Blog

Bangladesh has undergone a significant political shift, following large-scale protests that resulted in the resignation of the then Prime Minister and the dissolution of parliament. As an interim government has been formed under the leadership of Nobel Laureate Dr. Muhammad Yunus, the nation faces both significant challenges and potential opportunities.

Key leadership roles have been extensively shaken up since the interim administration took over. Dr. Salehuddin Ahmed, the new Finance Advisor, has vowed for financial sector reforms, transparent reporting, and strict inflation control by addressing market inefficiencies like extortion and syndication. With Dr. Ahsan H. Mansur as the new Bangladesh Bank Governor, there’s a clear shift toward a more proactive monetary policy. The sharp rally in the Dhaka Stock Exchange following the regime change reflects early investor optimism for meaningful economic reforms, renewed investor confidence, and a broader recovery of economic stability.

Highlights of the Changes to Our Macroeconomic Outlook from July Considering the New Reality:

• We expect a 150-200bps drop in inflation by Dec-24E due to further tightening and a higher base effect from August. Inflation spiked to a 12-year high of 11.7% in July, primarily due to improved transparency in economic reporting and supply chain disruptions. The magnitude of expected easing in inflation is unchanged from our earlier forecast, but the decline will be from a higher level. However, early tightening measures could result in a sharper reduction in inflation.
• Our Interest Rate (1-year T-bill) target is unchanged at 12.5%-13.5% for Dec-24E as the central bank is expected to maintain a tightening stance. However, we expect a sharper hike in the policy rate, a 100-150bps hike by Dec-24E, revised from our earlier expectation of 25-50bps, considering the newly appointed governor’s immediate priority of taming inflation over economic growth.
• Our view on the exchange rate is unchanged at the BDT stabilizing by 120-125 by Dec-24E due to the continued monetary tightening and a shrinking current account deficit. Reduced imports and stable remittances will mitigate the adverse effects of any slowdown in export growth.
• We have lowered our GDP growth expectation to 3.5%-4.0% for FY25E, reflecting anticipated sharper monetary tightening, reduced development expenditure under the interim government, and disruption to industrial activity and trade during the curfews, blockades, and internet blackout in July.

We are publishing our macroeconomic outlook for the second half of 2024, building on our previous forecasts for the first half of 2024 and previewing the upcoming monetary policy. Bangladesh Bank (BB) is scheduled to announce its monetary policy in July 2024. In line with IMF recommendations, BB is expected to unveil a continued contractionary monetary policy focusing on taming inflation.

• Recap of Last Six Months: In the first half of 2024, inflation persisted above 9.6%, driven by increased energy prices, a 6% upfront currency depreciation following the implementation of the crawling peg, and delayed monetary tightening measures. The government also projected negative expenditure growth for FY2024-25, tightening the belt in line with monetary tightening. These steps, aligned with IMF recommendations, led to the approval of a USD 1.15 billion third tranche of the IMF loan in June.
• Inflation: CAL expects inflation to decline gradually due to ongoing monetary tightening. The expected ease in inflation is likely to be driven by a slowdown in new inflation creation and a favorable base effect of the Consumer Price Index (CPI) starting in August. However, further energy tariff hikes and currency depreciation will keep inflation elevated within the higher end of our forecast range.
• Interest Rate: CAL projects 1-year treasury bill rates to be 12.5%-13.5% by December 2024, driven by a policy rate hike of 25-50 basis points and normalized government borrowing from the banking sector. A higher policy rate differential due to monetary easing in developed economies and rising real interest rates due to the gradual easing of inflation will likely prevent further hikes. However, lending rates may exceed 15.5%, constraining private-sector credit growth and increasing the risk of Non-Performing Loans in the banking system.
• Exchange Rate: CAL expects the BDT to stabilize between 120-125 against the USD by December 2024, contingent upon allowing the crawling peg to adjust to market conditions. A 7.3% currency depreciation since the crawling peg implementation and high interest rates should curb import growth, while export growth due to monetary easing cycles in Europe and the US will narrow the FY2024-2025 current account deficit. We do not expect any significant strain on the forex reserves even after the expected debt repayment of USD 4.5 billion in FY2024-25, considering our track record of raising foreign debt of USD 7.5 billion on average in the last five years.

The central bank has demonstrated flexibility by adapting its policy framework to include significant structural changes recommended by the International Monetary Fund (IMF) in the Monetary Policy for the first half of the fiscal year 2024. In our macroeconomic report titled “Navigating Rough Tides Ahead,” published on June 16, 2023, we outlined two potential policy responses that the central bank could adopt: an “Aggressive Response” and a “Progressive Response.” It appears that the central bank has chosen the progressive response, as outlined in our report, by hiking the policy rate by 50 bps along with an indication of the continuation of debt monetization which is consistent with that approach. However, CAL anticipates the progressive response might not be sufficient to anchor the macro variables.

CAL’s view on the policy measures:
Embracing Tighter Monetary Conditions:

The adaptation of a contractionary monetary policy stance is a notable step towards achieving macroeconomic stability. The tightening of monetary conditions is expected to discourage unproductive financial flows and mitigate demand-side concerns to some extent. However, it is evident that the central bank is exercising caution to avoid overly rapid rate increases, as this could potentially impede economic growth and contribute to the accumulation of non-performing loans (NPLs) in the banking sector. Nevertheless, the success of this contractionary policy stance hinges on its effective implementation.

The Adoption of SMART:

The introduction of the market-driven reference lending rate, known as SMART, is expected to result in lending rates surpassing the 10% mark. While this move will increase the cost of borrowing, it is also anticipated to alleviate some inflationary pressure. However, the calculation method based on a six-month moving average rate of treasury bill will introduce a certain time lag in effectively incorporating real-time market dynamics into lending rates.

Implementation of Unified Exchange Rate:

The implementation of a market-driven single exchange rate regime from July 2023 is expected to facilitate the establishment of an equilibrium price for the currency. This adjustment will help smooth the supply of USD for trade settlements, enhancing stability in foreign exchange transactions. However, it is important to consider that achieving currency stability, in conjunction with the normalization of external trade, will depend on the timeframe for adopting the Unified Exchange Rate and its effective implementation.

Domestic and Foreign Asset Growth Projections:

The policy steps outlined above are crucial for restoring macroeconomic stability. However, two significant factors will greatly influence the implementation of these policies by December 2023. Firstly, the notable 16.8% growth in domestic assets forecasted in the MPS indicates that the central bank is likely to rely on debt monetization to finance the budget deficit. Secondly, the substantial 20.3% forecasted decline in foreign assets suggests that the central bank may continue to sell reserves until December in order to provide support for the currency.

While the current MPS policy response leans towards the progressive response, the indication of continued sales of USD by the central bank will add a new dimension to it. If the central bank persists in selling USD until December, a reduction in the forex reserve may raise additional challenges in meeting the IMF’s Quantitative Performance Criteria (QPC) for December 2023.

• Global Outlook: Central banks globally are nearing the end of their tightening cycles, with the Federal Reserve signaling two additional rate hikes before reaching the cycle’s conclusion. The economic slowdown and a banking crisis in the US have diminished the urgency for further sharp rate hikes. As a result, the likelihood of the Dollar index strengthening is low, alleviating pressure on global currencies, including the Bangladeshi taka.
  
  
• Recap of policy measures in Bangladesh and its impact on the economy: In the past year, a contrast emerged between major advanced economies adopting tight monetary policies with substantial interest rate hikes, while Bangladesh pursued a macroeconomic strategy aimed at achieving low inflation, exchange rate stability, and stimulating economic growth through low-interest rates. This pursuit of the “impossible trinity” resulted in macroeconomic imbalances, including high inflation, currency depreciation, and a shortage of US dollars.
  
  
• Macroeconomic Outlook H1’FY2024: Considering external factors and involvement in an IMF program, the central bank of Bangladesh is scheduled to announce its monetary policy on 18^th June. The central bank finds itself in a challenging situation without any favorable options. Two policy paths lie before the central bank- an aggressive stance would help stabilize the macroeconomic situation but potentially lead to slower growth and an increase in non-performing loans within the banking system. Conversely, opting for a progressive stance would support growth but may result in higher inflation, and further depreciation of the currency.
  
  
• a) Aggressive Response: Under the Aggressive Response, the policy measures will be aimed at tackling inflation and currency depreciation through tighter monetary policies. Based on the policy measures, CAL expects interest rates for 364-day T-bills to be around 10.6% to 11%, c.7% depreciation of the taka against the dollar, and sustained elevated inflation of approximately 8.2% to 8.5%.
  
  
• b) Progressive Response: Under the Progressive Response scenario, the policy measures will be aimed at prioritizing policies that promote growth over cautious approaches. Based on the policy measures, CAL expects interest rates for 364-day T-bills to be around 8.3% to 8.6%, c.15% depreciation of the taka against the dollar, and an increase in inflation to 10.5% to 11.0%.
  
  
• Investment Strategy: In the event of a potentially aggressive stance, we recommend a shift towards short-term fixed-income securities to capture yield opportunities. In contrast, if a progressive approach is chosen, we recommend increasing exposure to equities and real estate assets due to potential opportunities from debt monetization.
• Consistent with our usual practice, we will publish an updated forecast in our monetary policy review for H1’FY2024 based on the adopted policy changes in the upcoming monetary policy statement by Bangladesh Bank.

In this year’s budget review, we will provide a broad overview of inflation, currency, growth, and interest rates, offering a general direction. The central bank’s policy stance after the parliamentary approval of the national budget will play a critical role in shaping the outcomes of these crucial macroeconomic factors.

Successfully navigating the complexities of participating in an IMF program, meeting the recommended policies for accessing the second tranche of funding, and managing the political pressures associated with an upcoming election year presents a significant challenge. Recognizing the magnitude of these macroeconomic challenges and the wide array of potential outcomes, we will present a more in-depth analysis in our forthcoming macroeconomic outlook report.

The FY2023-24 budget places emphasis on fostering digital inclusion for individuals and businesses, aligning with the SMART Bangladesh plan to drive digitization across various activities. Additionally, a universal Pension Scheme was also introduced.

Despite the prevailing macroeconomic challenges, the FY 2023-24 National Budget places a strong emphasis on stimulating growth.

Expenditure allocation for pay & allowances, interest, and subsidies equals 77% of revenue, which inflates the operating expenditure limiting fiscal space for development spending. On the other hand, the government has raised the social safety net allocation by 11% from last year’s budget while adding around 8 lac new direct beneficiaries under various programs aiming to provide relief during a high inflation environment.

The revenue collection target including grants has been raised by 15.5% to BDT 5,039 bn, with a special focus on the expansion of the tax base and tax policy reforms. However, a 26.6% increased revenue target from direct taxes, may be difficult to achieve due to unchanged tax rates and the adverse impact of global and local challenges on business activities.

The projected budget deficit is set to rise by 15.0%, accompanied by a 14.7% higher borrowing target from the banking system and a 22.3% increase in foreign sources. However, meeting these borrowing targets presents significant challenges.

Challenges in meeting higher bank borrowing targets under the budget may prompt interest rate hikes or debt monetization by the central bank, exacerbating inflationary pressures.

CAL unveiled its report on the apparel sector of Bangladesh titled “Rags First but Riches to Follow”, indicating a temporary downturn in global apparel exports in 2023 correlated with a slowdown in global output. Bangladesh’s apparel export growth is also expected to be negatively impacted in the short-term but to rebound by 2024.

1. GLOBAL APPAREL OUTLOOK: EMPTY POCKETS

World apparel export growth is expected to dip in 2023 in line with the global economy stemming from the amplified pace of monetary tightening to curb heightened inflation on the back of deteriorating geopolitical conditions. Among major apparel markets, the US is expected to be less impacted than the EU regions, as soaring energy bills dent discretionary spending. However, we expect a rebound in the global economy by 2024 as central banks swiftly shift to expansionary measures following early signs of a recession and a slowdown in inflation.

2. SHORT-TERM OUTLOOK: TIME TO TIGHTEN THE BELT

CAL expects the sober global apparel outlook in 2023E will have a spillover effect and push Bangladesh’s apparel export growth into negative territory. High inflation and increased energy prices will exert upward pressure on wage rates while production costs will remain at elevated levels. Difficulty in opening LCs on the backdrop of dollar shortage will also hamper production output. However, a sharp fall in cotton prices and currency depreciation will help ease pressure on the margins.

3. MID-TERM OUTLOOK: KNITTING THE NEXT PHASE OF GROWTH

We expect global demand to pick up steam in 2024E as central banks shift focus toward supporting growth as inflation recedes. CAL expects Bangladesh’s apparel export to witness a strong rebound with a c. 8.4% growth in 2024E. The apparel export size of Bangladesh is expected to reach USD 56.1 Bn by 2026E. The growth will be driven by three primary factors: i. focus on the MMF, the largest global apparel segment; ii. market share consolidation as order flow shifts from China due to China plus one strategy, and iii. greater product diversification and expansion in the non-traditional apparel markets.

4. GRADUATION FROM LDC: A FEW CARDS UP THE SLEEVE

Bangladesh is scheduled to become a developing country in 2026. Securing Preferential Trade Agreements (PTAs), Free Trade Agreements (FTAs), and establishing strong backward linkage could ensure a smooth transition for the apparel sector toward LDC graduation. Three trends likely to emerge from LDC graduation include i. market share consolidation of well-established apparel exporters ii. product portfolio to have a greater share in higher margin products iii. well-established companies shifting lower-margin manufacturing to countries that still enjoy duty benefits.