PRI Quarterly Policy Briefs on Bangladesh · PDF fileThe foreign banks and private banks are lukewarm to ... GCI Comparison between the 2010-2011 and 2013 ... PRI Quarterly Policy

PRI Quarterly Policy Briefs onBangladesh Economy

July 2014

Policy Research Institute of Bangladesh (PRI) Department for International Development (DFID)

Volume VI

ii

PRI Quarterly Policy Briefs on Bangladesh Economy July 2014

Foreword

The Government aims at becoming a middle income country by 2021, and improving further by 2041. Thiswould require sustained development at a high rate - say 7-8%, structural change and improvement, goodinstitutions and right kind of policies.

Knowledge is a critical input for achieving the goals that the Government has set. An independent think-tankcan make significant contribution to this national enterprise by independent analysis and realistic advice.

The present edition of PRI Quarterly Policy Brief moves in that direction. It addresses the issues of the bankingsector, the capital market, and export.

Banks play a critical role for the economy, making efficient allocation of financial resources to the sectorswhich are socially important. The nationalized banks, by and large, are the only institutions which lend forinvestment. The foreign banks and private banks are lukewarm to lending for investment; they prefer trade, importand export in particular, which has much less risk. The criteria for judging performance of the two types of banksneed to be differentiated by their lending strategies and attitude to risk.

Autonomy of central bank is recognized. However, while talking about autonomy of central bank, it isnecessary to separate its core function from the non-core or subsidiary functions. Monetary policy is its core function,which it ought to - and does actually - pursue with independence. Government's deficit financing could impactmonetary policy, but for decades deficit has remained stable at a low level. Disagreeing with the government is oftenconsidered autonomy, naively though. Quasi-fiscal operation or policy-based lending to preferred sectors or groupsis not part of the core monetary policy. In performing these tasks, the central bank acts as an agent of thegovernment or takes on a policy-related political function.

The stock market should function better to play its role in the development of the economy. However, thestock market may not get adequately strong unless the underlying assets are also in good shape. Stock marketanywhere in the world has a speculative element; an efficient market would contain within limit the speculativeelement and make the necessary corrections.

There is excessive dependence on export of RMG in terms of product as well as market. It is absolutelynecessary that there are initiatives for diversification.

RMG has grown very fast and the factory structures sometimes neglected safety standards. This needs to beremedied. RMG is essentially a global phenomenon; remedies of deficiencies also need coordinated global efforts.Compliance has a cost; and if each importer or group of importers defines its own standards, compliance gets muchmore complex and costly. ILO, the governments of the exporting country and of the importing countries, should jointo establish uniform - or at least compatible - standards. There is a need to provide accessible funds for financing thecost of compliance. More research is needed to identify the global contact-points.

Wage and productivity as well as the trade union practices are important areas for research and policy. Itseems that not enough has been done in these areas, especially for development of healthy industrial relations.While ILO embraces tripartite arrangement in industrial relations - the government, the employer, and the workers -other players also have entered the field who are not trade unions or institutions committed to professional researchin labor economics and trade union. This is a new phenomenon whose impact on trade unionism and industrialpeace should be examined carefully.

PRI deserves commendation for undertaking serious policy research addressing many of the relevant issues.

Dr. Mashiur RahmanEconomic Adviser to the Hon'ble Prime Minister

Government of the People's Republic of Bangladesh

iii


Contents

Summary: ................................................................................................................................. v

I. Implementation Challenges Related to the Macro-Financial Aspects of the Budget 1

Introduction and Background .............................................................................................1

Macroeconomic Targets and the Stances of Fiscal and Monetary Policies ........................1

Budget Size and How the Resources Allocated...................................................................2

Deficit Financing and Its Composition.................................................................................4

Concluding Observations and Some Key Recommendations .............................................5

II. Implementing Policy and Institutional Reforms of the FY2014-15 National Budget 7

Overview .............................................................................................................................7

Proposed Policy and Institutional Reforms .........................................................................7

Implementation Aspects of Policies and Institutions..........................................................7

Concluding Remarks..........................................................................................................10

III. Implementation Challenges - the Infrastructure Program........................................ 11

Context..............................................................................................................................11

Power and Energy Infrastructure ......................................................................................11

Communications Infrastructure ........................................................................................13

Conclusion.........................................................................................................................15

Specific Suggestions: .........................................................................................................15

Annex 3.1................................................................................................................................ 16

IV. FY2014-15 Budget and Trade Policy .......................................................................... 21

The Context .......................................................................................................................21

Mainstreaming Trade and Trade Policy ............................................................................21

Budget 2014-15 and Tariff Trends ....................................................................................22

Tariffs, Para-tariffs, and Protection...................................................................................23

Budget 2014 signals welcome change in direction ...........................................................24

Reviewing Duty Reduction on Inputs of selected domestic industries .............................24

Policy Issues and Recommendations ................................................................................25

Annex 4.1................................................................................................................................ 26

iv


List of Tables

Table 1.1: Selected Short Term Macro Indicators .................................................................. 1

Table 3.1: GCI Comparison between the 2010-2011 and 2013-2014 for Bangladesh ....... 11

Table 3.2: Infrastructure Allocations (in Crore Taka) ........................................................... 11

Table 4.1: Trends in Average Tariffs, Para-tariffs, and Nominal Protection rates.............. 22

Table 4.2: Distribution of CD, RD and SD by Product Category (FY2014)........................... 23

Table 4.3: NPR trend in product categories, FY10-15 .......................................................... 24

List of Figures

Figure 1.1: 2013 and 2014 Monetary Policy Targets vs Actual.............................................. 2

Figure 1.2: REER Index; index 2000-01= 100 .......................................................................... 2

Figure 1.3: Budget Targets ...................................................................................................... 3

Figure 1.4: Budgetary Expenditure Growth (in Percent) ....................................................... 3

Figure 1.5: Major Expenditure Components of Budget FY10 ............................................... 3

Figure 1.6: Major Expenditure Components of Budget FY15 ............................................... 3

Figure 1.7: Education Expenditure ......................................................................................... 4

Figure 1.8: Healthcare Expenditure ........................................................................................ 4

Figure 1.9: Social Protection Expenditure .............................................................................. 4

Figure 1.10: The Increased Dependence on Domestic Financing Is Fiscally Burdensomeand Entails High Rollover Risk ...................................................................................... 5

Figure 1.11: Trends in the Composition of Domestic Financing Points to GrowingDomestic Rollover Risk .................................................................................................. 5

Figure 1.12: Long-Term Restructuring of Financing of the Budget Deficit .......................... 5

Figure 4.1: Import-Based and Domestic-Based Taxes ......................................................... 22

Figure 4.2: Trend in Nominal Protection Rates (FY 00-FY15) .............................................. 23

Figure 4.3: Avg NPR on Outputs and Inputs ......................................................................... 23

v


Summary:

I. Macro-Financial Aspects of the Budget

Budget implementation should be done in such amanner that it guards against potential revenueshortfall. This would essentially imply prioritizationof projects and programs with a view to settingaside projects/programs which may be considerednon-priority or controversial.

On the financing of the FY15 budget deficit, thereis a risk that the external financing (net) assumed inthe budget is very ambitious and shortfalls on thatfront would put pressure on domestic financing.The Government has to find a better way to utilizemore foreign aid from the large pipeline and try toexceed the level of foreign aid disbursementassumed in the budget. Greater access toprogrammatic external financing in support ofmajor structural reforms may help fasterdisbursement of funds and improve policyenvironment. A medium and long term financingstrategy should be developed by the Ministry ofFinance to broaden the sources of both domesticand external financing, taking into account thematurity/rollover risk and diversification of sourcesof financing.

Higher allocations for social sectors are welcome,but this shift has to be sustained over the mediumterm. At the same time quality of spending oneducation and health and targeting of resources forsocial protection need to be improved.

Monetary management will continue to remaindifficult unless economic activity picks up rapidly,imports increase, and the pace of accumulation offoreign exchange reserves moderates to asustainable level. Bangladesh Bank is rightly buyingthe US dollar in the interbank market to prevent anappreciation of the Taka. However, given the higherdomestic inflation rate relative to the tradingpartners, this policy is still contributing to a rapidappreciation of the real effective exchange rate(REER), which will eventually hurt our exports.

A firmer approach to bring down inflation to theaverage level of Bangladesh’s trading partnerswould certainly help reduce the tension. Thatwould also help bring down the whole interest ratestructure leading to lower lending rates. However,given Bangladesh Bank’s appetite for higher

inflation (in the range of 6% or more) suchconvergence with trading partners and bringingdown the interest rate structure (both deposit andlending rates) faster will be difficult.

II. Implementing Policy and Institutional Reforms

Implementation of decentralization requires thedevolution of fiscal powers through properlegislation. Furthermore, substantial ground workinvolving capacity building, training etc. ianecessary. There is considerable internationalexperience that Bangladesh can learn from. Manydevelopment partners would be willing to providetechnical assistance to implement this criticalreform, provided the political hurdle constrainingdecentralization is crossed.

Implementation of modernization of land marketwill require substantial background work andtechnical assistance, assigning proper institutionalresponsibility, defining a time line forimplementation and monitor progress,simplification of registration and recordationprocess, and rationalization of associated fee toavoid land valuation problems.

The Government has already made some significantgains in revenue mobilization over the past fewyears. Further tax reforms are needed as follows:

The income tax measures have to bebroadened substantially with a well-articulatedincome and property tax reform, which couldinclude: Government adopt the principle that all

personal income derived from engaging ineconomic activities in Bangladeshirrespective of the source is taxable.

Concessions to encourage domestic andforeign investment should be designed ina way that does not undermine income taxcollections.

The tax base needs to be broadenedthrough stronger enforcement of tax laws,along with efforts to further simplify taxfiling and tax payments system.

A proper wealth tax in the form of a well-designed property tax should bedeveloped.

vi


The new VAT Act of 2012 modernizes the VAT,but this needs to be supported by a reformedVAT administration along functional lines andbacked by modern IT-based integratedbusiness processes

On trade taxes, highest priority is to rationalizesupplementary trade duties to reduceinvestment distortions.

The implementation of the NBR ModernizationPlan is very slow and needs to be substantiallyspeeded up.

The Government could take a number of steps tomanage the contingent liability problem: Stopping the source of financial bleeding

through proper reforms including pricingpolicies (energy), sound lending practices(public banks) and better corporategovernance (both non-financial publicenterprises and public banks).

Doing a full accounting of the stock ofcontingent liabilities from all sources anddevising a time-bound action plan to graduallyreduce this liability.

The commitment to adopt a new National SocialSecurity (NSS) program in the budget speech iswelcome but preparations should start for speedyimplementation of the strategy.

The idea of introducing a green tax iscommendable. Considerable work needs to bedone to make fiscal policy an effective instrumentfor fighting pollution and environmentaldegradation.

III. Implementation Challenges- The InfrastructureProgram

Adopt a phased implementation plan with high-priority projects on the frontline along with time-bound completion plans.

The absence of a long-term primary fuel strategy,especially coal policy, remains a serious weaknessof the Government’s energy policy.

Procurement continues to pose corruptionproblems and delays in infrastructure projectimplementation. Consider undertaking turnkeyprojects for large infrastructure to avoidprocurement debacles and capacity constraints.

The budgetary and some of the implementationrelated constraints could be overcome with anumber of projects being implemented throughPPPs. There were projects identified but because ofinstitutional constraints major infrastructure projectcontinue to face start-up and completion delays.

Specific Suggestions for strengthening PPP implementation:

There needs to be prioritization of projectstaking into account the availability of fundsand the availability of skilled staff.Procurement delays continue and are linked tobuilding institutional capacity and staff skills.There are knowledge and skill gaps incontracting process, which will have to beaddressed.

On the PPP front, Bangladesh needs to fill thegaps in its institutional framework with rulesand regulations that can be readily understoodand followed. The PPP framework should bemade legally binding, with clear allocation ofrights and duties to provide confidence tocontracting agencies that PPPs are wellorganized and will not cause them cost anddelay without a corresponding benefit, and tothe private sector that the process will not addcost and complexity (to an already difficultprocurement model) and will provide a levelplaying field in which to compete.

The Finance Division’s current role needs to bestrengthened to act as gatekeeper forGovernment liabilities and the ability to usefinancial resources to incentivize contractingagencies.

The PPP Office should be primarily focused onpromotion of PPP, in collaboration with thecontracting agencies, supporting projectidentification, pre-feasibility/feasibility studiesand preparing contract documents.

Contracting agencies (including line ministries)need to be given more support, in particularcapacity building, access to project preparationfunds and capital grants to make PPP projectsmore affordable where they provide positiveexternalities, like better, more robust services.

Selecting a winning bidder and achievingfinancial closure is not the end of the story.Implementing the project and monitoringperformance of all parties is essential to a

vii


successful PPP program. This function is left tothe contracting agency, and more supportshould be provided to the implementationphase of projects, sharing know-how andlessons learned and providing resources fordifficult phases of implementation like tariffresets, dispute resolution and renegotiations.

A detailed gap analysis should be performed toidentify laws and regulations that do notsupport PPP and amend accordingly.

A comprehensive set of rules and guidelines isneeded for allocating and monitoringGovernment support in its many forms,including in particular funding for projectpreparation, grants to defray project costs(VGF) and guarantees to mitigate project risks.

IV. Mainstreaming Trade Policy

In keeping with the guidance laid down in the SixthPlan, it is time to mainstream trade and trade policyand the annual National Budget is the rightinstrument to integrate trade policy issues in itsformulation as well as implementation. Thestrategic shift from reliance on trade-based taxes todomestic-based taxes should be continued andintensified.

Anti-intermediate goods bias of trade and industrialpolicy need to be eliminated for the domesticintermediate goods sector to expand, becomeexport-oriented, and seize the opportunitiesoffered from global value chains.

After many years of rising nominal protection thechange in approach is welcome and a move in theright direction, something that will infuse a modestdoze of competition while offering some price reliefto consumers who have traditionally borne thebrunt of the protection tax.

It is high time for Budgets to pay attention to consumerinterests and not simply focus on demands of producergroups with strong lobbying capacity who will always seekhigher tariffs on outputs and lower tariffs on inputs. Highprotection in perpetuity neither improves productivity norensures competitiveness in the long-term. New protectionneeds to be made time bound while prevailing highprotection needs to be scaled back in phases.

1


I. Implementation ChallengesRelated to the Macro-Financial

Aspects of the Budget

Ahsan H. Mansur1

Introduction and Background

The Fiscal Year 2014/15 (FY15) budget was placed forParliamentary Deliberations on June 5, 2014. After threeweeks of deliberations, the Parliament has approved theFY15 budget on June 29 with some minor modifications.The overall size of the budget still remains the same andother broad targets like the overall fiscal deficit and therevenue targets have also remained unchanged, despitesome changes in the tax policy measures in the approvedbudget.

Like previous budgets, this Budget is ambitious, particularlywith regard to macroeconomic objectives like growth andinflation and on the spending side. There are also challengesfor revenue mobilization as the Budget seeks tosubstantially increase revenues in order to finance theadditional expenditures. The Budget intends to keep thedeficit contained at around 5% of GDP, which is appropriateand sustainable, but there are substantial implementationissues relating to deficit financing and tax mobilization. Aparticular concern is the ability to mobilize deficit financingin a way that contains the interest cost, which is showingsigns of strain. The proposed 25% increase in tax revenues,while necessary, is by no means secure and will requireconsiderable work.

On the spending side the Budget provides substantialallocation for important infrastructure projects, includingthe Padma Bridge but a number of controversial projectshave also received large allocations under the budget.Government’s ability to mobilize related funding andstrengthen implementation capacity calls for significantpolicy reforms and flexible management of the spendingplan. A worrisome aspect of recent budgets is the relativelylow allocations for social spending on education, health andsocial protection. The policy brief will also examine theallocations under the FY15 Budget.

1 Ahsan Mansur is Executive Director of the Policy Research Institute ofBangladesh.

Macroeconomic Targets and the Stances of Fiscaland Monetary Policies

The two major macroeconomic targets established in thebudget are: (i) increasing the real GDP growth to 7.3% inFY15 from the 6.2% growth estimated for FY14; and (ii)containing inflation further to 6% from the current level ofaround 7.5%. In terms of desirability certainly the objectivesare laudable, but the question is whether these objectivesare attainable under the prevailing circumstances and thestance of fiscal policy. There are some signs of recovery insome key forward-looking macro indicators like growth ofimports, opening and settlement of letters of credit (LCs),increase in demand for private sector credit, and inflow ofworkers’ remittances. However, these recoveries are stillfragile and relatively week to justify a robust pickup ingrowth by more than 1 percentage points and to above 7%level which was never achieved in Bangladesh. Moreover,there is still no sign of a strong recovery in private sectorinvestment in relation to GDP, which is a pre-condition forhigher growth. Although at the moment there is no politicalunrest, the unsettled major political issues still simmeringbelow the surface and is a major concern and uncertainty forprivate investors. It is also interesting to observe that despitethe misplaced talk about the overall size of the budget, thefiscal deficit being at 5% of GDP essentially indicates thatthere will be no additional fiscal stimulus through fiscaloperations despite the weakness in the economy. Theseconsiderations notwithstanding, if the political situationremains under control, economic growth may accelerate to6.5% in FY15, which will be a respectable performance byany standard. This view is consistent with the projections ofmany multilateral organizations and also of BangladeshBank.

Table 1.1: Selected Short Term Macro IndicatorsUSD in Billions

Change between(%)

FY10

FY11

FY12

FY13

July

-Dec

FY1

4

July

-Apr

FY1

4

July

-Dec

FY1

4ov

er F

Y13

July

-Apr

'14

over

July

-Apr

'13

Apr

'13

to A

pr'1

4

Remittance * 11.0 11.7 12.8 14.5 6.8 12.9 -8.5 -3.6 10.6

Private Sector CreditFlow (BDT in billions)

2708 3407 4078 4529 4787.7 4924.1 10.6 10.9 11.9

Imports

Import Payments 23.7 33.7 35.5 34.1 16.0 30.2 -0.1 10.5 6.2

L/C Opening 28.8 38.6 37.0 36.0 18.8 33.4 10.3 11.6 13.2

L/C Settlement 23.1 32.0 34.8 32.4 17.8 30.6 11.6 14.2 15.3

*For remittances data is updated till May'14Source: Bangladesh Bank

2


On the inflation issue, despite some gains in bringing downinflation, in recent months the overall inflation rate hasremained stubborn at about 7.5% rate primarily due tohigher food inflation. Domestic supply situation has beenvery good due to series of good harvests in almost all majorcrops and other agriculture produce, and international foodprices have also declined or remained stable, but stilldomestic food price increases are continuing to frustrateBangladesh Bank’s efforts to contain inflation.

Figure 1.1: 2013 and 2014 Monetary Policy Targets vsActual

Source: Bangladesh Bank

Bangladesh Bank’s monetary policy implementation hasbeen in line with the MPS of January 2014. The surge in theNet Foreign Assets (NFA), well beyond theprojected/programmed amount, created liquiditymanagement problem for Bangladesh Bank. Nevertheless,through sterilization by issuing Bangladesh Bank bills,growth in all key monetary aggregates like Reserve Moneyand broad money were kept within the MPS limits. Weexpect Bangladesh Bank’s next 6-monthly Monetary PolicyStatement (MPS) to maintain the current restrainedmonetary policy stance with monetary targets in line withinflation in the range of 6%-7% and growth rate notexceeding 6.5%.

Based on the considerations noted above, it appears thatthe economy is recovering from the down turn experiencedup to December. Nevertheless the recovery is still relativelymild and the Government is most likely to miss on its twomajor macroeconomic targets, with GDP growth fallingshort by at least 0.7 percentage point and the rate of

inflation overshooting the target by at least 0.7-1.0percentage point. However, the nominal GDP growthshould still be achievable and if the exchange rate continuesto remain stable in nominal terms against the US dollar (alikely scenario in the event export growth continues), theGDP growth in dollar terms and per capita GDP in the USdollar terms will also be achieved. There will however be aproblem with the continued appreciation of the Taka in realeffective term, which already appreciated by more than 10%during the two year period FY11-FY13 and should haveappreciated further by another 7% or more in FY14. RMGsector may afford to absorb this real appreciation of the takadue to its inherent competitiveness for a few more years,but other exports are already faltering.

Figure 1.2: REER Index; index 2000-01= 100

Budget Size and How the Resources Allocated

Although there has been a lot of discussion on the “so calledlarge size of the budget,” we do not consider the increasedallocation as particularly large in view of a number ofconsiderations. If we compare FY15 budget with the FY14and other recent budgets, we observe that at 18.2% of GDPit was almost the same as FY14 budget and a little bit higherthan the other recent budgets. Certainly with the increasedsize of the economy and growing demand of the citizens forbroad range of public services and improved quality ofpublic services such modest increases are unavoidable.

17.7

18.5

16.1

14.0 17

.2

15.5

15.5

19.3

16.7

10.8 15

.0

50.4

16.7

11.1 13

.6

34.2

-5.0

5.0

15.0

25.0

35.0

45.0

55.0

Broa

d M

oney

(M2)

Gro

wth

Priv

ate

Sect

or C

redi

t Gro

wth

Rese

rve

Mon

ey G

row

th

Net

For

eign

Ass

ets

Broa

d M

oney

(M2)

Gro

wth

Priv

ate

Sect

or C

redi

t Gro

wth

Rese

rve

Mon

ey G

row

th

Net

For

eign

Ass

ets

FY13 FY14 (H1)

Target Actual

Mar

'13

2











17.0

16.5

16.2

10.015

.3

11.5

11.4

36.1

Broa

d M

oney

(M2)

Gro

wth

Priv

ate

Sect

or C

redi

t Gro

wth

Rese

rve

Mon

ey G

row

th

Net

For

eign

Ass

ets

FY14 (H2)

Mar

'14

Mar

'14

Apr '

14

Mar

'14

86.0

80.00

85.00

90.00

95.00

100.00

105.00

110.00

FY 03FY 04FY 05FY 06FY 07FY 08

REER Index

Source: Bangladesh Economic Review, Minitry of Finance

2











86.0

97.7

89.4

106.4

FY 07FY 08FY 09FY 10FY 11FY 12FY 13 FY14*

REER Index

Source: Bangladesh Economic Review, Minitry of Finance

3


Figure 1.3: Budget Targets

Source: Ministry of Finance

In terms of the increase in government spending relative tothe actual expenditure or the revised budgetaryexpenditure of the previous years we in fact observe a majordeceleration in expenditure growth compared with theexpenditure growth observed in the preceding years. As amatter of fact, expenditure growth in FY15 is 15.9 % over therevised FY14 budgetary spending, which is the lowestincrease recorded in any year of the Awami Leaguegovernment.

Figure 1.4: Budgetary Expenditure Growth (in Percent)


In terms of overall resource allocation over the years we donot observe major shifts, although allocations for transportand energy/power have increased in line with governmentpriorities for infrastructure and allocations for education,health and social safety net programs have decreased inrelative terms. It is also interesting to observe that despite

reservations expressed by many quarters, total interestpayments as a share of total spending has declined in recentyears but at 12.4% of total spending in FY15 is very close tospending on education and information technology.

Figure 1.5: Major Expenditure Components of BudgetFY10

Source: Budget Documents, Ministry of Finance



A matter of concern is the very rapid increase inmiscellaneous expenditure, the share of which increased bymore than three folds to 9.9% of total spending. Such a largeincrease in the unidentified miscellaneous category toalmost 10% of the budget or 1.8% of GDP is a matter ofconcern pointing to lesser transparency and potentialweakening of expenditure control.

16.4%16.8%

17.9%

18.5%18.7%

15.0%

15.5%

16.0%

16.5%

17.0%

17.5%

18.0%

18.5%

19.0%

FY10 FY11 FY12 FY13 FY14

As %

of G

DP

27.430.1

27.625.8

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

A=Actual, B=Budget, RB=Revised Budget

3














18.7% 18.7%

FY14 FY15

27.9

15.9

Health, 5.9Defense, 5.3

Agriculture, 4.5

PublicAdministration

, 13.6

Social Securityand Welfare, 7.3

MiscelleneousExpenditure, 3.1

Others, 16.8

Health, 4.2Defense, 5.8Agriculture, 3.8

PublicAdministration

, 7.5

Social Securityand Welfare, 5.6

MiscelleneousExpenditure, 9.9

Others, 17.3

3














Education &Information

Technology, 11.9

Interest, 13.9

Transport &Communication,

6.3

Local Govt &Rural

Development, 7.6Energy &Power, 3.8

Health, 5.9Defense, 5.3

Education &Information

Technology, 12.4

Interest, 12.4

Transport &Communication,

9.5

Local Govt &Rural

Development, 7Energy &

Power, 4.6Health, 4.2

Others, 17.3

4


In recent years the allocations for key social sector programswitnessed a secular decline in relation to GDP and the totalbudget. Total spending on three major social sectorsdeclined from 38.1% of total budget in FY10 to 27.6% oftotal budget by FY14. This decline had to stop. We arepleased to observe that FY15 budget has made a significantmove to reverse the secular decline. Total allocation to thethree social programs has increased by 4.3 percentagepoints to 31.9% of total budget, which is a commendablemove. This upward shift is visible in all three sectors. Wehope no cuts will be made in these allocations and effortswill be made to improve allocational and targetingefficiency of these important programs.

Figure 1.7: Education Expenditure


Figure 1.8: Healthcare Expenditure


Figure 1.9: Social Protection Expenditure


Deficit Financing and Its Composition

The government’s fiscal deficit level of 5% of GDP in thecontext of more than 6% real GDP growth is appropriate andshould not give rise to any debt sustainability issue.However, the emerging pattern in the composition offinancing with much greater reliance on high cost domesticfinancing and relatively short maturity structure andassociated very high degree of rollover is a matter thatshould get more attention in the financing strategy of thegovernment.

In particular, the government would need to diversify itssources of financing with proper mix of domestic andexternal financing, and on both fronts identify market basedadditional sources of financing. On the domestic borrowingfront, dependence on National Savings Schemes and short-term treasury bills should give way to long-term treasurybills and bonds, infrastructure bonds, etc. with propersecondary market and a well-developed yield curve (whichdoes not exist today). Bank financing primarily in the form oftreasury bills of short maturities (one year or less) andnonbank financing of medium-term maturity (3-5 years) arenot long enough in terms of maturity and the governmentmust develop the market for long-term bonds withmaturities of 10-30 years. This will help development ofmarket-based yield curve and encourage longer maturitybond issues by the corporate sector and public institutionsfor financing of investment projects and infrastructure.

On the external front, the dependence on traditionalconcessional borrowing from official bilateral andmultilateral sources should be complemented withadditional borrowings in the form of sovereign bonds ofvarious maturities (with preference for longer maturityperiod as in the case if Indonesia and Philippines) and other

13.3

15.414.4

12.2 12.1

1.9 2.2 2.3 2.0 2.0

0

2

4

6

8

10

12

14

16

18


In p

rece

ntag

es

As % of Total Budget As % of GDP

5.76.2

5.75.4 5.3

0.8 0.9 0.9 0.9 0.9

0

1

2

3

4

5

6

7


In P

erce

ntag

es


4













12.111.3

13.1

2.0 2.1 2.2

FY13 FY14 FY15

As % of GDP

4.3

5.0

0.8 0.9

FY14

As % of GDP

15.516.5 16.3

2.3 2.4 2.7

0

2

4

6

8

10

12

14

16

18

FY09 FY10 FY11

In P

erce

ntag

es

As % of Total Budget

4













14.613.3

12.0

13.8

2.4 2.2 2.3 2.6

FY12 FY13 FY14 FY15


5


sources of financing. Indonesia and Philippines are currentlyissuing sovereign bonds of 30-40 year maturity. Thegovernment should first try to establish its relations with theinternational capital market by launching its first sovereignbond very soon because both domestic and internationalmarket conditions are favorable for such a launch. Theproposed access to sovereign debt market should by nomeans divert the policy makers’ attention away fromaccessing greater concessional financing from officialmultilateral and bilateral sources with longer maturities. Theforeign aid pipeline of about $16 billion is already too highand cannot be allowed to grow further. The financing planproposed in the budget does not indicate any serious effortin increasing the utilization of external financing andcontinues to increase dependence on high cost and shortermaturity domestic financing.

Figure 1.10: The Increased Dependence on DomesticFinancing Is Fiscally Burdensome and Entails High

Rollover Risk


Figure 1.11: Trends in the Composition of DomesticFinancing Points to Growing Domestic Rollover Risk


The widening trend between the external and domesticfinancing since FY06 is a matter of concern. If no attention isgiven to higher utilization of external concessional aid inpipeline and new commitments, debt servicing wouldbecome increasingly costly for the budget, limitinggovernment’s scope for discretionary spending. At the sametime access to both domestic and external debt would needto be significantly broadened. On the domestic front thetraditional reliance on nonbank borrowing through NationalSavings Directorate (NSD) and short-term T-bills should besupplemented with long-term T-bills and bonds (10-30 yearT-bills and bonds). On the external financing front, greaterand regular access to international capital market throughissuance of long-term bonds will be important. The shiftsdescribed above are outlined in the schematic diagram onbudget financing and public debt management below. Theneeded strategic transformations should be done on thebasis of a comprehensive Government Financing and DebtManagement Strategy to be prepared by the DebtManagement Wing of the Ministry of Finance.

Figure 1.12: Long-Term Restructuring of Financing of theBudget Deficit

Source: PRI Staff Estimation

Concluding Observations and Some KeyRecommendations

The budget approved by Parliament is appropriatelyambitious and fiscally prudent in terms of the overall fiscaldeficit of 5% of GDP. The main risk to the budget originatesfrom its ambitious NBR revenue target, which would entail25% growth over the FY14 actual collection. Although thebudget has a number of fiscal measures on the VAT(particularly through taxation of tobacco products) anddirect tax fronts and imports are picking up, it will requireclose monitoring and expenditure control/adjustment tolimit the overall deficit and domestic borrowing at budgeted

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

FY80

FY82

FY84

FY86

FY88

FY90

FY92

FY94

FY96

FY98

FY00

FY02

FY04

FY06

FY08

FY10

FY12

FY14

As %

of G

DP

Net Foreign Finance Domestic Financing

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

As %

of G

DP

Bank Loan Non-bank Loan (Net)

Sovereign Bond/Non-Concessional External Borrowing

Long-term Bond

NSD

Bank Borrowing (2.3% of GDP in FY14)

Do

me

stic

Fin

an

cin

g(3

%o

f G

DP

in

FY

14

)E

xte

rna

l F

ina

nci

ng

(2%

of

GD

P i

n F

Y1

4)

Concessional Official External Borrowing

% of GDP

FY14-FY30

6


levels. As recognized by the Finance Minister, the majorchallenge will be to boost private sector investment if thegrowth target is to be achieved. The increased allocationsfor social sector programs like health, education and socialprotection in FY15 budget are welcome and we wouldexpect that actual spending will materialize along withhigher allocations in the coming years.

Against the overall assessment made above, someimportant recommendations are noted below.

1. The emphasis on transport, power, and makingserviced lands available to potential investors(domestic and foreign) is appropriate. However,these large infrastructure projects need to betranslated into real action on the groundthrough speedy implementation. Past experiencewith regard to implementation of major transportand power projects have been fraught with costoverruns, long delays, and quality control issues.Most of these projects mentioned in the budgethave been under consideration for a long time. Thistime, if we really want to see a real change inprivate sector investment sentiment, these largeprojects must get off the ground and their actualimplementation be started in FY15.

2. Budget implementation should be done in such amanner that guards against potential revenueshortfall. This would essentially imply prioritizationof projects and programs with a view to settingaside projects/programmes which may beconsidered non-priority or controversial. Inparticular, Ruppur Atomic Power Plant and Rampalcoal based Power Plant near the Sunderbans mayeasily be postponed while awaiting comprehensiveappraisals and environmental and social impactsassessments of these projects and after completionof open public debate on the appraisal andenvironmental assessment reports.

3. On the financing of the FY15 deficit, there is alsorisk that the external financing (net) assumed in thebudget is very ambitious and shortfalls on thatfront would also put pressure on domesticfinancing. The government has to find a better wayto utilize more foreign aid and try to exceed thelevel of foreign aid disbursement. Greater access toprogram financing in support of major structuralreforms (e.g., in the financial sector, civil servicereform, reforms in the operations of the Railways,

RMG sector relocation to new RMG Villages/Parks,etc.), may help faster disbursement of funds andimprove policy environment. A medium and longterm financing strategy should be developed bythe Ministry of Finance to broaden the sources ofboth domestic and external financing taking intoaccount the maturity/rollover risk anddiversification of sources of financing.

4. Higher allocations for social sectors arewelcome, but this shift has to be sustained over themedium term. At the same time quality of spendingon education and health and better targeting ofresources for social protection need to beimproved. The commitment to adopt a newNational Social Security (NSS) program in thebudget speech is welcome but preparations shouldstart for speedy implementation of the strategyalong the lines already approved by the Secretary’sCommittee.

5. Monetary management will continue to remaindifficult unless economic activity picks uprapidly, imports increase, and the pace ofaccumulation of foreign exchange reservesmoderates to a sustainable level. Bangladesh Bankis rightly buying the US dollar in the interbankmarket to prevent an appreciation of the Taka.However, given the higher domestic inflation raterelative to the trading partners, this policy is stillcontributing to a rapid appreciation of the realeffective exchange rate (REER) which will eventuallyhurt our exports. Economic theory says that whileBangladesh Bank can prevent the nominalappreciation of the exchange rate it cannot at thesame time prevent the real appreciation of theexchange rate. This policy dilemma will be achallenge for both monetary and exchange ratemanagement in the coming year and will haveimplications for growth.

6. A firmer approach to bring down inflation to theaverage level of Bangladesh’s trading partnerswould certainly help reduce the tension. Thatwould also help bring down the whole interest ratestructure including lower lending rates. However,given Bangladesh Bank’s appetite for higherinflation such convergence with trading partnersand bringing down the interest rate structure (bothdeposit and lending rates) faster will be difficult.

7


II. Implementing Policy andInstitutional Reforms of theFY2014-15 National Budget

Sadiq Ahmed2

Overview

The annual National Budget is usually the most explicitarticulation of the Government’s latest economic thinkingand policy intentions. The FY2014-15 Budget is noexception, although arguably it sets out a much moreambitious and longer-term view on a set of reforms. Thesereforms, if consistently pursued and well implemented, willhave major positive impact on Bangladesh development.Some analysts typically tend to ignore the reform aspects ofthe Budget and focus excessively on the numbers. While thenumbers are an important signal from a short termperspectives and they usually tend to be optimistic inregards to income, expenditure and financing targets, afocus on the planned reforms is equally important.

This is important both to examine the internal consistencyof the Budget numbers with policy actions to implement theBudget but also to check the consistency of the BudgetFramework with longer term development objectives.Importantly as well, the Government often has goodintentions but inadequate in-house analytical capacities thattend to prevent proper implementation. The objective ofthis Policy Note is to identify the critical policy andinstitutional reforms proposed by the Budget and suggestways the Government might seek to implement thesereforms. The implementation would most likely involve along-term process. So, key steps taken now will set thecourse for actions in the future budgets.

Proposed Policy and Institutional Reforms

From a strategic perspective, the Budget speech has anumber of attractive features that are very much welcome.These include:

1) Focus on decentralization2) Modernization of land market3) Raising public revenues by 4 percent of GDP over

the next 5 years.4) Modernization of the tax system through emphasis

on a progressive income tax system

2 Sadiq Ahmed is Vice Chairman of the Policy Research Institute ofBangladesh. He can be reached at [email protected].

5) Renewed commitment to a prudentmacroeconomic strategy that keeps budget deficitunder control and maintains monetary discipline tobring down inflation rate to 6%.

6) Emphasis on public-private partnership (PPP) forinfrastructure financing.

7) Emphasis on manufacturing exports.8) Strengthening infrastructure development9) Adoption of the National Social Protection Strategy10) Adoption of a green tax.

The merit of each of these proposed policy and institutionalreforms is hard to question. Many of these reforms were onthe table for a long time. It is naturally heartening to see theGovernment’s willingness to adopt these reforms explicitly.The main issue is whether the Government has done itshomework on the implementation side. In the spirit of beingconstructive, some ideas about how the Government mightgo about implementing them are provided in the remainderof the Policy Note.

Implementation Aspects of Policies and Institutions

a) Decentralization: By far the most challenging reformis decentralization. It is well known that the Finance Ministeris passionate about this reform and wants to implement it ina phased manner. But based on the results on the ground, itis not obvious that there is a full political buy-in at all levelsof the Government. The bottleneck has always been thesharing of power between the parliamentarians and themembers of the local government. An added challenge isthe decentralization of fiscal powers. The Government hastaken the first step by establishing elected localgovernments. It now needs to go to the next step bylegislating the devolution of spending and revenueauthorities to local governments. The development of thislegislation will require a lot of homework; but that can beeasily acquired as there is considerable internationalexperience that Bangladesh can learn from. The mainchallenge is to get the buy in from the political leadership.Once this huge hurdle is crossed, the issues of capacitybuilding, training etc will come in. Many developmentpartners are willing to provide technical assistance toimplement this critical reform.b) Modernization of the land market: Themodernization of the land market is an essential pre-requisite for modernizing the Bangladeshi economy. Landhas become a binding constraint for manufacturing as wellas for housing. It is arguably also the biggest source ofcorruption and conflict. Hence the proposed policy to

8


computerize land records, improve land survey and simplifyland transactions is a most welcome initiative. However,implementation will require substantial background workand technical assistance. There is also a need to assignproper institutional responsibility, define a time line forimplementation and monitor progress. Along with this,registration and recordation process has to be simplifiedand the associated fee rationalized to avoid land valuationproblems. A start can be made by requesting technicalassistance from one of the donor agencies.

c) Modernizing the tax system: The task of getting 4 %of GDP additional tax revenues over a 5 year period isambitious but not impossible. The Government has alreadymade some significant gains in revenue mobilization overthe past few years. This year’s Budget is significant in that italso aims to modernize the tax structure by increasingreliance on a progressive income tax system. This is a muchneeded reform. Presently, there is a huge hole in theincome tax system. In Bangladesh the top 10% of thepopulation owns 35% of the national income while personalincome taxes are a meager 1.5% of GDP. This is reflection ofa serious governance problem in Bangladesh, where the richand powerful do not pay their fair share of taxes. So, theattempt in this Budget to cover a part of the hole through arange of measures including taxation of capital gains fromland and stocks is very much welcome.

But the Budget goes only a part of the way. There are still anumber of areas where reforms are needed. The income taxmeasures proposed in this Budget is somewhat ad-hoc.They have to be broadened substantially and replaced by awell articulated income and property tax reform program.Essentially, the Government should adopt the principle thatall personal income derived from engaging in economicactivities in Bangladesh is taxable, irrespective of the sourcefrom which it is derived. If some concessions have to bemade to motivate additional domestic and foreigninvestment, the scope of those concessions should belimited in a way that it does not undermine tax collections.The tax base needs to be broadened through strongerenforcement of tax laws, along with efforts to furthersimplify tax filing and tax payments system. A properwealth tax in the form of a well-designed property taxshould be developed. Second, the Budget continues to relyrather heavily on supplementary trade taxes that are notconsistent with the objective of export diversification. Thesesupplementary duties will have to be rationalized to reduceinvestment distortions. Third, the implementation of theNBR Modernization Plan is very slow and needs to be

substantially speeded up. The Modernization Plan has all thekey ingredients of making the organization modern,efficient and capable of delivering the challenging theambitious revenue targets that it needs to achieve.However, not much has happened on that front so far,except some progress on the value-added tax (VAT) in thecontext of IMF supported ECF program. The new VAT Act of2012 modernizes the VAT, but this new law has to go handin hand with a reformed VAT administration alongfunctional lines and backed by modern IT-based integratedbusiness processes. Currently, Bangladesh VAT system is oneof the most inefficient in the world with the lowest VATproductivity. This must change. Without these broaderreforms, the 4% of GDP additional taxes will not likelymaterialize.

d) Commitment to macroeconomic stability: Prudentmanagement of the macro economy has been a hallmark ofBangladesh long-term development. So, the continuedemphasis on this is welcome. Keeping the budget deficit atthe 5% of GDP level is appropriate. Setting the inflationtarget to 6% is a smart move. However, there is a need tocarefully watch the consistency of policies with thesetargets. As the experience of 2010-12 shows, there is often atendency to push the Bangladesh Bank to loosen itsmonetary policy to cover the shortage in fiscal policy or tocompensate for policy failings in the stock market or publicbanks. This must be resisted. A particular risk is that theBudget adopts a very ambitious development spendingtarget and an attempt to implement this without adequaterevenues or foreign loans could put pressure on monetarypolicy and compromise the inflation target. Success with taxmodernization and resource mobilization will be a keydeterminant of the ability to deliver the planned budgetaryexpenditures while maintaining macroeconomic stability.Also, as chair of economic policy making, the FinanceMinister will have to watch both the implementation of theBudget and its consistency with inflation target andmonetary policy.

An additional area where considerable attention needs tobe given concerns “contingent liabilities”. Unfunded deficitsof public enterprises, especially the petroleum corporation,have caused the accumulation of a huge stock of debt ofthese non-financial public enterprises, mostly owed topublic banks. Furthermore, public banks are alsoaccumulating other non-performing assets, often theoutcome of theft and corrupt lending practices, which isleading to recapitalization of these bankrupt banks throughTreasury bailouts. Apart from ethical aspects of these

9


developments in public banking, together these twosources are building up a substantial contingent liability ofthe Treasury that could pose a serious challenge to fiscalprudence and fiscal stability over the longer term. TheGovernment could take a number of steps to manage thisproblem. First and foremost the source of financial bleedingmust stop through proper reforms including pricing policies(energy), sound lending practices (public banks) and bettercorporate governance (both non-financial public enterprisesand public banks). Second, a full accounting of the stock ofcontingent liabilities from all sources must be done with aview to devising a time-bound action plan to graduallyreduce this liability.

e) Implementing the PPP strategy for infrastructurefinancing: The infrastructure needs of Bangladesh are huge.Despite past progress, there is a yawning gap in the demandand supply of physical infrastructure. The resource needsare vast and the ability of the Government to finance therequired investment in infrastructure is limited. Recognizingthis, the Government has been seeking to encourageinfrastructure investment through public-privatepartnership (PPP). The strategy for PPP financing ofinfrastructure has been on the cards for a while. But theimplementation record is poor. This is not a reflection onthe Bangladesh economy. While political uncertainties are aproblem, Bangladesh remains an attractive destination forprivate investment. What is lacking is a well-thought outimplementation strategy for PPP.

International experience shows that securing PPP financingfor large infrastructure projects requires a managing entitythat is equipped with seasoned and competent technicalstaff that have the knowledge and experience indeveloping, negotiating and supervising these projects. Aproper legal framework providing internationally attractiveguidelines and incentive policies is also required.Bangladesh is lacking on both counts. PPP cannot bemanaged as a part of the day-to-day bureaucracy. Withoutthese essential reforms the ambitious 11 billion dollar plusPPP projects identified in the Budget will not materialize.The Government needs to move quickly on this. There isconsiderable capacity in Bangladesh outside theGovernment who can help develop a good PPP policy andsupport its implementation. The Finance Minister could takea lead role on this.

f) Promoting manufactured exports: The emphasis onmanufacturing exports is appropriate. This is an essentialelement of a strategy to secure higher growth andemployment. However, while the Budget is strong on

intentions it is weak on policies except in the RMG sector. Amajor problem is the continued policy bias against exportsprovided by trade tariffs and supplementary duties. It ishigh time that the NBR and Commerce Ministry should gettogether to develop a trade tariff policy that reconcilesrevenue mobilization with investor incentives. In the searchfor revenues the fiscal policy is completely oblivious ofimplications of the tariffs and supplementary duties forinvestment decisions. Research shows that the underlyingincentive regime favors inefficient domestic production thatmay not even be consistent with manufacturing growth andemployment targets. This has been a serious shortcomingof all the previous budgets and this budget is no exception.The implementation constraint here is stronger political will.The analysis of trade policy and its impact on incentives isavailable to initiate the next round of trade policy reforms.The Finance Minster and the Commerce Minister need to co-sponsor the implementation of this reform.

g) Renewed emphasis on infrastructure: The focus oninfrastructure continues from the first budget of thisgovernment in FY2009. This is appropriate as theinfrastructure deficit remains serious. Evidence suggests thatgood progress has been made in the power sector. In otherareas the record is mixed. Primary energy continues to posea challenge. The Budget talks about increasing gas supplybut there is no mention of a coal policy. The absence of along-term primary fuel strategy remains a serious weaknessof the Government’s energy policy. In the transport sectorthe Budget adopts a highly ambitious stance including theconstruction of the Padma Bridge. The emphasis ontransport is good but higher allocations through ADP arenot enough. A review of past experience shows a seriousimplementation constraint in the roads sector. Too manyprojects are ongoing with slow implementation. A betterstrategy would be to adopt a phased implementation planwith high-priority projects on the front line along with time-bound completion plans.

Procurement continues to pose corruption problems anddelays in infrastructure project implementation. Theimportance of doing turn-key projects for largeinfrastructure to avoid procurement debacles and capacityconstraints cannot be over-emphasized. The Governmentmay want to think seriously about this. Reliance ondevelopment partners (e.g. World Bank, ADB, IDB, and JICA)for doing turn-key style large infrastructure projects can beinstrumental in accelerating the supply of essentialinfrastructure.

10


h) Adoption of the National Social Protection Strategy(NSPS): The announcement of the adoption of the NationalSocial Protection Strategy (NSPS) in the Budget Speech is tobe celebrated. It is high time that Bangladesh introduces amodern social protection system that seeks to providepredictable cash transfers to the poor and the vulnerablemembers of the society through a combination of budgettransfers and employment based social insurance. Theadoption of the NSPS will be a major step forward in theGovernment’s effort to fight poverty and reduce socialvulnerability. However, considerable preparatory work willbe needed to implement the NSPS. Along with the NSPS,the proposed health insurance policy should also beimplemented.

i) Adoption of a green tax: Finally, the idea ofintroducing a green tax is commendable. Considerablework needs to be done to make fiscal policy an effectiveinstrument for fighting pollution and environmentaldegradation. Yet, the signal sent through this move is anexcellent step forward. The next step would be to preparethe ground work for incorporating a system of taxes andsubsidies in the future budgets for environmentalmanagement and climate change. There is considerablecapacity in the private sector to provide technical assistanceto the Government. Along with mobilization of thiscapacity, technical assistance could be sought from donoragencies to support the implementation of fiscal policies forthe management of environment and climate change.

Concluding Remarks

The Government should be commended for proposingmany substantive policy and institutional reforms in theFY2014-15 Budget. But implementation requiresconsiderable background preparatory work. TheGovernment should focus strong early attention to thischallenge. While it is understandable that there are capacityconstraints in the public sector, many of the technicalcompetence and required capacities exist in the privatesector. The Government is encouraged to seek thisassistance. The Government could also obtain technicalassistance from donors who will likely be very much willingto support the implementation of these far-reachingreforms.

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III. Implementation Challenges -the Infrastructure Program

G.M. Khurshid Alam3

Context

In the globalized framework of trade and investments it ismost important for countries to be competitive and qualityof infrastructure is key input for it. From the GlobalCompetitive Index (GCI) published by WEF (Table 3.1 below),it is evident that Bangladesh while making some progress inits country rankings between 2011-12 and 2013-14continues to face infrastructure challenges, but with somevisible progress is electricity supply, where its has risen to2.2 form 1.6. But other key infrastructure, roads, has slightlydeclined to 2.8 from 3.0. Railroad has also slightly declined(from 2.5 to 2.4), but Ports slightly improved (35 from 3.4).

Table 3.1: GCI Comparison between the 2010-2011 and2013-2014 for Bangladesh

YearCountryRanking

OverallInfrastructureScore

Electricity

Roads Railroads Port

2013-2014

110* 2.8 2.2 2.8 2.4 3.5

2010-2011

130** 2.7 1.6 3.0 2.5 3.4

Source: 2013 World Economic Forum, the GlobalCompetitiveness Report 2013-2014

* Ranking out of 148 countries; ** Ranking out of 139countries

The Sixth Five Year Plan (SFYP) rightly prioritized the needfor improved power, energy, transport and otherinfrastructure for achieving its growth strategy. The FY15budget has been anchored on an annual growth target of7.3%, which in 2021 is projected to reach 10%. Severalpolicies and strategies have been stated in the budget tohelp achieve these goals, and out of which the followingtwo strategies from the budget speech are directly linked tophysical infrastructure improvements.

“In continuation of our past strategy, we will attachpriority to the power, gas and port development.We will increase power generation from the present10,000 MW to 24,000 MW and ensure that the real

3 Operations Director, Policy Research Institute of Bangladesh (PRI)

supply does not fall below 80% of actualgeneration.”

“In order to attract private investment forinfrastructure development, we will encourageimplementation of project through Public PrivatePartnership (PPP).”

Is apparent that from the strategies that given the resourceneed the government wants more private sectorinvestments to complement the public investments ininfrastructure. This is also in conformity with the strategicdirection provided in the SFYP. The Government hasresponded to the strategic need and provided substantialresources for energy, power, and communicationinfrastructures. The FY 2014-15 allocation in these sectors isin Table 3.2.

Table 3.2: Infrastructure Allocations (in Crore Taka)Sectoral

Allocations inFY 2014-2015

Powerand

Energy

Communication InfrastructureRoad

DivisionRailwayDivision

BridgeDivision

Others

Budget(Development&NonDevelopmentCombined)

11,540(4.61%)

6,858(2.74%)

6,359(2.54%)

8,737(3.49%)

1,182(0.47%)

ADP 11,496(14.3%)

4,608(5.7%)

4485(5.6%)

8,735(10.9%)

884(1.1%)

Power and Energy Infrastructure

Power Sector: The budget lays out the strategic goal ofimplementing medium and long-term plans, with a target ofgenerating 24,000 MW by 2021 and reaching electricity toevery household within the next five years. The followingmilestones have identified to achieve the target:

“To take initiatives, apart from increasing domesticproduction, to generate and allocate power throughbilateral, multilateral and regional agreements withneighboring India, Bhutan and Nepal.

To raise generation capacity to 18,162 MW of electricityby 2017.

To establish coal based power plants with a generationcapacity of 1426 MW by 2017 – this will shift the burdenfrom gas, which contributes to 78 percent of powergeneration in the country.

To establish two nuclear power plants at Ruppur with atotal generation capacity of 2000 MW of electricity.

To produce 800 MW of electricity by 2015 usingrenewable energy. A special fund has been established tofinance renewable energy based power plants. The sizeof the fund will stand at Taka 400 with this year’sallocation.

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To install more than 60,000 pre-paid metres to ensureefficiency, transparency and accountability in powermanagement. “

Implementation Challenges: The budget providesestimates of generation capacity it expects to achieve by2017 on the basis of contracts that has been made. Table A(Annex 3.1) lists the power plants in the public sector wherecontracts have been signed. These plants once completedare expected to generate 3,902 MW of electricity in thepublic sector. Given that these are larger plants they shouldbe more efficient and once in operation can be expected toimprove the sectors financial position. Except for one all theother contracts were signed between 2011 and 2013. Twoof the plants whose contracts were signed in 2011 aresupposed to be in operation by this year (2014). While 90%progress is reported for Sirajgonj, only 33% progress isreported for larger Ashugonj plant. Again, less than 50%progress has been reported for those plants that aresupposed to come into operation in 2015. The moreworrying factor is that financial closure could not yet becompleted for some of the plants whose contracts weresigned in 2012 and 2013.

It is apparent that at the present pace of implementationit will be difficult to attain the targets set in the budgetspeech though very important groundwork of awardingcontracts has been made. Given the contracts have beenawarded and resources have been placed, it is likely thatthere are other contract related implementation problems.The Government immediately needs to raise its monitoringand provide necessary institutional and budgetary supportso that the timelines are adhered. The majorimplementation challenge is in the long time lag to projectcompletion.

Independent Power Producers/PPPs: The Power Divisionhas been much more advanced in awarding PPP contractsthrough IPPs. In support of the Government’s strategy onthe power sector they have awarded 20 IPP contracts thatare expected to produce additional 3,396 MWs by FY2017.The implementation status of the private power stations arerelatively better (see Table B, Annex 3.1), especially giventhat test run has started on Meghnaghat 450 MW andGhorasal 108 MW and two others which are over 88%complete. However, for the remaining plants listed in TableB (Annex 3.1) the progress has been slow. While hecontracts of those IPPs were given in 2011 and 2012, lessthan 33% completion has been achieved in some, and thereare others where financial closure is yet to be reached.

Implementation Challenges: In any PPP/IPP successfulimplementation will depend arranging private finance bythe bidding firm and coming to a financial closure. This willdepend on the bankability of such projects. Unless thecontracted firms can complete financial closure quickly itwill be difficult to complete those projects within thedesired time period of 2017, and some may not evenmaterialize. One reason for such delay in making a financialclosure maybe lack of access to adequate finance, which thecontractors should have made certain when they werebidding. If such is the case then there are likely gaps in theIPP procurement process that should be bridged.

Given Bangladesh’s successful experience in the firstgeneration IPPs the above should not have happened. Itmay also be the case that there are more private powerplants in the pipeline than what the market will support.These issues will have to be looked into and solutions found.Two of the IPPs listed are supposed to use imported coal.The Government is processing 5 more coal based largepower plants. Both the coal based power plants listed inTable B (Annex 3.1) were contracted out in 2012 and as ofnow it has not started effective implementation and sounlikely to start production by 2017. Now another 17 newIPPs (including 5 coal powered) are being processed forbids. Lessons need to be learnt from the slow progress inthose already contracted out and the new IPPs contractingshould use that knowledge. A striking issue is the lack of FDIinterest in what should otherwise be profitable ventures.The first two IPPs in the nineties had lot of FDI interest andthe result was highly efficient plants built andcommissioned within time. Inadequate procurementprocess will also keep donor funds out which couldotherwise help leverage foreign as well domestic privateinvestment. This issue needs to be addressed.

Energy Sector: On the energy issue the Budget has laid thefollowing strategic vision of the Government – “nsurereasonable extraction and utilization of natural gas. Steps areunderway to enhance the capacity of BAPEX. Special emphasiswill be laid on discovery of new gas and oil fields. In addition,scope of assistance and cooperation with internationalorganizations to explore new gas and oil fields in the coastaland deep-sea areas will be widened. Alongside, we will takenecessary steps to dig 21 wells in order to enhance gasgeneration capacity by 2015–16.” It should be noted thatwhile there is discussion on oil and gas exploration nothingis being said about coal policy. Yet the Government isembarking on power production using imported coal.

13


Implementation Challenge: Primary energy continues topose a challenge. The budget talks about increasing gassupply but there is no mention of a coal policy. The absenceof a long-term primary fuel strategy remains a seriousweakness of the government's energy policy.

Communications Infrastructure

The transport system of Bangladesh consists of roads,railways, inland waterways, ports, maritime shipping, and airtransport. Among the different modes of transport, roadtransportation has become the dominant mode, carryingover 70% of passenger and 60% of freight traffic. The SFYPrecognized the importance of transport sector and hasprovided the strategic framework for a more efficient andbalanced multimodal transport system along with regionalconnectivity that helps improve the competitiveenvironment of the country. The budget speech recognizesthe need to improve the transport infrastructure, andprovides resources to repair, maintain, improve and expandroads on a priority basis. The Government has maderelatively higher allocations through ADB to Roads, Railway,and Bridges Divisions. The stated budget priorities are:

“Contract signing for the construction of Padma MultipurposeBridge – This will be done this month and construction will becompleted by 2018.

Construction of a tunnel underneath the Karnaphuli River inChittagong.

Conversion of nationally important highways into four lanesgradually.

Continuation of investment to reform and modernize railways. Construction of circular railroad track around Dhaka City. Construction of the 3rd seaport at Payra in Patuakhali. Construction of a seaport and a LNG terminal at Moheshkhali. Making Biman a profitable organization by improving its

management and enhancing the capacity of passengertransport.”

Roads Sector: Table C (Annex 3.1) below lists a sample ofthe Roads related projects that are being implemented bythe Roads and Highways Department (RHD). It needs to benoted that RHD Department has 170 projects underimplementation and only 8 are listed below for analyticalpurpose. Table C (Annex 3.1) includes columns that showIMED’s evaluation as of June 2013 of the progress ofimplementation.

Implementation Challenges: There is definitely a commontrend as far implementation efficiency is concerned– theroads projects take a long time to complete. For example, the“Sarail-Nasirnagar-Nabinagar-Lakhai Road”, started in 1999and stated to complete by June 30, 2014, has achieved 75%

progress as of June 2013 according to IMED evaluation. It isapparent from Table C (Annex 3.1) that given that there isallocation made under MTBF for this road until FY17; and soit is likely that it will take a few more years to complete.Most important is that this road could not be completed in 14years. Review of other projects in Table C (Annex 3.1)indicates similar story for other roads.

A classic example of delay, of what could be termed as themost important infrastructure project, is the 4-Laning of theDhaka-Chittagong Highway. As per IMED evaluation only41.34% of physical work has been completed though theproject started in 2006. Given that MTBF has providesallocations until FY17, it is again likely that it will take fewmore years to complete. Similar is the fate with other roadslinked to accelerated growth, which are highlighted in theTable C (Annex 3.1).

There needs to be a review of the Roads project portfolioand high priority projects from growth perspective shouldbe identified and those should be completed in time andwithin costs. There should be review of 170 projects underRHD and rationalized on the basis of economic benefit.

Railways Sector: Government has provided emphasis indeveloping the railway sector and has provided resourcesfor completion of some of the critical projects. Table 6below lists a sample of the Railway projects for analyticalpurpose. The Bangladesh Railway has 57 projects underimplementation and only 5 are listed below for analyticalpurpose. Table 6 includes columns that show IMED’sevaluation as of June 2013 on progress of implementation.

Implementation Challenge: The performance of the railwaysector is also not different from that of the roads sector.Two critical railway projects (highlighted in Table D of Annex3.1) that are linked to improving efficiency of the ChittagongPort are taking a long time to complete. The project was forconstructing the double-line from Tongi to Bhairabbazar. Itstarted in July 2006 and now showing completion date ofDecember 2014. However, as per IMED report only 43% ofphysical work was completed until June 2013. Similarly,construction of double track between Laksham (Comilla)and Chinki Astana (Chittagong) started in July 2007 and asof June 2013 only 44% of the physical work had beencompleted. While budgetary allocations have been madethe challenge will be to complete them within timeline andfor that necessary institutional challenges will have to beovercome.

Bridge Authority Projects: There are 7 projects underimplementation and Table 7 lists the three high priorityprojects. The contract for building the bridge portion of thePadma Bridge has been signed.

14


Implementation challenges: In the transport sector thebudget adopts a highly ambitious stance including theconstruction of the Padma Bridge. It is an important projectalready long delayed. Since domestic resources have beenpledged it is all the more important that the time-lines andquality of the construction are maintained throughadequate supervision and monitoring. The river trainingcontract is yet to given out. While it is important to come toclosure on contract award for this complex and specializedwork, it is important that high quality reputed contractor beselected for it.

The Bridge Authority is also implementing a high priorityPPP project listed in the budget speech– the Dhaka ElevatedExpressway. This project was also supposed to becompleted by December 2014, but construction is yet tostart. The challenges facing PPP projects and will bediscussed below. One aspect of the project is thatGovernment is providing substantial budgetary support (asreflected from FY 14 to FY 17 MTBF allocation in Table E ofAnnex 3.1), probably from its Viability Gap Fund. This isimportant for making projects bankable where externalitiesexist. The challenge will be for the Finance Division toassess the need and provide the budgetary resources basedon transparent criteria.

PPP initiative in the Transport Sector: The investmentneeds in the infrastructure sector is huge. Bangladesh hadsome success in bringing in private investments throughIPPs in the power sector. The Government also made aneffort in expanding the role of PPP investments by putting inplace a regulatory and institutional framework. Governmenthad issued the Bangladesh Private Sector InfrastructureGuidelines (PSIG) for PPP Projects. In FY 2010 theGovernment formally announced the PPP policy andguidelines, gazetted in the “Policy and Strategy andGuidelines for Public-Private Partnership (PPP), 2010”. Someof the core features of this new policy are the establishmentof a PPP Office under the Prime Minister’s Office (PMO),objectives, and definition of PPPs. The guidelines providethe process of approval of PPPs and the roles of the differentagencies in the approval process. There is also provision fora Viability Gap Fund (VGF) to be administered by theFinance Division.

The budget speech clearly recognizes the need forleveraging resources through PPPs and has been stated asone of the core strategies in the current budget to meetinfrastructure needs. The budget speech includes a list of 34possible PPP projects covering Transport, Tourism, Heath,Civil Accommodation, IT sectors. This is a positive move.

Table F (Annex 3.1) consists of a list comprising only thoseprojects linked to building of communicationsinfrastructure. Out of the 14 transports related listed PPPprojects, so far only one project, implemented by theBangladesh Bridge Authority (BBA), the Dhaka ElevatedExpressway, had reached the final stages of contracting.However, that contract ran into new issues for which arevision of the contact has been made. The projectimplementation is yet to start after the contract revision.This project may also be affected by the “financial closure”delays that are affecting some IPPs (discussed above in thePower related section). Under IT sector, the Hi-Tech-Park atKaliakor has been under implementation for many years andyet no closure achieved.

Implementation Challenges: The institutional frameworkcreated to support a PPP program needs to include two keyfunctions: promotion and gate keeping. The promotionfunction is designed to encourage PPP projects, and thegate keeping function is intended to ensure that onlyprojects that represent value for money, with a positiveeconomic rate of return and where project related risks areappropriately assigned and mitigated, are developed. Animportant part of the gate keeping function is themanagement and monitoring of fiscal risks linked to PPP, inparticular ensuring that any liabilities incurred by theGovernment are justified by the value for money reflected inthe project. It is important to maintain a good balancebetween promotion and gate keeping functions of thegovernment. The gate keeping function needs to bestrengthened within the Finance Division. Private investorshave to be given the right message about government’sapproach to PPP.

Successful PPP projects always rely on the buy-in from therelevant contracting agency (line Ministry/Agency)interested in making PPP project a success. The institutionalframework therefore needs to include a clear set of dutiesand obligations on the contracting agency, and support forthe “PPP nodes” located in these agencies. This morepromotional function is not clearly set out in the currentinstitutional setting.

PPP procurement is significantly different from standardpublic procurement, and therefore procurement rules needto be developed to address PPP specific issues, for examplethe use of a special purpose vehicle for bidding andcontracting, the need to score changes to risk allocation andfinancing proposals in the bid evaluation process, etc..Thereis no legislation specific for PPP, though the ProcurementAct makes reference to PPPs.

15


The strategy for PPP financing of infrastructure has been onthe cards for a while. But implementation record is poor.This is not a reflection on the Bangladesh economy. Whilepolitical uncertainties are a problem, Bangladesh remains anattractive destination for private investment. What is lackingis a well-thought-out implementation strategy forPPP. While the Government has established an overallframework, there remains significant gaps/inadequacy inthe regulatory and contractual framework, clarity in theGovernance structure, clarity in roles and responsibility,clear and transparent incentive framework, clear andtransparent procurement methods and capacity in thepublic and private sectors to implement PPPs on a largerscale and to create more certainty and predictability inmarket place.PPP cannot be managed as a part of the day-to-day bureaucracy. Without these essential institutionalreforms the ambitious $11 billion plus PPP projectsidentified in the budget will be hard to materialize.

Conclusion

The emphasis on infrastructure is good but higherallocations through ADP are not enough. A review of pastexperience shows a serious implementation constraint inthe power, energy, and transport sectors. Too many projectsare ongoing with slow implementation. A better strategywould be to adopt a phased implementation plan with high-priority projects on the frontline along with time-boundcompletion plans. Procurement continues to posecorruption problems and delays in infrastructure projectimplementation. It will be important to considerundertaking turnkey projects for large infrastructure toavoid procurement debacles and capacity constraints. Thegovernment may want to think seriously about this. Relianceon development partners (such as World Bank, ADB, IDB,and JICA) for doing turnkey style large infrastructureprojects can be instrumental in accelerating the supply ofessential infrastructure. Besides budgetary and proceduralconstraints, the implementing Ministries/Divisions/AgenciesMinistry face inadequacy of qualified staff, and longapproval process. The budgetary and some of theimplantation related constraints could be overcomethrough a number of projects being implemented throughPPPs. There were projects identified but because ofinstitutional constraints major infrastructure projectcontinue to face start-up and completion delays.

Specific Suggestions:

There needs to be prioritization of projects takinginto account the availability of funds and theavailability of skilled staff.

Procurement delays continue and are linked tobuilding institutional capacity and staff skills. Thereare knowledge and skill gaps in contractingprocess, which will have to be addressed.

On the PPP front, Bangladesh needs to fill the gapsin its institutional framework with rules andregulations that can be readily understood andfollowed. The PPP framework should be madelegally binding, with clear allocation of rights andduties to provide confidence to contractingagencies that PPPs are well organized and will notcause them cost and delay without a correspondingbenefit, and to the private sector that the processwill not add cost and complexity (to an alreadydifficult procurement model) and will provide alevel playing field in which to compete.

The Finance Division’s current role needs to bestrengthened to act as gatekeeper for Governmentliabilities and the ability to use financial resourcesto incentivize contracting agencies.

The PPP Office should be primarily focused onpromotion of PPP, in collaboration with thecontracting agencies, supporting projectidentification, pre-feasibility/feasibility studies andpreparing contract documents.

Contracting agencies (including line ministries)need to be given more support, in particularcapacity building, access to project preparationfunds and capital grants to make PPP projects moreaffordable where they provide positiveexternalities, like better, more robust services.

Selecting a winning bidder and achieving financialclosure is not the end of the story. Implementingthe project and monitoring performance of allparties is essential to a successful PPP program.This function is left to the contracting agency, andmore support should be provided to theimplementation phase of projects, sharing know-how and lessons learned and providing resourcesfor difficult phases of implementation like tariffresets, dispute resolution and renegotiations.

A detailed gap analysis should be performed toidentify laws and regulations that do not supportPPP and amend accordingly.

A comprehensive set of rules and guidelines isneeded for allocating and monitoring Governmentsupport in its many forms, including in particularfunding for project preparation, grants to defrayproject costs (VGF) and guarantees to mitigateproject risks.

16


Annex 3.1

Table A: Under Implementation Power Plants (Public Sector)Name of Power Plant Date

ContractSigned

GenerationCapacity MW

Type of Fuel ExpectedCommissioni

ng date

Remarks

Up gradation of Sirajgonj150 MW Peaking PowerPlant to 225 MWCombined Cycle Plant

08/08/2012 75 Gas/Diesel June 2014 Progress 90%

Ashugonj 225 MW CCPP 05/10/2011 225 Gas GT:December’14

ST: June’14

Progress 33%

Shiddhirgonj 335 MWCCPP

28/5/2012 335 Gas GT: April’15ST:Dec.’15

Progress 48%

Ashugonj 450 MW (south)CCPP

17/5/2012 373 Gas June’15 Progress 30%

Kadda, Gazipur 150 MWPower Plant

03/1/2013 150 Gas/HFO Sep’15 Progress 22%

Upgradation of Khulna150 MW Peacking Plant to225 MW CCPP

17/12/2013 75 Gas/Diesel Sep’15 No progressreported

Bibiyana 450 MW (3rd unit)CCPP

26/12/2012 400 Gas GT: Feb’16ST: Dec’16

ECA Financingand FinancialClosure notcompleted

ChapaiNawabgonj 100MW Power Plant

31/03/2013 104 HFO June’16 ECA Financingand FinancialClosure notcompleted

Shazibazar 330 MWCombined Cycle powerPlant

20/5/2013 332 Gas GT: Mar’16ST:Dec’16

FinancialClosure

CompletedBhola 225 M.W. CombinedCycle Power Plant.

09/04/2013 195 Gas GT: Nov’14ST: Aug’15

Progress 29%

Ghorasal 363 MW CCPP 29/5/2013 363 Gas GT: June’16ST: Mar’17

FinancialClosure not yet

completedAshugonj 450 MW CCPP(North)

01/12/2013 381 Gas January’17 No Progressreported

Ghorasal Unit-3Repowering

12/01/2014 206 Gas January’17

Barapukuria 275 MWPower Plant (3rd unit)

04/7/2013 274 Coal June’17 FinancialClosure NotCompleted

Bheramara 360 MW CCPP 16/3/2014 414 Gas January’17 No Progressreported

Source: FY 15 Budget Documents

17


Table B: Under Implementation Relatively Bigger Private Power Plants (IPPs)

Name of PowerPlant

Date ContractSigned

GenerationCapacity

MW

Type ofFuel

ExpectedCommissioning

date

Remarks

Ghorasal 108 MW 24/9/2012 108 Gas June 2014 Test Run going onGagan Nagar 102MW

01/8/2012 102 HFO June 2014 Progress: 95%

Patiya-Chittagong100 MW powerPlant

25/8/20/11 108 HFO July 2014 Progress: 88%

Meghnaghat 450MW CCPP(Summit)

12/5/2011 335 Gas/HSD GT: May’14 ST:Aug’14

GT Test Run going on.

Basila: Keraniganj108 MW

11/12/2011 108 HFO Dec’14 Progress: 32 %,Financial Closure not

yet completedKernanigonj 100MW PeakingPower Plant(Khulna)

25/08/2011 100 HFO June’15 Financial closure notyet completed

Gabtoli, Dhaka 108MW Power Plant

25/8/2011 108 HFO June’15 Progress: 22%,Financial Closure not

yet completedBasila, Keranignj108 MW

12/10/2011 108 HFO June’2015 Progress: 22%,Financial Closure not

yet completedAshuganj 200 MWModular

27/10/2013 195 Gas June, 2015 Progress: 16%

Sirajgonj 225 CCPP 13/9/2012 218 Gas GT: Mar’16 ST:Dec’16

There is move tochange site; and GSA

not signedBibiyana 450 MWCCPP (2nd Unit)Summit

12/05/2011 341 Gas GT: Jan’15ST:Jan’16

Progress: 21%

Mawa, Munshigonj522 MW Coalbased power plant- Orion

27/6/2012 522 ImportedCoal

Dec’17 Progress: 3% FinancialClosure did not

happen Soil testingstarted

Khulna 565 MWCoal based powerplant

27/6/2012 630 ImportedCoal

Jan’18 Progress: 3% LandPurchase under process

Source: FY15 Budget Documents

18


Table C: Road Infrastructure Projects under RHD (Taka in Crores)

Project Name &CodeApprovedPeriod of

completion

ProjectCost Tk.

IMED Cumulative Statusas of June 2013

Rev.Budget

FY 14Tk.

Medium Term BudgetEstimate

Fin.Expenditur

e Tk. (%)

% PhysicalCompletio

n

FY 15Tk.

FY 16Tk.

FY 17Tk.

5041-5040 Sarail-Nasirnagar-Nabinagar-Lakhai Road

01/07/99 -30/06/14(Revised)

120 89.85 (75%) 75% 07 20 21.20 22.47

5041-5044 Birulia –Ashulia Road

01/07/2000-30/06/13(Revised)

36.8334.15

(92.72%)95% 7.5 8.01 8.49 09

5041-5093 Gazipur-Azmatpur-ItakholaRoad

01/07/2000-30/06/13(Revised)

214.41 78 (38.38%) 46.26% 05 10 10.06 11.24

5041-9720 4-Laning ofDhaka-ChittagongHighway (Daudkandi-Chittagong Section)

01/01/06-31/12/14(Revised)

3190.291121.96(35.17%)

41.34% 500 500 530 561.8

5041-9150 Demra-Amulia-Rampura Roadand improvement ofDemra-Sayedabad Road

01/07/03-30/06/13(Revised)

97.8789.25

(91.19%)91.19% 09 9.90 10.49 11.13

5041-5069Development ofJoydebpur-Mymensingh Road

01/07/2010-30/06/13

992.1334.67

(33.73%)35.91% 414.26 397.94 421.82 447.13

5041-5081 8-Laning ofJatrabari-KanchpurRoad

01/01/11-30/06/13

120 07 (5.82%) 5.83% 40 40 42.40 44.94

5041-5161 Upgradationof Gabtali-SwarighatRoad into 4-Lanes

01/01/2011-31/12/2013

71.131.28

(1.80%)1% 1.25 0 0 0

Source: FY 15 Budget Documents

19


Table D: Railway Infrastructure Projects (Taka in Crores)


completion

ProjectCostTk.

IMED Cumulative Status asof June 2013 Rev.

BudgetFY 14

Tk.

Medium Term BudgetEstimate

Fin.Expenditure

Tk. (%)

% PhysicalCompletion

FY 15Tk.

FY 16Tk.

FY 17Tk.

5131-5014 CompleteRenovation of ChinkiAstana-Ashuganj ErodedRail Section and otherAncillary Work

01/07/2012-31/12/2014

234 0 0 80 180 0 0

5131-5015 Constructionof 3rd and 4th Dual GaugeLine of Dhaka-TongiSection and Dual GaugeDouble Line of Tongi-Joydebpur Section ofBangladeh Railway.

01/07/2012-30/06/2015

849 0 0 .03 163.73 641.15 236.34

5131-6640 Dhaka-Chittagong RailwayDevelopment Project(Construction of TrackDoubling betweenLaksham and ChinkiAstana Component)Project.

01/07/07 –30/06/15

1525 704 (46%) 44% 538 290 0 0

5131-9050 BangladeshRailway SectorImprovement Project(Bangladesh RailwayReforms Component).

01/07/06 –30/06/13

251 70.38(28.01%)

58.01% 62 50 50

5131-9040 BangladeshRailway SectorImprovement Project –Construction of Doubleline betweenTongi&Bhairabbazarwith Signalling SystemComponent.

01/07/06 –30/12/14

2037 840 (41%) 43% 488 452 0 0

Source: FY 15 Budget Document

Table E: Bangladesh Bridge Authority Projects (Taka in Crores)


completion

Rev. BudgetFY 14Takas

Medium Term Budget EstimateFY 15Takas

FY 16 Takas FY 17 Takas

7105-9041 – PadmaMultipurpose Bridge(revised)

01/8/2008-30/6/15

2043 8100 8000 8000

7105-7000 - Support toDhaka Elevated ExpresswayPPP Project

01/7/2011 –31/12/14

30 600 915 1000

7105-5015 Construction ofTunnel under KarnaphuliRiver

01/01/2014 -30/6/2018

0 0 10 357

Source: FY 15 Budget Document

20


Table F: List of Communications Infrastructure PPP projects (other than IPPs)

SL No. Sector Name of ProjectEstimated Cost

(Mil USD)1 Transport Dhaka – Elevated Expressway 12002 Transport 2 Jetties at Mongla port through PPP 503 IT Hi-tech Park at Kaliakor -4 IT IT village at Mohakhali 205 IT Hi-tech Park at Sylhet 20

6 TransportMulti-Mode Surveillance System (Radar, etc.) at

HazratShahjalal International Airport25

7 TransportFlyover from Shantinagar to Mawa Road via (new)

bridge over Buriganga River300

8 Transport Dhaka-Ashulia Elevated Expressway 1500

9 TransportUpgrading of Dhaka bypass to 4 lane (Joydevpur –

Debogram – Bhulta – Madanpur)100

10 Transport Dual gauge Double line Bangabandhu Bridge 100011 Transport FulchhariBahadurabad MG Railway Bridge 150012 Transport Hemayetpur – Singair – Manikganj PPP Road 8513 Transport Dhaka – Chittagong Access controlled Highway 1500

14 TransportConstruction of a New Inland Container Depot

(ICD) in Dhirasram Railway Station200

15 TransportConstruction and Operation of Inland Container

Terminal (ICT) at Khanpur30

16 Transport2nd Padma Multipurpose Bridge at Paturia-

Gualondo1,500

17 Transport 3rd Sea Port 1,200Source: FY 15 Budget Document

21


IV. FY2014-15 Budget and TradePolicy

A Welcome Change of Direction, Finally

Zaidi Sattar4

The Context

The FY2014-15 Budget signals a welcome in change in tradepolicy direction, perhaps little known to the vociferous localmedia. Since the announcement of the budget for fiscal year2014-15 on 05 June, 2014, the least discussed topic aroundthe budget has been its implications for trade policy. Yet,hidden behind the various revenue propositions in thebudget document lie several pages of tariff and para-tariffadjustments having serious implication for incentives inbusiness and investment, not to mention the long-lastingdistributional consequences of these measures for differentstakeholder groups. Observers of the Bangladesh economicscene might be justified in wondering what the budget – aprimarily fiscal policy instrument – has got to do with tradepolicy, which ought to be a concern of the Ministry ofCommerce (MoC). The fact is that under the currentministerial configuration, though trade policy is a subjectmatter to be handled by the MoC, its focus has shifted fromaddressing such trade policy issues as tariff and non-tariffmeasures for protection of domestic industries to thepursuit of global market access issues and Bangladesh’sinternational trading relations under the auspices ofbilateral, regional, and multilateral trading arrangements. Itappears that the Bangladesh Tariff Commission (BTC) haslost its competitive technical advantage in adjudicating orarticulating tariff and protection policies, leaving theNational Board of Revenue (NBR) and Internal ResourcesDivision (IRD) of the Ministry of Finance to become theultimate arbiter of protection policies through theinstruments of tariffs and para-tariffs following the virtualelimination of quantitative restrictions (QRs) with protectionobjectives. The annual National Budget has thus, by defaultor by design, become a primary instrument of trade policyas it affects incentives for production directed to exports ordomestic sales of import substitutes. The FY2014-15 Budgethas finally signaled some change in direction – albeitmodest – towards lowering of average protection in themanufacturing sector, though selectively choosing to raiseprotection in some instances.

4 Chairman, Policy Research Institute of Bangladesh (PRI)

Mainstreaming Trade and Trade Policy

It is time the annual Budget became a key instrument formainstreaming trade and trade policy. Every year thebudget document contains a list of adjustments in import-export taxes and levies, largely as a statement of revenuemobilization. As they affect relative incentives, this isnothing but an articulation of trade policy by influencingincentives in production of exports and import substitutes5.Trade is gradually becoming the lifeline of the Bangladesheconomy with the trade-GDP ratio reaching close to 50% inFY14. It is time to realize that trade could play a moresignificant role in promoting accelerated, inclusive andsustained growth in Bangladesh. Evidence thus far showsthat Bangladesh has been one of the greatest beneficiary oftrade openness in the past three decades. So, why notpursue with more vigor policies that have yielded gooddividends in terms of jobs, growth, and poverty reduction. Itis a good sign that Bangladesh is a signatory to the 2013WTO Ministerial Declaration (at Bali) which holds “tradefacilitation” as its core theme. Implementation of tradefacilitation programs around the globe is expected to addone trillion dollars (or 1.7%) to global GDP. One way tofurther the objective of trade facilitation is to mainstreamtrade and trade policy. That way, trade policy could be usedin a deliberate sense to enhance consumer welfare or topromote export competitiveness in a more generalized way.

True, that might require challenging the prevailing mindsetthat runs in policy and business circles. But that is notunknown in history or across countries. Long beforemacroeconomics was conceived as a branch of economics,trade theory and policy was the centerpiece of economicanalysis expounded by the likes of Adam Smith, DavidRicardo, and John Stuart Mill. Not surprisingly, theircontrarian views had to challenge the conventional wisdomthat was dominated by mercantilist thinking which werewary of the notions of free trade. A similar challenge prevailsin Bangladesh and much analytical work is needed tochange mindsets in the direction of trade openness as ameans to trade out of poverty. Annual Budgets could serveas the starting point.

Thus mainstreaming trade and trade policy should becomea key agenda for policymakers and planners. This meanstaking trade-related issues into account when planning andexecuting broader development objectives. It further

5That this articulation is done by individuals without any serious training onthe pros and cons of industrial protection might be considered a shortcomingin the management of trade policy. But that is a subject of another policynote.

22


implies using trade proactively to attain specific nationaldevelopment goals, including poverty reduction. In otherwords, trade policy agenda – with a focus on market accessand competitiveness -- has to be an integral part of thedevelopment agenda which has a focus on growth, jobs,and social stability.

East Asian countries reaped an early harvest of acceleratedeconomic prosperity by embracing trade orientation andexport-led growth in the 1970s and 1980s. Empiricalevidence of the economic prosperity of many othersuccessful economies shows that they were largely drivenby trade integration, export expansion and heighteneddegree of export competitiveness. It is also for this reasonthat the issue of mainstreaming trade into nationaldevelopment strategies has increasingly gained currencysince the mid-1990s. Now that trade and exports havegrown in importance in Bangladesh’s economic structure, itis time for trade policy to become an integral part ofnational policymaking. Likewise, for trade reform to unleashits catalytic potential, it should be designed as part andparcel of Bangladesh’s Five Year Plans and other longer-term Plans, where its role will be given due cognizance andthe necessary facilitating infrastructure adequately providedto make trade policy perform. Once the role of trade isestablished within a coherent national policy context, trade-related needs could be better defined, prioritized andsequenced.

Budget 2014-15 and Tariff Trends

Though on a downward trend as a share of total taxes,customs tariffs and other import taxes and levies continueto be a major source of revenue. Trade and taxation theorytells us that trade taxes are most distortionary. Developedcountries have minimal reliance on trade taxes for collectionof revenue. The more dynamic developing countries are alsomoving away from trade taxes as this approach becomes apre-condition of trade openness. Bangladesh is also on agradual path of shifting from trade taxes to domestic-basedtaxes (Figure 4.1), a move that is appropriate and needs tobe hastened. A problem that remains is the high rate oftariffs and para-tariffs with the ostensible objective ofrevenue mobilization. This objective gets diluted when it ismixed with the pressure of providing protection to domesticindustries by keeping import substitutes at bay throughhigh tariffs. Then the revenue and protection objectives arein conflict. Higher tariff protection by restricting importshave a deleterious effect on revenue. Bangladesh tariffs andpara-tariffs in combination are high relative to most

comparator countries signaling a predominance ofprotection rather than revenue goals.

Figure 4.1: Import-Based and Domestic-Based Taxes

Source: National Board of Revenue and PRI Tax Database

Past tariff trend could be summarized as follows: Input tariffswere falling sharply since FY 08 and output tariffs wererising sharply since FY 09. This trend continues until FY13with high tariff escalation at the last phase of processing.This indicates a policy of rising protectionism. FY14 showedonly modest signs of bucking this trend. The good news isthat after several years of rising average rates of nominalprotection (NPR)6, the Budget of 2014-15 comes with tariffadjustments that signal a notable reduction in the averageNPR in FY15, to 26.9% from 28.1% in FY14 (Table 1 andFigure 4.2). If this is a signal for more downward trend infuture,

Table 4.1: Trends in Average Tariffs, Para-tariffs, andNominal Protection rates

Avg. CD 21.1 16.3 13.7 13.9 13.2 13.2Avg. para-tariffs 7.1 10.2 10.2 15.1 14.9 13.7Avg. NominalProtection 28.2 26.5 23.9 28.9 28.1

26.9

Avg Import Taxes (All) 51.8 47.4 47.4 53.2 52.2 50.8Top NPR* 59 60 79 117 108 108(*) excludes tariffs on cars, alcoholic beverages, and cigarettesSource: PRI staff estimates based on NBR ASYCUDA and Budget data

this augurs well for infusion of greater doze of competition,which is essential for a dynamic manufacturing sector of thefuture. As can be seen from Table 1, the secular decline incustoms duty (CD) is duly compensated by the rise in para-tariffs (comprising supplementary duty, regulatory duty, and

6 Nominal ProtectionRate =

Customs Duty (CD) + Regulatory Duty (RD) +Protective effect of Supplementary Duty (SD)

0.00.51.01.52.02.53.03.54.04.5

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

FY01

FY05

FY09

FY13

Impo

rt-b

ased

taxe

s as %

of G

DP

As %

of T

otal

Tax

es

Import- based Domestic-basedImport-based as % of GDP

23


even some protective effect of VAT in the case of textiles), somuch so that the share of para-tariffs in average NPRexceeds 50% for FY14-15.

Figure 4.2: Trend in Nominal Protection Rates (FY 00-FY15)

Tariffs, Para-tariffs, and Protection

A relevant point of enquiry is whether this whole tariffregime and particularly the para-tariffs is serving theobjective of revenue or protection. Table 4.2 which presentsa summary of the commodity distribution of tariffs and para-tariffs will give a fair idea of where things stand.

Table 4.2: Distribution of CD, RD and SD by ProductCategory (FY2014)

Top CD Rate (25%) +RD Rates (MFN)

Supplementary DutyAverageNPR

ProductCategory

#HS8Codes

Percentage#HS8Codes

Percentage

Final ConsumerGoods

2140 74.13 1216 82.89 50.66

IntermediateGoods

517 17.91 152 10.36 15.25

Capital Goods 159 5.51 60 4.09 9.54

Basic RawMaterials

71 2.46 39 2.66 13.71

Total 2,887 100 1,467 100

Source: Operative Tariff Schedule based on NBR ASYCUDA database; PRIstaff estimates

Note that in FY2014 the top rate of CD is topped up withregulatory duty (RD) of 5%. The Budget of FY15 has raisedRD to 10% on 18 products (spices) and 15% on 3 products(which includes tea). It turns out that 74% of products

subject to this top duty rate are final consumer goods (FCG),mostly produced by local industries (with the exception ofautomobiles). Again, 83% of SD is imposed on this sameproduct category, FCG. The average NPR for this productgroup works out to 50.7% compared to 15.3% forintermediate goods. The average for all input group(intermediate, capital and basic raw materials) works out to12.8%, creating a significant wedge between average NPRon outputs and inputs (Figure 4.3). This analysis leads to theconclusion that whatever the ostensible purpose of theimposition of para-tariffs, the lasting effect of thesemeasures is to raise profitability and protection levels ofdomestic consumer goods industries. And because of theirrestrictive effect on imports, revenue outcome is certainlyundermined. On the other hand, if protection is to have apositive impact on price and competitiveness, the only waythis can be done is to make protection time bound, withstaggered reduction in protection levels over a pre-announced time period.

Figure 4.3: Avg NPR on Outputs and Inputs

We draw the following inferences from the above analysis:

Protection to domestic consumer goods industries– not revenue mobilization -- appears to be thestrong underlying objective if not the consequenceof imposition of SD, RD, and the top CD rate.

Average NPR for intermediate goods at 15.3%compared to 50.7% on final consumer goodsindicates very high tariff escalation and,consequently, very high effective protection levels7.

7 PRI-World Bank study of Effective Rates of Protection (ERP) revealed ERPrates of 100% to 400%, in many sectors. See PRI (2012). “Assessment ofEffective Rates of Protection. 2012 Survey of Manufacturing Industries”.Unpublished report prepared for World Bank-WTO Diagnostic TradeIntegration Study (DTIS).

0

5

10

15

20

25

30

35

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

(%)

Avg. CD Avg. Para Tariff

Source: NBR ASYCUDA database

23









ProductCategory

#HS8Codes

Percentage#HS8Codes

Percentage

Final ConsumerGoods

2140 74.13 1216 82.89 50.66

IntermediateGoods

517 17.91 152 10.36 15.25

Capital Goods 159 5.51 60 4.09 9.54

Basic RawMaterials

71 2.46 39 2.66 13.71

Total 2,887 100 1,467 100









FY12

FY13

FY14

FY15

Avg. NPR

37.10 37.833.3

19.4717.8

2000 2003 20060

10

20

30

40

50

60

Tariff Rate(%) Consumer Goods

23









ProductCategory

#HS8Codes

Percentage#HS8Codes

Percentage

Final ConsumerGoods

2140 74.13 1216 82.89 50.66

IntermediateGoods

517 17.91 152 10.36 15.25

Capital Goods 159 5.51 60 4.09 9.54

Basic RawMaterials

71 2.46 39 2.66 13.71

Total 2,887 100 1,467 100









33.3

41.3

51.448.0

11.8 12.2 13.5 12.9

2006 2009 2012 2015

Consumer Goods Inputs

24


Protection policy discriminates againstintermediate goods production; hence signals anti-intermediate goods bias. Consequently,Bangladesh’s small intermediate goods sector willface uphill battle to expand and grow into anexport-oriented sector.

Given the current state of the tariff regime, themove towards uniform tariffs, which is longoverdue, will face strong hurdles from vestedquarters, and reaching the kind of uniform tariffs onoutputs and inputs that countries like South Korea8

has achieved couldtake decades.

Budget 2014 signals welcome change in direction

That brings us to a discussion of some tariff adjustmentssignaled in the Budget proposals for 2014-15. The mostnotable change in direction of course is in the reduction ofSupplementary Duties in about half of the tariff lines subjectto SD, i.e. 773 out 1467 (see Table 4.2 and Annex 4.1). TheBudget statement makes the case that this was done as afirst phase of the realignment of taxes in order to launch inJuly 2015 The VAT and Supplementary Duty Act, 2012. Bethat as it may, the fact that bulk of the reduction was on finalconsumer goods (667 tariff lines), half of which has domesticproduction, indicates a substantial change in direction as faras protection policy is concerned. In consequence, averageNPR on FCG products declined by a good two percentagepoints where it was on a rising trend since FY09. However,though adjustments on the input side continued theirdownward slide, the wedge between output and inputtariffs is also lower in FY15 by 2.8% (48.0-12.9 in FY15 versus51.4-13.5 in FY13). Table 3 presents a summary of NPRtrends for the different product categories during FY11-15,showing that FCG protection is tapering off since the lastfiscal year. If this is a long-term trend, it would help movethe tariff regime in the right direction for the future by alsoadding a modest doze of import competition. Revenueimplications of this move are likely to be favorable as someof the high protective tariffs served as de facto bans onimports. It might be noted that this trend is also in keepingwith the propositions made in the Sixth Five Year Plan 2011-15 for developing a dynamic manufacturing sector for thelong-term.

8 S. Korea’s average input and output tariffs have converged at uniformlevels of 11.45-12.45%, as the country is a major player in the export ofintermediate goods, the fastest growing segment of world trade today. SeeSattar (2014). “Challenge of Export-led Growth: Breaking into New Marketsand New Products”. Paper presented at the First Conference of BangladeshEconomists’ Forum, Dhaka, 21-22 June, 2014.

Table 4.3: NPR trend in product categories, FY10-15ProductCategories


Basic RawMaterials

12.3 12.4 13.7 13.7 13.9

IntermediateGoods

15.8 15.9 16.2 15.3 15.1

Capital Goods 8.6 10.6 10.5 9.5 9.7

Final ConsumerGoods

41.3 48.4 51.4 50.7 48.0

Overall 23.7 27.0 28.9 28.1 26.9

Source: PRI staff estimates based on Budgets of different years.

Reviewing Duty Reduction on Inputs of selecteddomestic industries

While the general thrust of the comprehensive SD reductionwas to reduce protection on a wide range of domesticallyproduced consumer goods, a number of high profile sectorswere identified for protection support (raising profitabilityand protection levels) primarily by scaling down CD oninputs which are basic raw materials and intermediategoods. A list of these preferred sectors for input dutyreduction provided in the budget document includesproducts like Alopethic and Ayurvedic medicines, poultryand livestock industry, paper, ceramics, furniture, plastic,baby diaper, and electrical goods. While the move appearspopular, two pertinent issues arise:

a) The rationale for selecting these particular sectorsand not other equally or more promising sectorsremains unclear.

b) It is not also clear if the price effects and consumerinterests related to these duty adjustments havebeen properly thought through.

The problem regarding (a) is that any protection policy thatrelies on non-uniform tariffs is likely to end up preferringone sector over another without any valid rationale. It ispractically impossible to figure out the basis for grantingdiscriminatory effective protection levels to differentindustries. Consequently, these discriminatory tariffadjustments become subject to lobbying by particularquarters making it difficult for policy makers to come to ajudicious assignment across all sectors.

With regard to (b), there is the popular notion that, for theproducts selected, these duty reductions should result inbenefits for consumers in terms of lower prices of medicinesand other popular consumer items produced domestically.This expectation is far from being realistic. The economic

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principle underlying the price effect of these adjustments issimple: for consumers to get relief in terms of pricereduction of these selected products, tariffs on outputwould have to be reduced as well. If they were not, then thereduction of duties on raw materials will simply raiseprofitability of the firms producing these preferred productssimply as a result of these tariff adjustments rather than anyimprovement in efficiency or productivity. A somewhatdifferent situation exists for the medicine manufacturers.Since a de facto ban exists on import of drugs and domesticpharmaceutical companies meet some 97% of all ofdomestic demand, there is a tacit policy of controlling retailprice of locally produced drugs. In that case, it rests with theDG Drug Administration to reduce the cap on the price ofselected medicines in order to give consumers some reliefagainst the reduction of raw material duties.

Policy Issues and Recommendations

In reviewing the trade policy implications of the proposedBudget for FY2014-15, the following assessment may berelevant for policymaking in the near and medium-term:

In keeping with the guidance laid down in the SixthPlan, it is time to mainstream trade and trade policyand the annual National Budget is the rightinstrument to integrate trade policy issues in itsformulation as well as implementation.

The strategic shift from reliance on trade-basedtaxes to domestic-based taxes should be continuedand intensified.

Anti-intermediate goods bias of trade and industrialpolicy need to be eliminated for the domesticintermediate goods sector to expand, becomeexport-oriented, and seize the opportunitiesoffered from global value chains.

After many years of rising nominal protection thechange in approach is welcome and a move in theright direction, something that will infuse a modestdoze of competition while offering some price reliefto consumers who have traditionally borne thebrunt of the protection tax.

Because of many years of secular reduction of inputtariffs without compensatory reduction of outputtariffs (contrary to the approach taken by almost allcomparator economies), there is a long way to go inorder to bring output and input tariffs in closeproximity to each other. So the trend that wasbegun in FY15 Budget ought to be continued.

Reduction of input tariffs is not expected to bringprice relief to consumers; output tariffs must bereduced in tandem to impact prices.

It is high time for Budgets to pay attention toconsumer interests and not simply focus ondemands of producer groups with strong lobbyingcapacity who will always seek higher tariffs onoutputs and lower tariffs on inputs. High protectionin perpetuity neither improves productivity norensures competitiveness in the long-term. Newprotection needs to be made time bound whileprevailing high protection needs to be scaled backin phases.

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Annex 4.1

Significant Tariff Changes by Category & Duty Type at 8-Digit HS Code

CategoryNo. of

HSCodes

Comments

Customs Duty: Decrease

Basic Raw Materials 10 D-Prod. No-9, Yes- 1

Intermediate Goods 25 D-Prod. No-14, Yes- 11

Capital Goods 5 D-Prod. No-4, Yes- 1

Final Consumer Goods 7 D-Prod. No-3, Yes- 4

Regulatory Duty: Increase

Intermediate Goods 21 CD- 25 (New)- 06, D-Prod. No-2,Yes- 19

Capital Goods 9 CD- 25 (New)- 09, D-Prod. No-1,Yes- 8

Final Consumer Goods 6 CD- 25 (New)- 04, D-Prod. No-2,Yes- 4

Supplementary Duty:Decrease

Basic Raw Materials 6 D-Prod. No-2, Yes- 4



Final Consumer Goods 667 Motor Car – 08, D-Prod. No-316,Yes- 351

Supplementary Duty:Increase

Basic Raw Materials 3 D-Prod. No-3



Final Consumer Goods 72 Motor Car – 67, D-Prod. No-68,Yes- 4

Note: D-Prod means whether or not there is domestic production