How global economic instability is hurting Bangladesh, until recently an Asian tiger in the making

Bangladesh had been performing exceptionally well before the Covid-19 pandemic. The economy had expanded, the per capita gross domestic product had increased, reserves of the dollar had grown, inflation was low and poverty levels were decreasing.

In 2021, Bangladesh’s economy had begun to recover well from the pandemic and gradually returned to its pre-Covid track.

But since mid-2021, global commodity prices, especially of oil, have begun to rise. This was intensified by the Russian invasion of Ukraine in March.

As a consequence, Bangladesh, as a major energy importer, is facing a number of challenges. Its foreign currency reserves are declining and the value of its currency, the taka, is weakening. Electricity load shedding has worsened, adding to the woes of citizens.

What went wrong so quickly? Is Bangladesh heading for a recession or will the economy recover soon?

Economic and political situation

The situation in Bangladesh is largely driven by global economic and political crises. Following the Covid-19 economic recovery, the global commodity market had become volatile, but the Russia-Ukraine war worsened it.

The war, trade embargoes and financial sanctions against Russia have disrupted global supply chains and increased the prices of many essential commodities as well as the cost of shipping. Food, fuel and feed prices have risen significantly on the global market.

As a result, the cost of imports in Bangladesh has increased significantly even as earnings from exports have increased only moderately.

In the financial year 2022, the expenditure on imports increased by 36%, compared to 20% the previous financial year. The high import cost is due in part to the increased demand for imported goods and in part to the higher import prices on the global market.

As a result, the terms of trade have gone against Bangladesh. During 2021-’22, the import-price index increased by 5.06%, while the export-price index increased by 3.23%. This has hurt the current account balance.

In the financial year 2022, the current account balance reported a deficit of $18.70 billion compared to the previous year’s deficit of $4.58 billion – as can be seen in table 1.

The current account deficit in Bangladesh is generally met by remittances from abroad, which have also decreased significantly in the financial year 2022. Remittances fell by 14% in the financial year 2022, following a 36% increase in the financial year 2021. This has affected the balance of payments, foreign currency reserves, and weakened the taka against the US dollar.

Despite adjusting the exchange rate to match the market demand, the Bangladesh Bank continued to sell dollars from reserves to keep the taka stable. As a result, reserves declined further.

Foreign currency reserves fell to $39.77 billion on July 14 from $46.39 billion the previous year. Though the country has received relatively large remittances from expatriates in July due to Eid, the taka’s value against the dollar is deteriorating.

Foreign exchange reserves are not only critical for maintaining the exchange rate of domestic currency but also contribute significantly to increased capital investment and long-term economic growth.

To keep the taka’s value stable, the Bangladesh government and Bangladesh Bank have taken measures to reduce imports and increase the flow of dollars. The government has discouraged the import of luxury items. The depreciation of the taka compelled the government to seek a loan from the International Monetary Fund. Only a year ago, Bangladesh had supported Sri Lanka with $250 million.

The weakening of the Taka against the dollar not only makes imports more expensive, but also raises the domestic prices of imported goods and other non-imported goods due to the substitution effect – which is when the sales of a product decline due to an increase in its price which prompts consumers to switch to cheaper alternatives. This worsens inflation.

Inflation at 9-year-high

For the past few years, inflation in Bangladesh had been under control but it began to increase in 2021 and has now risen to 7.56% according to official accounts, though the actual rate is thought to be much higher. The prices of rice, wheat, edible oil and other essential commodities are increasing and the inflation rate has climbed to a nine-year-high.

Several studies indicate that low-income citizens are struggling to cope with the high prices of essential commodities and compromising on their food and nutrition.

The government recently hiked urea fertiliser and fuel oil prices without implementing measures to improve the management of the energy sector and reduce inefficiency and system loss.

When the government is unable to import sufficient fuel to generate electricity, it has to pay large amounts of money as capacity charges to quick rental power plants while keeping them mostly idle. The government could have avoided the massive loss had it planned ahead and cancelled some of the contracts earlier.

The high fuel prices come at a time when people are already struggling to keep up with rising food prices. This has further increased the cost of transportation of goods and fueled a rise in the prices of almost all essential consumer goods. As the price of fuel rises, it contributes to a cost-push inflation and the cost of daily commodities, including transportation will rise.

Moreover, millions of farmers use diesel for irrigation. The increased diesel price will increase irrigation costs further and may affect food security if necessary measures to support farmers are not taken.

The rationing of electricity and frequent load shedding have worsened the suffering of residents. Electricity is essential for productive activities that support economic growth but the recent frequent power outages have hampered production and businesses.

While large industries have their own generators, most small and micro industries do not have sufficient capital to purchase back-up power infrastructure. Load shedding, thus, halts the operations of small industries, lowering productivity – at times even damaging equipment – and degrading production quality.

Some solutions

The current situation indicates that if strategic action is not taken, the Bangladesh economy may suffer from slow economic growth in the coming years and may not be able to return to its pre-Covid-19 levels in the near future. A slower economic growth can shrink the job market and increase unemployment among the youth.

Strategic planning and decisive action are required to ensure power supply and improve energy-sector management, eliminate expensive rental power systems, and gradually reduce the dependency on external sources.

Energy and food price increases will disproportionately affect low-income households, exacerbating already-growing inequalities. To curb this, social protection measures need to be strengthened further to protect the poor from high inflation. Exports are crucial to reduce the trade deficit and build up foreign exchange reserves, which in turn will help manage exchange rates and the weakening taka.

To cope with the current economic crisis and manage the balance of payments, it is important to continue the existing restriction on the imports of luxury goods and accelerate the promotion of exports. However, while tightening imports, care must be taken not to restrict the import of raw materials and intermediary goods, as Bangladesh’s exports rely heavily on imported inputs.

Special attention must be paid to increasing remittances and foreign direct investment and preventing capital flight from the country.

Golam Rasul is a Professor at the Department of Economics, International University of Business Agriculture and Technology in Dhaka, Bangladesh.