared to set forward acomprehensive program. of reform in policies, institutions, criteria, incen-tives aimed at creating an efficient export-led industrial development anddiAsp4eling the current linger4ng doubts about its com-.itment to the funda=~L*~* .Lfl

5A. .LL U.LJUL. 0 L.UU A.£L LU1L LL1IL L L . IU

mental changes involved.

5.35 The Bank coulid assist GOB further by providing assistance for im-proving the efirc4iency of public enterprLses especialy in the more complexareas - such as gas based industries and engineering (where special problemsexist in using the large complexes and integrating them into agro-industryactivities). Other possibilities for technical assistance include develop-ment of the strategy orn exports, strengthening the Tariff Commission, further

- 86 -

work in the development banks and assistance to the Department of Industriesfor sub-sector studies. Current possibilities for a direct project or sectorfinancing include the paper, pulp, cement, and chemical industries, as wellas jute and textiles.