Risk drivers and outlook

Medium- to long-term political risk remains high in Bangladesh although the country manages to preserve macroeconomic stability. One major explanatory factor lies in the long history of political instability and violence that peaked last year. The general election boycott by the opposition last January has maintained political uncertainty with the risk of renewed social unrest and business disruption. A military intervention could become necessary at some point given the absence of compromise prospect in a deeply polarised country. The spread of Islamism and terrorism together with ethnic tensions are also risks to take into consideration.

The garment sector, the country’s top exporting industry, was hit last year by tragic factory collapses, thereby putting it under the spotlight. Since then, the government and world’s major textile groups have been cooperating with the aim to improve future working conditions. Even though the low-cost advantage is expected to remain, there is an underlying risk due to Bangladesh’s economic dependence on a sector in a transition phase and subject to fierce regional competition. Moreover, the economy is vulnerable to climate change, with frequent natural disasters, and poverty remains huge despite significant progress in human development and a decade of resilient and strong growth. Weak public finances, especially regionally low fiscal revenues, hamper anti-poverty policy and public investments in infrastructure that are badly needed, thus hindering economic development. Looking forward and despite several vulnerabilities, Bangladesh has the potential to raise its growth trajectory, notably thanks to a fast-rising middle class, provided the business environment and political stability are improved, which is a big challenge for the country.

Bangladesh presents a more favourable short-term political risk profile thanks to much improved external liquidity fuelled by record-high foreign exchange reserves. These have been sharply built up mainly as a result of robust garment exports in an adverse climate and strong workers’ remittances from the Gulf. Until a satisfying outcome is found, the short-term outlook is, however, clouded by risks related to the political crisis.

Facts & figures

Pros

  • Macroeconomic resilience to shocks
  • Recipient of huge workers’ remittances
  • Competitive in low-cost manufacturing
  • Good track record in human development policy

Cons

  • Recurrent political instability and violence
  • Overdependence on garment sector
  • Vulnerable to natural disasters
  • Low fiscal revenues penalise infrastructure development

Main export products

  • Garment (49.7% of current account receipts), workers’ remittances (34.6%), fish (2.1%), ICT services (1.2%)

Income group

  • Low income

Per capita Income (USD)

  • 840

Population

  • 157 M

Description of electoral system

  • Presidential: next election in 2018 (5-year cycle)
  • Legislative: next election in 2019 (5-year cycle)

Head of Government

  • Sheikh Hasina Wajed

President

  • Mr Abdul Hamid

Country risk assessment

Uncertain and unstable political outlook after boycotted elections

Bangladesh is living one of its worst political crises in a decade. Political turmoil and violence are recurrent in a country historically polarised between two parties that have alternated power since independence, namely the ruling secular Awami League (AL) and the Islamic Bangladesh Nationalist Party (BNP). The AL’s previous mandate was rather stable until it was plagued last year by deadly textile factory collapses, high violence and radicalisation of BNP supporters. Their anger has been fuelled by adverse judicial proceedings (jail or death sentences) against their – and their ally Jamaat-e-Islami’s – historical leaders at the International Crimes Tribunal set up to try criminals during the Bangladesh’s 1971 independence war from Pakistan. The risk is that those tensions eventually fuel radical Islamism in a Muslim country where the majority of the population is moderate and defends democracy over an Islamic state. Faced with a government criticised for corruption and electoral fraud, domestic terrorism could grow and the popularity of Islamic parties – supported by the poor for their positive social role – be boosted as witnessed at recent local elections and in previous polls.

In this tense climate and given that BNP contested AL’s refusal of a neutral caretaker government to monitor last January's Parliamentary elections, the internal situation has been chaotic for months with strikes, violent protests (with a record of victims last year) and business disruption. The BNP’s election boycott has harmed the credibility of AL’s easy victory and strengthened the political stalemate. In spite of domestic and external pressure, AL’s historic leader and re-elected Prime Minister Sheikh Hasina has so far resisted from holding new elections for  fear of losing them – as expected – and being the target of retaliatory actions from BNP if it returns to power. As  a consequence of this political deadlock and increasing domestic polarisation, a powerful but reluctant army  could be compelled to intervene. It would thereby become more influential in the political game by installing, as in 2007, an interim military-backed government until fair elections are organised.

Calm has returned and activity normalised since January. However, unless a difficult political compromise is found and leads to new elections or the army ultimately intervenes, the political situation is likely to deteriorate and again increase political risk.

A dominant garment sector in transition after resounding safety scandals

So far the economy has somewhat managed to withstand the political shock, particularly the crucial ready-made garment sector for which demand is moderately elastic. Provider of millions of jobs, it has a dominant contribution to the domestic economic activity as it accounts for about 80% of total export of goods with 60% going to the EU market where Bangladesh benefits from a preferential access. In a country where the services sector share  keeps increasing (accounting today for half of GDP) and the majority of people still work in agriculture, Bangladesh is thus over-reliant on a single garment sector for its exports. Given intense competition with South- East Asian countries (Cambodia, Vietnam, Indonesia and potentially Myanmar), the authorities would have to consider somehow developing export diversification in the long term. It is advised to reduce the risk that a top economic and social force becomes one day a weakness and to alleviate negative shocks hitting the industry as illustrated by the latest events.

Indeed, last year, the sector was tragically shaken by deadly factory collapses due to poor safety conditions, particularly the Rana Plaza building disaster that left over 1,100 workers dead, triggering protests and western criticism. A government national action plan and agreements between local factory owners and foreign fashion retailers were set up. The overall goal of this local and international cooperation is to raise safety standards at Bangladesh’s 4,000 existing textile factories and improve working conditions. As a result, more than a quarter of factories have already been inspected and several shut. Trade unions have been accepted and the minimum monthly wage sharply raised (by 77%) to 5.300 takas (USD 68). Progress has thus been made since those initiatives were taken. Future compliance and pace of this structural process is uncertain given the resistance from employers and the threat of job losses if the cost advantage decreases. There is nonetheless some optimism considering the vital importance of the garment industry to Bangladesh that should be an impetus to make the process deliver some positive results. Meanwhile, labour costs in the sector remain regionally very competitive (only Myanmar is cheaper in Asia) in absolute and relative terms given the upward trend in wages across Asia. Therefore, Bangladesh’s attractiveness as the world’s second most important garment industry, after China, is not under threat provided the enhancing safety process delivers results to avoid a repeat of tragic events that fuel social tensions and increase reputational risks for foreign textile groups.

The outlook is cautiously positive on the back of economic resilience

Thus, against the odds, Bangladesh’s key industry keeps recording strong performances. Increasing garment exports partly illustrate Bangladesh’s remarkably high economic resilience as they have been growing by over an average 6% in the last ten years despite weather-related and exogenous economic shocks such as the 2009 global recession. Latest adverse developments have however lowered annual GDP growth in the 2013/14 fiscal year to around 5.5%, i.e. below 6% for the first time since 2003, before moving up towards 6.5-7% in the medium term. The economic outlook will nevertheless largely depend on the resolution of the political crisis. Political uncertainty, renewed social unrest and business disruption are main risks as they can hamper economic development, foreign investment plans, and affect public finances and a weakened banking sector.

Bangladesh_Graph1EN

Lastly, domestic demand (accounting for 75% of GDP) has been hit by slowing credit growth, workers’ remittances and stagnating investment. The current account balance is in surplus although it is expected to turn into deficit as from next year as investment-related imports are expected to pick up. Remittances from Bangladeshis working abroad are a powerful buffer against external shocks as they account for one third of total current account receipts and tend to be very resilient. They offset the country’s huge trade deficit and allow the current account to fluctuate chronically around balance. Last year’s restrictions against recruitment of Bangladeshis in the Gulf countries, where they are mainly working, have slowed the growth in remittance inflows though. The country’s balance of payments is not expected to face pressure as foreign direct investments (FDI) should meet future financing needs.

Economic performances are clouded by a weak budget position

Bangladesh continues to be granted IMF financial support from a successful three-year Extended Credit Facility, which shows constant government commitment to macroeconomic stability and thus participates to improve overall fundamentals. Still, public finances remain a source of real concern with a budget deficit chronically above 3% of GDP as the government keeps recording structurally very low fiscal revenues (stuck at 12.4% of GDP, cf. graph) that have also been hit by the recent economic slowdown. Raising fiscal revenues is crucial to finance not only heavy interest charges (equal to 18% of budget receipts) but particularly high social spending and necessary public investment in poor infrastructure. Nevertheless, fiscal policy is cautiously managed, fiscal reforms are underway or still to be implemented and public debt is moderate, increasingly domestic and expected to gradually decline under 40% of GDP.

Bangladesh_Graph2EN

Stability prevails for the monetary policy with the inflation rate maintained around 7%, and for the exchange rate with the taka kept stable against the USD over the past 12 months. Besides, default risk on foreign debt is low as it is sustainable at 20% of GDP and principally contracted at favourable terms with multilateral creditors.
Bangladesh’s external liquidity has never been so strong, boosted by foreign exchange reserves soaring to a historic peak – enough to cover 5 months of imports and more than twice the short-term debt – which is mainly explained by a combination of slowing imports and rising exports and FDI. The situation is less rosy for the banking sector. In a context of political instability and weaker economic activity, its health has been deteriorating. This is particularly true for the four State banks (representing about a quarter of total banking assets) where bad loans are high and rising due to malpractices and non-compliance with rules in lending activity. Hence, a partial recapitalisation is planned provided governance is improved.

One of the most significant achievements for Bangladesh probably lies in progress in human development as shown by the steady improvement in a range of indicators such as literacy, child mortality or life expectancy. This is primarily due to the key role of women as working force (mainly in textile), to broad supply of microcredit and large money transfers to rural areas from workers active abroad. Therefore, Bangladesh fares better than the Indian neighbour in health and education, which contributes to raise its economic potential.

Poverty, climate change and infrastructure gap impede economic development

Yet, deep poverty is one of Bangladesh’s three structural challenges. It is still widespread throughout its overcrowded territory (157 Mio people) where GDP per capita is around USD 850, which is one of the lowest levels in Asia. Although poverty has been gradually reduced in the past ten years, Bangladesh needs to address high food price inflation, achieve a more inclusive growth to fight rising income inequality and record higher growth rates to reach faster and more significant results, especially when compared with poverty levels in other fast-growing countries in the region.

Bangladesh_Graph3EN

Another risk comes from the vulnerability to climate change (e.g. rising sea level) with the threat of worsening and more frequent weather-related shocks (cyclones, floods…) in the future, thereby further affecting socio-economic activity and poverty. A third one, infrastructure deficiencies, is common to all South Asia. A poor transport  network and recurrent power cuts hinder business and hold back economic development and growth. Therefore, major multi-year (public and private) investments are planned to boost infrastructure development. Infrastructure shortfall, together with red tape and high corruption – among the highest in Asia (ranked 136th out of 177 countries according to Transparency International) – make the business environment difficult. Despite this, Bangladesh’s systemic commercial risk is classified in category B thanks to good domestic economic and  financial conditions enjoyed by local companies.

Analyst: Raphaël Cecchi, r.cecchi@credendogroup.com