Bangladesh is an outstanding example of a country that has successfully transformed its economy from a per capita income of below $100 in fiscal 1972-73 to $2,064 in fiscal 2019-20.
A major contributor to this performance is the rapid growth in exports, rising from below $0.4 billion in 1973 to $41 billion in fiscal 2018-19.
This successful push for export growth has come under pressure over the past several years even before the onset of COVID-19.
Exports growth slowed down considerably since fiscal 2013-14, growing at a pace of 6 per cent per annum between fiscals 2013-14 and 2018-19 as compared with 13 per cent per year between fiscals 1989-90 and 2013-14.
The onset of COVID-19 in March last year devastated the export sector as earnings plummeted by 17 per cent, falling from $41 billion in fiscal 2018-19 to only $34 billion in fiscal 2019-20.
While recovery is underway, export earnings in fiscal 2020-21 will at best recover to around $40 billion.
This implies that export growth would average a mere 4.2 per cent per year from fiscals 2013-14 and 2020-21, which is a far cry from the solid performance of 13 per cent plus growth registered between fiscals 1989-90 and 2013-14.
The recovery of exports growth to double digits is critical to enable Bangladesh to attain upper-middle-income country (UMIC) status by fiscal 2030-31, restore the momentum of job creation and eliminate the incidence of extreme poverty.
It is therefore very important for Bangladesh to prepare and implement a post-COVID-19 rapid recovery strategy to restore export performance to the fiscals 1989-90 and 2013-14 path.
Bangladesh export performance during the upswing benefitted from several policies and international enabling factors.
On the policy front, exports benefited from a sound macroeconomic policy framework that kept inflation and interest rates low, good access to low-cost bank credit, a flexible and competitive exchange rate, dismantling of trade and investment barriers, especially the removal of quantitative trade barriers and reduction in import duties, strong policy support to the leading export activity -- garment, and infrastructure improvement, especially power supply.
The garment sector led the charge in export performance, taking advantage of low-cost labour and partnership with the Korean firm Daewoo that brought in technology and foreign direct investment in the garment sector.
The initial spurt was provided further impetus by a number of major policy support from the government including the access of garment to duty-free imports of intermediate goods through a system of bonded warehouses (BWS), back-to-back line of credit that allowed garment exporters to finance imports from export earnings and special fiscal incentives.
The external environment was also supportive of garment exports initially through the phasing away of the Multifibre Agreement that eliminated quota restrictions on garment export volumes and through duty-free access to European markets based on Bangladesh’s least-developed country status.
A number of constraints have started dominating the export environment in recent years.
Trade reforms have faltered, while a range of complex and unpredictable supplementary and regulatory duties on imports took over to largely offset the reduction in customs duties.
The high rates of duties for consumer goods relative to intermediates and capital goods also meant that the effective rate of protection (ERPs) for these products are substantially larger than for intermediate and capital goods.
Investors soon discovered that it is a lot more profitable to produce consumer goods for the domestic market based on high ERPs than invest in exports. Furthermore, the exchange rate since fiscal 2005-06 has turned against exports.
The appreciation of the real effective exchange rate (REER) has been particularly sharp after fiscal 2010-11, appreciating by 71 per cent between fiscals 2010-11 and 2019-20 (Figure 1).
This is a huge tax on exports and serves as a double penalty on top of the large ERPs for domestically produced consumer goods.
It is hardly surprising that non-garment exports have failed to take off in this policy environment of huge anti-export bias.
The government has tried to offset these disincentive effects of trade policy and exchange rate appreciation on exports through export subsidies and tax breaks.
But these interventions are much smaller in size relative to the disincentive effects to make any material difference.
Garment exporters are also unhappy.
While they have succeeded in extracting special fiscal incentives, including export subsidies, concessional credit and large tax breaks, they complain that profit margins are sharply down owing to the large appreciation of the REER.
Additionally, the fiscal cost of these incentives is substantial in an environment of fiscal resource constraint.
The economic literature is unambiguous that a long-term REER appreciation is bad for exports.
Many development economists even argue for an under-valued REER to support export-led growth at the early stages of development (low- to middle-income countries).
China’s example is the most well-known case for this.
The policy challenge, however, is the feasibility of implementing such a policy.
In the case of Bangladesh, the government did a commendable job in the early phase of the export boom by depreciating the currency and keeping REER stable with a slight depreciating trend (Figure 1).
However, this policy could not be sustained.
REER appreciation was initially caused by excessively expansive monetary policy over the fiscals 2008-09 and 2011-12 periods that saw a sharp rise in inflation and pressure on the balance of payments.
Corrective measures were quickly taken including the depreciation of the taka and a reduction in the monetary growth rate.
However, following an initial correction, the REER appreciation path has continued owing to the heavy influx of remittance earnings and acceleration in GDP growth.
Since the balance of payments is either in surplus or in mild deficit, there is a perception that the REER appreciation is market-determined and therefore an equilibrium phenomenon.
The policy challenge is seen as one of ensuring that the volatility of the exchange rate is minimized without worrying about the sharp upward trend.
Using the current account surplus as an indicator of equilibrium in the exchange market is misleading for several reasons.
First, it is predicated on continued rapid inflows of remittances that are by no means guaranteed.
Remittances could well disappear as per capita income grows in Bangladesh and demand for domestic labour expands.
Second, the favourable outcome in the current account is sustained not only through trade protection that lowers import demand but also through huge restrictions on services account.
Exchange controls are rampant in Bangladesh with many restrictions on services imports, Bangladeshi investments abroad, foreign exchange surrender requirements etc.
These exchange controls are not consistent with the emergence of a dynamic economy that needs to be much more open to FDI and that seeks to attain UMIC status within the next 10 years.
In the present policy environment of Bangladesh, the simplest way to reinvigorate exports is to lower trade protection and reverse the sharp appreciation of the REER.
These policy reforms can be done literally by the stroke of a pen and the results in terms of export response will be fairly rapid.
Notably, the sharp appreciation of the REER at this stage of Bangladesh development is hurtful of exports, employment and overall growth prospects and must be corrected.
The adjustment of the nominal exchange rate downward to compensate for the REER overvaluation is resisted by policymakers on the ground that this would stoke inflation.
One possible way to compensate for that is to combine this policy with a reduction in trade protection.
The two policies will not only reinforce each other in terms of improving the incentives for exports, but the inflationary effects of nominal exchange rate depreciation can also be avoided.
Reduction in trade protection will boost imports that will support private investment and GDP growth and also help contain the appreciating influence of remittance inflows on REER.
Additionally, as the services account is further liberalised, demand for foreign exchange will go up and the current account surplus will vanish.
The author is vice-chairman of the Policy Research Institute of Bangladesh