Report No. 5409

Bangladesh: Economic and SocialDevelopment Prospects(In Four Voiumes) Volume 11: Recent Developments and Medium-lerm ProspectsApril 2, 1985

South Asia Programs Departmient

FOR OFFICIAL USE ONLY

Document of the World Bank

This report has a restricted distribution and may be Lused by recipie.flsonly in the performance of their official duties- Its contents may no., otherwisebe disclosed without World Bank authorization.

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CU1RENCY EQUIVALENTS

The external value of the Bangladesh Taka (Tk) is fixed in relation to abasket of reference currencies, with the US Dollar serving as interventioncurrency. The official excb3nge rate on February 28, 1985 was Tk 26.47buying and Tk 26.53 selling per US Dollar. Unless noted otherwise, the ratesshown below have been used throughout this report:

US$ 1 = Tk 26.50Tk 1 = US$ 0.038Tk 1 million = US$ 37,736

The average annual exchange rate for recent fiscal years is shown inStatistical Appendix Table 6.1.

WEIGHTS AND MEASURES

1 acre (ac) = 0.405 .iectare (ha)1 maund (md) = 82.27 pounds (lbs) = 37.3261 kg1 seer (sr) = 2.056 pounds (lbs) = 0.933 kgI cubic focc per second (cusec) = 0.0283 cubic meter per second1 mncf = I million standard cubic feet

ADMINISTRATIVE STRUCTURE

Old New

Union 6-12 villages UnionThana (Police Stationj 6-15 unions 'JpazilaSubdivision 5-i2 thanasDistrict (Zilla) 1-6 Subdivisions/12-30 Upazilas Zila (District)Division 5-7 Districts

FISCAL YEAR (FY)

July 1 - June 30

FOR OFFICAL USE ONLY

List of Abbreviations and Acronym Used

ADB - Asian Developaent BankADP - Annual Development ProgramABC - Adult Education CenterACD - Approved Grain DealerAman - Rice planted before or durin the monsoon and

harvested in November-JaruaryAMs - Rice planted during March-April and harvested

during July-August

BADC - Bangladesh Agricultural Development CorporationBBS - Bangladesh Bureau of StatisticsBFS - Bangladesh Fertility SurveyBJiC - Bangladesh Jute Hills CorporationBKB - Bangladesh Brishi BankBINF - Bangladesh Machine Tools FactoryBoro - Rice planted in vinter aDd harvested during April-JuneBPDB - Bangladesh Power Development BoardBRAC - Bangladesh Rural Advancement CormitteeBEDB - Bangladesh Rural Development BoardBRSFB - Bangladesh Retrospective Survey of Fertility and MortalityBSB - Bangladesh Shilpa BankESCIC - Bangladesh Small and Cottage Industries CorporationBSRS - Bangladesh Shilpa Ein SangathaIWDB - Bangladesh Water Development Board

CDST - Customs Duties and Sales TaxesCED - Country Economic MemorandumCIF - Cost, Insurance and FreightcIS - Census of Cottage IndustriesCHI _ Census of Manufacturing IndustriesCPR _ Contraceptive Prevalence EbteCEPSC - Committee for Reorganization of Public Statutory Corporations

DFI - Developsent Finance InstitutionsDGI - Director General of IndustriesDSL - Debt Service LiabilitiesDTW - Deep Tubevell

ECGS - Export Credit Guarantee SchemeEPZ - Export Processing ZoneERC - Employment Resource Center

FERI - Foreign Exchange Risk InsuranceFPW - Food-for-WorkFN - Fabrique NationalFOB - Free on BoardFY - Fiscal Year

Ihis docnnent has a restd distnbution and may be used by recipients only in the performance of |their official dudes. Its contents may not otherwise be discbsed without World Dank authorization.

GOP - Gross Domestic ProductGOB - Government of BangladeshGR - Gratuitous and Test Relief

BSC - Higher School CertificateEYV - High Yielding Variety

IDDS - Import Duty Drawback SchemeIEC - Import Entitlement CertificateIIS - Industrial Investment SsheduleIm - Internat4onal V.,netary FundIKE - Irrigation Management Pilot Program31R - Infant Mortality Rate

L.P - Low Lift PumpLIMC - Long-term Marginal CostiSD - Local Distribution Center

WCE - Maternal and Child HealthmCm - Mother and Child Welfare CenterMIS - Nanagement Information SystemNo - Medical OfficerIMPO - Master Planning OrganizationMR - Modified Rationing11W - megawatts

NCB - Nationalized Commercial BankNIM - New Industrial PolicyNGO - Non-Government Organizations

0EM - Operation and Maintenanceans - Open Market SalesORT - Oral Rehydration Therapy

PPDS - Public Food Distribution SystemPG - Priority GroupsPTI - Primary Teachers Institutes

RSS - Rural Social ServicesRiP - Rural Works Program

SACP - Special Agricultural Credit ProgrameSIS - Census of Small IndustriesSR - Statutory RationingSSC - Secondary School CertificateSTW - Shallow Tubewell

TCF - Trillion Cubic FeetTFR - Total Fertility Rate3FYP - Third Five Year PlanTIP - Trade and Industrial PolicyTOE - Ton of Oil EquivalentTJ - Tetanus TozoidTTC - Technical Training Center

UCCA - Upazila Central Cooperative AssociationUEO - Upazila Education OfficerUF&PO - Upazila Finance & Planning OfficerUFWC - Union Level Health and Family Welfare CenterULC - Upazila Literacy CommitteeUNDP - United Nations Development ProgrammeMDO - Upazila Nirbahi OfficerUPC - Upazila Parishtd ChairmenUZP - Upazila Parishads

VGF - Vulnerable Group Feeding1I - Vocational Training Institute

iDR - World Development ReportWES - Wage Earners" SchemeWFV - Works Program Wing

XPL - Export Performance License

BANGLADESH

ECONOMIC AND SOCIAL DEVELOPMENT PROSPECTS

TABLE OF CONTENTS

Paite No.

VOLUME I: EMZCUTIVE SUMKARY

VOLUME II: RECENT DEVELOPMENTS AND MEDIUM-TERM PROSPECTS

Chapter 2: RECENT ECONOMIC DEVELOPMENTS AND MAXAGEMENT ISSUES 1

A. Economic Growth ........................................... .... 1B. Monetary Policy ................ ...... . 4C. Balance of Payments Management ........ .... 11D. Public Finance: Recent Performance ........................... 20E. Public Finance: Policy Issues .... ....... .... 26

Chapter 3: RECENT DEVELOPMENTS IN AGRICULTURE AND THE FOODGRAIN SITUATION 31

A. Foodgrain Production... ..... 32B. Availability of Foodgrains . . .35C. Agricultural Inputs .... ..... 46D. The Jute Sector........ .... .... 54E. Medium-term Agricultural Development Issues 57

Chapter 4: THE PUBLIC FOODGRAIN DISTRIBUTION SYSTEM 60

A. Procurement Policies ..................... 60B. Public Foodgrain Distribution . . .61C. Policy Issues .. ....... I . ................ 67

Chapter 5: INDUSTRY 71

A. The Structure of Bangladesh Industry 72B. Public Sector Reforms ....... . ................ 86C. Policy Changes Affecting the Private Sector 90D. Outstanding Issues.... 97

Chapter 6: DEVELOPMENT ADMINISTRATION 99

ChaRter 7: MEDIUM-TERM PROSPECTS AND ISSUES FOR THE THIRD FIVE YEAR PLAN 110

A. Preparing for the Third Five Year Plan ...... 110B. Prospects for External Assistance ....... ............. 114C. The Availability and Distribution of Foodgrains .............. . 120D. Balance of Payments Prospects ............... .. ................ 127E. Domestic Resource Mobilization ........................ . . ...... 135F. The Scope for Public Expenditure ..... ......................... 140G. Recommended Aid Commitments for FY86 ................... a...... 146

VOLUME III: POPULATION GROWET AND LONG-TERM DEVELOPMENT ISSUES

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LIST OF TEXT TABLES

RaLq_No.

VOLUME II: RECMT DEVEWIPIETS AND MEDIU-TERK PROSPECTS

ChaRter 2: RECENT ECONOMIC DEVELOPMENTS AND MANAGEMERT ISSUES

2.1 GDP Grovth by Sectors, FY73-FY84 .* .... **........ 32.2 Money Supply and Domestic Liquidity ............. 52.3 Outstanding Advances of the Scheduled Banks

to the Private Sector ................. *...... 82.4 Price Developments, FY81-FYS4 ................... IC2.5 Balance of Payments. FY80-FY85 .................. 132.6 Merchandise Exports, FY8C-FY85 .................. 152.7 Merchandise Imports, FY8G-FY85 .............. .. 162.8 Government Current Budget, FY83-FY85 ............ 222.9 Financing of the Annual Development Program,

FY84 and FY85 ... * ..... ** **................... 232.10 Consolidated Budget Overview, FY85 .............. 29

Chapter 3: RECENT DEVELOPMENT3 IN AGRICULTURE AND THE FOODGRAIN SITUATION

3.1 Trends in Agricultural Production and ValueAdded, FY79-FY85 ........................... 33

3.2 Foodgrazn Prices and Procurement, FY80-FY85 .... . 373.3 Monthly Cereal Stock Flow (July 1984-June 1985) . 393.4 Actual and Projected Arrival of Foodgrain

Snipments' (July 1, 1984-June 30, 1985) ........ 403.5 Index of Minimam Market Price for Coarse Rice,

FY8O-FY84 ... ***.........***.*................ 423.6 Summary of the Foodgrain Situation, FY79-FY86 ... 443.7 Provision and Utilization of Agricultural

Inputs, FY79-FY85 ..***....................... 473.8 Indices of Rice, Wheat, and Fertilizer Prices,

FY79-FY85 .. ..... 503.9 Agricultural Credit Recovery Performance by

Institution, FY81-FY84 ............... 533.10 Share of Refinance in Total Agricultural Lending

by Institution, FY81-FY84...................... 533.11 Agricultural Credit Disbursements and Financing,

3.11Yut Supply .and .Dispositio .FY.-FY8. 533.12 Raw Jute Supply and Disposition, FY79-YY85 .... 56

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Pase No.

Chapter 4: THE PUBLIC FOODGR&AIN DISTRIBUTION SYSTEM

4.1 Economic Subsidy on Public FoodgrainsDistribution, FY79-FY84 ...................... 64

Chapter 5: INDUSTRY

5.1 Structure of Bangladesh Manufacturing, 1981-82 .. 735.2 Sectoral Distribution of Manufacturing

Establishments, Workers and Value Added(1981-82) ........... .......................... ,5

5.3 Manufacturing Output and Investment ............. 775.4 Ratios of Value Added to Gross Output by Sector . 795.5 Factor Shares in Gross Output ....... ..... O... 795.6 Government Annual Development Expenditures ...... 83517 Performance Indicators of Public Industrial

Corporations .................................. 88

Chapter 7: MEDIUM-TERM PROSPECTS AIND ISSUES FOR THE THIRD FIVE YEAR PLAN

7.1 Commitments of External Assistance, FY74-FY90 .... 1167.2 Cormitments and Disbursements of External

Assistance, FY83-FY9C .. .............. 1187.3 Foodgrain Requirements and Supplies, 1Y84-FY90 ... 1227.4 Public Foodgrain Distribution System

operations, FY84-FY90 ............................. ......... . .... 1247.5 Public Foodgrain Distribution System, Sources and

Uses of Funds, FY84-FY90 ...... 1267.6 Balance of Payments, FY84-FYO0 1307.7 Sensitivity Analysis of the Capacity for Imports . 1347.8 Government of Bangladesh Budget.... 1397.9 (A) Budget Overview (Sources of Funds) .142

(B) Budget Overviev (Uses of Funds) . 1437.10 Foreign Ezchange Requirements and Sources,

FY85-PY87 ................. .. .. 1497.11 External As 8 i,-.nce, Colmitments, Disbursements

and Pipeli; , 7Y84-FK86 ....................... 151

Chapter 2: RECENT ECONOMIC DEVELOPMENTS AND MANAGEMENT ISSUES

2.01 The past two years, FY83 and FY84, were years of untypiczlLyfavorable balance of payments. The accumulation of a reasonable cushion offoreign exchange reserves during these years proved to be vitally important,by making it possible for the Government of Bangladesh to respond in anefficient and timelv manner to the foodgrain losses caused by the 1984floods. The pressure on the Public Food Distribution System has begun toabate from late 1984. On the other hand, the pressure caused by a very rapidand unsustainable rate of growth of domestic credit during the 18 months tothe end of 1984 is still, placing pressure on domestic prices and the balanceof payments.

2.02 This chapter discusses recent developments and emerging policy issuesfor monetary, balance of payments and fiscal management. The a-alysis sug-gests that, due to the deterioration of demand management represented by thesubstantial additions to private sector purchasing power through the creditsystem, there will be serious problems in managing the economic situationduring the remainder of FY85 as well as during FY86. The sharp decline inreserves of foreign exchange during the tirst half of FY85, due to a combina-tion of rising import demand for foodgrains and imports through the secondary(WES) foreign exchange market as well as declining remittances, is an unwel-come development. As discussed in Chapter 7, the balance of payments outlookfor FY86 and FY87 is bleak and there is a serious danger that the recentwelcome resurgence of activity in the industrial sector may be constrainedduring the coming year by an increasingly serious shortage of foreignexchange. GOB is clearly aware of these emerging problems and, as discussedbelow, it has taken a number of important measures to help bring the short-term economic situation under control. These measures include the upwardadjustment of key interest rates, the setting of strict limits on domesticcredit for the remainder of FY85, minor adjustments of the official and WESmarket exchange rates and an expected downward revision of the ADP for FY85.Dealing with the economic difficulties expected during the next 12-18 monthswill require a continuation of careful and sound macro-economic management.The expansion of domestic credit will need to be kept under cortrol; budgetexpenditure targets will need to be set in line with realistic projections ofavailable domestic and external resources; and balance of payments managementwill have to be reinforced by appropriate, flexible management of the offi-cial exchange rate as well as of the secondary foreign exchange market.

A. ECONOMIC GROWTH

2.03 Between FY73 and FY79, GDP increased by about 6.5-7.0% p.a., despiteseveral serious setbacks in agricultural production which continues to be thekey factor determining economic growth in Bangladesh. Between FY80 and FY82,the country passed through a very difficult period when oil prices increasedsharply, jute export prices declined, the terms of trade deteriorated and aidinflows stagnated in real terms. The situation became particularly difficultin FY82 when crop production actually declined due to drought conditions.

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GDP growth fell to about 1% and the current account deficit widened sharply.In response to the severe deterioration in the country's economic and finan-cial situation, the Government had to initiate a wide range of adjustmentmeasures. Drought conditions continued into early FY83, but agriculturalproduction recovered to over 3Z due to a favorable aman rice crop followed byrecord wheat and boro rice crops. The non-agricultural sectors, however,remained severely depressed, largely as a result of unavoidable reductions inthe Government's investment program in line with a reduced availability ofresources. FY83 was a difficult year for industry, particularly for large-scale manufacturing. The output of food processing, paper products, basicmetals and petroleum refining declined; only textile and chemical industriesshowed small gains. However, national accounts statistics showed a 3Zincrease in value added created by small-scale industry despite the declinein value added by the manufacturing sector as a whole during FY83.

2.04 Economic performance in FY84 showed, once again, a mixed pattern.According to preliminary estimates, GDP growth reached around 32, compared toa planned growth rate of 6Z. Agricultural production was significantlyaffected by late floods in Autumn 1983 as well as drought and early severefloods in spring 1984. As a result, FY84 food production reached only 15.5million tons compared to a target of 16.1 million tons and agriculturalgrowth was only slightly above 2%. On the other hand, there was a graduallyaccelerating recovery in the non-agricultural sectors. In particular, theindustrial sector rebounded sharply from the weak performance of the preced-ing years. In fact, the 4.5% growth rate estimated for manufacturing by BBSis likely to be an understatement and even the 6.0X growth tentativelyestimated in this report may be on the conservative side.

2.05 Industrial recovery from FY84 has been supported by significantimprovement in the policy environment for industry, including the liberaliza-tion and rationalization of the investment sanctioning process as well asincreased access to the secondary exchange (WES) market for both capitalgoods as well as raw materials. International prices for traditional exports(jute, jute products, leather) also improved, reversing to some extent theterms of trade losses of FY81 and FY82. Furthermore, the increase inagricultural production in FY83 created additional demand for manufacturedgoods in the following year and the rapid expansion of liquidity contributedsignifican'l-y to the resurgence of the industrial sector.

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Table 2.1: BANGLADESH: GDP GROWTH BY SECTORS, FY73-FY84

FY73- FY80-FY79 FY84 FY80 FY81 FY82 FY83 FY84 /a

Agriculture 4.1 3.0 0.2 5.3 0.9 4.6 3.9(Crop Sector) (4.8) (1.7) (-0.3) (6.0) (-0.7) (4.9) (3.4)(Others) (1.5) (4.2) (2.0) (3.0) (6.9) (3.6) (5.6)

Manufacturing 16.1 1.0 -4.8 5.4 1.6 -1.6 4.5Construction and Utilities 8.1 0.5 -19.1 13.2 6.6 0.0 1.7Trade and Transportation 7.1 2.5 5.8 1.9 -5.0 4.8 4.9Other Services 8.5 6.0 5.8 14.5 3.7 2.6 3.4

GDP at Market Prices 6.6 3.2 1.3 6.8 0.8 3.3 3.9

/a Preliminary estimates.

Source: Bangladesh Bureau of Statistics.

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

FY73- FY80-FY79 FY84 FYB0 FY81 FY82 FY83 FY84 /a

Agriculture 4.4 2.2 0.1 5.5 -0.1 3.2 2.2(Crop Sector) (5.3) (2.0) (-0.4) (6.1) (-1.5) (3.5) (2.2)(Others) (1.5) (3.0) (2.0) (3.0) (5.5) (2.3) (2.4)

Manufacturing 15.7 2.5 0.2 7.7 0.3 -1.6 6.0Construction and Utilities 7.5 5.2 8.5 3.5 3.2 5.8 5.0Trade and Transportation 11.3 5.6 12.2 2.3 4.2 3.9 5.4Other Services 3.5 4.5 5.0 11.3 2.2 1.5 2.5

GDP at Market Prices 6.8 3.3 3.7 5.9 1.4 2.7 3.0

/a Staff estimates.

Source: Staff estimates based on data from the Bangladesh Bureau of Statistics.

Note: The methodology used by the Bangladesh Bureau of Statistics forestimating the national accounts has been improved significantly.However, its new methodology introduced in November 1983 stillcontains deficiencies in several sectors. The CEM mission could notresolve the differences with BBS at this time and thereforepresents the GDP growth rates according to BBS estimates as well asaccording to the methodology used by Bank staff for the preparationof the last CEM.

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2.06 Prospects for FY85 have been adversely affected by the severe croplosses caused by the extensive floods in nummer and autumn of this year, soit would be unrealistic to assume that rhe Government's 6% CDP growth targetcan be attained. An agricultural sector growth of 4% would require that asubstantial part or the transplant. aman crop will be made good by higheryields in areas less affected by floods and no further major wheat and ricecrop losses will occur during FY85. Therefore, it is more likely thatagricultural growth wi,l not exceed 2Z in this year. However, short-termprospects for the non-agricultural sectors are more favorable. Industrialproduction could reach again a 6X growth if the current expansion continues,and the service sectors may also achieve gains of 4-5%. On the basis ofthese assumptions, overall economic growth for FY85 could approach 4%,provided there is no unexpected damage to crops yet to be harvested.

B. MONETARY POLICY

2.07 The need for a consistent and effective monetary policy has become acritical issue for Bangladesh's economic and financial management. Over theperiod of the two years ending June 1984, total liquidity (M2) increased byover 80% which is more than 35% faster than nominal GNP. Unless this con-tinuing and accelerating trend of growth in money supply can be kept success-fully under control over the next years, it will lead to an acceleration ofdomestic inflation and contribute to the expected strain on the balance ofpayments, leading to a very difficult short-term economic situation forlaunching the Third Five-Year Plan.

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Table 2.2: BANGLADESH: HONEY SUPPLY AND DOMESTIC LIQUIDITY(billions of taka)

June 30, June 30, June 30, Jan. 3,1982 1983 1984 1985

1. Credit (net) to Government 15.5 15.3 18.9 18.9(of which Special Treasury Bonds) () (1.9) (1.9)

2. Credit to Public Sector 26.0 26.1 24.7 31.13. Credit to Private Sector 23.1 31.2 49.0 62.94. Total Domestic Credit (1+2+3) 64.6 72.6 92.6 112.95. Net Foreign Assets -14.3 -10.1 -5.0 -7.06. Other Liabilities (net) 3.2 2.2 2.3 3.8

7. Total Liquidity (H2) 47.2 60.3 85.3 102.5

8. Currency Outside Banks 9.1 11.6 16.3 17.79. Demand Deposits 12e6 15.2 20.3 25.410. Currency and Demand Deposits (Hi) 21.7 26.8 36.6 43.111. Time Deposits 25.5 33.5 48.7 59.4

Changes by Major Components (Z)

June 1982/ June 1983/ End 1983rJune 1983 June 1984 End 1984

1. Credit (net) to G,vernment andPublic Sector Credit -0.4 5.3 13.7

2. Credit to Private Sector 35.1 57.0 68.43. Total Domestic Credit 12.3 27.6 38.04. Total Liquidity (M2) 27.7 41.5 35.75. Currency 27.9 40.4 28.66. Demand Deposits 19.9 33.8 33.17. Currency and Demand Deposits (Ml) 23.5 36.6 31.28. Time Deposits 31.5 45.4 39.2

Soutce: Bangladesh Bank, Research Department, Honey and Banking Division.

2.08 During FY83, the Government was reasonably successful in controllingthe monetary situation; domestic credit expansion was limited to 12%. Credit.to public sector corporations remained virtually unchanged as their overallfinancial position improved significantly due to increases in administeredprices. In addition, the Government accumulated a small surplus with thebanking system through its food operations. The modest credit requirementsof the public sector made it possible for the authorities to allow for a 35Zexpansion of credit to the private sector as part of its efforts to overcome

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the economic recession. Advances by Bangladesh Krishi Bank (BKB) andBangladesh Samabaya Bank (BSB) expanded by over 50Z. Reduced interest rateson export finance and a reduction in the margin requirements on letters ofcree:t for private sector imports through the official and secondary foreignexchange markets contributed to an increase by almost 30Z of bank lending forthose purposes. Advances against securities other than export and importcredits extended by scheduled banks to private sector customers (includingjute crop and other crop loans) increased by over 40Z, partly to financepurchases of agricultural inputs. However, despite the slowdown in thegrowth of total domestic credit, total liquidity (82) expanded by 28% inFY83, mainly due to an unexpectedly large net inflow of foreign assets;external reserves recovered by $235 million during FY83, as a result of amore favorable trade balance and the rapid growth in the inflow of workers'remittances.

2.09 The monetary expansion in FY83 would probably have served as a usefuland not excessive stimulant for the economy, if it had been followed sub-sequently by a more modest growth of money supply. However, monetary expan-sion during FY84 continued at a considerably higher rate: total liquidity(M2) grew b- 41.5% during the year. As shown in Table 2.2, over 70% of thisexpansioL ias attributable to an excessive increase in outstanding credits tothe privrte sector; only about 23Z of the increase was due to a furtherincrease in net foreign assets. Public sector borrowing was, once again,only a minor factcr in the liquidity expansion. The increase in net creditto Government, largely accounted for by the issue of Tk 1.9 billion ofSpecial Treasury Bonds, was partly offset by a Tk 1.4 billion decline in theoutstanding credit to publUc sector corpora'ions.

2.10 By early FY84, GOB acknowledged that the relatively rapid liquidityexpansion which had occurred in FY83 could not be tolerated for an extendedperiod of time because of the risk of causing increasing and potentiallydisruptive inflationary pressure. However, corrective monetary and creditpolicy measures were not applied during FY84 to moderate the expansion; infact, the growth 2.n money supply accelerated sharply during .he second halfof FY84, even thotgh net foreign assets declined during the last quarter.The authorities lack of action to curb monetary expansion decisively waspartly due to their reluctance to reduce the flow of ilew credit to theprivate sector at a time when they were seeking to encourage a fasterrecovery of the economy. Moreover, credit curbs would have required thecurtailment of ongoing or new credit programs, especially in the ruralsector, which would have proved difficult following the 1984 floods.However, by the end of 1984, COB's heavy reliance on credit expansion as ameans of overcoming the recession led to a situation that threatened monetarystability.

2.11 Table 2.3 below shows that virtually all categories of bank creditsto the private sector rose sharply during FY84. However, there was a par-ticularly pronounced growth of almost 100% in outstanding "Secured

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Advances,"'l only about one third of which represent crop loans in a narrowersense. No data is available on the use of private credit for investmentpurposes but growing pressure on the prices of consumer goods including foodand housing suggest that a considerable part of available credit may not havebeen used for productive purposes.

1/ Advances by Scheduled Banks other than BKB and BSB against securitiesother than exports and imported goods. It includes advances secured bycrops (about 113 of the total) as well as credits secured by any othercommodities.

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Table 2.3: BANGLADESH: OUTSTANDING ADVANCES OF THE SCHEDULED BANKS TO THEPRIVATE SECTOR BY SECURITY - COMPOSITION AND CHANGE

Z Shares of Total Advances Percent Change inJune 30, June 30, June 30, Advances During:.

1982 1983 1984 FY83 FY84

Merchandise 29.0 27.4 27.5 +27.2 +64.0(Export Commodities) (8.8) (9.0) (8.8) (+36.5) (+59.8)(Imported Goods) (15.8) (14.0) (13.8) (+19.6) (+60.7)(Other Merchandise) (4.4) (4.4) (4.9) (+35.5) (+82.9)Machinery and Other

Fixed Assets 2.1 2.2 2.4 +24.5 +79.3Real Estate 3.7 3.5 2.7 +26.9 +26.6Financial Obligations 2.8 2.9 4.0 +37.1 +127.8

Other Advances 24.7 23.5 26.1 +28.1 +81.2of which:Secured Advances/a (19.1) (20.0) (23.9) (+40.7) (+95.5)Unsecured Advances (5.6) (3.6) (2.2) (-15.0) (+1.2)

Foreign Bills 4.0 3.5 3.6 +17.1 +64.2

Advances by BKB and BSB 30.7 34.4 32.2 +50.8 +52.7

Precious Metals & StockExchange Securities 3.0 2.6 1.5 +18.6 -3.4

Grand Total 100.0 100.0 100.0 +34.5 +63.3

(in million Taka) 23,630 31,772 51,881

/a Including jute crop loans and other non-jute crop loans which accounted forabout 36% of "Secured Advances" as of June 30, 1984. No separate figureswere available for earlier years.

6Souree: Bangladesh Bank, Research Department, Money and Banking Division.

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2.12 Agricultural loans accounted for 55% of the increase in FY84 incredit to the private sector. The worsening performance in agriculturalcredit recovery has contributed to some extent to the rise in agriculturalloans outstanding; the credit recovery rate 1/ declined overall from 49Z in1980/81 to 42Z in 1983/84. However, the substantial refinancing of credit byBangladesh Bank to various sectors, especially agriculture, has been a mostimportant contributing factor in allowing domestic credit expansion duringFY83 and FY84 up to the liquidity limits of the couercial banking system.Outstanding borrowings of the Scheduled Banks from Bangladesh Bank againstrefinance schemes rose from Taka 9.96 billion to Taka 12.27 billion betweenDecember 1983 and June 1984. Agricultural credit (excluding cooperatives)alone expanded from Taka 6.48 billion to Taka 8.88 billion during thisperiod. I

2.13 Monetary indicators shGw that the liquidity situation worsened fur-ther during the first six months of FY85. The rate of growth of privatecredit expansion continued to increase (from an annual rate of 57% duringJune 1983/June 1984 to 68% during end-1983/end-1984). At the same time,there was also an increase in public sector credit, partially in response tourgent credit needs of public sector corporations, to a large extent in thejute sector. Total money supply (M2) grew by 35% during the December 1983/Decem-ber 1984 period, with the more recent monetary growth virtually entirely dueto domestic credit expansion, while foreign exchange reserves fell by overUS$100 million between June and December 1984.

2.14 By the end of 1984, GOB recognized that strong corrective measureswere urgently needed to regain control of monetary management. A number ofmonetary policy measures have been announced recently to curb the furtherexpansion of liquidity, including: (i) an increase in the Bangladesh BankRate from 10.52 to 11% as of January 1, 1985; (ii) a temporary moratorium onall rediscounting by Bangladesh Bank except for special cases in the exportand agricultural sectors; (iii) an increase in interest rates on advancesagainst fixed-term deposits from 16% to 20%, and (iv) an increase from 16Z to18% in interest rates on trading credits and advances against financial papersecurity. Interest rates on rural individual savings deposits were alsoraised. Finally, and perhaps most importantly for short-term management,Bangladesh Bank has imposed tight ceilings on advances by domestic banks,designed to restrain domestic credit expansion in FY85 to around 18%.

2.15 The difficulties confronting he Government in its recent effort tocurtail credit expansion are considerable. Enforcement of the limitation ofcredit expansion by the banks to 18Z during FY85 will be difficult sincedomestic credit expansion had already risen by 22% over the end-FY84 level bythe middle of FY85. Adherence to such targets will only be possible if there

1/ Defined as actual recovery of principal and interest as percentage ofannual "demand for recovery" (i.e., current dues plus arrears).

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is a massive and successful effort with respect to credit recovery especiallyin the rural sector. Such an effort is certainly welcome, but it will bedifficult to achieve a sudden improvement. However, unless recoveries ofloans are stepped up, there will be a severe disruption in new credit forproductive purposes. The provision of an adequate supply of agriculturalcredit remains important in the aftermath of the recent floods. Abruptintervention by means of credit restrictions could also run the risk ofaffecting the growth of the industrial sector. However, unless tight creditceilings can be adhered to for at least the next 12 months, there would beincreasingly dangerous pressure on the balance of payments and on domesticprices.

Table 2.4: BANGLADESH: PRICE DEVELOPMENTS(Average Annual Changes in Percent Through FY84)

Indices FY81 FY82 FY83 FY84

Dhaka Middle-Income Consumer PricesGeneral 17.1 7.5 13.9 12.3Food 14.6 8.4 12.6 17.5

Dhaka District Rural Consumer PricesGeneral 16.9 13.1 12.2 13.7Food 0.5 22.0 5.6 12.1

Industrial Workers of NarayanganjGeneral 8.9 17.4 2.6 9.1Food 5.6 16.4 4.3 13.6

Rice Prices, Dhaka (wholesale, coarse) -16.4 30.8 8.7 10.5

Source: Bangladesh Bureau of Statistics.

2.16 Prices and Inflation: Despite the rapid increase in domesticliquidity, price increases were relatively modest during FY84. The consumerprice indices 1/ rose by only 12-14% during the year. More recently, in theaftermath of the recent floods, food prices increased considerably faster,despite GOB's intervention through foodgrain operations. Wholesale pricesfor coarse rice increased by close to 40% during the twelve months toSeptember 1984. There have also been pronounced increases in the prices ofother foodstuffs (e.g., vegetables) and of non-food commodities (includinghousing and textiles), inter alia in the urban areas outside Dhaka, as shownin Table 2.4. While price pressures have abated recently following the Amanharvest, it is expected that the rate of inflation will rise gradually abovethe 11% inflation rate assumed by GOB for FY85. UnLess the rapid expansionof liquidity is successfully curbed for the rest of the year, the inflationrate could accelerate beyond the 13-15% projected in this report for FY85.Unless GOB responds promptly to any increases in the general price level byadjustments in a number of key administered prices, any increase in inflationwould add to existing price distortions in the economy.

C. BALANCE OF PAYMENTS MANAGEMENT

2.17 Bangladesh's balance of payments continues to be characterized bya massive structural trade deficit and a correspondingly heavy dependence onexternal aid. Export earnings cover only about one third of importrequirements, with raw jute and jute products traditionally accounting forclose to 60% of merchandise export earnings. Exogenous factors beyond thecontrol of GOB (such as the vicissitudes of weather, fluctuations in theterms of trade, in world market demand for Bangladesh's exports and in theavailable level of external assistance) have continued to influence themanagement of the country's external resources. During FY81 and FY82,Bangladesh suffered several adverse developments: the terms of tradedeclined by 30% due to rising oil prices and falling prices for jute; exter-nal aid disbursements stagnated in real terms in FY81 and rose by only 4% inFY82. As the current account deficit widened to almost 15% of GDP in FY82,foreign exchange reserves declined to the equivalent of only about two weeksof merchandise imports by June 1982.

2.18 There was a significant, albeit only temporary, improvement in thebalance of payments in FY83 as the terms of trade recovered by about 15% and

I/ Dhaka Middle-Income Consumer Price Index and Dhaka District RuralPopulation Consumer Price Index. It should be noted, however, that theindices may not be representative and not always indicative of actualprice movements. For example, in its coverage foodgrain prices thataccount for 20% of the weight in the Dhaka Middle-Income Index reflectlargely the movements of ration prices. A comprehensive review of theprice indices used by the Bangladesh Bureau of Statistics is thereforerecommended.

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merchandise export earnings rose by 1OZ. A major positive development was a45Z increase in workers' remittances to $628 million, equivalent to 90% oftotal export earnings in that year. Import demand continued to be severelydepressed due to the economic recession and to GOB's efforts to adjust tothe external resource constraints. Consequently, the current account deficitin FY83 narrowed to $1.1 billion and was fully covered by external aiddisbursements. By the end of June 1983, foreign exchange reserves hadrecovered by $235 million, reaching almost two months' import requirements(see Table 2.%).

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Table 2.5: BANGLADESH - BALANCE OF PAYMENTS, FY80-85(million US$)

FY80 FY81 FY82 FY83 FY84 FY85L&

Merchandise exports, f.o.b. 722 711 626 686 822 900Merchandise imports, c.i.f. -2,372 -2,533 -2,572 -2,309 -2,353 2,800Trade Balance -1.650 -1.8!2 -1.946 -1.623 -1.531 -1.900

Services (net) 215 394 354 516 519 375of which Remittances (210) (379) (424) (628) (552) (450)

Current Account Balance -1.435 -1.428 -1.592 -1.107 -1.012 -1.525

Aid Disbursements 1.222 1.147 1.236 1.345 1.268 1.378Food aid (374) (194) (231) (255) (277) (303)CominoditylProgram aid (378) (393) (421) (452) (439) (475)Project aid (470) (560) (584) (638) (552) (600)

M&LT Amortization -50 -50 -39 -74 -71 -90

Deferred PaymentFood Imports /b - - - - 46 165

Food Loan Repayments lb - - - - -60 -44Short-tern and Other

Borrowings (net) /c 33 28 65 -36 7 -30Net DIF Purchases and Changes

in Other Liabilities /d 111 281 188 114 -12 -11Changcs in Gross Reserves

(- - increase) 119 22 142 -242 -166 157

Memorandum Items:Gross Reserves in million US$ 271 249 108 350 516 359

(in months of imports) (1.4) (1.2) (0.5) (1.8) (2.6) (1.5)Current Account as Z of GDP 12.7 11.9 14.5 10.4 8.3 12.0Import Price Index (FY73-100) 234.9 263.9 259.9 237.4 225.2 220.1Export Price Index (FY73-100) 198.9 175.7 147.7 154.5 181.5 188.7Terms of Trade Index (FYB-100) 100.0 78.6 67.1 76.9 95.2 101.2

la Staff projections.Lb Food transactions on GOB account, i.e., excluding food aid. The figures

shown here are value of purchases ou deferred payment terms, lessfreight and any cash down payments paid by GOB.

/c Includes net short-term borrowing of the commercial banks and theBangladesh Petroleum Corporation, and unused foreign currency accounts.

{d Includes errors and omissions and currency swaps with and short-ternm depositsfrom Indonesia, Iran, Saudi Arabia, and the OPEC Fund for Development.

Source: Bangladesh Bank; Bangladesh Bureau of Statistics.

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2.19 Bangladesh's balance of payments position remained relatively comr-fortable during FY84. Export earnings increased by 20%, helped by sig-nificantly higher than average prices for jute and jute products as well asfor tea. However, the volume of traditional exports did not increase:export shir.ients of raw jute declined by 15%; while the volume of jute goodsexports rose only marginally. The volume of tea exports also stagnateddespite a more favorable world market following a temporary ban on Indiantea exports. On the other hand, there was a significant increase in thevolume of other exports (especially frozen fish, shrimp and froglegs, andready-made garments). Even though these exports still represent only aboutone-third of merchandise exports, the recent developments represent anencouraging step toward the urgently needed diversification of exports andthe establishment of a significant and viable labor-intensive exportindustry.

2.20 Merchandise imports in FY84 remained close to the FY83 level innominal terms as the economic recovery in the non-agricultural sectors wasslow to emerge and aid-financed capital goods imports were depressed by asubstantial delay in project preparation and implementation. Consequently,the trade deficit was further reduced to $1.5 billion. The ratio of totalimports financed by export earnings increased to 352 in FY84, compared to 26Zin FY81-82 and 30% in FY83. Even though workers' remittances began todecline noticeably in early 1984, the current account deficit for FY84 as awhole fell to just over $1 billion and gross foreign exchange reserves con-tinued to rise up to March 1984 when they reached a peak of $558 million,equivalent to about 3 months' import requirements.

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Table 2.6: BANGLADESH: MERCHANDISE EXPORTS, FY80-FY85

(million US dollars)

FY80 FY81 FY82 FY83 FY84 FY85/a

Raw jute 144 119 102 110 117 122Jute goods 384 357 284 318 356 386

Tea 33 41 38 46 69 77Leather 66 57 63 58 85 86Fish, Shrimp andFroglegs (frozen) 38 42 54 72 95 91

Ready-made Garments - - - 11 36 81

Other Goods 58 95 86 71 64 57(Naptha, Furnace oil) (23) (49) (41) (31) (26) (21)(Fertilizer) (-) (10) (-) (10) (20) (10)(Other) (36) (36) (46)/b (30) (18) (26)

Total Exports, incurrent prices 723 711 627 686 822 900

In constan. (FY73) pricesTotal Exports 363 404 425 444 453 477TraditionaL Exports /c 305 333 345 356 371 376Non-traditional Exports 58 72 80 88 82 101

/a Projected.7i Includes exports of 20,000 tons of rice valued at US$6 million.7T Raw jute, jute goods, tea and leather.

Sources: Export Prcmotion Bureau; staff estimates.

2.21 Since the last quarter of FY84, however, Bangladesh's balance ofpayments position has again begun to deteriorate, a serious challenge for thecountry's short and medium-term economic management. After an extendedperiod of relatively low domestic activity, import demand increased substan-tially during the second half of 1984. This is to be welcomed to the extentthat it reflects a recovery of the non-agricultural sectors from the recentrecession. At the same time, imports have also been stimulated considerablyby the expansion in domestic Liquidity over the past 18 months and the pres-sure on the balance of payments has been further heightened by the need forsubstantial food imports in the aftermath of the 1984 floods.

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Table 2.7: BANGLADESH: MERCHANDISE IMPORTS, FY80-FY85(millions US dollars)

FY80 FY81 FY82 FY83 FY84 FY85 /a

Foodgrains 623 250 285 385 398 591Petroleum 383 503 561 411 355 332Crude petroleum (257) (344) (334) (240) (233) (225)Petroleum products (126) (160) (227) (171) (122) (107)

Capital goods 545 683 676 655/b 608 700Edible oil, oilseeds 93 103 76 83 87 87Fertilizers 134 104 104 68 75 120Raw cotton, cotton yarn 64 128 101 90 173 160Cement 36 33 31 44 37 30Textiles 34 36 24 14 26 30Other intermediate andconsumer goods 460 692 729 560 594 750

Total imports,in current prices 2,372 2,533 2,587 2,310 2,353 2,800

Imports in constant (FY73)prices 1,010 960 989 971 1,045 1,272

Non-food import , inconstant I i3) prices 643 832 837 750 748 847

la Projecte-7ib Includes $57 million for purchase of DC-lOs for Bangladesh Biman.

Sources: Bangladesh Bank; staff estimates.

2.22 Foodgrain imports in FY84 amounted to just under $400 miLLion, ofwhich about $280 million was aid-financed. As a result of the severe croplosses caused by the widespread floods in June-September 1984, GOB began tomake large-scale procurements of foodgrain in the international commercialmarkets when grain stocks reached a perilously low level of less than 800,000tons in July. Total foodgrain imports for FY85 are now estimated at 2.8 to2.9 million tons, compared to original projections of 1.65 million tons.These increased imports will be needed to assure a continuous adequate grainsupply during the year; however, as a result of the high rate of distributionthrough the PFDS, public foodgrain stocks are expected to be below 1.0 mil-lion tons at the end of FY85. Food aid arrivals are expected to increase to

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over 1.6 million tons during FY85 in response to the emergency situation, butalmost half of total import needs for FY85 will need to be financed fromGOB's own resources. Most of these imports were committed by the end of thefirst quarter to ensure their timely arrival.

2.23 Given the extent of the foodgrain shortage caused by the 1984 floods,these purchases by GOB were necessary to prevent a potential food crisis inthe country and GOB should be given credit for its foresight to havereplenished its low foodgrain stocks expeditiously by purchasing in the openmarket. To secure these imports, Government has made cash purchases of about$60 million. In addition, foodgrain imports of almost $200 million areestimated to have been contracted on a deferred payment basis; this substan-tial debt incurred on commercial terms is due to be repaid from FY86-FY88,increasing the difficulty of medium term balance of payments management.

2.24 Compounding the pressure on the balance of payments, the inflow ofworkers' remittances that had become the country's second largest source offoreign exchange (after jute and jute products) continued to decline duringthe latter part of 1984. Workers' remittances, which averaged over $50million per month in the first half of FY84, and $46 million per month duringthe second half, fell to about $37 million per month in the first half ofFY85. Accordingly, the projected leveL of remittances for FY85 is $450million, compared to over $600 million in FY83 and just over $550 million inFY84. The decline in remittances has affected not only Bangladesh, but mostcountries with a sizable unskilled or semi-skilled work force in the MiddleEast and North Africa, reflecting the emerging financial constraints of thehost cauntries at a time of declining oil prices as well as a new stage ofdevelopment in some of the host countries with less need for unskilled for-eign workers after the completion of major construction projects. Thedecline may also point to a gradual change in the savings and consumptionpattern of the workers in the host countries. In response to these trends,the authorities in Bangladesh will have to make even greater efforts toprovide incentives and to remove any potential disincentives for therepatriation of foreign earnings. Appropriate management of the WageEarners' Scheme (WES) will be very important in this context.

2.25 The seriousness of Bangladesh's current balance of payments difficul-ties is evidenced by the rapid decline in foreign exchange reserves: reservesfell by more than $150 million from their March peak to a level ofapproximately $400 million by the end of December 1984. Reserves areprojected to decline further to around $360 million by July 1985, which wouldrepresent no more than a minimal 6-7 weeks' coverage of imports. There willbe no further margin for running down reserves during FY86 which promises tobe a very difficult year for balance of payments management. No realincreases can be expected in workers' remittances, there will be substantialloan repayments for foodgrain imported in FY85 on a deferred payment basis,a likely decline of jute and jute product prices from the currently highlevels, together with obligations (repurchases plus service charges) of overSDR 100 million due to the IMF daring FY86 dnd FY87.

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2.26 Due to these factors (which are discussed in more detail inChauter 7), the capacity for imports will be tightly constrained during FY86.Within the overall limit on imports, a high level (over 2 million tons) offoodgrain imports are again foreca. - to be required to build up foodgrainsecurity stocks to a more adequate level of 1.25 million tons and this volumemay need to be increased if there are any further weather-related disruptionsto crop production. Consequently, there will be a particularly tight con-straint on imports other than foodgrains: the level of such imports islikely to be constrained below FY85 levels in real terms. To minimize theneed for quantitative limits on imports, the authorities should use allavailable instruments cf balance of payments management in a flexible manner,and to ensure that balance of payments management is backed up by effectivedemand management. It will be essential to maintain the more prudentapproach to credit expansion which has been adopted since January 1985.

2.27 The Secondary Exchange Market: Over recent years, an importantinnovation in Bangladesh's import policy regime has been the considerableexpansion of the scope for financing imports through the secondary foreignexchange market (the WES market) where supply and demand determine the priceof foreign exchange and hence its allocation among competing users. Therelative importance of this market has grown significantly. The proportionof total imports financed through the WES market has increased from 8% inFY79 to over 20% in FY84. Expressed as a proportion of imports covered byImport Policy Orders,l/ imports financed through the WES market haveincreased from 12% in FY79 to about 40% in FY84. With certain exceptions(e.g., foodgrains, coal, fertilizer, arms and ammunition), virtually allitems that may be imported by industrial or commercial importers can also befinanced through the WES market. Major imports under these arrangements inFY84 were petroleum products, edible oils, manufactured goods and machineryand transport equipment. As discussed in Chapter 5, access to the WES marketfor imports of both capital goods as well as raw materials has been a crucialfactor in the recent recovery of the industrial sector.

2.28 Access to imports through the WES market was well managed during theperiod when the large and growing inflow: of workers' remittances providedthis market with an adequate supply of funds, while demand was constrainedby a recession in non-agricultural activity. More recently, workers' remit-tances have been declining and the demand for imports has recovered, so thatthe authorities currently face an inherently difficult problem of matchingdemand and supply on the WES market. In response to the increasing pressureon the exchange rate in the secondary market, the authorities introducedceilings on the exchange rate premium from July 1984. Under that policy, the

11 Imports not covered by Import Policy Orders include those which arefinanced directly by project assistance, barter arrangements or commodityaid supplied in kind.

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WES rate was fixed within a narrow band around the official exchange rate:this stabilization was to be achieved by Bangladesh Bank being prepared topurchase foreign exchange from the WES market when supply exceeds demand (aswas the case during period of 1983) or, as has been the case since the intro-duction of the new policy, to sell foreign exchange when demand for foreignexchange for importing through the WES market exceeded the supply. For aperiod of five months, the exchange rate premium in the WES market was fixedat 7-IOZ above the official exchange rate. Substantial sales of foreignexchange 1/ by Bangladesh Bank through the WES market were required to main-tain this rate. The fixed ceiling was lifted at the end of November 1984:the premium is now reset from time to time by a committee. By February 1985the margin had been allowed to widen to 13-14Z, while the official exchangerate was depreciated from Tk 25.2 per US$ in July 1984 to Tk 26.5 per US$ byFebruary 1985.

2.29 As workers' remittances remain low as compared to the rate of inflowsduring 1983 and prospects for a recovery of remittance flows remainuncertain, the obiectives of the secondary exchange market and its role as aneffective tool of short-term economic management need to be reassessed. Thesecondary exchange market should continue to be able to fulill its functionof enabling private entrepreneurs to procure from abroad capital goods,intermediate products and raw materials without being required to go throughcomplex import and investment sanLtioning processes. Diminiehed access tosuch imports would jeopardize the emerging industrial recovery of the past 18monthr. In addition, the {ES rate should retain its "signaling" function ofreflecting the underlying p-essures tn the official exchange rate.

2.30 These objectives call for a flexible management of the secondarymarket in tne future, but such management should not be viewed as a sub-stitute for effective demand management -E the economy by a combination ofprudent fiscal and monetary policies. The WES rate by itself cannot beexpected tc equate demand and sup'ly in that market if there is a sustaineddowrmiard trend in the supply of fcreign exchange to that market, especiallyif the demand for imports through che market is rising. It needs to berecognized that the primary objective of the use of official foreign exchangereserves is to avoid severe disruptions in the flow of essential imports,rather than to stabilize exchange rates regardless of the pressures set up byother policies or exogenous factors. In an economy with a limited resourcebase and heavy deperAdence on trade, no exchange regime can ensure a satisfac-tory balance of payments position unless it is backed by sound management ofoverall demand.

1/ Net sales of foreign exchange by Bangladesh Bank to support the WESmarket between July 1984 and January 1985 amounted to over $200. To someextent, this figure represented a diversion of imports from the officialto the WES market, but some of the demand for imports could have beenreduced by allowing a higher premium on the WES market.

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D. PUBLIC FINANCE: RECENT PERFORMANCE

2.31 During the last fe. years, the Government of Bangladesh has pursueda relatively cautious fiscal policy and significant efforts have been made toaddress some of the structural and administrative weaknesses in Governmentfinances. More recently, however, budg2t planning and fiscal management haveproved less effective. Deficit spendiEg has not been a serious macro-economic problem since FY82, but since FY83 deficits have been avoided onlybecause shortfalls in revenues have bean more than offset by significantshortfalls in Government development spending.

2.32 In FY83, the Government made impressive efforts to master the dif-ficult task of economic management by implementing a wide range of adjustmentmeasures; including tax increases, substantial price adjustments and subsidyreductions as well as reforms of budgetary management. Most important amongthe latter was the designation of a protected core program within the ADP, asubstantial reduction in the number of projects included in the ADP, and thestreamlining of the mechanisms for the release of funds tc project implement-ing agencies. Resource mobilization measures taken in the context of theFY83 Budget raised additional revenues in the order of Tk 6 billion (increas-ing tbe tax/GDP ratio to about 8.7%), while the FY83 ADP reflected, in termsof overall size, resource planning and estimated project implementationcapability, a realistic assessment of the potential availability and use ofresources.

2.33 In the FY84 Budget, COB sought to consolidate the gains made in thepreceding year, while helping set the stage for a broadened domestic resourcemobilization effort in the future. However, the actual outcome fell short ofthe budget assumptions. On the resource side, actual tax collections were15% below the original budget estimate, largely due to a 30% shortfall inrevenues from customs duties and 17% lower sales tax receipts as dutiableimports were significantly, less than estimated. This shortfall underlinesthe tax system's vulnerability due to its considerable dependence on imports:customs duties and sales tax on imports taken together accounted for 55% oftax revenues in FY83 and FY84. New tax measures and improved tax administra-tion yielded some increases in excise duties and income tax revenues abovethe budget estimate, but land development tax continued to lag behind expec-tations with only half of the budgeted amount actually coLlected. Non-taxrevenue fell about 6% short of the budget estio:ntes, despite higher interestreceipts, largely because actual profit transfers from non-financial publicenterprises were considerabLy below budget estimates.

2.34 Recurrent expenditures in FY84 exceeded only slightly the budgetedamount which was about 20% above actual outlays for FY83. This increase wasnecessary as a minimum to improve public remuneration and to increase theavailability of urgently needed resources for the operation and maintenanceof completed development projects and programs. However, the FY84 actualsreflect only marginally the major across-the-board increases in public

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salaries introduced during the last quarter: most of the budgetary impact ofthese salary increases will be during FY85. The reduction in resources fromthe recurrent budget available for financing the FY84 ADP was theref_rZmainly due to the shortfall of revenue.

2.35 Turning to other resources for financing the ADP, Lhe net transferof budgetary resources to the Food Budget was much lower than anticipated forFY84, caused by a number of factors including additional receipts from higherthan anticipated foodgrain sales, Lower transfers to the foreign aid depositaccount, and substantially lower domestic procurements than originallyplanned. Moreover, a subs:antial part of the additional foodgrain importedfrom abroad to supplement the domestic a-rilability of foodgrains was pur-chased on a deferred payment basis.l/ There was also an appreciable short-fall in the disbursement of commodity and cash aid in FY84 (Tk 9.9 billion asagainst Tk 11.2 billion in the budget), related to the slow growth of importsduring the year.

1/ The reasons underlying the developments in the food budget are dis-cussed in some detail in Chapter 3.

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Table 2.8: BANGLADESH: GOVERNMENT CURRENT BUDGET(In millions of Taka)

Preliminary Preliminary GOB COB PreLiminaryActual Budget Actual Budget Revised WorLd BankFY83 FY84 FY84 FY85 Estimates/a Estimate FY85

A. Current Revenje 26,510 33,967 29,529 35,690 34,900 34,800

Tax Revenue 21,210 28,070 23,954 28,870 28,060 28,400Customs Duties 8,700 13,300 9,480 11,600 11,000 11,100Sales Taxes 2,980 4,340 3,590 3,900 4,060 4,300Excise Duties 4,975 5,460 5,960 6,750 7,050 7,050Income Taxes 3,260 3,100 3,350 3,750 3,870 3,870Land Revenue Tax 220 600 300 500 400 400

Other Taxes 1,13' 1,270 1,274 1,330 1,680 1,680Revenues from New

Tax Measures - - - 1,040 /b /b

Non-Tax Revenue 5,240 5,897 5,575 6,820 6,840 6,400Nationalized

Industries 230 363 280 731 300 300Financial

Institutions 1,000 900 950 1,190 1,370 1,370Interest Receipts 910 932 1,190 1,184 1,180 1,180Railway Revenues 1,470 1,776 1,470 1,620 1,700 1.700PO & TT (net) 150 -48 12 -87 -150 -150Other 1,480 1,974 1,673 2,182 2,440 2,000

B. Recurrent Expenditure 20,377 24,135 24,520 28,030 29,380 29,400

C. Recurrent BudgetSurplus 6,133 9,832 5,009 7,660 5,520 5,400

/a Based on preliminary estimates provided by GOB, February 1985.7i Revenues from new measures have been allocated among other revenue items.

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Table 2.9: BANGLADESH: FINANCING OF THE ANNUAL DEVELOPMENT PROGRAM, FY84 AND FY85(In millions of Taka)

PreliminaryBudget Preliminary GOB GOB World BankFY84 Actual Budget Revised Estimate

FY84 FY85 Estimates/a FY85

Budgetary Resources (net) 6,242 4,122 /b 6,030 4,780 5,728Recurrent Budget Surplus 9,832 5,009 7,660 5,520 5,400Other Domestic Capital (net) -1,660 -417 -1,330 -1,330 -1,300Transfer from/to the Food Budget -1,930 -470 -300 590 1,628

Extra-Budgetary DomesticResources (net) 443 930 /b 1,630 2,790 1,710Self-financing by AutonomousBodies 163 420 1,330 1,330 800

Debentures issued by AutonomousBodies 280 150 300 850 300

Accumulated Balance ofAutonomous Bodies - 130 - 610 610

Accumulated Materials and Stocks - 230 - - -

Domestic Resources Total 6,685 5,052 7,660 7,570 7,438

External Assistance 28,156 23,107 31,300 27,430 26,605Project Aid tincludingreimbursable technical 15,226 12,198 18,470 16,000 14,560assistance)

Commodity & Cash Aid 11,160 9,879 11,900 10,500 11,115Food Aid (PL-480 deposits on7y) 1,770 1,030 930 930 930

Total Resources Available 34,840 28,159 38,960 35,000 34,043

Annual Development Program 34,840 30,079 /b 38,960 /c /c

Domestic FinancingTreasury Bonds - 1,920 - -

/a Based on vreliminary estimates provided by GOB, February 1985.7T Increase in net credit to Covernment of Bangladesh Bank in the amount of

Taka 1,671 million has yet to be fully allocated, however, it isestimated that over Tk 1,000 million is accounted for by a payment ofsaLaries relating to the first pay period of FY85.

/c To be finalized by GOB.

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2.36 The substantial shortfall on the resources side was largely offsetby major underspending in development expenditures. Actual FY84 ADP expendi-tures amounted to only Tk 30.1 billion as against a budget estimate ofTk 34.8 billion. The shortfall in ADP expenditure was due to a well-belowtarget performance in terms of project aid disbursements (Tk 12.2 billionas against Tk 15.2 billion), attributable almost entirely to physical andadministrative constraints on project preparation and implementation. Localcurrency allocations for the FY84 ADP were spent almost completely but only67% of the budget estimates of foreign aid disbursements took place: thepercentage of actual ADP expenditures from foreign financed project aid ascompared to ADP budget estimates has declined continuously in recent yearsfrom the 91% utilization rate achieved in FY81.

2.37 It should also be .oted that if disbursements of project aid had notbeen held up for largely non-financial reasons, the limited availability ofdomestic currency resources would have posed a serious limit on projectedimplementation or resulted in a higher borrowing requirement for Governmentoperation. The experience of FY84 has underlined the urgent need for moreeffective resource planning and administration, especially to improve therealism of estimates of project aid utilization and to ensure that theseestimates are consistent with the likely availability of domestic resources.A continued pattern of overestimating expenditures would weaken the effec-tiveness of the ADP as a tool for planning and managing GOB's developmentexpenditures.

2.38 It may be noted that, despite the shortfalls in ADP expenditures andthe lower than expected closing stock of foodgrains, borrowing was requiredto finance GOB's operations during FY84. Some borrowing took the form ofspecial high-yielding Treasury Bonds, with an effective yield of around 14Zto 16% p.a. Total issue of these Bonds from the scheduled banks was in theorder of Tk 2.4 billion with net sales of over Tk 1.9 billion. Since therewas no offsetting decrease in net credit to Government from any other part ofthe domestic banking sector, the proceeds from these Treasury Bonds wereused, indirectly, as a source of financing for the FY84 ADP. In terms of itslonger-term effects on credit expansion, financing of Government operationsby borrowing from commercial banks is preferable to deficit financing byborrowing from the central bank. However, in view of the substantial expan-sion of liquidity due to other factors during FY84, it would have been evenmore preferable to have had no net increase in domestic bank credit to theGovernment during FY84. Moreover, it should also be noted that need forrecourse to domestic bank-finance for the budget was Limited in FY84 byshort-term borrowing from abroad (to be repaid over three years) for part ofGOB's food import purchases. As discussed in subsequent chapters, there weresound reasons for such imports and their mode of financing. However, it isimportant to take a consolidated view of the total borrowing requirements ofthe ADP, together with the food budget, for assessing the overall macro-economic impact of GOB's fiscal policies.

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2.39 FY85 Budget: The FY85 Budget was cautious in its resource mobi-lization estimates, but was again very ambitious with respect to theaggregate size of the ADP. The budget was based on the assumption of a 6%GDP growth during FY85, compared to an actual growth of about 3% in FY84. Itincluded only minor tax reforms and revenue measures with an estimated yieldof about Tk 1 billion, equivalent to only 4% of total budgeted tax revenues.On the other hand, ADP expenditures were budgeted to total almost Tk 39billion, or 30% more than the FY84 preliminary actuals; the projected projectaid disbursements for FY85 were to be 50% higher than the preliminary actualdisbursements in FY84.1/ The preliminary results for the first half of FY85suggest that the ADP targets with respect to project aid disbursements willnot be attainable. Disbursements of about Tk 14.5 billion (based on theassumption of a 17% disbursement from the project pipeline as of July 1,1984) are likely to be the upper limit, and would still require a significantincrease over last year's performance (see Table 2.9).

2.40 The FY85 Budget provides for a 16% increase in recurrent expendituresover the FY84 preliminary actual. This provision is reasonable but may haveunderestimated the full impact of the FY84 increases in public salaries andthe remuneration increases that may follow during FY85. In general, a con-vincing case can be made for significantly higher recurrent expenditures ifsuch increases represented a planned and coordinated Government effort fora general reallocation of additional financial resources to improve theoperation and maintenance of development projects and programs.

2.41 On the domestic revenue side, prcspects are more favorable. Duringthe first few months of FY85, tax revenues have been buoyant with an overallincrease of about 20% above the previous year. This reflects primarily therecent sharp rise in dutiable imports which according to recent GOB estimatesare projected to increase over the year by about 27% in Taka terms. Inaddition, there has also been a strong performance of excise tax collections.While shortfalls in budgeted tax revenues are unlikely in FY85, non-taxrevenues are now projected lower than in the budget because of continued poorperformance of many of the non-financial public enterprises. Although domes-tic resources may be close to their budgeted levels, a substantial shortfallin external resources will follow from a lower than expected rate of projectaid disbursements. On balance, as set out in Table 2.9, the total resourceslikeLy to be available for the financing of the FY85 ADP are in the order ofTk 34 billion, which is well short of original estimates.

1/ The incorporation of such high estimates in the FY85 Budget may be dueto the lengthy delays in estimating actuaL results for the FY84 Budget."Preliminary actual" estimates of FY85 ADP outlays were not availableuntil October, four months after the end of the fiscal year. It would bedesirable not only to reduce this lag, but also to ensure a higher degreeof realism of the process of reviewing the progress of ADP implementationduring the fiscal year.

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2.42 Table 2.9 also indicates a substantial projected transfer from thefood budget as part of ADP financing for FY85. It is important to recognizethat such a "transfer" is made possible only by the conventions used in thepresentation of the Budget. The projected operations of the Public FoodDistribution System (PFDS) for FY85 point to a large net cash deficitfinanced by substantial borrowings from abroad, corresponding to large foodimports financed on a deferred payments basis. The resort to such borrowingpermits the food budget to show a surplcs which can make a notional contribu-tion to ADP financing. This accounting practice points again to the need fora comprehensive overview of the Government's financial receipts and outlays,which would show that even a reduced ADP will still involve substantialborrowings for overall Government operations during FY85.

2.43 For all of these reasons, it is highly desirable that the FY85 ADP bekept under review so as to ensure its realism. The retention of over-ambitious ADP targets would not only undermine the management of theimplementation process for the remainder of FY85, but would also lead tomisallocation of resources. For example, given the urgent need for providingadditional resources for repair and rehabilitation as well as for operationand maintenance in general, it would be inappropriate to earmark for too longin the fiscal year scarce Taka resources for projects which cannot beexpected to be implemented during the year.

E. PUBLIC FINANCE: POLICY ISSUES

2.44 During the past three years, GOB has implemented a number of measuresto improve budgetary and financial planning. The experience of FY84 and theemerging trends for FY85 underscore, however, the need for further attentionto the process of designing and implementing effective budgetary and fiscalpolicies and procedures.

2.45 Budgetary planning and management: Significant progress has beenmade with respect to the delegation of financial authority to line ministriesand project agencies, the streamlining of budgetary procedures, thedecentralization of administrative activities, the denationalization ofpublic enterprises, and the restructuring of public sector corporations. Atthe same time, weaknesses persist in budgetary planning and administration,which are reflected by the tendency to overestimate the availability ofresources as well as the capacity for project preparation and implementation.

2.46 Administrative and institutional reform are needed in the followingareas:

(i} Strengthening of the capacity for monitoring and accountingwithin the Finance and Planning Ministries as well as in theline ministries and other agencies to ensure that reliableactual budget data are available soon after the end of each

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fiscal year; ideally, quarterly reports should be availablewithin a month after the end of each period.

(ii) Establishment of reliable data on actuaL ADP expenditures:overambitious claims for ADP resources should be corrected at anearLy stage in the fiscal year. The selection of core projectsneeds strengthening but the ADP's non-core portion also requirescareful assessment to prevent wastage and misallocation ofresources.

(iii) Realistic planning of project aid implementation on the basis ofmore frequent evaluations of project performance.

(iv) The introduction of a medium-term programming and budgetinginstrument to overcome the strictly one-year time horizon forbudgetary forecasting of resources and outlays.

2.47 Consolidated Budget Overview: The budget system currently in usein Bangladesh is very complex. The inter-relationships among the RevenueBudget, the ADP and the Food Budget are unnecessarily intricate, posingdifficulties for the planning, budgeting and monitoring of the availabilityand use of resources by GOB. Most importantly, as noted above, the sig-nificance of GOB's foodgrain operations need to be clearly assessed as partof the total financial/budgetary operations of the Government. The presentdetailed presentation of the individual budget components may be adequate foradministering and controlling the provision and use of budget resources forcurrent activities and for reviewing past activities under the variousadministrative budget categories, but it does not provide a concise overviewof the total availability and use of resources by the Government which isnecessary for macro-economic analysis and economic management.

2.48 Disadvantages of the accounting framework currently used for the GOBbudget include the following:

(i) Several different accounting statements, in addition to theRevenue Budget, the Food Budget, and the ADP need to be con-sidered simultaneously in order to obtain a complete picture ofgovernment revenue and expenditures. Statement I ("Budget ata Glance") of GOB's budget presentation brings together figuresfrom the various budgets and shows that there is an overallbalance of revenues and outlays; however, it could be substan-tially simplified and rearranged to enhance its usefulness interms of providing an analytical summary of overall resourceavailability and uses.

(ii) "Revenue expenditures" and "ADP" are frequently used as synonymsfor "current expenditures" and "investments," respectively,although some investments are financed out of the revenue budgetwhile some recurrent expenditures are included in the ADP.

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(iii) Some of the present practices determining which activities shouldbe fully consolidated into the Government budget (thel.r revenuesappearing on one side and their expenditures on the other with noseparate net balance shown) and which should be shown net (withonly the net balance between their revenues and expendituresentered into the government budget) appear to have outlived theirprevious relevance. Among state enterprises, only the railwaysare consolidated into the budget, a practice which reflects theimportance of railway investment and finance in the colonialfinances of nineteenth century India, a situation no Longer validfor Bangladesh. Biman Airlines, on the other hand, is notconsoLidated. Most importantly, the food budget which is a largeand volatile budget component is not effectively consolidatedinto the current presentation of Government accounts.

(iv) One particular weakness is the treatment of food purchases madeon a deferred payments basis. These operations are equivalent toborrowing, the proceeds of which are used to purchase foodgrainsand whicih result in debt service obligations for future years.In many such cases, no cash transactions actually take place atthe time the foodgrain import occurs, so the deferred paymentpurchases are only recorded in the budget as payments become due,not when the purcbases are made. This practice understates thevalue of the total foodgrains acquired by GOB in food deficityears such as FY85 and also understates the total borrowingrequirements for GOB's overall operations. In the current GOBpresentation, the food budget may show a "surplus" in years whena substantial part of total foodgrain needs are obtained on adeferred payments basis even though substantial debt obligationsare incurred.l/ It would be preferable to include the total costof these purchases both as a current expenditure and as a capitalreceipt in a consolidated budget presentation which would presentan integrated picture of the additional debt obligations incurredby GOB in the year concerned.2/

Table 2.10 below presents one approach to the presentation of a consolidatedoverview of the Budget: GOB is also considering the use of some consolida-tion of its current presentations for analytical purposes.

1/ This "surplus"' is represented by a positive net transfer of funds fromthe food budget to ADP financing as shown in Table 2.9. In years whensuch a transfer is financed by borrowing for food, such a transfer merelyrepresents a form of indirect borrowing for financing the ADP.

2/ Such a treatment would be analogous to the treatment of food imports ona deferred payments basis in the balance of payments. In Table 2.5, allsuch food imports are included in the figure for total imports, while the"notional" borrowing to pay for them is shown as a capital inflow.

Table 2.10: DUIIlR; Cosolidated ndst Overview, n8s(crores of Tan: I crm - 10 million)&

Originl Budget Lk Revised Estimate. LTk Crore! AX) XT Crors c (7

A. SOURCES OF FNDS

I. ClAL R 3.250 (36.9) 3,153 (35.9)A. Tazes 2,5 7 2,840

1. Indirect 2,260 2,245a. CDST 1,5B5 1.540b. Excise 675 705

2. Direct 627 595B. ln-Tcx 363 313

1. Public Enterprises (net) 153 1262. User Pees sad Other 210 15

II. AID DISEUSITS 3.897 (44.3) 3,356 (38.2)A. pood 625 7WD. Project 2.082 1,456C. Comodity 1.190 1,112

III. FOOD mnVnis 1,089 (12.4) 1.343 (15.3)A. Casb Sales D55 984B. FFiVCMITE Credits 224 359

IV. nouzuxC 566 (6.4) 926 (10.5)A. Domstic 480 490

1. Debt, Loans sad Ads ices 390 3902. Official Accountu 90 100

B. Foreign 86 4361. Deferred Payment Food Imports 79 4292. Otber 7

TOTAL RESOURCES 3,802 (100.0) 8.7Jt (i00.0)

S. USES OF FUNDS

V. EMRRAL mEDITUlRES 2,178 (24.7) 2.380 (27.1)*. Administration 363B. Justice, Police and Defefae 862C. Education and Social Welfare 754D. Scientific ad Economic 256r- Contingencies 123

VI. INVESTHEU 4.428 (50.3) 3,R76 (44.1)A. Projects 4,167 3,6953. Financial 91 91C. Increase in Food Reserves 170 90

VII. F00D WPEDITURES 1.332 (15.1) 1,749 (19.9)A. Food Costs 1,150 1,463

1. Imports (f.o.b.) 836 1,368a. Aided 625 788b. Own Resources 211 S3

i. C"b 132 151ii. Deferred Payment 79 429

2. Freight Costs 73 1053. Domestic Procuremsnt 411 804. (l-es) Incr. Food Reserves -170 -90

3. Program Coste 182 2861. Operating 1502. Overbhds sad Killing 32

VIII. DEnT SERVICE 862 (9.8) 769 (L 8)A. Domestic 375 257

1. Principal 329 3292. Interest (net) 46 -72

B. Foreign 487 5121. Deferred Psyment Food Imports 130 1142. Other Principal 203 1993. Other Interest 154 199

Errore and Omissions 2 4

TOTAL USES 8,802 (100.0) 8.778 (100.0)

L& For easier comparability with original Bangladesh budget date, this table is presented inCrores of Taka. 1 Crore - 10 million.

Lk Source: fB85 Budget Summary Statemets, Ministry of Finance.Lt Staff estimates, March 1985.

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2.49 The proposed format of presenting an overview budget as set out inTable 2,10 is meant to complement rather than substitute for the currentofficial presentation, which is designed to conform to the legal requirementsof the Bangladesh Constitution as well as to agreements with foreign donorswith respect to the notional allocation of counterpart funds generated bysome components of food and commodity aid. The consolidation, simplificationand rearrangement of budget entries is designed to facilitate a policy-orientecl analysis of budget aggregates. It is derived wholly from datacontained in GOB's official budget presentation. On the revenue side, itshows tnat aid disbursements, as budgeted, would account for 44% of totalresources; the remaining 56% is made up of General Revenues (37%, of whichhalf are taxes related to imports), food revenues (12%) and borrowing (6%).In the expenditure column, investment (including parts of the ADP) accountsfor 50% of the total. If the amount budgeted for investment in new projects(4.4 billion Taka) is compared with the allocation for salaries and otheroperational expenses in support to economic sectors (0.26 billion Taka), itdemonstrates that major investment in infrastructure and other facilitiesthat have been made in the past have subsequently been allowed to deterioratefor lack of maintenance or have been inefficiently utilized because of inade-quate funding of operations.

2.50 The overview presentation would also prove useful for assessing themacro-economic impact of changes in the food situation. The volatility ofthe Government's foodgrain operations and the nature of its sources and usesof funds suggests that even with most careful planning substantial deviationsfrom budget estimates may be expected to occur during most fiscal years. Forexample, the right-hand column of Table 2.10 shows clearly increased borrow-ing requirements which have been made necessary by the emergency food importsduring FY85, in comparison with the original budget estimates. It also showsthe consequent increases in total expenditures for food which largely offsetthe reduced estimates for investment due to a lower than expected pace ofproject implementation.

2.51 Domestic Resource Mobilization in the Public Sector: Although thetax/GDP ratio has been raised from only 4.4% in FY75 to 9.5% in FY84, it isstill one of the lowest in the world. The structure of the economy and thelow average per capita income set limits both for the scope of an increase indomestic public resource mobilization and also for the pace at which such anincrease can be realized. Nevertheless, increased efforts are necessary tobroaden the domestic revenue base if the country's overwhelming dependence onforeign aid is to be reduced, which not only provides for capital goods forpublic sector projects but also for local currency through the generation ofcounterpart funds from the sale of aid-financed commodities. Moreover, thelow level of public domestic resource mobilization severeLy limits theavailability of adequate funds for operation and maintenance of existingcapital assets and services. The need for and the possibLe scope forimprovement in domestic resource mobilization is discussed further in theanalysis of medium-term prospects for the period of the forthcoming ThirdFive-Year Plan in Chapter 7.

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Chapter 3: RECENT DEVELOPMENTS IN AGRICULTURE AND THE FOODGRAIN SITUATION

3.01 Foodgrain production in both FY84 and FY85 was adversely affected bya series of floods. Three successive rice crops were severely damagedresulting in total losses estimated at around 1.5 million tons. As a resultof higher yields in areas and crops not affected by the floods, there was amodest net increase in aggregate foodgrain production. However, the lossesnecessitated record levels of foodgrain imports for FY85.

3.02 Rising foodgrain prices, high offtake from the Public FoodgrainDistribution System (PFDS) and the consequent declines in public stock causedserious difficulties for foodgrain management from early 1984, even beforethe first floods. The situation became an emergency with the onset of floodsin May 1984. The danger of a famine was averted and the rise in foodgrainprices were contained only as a result of a prompt and effective Governmentresponse in terms of contracting over one million tons of commercial grainimports and undertaking large-scale public food distribution and reliefoperations in the critical period before domestic foodgrain supply improvedfollowing the beginning of the Aman harvest.

3.03 The most immediate issues facing the Government in the aftermath ofthe floods are to maintain adequate management of the foodgrai. situation;including a need to rebuild public stocks; to reduce avoidable pressures onlimited public stocks by raising ration issue prices; to respond quicklythrough open-market operations to prevent any re-emergence of high foodgrainprices; to pursue more prudent macro-economic policies to contain inflation-ary pressure on foodgrain prices; and finally, to monitor the nutritionstatus and maintain relief operations for vulnerable groups worst affected bythe floods. A special effort by aid donors to replenish public food stocksis warranted because the Government has practically exhausted its limitedforeign exchange resources in contracting sizable commercial grain imports inFY85.

3.04 A second set of urgent issues concerns the supply of agriculturalinputs and credit. The distribution and use of minor irrigation equipment,fertilizers and credit increased significantly in FY84 and FY85. However, a.lackening of pace of irrigation development, serious shortage of fertilizerscombined with continuing subsidies on fertilizer sales and an unsustainableexpansion in agricultural credit are posing serious difficulties. TheGovernment will need to take some immediate measures to improve the implemen-tation of irrigation projects, to increase the availability of fertilizersand to curb an excessive growth of outstanding agricultural credit byvigorous collection of agricultural loans. In addition to attending to thesepressing problems, GOB will also need to address issues relating to thelonger-term prospects for agriculture; as stressed repeatedly in this report,a sustained, rapid development of this sector is fundamental to any hopes forthe gradual reduction of poverty in Bangladesh. The final section of this

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chapter returns to outline a number of medium-term issues, following adescription of recent developments.

A. FOODGRAIN PRODUCTION

3.05 The events of the past two years have again illustrated the vul-nerability of Bangladesh agriculture to natural disasters, but they have alsoshown evidence of a greater resilience than in past years of seriousflooding. The improved resilience of aggregate foodgrain production wasreflected by increases in production estimated at 2.82 for FY84 and close to2% for FY85, despite the very adverse weather conditions in both of theseyears. These results have been due to the considerable success in diver-sification from rice to wiheat, the expansion of irrigation facilities allow-ing a major increase in the irrigated boro rice crop, and the intensificationstrategy which has been followed over the past few years Leading to a sig-nificant increase in yields. The increased availability of fertilizer,expanded HYV acreage, and the expansion of agricultural credit facilitieshave played important roles. However, the experience of the past few yearsalso points to the remaining, albeit reduced, vulnerability of aggregatefoodgrain production to weather conditions: it has not yet proven possibleto achieve a sustained and stable high rate of growth. The average rate ofgrowth in foodgrains production over the six-year period between FY79 andFY85 has been about 3.3Z p.a., which is only sLightly above the rate ofgrowth in population. It will be necessary, and should be possible, to raisethe rate of growth to 4.0% p.a. if sufficient progress towards foodgrainself-sufficiency, and improved rural incomes, empLoyment and nutrition objec-tives is to be achieved over Zhe next few years.

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Table 3.1 RUMDS IN AGRICDLTRLAL PRODUCTION AND VALUE ADDED, 1Y79-FY85

Estimated ProjectedFn79 FY80 FY81 FY82 FY83 FY84 FY85

A. Production ('000 ton', unless indicated otherwise)

Foodgrains 13,081 13.400 14.790 14,419 15,118 15,536 15,824Rice 12,543 12.539 13,663 13,415 13,931 14,282 14.450-Anu (3.88) (2,809) (3,237) (3,218) (3,018) (3,171) (2.740)-bAn (7,326) (7,303) (7,837) (7,095) (7,483) (7.811) (7,950)-Boro (1.929) (2.427) (2,589) (3.102) (3,490) (3.295) (3.760)Wheat 486 810 1,075 952 1,078 1,195 1,320Others 52 5., 52 52 50 54 54

Jute ('000 bales) 6,442 5,963 4,943 4,648 4,881 5,216 4,573Cotton (t000 bales) 7 6 10 24 36 46 35Pulses 225 224 218 214 210 205 215Oilseeds 265 246 247 252 249 267 265Sugarcane 6.828 6,340 6,495 7.023 7,242 6,960 6,700Potatoes 895 930 983 1,067 1,131 1,166 1,100Sweet potatoes 782 779 693 681 702 713 740Tea (mill. lbs.) 84 81 88 85 90 93 100Tobacco (mill. lbs.) 52 50 105 100

B. Value added. in constant prices of FY73 (million Taka)

Crops 26,941 26,841 28,481 28,050 29,032 29,670 30,085Livestock 3.308 3,392 3,477 3,680 3,767 3,777 3,872Forestry 1,520 1.579 1,703 1,882 1,925 1,946 1,986Fisheries 2,103 2.097 2,101 2,120 2,258 2,323 2.393Total Agriculture 33.872 33.909 35.762 35.732 36.892 37.716 38.336

Real Growth in Value Added (Z p.a.)

Crops 1.8 -0.4 6.1 -1.5 3.5 2.2 1.4Livestock 4.5 2.5 2.5 5.8 2.4 0.3 2.5Forestry 2.0 3.9 7.9 10.5 2.3 1.1 2.0Fisheries -27.8 -0.3 0.2 0.9 6.5 2.9 3.0Total Atriculture -0.4 0.1 5.5 -0.1 3.2 2.2 1.6

Agricultural Wages Deflated 100.G 90.5 115.0 105.8 95.9 95.5 95.0by wholesale rice pricesFT79=100

Source: Statistical Appendix, T&SV2s 2.2 and 7.6.

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3.06 The main factor contributing to growth in output during FY84 was asubstantial 6Z improvement in aus crop yields, an improved transplant amancrop where a production increase o' 6% was achieved through a 2Z increasein acreage and a 4Z increase in yields, and an excellent wheat crop whichincreased by about 11% as a result of improved yields. However, these gainswere partly offset by major flood losses of about 200,000 tons for the amancrop and about 330,000 tons for the boro crop. Floods caused by plentifullate rainfall in September/October affected the aman crop in primarily low-lying flood-prone land. This couLd normalLy be expected to be compensatedfor by berter yields in other areas but the actual reported overall yieldgain was relatively small, despite expanded HYV acreage and fertilizer use.The wheat crop, however, benefited from the late rainfall as well as from asharp increase in fertilizer ase. The severe drought in the periodFebruary-April increased irrigation requirements 'or the boro crop, butplanted acreage nevertheless expanded by about 4Z and fertilizer useincreased commensurately. The boro crop is usually insulated from floodloss; however, in 1984 the dry season following the drought spell was fol-lowed by unprecedented rainfall in May/June, which seriously damaged theripening boro crop in several major growing areas of the country. Withoutthe flood losses total foodgrain production may have reached 15.9 milliontons and growth in FY84 might have been close to 5%, compared to the 2.8%actually achieved.

3.07 The impact of lS-,A floods were partirularly serious because threeseparate inundations occurred in rapid succession, damaging successive ricecrops at the worst time: the May floods affected the eastern regions and theboro and aus crops, the June-July floods caused dAmage primarily to the ausand broadcast aman crops along the banks of the major river systems and,finally, the September floods caused severe damage to the transplant amancrops in the north-west and elsewhere. The May floods were flash floodsresulting from excessive rainfall, the June-July floods were a combination ofconcentrated rainfall and river flooding, while the September floods were acombination of abundant rainfall and overflow of river waters already at highlevels. The total crop loses caused by the floods in 1984 are estimated tobe about 1.5 million tons, which is comparable to the total crop losses inthe most severe past flood and famine year of 1974.

3.08 The aus and broadcast aman crops are normally flood-prone and theFY85 losses due to floods for the two crops were severe. Aus production isestimated at about 2.75 million toas as a result of Liood losses of about107 (just under 300 thousand tons) of the planted crop, and broadcast amanproduction is estimated to be only 1.1 million tons as a result of floodlosses of about nearly 30% of the planted crop (or about 400 thousand tons).The transplant ..man crop is usually insulated from major flood losses, butvery high losses of about 8% of the planted crop (or about 450 thousand tons)were caused by the unusual severity of the September floods. Nevertheless,owing to a significant 18% improvement in yields on non-flooded acreage, thetotal transplant anan crop in FY85 is estimated to have increased by about10% over FY84 levels to reach approximately 6.9 million tons. It is not

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unusual in flood years for transplant amen average yields to improve sig-nificantly since the increased rainfall can benefit higher elevated lands;moreover, total fertilizer use for the FY85 aman crop is estimated to haveincreased by about 12.5Z over FY84 level which was, in turn, about 18Z higherthan in FY83. Finally, the proportion of HYV acreage is reported to haveincreased significantly from 23Z in FY84 to about 27Z in FY85. Because ofthe improvement in the transplant aman yields, the total 1984 aman productionis estimated at between 7.9 and 8.0 million tons, which is slightly higherthan in FY84. The acreage and yields for the FY85 wheat crco are alsoexpected to increase significantly because of the good planting conditionsand it should be possible to reach 1.3 million tons of production, Theirrigation facilities in place should also allow a high level of boro acreageand FY85 production is forecast to be over 3.7 million tons. Total foodgrainProduction in FY85 may, therefore, increase to about 15.8 million tons, orabout 1.9Z higher than in FY84, despite the major crop losses due to floods.

B. AVAILABILITY OF FOODGRAINS

3.09 The Government faced a difficult situation in the latter part of FY84following a modest aman harvest, rising foodgrain prices and low levels ofpublic stocks. The situation developed into an emergency by the beginning ofFY85 as the extent of the flood damage became known. The response to thecrisis was quick and effective and a potential disaster was averted by theanticipation shown by the Government in contracting substantial foodgrainimports using its own resources early in FY85 to allow it to mount a large-scale foodgrain distribution and relief effort. The foodgrain operationswere successful in containing a rapid rise in foodgrain prices and channelingrelief supplies to the flood-affected population. Although the extent of the1984 floods has been comparable to that in 1974, the most obvious signs ofdistress and famine conditions prevalent ten years ago were not evident in1984. With some improvement in the overall availability of foodgrains, themain task facing the Government in 1985 is to maintain needed relief opera-tions in flood-affected areas, to replenish public stocks to more tolerablelevels, and to prevent any re-emergence of high foodgrain prices. With itsown financial resources severely stretched by the expanded foodgrain opera-tions in 1984 the need for increased food aid in the remainder of FY85 andthe first half of FY86 is clear.

3.10 The increases in foodgrain prices from January 1984 were caused by acombination of several factors: rapid growth in money supply In rural areas,a modest aman crop, higher levels of stockholdings on farms and by traders,and higher levels of consumption.l/ These rising foodgrain prices causeddifficulties for the Government, but did signal early in 1984 the need for

1/ Rice and wheat prices in January 1984 were about 9% and 6% higher,respectively, and by April 1984 were about 132 and 8% higher than thecorresponding prices in the previous year.

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replenishment of public stocks which had been very low during the precedingtwo years. With market prices well above procurement prices (except forwheat) the prospects for significant domestic procurement were poor and, inFebruary 1984, the Government initiated plans for the import of sizableadditional foodgrains from its own resources. Domestic procurement of wheatin FY84 turned out to be somewhat better than earlier expected, but totalprocurement of 267,000 tons remained well below the original FY84 Budgettarget of 700,000 tons. Consequently, it was not sufficient to replenishpublic stocks, especially with higher offtake of grains from public stocksbeginning in April 1984.

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Table 3.2: FOODGRAIN PRICES AND PROCUREMINT, FY8O-85

Ration Miinima Open Growers Price of Procurement Price Differe~ncePrice Market Price Paddy and Wheat Prices (1-2)(T/d (CmI.d) (Tkhhad)(1) MTIM052) (Tk/ad)

RiLce iWhet Rice Wheat ~Amn Dr Boro Wheat /b4.sLr_ bos At Boro !kat(Nov-Jan) 'Mar-May)

FY80 120 90 183 117 1321 124 105 110 110 110 21 14 -5FY81 140 110 158 107 105 100 96 115 115 115 -10 -LS -19FY82 165 120 202 150 132 136 135 124 124 124 8 1.2 11FY83 205 140 228 144 158 144 130 134 134 135 24 10 -4FY84 225 150 243 154 163 154 139 144 144 144 19 12 -5FT 85 &a 268Lc. n.e.Ld 284 165 188 190 149 165L!. 165 162 23 15 -13

Procurement Volume('OOG tons rice eau ivalent)

Ama* Boro Wheat Aux Total Lf

FY80 175 49 124 - 348FY81 501 252 176 88 1, 017FY9 2 117 148 13 20 298FYf83 93 74 24 1 192FY84 84 51 127 5 267FY85 Lat 24 26 98

La Etimated.Lb 90Z of miinim,. retail price of wheat.fc Effective from December 31, 1984.Li No increase in the ration price of wheat for FY85 was announced up to the time of publication.Lt Procureumet prices for paddy were raised to Tk 1651md in mid-November 1984 and to Tk 1751md

in selected districts from February 1985. In those districts the procurement price forrice was also raised to T1 2631md.

Li In rice equivalent.

Sou-rces: World Food Programme, Dba2ka; Bangladesh Bureau of Statistics; Ministry of Food; andmission estimates.

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3.11 The May floods increased the urgency of replenishing public stocksand in early June the Government contracted for the commercial import of465,000 tons of rice to arrive early in FY85. With new flooding in June andJuly and severe actual and projected losses from the 1984 boro, aus and amancrops, it became clear that a crisis was looming. With very high levels ofpublic food distribution, even with the expected arrival of commercialimports, public food stock levels were projected to be irsufficient to main-tain public foodgrain operations at expanded levels or for extended reliefoperations beyond December 1984. Projected food aid receipts during the yearwere also insufficient to fill the gap between expected offtake andavailability of public stocks. The Government convened a donors meeting andissued an appeal for increased food aid in August. Because of the limitedaid response and further serious flooding in mid-September, the Governmentcontracted for additional foodgrain imports of 65,000 tons of rice and610,000 tons of wheat on commercial terms (cash and deferred payment). Totalfoodgrain imports contracted commercially by early FY85 thus amounted toabout 1.1 million tons; these imports were essential in order for theGovernment to be able to mount a quick and effective food distribution andrelief effort in the latter part of FY84 and the first few critical months ofFY85, when the impact of the floods was most serious. Of total importarrivals of 1.2 million tons during the critical lean season periodJuly-November 1984, aid shipments were only 300,000 tons. During the sameperiod the Government distributed about 1.3 million tons of foodgrains, ineffect running its food operations by matching the offtake of public grainswith import arrivals, and by reducing the monthly level of stocks to a bareminimum of about 600,000 tons (see Tables 3.3 and 3.4).

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Table 3.3: NONILY CEREAL STOK FLW (July 1984-June 1985)('000 metric tone)

Actual Proiectedklz. A4ugst Sept. Ocy tow. IlitS. ia_. Deh -Mhrc. Arl c.a Josn e Tult

pis,Bet. opening stock 90 100 206 208 228 244 257 284 310 386 325 274Da. procuresent 3 0 0 0 3 11 12 15 5 0 0 0 50Arrivals 50 160 69 67 57 44 52 47 116 0 0 0 661Offtake 41 53 64 45 41 38 34 33 41 55 47 33 525Tentative loe 1 1 3 3 3 3 3 4 4 5 4 4 39Est. closing stock 100 206 208 228 244- 257 284 310 386 325 274 237

WbeatRut. opening stock 710 653 465 333 372 506 54 560 574 458 552 666

Do_ procurement 3 0 0 0 0 0 0 0 5 50 30 10 93Arrivals 132 25 102 285 260 243 241 240 95 185 196 123 2.226Offtake 182 205 227 241 221 198 218 219 208 135 105 98 2,257Tentative lou 9 9 6 4 5 7 7 7 8 6 7 9 85get. closing stock 653 465 333 372 506 544 560 574 458 552 666 692

Totalget. opening stock 800 754 670 541 600 750 801 885 885 844 875 939Do proureuat 6 0 0 0 3 11 12 15 10 50 30 10 143Arrivals 182 185 171 352 417 287 293 287 211 185 196 123 2,887Offtake 223 258 291 286 262 236 251 251 249 190 152 131 2,782Tentatie lome 11 10 9 8 8 10 11 11 19 14 11 13 124let. closing stock 754 670 541 600 750 801 845 885 844 875 939 929

Source: World Food Program, Dhaka.

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Table 3.4: ACTUAL AMD PInOJCTED ARRIVAL OF FOODGRIXI SHIKNTS (JOul 1. 194S-Jun. 30. 1985)(azpreamed in metric tLoa)

Actual Proiected Totalsjgt Augs Set. Oct. llo Rr.L JDecrh. J 1rch Drxil 14w June (WOO0)

ginCbins 5. Oe 5Japsn (KR) 16.536 30,464 47LSA rL 480 III 11.383 67,000 78GOB Co.. (Borma) 3.869 16.650 13.345 4,017 3.027 41Go Ceo. (China) 14.300 30,240 20.125 65GOB Cm. (Thai) 45.772 143.166 55.300 63.173 23.200 13.700 32007 30.610 L09 425

Subtotal 49,641 159.816 68.645 67.190 57.110 43,940 52.135 47,146 115.554 661

1%tAustralia 55,000 55Canada 87.349 24.742 31,500 100.00o 100.000 344IIEC 129, ,70 130France 14.033 14MIC 20.000 O.0DOO 40lletherludmi 26,968 27Sadi Arabia 31,770 18.230 50Onited Kingdom 24.000 24USA 2480 1! 70,000 20,000 90

U PL 480 III 64.639 91,691 75,000 60,000 59.000 370WFF 30.536 6,600 161,946 16,241 35. 521 77.920 26.000 2.632 357W.S 2,500 3COB Cam. (USICred.) 69,065 107.267 166,104 68,650 102.404 513

GCM Com (AAaat.Cred.) 26,249 78.250 104GOB Cam. (cash) 3_ 9.636 _ __ _ _ 100

Subtotal 131.918 24.742 101,914 285.153 359.820 242.760 241,3S1 239.893 91,500 183.420 196,000 122,632 2,221

GRA! TOTAL t 0c) 182 185 171 352 417 287 293 287 207 183 196 123 2,82

Source: alrld Food Progrine, Dhaka.

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3.12 During the period from May to November 1984, the average level ofmonthly public distribution of foodgrains rose from the previous year's levelof about 140,000 tons to about 230,000 tons. Of this increase, nearly 40Zwas accounted for by relief distribution, amounting to about 60,000 tons permonth, compared to more typical recent levels of about 20,000 tons per month.The success of the food distribution effort was reflected by the relativelymodest increases in food prices during this period, despite the severity ofcrop losses (see Table 3.5). Prices are expected to decline from November toJanuary period as the aman harvest comes into the market, but there may be aseasonal increase in prices during February-April. Two additional factorsmay contribute to an acceleration in food prices after January: firstly,although good wheat and boro crops are forecast, it will take major gains inproduction to reverse the upward trend in prices; and secondly, inflationarypressures in the economy can be expected to persist for the same time (seeChapter 2). In view of the already high level of foodgrain prices it willnot only be extremely important to pursue more prudent monetary and creditpolicies, but also to respond quickly with available food policy instruments(including increased food distribution through open-market operations) in theevent of a re-emergence of any sharp upward movement of foodgrain policies.The experience during early 1984, when foodgrain prices increased despite agood aman crop, shows that it can be extremely costly to delay appropriateresponses to such a situation. Procurement prices of rice and wheat wereincreased by 10% and 14% respectively in early-FY85. The ration issue priceof rice was adjusted upward in mid-FY85, but wheat issue prices have not beenadjusted since the end of 1983. With rising market prices, the subsidyelement of ration issue prices of rice and wheat increased during 1984,contributing to higher offtake and pressure on public stocks.

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Table 3.5: INDEX OF MINIMUM MARKET PRICE FOR COARSE RICE, FY8O-84(in FY81 prices, FY81l100) a

InstabilityAnnual Index of

Instability Jb Real Rice PriceAverate July-Oct. Nov.-Jan. Feb.-A2ril May-June Index FY8O-84

FY80 136.7 154.1 131.7 138.2 122.8 6.8% aFY81 100.0 101.6 95.4 101.3 101.6 7.2% IFY82 111.5 95.4 104.6 135.0 111.4 17.47 U 13.52FY83 108.6 111.9 107.8 110.1 104.5 5.42 1

FY84 107.1 105.4 1C7.2 115.7 113.9 6.62FY85 118.0 /c 117.5 115.7 c 123.3 /c 115.4 /c 5.7Z /c I

la Minimum market prices deflated by a non-food consumer price index; minimum market pricesare the lowest market price quotations of retail prices of coarse rice.

/b Coefficient of variation of non-deflated monthly minimum market prices./c Estimated.

Source: World Food Pregramme, Dhaka; Ninistzy of Food; mission estimates.

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3.13 The relative absence of severe distress conditions that have accomr-panied comparable floods in previous years, such as a sharp decline inagricultural wage-rates, distress land or other asset (livestock) sales,labor-migration and starvation deaths, may mask some less obvious, butserious effects of flood disaster in flood affected areas where rapid declinein nutrition levels and health of particularly vulnerable groups haveoccurred. It will be critical for the Government to maintain relief effortsfor these groups through the end of FY85; even though overall foodavailability will have improved, as measured by total grain production orsupply, profound income losses sustained by certain regions and groups willrequire exceptional efforts on the part of Government to devise and implementrelief operations that reach such regions and population groups. The gain inaman and in wheat and boro crop production in FY85 will only partiallymoderate the severity of the probLem in the worst-affected areas.

3.14 The noteworthy factors contributing to the effectiveness of theGovernment's food distribution and relief efforts in FY85 were(i) significant additions to public storage capacity in local distributioncenters (LSDs) over the past few years; (ii) local transport improvementsthrough road, bridges and ferry construction programs; (iii) improvements inmanagement, information, organization and logistical capacity of the FoodMinistry; (iv) effective coordination of food operations between differentministries and line agencies (food, agriculture and reLief and UpazilaAdministration) and (v) better targeting of relief operations using a quan-titative irdex of flood damage in different areas.

3.15 One factor which hampered relief operations in FY85 was the absenceof information on the nutrition status of different groups of the populationand on the effectiveness of relief operations in reaching vulnerable groups.The Government's agencies involved in relief and nutrition should be givengreater responsibility in future for continuous monitoring of the nutritionstatus of vulnerable groups and the effectiveness of relief and nutritionprograms in the country.

3.16 Another area of concern for the Covernment will be to rebuild publicfood stocks to more tolerabLe levels by end FY85 and early FY86. Table 3.6provides an assessment of the foodgrain availability, and publicdistribution, stocks and import requirements in FY85 and FY86. Domesticprocurement of foodgrains in FY85 is unlikely to exceed 200,000 tons becauseof expected high market prices. With record levels of public distributionmatched to some extent by a very high level of commercial imports as well asa modest increase in aid shipments, year-end stocks are expected to increaseto about 930,000 tons in FY85. However, this level of stocks could be rundown again in early FY86 to very low levels in the absence of substantialfood imports in early FY86, even assuming a significant increase in domesticproduction and procurement of grains and a relatively low level of totalpublic grain distribution. Since Bangladesh has practically exhausted itsown resources for the commercial import of foodgrains it will be essentialfor aid donors to mount a special effort in FY86 to replenish public stocklevels which have been run down in the aftermath of the floods. It is there-fore recommended that about 1.7 million tons of food aid should be madeavailable in FY86 to bring year-end stock levels to at least 1.25 milliontons (see Table 3.6).

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Table 3.6: SUMMARY OF THE FOODGCAI SITUATION, FY79-FY86(in '000 tons)

ProieccedFY79 FY80 FY 8 FY82 FY83 FY84 FY 85 FY86

Domestic production, gross 13,029 13,349 14,738 14,367 15,068 15,482 15,770 16,700Domestic production, net /a 11,726 12,014 13,264 12,930 13,561 13,934 14,193 15,030Domestic supply net /b 11,785 11,822 13,172 12,814 13,433 13,964 14,161 14,956

Government operations

Opening stocks 591 209 779 1,229 625 630 800 929Domestic procurement 355 348 1,017 298 192 267 148 323Imports 1,146 2,739 1,059 1,236 1,844 2,057 2,887 2,248

-own resources 21 800 260 100 700 569 1,235 548-aided 1,125 1,939 799 1,136 1,144 1,488 1,652 1,700

Total distribution 1,796 2,402 1,522 2,036 1,935 2,051 2,782 2,145Statutory rationing (417) (492) (343) (307) (307) (294) } }

Priority groups (754) (907) (601) (656) (647) (641) }(1,676) }(1,240)Modified rationing (312) (385) (179) (483) (368) (398) } }Belief (45) (57) (50) (70) (84) (120) (357) (150)Food-for-Work (216) (440) (349) (365) (411) (441) (494) (500)Market sales ic (52) (121) ( . ) (154) (118) (156) (255) (255)

Losses 87 115 104 80 96 103 124 105Exports - - - 20 - - - -

Closing stocks 209 779 1,229 625 630 800 929 1,250

Total availability /d 13,227 13,876 13,677 14,552 15,176 15,748 16,795 16,778

Per capita LeAvailability (ounces per day) 15.30 15.50 14.93 15.49 15.74 15.88 16.37 15.70

Per capita ke LfAvailability excludingPublic foodgraindistribution (ounces per day) 13.24 12.82 13.27 13.32 13.73 13.79 13.66 13.69

la Gross production minus 101 for seed, feed and waste./b Adjusted for crop cycle overlap with fiscal years./t Includes open market sales, marketing operations and free sales.id Domestic net supply minus government procurement plus public distribution./e Including increases/decreases in private stock holdings.Lf Net domestic supply minus public procurement.

Source: Ministry of Food; World Food Prograzne, Dhaka; and mission estimates.

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3.17 The experience of the 1984 floods and foodgrain operationsunderlines, yet again, the need to have adequate public stocks of foodgrains(a) to maintain and operate the public foodgrains distribution system undernormal circumstances and (b) to cope with any unexpected shortfalls in theavailability of foodgrains as a result of severe floods, droughts or otheremergencies which occur frequently in Bangladesh.

3.18 The requirement of minimum operational stocks can be asstmed to beabout 600,000 tons on July 1 (and a somewhat smaller amount of about 500,000tons on November 1), based on the experience of the 1984 and previous yearswhen the run-down of operational stocks below or near these levels imposedserious risks in operating the food distribution system. The requirement ofsuch a level of operational stocks is dictated by the fact that about 200,000tons of stocks in the system represent 'dead' stocks or stocks scattered orin transit to widely dispersed storage points throughout the country. Inaddition, there is a stock requirement of at least two month of normal dis-tribution levels, of about 180,000 tons per month during the main lean seasonperiod of July-October and 130,000 tons per month between November andFebruary, which are necessary to maintain food distribution for that period.This requirement of minimum operational stocks assumes that normal monthlyfood import arrivals (or domestic procurement) are known in advance with somecertainty and will cover operational requirements beyond two months. As theexperience of 1984 shows, with monthly operating stocks falling to about600,000 tons, close to 400,0uO tons were in transit or in storage at localdistribution points, leaving only about 200,000 tons of stocks readily avail-able to cope with any disruption of the pipeline of food supplies from portsto in-country distribution points. The pipeline was thus thinly stretchedand given the high risk of disruption of supplies in Bangladesh during theJuly to November period because of possible occurrences of flash floods andtyphoon, an actual disruption might have had far-reaching consequence for theability of the system to maintain supplies during those critical months of1984.

3.19 Given the inadequate level of in-country stocks, an adequate pipelineof food supplies from import arrivals to in-country distribution was onlyfeasible in 1984 because of the early decisions to import foodgrainscommercially, backed by the availability of foreign exchange reserves. Itcannot be assumed readily that foreign exchange reserves will be alwaysavailable at the right time. Secondly, the response of food aid donors tothe foodgrain crisis was slow and relatively limited, even when the extent ofsevere flood damages became known. Thirdly, although early decisions oncommerciaL foodgrain imports were taken by the Government, there was at leasta four month gap between initial import decisions and actual arrivals(between March and July, and September to January). An important lesson tobe learned from this experience is the necessity for maintaining minimumreserves of emergency food stocks to cope with unforeseeable crop failures orother disasters. The requirement of such emergency food stocks is estimatedto be at least 700,000 tons. This is based on the assumption that, evenunder the best of circumstances, there would be a four-month lag beLween

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increased requirement of foodgrain supplies to deal with serious shortages offood, and actual increased import arrivals. The estimate of the requiredsize of these emergency stocks assumes that the annual loss to the mainrain-fed crops can often be about 500,000 tons and may reach a level as highas one million tons in exceptional years. In these circumstances, such alevel of emergency food stocks would be sufficient to mount a monthly reliefdistribution of about 80,000 tons (compared to actual Itevel of about 60,000tons in the period July-Octobe- 1984) to meet the absolute minimum foodgrainrequirements for about 6% of the country's population, together withincreased requirements of the traditional foodgrains ration distribution ofabout 60,000 tons a month (compared to actual increase of about 58,000 tonsper month in the period July-November 198a inr.d increased open-market salesof about 30,000 tons a month (compared to a2ual increase of about 20,000tons a month in 1984) in order to contain rapid increases in market prices.1/

3.2u Therefore, from the point of view of futurr operations, theGovernment should aim to have in hand year-end total stocks of foodgrains ofat least 1.25 million tons, comprised of minimum operational stocks of about500,000-550,000 tons and emergency stocks of at least 700,000-750,000 tons.The availability of foreign exchange reserves to import food commercially atshort notice could substitute for a small part of this requirement, but it isa less effective guarantee against the risk of major supply disruption.Given the consistently difficult balance of payments situation of Bangladesh,and the fact that Bangladesh has shouldered the main brunt of the seriousfood crisis in 1984 by using its own resources, it will be important for aiddonors to increase food aid to the country to allow public foodgrain stocksto be rebuilt to more tolerable levels in FY86.

C. AGRICULTURAL INPUTS

3.21 As indicated in Table 3.7, the distribution and utilization of minorirrigation equipment and fertilizer and agricultural credit disbursementsincreased significantly in FY84. In addition, foodgrain procurement priceswere also increased to maintain remunerative output prices, and market pricesof foodgrain and non-foodgrain crops were considerably higher in FY84 than inthe previous year. In view of all these factors a significant outputresponse was expected. However, while average yields did improve, actualcrop production was below expectations, because of adverse weatherconditions.

1/ The assumed shares between the different categories of distribution arebased on the existing structure of :he PFDS; it should be possible toreduce the share of the traditional categories and increase those forrelief and open-market sales in the future (see Chapter 4, dealing withfood policy reform options).

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Table 3.7: PROVISION AND UTILIZATION OF AhICRCLTURAL INPUIS, Ff79-F 85

Estimated ProjectedFY79 1180 FY8 782 FY83 FY84 1185

WIPs fielded, ADC L/ 35,895 38,389 35.951 37,826 38,954 43,615 45.000STWs in operation. BADC lb 8.374 10,980 20.931 42.955 78,768 98,344 118.000STIs sold BSB (c mlative) 8.596 11,766 17.480 21.990 28.106 39.868 41, 000DTWs in operation. bADC 9,329 9,795 10.131 11.486 15.307 15,519 19.000

Acreage irrigated by BUD! ('Q00 ac.)... 117 285 324 342 481 691 854

Total acreage irrigated (W000 ac.)... 3,662 3,873 4.050 4.264 4,566 4,744 /c 5.058 /c- by modern methods ('000 ac.) 1.959 2,223 2,496 2,752 3,072 Ls 3,295 Lc 3,608 Li- by traditional methods (-000 ac.) 1.702 1,649 1,554 1.512 1,494 le 1,449 jc 1,450 Ic

Fertilizer sales (-000 tons) 742 827 875 829 968 1,129 1,300 Li

Agricultural short-term creditdisbursed (mill. Taka) 987 1,354 1.939 2,167 3.830 6.358 11.000 Lidisburmed (will. Taka) 1,720 2,689 3.467 4,034 6,242 9,953 15.000 le

Seed Distribution, by EADC (tons) 6.250 16,100 15.486 12,807 15,829 16,522- Paddy 1,458 2,316 1,560 1,905 2,624 2,626 ...- Wheat 4.792 13,784 13,926 10,902 13.196 13,897

.. . not availvJle

La Including Li's sold as well as rented..b Including STNs sold by both BADC and private suppliers.le Estimated.Ld Government projections.

Source: Statistical Appendix, Tables 6.6 ; 7.19-7.28, BADC, and issionestimates.

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3.22 The distribution and fielding of minor irrigation equipment in FY84showed considerable differences in performance between the different agenciesinvolved. Total STW saLes declined from the FY83 levels, but the number ofequipment fielded increased to about 140,000. Consistent with theGovernment's policy objective of reducing the public sector's role, BADC'ssales of STWs declined from about 19,000 in FY83 to only about 7,000 in FY84;this was in contrast to BKB's performance in doubling and the privatesector's performance in maintaining STW sales in FY84. BADC's sales of LLPswas maintained at about 12,000 maintained primarily as a result of sales ofold equipment, mainly of 2-cusec pumps, a considerable proportion of which islikely to find non-agricultural uses. The sales of old equipment havereduced the fielding of rental equipment, which the Government previouslyintended to complete by June 30, 1984. Because of slower than expectedprogress, the Government now expects to phase out .he rental program on LLPsby June 30, i985. However, in the case of DTWs where the public sector hasbeen assigned a continuing role, BADC's fieldings of DTWs also showed adecline from about 3,000 in FY83 to about 2,300 in FY84. BADC's poor perfor-mance in the distribution and fielding of DTWs during FY84 was mainly areflection of organizational and management problems.

3.23 Problems of lack of surface water facilities for expansion of LLPsales, over-exploitation of groundwater in certain districts, poor main-tenance and ccnsequent non-operation of pumps already in the field, andconsiderable under-utilization of equipment continue to be serious. Theseproblems need urgent attention, but not at the cost of further realization ofthe potential for irrigation, as has tended to be the case in FY84 and FY85when the efforts of the Government were directed towards the design andimposition of restrictive controls, rather than on the development of apositive strategy for expansion of minor irrigation potential. Controls havebeen imposed on the siting of equipment, imports of equipment have beenbanned, and there have been cumbersome procedures and delays in decisions.In GOB did not adjust equipment prices *f LLPs and STWs in the FY85 Budget toreflect increased costs, thus hindering effective private sector participa-tion in sales of equipment (LLPs). At the same time there was very littleeffort to revitalize the essential irrigation management program (IMP) toexpand coverage of irrigation equipment in place. These decisions are likelyto impose serious constraints on the agricultural sector's medium-termdevelopment potential.

3.24 The distribution of fertilizers has been reasonably well-managed inthe past few years, partly because of the greater reliance on private sectordistribution (at the retail level), and partly because of improvements indomestic production and supply of fertilizer. BADC's fertilizer distributionsystem at the wholesale level has also been well managed in recent years, incontrast to its performance in the distribution of minor irrigationequipment. However, in FY85 low stocks of fertilizer at primary distributionpoints, lack of timely fertilizer imports, and inability of BADC to liftfertilizer from available stocks at ports and factories because of 'lowfreight rates paid to private transport operators by BADC led to serious

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shortage of fertilizer availability. With high demand for fertilizer byfarmers, market prices of fertilizers rose to about 20% above officialwholesale prices of urea and 90% above official prices for TSP and MP in thelast few months of 1984.

3.25 The experience in FY85 confirms the relatively buoyant demand forfertilizer by farmers. Official wholesale prices of fertilizer were notadjusted in FY84 and with high market prices for all significant agriculturalproducts the off-take of fertilizer increased by about 17% in FY84 (seeTable 3.7). Fertilizer prices were increased by 10% in July 1984 and againby 7% in January 1985 to reduce the level of per unit economic fertilizersubsidy to about 17Z,ll but with increased output prices and a major increasein agricultural credit facilities, the off-take of fertilizer in the firstfew months of FY85 has further increased to be about 15% over the correspond-ing period in F.84. Because of scarcity of fertilizers, farmers were effec-tively paying unsubsidized prices for fertilizer, but the official wholesaleprice continued to be subsidized, with large budgetary losses to theGovernment. The foodgrain-fertilizer price ratio in Bangladesh continues tobe highly favorable compared to many other countries and to current andexpected long-term levels in the world market (see Table 3.8). Accordingly,there remains scope for the further reduction and elimination of fertilizersubsidies.

1/ Economic subsidy defined in relation to world market prices, using exportparity prices for urea and import parity prices for other fertilizers.

Table 3.8: Indices of Rice, Wheat, and Fertilizer Prices, VY79-85 (7Y79-100)

Domestic Prices World Parity Prices /aRation Procurement Market Prieoc fertilizer Paddy/ Wheat/ Paddyl wheat/Prices Prices Prices Urea Urea Ures Urea

Price Price Price Price-bar R wheatk lice Nuti Liknt Deot I lUrec R a" IU Bl ee Pin t RA h

7179 100.0 100.0 100.0 100.0 100.0 100.0 100.0 1.45 1.16 100,0 100.0 100.0 1.48 0.96

nY80 116.7 123.0 128.8 122.2 132.3 123.0 129.0 1.49 1.11 111.6 121.3 126.2 1,30 0.92

FY81 137.6 133.0 132.6 127.8 110.6 133.0 157,1 1.02 0.96 140.6 135.9 148.0 J.40 0.89

FY82 163.2 149.0 143.9 137.8 144.7 160.7 188.6 1.11 0.99 146.2 156.B 155.0 1,38 0.97

FT83 178.6 159.8 159.1 150.0 157.4 189.7 211,4 1.08 1.04 127.3 172.6 144.0 1.29 1.15

Y184 195.7 171.3 170.5 160.0 171.8 193.3 211,4 1.18 1.05 130.3 178.0 155.0 1.24 1.10

1185 223.0 171.3/b 187.9 183.3 197.7Is 211.3L/ 248.9 1.15Ln. 0.98L 128,8 Is. 187.0 Ls, 196.0 La 0.97 Lc 0.92 LIL

1Y86-90 Li to to to to to to 150.0 175.0 256.0 0.86 0,66

Annual Rateof Increace

FY79-85 13.5 11.8 11.1 10.6 12,_ 13.3 15. ., ., 6.4 11.0(K p.m.)

LL World market U. 8. Dollar current prices converted to Taka prices at ruling exchange ratet in each year.Lk Effective as of July 1984.1iL Projected ca of January 1985, in constant FY85 prices and exchante rates.

Source: Appendix Table. and World Bank comodity price projections.

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3.26 Agriculture credit disbursements increased sharply in FY84, fromTk 6.7 billion in FY83 to about Tk 10.0 billion, primarily as a result ofrapid growth in short-term agricultural credit. The growth in short-termagricultural credit, mainly for crop agriculture, has been about 77% in FY83and about 66Z in FY84. A further rapid increase is projected for FY85. Therate of increase in medium-term credit for irrigation in FY84 has been muchlower, related to the slow rate of increase in fieldings and sale of minorirrigation equipment. Term credit for other non-crop agriculture (e.g.fisheries) and services (marketing, transport and agro-industries) has,however, increased very rapidly. The very high rate of growth of short-termcredit is in part related to the increased use of inputs such as HYV seedsand fertilizers. However, since a major share of the increase in moderninput use is closely related to the expansion of irrigation facilities, itappears that the expansion in short-term agricultural credit is also due toits use by the Government as a major instrument to expand use of moderninputs in non-irrigated areas as well as to help farmers to adjust to higherprices of inputs. The main problem with this approach is that the economicprofitability of the use of such modern inputs to farmers in non-irrigatedareas should be the main criterion guiding the increased use of such inputs,rather than excessive reliance on the expedient of increasing theavailability of short-term credit. In order to address the problems ofnon-irrigated crop agriculture, much greater attention will have to be givento increasing the effectiveness of existing drainage and flood controlprojects which are known to be in need of rehabilitation, redirectingagricultural research efforts to deal with the problem of poor performance ofexisting rain-fed varieties, and finally, ensuring that the Government'sextension services reach the rain-fed farmers. Past efforts on agriculturaldevelopment have focussed largely on dry-season irrigated crops, with inade-quate attention paid to the problems of the main rain-fed crops.

3.27 As shown in Table 3.9 the very rapid increase in agriculturaL lendingover the past four years has been accompanied by a deteriorating level ofagricultural credit recoveries. With recoveries of past loans only amountingto about 42% of current dues plus arrears, the lending agencies have reliedheavily on agricultural refinance from Bangladesh Bank to maintain theirlending to the agricultural sector. The share of refinance in total agricul-tural lending in FY83 and FY81 has thus been over 60% (see Table 3.10). Eventhough the commercial banking system as a whole had liquidity well in excessof minimum requirements in FY84 it drew on increased refinance from thecentral bank to expand agricultural lending in FY84 as shown in Table 3.11.

3.28 There are two major policy issues confronting the Government.Firstly, it is highly doubtful whether the major increases in agriculturallending which took place in FY83 and FY84, could have all been channeledeffectively into productive uses. It is possible that a large proportion was

1/ Source: Bangladesh Bank, Agricultural Credit Department.

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either diverted to non-agricultural uses or to consumption expenditures;either of these possibilities will inevitably create problems for agriculturecredit recoveries in the future. Secondly, with deteriorating levels ofagricultural credit recoveries, the agricultural credit system can only besustained with increased levels of refinance from the central bank. However,increased levels of refinance will increasingly conflict with the centralbank's objective of maintaining stable growth in money supply consistent withoverall growth of the economy.

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Table 3.9: AGRIClULTURAL CREDIT RECOVERT PERFORMANCE BYIISTITUTION, FY81-84

Credit Recavery Rate Z

Banks Share in total 1980181 1981/82 1982183 1983/84lending (FY84)

NCBS /b 38.6 36.3 33.6 33.2 34.8I1n 58.8 67.8 67.8 49.6 49.8BSBL 2.6 29.5 29.0 39.4 23.5

TOTAL 100.0 48.9 48.5 41.9 41.8

/a Defined as actual recovery of principal and interest as percentageof annual 'dezand for recovery' (i.e. current dues plus arrears).

lb Average of 6 Nationalized Cmercial Banks.

Source: Bangladesh Bank.

Table 3.10: SHARE OF REFINANCE IN TOTAL AGRICULTUrAL LENDINGBY INSTITUTION, FY81-84

Share of Refinance (2)

Banks 1980/81 1981/82 1982/83 1983/84

NCS /a 24.2 24.5 65.3 58.9ff 67.6 46.7 64.6 63.6BSBL 92.3 94.0 97.4 80.1

TOTAL 53.9 41.7 66.0 62.2

/ Total of 6 Nationlized Commercial Banks.

Source: Bangladesh Bank.

Table 3.11: AGRICULTURAL CREDIT DISBURSEMENTS AND FIANCING, nY81-84

1980181 1981/82 1982/83 19832 84

Ag. Credit Disbursement ('000 mil.) 3,734 4,238 6,788 10,087

2 Increase 28.5 12.5 60.2 48.62 of Ag. GDP 3.4 3.5 5.0 7.0

Ratio Incremental Credit/Incremental 8.8 3.9 18.6 36.5Agricultural GDP

Source of Financing (2)- Recovery of credit - 52.2 46.3 33.9- Incremental refinance - 15.7 45.3 25.5- Own resources - 32.1 84 40.6

Own resources as Z of deposits - 40.0 4.3 18.1

Source: Bangladesh Bank

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3.29 The information available for the initial months of FY85 indicates afurther major increase in agricultural credit disbursements and a continueddeterioration in the Level of agricultural credit recoveries. To someextent, the agricultural credit system has been used to stabilize ruralincomes which had been adversely affected by recent floods so that agricul-tural lending was increased dramatically in the first few months of FY85. Inaddition, farmers who did not repay short-term loans taken in FY84 were madeeligible for fresh loans in FY85, repayment of loans for the boro, aus,broadcast aman and jute loans in 1984 were rescheduled by one year, andinterest payments on these loans were waived for one year because of thefloods. Total agricultural lending in the first few months of FY85 areestimated to have more than doubled that in the corresponding period of theprevious year. Some of the credit will have been used for productive pur-poses (replanting of crops cost to floods and increased use of fertilizers),but it is again possible that a significant proportion may have been used forconsumption purposes to make good the short-term income losses resulting fromflood damage.

3.30 Against this background of a continued deterioration of agricuLturalcredit recovery and rapid expansion in agricultural lending, the agriculturalcredit policy changes undertaken by the Government in the recent past, suchas increased levels of interest rates on agricultural lending and increasedinterest rates on central bank refinance for agricultural lending aredesirable, but ineffective in dealing with the major policy problems con-fronting the agricultural credit system. Alternative policy instruments,including quantitative controls on expansion of agricultural refinance andagricultural lending, linked to vigorous efforts to improve agriculturalcredit recovery performance for the different lending institutions couldbecome necessary if the financial situation of the credit institution isallowed to deteriorate further. One recent measure to improve the agricul-tural credit system is the decision taken by the Government to eliminate theSpecial Agricultural Credit Programme (SACP) which was backed by Governmentguarantees against non-recovery of loans. In addition, as part of itsefforts to reduce the rate of credit expansion, GOB is seeking a substantialrecovery of outstanding agricultural credit during the second half of FY85.It is hoped that this effort will be successful in reversing the past trendof deterioration evidenced by Tables 3.9 to 3.11.

D. THE JUTE SECTOR

3.31 Raw jute production was seriously affected by the 1984 floods. Thecrop losses due to floods are estimated to be about 1.0 million bales, orabout 18% of the expected crop in 1984, and the harvested crop for FY85 isestimated to be just over 4.6 million bales. The crop losses in India werealso severe and production was insufficient to i.;eet the demand in India. Inaddition to these unexpected crop losses, worldwide raw jute stocks werealready very low after having been run down over the past few years as aresult of low production levels in Bangladesh and other major producingcountries. Accordingly, raw jute prices which had already risen from

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$290/ton to $410/ton during FY84 accelerated dramatically in early FY85.Since June, export prices have risen to a level of over $800 per ton, repre-senting a more than 2401 increase over an eighteen month period. Such anincrease in prices is consistent with the short-fall in worldwide raw jutestocks and production in FY84 and FY85, combined with the low short-termprice elasticity of world demand which is estimated to be only around -0.2.

3.32 The rise in raw jute prices has caused serious difficulties for thejute mill sector in Bangladesh and for overseas buyers of raw jute. Jutegoods export prices have also increased over the past eighteen months, butthese price changes have been far less than the increase in raw jute prices.The main reason for the relatively modest increase in jute goods exportprices is the competition from synthetic products in major markets. Thedomestic jute mills are expected to incur sizable financial losses in FY85,mainly as a result of the very high raw jute prices, but also because of theadded difficulties caused by the wage increase awarded in May 1984. Thetotal financial losses of the jute mill sector in FY85 are expected to exceedTk 2.5 biLlion.

3.33 Apart from the problem of very large losses of the jute mill sector,the Government also faced serious difficulties in trying to balance thesupply requirements to maintain the production and exports of the mill sectorwhile bearing in mind the requirements of the export market. Overseas demandfor raw jute was high in early FY85 because of exceptional purchases byIndia, a jute produc:ing country which is not normally a large buyer of rawjute from Bangladesh. With low in-country stocks, in late 1984 theGovernment imposed a ceiling of about 1.5 million bales on raw jute exportsin FY85, compared to actual exports of 1.9 million bales in FY84: once theshortage of raw jute had eased, the ceiling on exports was removed at the endof February 1985. Because of increased purchases by India, the availabilityof raw jute for other buyers was severely reduced (Table 3.12). In the shortterm, despite lower export volumes of about 1.5 million bales of raw jute andabout 450,000 tons of jute goods, total export earnings from jute in FY85 areexpected to exceed $500 million, compared to about $470 million in FY84.

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Table 3.12: RAW JUTE SUPPLY AID DISPOSITION, FY79-FY85('000 bales)

ProjectedFY79 FY80 FY81 FY82 FY83 FY84 FY85

Opening stocks 692 2.332 4.220 3.253 1.852 1,350 956Production, total 6,520 6,035 4,985 4,686 4,920 5,256 4,612

- Jute (6,442) (5,963) (4,943) (4,646) (6,881) (5,216) 4,573- Mesta ( 88) ( 72) ( 42) ( 40) t 39) t 40) ( 39)

Adjustment /a 191 1,203 -202 -369 594 - -

Market arrivals 6.721 7.238 4.783 4.317 5.514 5.256 4.612

Total surnpl 7.413 9.570 9.003 7.570 7.366 6.606 5.568Kill consumption 2,809 2,982 3,356 3,346 3,320 3,328 3,300- BJMC mills (2,809) (2,864) (3,251) (3,191) (3,150) (1,859) (1,850)- Private mills ( ... ) ( 118) ( 105) C 155) ( 179) (1,469) (1,450)Other consumption 300 300 400 400 400 400 300Losses 5 100 50 62 50 20 15

Total domestic uses 3.144 3.382 3.806 3.808 3.770 3.748 3.615

Registered exports 1.968 1.968 1.944 1.911 2.246 1.902 1.400

Total disposition 5.082 5.350 5.750 5.719 6.016 5.650 5.015

Closing stocks 2.332 4.220 3.253 1.852 1.350 956 553

la Difference between estimated crop size and estimated market arrivals.

Source: Mission estimates.

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3.34 With high raw jute prices and also relatively high jute goods prices,there will inevitably be serious medium-to-longer term consequences for thecompetitiveness of jute vis-a-vis synthetics. The medium-term price elas-ticity of demand is about -0.5, which, although low, is significantly higherthan in the short term. The high raw jute prices are likely to prompt alarge supply response in 1985 from jute growers in major producing countries,including Bangladesh, which will moderate jute prices in FY86. It ispresently expected that the loss in markets for Bangladesh in FY84 and FY85as a result of high prices and low supplies of jute could be recouped,although a long-term erosion of the market share of jute cannot be ruled out.

E. MEDIUM-TERM AGRICULTURAL DEVELOPMENT ISSUES

3.35 The Government faces several major constraints in its efforts toaccelerate the pace of agricultural development over the next few years. Thetwo main priorities are to achieve a sustained rate of increase in foodgrainproduction well above that of population growth and to diversify agricultureinto sub-sectors with potential for efficient growth.

3.36 In the area of foodgrain production the most important contributionhas coma and will cont;nue to come from the growth in irrigated high-inputuse and high-yield dry season (boro) rice and wheat production.l/ About 85Zof the total increase in foodgrain production in the past five years(FY79-FY84) has originated from boro and wheat production, and only 15% fromthe main rainfed aman rice crop, while the production of the summer rice(aus) crop has been stagnant. The increase in irrigation facilities has beenthe main factor contributing to the accelerated rate of growth in foodgrainproduction of about 3.3% p.a. in the past five years, but increasing dif-ficulties are being encountered in sustaining the pace of irrigationdevelopment. These difficulties are partly the result or rapid exploitationof the reLatively easier modes of irrigation development, namely, shallowtubewell and low-lift pump irrigation. However, there remains considerablepotential for further development provided major difficulties in the effi-cient design and implementation of projects and programs in the irrigationsector are resolved. These problems include inadequate planning andorganization, slow decision-making, lack of financial resources, and finally,a failure to promote more efficient use of existing irrigation investment andfacilities. In the past five years an investment of about $500 million hasgenerated an increase in irrigated aci-ige which only about one half of thepotential increase in command area which is estimated at 2.8 million acres.The utilization of new capacity is thus estimated to have fallen to onlyabout 35Z in FY84, compared to about 75% in FY79. If the utilization ofexisting irrigation investment could be increased to at least 70%, an

1/ Rice is a relatively water-intensive crop and it may bear examinationwhether the growth potential from other cereals or crops may be greaterthan that from irrigated rice.

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increase in irrigated acreage of over 700,000 acres could be achieved. Newinvestment in irrigation facilities should also increase irrigated acreage byat least 250,000 acres annually. Thus, with the greater utilization ofexisting capacity and future planned investment in the irrigation sector, itshould be feasible to expand irrigated acreage by at least 1.5-2.0 millionacres over the next five years. This, in turn, would allow dry-seasonfoodgrain productien to increase by about 2.3-3.0 million tons, using pasttrends in the relationship expansion. However, in order to achieve thispotential, Gover-ment support services and institutions will need to berevitalized, expanded private sector participation sought, appropriate pric-ing policies followed with respect to water charges and minor irrigationequipment pricing and agricultural loans recovered in order to provide ade-quate resources for support services and planned investments as well as tofoster greater efficiency in the use of scarce water resources.

3.37 It should also be possible, and will be necessary, to raise thegrowth in aman and aus production to at least 2.0X p.a. Critical to thiseffort will be the redirection of agricultural research and extensionefforts, dissemination of knowledge on improved cultivation practices,increased use of HYVs and supplementary irrigation, propagation of new floodresistant varieties, and finally, increase in the effectiveness of existingand planned drainage and flood control schemes. Based on these aboveassumptions, it should be possible to raise the rate of growth in aggregatefoodgrains production to 4.0% p.a. in the period FY86-FY90, as follows: amanand aus production could be increased at 2.0: p.a., boro production at 8%p.a. and wheat production at 10% p.a.1/ These would be ambitious, butdesirable goals for the Third Five Year Plan period.

3.38 As regards the potential for non-foodgrain sectors, there are threemajor sets of constraints to agricultural diversification in Bangladesh.Firstly, as the experience of the past decade shows unless sustained growthin foodgrains production is achieved scarce land, water and investmentresources will continue to be diverted to the foodgrain sectors at theexpense of the non-foodgrain sectors, except in a few instances (potatoes,tobacco, shrimp-firming and leather sub-sectors). Thus, acreage under tradi-tional dry-season and pre-monsoon crops such as oilseeds, pulses, minor

1/ The base year (FY86) production level for these projections is assumedto be 16.7 million tons, in order to avoid the bias involved in choosinga low FY85 base, when production was affected by floods. These numbersare only indicative and will need much more careful evaluation on thebasis of a comprehensive study which should be undertaken in the nearfuture. IDA plans to undertake such a review in FY86. The MasterPlanning Organization (MPO) of the Bangladesh Water Development Boardis currently undertaking a careful assessment of the investment strategyin the water sector, under the UNDP-financed National Water Plan project;COB is also undertaking work in the context of the 3FYP.

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cereals as well as jute have been increasingly diverted to rice and wheatproduction. In addition, Government services and programs have been heavilyoriented towards the foodgrain sector and investment choices have been madeat the cost of non-foodgrain sectors. Thus, drainage and flood control andmajor irrigation projects have adversely affected traditional capturefisheries. Secondly, even where the economic and financial criteria shouldallow the growth of non-foodgrain crops and activities, pricinig and marketingpolicies and rrwnstraints have seriously limited growth in these activities.Thus, the growth and diversification into wheat production has been helped bythe public procurement system, whereas oilseeds have suffered in the pastfrom subsidized public distribution of imports. Turning to sub-sectors otherthan foodgrains, the growth achieved in recent years has been mainly in thenewer export-oriented activities, namely, tobacco, shrimp-farming andleather. Even in these export activities, marketing and supply constraintsare proving to be increasingly difficult. Finally, serious supply con-straints are evident in major non-foodgrain sub-sectors such as fisheries,livestock and forestry. The role of the public sector could tie essential inorder to alleviate these supply constraints and allow the private sector toplay an effective role, e.g., through the development of viable aquaculturefisheries by the private sector in inland public water bodies, social andcommercial forestry in public lands, and the promotion of improved animalhusbandry, and feed practices and veterinary services in the livestocksector. However, the capability of public sector institutions in thesesectors needs support and strengthening.

3.39 It is suggested, therefore, that the essential preconditions forsuccessful agricultural diversification are sustained and rapid growth infoodgrain production, an integrated approach to the development of theagriculture sector, and finally, adequate institutional capacity of publicsector agencies to plan, implement and develop viable non-foodgrainactivities. All these areas will need serious attention. In addition, thecritical role of the private sector and the potential tor exports or effi-cient import-substitution should be given priority because in most cases ofsuccessful diversification to date the main impetus has largely originatedfrom these sectors. Over the next few years diversification of agriculturewill assume increasing importance in order to Lay the basis for sustainedgrowth in incomes and employment in agriculture.

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Chapter 4: THE PUBLIC FOODGRAIN DISTRIBUTION SYSTEM

4.01 The experience of dealing with the 1984 floods has shown thedesirability of continuing the public food policy reforms of the past fewyears in order to enhance the effectiveness of the public foodgrain distribu-tion system (PFDS) in meeting its most essential objectives efficiently andequitably. The five major and inter-related longer-term objectives for themanagement of the PFDS are:

(i) to ensure an effective, adequate and stdble minimum 'floor'price to farmers through procurement pricing policy and domesticpurchasing operations;

(ii) to ensure an effective and stable maximum 'ceiling' price offoodgrains to both rural and urban consumers through the dis-tribution and sale of public foodgrains;

(iii) to reduce over time the level of food subsidies to the rela-tively better-off urban consumers and other protected groups;

(iv) to target an increasing share of total public foodgrain dis-tribution through various programs designed to reach the verypoor, who would face serious hardship in the absence of suchprograms: programs such as Food-for-Work could also generatesubstantial resources for investment in public works programs inagriculture and rural development; and

(v) to distribute emergency food relief to areas and populationsaffected by natural disasters such as floods and droughts.

A. PROCUREMENT POLICIES

4.02 Procurement prices have been adjusted regularly to provide producerincentives for increased agricultural production through an increasing use ofyield-increasing inputs and cultivation methods. At the same time, the focusof procurement operations has been shifted from that of ensuring adequatepublic stocks by setting targets for dom2stic procurement to one designed toguarantee minimum remunerative prices for producers. In keeping with thisobjective, the major improvements in policies over the past few years havebeen the announcement of procurement prices in advance of crop planting inorder to have maximum impact on farmers' decisinns. In some years (as inFY81) market prices remained well below procurement prices, but extensiveprocurement operations did protect floor prices to farmers to a reasonableextent. In other years market prices rose well above procurement prices andprocurement was very limited, yet the Government did not attempt to meetquantitative procurement targets by raising procurement prices or by imposingrestrictions on private grain trading. Instead, the Government's effortswere directed at expanding operations in surplus producing districts where

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prices may have fallen below floor prices as well as importing foodgrains tomaintain public stocks.

4.03 In the past few years, rising domestic foodgrain prices have causedincreasing difficulties for the Government. Domestic procurement has beenvery low and, for FY85, the Government has taken a decision to raise procure-ment prices substantially in line with domestic markJet prices. There are twomajor reasons why such a reaction could have adverse implications for futurefood policy. FirstLy, procurement prices sbould be floor prices whose levelsshould be related to medium-term trends in both domestic and external marketprices for foodgrains and to trends in production costs. Short-term marketprices, particularly for rice, are volatile, and such short-term fluctuationsdo not necessarily provide an adequate basis for setting procurement prices.

4.04 Secondly, and perhaps more significantly, if there is a marked diver-gence between trends in domestic market prices and trends in world prices forfoodgrains, then procurement pricing decisions would become very difficult.If procurement prices follow domestic market prices under thesecircumstances, wrong price signals could be provided to producers and undulyhigh prices charged to consumers. In the past few years, procurement priceshave generally been adjusted in line with domestic market grain prices, whichhave risen much faster than world market parity prices, particularly in thecase of rice, as shown in Table 3.8. It must be recognized that interna-tional rice prices have been low in recent years; however, the relative rapidincrease in domestic prices, despite the increased per capita produscion andavailability of foodgrains in Bangladesh over the past few years is a causefor concern. Part of the reason for the high domestic market prices offoodgrains must be attributable to the restricted ability of the Government'sPFDS to play an effective role in stabilizing market prices. However, someof the growth in foodgrain prices must also be attributed to factors outsidethe foodgrain cector; particularly to expansionary monetary policies whichare contributing to inherent inflationary pressures in the economy.Improvements in this area of macro-economic policy will be essential ifpublic pricing policies in the foodgrains sector are to be successful instabilizing producer and consumer prices of foodgrains.

B. PUBLIC FOODGRAIN DISTRIBUTION

4.05 A number of improvements have been made over the past few years inthe management of public foodgrain operations. These have led to a greaterdegree of stability in market prices, but structural problems continue toconstrain the scope for intervention in the market and the targeting of foodoperations to benefit a wide section of the country's population, par-ticularly the poor.

4.06 Public Stocks: The ability to intervene effectively in the market tostabilize prices is dependent on the availability of adequate public stocks.Over the past three years, public stocks (particularly rice stocks) have beenvery low. COB has arranged foodgrain imports to supplement food aid arrivals

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and to cope with unexpected shortfalls in domestic foodgrain availability,but imports have not been sufficient to maintain adequate public stocks. Dueto low stock Levels and to rigidities within the structure of publicfoodgrain distribution, the Government has been unable to expand thoseinstruments of public distribution, such as open-market sales, that are mosteffective in stabilizing the market prices of foodgrains.

4.07 The main constraint to importing sufficient grains to replenish andmaintain adequate public stocks in most years has been the tight balance ofpayments position. Since it is unlikely that this con;traint will bealleviated in the medium term, the Government will need to look for ways tomake its public foodgrain distribution system more effective in stabilizingmarket prices of foodgrains. At the same time, it could explore the pos-sibilities for negotiating more flexible multi-year agreements with fooddonors which could ensure increased food assiatance to maintain adequatepublic food stocks and distribution during periods when increased food dis-tribution is necessary for the effective stabilization of market prices,simultaneously with the need to increase relief distribution: periods ofaggregate food shortages and consequent high market prices usually coincidewith floods or other natural disasters.

4.08 The Government has made some improvements in the PFDS to shift itsfocus from that of providing subsidized foodgrains to the uirban and otherprotected sectors towards stabilizing market prices throughou. the year atlevels which are within the reach of the poor and are also consistent withthe objectives of providing adequate economic incentives to producers. Inkeeping with this o'jective, entitlements and quotas for some preferredgroups have been reduced and the shares of rice and wheat in t1he quotas have1-.en shifted in favor of lower cost and less highly subsidized wheat. Thesales prices of grains sold to preferred groups have also been increasedgradually to reduce the size of food subsidies to the relatively better-offconsumers as well as to reduce the spread between market prices and issueprices.'/ These chances have also made it possible for the Government toembark upon and expand open-market sales of foodgrains, particularly of rice.Food for work and other targeted food distribution programs for the poor havealso been significantly expanded. Despite these changes, the effectivenessof market price stabilization has been limited, since sales through theration system still pre-empt a significant Ehare of total distribution.

4.09 A large part of the distribution capacity of the PFDS in any givenyear is taken up by the provision of ration entitlements and allocations forpreferred groups. The main programs are statutory rationing (SR), and dis-tribution to essential and other priority groups .i'-). SR covers consumers

1/ A small but specific example of the continuing change in this directionis the recent decision of the Government to charge flour-mills marketprices of wheat sold to the mills from the PFDS.

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in six cities - Dhaka, Chittagong, Khulna, Narayanganj, Rajshahi, andRangamati. Eligible consumers (who are issued ration cards which entitlethem to draw weekly supplies from ration shops) are mainly governmentemployees since the issue of new ration cards to consumerr other than govern-ment employees has been discontinued from 1974. The individual ration entit-lement has been reduced from about 3 seers per week in FY76 to about 2 seersat present, and the mix of rice and wheat has been shifted from about 2:1 to1:3 over the same period. Nevertheless, SR distribution still accounts forabout 15% of total public foodgrain distribution (see Table 3.6).

4.10 Distribution to priority categories (PG) covers the supply of rationsto defense personnel, employees in large industries (e.g., jute, textiles,etc.), government employees outside the six SR areas, police and other groupssuch as jails inmates and hospital patients, students' hostels, etc. Thesepriority categories are guaranteed supplies at the same or even a lower rateas card holders in SR areas; priority categories account for 32% of totalpublic distribution of grains.

4.11 The modified rationing system (MR) covers those areas of the countrynot covered by SR and PC. Eligibility for MR is, in principle, inverselyrelated to the amount of tax paid by individual families to target coverageof the rural population at low income levels. Thus, only low-income familiespaying nil cr negligible taxes are supposed to be eligible for MR and areissued HR ration cards. Allocations for MR distribution are less automaticand regular than through SR & PG and are administratively determined. Inrecent years, they have accounted for about 19% of total distribution throughthe PFDS. MR entitlements are half of those for SR; allocations and offtakeusually increase when there are foodgrain shortages and/or high marketprices.

4.12 Grain sales through the SR, PC, and HR channels are subsidized,relative to market prices and to the full cost of domestic or externalprocurement. Although the level of subsidization has been substantiallyreduced over time (see Table 4.1) by periodic adjustments of issue prices andchanges in the ration mix, the current level of unit economic subsidies isstill high at about 20% and constitutes a significant burden on theGovernment's budget since the total economic subsidies on such sales amountto about Tk 1.8 billion or about $70 million annually;l/ the subsidies arecommonly viewed by the beneficiaries, particularly beneficiaries under the SRand PC programs, as income in kind. It is also generally believed that asignificant part of ration and other entitlement are resold or redistributedby beneficiaries.

1/ Economic subsidies are measured by relating issue prices to domesticprocurement and world prices of foodgrains. The budgetary subsidy iseven higher, over Tk 3.5 billion annually, because of the high pricesattributed to food aid imports, the frequent lags in adjustment of issueprices, and the very low issue prices of some categories of PFDS sales.

Table 4.1t ECONOKIC SUBSIDY ON PUBLIC FOODGRAINS DISTRIBUTION, VY79-FYB4

Domestic Import ParLt, WeightedEconomic Price Economic PriceLb Economic Priceal Issue PrieaLd Unit Economic Subsidy Total Econoic SubsidyL&

(Tk/ton) (Tk/ton) (Tk/ton) (Tk/ton) (2) (TIk billion)Rice Wheat [ic WheatRic liWA DAu" At 0 [ Whgt auc Whet S Aotl l IFY79 4541 3084 5334 3068 4938 3076 2720 2176 44.9 29.3 35.0 1.24 0.88 2.12FY80 5850 3774 5953 3722 5901 3746 5266 2448 44.7 34.7 37.9 1.59 1.69 3.28FY81 6021 3942 7500 4170 6761 4056 3808 2992 43.7 26,2 32.5 1.25 0.80 2.05FY82 6537 4249 7799 4812 7168 4531 4408 3264 37.4 28.0 33.0 1,78 1.31 3.09FY83 7226 4626 6790 5297 7008 4961 5576 3794 20.4 23,5 22.1 0.93 0.92 1.85FY84 7742 4935 6950 5463 7346 5199 6120 4080 16.7 21.5 19.9 0.58 1.16 1,74 *LI Domestic economic price at retail level is assumed to be 262 above domestic procurement prices of rice and wheat, to account for storage

costs and handling and distribution cost.Lk Import parity prices are derived from f.o.b. values of Thai 5 broken rice, and U.S. No. 1 soft winter wheat, discounted by qualitydifferentials of 252 for rice and 1OZ for wheat; transport costs are added to obtain c.i.f. parity prices and average exchange rate

applied to derive taka c.i.f. parity prices; a 25Z margin is then applied to obtain applicable retail parity prices.c Equal weights assigned to domestic economic price and import parity economic price.

Ration issue prices for each year, not adjusted for lag.le Weighted average of unit economic subsidy, veights being rice and wheat distribution excluding relief distribution; budgetary subsidy islikely to be substantially higher than economic subsidy because of high costs of imported grains under food aid, lags in adjustment of issueprices in each year, and very low prices of grains sold under soma categories of food distribution.

Source. HiMsion estimates.

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4.13 After allowing for SR, PG and MR which, taken together, constituteabout 662 of total distribution through the PFDS, there is only a relativelysmall quantity of public grain available for either open-market operations(OHS) or for targeted programs for the poorest groups with the lowest nutri-tional standards, tbrough such programs as the food-for-work (FFW), vul-nerable group feeding (VGF), and gratuitous and test relief (GR) programs.In fact, because the FFW, VGF and GR programs are usually tied to specificfood aid programs and constitute nearly 26Z of total grain distributedthrough the PFDS, there is a residual amount of only about 82 left for pricestabilization efforts through open-market sales (OMS). Paradoxically,because direct market stabilization through OMS is quantitatively limited andtherefore less effective, it leads to a situation where the lack of assuranceof stable market prices makes the removal of access to ration and otherentitlements more difficult.

4.14 Open-market sales (OMS) commenced in FY79. Under present operatingprocedures, OMS are initiated through grain dealers when retail marketprices rise 15% above the procurement price of rice and 20% for wheat. Thegrain is usually sold at a price approximately half way between the currentmarket price and the OMS trigger price.

Recent ExRerience of 0 en Market Sales (OHS)

4.15 The experience from FY83 demonstrates that OMS operations can beeffective particularly when adequate quantities of rice are included withwheat and sales operations.l/ In September 1982. the minimum retail pricesof coarse rice and wheat rose by over 27% and 37% above the procurementprices. In response, substantial levels of OHS, amounting to about 27% oftotal PFDS distribution of grains were initiated between September-November1982. This brought down rice and wheat prices to about 22% above procurementprices by November 1982; following the commencement of the aman harvest inDecember, minimum market prices of both rice and wheat were down to about 16%above the procurement price of rice and 19% for wheat. Furthermore, accord-ing to surveys undertaken, beneficiaries of the OMS operations in the ruralareas were primarily daily laborers and other relatively poor selections ofthe population. The net financial costs to the Government was relativelyhigh at about 16Z,2/ but far less than if the same quantities had been dis-tributed through MR and SR. On the other hand, the benefit to the consumers

1/ Because the cross-elasticity of wheat to rice is estimated to be only0.58 it takes almost twice as much wheat sales as rice in order toachieve the same effect on rice prices.

2/ This estimate is based upon gross costs of about Tk 267/md for riceand Tk 200/md for wheat, compared to average OMS sales price of aboutTk 256/md for rice and Tk 154/md for wheat, on sales of 33,000 tons ofrice and 77,000 tons of wheat.

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through lower market prices was about six times as much as the cost of theGovernment.li The OMS operations in FY83 were thus quite successful incontaining seasonal price increases which widely benefited the poor andnot-so-poor.

4.16 Although the benefits of OMS in stabilizing market prices have beendemonstrated, the potential has not been realized primarily because thevolume of grain available for OHS operations has been limited. OHS marketintervention needs to be backed by the willingness to sell large quantitiesif it is to be effective in containing price increases. Although the opera-tional rules governing OMS intervention are clear, the Government's continu-ing heavy emphasis on grain sales through traditional distribution channelshas limited the role of OMS to a rather residual one to date.

4.17 The constraints imposed on OHS operations were clearly underlined bythe experience of 1984. The increase in offtake through SR, PC and MR duringthe period July-November 1984 amounted to about 290,000 tons over the pre-vious year (from about 550,000 tons to about 840,000 tons); relief programsincreased by about 180,000 tons (from about 130,000 tons to 310,000 tons)while OMS operations increased by only about 100,000 tons (from about 60,000tons to about 160,000 tons). With average market prices much higher (byabout 36% for rice and 19% for wheat) than issue prices, the demand forgrains from the PFDS was considerably higher than in FY83. Moreover, reliefefforts also needed to be expanded sharply, but increased less than sales topreferred categories. Regional PFDS managers had to meet the needs for SR,MR and PG entitlements and for relief allocations before they could considereven limited OMS from their diminishing foodgrain stocks. For these reasons,the increase in OMS operations did not exert as significant a stabilizinginfluence as it could have had on country-wide minimum retail prices ofcoarse rice and wheat, which remained at Levels about 25% higher than theprocurement prices prevailing in the latter part of FY84.

4.18 A comparison of the FY83 and FY85 OMS operations indicates some majordifferences. In FY83, OMS were initiated in September when market pricesrose rapidly, and during the month of October OMS operations were expanded toas much as 27% of total PFDS distribution with an imnediate and noticeableimpact on foodgrain market prices. In FY85, market prices were already wellabove trigger prices for initiating OMS as early as in July 1984, andalthough OMS were undertaken, they accounted for only about 12% of total PFDSdistribution. Even when relief distribution is excluded, OMS in FY85accounted for only about 15% of total PFDS distribution during the leanseason period. The effect of OMS on market prices was,thus, much less marked

11 It was estimated that OHS operations reduced market prices of rice by14% (from Tk 255/md to Tk 220/md) from Levels that would otherwise haveprevailed. Total volume of market sales of rice in the period wasestimated at about 700,000 tons.

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than in FY83. An additional reason for the relatively modest impact of OMSon foodgrain prices in FY85 was a limited amount of rice sold under OMS.Only as a result of the arrival of large commercial rice imports inSeptember 1984 was it possible for the Government to initiate significantrice sales under OMS. In FY85 it may have been more effective to utilizeearly arrivals of commercial rice imports (in July-August) for increased OHSdistribution than for other categories of distribution.

4.19 A smaLl but important policy improvement in FY85 to increase OMSsupply was the decision taken by the Government to eliminate the marketingoperations (HO) category of PFDS, which has not been a fully-fledged OMSoperation because decision on prices and quantities sold under MO were notaccording to well-defined criteria.

C. POLICY ISSUES

4.20 Based on the experience to date, the challenge for the Government isto find ways to increase the share of open market operation by reducing theclaims of preferred categories, to reduce the size of consumer food subsidiesto the relatively better-off consumers, and to increase the share of targetedfood programs for the needy. Several options are available. A pre-requisitefor all these options, especially the ability to enter into sizable OMSoperation to stabilize market prices, is the availability of adequate foodstocks, particularly rice stocks, for the PFDS.

4.21 The MR program performs poorly in stabilizing market prices and doesnot benefit a wide section of the ruraL population, because the MR program isdetermined administratively with weak linkages to trends in market prices indifferent parts of the country. However, the gradual transformation of thesubstantial MR program into OMS operations would provide considerable poten-tial for stabilizing market prices for a wider section of consumers in ruralareas. An option that could be considered would be subordinate MR at thelocal level to OMS: when market prices rise above OMS trigger Levels in acertain area, there would be no further MR in that area until market pricescome back below the OHS trigger prices, with all 'normal' MR allocationstransferred to OMS operations during this time.l/

4.22 Over the medium term, the objective of policy reforms concerning theSR and PG categories should be to reduce the rigidity imposed on the PFDS bySR and PC obligations. The quantity distributed under SR and PC has beenreduced to some extent over time; it will be very difficult to make furtherreductions unless GOB's pricing policy is such as to reduce or eliminate the

1/ A more gradual transition from MR to OMS could be provided by an alterna-tive option which specified that MR allocations would be cut to half orsome other proportion of their 'normal' levels when prices rose abovetrigger prices.

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incentives for the beneficiaries to draw on such zupplies - the main incen-tive being the difference between market prices and issue prices. Issueprices have been raised repeatedly over the past few years, reducing somewhatthe average spread between market and issue prices. However, ration issueprice changes are currently made usually once a year, and in rare instances,twice a year. As a result ration prices lag behind market prices and candiverge significantly from market prices during the year, particularly duringthe lean seasons. This leads to a situation where demand for grains throughSR and PG from the PFDS increases significantly, reducing the flexibility ofthe Government to increase OHS precisely when thev are most needed. The SRand PC programs only cover about 8 million people, or about 8% of thecountry's population, and obviously cannot perform an effective price stabi-lizing function for a wide section of the country's population who areexcluded from the programs.l/ The cost of stable prices for thebeneficiaries of the SR and PG programs are, thus, borne directly by theGovernment and indirectly by the population excluded from these programsbecause such programs prevent the Government's ability to respond to highmarket prices through expanded OMS.

4.23 An option that could be considered would be to make SR and PG issueprices similar to OMS pricing, i.e. equal to free market prices wher freemarket prices are below the "trigger" price for initiating OMS (i.e., 151 and20% higher than procurement prices for rice and wheat respectively) and whenmarket prices are higher than OMS prices, issue prices would be raised to thestarting price of OMS sales. If market prices continue to rise during theyear, OMS prices have to be raised from starting levels. Considerationshould also be given to raising issue prices correspondingly. There is noobvious merit in providing complete protection from fluctuation in foodgrainprices to one small group in the community, especially if this guaranteeconstrains the Government's ability to stabilize prices for everyone else inBangladesh. In the transition to OMS-type of pricing the Government coulddecide to raise issue prices to a smaller fixed percentage of the increase inOKS prices from starting levels during the year; such a fixed percentagecould be raised each year over a period of years at the end oi which issuepricing would become identical to OMS pricing.

4.24 Under such a change in pricing policy, SR and PG beneficiaries wouldbe exposed progressively to market prices, but even when market prices areabove OMS trigger prices SR and PG beneficiaries would still be ensuredsupplies at prices which would be less volatile than market prices; moreimportantly, when market prices are below OMS 'trigger' prices, SR and PGcardholders would also benefit from periods of low market ,rices during theyear.

1/ With normal monthly SR and PG distribution approximating about 750,00tons, and using a per capita weekly entitlement of about 2 seers a week,the total potential coverage is about 10 million people.

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4.25 The cost to beneficiaries of the SR and PG system which would resultfrom charging issue prices equal to that of OMS or free market prices wouldbe relatively small, because the difference between issue prices and marketprices has been reduced over time. Thus, assuming that 202 once and for allincrease in issue prices may be required to initiate such a new pricingpolicy, the net effect on the beneficiaries would be to raise expenditures ongrain bought from the SR and PG distribution by only about Tk 8.75 per headper month. For a family of six, the increase in monthly expenditure wouldamount to about Tk 52 per month as a result of this change in issue prices.Even for the poorer categories of beneficiaries of the SR and PG programs theincrease would amount to about 8X of income of about Tk 650 per month. Forhigher income categories the effect would be considerably smaller. Thereduction in total foodgrain subsidies by the increase in prices would,however, be significant, since increased issue prices of about 20% would leadto annual budgetary savings of over Tk 1.5 billion.l/

4.26 Modest increases in issue prices may not be sufficient to sig-nificantly reduce the demand for grains through the SR and PG programs. Itway therefore also be necessary to consider the elimination of the rice quotain the SR and PG programs, and to channel such rice sales to only OMS opera-tions to stabilize market prices of rice. The effective stabilization ofmarket prices of rice is far more important to consumers, even for thoseconsumers benefited by the SR and PG programs, since on average the SR and PGdistribution supplies only about 30% of the foodgrain requirements of theaverage household eligible for SR and PG.

4.27 For some priority groups within PG, issue prices are very low, andthe raising of issue prices to levels comparable to other groups may bedifficult without offsetting measures. For some other groups (jails, hospi-tal inmates, etc.) the raising of issue prices may again be difficult withoutsome offsetting budgetary compensation because of the lack of sufficientrevenues or incomes of such groups. The subsidies on such distribution areborne by the Food Ministry, but should be taken out of the Food Budget; ifnecessary, explicit budgetary support should be provided through other headsof expenditure so as not to distort the food operations and the food budget.

4.28 It is estimated that if the above measures were undertaken the annualavailability of foodgrains for OMS operations would increase from about 8%(or 160,000 tons) of total PFDS distribution to about 37.5% (or about 750,000tons), assuming that about 30% of the current MR and rice distributed throughSR and PG would be eliminated. With such a level of OMS distribution, espe-

/ A 20% increase would amount to about Tk 1350 per ton for rice and Tk 940per ton for wheat; with total quantities of SR, PG and MR distributedbeing about 500,000 tons and 900,000 tons for wheat and ricerespectively, the increase in revenues is about Tk 1.5 billion.

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cially if adequate quantities of rice were available to intervene in themarket, it should be feasible for the Government to exert a far greaterstabilizing influence on foodgrain prices throughout the year than is pos-sible now with the present structure of PFDS distribution. The reduced demandfor SR and PG offtake as a result of higher issue prices would also provideincreased scope for targeted food distribution to the poor which could beexpanded over time. More crucially, the enhanced ability of the Governmentto stabilize market prices of foodgrains throughout the country at levelswithin the reach of the rural and urban poor could have far greater effectson improving the nutritional status of the poor. The reduction of foodgrainsubsidies would also enable the Government to other essential investmentexpenditures, including additional allocations for agricuLture and foodsectors.

4.29 The Role of the Private Sector: Over the past several years theGovernment has also attempted to allow an expanded role for the privatesector in foodgrain distribution, in order to reduce the burden on publicfoodgrain operations. One important indication of this is that the share ofthe PFDS in total distribution of foodgrains in the country has notincreased, and, in fact, has marginally declined from about an average levelof 16% in the period FY73-76, and about 14Z in the period FY77-80, to about13% in the most recent period, FY81-84.

4.30 In addition to the above, important restrictions on the private graintrade have been eliminated over the past few years. Anti-hoarding laws havebeen suspended to encourage private storage, and the procedure of appointingApproved Grain Dealers (AGDs) to procure grain from farmers on behalf of theGovernment has also been eliminated to ensure equal access and greatercompetition, which ultimately benefits the farmers. Most recently, in FY85,the private sector has also been allowed to import foodgrains through thewage-earners' scheme market, under which some 15,000 tons of rice wasimported. These improvements have added a small, but potentially importantelement of confidence to the private grain trade to perform their normalprice-stabilization function, which could be given further incentives in theyears ahead in order to reduce the burden on public sector food operations.Consideration could be given to allowing some credit for grain trading,particularly for foodgrain imports by the private sector. Increased privatesector storage of foodgrains could also be giwon more institutional andpolicy support.

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Chapter 5: INDUSTRY

5.01 Gross industrial output rebounded sharply during FY84, increasing by13.6%, in contrast to a 6.5X decline in FY83 and almost zero growth inFY82.l/ The recovery was partly due to the increases in agricultural outputduring 1982 and 1983 which created increased demand for manufacturedproducts, but industrial exports also increased both in quantity and valueterms due to improved prices for traditional exports such as jute productstogether with significant increases in non-traditional exports. In addition,the expansion in liquidity discussed in Chapter 2 has also increased thedemand for industrial products. The vigorous response of industrial outputto increases in internal and external demand have been made possible by farreaching reforms in both investment and import policies. The new industrialpolicy (NIP), announced in FY82, set out an agenda of reforms which are farreaching in their coverage of both the public and private industrial sectorsas well as in terms of policy instruments. The improved policy environmentcreated by NIP has permitted industry to respond to increased demand byincreasing output rather than by increased prices charged by domesticindustry. Whether 1984 is the beginning of an era of higher industrialgrowth, or a short lived boom fueled by an excessive growth of domesticcredit and followed by a relapse to the lower growth rates recorded in thepast will depend on whether the new industrial policies can be maintained andimproved.

5.02 This chapter presents an evaluation of the structure and performanceof the manufacturing sector in Bangladesh, together with the possible deter-minants of this performance. This is followed by a discussion of the policyreforms initiated and implemented under the NIP. Although significant andfar reaching policy changes have been implemented or initiated, it must berecognized that considerable room remains for further improvement in someaspects of industrial policy. For example, there has been little effectiveaction taken to improve the problems of development finance institutions andcreate an envirunment in which the financial obligations to these institu-tions are honored. Given the importance of these institutions and the credit"environment" in steering private investment and growth patterns, the weak-ness in their capacity to evaluate proposals and enforce debt obligations iscontinuing to lead to serious misallocation of scarce resources. These and anumber of other outstanding issues and further improvements are outlined inthe last section of the chapter. However, it should be pointed out thatsince most of the policy reforms are either very recently implemented or arein the process of implementation, it is too early for a thorough evaluation

1/ The data used in this chapter are mission estimates derived by usingthe Quantum Production indices, the Census of Manufacturing Industries,and other partial data sources. Therefore, they may not be identical tothe GDP numbers presented in Chapter 2 and the Statistical Appendix.

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of their effects on the industrial sector. Accordingly, the outstandingissues that are identiiied are not directly concerned with the evaluation ofthe NIP or its effectiveness, but are issues which have yet to be adequatelyaddressed within the NIP.

A. THE STRUCTURE OF BANGLADESH INDUSTRY

5.03 A thorough evaluation of the structure and the recent performance ofindustry in Bangladesh is very difficult, due to a lack of reliable or com-prehensive industrial statistics. The limited data available relates mostlyto large-scale public enterprises whose weight in the economy has beendeclining and there is ver; little information available on the performanceof small scale and cottage industries. However, recent TIP studies,l/ usingpartial data from different sources, have sought to describe the structure ofindustry in FY82. According to their classification, the manufacturingsector is first grouped into public and private establishments. Within theprivate sector establishments three separate groups have been identified,namely: large-scale private units mostly covered by the census of manufac-turing industries (CMI), small industries (SIS) and cottage industriesincluding handlooms (CIS). Table 5.1 presents the distribution of manufac-turing activity according to this classification, showing that the bulk ofthe employment (64.6%) in the industrial sector is in cottage industries,within which almost half of the employment is in the handloom sector. Thevalue added per worker in cottage industries excluding handlooms is Tk 3,750and for the handlooms value added per worker is only Tk 2,773, indicatingthat the majority of industrial labor force are employed in jobs with verylow preductivity. The public sector, with only 303 enterprises out of425,000 accounts for 46% of value added in industry. In terms of employment,public sector corporations employ only approximately 14Z of the industriallabor force. The large-scale private sector is also very small, employingonly 4% of the industrial labor force and generating 11% of the of the value

1/ In April 1983, GOB initiated a series of studies for a Trade andIndustrial Policy (TIP) Reform Program; the studies are being financedunder an IDA Technical Assistance Credit. The TIP Reform Program isexpected to lead to the specification and subsequent implementation ofsignificant corrective actions and reforms in export policies andprocedures, tne tariff structure, domestic indirect taxation, investmentincentives, macro-industrial planning process for public sectorindustrial investments, and the micro-mechanisms for private industrialinvestment promoti=n. Besides the improvement of planning and promo-tional activities in the most pressing areas affecting public and privateindustrial investment, the TIP Reform Program encompasses policy studieswhich are expected to result in concrete recommendations to theGovernment on required policy changes.

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added.l/ Although the average size of public sector establishments is muchbigger compared to large-scale private units, value added per worker iscomparable: while the value added per establishment in public and large-scale private units are Tk 882,000 and Tk 28,647 respectively, the valueadded per worker in the two groups are only Tk 28,000 and 23,000. The muchlarger size of public sector enterprises have not led to economies of scalereflected in proportionately larger labor productivity.

Table 5.1: STRUCTURE OF BANGLADESH MANUFACTURING: 1981-82 /a

ValueEmployment 2 Added X

No. Units ('000) Share (m. Tk) Share

Public Sector /b 303 310.2 (13.7) 8,680 (46.1)

Private Sector 425,089 1,958.5 (86.3) 10,156 (53.9)

a. Large Scale Units 2,425 93.2 ( 4.1) 2,139 (11.4)b. Small Scale Units 24,217 400.0 (17.6) 3,205 (17.0)c. Cottage Units 398,447 1,465.3 (64.6) 4,812 (25.5)

i) without handlooms 248,447 765.3 (33.7) 2,871 (15.2)ii) with handlooms 150,000 700.0 (30.9) 1,941 (10.3)

TOTAL 425,392 2,268.7 (1,000) 18,836 (100.0)

/a Taken from Abraham, W. I. "Features of Bangladesh ManufacturingIndustries", TIP Draft Report, July 1984.

/b Prior to the 1982 disinvestment of textile, jute and otherlarge manufacturing units.

5.04 Table 5.2 sets out the sectoral composition of manufacturing activityfor FY82: where the broad category of textiles, (including jute, garmentsand leather) constitutes the largest industry with 33.5% of manufacturing

11 It should be noted that this composition of output refers to FY82,which is before the recent denationalization of about 70 large-scaleenterprises. Moreover, investments by private 3ector have increasedsubstantially since FY82. Both these developments imply that the shareof private sector in FY84 would have been much higher than shown for FY82in Table 5.1.

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value added, followed by food (25%) and chemicals (12.9%). Of theseindustries, textile, chemicals and basic metals were in the public sector inFY82. (With the denationalization of jute and textile units after 1982, theshare of public sector would since have been considerably reduced in thesesectors.)

Table 5.2: SECTORAL DISTRIBUTION OF MANUFACTURING ESTABLISHNENTS, WORKERS AND VALUE ADDED (1981-82)

I IP u b l i c S e c t o r I Pr i v a-t e S e c t o r _ T o t a 1 I n d u a t r I

No. Value I No. Value INo. Workers Added I No. -4orkers Added I No. HA.Wokeris VAMlu Added

Division Units ('000) (Tk.M) I Units ('000) (Tk.m) I Units ('000) Z (Tk.M) Z

I IFood, beverages,II

tobbaco 65 21.4 690.1 I 74,294 421.1 3,527.4 I 74,359 442. 28.2 4,217.5 25.0

Textiles, LAgarments and I Ileather 134 245.2 4,364.6 I 45,812 266.1 1,289.6 | 45,946 511.3 32.6 5,654.2 33.5

Wood, furniture 10 1.9 52.5 I 71,673 288.0 839.6 I 71,683 229.9 14.7 892.1 5.3

Paper, printing 9 8.0 294.1 I 2,912 22.5 456.8 I 2,921 30.5 1.9 750.9 4.4

Chemicals 32 16.4 1,557.2 1 2,128 26.8 616.5 I 2,160 43.2 2.7 2,173.7 12.9I I

Non-metallic I Imineral products 6 2.3 159.6 I 18,796 94.5 331 .7 I 18,802 96.8 6.2 491.3 2.9

Basic metal 11 5.7 1,078.7 I 30 3.3 42.4 I 41 9.0 0.6 1,121.1 6.6

Metal products 36 9.3 483.3 I 25,807 110.4 811.7 I 25,843 119.7 7.6 1,295.0 7.7

Other, handicrafts - - - I 33.637 _85 299.1 I 33.637 _ _8 85 5.4 229.1 1.8A

TOTAL 303 310.2 8,680.1 | 275,089 1,258.5 8,214.8 I 275,392 1,568.7 100.0 16,894.9 100.0

/a Excluding handlooms.

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Industrial Performance: 1974-1984

5.05 Table 5.3 presents some selected indicators of industrial activitybased on the limited historical information available on the past performanceof the manufacturing sector. The growth rates of real gross output exhibitsuch large fluctuations that it is difficult to interpret the underlyinglong-run trend growth rate, but as shown, average annual growth rate of grossoutput over the last decade (FY74 to FY84) has been only 5.7%. If oneabstracts from the short-run fluctuations which have been caused, to a largeextent, by the fluctuations in agricultural incomes, import availability andmonetary policy, it is possible to differentiate two district time periods.Between FY74 and FY78 output grew quite rapidly at 9% per annum, mainly dueto better utilization of the existing capital stock resulting in a continuousdecline in capital-output ratio up to FY79.1/ After FY78 the growth rateshave declined significantly: even with a 13.6% growth in FY84, the averageannual growth rate between FY78 and FY84 has been below 4%.

I/ FY70 level of output was only reached in FY78. See Q. K. Ahmad, "TheManufacturing Sector in Bangladesh - An Overview", Bangladesh DevelopmentStudies, (Autumn, 1978).

Table 53: HMANUFACTURING OUTPUT AND INVE8TMENT La

(in millions of Taka in FY74 Prices)

Gross (Growth Value (Growth Public Private Total Capital Capital-GrossOutput Rate) AddedLd Rate) Investment Investment Investment Stock Output Ratio

1973/74 7,729 3,864 525.0 81.0 606.0 6,980 .90197'/75 8,154 ( 5.5) 3,157 (-18.3) 431.5 88.5 519.8 7,151 .881975/76 9,173 (12.5) 2,899 (- 8.2) 605.7 88.2 693.9 7,470 .811976/77 9,797 ( 6.8) 3,503 (20.83) ok3.6 270.4 894.0 7,954 .811977/78 10,914 (11.4) 3,874 (10.6 ) 763.8 392.0 1,155.8 8,657 .791978/79 11,294 ( 4.4) 4,311 (11.28) 1,088.9/b 351.7 1,440.6 9,586 .841979/80 11,861 ( 4.1) 4,294Lc (-0.5, 1,172.3/b 478.8 1,651.1 10,652 .901980/81 12,597 ( 6.2) 4 , 3 54 /c ( 1.4) b50.5 634.0 1,584.5 11,569 .921981/82 12,672 ( 0.6) 4,172 (-4.2) d?9.1 648.9 1,528.0 12,354 .971982/83 11,849 (-6.5) 676.2 876.2 1,552.6 13,083 1.101983/84 13,460 (13.6) 639.8 905.6 1,545.4 13,728 1.02

Li The data in this table are mission estimates derived from different data sourcesca The bulk of the increase in public sector investment in these years was due to the construction of the

Zia Fertilizer Factory at Ashuganj.Li Interpolated between FY79 and FY82.Ld Value added is estimated by taking the revised Quantum Production Index and applying to it the ratio of

value added . gross output taken from the Census of Manufacturing industries. It corresponds to realincome originating in the manufacturing industry. For FY83 and FY84 the CMI data are not yet available.

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5.06 The trend in real value added in the manufacturing sector, has beenmuch less satisfactory; the growth of output has not been translated into asimilar growth in value added which grew only 1% per annum. In contrast tothe 41Z growth of output between FY74 and FY78, there was no growth in valueadded during the same period, so that value added as a percentage of grossoutput declined from 0.50 in FY74 to .39 in FY78 and subsequently to 0.33 inFY82. Such a decline in the ratio of value added to gross output can beexplained by a relative expansion of activities with lower value added and/orby the increase in the ratio of intermediate input prices to the outputprices. The speed of the decline observed in Bangladesh is too pronouncedto have been caused by major changes in the structure of output. Therefore,it can be assumed that the decline in value added was caused primarily byintermediate input prices rising faster than output prices.

5.07 Table 5.4 shows that the decline in ratio of value added to grossoutput took place in all industries. It should be noted that some of thedeclines in value added to gross output ratios were inevitable given theseverity of the increases in the price of imported oil in the 1970s. Thedecline was greatest in petroleum products (i.e., refinery and trading).However, even if this subsector is excluded, the declines are stillsignificant, indicating that increases of intermediate input prices were notpassed on to product prices. In seeking to explain the reasons for thedecline in value added, it would be desirable to distinguish betweenadministrative pricing decisions of the public corporations from theinability to pass on cost increases due to competitive pressures. Sincereliable separate series for public and private establishments do not exist,it is not possible to distinguish clearly between the importance of thesefactors, but in view of the dominance of public corporations in the sample,the role of government pricing decisions were almost certainly quiteimportant. Since real value added has remained almost constant inmanufacturing, the real income received by the primary factors of productionhave decreased as a result of the substantial increases in capital and laborused. This decline of returns to factors of production also indicates thatthe bulk of the adjustment to external shocks was borne by the manufacturingsector and was not passed on to the rest of the economy.

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Table 5.4: RATIOS OF VALUE ADDED TO GROSS OUTPUT BY SECTOR

Industry /a 1969/70 1973/74 1975/76 1978/19 1981/82

Food (12.88) .3513 .4078 .3164 .3065 .3078Tobacco ( 7.43) .6160 .&330 .6852 .6787 .6619Textiles (31.71) .5424 .4337 .3272 .3841 .4010Paper ( 2.63) .6239 .1754 .1387 .3333 .2503Leather ( 5.14) .1429 .1630 .1448 .2060 .1605Chemicals (11.97) .5401 .5669 .3244 .4780 .4403Petroleum ( 7.16) .6334 .4286 .0588 .0129 .0079Basic Metals ( 9.47) .2500 .5759 .1908 .4529 .2974TotalManufacturing (100.00) .4699 .4999 .3150 .3784 .3292

Total ManufacturingLess Petroleum .4998 .3394 .4066 .3853

/a Figures in parentheses are the weights of each industry in totalmanufacturing gross output as of 1978/79.

Source: Census of Manufacturing Industries, BBS.

Table 5.5: FACTOR SHARES IN GROSS OUTPUT

1969/70 1973174 1975/76 1978/79 1981/82

Labor's Share .1218 .1701 .1086 .1209 .1070

Capital's Share /a .3480 .3298 .2065 .2576 .2222

/a This is the gross share of capital, including taxes, interest,and depreciation.

Source: Census cf Manufacturing Industries, BBS.

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5.08 Table 5.5 shows that the decline in income originating in themanufacturing sector have been shared by the factors of production: theshares of both labor and capital have declined significantly.l/ Indices oflabor productivity and real wages shown below indicate that in spite of a 20%increase in productivity over the period from FY74 to FY82, real wages havedeclined by about 25%. More recently, the increasing trend in labor produc-tivity has been reversed and labor productivity actually decLined betweenFY79 and FY82.

Indices of: 1973/74 1978/79 1981/82

Labor Productivity 100.00 129.51 120.13Real Wage 100.00 92.01 75.55

5.09 The share of capital in manufacturing has declined continuously sinceFY70. Using the capital stock figures from Table 5.3, it is possible todecompose the changes in share of labor into the movements of the capital-output ratio and to real rate of gross return on capital, as shown below:

Indices of: 1973/74 1978/79 1981/82

Capital-output Ratio 100.00 93.33 107.78Real Gross Return on Capital 100.00 79.31 62.85

According to these estimates, the real rate of return on capital measured bygross margins inclusive of taxes and interest fell by 38% between FY74 andFY82. rhis decline can be expected to have had a significant effect on theability of enterprises to generate internal funds for reinvestment.

5.10 The results can be summarized as follows:

(a) Output growth in manufacturing sector has averaged around 5.7%per annum between FY74 and FY84. This is quite low, especiallyin light of the fact that the economy started with 3ignificantunused capacity after independence. The bulk of the growth

1/ Labor's share in gross output equals labor per unit of output (theinverse of labor productivity) multiplied by the real wage in terms ofthe product price. Labor's share will stay constant if the increase inlabor productivity equals the increase in the real wage. Likewise,capital's share equals capital-output ratio (inverse of capitalproductivity) multiplied by the real return to capital in terms of theproduct price.

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occurred in the FY74 to FY78 period, primarily due to improvedoperation of the existing enterprises. After FY78, the outputgrowth rate has been only 3.6X per annum which is barely abovethe population growth rate and below the growth rate of urbanlabor force.

(b) Performance in terms of value added in the ma-nufacturing sectorwhich corresponds to real income originating in manufacturinghas been even worse, growing at only 1% per annum over the pastdecade in spite of the increases in the quantity of labor andcapital inputs to manufacturing. The relative decline in valueadded have been caused by mainly terms of trade losses as inter-mediate input prices have increased faster than output prices.

(c) The decline in factor incomes have affected both capital andlabor. Between FY74 and FY82 real wages and real returns tocapital declined by 25Z and 38% repvectively. In addition,after FY78 the productivity of both labor and capital havedeclined, although less rapidly than the decline in realreturns.

5.11 The reasons for the poor performance of the manufacturing sector canbe attributed to a number of factors.l/ First, the country at the time ofindependence inherited a structure of industry that was not compatible withits needs and resources. Second, external shocks such as the oil priceincrease and other changes in the terms of trade as well as domestic factorssuch as fluctuations in agricultural output and the limited availability offoreign exchange contributed significantly to the poor performance. However,in view of the pervasive influence of the Government in the manufacturingsector of Bangladesh, through its ownership of the bulk of the large-scaleenterprises as well as its control on all facets of manufacturing activity,some of this poor performance can be attributed to the role of and thepolicies followed by the Government. Until very recently, the Government hasbeen either the producer, the distributor or the buyer of the bulk of theproducts of the large-scale industrial sector. For example, in the textilesector, the Government either produced or imported the yarn and distributedit to the mills and the handloom operators. In the steel industry,Government produced or imported the bulk of the billets which were used forrerolling (again mostly in public mills) and the products were used largelyin public construction projects. Diesel engines, pumps and G.I. (galvanizediron) pipes were either produced or imported by the Government to be rentedto the farmers. In the fertilizer and sugar subsectors, the Government wasagain the only supplier either through its own production or imports. In

11 I; should be noted that the data on which these conclusions are basedpertain primarily to medium and large-scale enterprites which might notbe equally applicable to the performance of small and cottage ur.its.

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jute products, until 1982, all the jute rmills were owned by the Government.In subsidiary activities, the size and the spending patterns of governmentdetermined the markets for the outputs of large-scale private enterprises.

5.12 The policy environment for the private sector was characterized bypervasive government controls on most facets of economic activity, especiallythe investment sanctioning and import allocation systems. There were alsovery rigid controls on the activities of public sector corporations. Inorder for this type of government-led and controlled induserialization to besuccessful, three conditions would need to be satisfied. Firstly, Governmentexpenditure patterns have to be stable and have to increase at reasonablyhigh rates to provide secure and expanding markets for prospective suppliers.Secondly, a significant part of these expenditures have to be supplied by thedomestic producers so that the demand which is generated is transformed intoadditional domestic production and employment. Thirdly, for this type ofGovernment expenditure led industrialization to generate efficient resourceallocation, the products demanded by the Government would have to be theproducts that the country has a long-run comparative advantage in production.None of these conditions has been adequately satisfied in Bangladesh.

5.13 The pattern of Government investment well as its rate of growth hasshown substantial variation since FY74 as shown in the following table:

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Table 5.6: GOVERNMENT ANNUAL DEVELOPMENT EXPENDITURES

Real ADP Ratio of ADP toYears Real ADP /a Index Growth Rate /b non-Agricultural GDP /c

1973/74 4,638 100.0 .15681974/75 3,285 70.8 -29.2 .11141975176 4,365 94.1 32.9 .18951976/77 4,713 101.6 8.0 .19461977/78 5,286 114.0 12.2 .20731978/79 6,382 137.6 20.7 .24271979/80 8,471 182.6 32.7 .28571980/81 7,209 155.4 -14.9 .23551981/82 7,030 151.6 - 2.5 .23181982/83 7,085 152.8 0.8 .22171983/84 6,160 132.8 -13.0 .1911

ia In 1973/74 prices. The deflator for investment is constructed on theassumption that 60X of investments are construction and 40X equipment.

/b Percent per annum.7c In current prices.

5.14 Public investment expanded rapidly from FY76 to FY80, when the ADPrepresented almost 30% of non agricultural GDP. This growth was followed hasbeen an eqv.ally dramatic dlecrease in ADP in real terms. Since it can beassumed that both public and private sector investment decisions were basedon the expectation of very high rates of investment spending and rapidlyexpanding markets, the decline in ADP expenditures as part of an unavoidableadjustment to limited resources has eliminated a large part of the expectedmarkets for these firms. As discussed in Chapter 7, the decline in ADPcannot be seen as temporary phenomenon. Given the resource constraints whichwill continue to be faced by the Government, it is highly unlikely that thehigh growth rates of government investment of the late 1970s can be repeatedin the foreseeable future. Therefore, the industrial capacity which wascreated on the expectation that government spending will grow at very highrates will probably not be fully utilized.

5.15 The relative decline in both the role and the size of government hasbeen compensated, to some extent, by the emergence of new sources of demandfor industrial products namely: (a) demand generated by higher agriculturalincomes; (b) demand generated by remittances; and (c) demand for non-traditional exports. The structure of these new, growing sources demand issignificantly different from the pattern of government demand. Therefore,it is quite possible that the low industrial output growth rates in the early

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1980s were caused by unavoidable delays involved in adjusting to the sig-nificant shifts observed in the structure of demand.

5.16 The condition that government investment demand be met by domesticsuppliers has also not been met for several reasons. Perhaps mostimportantly, the physical resource endowment iud the total size and structureof demand in the Bangladesh economy is not such that the type of industrialproducts needed as inputs to Government investments can be competitivelymanufactured within Bangladesh. Irrespective of the efficiency of managementof the domestic enterprises, Bangladesh does not possess comparativeadvantage in the production of many of these goods. Insistence on protectivemeasures to increase the "local content" of government projects wouldincrease the costs and reduce the benefits of such projects and make it evenless likely that a reasonable proportion of the capital and recurrent costsof the project can be recovered from its beneficiaries. It must also berecognized that project aid, which should not be expected to increase consis-tently in real terms, cannot be expected to be an important driving force forBangladesh industry. Sustained demand will, instead, need to be generatedfrom a further growth of the agriculture and associated service sectors andto an increasing extent from a growing and diversified volume of industrialexports.

5.17 Even within the volume of aided projects (which account for up to 70%of the ADP in recent years) and within those categories of goods which couldbe produced efficiently in Bangladesh, there are problems in promoting theuse of domestic goods. In some cases, aid is strictly tied to exports fromthe donor country. In other cases, in order to ensure unbiased and efficientprocurement decisions, competitive bidding procedures are used. For largercontracts, international competitive bidding is required (in some cases, somepreference is given to domestic producers 1/). To a large extentBangladesh-based firms (in either the public or private sector) have not beenable to win contracts under these conditions. Although the main reason forthe relatively high cost of domestic producers is technologicalinefficiencies, they were also often disadvantaged further by negativeprotection, i.e., they were paying taxes on their inputs and were expected tocompete with non-taxed, if not subsidized, exports from other countries.Their ability to compete is also adversely affected by the fact that procure-ment for Government investments are tied to specific projects which tend tobe lumpy with cont=act sizes beyond routine domestic capacity. If domesticcapacity were created to fulfill such contracts, then there would be a riskof such capacity being idle once a specific project or group of p-ojects werecompleted. These factors have been largely responsible for the very lowlevels of capacity utilization and production in capital and intermediategoods industries which have been set up to supply government demand.

1/ For example, IDA gives 15% cost advantage to domestic producers.

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5.18 Partly in recognition of such limiting factors on Government-ledindustrial development, GOB has tried, especially after 1975, to encouragethe private sector to take more active role in the manufacturing sector.Credit to the private sector, channeled primarily through the two maindevelopment finance institutions (BSB and BSRS) was increased, promoting anincrease in private investment from Tk 200 million in FY76 to Tk 1,481 inFY80. However, the expected increases in efficiency in resource allocationfrom privatization have been hampered by the major inefficiencies caused bythe credit allocation by the financial system. In most cases, the industriesthat were chosen by the DFIs to be financed have been determined by govern-ment policies in the same ad hoc manner as the public sector investments.Moreover, these investments were financed in such a way that the owner'sequity could be quite nominal and thus easily recoverable even before thecommencement of production. In an environment in which borrowing can be moreprofitable than production and in which the debts have not been expected tobe repaid on schedule have helped to create a situation where a large portionof private sector invcstments have been allocated to areas with little com-mercial prospects in the near future. It is highly doubtful whether most ofthese enterprises will be viable without specific subsidies created by theGovernment.

5.19 Thus, the mixture of inappropriate investments (public and private)as well as changing demand patterns caused by both structural and policychanges, have created a manufacturing sector which is characterized by excesscapacity in some subsectors together with shortages in other subsectors.Furthermore, as clearly shown above, the growth of manufacturing output fellsignificantly short of expectations. To respond to some of these problems,GOB announced its New Industri'l Policy (NIP), in June 1982. The NIP iscomprehensive stat-. ent of positive policies endorsing a greater role for theprivate sector within a mixed economy. Among its stated objectives were: toimprove the efficiency and performance of public sector enterprises; toprovide an improved policy environment for the private sector, to foster thedevelopment of efficient export-oriented and import substituting industries;to encourage the spatial dispersal of industries especially to "backwardareas"; and to provide increasing opportunities for productive employment inthe industrial sector.

5.20 The announcement of this broad policy framewark has been followed upby a large number of specific measures during the last two years. Takentogether, these measures constitute an agenda of reforms that are bothextraordinary and far reaching in their implications; extraordinary becausethey represent a major break with past industrial and trade policies follcwedin Bangladesh and far reaching in their coverage of both the public andprivate industrial sectors as well as in terms of ie array of policy instru-ments used.

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B. PUBLIC SECTOR REFORMS

5.21 The most important changes under the NIP affecting the public sectorhave been: (i) the divestment and reorganization of the public sector units;(ii) the capital restructuring and financial rehabilitation of the retainedunits; and (iii) pricing reforms.

5.22 Nearly 110 major public sector units were divested during FY83,including 33 jute mills and 26 ce:.ton textile mills. Many of thcsa WAliEShave been returned to their former owners, while others have been sold byauction. This large-scale divestment has been undertaken in order to reducethe burden on public sector management, to increase the role of the privatesector and, eventually, it is expected that the efficiency of the unitsdivested can improve under private management. Forty more units are expectedto be divested during FY85: in some other cases, 49% of the share capital ofsome profitable units whose control is to be retained in the public sector isto be offered to the private sector. Two out of six previously nationalizedbanks have also been returned to private ownership.

5.23 These divestments have facilitated a major reorganization of theremaining units in the public sector corporations. This reorganization andconsolidation effort was set as the main terms for reference for theCommittee for Reorganization of Public Statutory Corporations (CRPSC) whichsubmitted its report in June 1983. Of the 155 organizations under publicstatutory corporations the CRPSC recommended that 13 be abolished, 30 othersbe amalgamated into 12 units and 21 others undergo major restructuring. Afurther examination of the remaining 91 units is being carried out with aview best to reorganize and consolidate them as appropriate. COB has alsoaccepted, in principle, the recommendacion of the CRPSC that, to the extentpossible, the enterprises remaining in the public sector should be governedby commercial criteria and given adequate operational autonomy once theirobjectives have been clearly defined and criteria for their performance havebeen determined. It is hoped that GOB will also act, over time to implementa further recommendation that, wherever possible, subsidies to the publicsector corporations should be made explicit, especially where losses accruedue to government actions or the adoption of non-commercial performancecriteria.

5.24 GOB has also recognized that in the absence of an adequate managementinformation system (MIS) and financial controls to facilitate performancemonitoring it will not be possible to resolve the conflicting social andcommercial goals nor will it be possible to measure explicitly the realsubsidies in the public sector. A special unit has been set up in theAutonomous Bodies Wing of the Department of Finance to develop and implementpublic enterprise monitoring system; the work of this unit is being fundedunder a UNDP technical assistance project.

5.25 These programs aimed at reorganization and consolidation have beenaccompanied by a process of capital restructuring and financial rehabilita-

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tion of the selected public sector statutory corporations. A review of thecapital and debt structure of 17 public sector corporations by the FinanceDivision led to two major changes; firstly, large amount of debt was con-verted to equity (to the amount of Tk 5.5 billion) or grants (Tk 1.3billion); second, after determining appropriate debt se.vice payments thedebts were rescheduled. By the end of February 1984, 7 more corporationshave been dealt with and an additional debt of Tk 650 million has been con-verted to equity. Up to February 1984, the government has also extendedadditional equity to the extent of Tk 900 million to various public sectorcorpora-2ions. The t-.nsfer of ownership of individual establishments to thesector corporations which would be converted into holding companies is beingconsidered. This move aids in internal resource mobilization by the corpora-tions which will enable them to write off the profits of one enterpriseagainst the losses of another. By reducing the tax liability, it will reducethe corporations' dependence on ADP for investments. Further, separate debtservice collections have been authorized directly from the Annual DevelopmentPlan (ADP) allocations. These measures have gone some way in restoring thefinancial viability of the public sector corporations although the problemsare far from resolved. Progress has also been made towards closing thegrowing gap debt service liabilities (DSL) of public corporations to thegovernment and actual collections. Special procedures are now being appliedto recover DSL from agencies unable to pay, whereby DSLs are directlydeducted from the ADP in quarterly installments.

5.26 Attempts have been also made to make public enterprises (as well asprivate firms) more competitive in winning supply contracts in foreign aidedgovernment projects. In 1982, domestic producers supplying goods againstforeign exchange were given access to duty drawback on imported inputs toeliminAe. negative protection on their outputs. From September 1983, allincentives available to exporters (such as XPL, rebate on income taxes, dutydrawback and rebates on insurance premiums) were also granted to all locallymanufactured products sold against foreign exchange. To eliminate the delaysin the duty drawback system and the resulting costs, exporters are entitledto use bonded warehouse facilities under new arrangements introduced in theFY85 budget. It is too early to conclude how effective these policies willbe in helping local producers to be more competitive contracts.

5.27 A further important policy measure, needed to restore autonomy and toallow the public sector corporations to be held responsible for theirperformance, is to allow for greater autonomy in setting their prices. Inthis context GOB has given mixed signals. On one hand, public sectorenterprises have been given greater leeway to adjust prices; for example,they can adjust prices by 10% to cover increased foreign exchange costs ofimported inputs or increased energy costs without government approval.However, any price increase still requires government concurrence, which isby no means automatic. Furthermore, gove-knment announced large wageincreases starting in April 1984 and made them retroactive for some groups ofworkers without giving the corporations the automatic right to pass on theincreased cost.

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5.28 It is very difficult to assess the results of these policies due tcthe lack of adequate data to make the necessary comparisons. There are,however, some indicators of improved performance in the PSEs. These includean overall improvement in profits (or a reduction of losses); a redueedpercentage of the budget and the ADP being used to write off PSE losses anddebt service liabilities and considerable reduction since FY83 on publicsector borrowing to finance PSE operations and liabilities. In the broadindicators of Public Industrial corporations are presented in Table 5.7,ratios of profits to sales of PSEs have improved significant'ly since FY82,while their net borrowing from the banking system has decreased significantlyin FY83 (largely due to conversion of part of their debt into equity) moreimportantly, it did not increase at all in FY84.

Table 5.7: PERFORMANCE INDICATORS OF PUBLIC INDUSTRIAL CORPORATIONS Ia

Profit-Sales Net BorrowingNet Profits /b Net Profits Profit-Sales Ratio from the

(All (Excluding Ratio (All (Excluding Banking SystemCorporations) BJMC) Corporations) BJMC) Z Change

1973/74 5 229 - 7.31974/75 -271 100 -4.4 2.41975/76 -507 -142 -6.1 -2.61976/77 -759 -251 -8.2 -4.01977/78 -1,081 -132 -8.8 -1.61978/79 -489 96 -3.6 1.11979/80 876 -186 5.3 -1.8 68.61980/81 5Fs 248 3.0 1.9 30.21981/82 -90'i -249 -4.6 -1.9 31.61982/83 912 707 5.1 5.8 -28.11983/84 717 652 3.2 3.8 0.6

/a In Table 5.7, net profits are given for total public manufacturingcorporations with and without BJMC. The reason is that because of worldmarket conditions, the profitability of BJMC shows large fluctuations,which have more to do with differential price changes between raw juteand jute products than with its management.

lb Net pre-tax profits. Negative sign denotes net losses.

Source: Statistical Annex Table 5.7.

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5.29 Through the implementation of the NIP, including NIP and large-scaledivestments, the public manufacturing sector has been streamlined, and someattempts have been made to give greater autonomy to the corporations.Howe,er, there are two outstanding issues that have not been completelyresolved. These are: (a) the problems of the perennial loss making unitsand; (b) the future role of the public sector in manufacturing.

5.30 Public corporations have inherited a number of large, unprofitableunits which have to be restructured and rehabilitated if they are to becommercially viable. However, this restructuring should be carried out in away which does not add an undue burden on downstream industries. Successfulrestructuring will require plant by plant engineering studies, the iden-tification of prospective markets as well as the cost-benefit analysis ofrehabilitation. A management conrract which has been signed between FabriqueNational (FN) of Belgium and Bangladesh Machine Tools Factory (BMTF) is astep in this desirable direction. Specific solutions should be formulatedfor each major enterprise, taking into account their special problems.

5.31 As the reorganization of pubLic industrial units progresses and aneffective system for monitoring the financial performance of publicenterprises is put into place, attention should also be given to clarifyingthe future role and objectives of public investment in economic enterprises.For the remaining public industrial units, a general policy framework shouldbe drawn up, setting out guidelines for future investments, if any, by theseenterprises. The New Industrial Policy currently limits public industrialinvestments to areas that the private sector will not enter: such broadguidelines may give adequate assurance to private entrepreneurs, but wouldneed some elaboration to guide detailed investment decisions for publicindustry. For those industrial units which are operating profitably, theguidelines may appear to preclude investment in an additional capacity.However, no corporation can be expected to retain high efficiency and moralein the absence of some growth and evolution. If such units are to beretained under public ownership, it would be reasonable to permit them tomake some investments, provided they were financed without the need foradditional government equity or guarantees for borrowing. The nature of suchinvestments financed from the enterprises own resources could be left up tothe enterprises so long as they are in areas closely related to their exist-ing range of products.

5.32 The converse of the existing NIP guidelines could also be interpretedto mean that public investment should be undertaken in all fields of industrywhich are consilered to have priority, but where the private sector appearsto be unwillivg to invest. This would not be an appropriate policy: in manysub-sectors private investment is absent because of a perception that invol-vement in thase activities would be either inadequately profitable or toorisky. There is no obvious reason to assume that public investme.at in thesesub-sectors would prove more profitable or less risky: given its limitedresources, GOB should be just as reluctant as private entrepreneurs to under-take unprofitable or risky investments. Before such investment decisions are

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taken, a careful examination should be made of GOB policies affecting thesub-sector to check whether its profitabiLity is being inadvertently undercutby protective or fiscal policies tailored to other sectors. It may also bepossible to reduce the risks inherent in certain sectors without the publicsector assuming all of these risks. However, there are some other subsectorsin which the private sector might be unable to undertake investments notbecause it is unprofitable, but because the large size of the investmentsthat are required are beyond their capacities. Under such circumstances,public enterprises could have an-important role to play, possibly in someform of cooperation with private enterprise.

C. POLICY CHANGES AFFECTING THE PRIVATE SECTOR

5.33 Policy changes to improve the economic environment for privateindustrial activity have also been comprehensive in nature and are designedto spur private industrial growth, to increase private investments bothdomestic and foreign in the industrial sector and, above all, to provideincentives for a rapid growth of non-traditional industrial exports. Theserecent policy measures can be grouped into five categories: (i) incentivesfor accelerating investments; (ii) export incentives; (iii) importliberalization; (iv) incentives for foreign investments; and (v) industrialfinance: each of these is discussed below.

5.34 Investment Incentives and Licensing. Investmen: policy is designedto promote private industrial investments and guide these into backward areasand what are perceived to be "priority sectors" including concessions onimport duties and taxes for investments in backward areas, the liberalizationof the investment licensing (sanctioning) procedures and controls as well asthe promotion of insurance against foreign exchange risks.

5.35 To encourage increased investments, new industries have been grantedaccelerated depreciation provisions. Import duties in machinery destined foruse in backward areas as well as for industries using 70% or more indigenousinputs have been reduced from 15Z to a nominal 2.5%. Tax holidays have beenextended to new industries for 5 years after initial investments (9 yearsin backward areas) and the fees for investment licensing and import permitshave been reduced for industries in backward areas.

5.36 The Government announced its intention to dismantle all controls onlicensing private investments, to be implemented in a phased manner. Underthe revised 1982 Industrial Investment Schedule (IIS) only six industries arereserved for public investments (arms and munitions, atomic energy,telecommunications, air transportation, the generation and distribution ofelectricity and mechanized forestry), while another 13 have been placed onthe concurrent list of sectors in which both public and private invesrmentsare allowed. The number of industries in which explicit sanctions forinvestment are required has been significantly reduced. Consideration isbeing given to moving towards a "negative list" system of sanctioning underwhich a list is compiled of only those sectors in which private investments

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will not be allowed or for which investments sanctions will be required,leaving the private investments to be undertaken without sanctions in allother sectors. The introduction of such a list would reduce the government'srole of oversight and control of investments and allowing GOB to concentrateits policy deliberations to a smaLler number of sensitive sectors.

5.37 The number of industries freed from requiring any sanctions has beenincreased from 19 to 49; these industries require no sanctions for newinvestments provided that the capital goods imports for these sectors arefinanced via the Wage Earners Scheme (WES), the Export License Scheme (XPL),by suppliers credits or by non-repatriable direct foreign investments. Tostreamline the sanction procedures for other sectors, the Director General ofIndustries (DGI) has set up an Investment Assistance Unit to provide a "onestop" service to handle all licensing requirements of private investors. Inaddition, the authoritv to sanction investments on smaller projects has beendecentralized to regional offices and time limits have been placed on sanc-tioning loans and authorizing disbursements against imports. The commercialbanks and the DFIs have also been given authority to approve investments andto provide working capital. Finally, ceilings on private investments are tobe withdrawn. These steps have gone a considerable way to reduce the bot-tlenecks introduced by the investment sanctioning procedures and willdefinitely have a positive effect once the system is better understood andput into wider operation. There are already some preliminary indicationsthat imports of capital goods under WES market have increased significantlyand surpassed the imports under cash licenses in the first quarter of 1984 inspite of around 10% premium in the WES market. This is one indication thatthe ease of acceGs to capital and foreign exchange may be just as importantas its price.

Export Incentives

5.38 The most important incentive for increasing exports has been theexchange rate policy pursued since 1982 which provides for avoiding anincrease in the real effective exchange rate and entails a gradual deprecia-tion of the nominal exchange rate and entails a gradual depreciation of thenominal exchange rate to the extent the rate of domestic inflation exceedsthat of Bangladesh's trading partners. This poiicy not only makes allexports more competitive, but also economizes the use of scarce importedinputs into the non-traditional sectors. The exchange rate regime has alsobeen used creatively to allow a more efficient allocation of scarce foreignexchange for essential inputs needed by exporters. This is beinL achieved bythe use of Import Entitlement Certificates (IECs) given to the exportersthrough the Export License Scheme (XPL). The IECs allow all exporters to beentitled to import goods to an amount equal to a certain percentage of thevalue of goods exported. All non-traditional exports have beer madeautomatically eligible for a 40% entitlement. At the same time, the entitle-ment rates have been raised and many products have been moved to 60% and 80%category. These IECs earn an exchange rate premium (the WES rate) when soldon the foreign exchange market. Since foreign exchange for imports under the

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XPL system are obtainable at the official exchange rate, IECs also serve asan export incentive. The innovative feature of the scheme (at least in theBangladesh context) is that IECs are freely transferable and can be sold andtraded in the secondary foreign exchange market along with foreign exc.angeavailable under the WES. This is an efficient as well as flexible systembecause it increases the foreign exchange pool from which potential importerscan meet their requirements and the highest bidder to actually obtain theforeign exchange he needs.

5.39 A notional Import Duty Drawback Scheme (IDDS) for exporters wasintroduced in 'q82 and the coverage of this scheme has been graduallyextended to 14 commodities. This scheme was instituted mainly to eliminatethe costly delays experienced under the previous duty drawback scheme and isimplemented through a bonded warehouse system. The notional IDDS is comple-mented by liberal export credits. This has facilitated the dramatic increasein the exports of ready-made garments whose value has grown from negligibleamounts in FY82 to US$11 million in FY83, US$31 million in FY84; preliminaryestimates indicate that ready made garments exports may be close to US$130million in FY85.1/ If these policies and the realistic exchange rates can bemaintained, there is no reason why the success in ready-made garments cannotbe extended into other labor intensive products.

5.40 Other measures taken recently to promote and diversify exports alongnon-traditional lines include: increased tax rebates on export incomes frcn30% to 50%; reduced duties on capital imporcs; liberal credits of up to 90%of exporters' working capital requirements; quicker processing of exportcredit applications by the central bank; revised loan repayment terms (theinterest rates on export credits have been reduced from 11.5Z to 9% and forrefinancing from 8.5% to 5Z by the Bangladesh Bank 2/), the easing of travelfacilities and regulations for business travel and special rebates on firea.,d marine insurance. All of these incentives have also been extended todomestic production of inputs used in the manufacture of export products andimport-replacement products sdpplied under donor procurements, thus removinganomalies in the incentive structures. In addition, the Bangladesh Bank hasset up a special office to monitor and review export financing and specialexport credit units are also being set up in the NCBs; it has also initiatedan Export Credit Guarantee Scheme with refinancing rates being lowered from9Z to 8%, and is expediting existing claim settlements against the scheme.

1/ Growth of ready-made garment exports was also aided significantly bythe ability of these producers to import capital goods under WES withoutrequiring formal investment sanctions.

2/ Jute and jute products have been excluded from these lower rates thatwent into effect in July 1983.

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5.41 In response to these incentives, in spite of a vorld wide recession,the non-traditional 1/ exports in US dollars have grown by 11.4Z in FY82,19.5Z in FY83 .nd 43.5% in FY84. The share of non-traditional exports intotal exports have gone up from 25.7Z in FY82 to 35.7% in FY84. The projec-tions for FY85 indicate the continuation of the past trends.

5.42 One significant emerging problem is that, in response to extremelyrapid growth of garments exports, most developed countries have starteddiscussions on placing quotas on garment exports from Bangladesh. The bulkof garment exports from Bangladesh are concentrated on a small number ofproduct lines (e.g., cotton shirts and coats), and quotas are expected onthese lines in the near future. At the same time, capacity expansion toproduce the same lines has accelerated. It is expected that by the end ofFY86 there would be close to 450 garment factories in operation with 802 oftheir capacity primarily in the four areas threatened by quotas.2/Therefore, unless attempts are made for rapid diversification and a veryefficient quota monitoring and allocation system is introduced, the resultmight be wide-spread losses with an adverse effect on the future of this veryimportant sector. Given the importance of this export sector both in termsof employment and export earnings, it is imperative that both the quotamonitoring and allocation systems should be developed with close cooperationof the representatives of the garment industry, so as to assure the transi-tion to a quota system with minimal disruption.

Import Liberalization

5.43 In addition to improved incentives for exports, measures to liberal-ize imports have also been undertaken. The WES/XPL market in which remittan-ces and IECs can be exchanged at a premium, has been expanded significantlyand more goods have been made eligible to be imported under WES. The majoradvantage of importing under WES is the avoidance of lengthy processes ofimport licensing; Government is in the process of liberalizing the importregime further by moving to a "negative list" for imports, where goods notincluded in the "negative list" would be freely importable under WES. The

1/ Non-traditional exports are defined as all exports except raw jute,jute manufactures (excluding jute specialty products) and tea.

21 These cycles of overinvestment are not limited to garments but is beingexperienced in most of the other subsectors. The primary reason seems tobe lack of real risk-taking by entrepreneurs, which operate on theassumption that loans given by the banking system are not expected to bepaid back. Thus, the capital costs of the project are treated as beingclose to zero. In such an environment, a project is treated as viable ifthe revenues cover just the variable costs. The creation oc excesscapacity also lowers the rates of return on the projects of more genuineentrepreneurs, thus tending to create a vicious cycle of non-repayment.

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share of imports financed via the WES/XPL schemes has risen from 8Z in FY79to around 21X of a growing and varied import bill in FY84 (if aid and goodsimported under donor agreements are excluded, this share increased from 12Zin FY79 to 42Z by FY84).

5.44 In July 1983, GOB initiated a Foreign Exchange Risk Insurance schemeto give some protection to those investors who have taken loans denominatedin foreign currencies. With the continual depreciation of the Taka, suchloans and their interest charges have come to present a major burden to manyinvestors, depleting their cash reserves, reducing profitability and in somecases threatening the viability of their undertakings. Under this scheme,investors are required to pay a 2.5% insurance premium - over and abovetheir loan rate - to financing institutions to protect them against foreignexchange risks. This premium is deposited with the Bangladesh Bank, whichthen bears all exchange rate fluctuations. The scheme also has some retroac-tive provisions in that it allows a proportion of the debt liabilities aris-ing from exchange rate fl1u;tuations (30% of the loan value for those loanstaken before 1975 and 50Z of the Loan value for loans after that are eligibleto be converted into equity by lending agencies). The scheme is relativelynew and the evidence to date suggests that new investors have not had anyextensive recourse to it. A potential problem inherent in this scheme isthat in some circumstances the Bangladesh Bank could then be left with con-siderable risks to cover. It is extremely important that exchange rateadjustments which are warranted to avoid an appreciation of the real effec-tive exchange rate of the Taka should not be delayed or avoided in order toavoid such losses. If Bangladesh Bank anticipates that domestic inflationrates cannot be limited to stay cLose to international inflation rates, thisscheme will require higher premiums or will have to be redesigned ordiscontinued.

5.45 Both the measures for promoting exports and liberalizing imports andproviding access foreign exchange to all potential importers have workedreasonably well because they have also been accompanied by a considerableliberalization of price controls in the domestic market. The EssentialCommodities Act had hitherto allowed the Commerce Division to exercise con-trols over the prices of "essential" manufactured goods. These controls havenow mainly been abolished. The number of items subject to price controlshave been reduced from 47 to four (newsprint, infant milk foods, cement andpharmaceuticals).

5.46 Although the import regime has been significantly liberalizea, onlya modest beginning has been made towards the rationalization of the protec-tion system. GOB has made some progress towards eliminating the differentialrates of protection among similar products. In FY84 for example, customsduties on imported inputs and on finished products have been equalized amongdifferent types of textiles, i.e., cotton, synthetics and mixed blends.Further rationalization may follow GOB's review of the findings of the TIPconsultant team which has been commissioned by GOB: their findings areexpected to be finalized during 1985.

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Incentives for Foreign Investments

5.47 The NIP envisages a growing role for foreign private investments andseeks to encourage them. The Foreign Private Investments (Promotion andProtection) Act of 1980 was drawn up to favor foreign investments in whichspecific technology transfers would occur and, better use could be made ofdomestic resources to improve the balance of payments situation, to provideadditional employment and to contribute to higher growth in the industrialsector. This Act gave assurances on protection against non-business risks,on profit and capital repatriation and on compensation in case ofnationalization. More recently a special Foreign Investment Cell has beenset up in the Ministry of Industries to monitor foreign investments.

5.48 Bangladesh has also opened an Export Processing Zone (EPZ) inChittagong where wholly owned foreign enterprises can set up shop to takeadvantage of the large pool of extremely low cost labor. The incentives inthe EPZ include a 5-year tax holiday and complete exemptions from customsduties. This initiative has so far met with only limited success. Fourfactories (all garment) have started production in the EPZ. An additionalten factories are expected to start production by the end of FY85.

Industrial Finance

5.49 Term lending for the industrial sector in Bangladesh has been carriedout primarily by the two development finance institutions (DFI), BangladeshShilpa Bank (BSB) and Bangladesh Shilpa Rin Sangstha (BSRS). In recentyears, commercial banks have also engaged in term lending mostly for smallscale industries. The two DFIs have experienced financial problems sinceindependence, primarily because they have not been able to collect theirloans. BSB's cash collection rate as a proportion of payments due havefluctuated between 5% and 50% over the last decade. It has been as low as30% in FY82, 18% in FY83 and 16Z in FY84. BSRS's performanL: has beenslightly worse. The collection rates for industrial lending by the commer-cial banks are higher but still less than 50% as of FY84. Thus, as of FY84,almost 80% of the outstanding loans are not being paid back.

5.50 As noted above, the poor repayment record can be attributed to amixture of inappropriate projects coupled with a general environment in whichthese debts were not expected to be repaid: it is not clear what proportionof arrears are caused by willful defaults and what proportion is caused by

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firms in serious difficulty.l/ The process of liberalization and movement tofree markets are justified on the basis that, by progressively reducing thedistortions in the price system, it would lead to more efficient allocationof resources. However, in an environment where industrial loans are notexpected to be paid back, the effective price of capital becomes close tozero or even negative. Under such circumstances, it should not be surprisingto find considerable misallocation of resources to sectors that have littlelong run viability. It can be argued that the distortions created byindustrial term finance in Bangladesh have become the most important bot-tleneck to the creation of a dynamic and efficient industrial sector. Unlessserious actions to re-establish financial discipline are undertaken, themisallocation of resources created by industrial term finance will mitigatethe positive effects that are expected from the New Industrial Policy.

5.51 To address the problems of these development finance institutions, aUNDP financed study on the institutional review and portfolio audit of BSBand BSRS has been completed and the recommendations of this study have beenevaluated by GOB. These recommendations were also discussed in a meetingheld in Dhaka in February 1985 which included representatives from GOB, IDA,ADB, KfW and UNDP. In this meeting a m2morandum of understanding was signedby the attending parties, setting out the future course of action to be takento reform the DFIs. By the end of May 1985, GOB will prepare a specificaction program to implement an effective debt recovery system and to create amore healthy industrial financing environment. This action program and thetimetable associated with it will contain the following elements agreed inthis meeting.

a) A restructured BSB will function as the primary lending institu-tion in Bangladesh, while a restructured BSRS will keep itspresent portfolio but move towards an institution that willsupply technical and management services for defaulting companiesas well as supply industrial promotion, research and consultancyservices;

b) The Orders of BSB and BSRS will be amended i) to allow theirboards and managements full autonomy in areas such as appointmentand dismissal of staff, staff compensation policies and lendingand other operational policies; ii) to allow foreign equicyparticipation from foreign financial institutions and the privatesector; and iii) to allow adequate private sector representationon their boards;

1/ In a study of repayment performance, Sobhan and Mahmood have not beenable to find significant differenced in repayment rates by size, sector,region or lending institution. See R. Sobhan and S. A. Mahmood "Repay-ment of Loans to Specialized Financial Institutions in Bangladesh"Bangladesh Development Studies, (Winter, 1981).

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c) The action program will also include i) a comprehensive statementfrom GOB summarizing the effective legal remedies that will beavailable to DFIs; ii) adoption of formal arrangements amongrelevant GOB agencies and financial institutions for denial ofadditional credit lines and import licenses to the defaulters offinancial institutions; and iii) to facilitate tracking ofdefaulters, BSB will streamline and formalize a "credit clearinghouse"; and

d) For purposes of efficient implementation of the action program, acoordinating advisory committee will be established and it willinclude, in addition to GOB representatives, a liaison repre-sentative nominated by the donor agencies.

D. OUTSTANDING ISSUES

5.52 In response to the poor performance of the manufacturing industryover the last decade, Government has taken bold steps to change theindustrial policies, particularly through the liberalization of investmentsanctioning and of import policies through the WES/XPL market. To anincreasing extent, imports of both capital goods and raw materials in thesectors open to private investment as well as the raw material imports formost other industries are being channeled through the WES market. The futureof these successful policies will depend crucially on the continuedavailability of foreign exchange in the WES market. In FY83 and FY84,favorable flows of remittances together increased non-traditional exports onthe supply side and a domestic recession on the demand side, have enabled theliberal import policies to work without any foreign exchange bottlenecks. InFY85, with the reflation of the economy and declines in the remittances, theliberal import policies were maintained only by rapidly drawing down theforeign exchange reserves. Although some of the excess demand in the WES iscaused by unsustainable increases in the money supply and inadequate adjust-ments in the exchange rate, there still remains a structural gap that willhave to be filled by some alternative source of foreign exchange. In theabsence of flexible and astute management of the secondary foreign exchangemarket and the official exchange rate, the positive effects expected from theNIP might not be realized.

5.53 With increasing liberalization and privatization of the industrialsector, the role of the financial institutions in channeling resources tomost efficient areas have become even more important. The success of newindustrial policies depend on the reforms in the industrial term finance:GOB should take further, vigorous and effective actions to change theprevailing atmosphere in which debt to financial institutions is not expectedto be repaid; and, at the same time, Government should acknowledge thatinappropriate projects have been set up in the past and, wherever feasible,every attempt should be made to rehabilitate and restructure theseenterprises. Finally, the DFIs should be restructured in a way that can

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avoid the problems encountered in the past. For this purpose, it is veryimportant that the action program to be developed by GOB should be imple-mented without hesitation in a coordinated and consistent manner.

5.54 Through the implementation of NIP, the public manufacturing sectorhas been streamlined, and attempts have been made to give greater autonomy tothe sector corporations. If these policies are successful many of the unitsshould be generating internal funds that can be used for investments.However, the future role and expected directions for growth of these corpora-tions have not been clearly delineated. For these units, a general frameworkshould be drawn up, setting out guidelines for their future role in theeconomy. More specifically, the Government has to:

(a) redefine the relationship between GOB and PSEs both in termsof financial flows and future investment patterns;

(b) define the relationship of PSEs vis-a-vis the private sector;and

(c) separate the problems of perennial loss making units and developa program of action to address these problems.

5.55 Although an extensive number of policy reforms have been initiated,sectoral incentives and the protection system are still characterized byad hoc rules and inconsistencies. General incentives as well as the systemof protection have to be rationalized to reduce the distortions which remain,in order to help create an environment where resources can be allocated in anefficient manner.

5.56 Through the Notional Import Duty Drawback Scheme, XPL and the main-tenance of realistic exchange rates, non-traditional exports have shown anincreasing trend in the last few years, albeit from a very small base. Giventhe natural resource constraints of Banglae-sh, a rapid growth of theindustrial sector will depend on the availability of imports. That is,directly or indirectly, the import content of domestic production isextremely high. Without rapid growth of exports, a sustained and reasonablyhigh rate of industrial growth is not possible. Even if the domestic demandgrows rapidly due to developments in other sectors, the supply to met thisdemand will require additional imports that will have to be paid for bygrowing exports. Therefore, it is important that the relevant institutionsshould be strengthened and the policies to develop a diversified exportsector be maintained and improved.

5.57 Finally, the lack of comprehensive and reliable industrial statis-tics in Bangladesh have been pointed out throughout this chapter. It isvital for appropriate policy decisions to have access to reasonably accurateand representative industrial statistics. For this purpose efforts as wellas resources should be directed towards improving the coverage and timelinessof the industrial statistics produced hv the Bangladesh Bureau of Statistics.

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Chapter 6: DEVELOPMENT ADMINISTRATION

6.01 The strengthening of institutions and management capabilities remainsas an essential component of the effort to promote economic development inBangladesh. Further improvement of the quality of development administrationwould offer an opportunit- to accelerate the growth of the economy at rela-tively low financial cost. The need to improve development administrationhas been clearly recognized by COB and a remarkable number of reforms hasbeen initiated and, in many cases, implemented since 1982. The reforms havebeen aimed at:

- improving the efficiency of public enterprises;

- review of public service compensation policies;

- delegating important responsibilities to local government; and

- accelerating project implementation.

Public Enterprises

6.02 As discussed in Chapter 5, a number of important steps have beentaken which have already been effective in improving the profitability andreducing the borrowing requirements of public enterprises. As the reor-ganization of public industrial units progresses and an effective system formonitoring the financial performance of public enterprises is put into place,attention should also be given to clarifying the future role and objectivesof public investment in economic enterprises. For public enterprises ingeneral, not just those in the industrial sector, clearer guidelines arerequired in order to avoid conflicting objectives. As in many countries,public enterprises in Bangladesh are expected to pursue social as well ascommercial objectives. This requirement can undermine performance if thetrade-offs are not clearly understood; for example, if results cannot bemeasured against clear expectations, losses can be attributed too easily tosocial pressures, concealing problems which may be due to poor management.The potential for conflict arises most frequently between comercial profitobjectives and social goals which may be pursued by using public enterprisesas (a) a means of providing employment in excess of levels consistent withefficient operation; or (b) as a means of providing implicit subsidies toconsumers by setting prices which do not reflect the long-term real marginalcost of efficient operations. If the costs and benefits of pursuing suchobjectives could be quantified and the subsidies involved made explicit, theGovernment would be in a far better position to judge the merits of usingcoumercial enterprises for non-commercial operations.

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Public service compensation

6.03 In addition to completing a major exercise aimed at streamlining thestructure of the central government, GOB has also begun to address the impor-tant issue of public sector compensation. It has been more and more clearlyrecognized that the real value of public salaries has been considerablyeroded during the years since independence and that public service compensa-tion (comprising salaries and other incentives) needs to be improved in orderto enable the public sector to attract, retain and motivate adequatelyqualified personnel. An initial round of public service salary increases ofaround 30% were awarded in May 1984, partly as a reaction to industrialaction. These increases have been far less than the erosion of real salariesover recent years, but have been sufficiently large to make it clear thatmaking good all of tha deterioration of salaries which has occurred over thewhole of the past decades for all civil servants would be extremelyexpensive. On the other hand, some adjustments would be warranted, providedthat they could lead to an enhanced quality of administration and to a fasterpace of project implementation. GOB's review of the forthcoming recommenda-tions of the National Pay Comi-Ussion will provide an opportunity for a moreconsidered and selective approach to these difficult problems.

6.04 A viable longer-term strategy for public service compensation willneed to deal with the issue of different4%ls, rather than awarding across theboard increases in the interests of maintaining "equity.'t It must be recog-nized that a compression of civil service salary differentials would only bea very partial approach to improving the distribution of ove.aLl nationalincome: for most of the population, a secure government job at the lowestlevels is very attractive even at present salaries. Salary differentialswill need to evolve over time to reflect the significant differences betweenthe responsibilities at the upper and lower end of the civil service and thedifferent alternative employment opportunities available to those with dif-ferent qualifications and experience.

6.05 Increased attention will also need to be given to the composition ofthe compensation package comprised of salaries, perquisites (such as freetransportation) and the availability of some goods and services at explicitlyor implicitly subsidized prices. Partly in reaction to the squeezing ofsalary differentials, the compensation of more senior civil servants dependsto a substantial extent on benefits such as overseas training, orientationtravel, the provision of vehicles or the permission to take on consultingwork. The availability of such perquisites can be a significant supplementto the total value of compensation, but leaves disposable cash incomes verylimited. The progressive "monetization" of such perquisites could allowcivil servants to allocate their disposable (as against notional) incomesmore in line with their preferences.

6.06 Many services, ranging from housing, water, sewerage, electric power,natural gas to foodgrains are available to urban middle-class consumers,including civil servants at subsidized prices. These subsidies, which are

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sometimes significant and most often implicit, are often considered justifiedand will prove extremely hard to remove because of the perception that thepurchasing power of the civil servants benefiting from these subsidies hasbeen considerably diminished by past inflation. If the benefits conferred bymeans of these subsidies are considered to be essential to provide an ade-quate total value of compensation to civil servants, then serious considera-tion should be given to coordinated (though not necessarily fully offsetting)policy measures to improve the salaries while, at the same time, phasing outsubsidies such as those on foodgrains and public utilities. The implementa-tion of the recommendations of the National Pay Commission would offer anopportunity to begin such a process. While civil servants could be left witha not greatly different value of total compensation, there would be a sig-nificant difference in the financial situation of a number of publicutilities, particularly those providing urban services (see Chapter 11). Ineffect, public servants would be paid enough to allow them to pay the fullcost of the public goods and services they receive. This would be consistentwith maintaining the financial viability of the public utilities providingthese services and wou'd be preferable to the present situation of indirectlycompensating public servants by means of equity injections to publicutilities in order to offset losses they incur by providing services at belowcost.

6.07 A gradual approach to "monetizing" a larger part of the total compen-sation package by reducing subsidies at the same time as salaries areincreased should not be confused with a policy of automatic compensation ofcivil servants against all cost increases. No nation can afford to providesuch guarantees to its civil servants at all times. Nevertheless, it shouldbe recognized that a regular review mechanism is needed to adjust salaries inthe light of changing responsibilities, opportunities, trends in availableresources as well as changes in domestic price indices. While full andunconditional "indexation" of civil servants salaries would impose anintolerable degree of rigidity into fiscal management, allowing several yearsto pass before making any adjustments for inflation or other factors is boundto lead to costs, inequities and distortions which, as experience shows, canprove all but impossible to correct.

Decentralization of Administration

6.08 The 1984 CEM discussed the reasons for COB's major initiative todecentralize powers and delegate responsibilities to the Upazilas (sub-districts). The main objectives of the devolution of authcrity and decisionmaking, based on past experience with promoting rural development, are:

(i) to encourage local participation in identifying, planning andimplementing development projects;

(ii) to ensure coordination of many government agencies operating atthe local level; and

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(iii) to foster self-reliance through the mobilization of localresources.

These objectives are to be achieved through a revised administrative systemwhich makes Upazila the focal point of all development activities, and effec-tive local governments. The Upazilas are to be administered by a Council,the Upazila Parishad,l/ headed by a diirectly elected chairman, who will ha-eeffective control over the activities of all government officials posted atthe Upazila level. The administrative reforms provide for upgrading thestaff at the Uipazila level in order to ensure improved administr:tive,managerial and technical capacity for providing appropriate services to thepeople. The Government has also established an 'Upazila Development Fund,'and given additional revenue raising powers to Upazilas in order to promotelocal resource mobilization and encourage local initiative designed to solvelocal problems. Furthermore, the reforms provide for a reduction in thenumber of layers of Government between the village and the center by abolish-ing sub-divisions and divisions.

6.09 Tne 1984 CEM also set out several crucial issues which needed to beresolved if the decentralization program was to achieve its statedobjectives. These issues pertained to leadership, training in the techniquesof planning and budgeting, identification of projects, local revenue raising,accounting and auditing, and monitoring and evaluation of the program.2/

6.10 During 1984, the Government's attention was focussed on makingdecentralization operational: appointing staff at all levels, constructingoffice and living space for the officials, organizing orientation and train-ing for the Upazila Nirbahi Officers (UNO)31 and Upazila Finance and PlanningOfficers (UF&PO), working out administrative and budgetary details of deput-ing line ministry officials to the Upazilas, and developing a mechanism formonitoring the Upazila Development Fund. In addition, the Governmenteliminated one layer of administration (sub-divisions) by upgrading thepreviously existing sub-divisions into districts; there are now 68 districtsin aLl compared to 22 existing before decentralization reforms. At theUpazila level, the process of local level planning and implementation ofprojects financed from the Upazila Development Fund was initiated following

1/ The Uoazila Parishads consist of elected chairmen of Union Councils andfour nominated members (voting members), and Upazila level officials(non-voting members).

2/ For a detailed discussion of these issues see Bangladesh: EconomicTrends and Development Administration, Bank Report No. 4822, February 27,1984, Vol. I, Chapter 7.

31 The UNO, or the Upazila Executive Officer, is the most senior publicservant posted at that level.

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guidelines issued by the Planning Commission. The basic administrativemachinery for decentralization is now largely in place. The onLy majorremaining step to be taken is the election of the Upazila Parishad Chairman;the Upazila elections, originally scheauued for Xarch 1984, have beendeferred indefinitely. Ib the interim, the UNO is acting as the Chairman ofeach Upazila Parishad. While substantial progress has been made in terms ofadministrative changes, the realization of decentralization objectives wouldseem to require some new approaches to guide the Upazilas.

6.11 Coordination at the Upazila Level: The main rationale fordecentralization was the realization that the process of rural development inBangladesh has been seriously hampered by the very inadequate coordination offield services at the local level as well as by the lack of popular par-ticipation in administration. The strategy is designed to remedy theseproblems by posting more senior officials at the Upazila, upgrading technicalstaff and making them accountable to the Upazila Parishad. These changeswere expected to make the management and operation of rural developmentprograms more efficient, and effective. The implementation of this strategyhas been impeded in two ways. Firstly, the deLay in the election of theUpazila Parishad Chairman has meant that the UNO, in addition to heavyadministrative duties, has also been required to perform the functions of theParishad Chairman. Secondly, the desired strengthening of the technical andmanagerial capability at the Upazila has had to be compromised to someextent, due to the limited availability of appropriately qualified staff.The situation was made more difficult by the creation of 46 new districtsrequiring additional senior level staff.

6.12 The Upazila Parishad has been designed to be the main coordinatingmechAnism at the local level. However, the Acting Chairmen have not beengiven any specific role in this process except to exercise discipline throughthe preress of writing annual confidential reports of the officers posted atthe UpazIla. Since the local heads of depArtments are members of theParishad, they are accountable to the Parishad, and coordination of theiractivities is expected to be carried out in the Parishad meetings. At thesame time, there are other officials in the Upazilas such as the Chairman ofthe Upazila Central Cooperative Association (UCCA), whoss role should also becoordinated, but are not under the direct purview of the Parishad. Fieldobservations and discussion with GOB officials in Dhaka suggest that thepowers of the Parishad are not yet completely understood. Social and cul-tural constraints inherent in the traditional bureaucratic/public relation-ship have also been observed to obstruct the full exercise of power by theParishads; for example, GOB officials are still addressed as "sir" by theUnion Parishad Chairmen (voting members of the Upazila Parishad) who continueto expect favors from the officials. Until the Parishads have an electedchairman, are aLle to raise their own resources and have substantial controlover the posting of officials, the effective control of this elected bodyover officials and their coordinating role will remain tenuous. The longerthe delay involved in election of the Chairmen, the more difficult it will be

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to establish a more desirable relationship between the comiunity and locallyposted officials.

6.13 The UNOs have been given an extremely difficult assignment and aheavy workload. They have dual responsibility and allegiance. On the onehands they are responsible for the very important range of functions retainedby the Central Government (such as maintenance of law and order, administra-tion of land revenues, granting of licenses, management of secondaryeducation, supervision of Union Parishad elections) and are accountable forthese to the Central Government. At the same time, they are also the chiefexecutive officers of the Upazila Parishad, responsible for planning andimplementation of development projects, running the office of the Parishad,conducting meetings of Parishads as well as controlling a large number ofstaff. The successful performance of these functions would require that theUNOs be given adequate and thorough training together with a status relativeto other local officials which is commensurate with the UNOs envisaged roleand responsibility. Neither of these requirements has been adequately met.The existing two-week training and orientation course for UNOs provided bythe Public Administration Training Center is not sufficient to train them fortheir important leadership role. Moreover, there is little differencebetween the status and salaries of UNOs compared with other officials in eachUpazila.l/ This makes it difficult to achieve the teamwork required for thecoordination of development activities, since the leadership capacity of theUW5s are often questioned by the heads of sectoral departments and agencies.=ne UNO is assisted by an Assistant Commissioner who also has to perform adual role: the Assistant Commissioners are 'magistrates' and support theULOs in managing functions retained by the Central Government; they also actas Planning and Finance offices of the Parishad. The Assistant Comissionersare, however, only probationary officers without relevant previousexperience. These problems of leadership and competenc2 of UNOs to perform awide range of responsibilities are serious issues which requires urgentresolution.

6.14 Cpazila Parisbad Resources: The two important and distinct featuresof the new decentralization initiative are the powers given to the UpazilaParishads to raise their own revenue and the block allocations provided fromADP throigh the Upazila Development Fund.

6.15 Lpazila Parishads are expected :o raise their own resources, espe-cially for maintenance and recurrent expenses. The revenue sources are,lowaver, relatively insignificant in potential. They include lease money onwater bodies, tax on professions and trades, street lighting tax, fees forfairs, exhibitions and tournaments, fees for licenses and permits, tolls on

1/ There are two grades of UWOs: one of these is similar to that of theAdditional Deputy Commissioner with a salary of rk 1,400 per month, whilethe lower grade receives Tk 1,150 per month.

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services and facilities maintained by the Parishads, and lease money fromhats, bazaars and ferries. However, most of the sources specified are alsosources of revenue for the Union Parishads and Pourashavas (urban councils)within the Upazilas. Therefore, since Upazilas must, in practice, avoid anysignificant double taxation on any items on which taxes and fees have beenlevied by the Union Parishaas or Pourashavas, these sources cannot beexpected to mobilize significant funds for the Upazilas. Some Upazilas haveleased out water bodies, but this source of revenue is rather limited and notavailable to all Upazilas. Unless Upazilas are given additional sources ofrevenue which tax the beneficiaries of development projects and which arewithin their capacity to collect, they cannot be expected to assume theresponsibility required to make meaningful progress towards the stateddevelopment objectives of the decentralization reform.

6.16 As the development responsibilities of Upazilas increase, they wouldneed substantial funds for maintenance and other recurrent expenditures.Furthermore, in order to increase the sense of financial responsibility andqualit7 of planning it is important that Upazila Parishads raise additionalrevenues from their own constituencies, particularly from beneficiaries ofdevelopment expenditure. While additional sources of revenue would be neededto achieve such objectives, land development or agricultural taxation appearto be the only likely substantial source of revenue for the Upazilas. Anyland taxes levied should be related to productivity rather than based simplyon the size of holding, it would also be appropriate to tax unused land. TheGovernment should seriously consider appropriate agricultural taxation withadequate share for the Upazilas. Whatever the sources, the Upazilas wouldalso need incentives to use their given revenue raising autonomy. It wouldbe reasonable, as recommended in the 1984 CEM, to reflect revenue raisingefforts within the formula for allocating grants from the Upazila DevelopmentFurd.

6.17 The FY84 ADP allocated Tk 1,660 million for development assistanceto Unazila Parishads: a little over half of these funds were spent beforeJune 30, 1984; the balance is to be carried forward to FY85. The allocationsto Upazilas in FY84 were made on an ad hoc basis, but future allocations forindividual Upazilas were to be related to a weighted average of measures ofpopulation (50Z), area (10%), extent of backwardness (20%) and performance(20%). However, ir the absence of agreed criteria for evaluating backward-ness and performance, and perhaps more importantly due to the possibleimplications of making widely varying allocations to different Upazilas, theGovernment has decided to provide an equal allocation of Tk 5 million to allUpazilas for FY85.1/ However, a system of equal grants is unfair to the moredensely populated Upazilas. Moreover, the availability of grants whose

1/ The first installment of Tk 2.5 million has already been released. Itseems unlikely that more detailed criteria will be used for the secondallocation in FY85.

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volume is not at all linked to performance is, in some cases, likely tobecome a substitute for what some Upazilas could otherwise raise from theirown resources. Tying a proportion of block grants to mobilization of localrevenues could provide a valuable opportunity for greater mobilization ofresources. It is therefore important not only to develop workable criteriafor measuring backwardness and performance, but also to provide additionalallocations as an incentive to local resource mobilization.

6.18 The total block grants to Upazilas for FY85 were budgeted at Tk 2,300million. In addition, the allocation of wheat under the Food-for-WorkProgram has been increased from 335,001 tons in FY84 to 410,000 tons, amount-ing to Tk 1,916 million 1/ in FY85. Adding the unspent portion of FY84,total resources available to Upazilas for implementing development schemes oflocal importance in FY85, thus, amounts to nearly Tk 5 billion, which repre-sents close to 15% of the originally budgeted FY85 ADP. Efficient utiliza-tion of resources of this magnitude requires considerable managerial andtechnical capacity for planning and implementation at the Upazila level; ifspent on building up the rural infrastructure which is badly needed tofacilitate production, locally available resources have the potential tocreate over 600,000 man-years of employment in construction activity forFY85. Furthermore, the Upazilas are also expected to perform agency func-tions on behalf of the Central Government for implementing 'divisible" com-ponents of selected ADP projects; these include projects relating to con-struction of family weLfare centers, godowns, aquaculture, development oflocal markets, rural forestry, etc. However, no arrangements have yet beenmade for transfer of corresponding ADP allocations to Upazilas, nor themechAnism for technical support and the supervision of implementation bynational and regional level officials has yet to be designed. This delay canbe attributed in part to a lack of confidence in the capacity of Upazilalevel staff to efficiently perform their responsibility, and to some reluc-tance by Ministries to give up their direct involvement and influence oversuch projects.

6.19 Monitoring of Performance and Training Requirements: During FY84,alL Upazilas prepared Upazila ADPs, based on guidelines and project prepara-tion instructions issued by the Planning Commission as well as several cir-culars issued by the Ministry of LocaL Government. Most of the Upazilas havesubsequently submitted reports on financial and physical achievements, butthese have not yet been evaluated. A preliminary survey of some of thereports shows that the Upazilas generally adhered to the guidelines forsectoral allocations: 25-35% for physical infrastructure; 30-40% foragriculture, irrigation and industry; 17.5-27.5% for socio-economicinfrastructure; 5-10Z for sports and culture; and 2.5-7.5% for miscellaneousprojects. There were some deviations from the prescribed sectoral

11 Valued at average retail price of Tk 175 per maund. The above grantsand alloca:ions are subject to review in the revised FY85 Budget.

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allocations, since many Upazilas found it difficult to identify appropriateprojects for agriculture and industry; most of the deviations were in favorof physical infrastructure projects - this also reflects the availablecapacity for planning and implementation of such projects.

6.20 Under the Planning Commission's guidelines, monitoring of theDevelopment Fund is to be carried out mainly by the Upazila Parishad itself,with periodic field inspection by the Deputy Commissioner (the highest rank-ing official at the district level). No systp-atic approach has beendeveloped to date for Deputy Commissioners to inspect projects and no addi-tional staff have been assigned to assist in this task. On the accountingside, officials have been designated at the Upazilas and district levels toundertake internal audits. The central ministries have been given aperipheral role of monitoring reports from the Upazilas, with occasionalfield visits by senior officers in the Central Government (Joint Secretaryand above). More recently, the Local Government Division has now been giventhe main responsibility for monitoring the implementation of the DevelopmentFund. The Planning Commission and the Cabinet Division also have smallmonitoring units staffed by 1-2 officials: the main focus of these twomonitoring units is on the implementation of the guidelines and on the per-formance of the officials, respectively. The Local Government Division isutilizing a small monitoring unit in the Works Program Wing (WPW), which wasoriginally intended to monitor the special programs under the WPW, such asthe Intensive Rural Works Programme. The unit has been expanded to includemonitoring of the Upazila Development Fund. It is staffed with twoengineers, one economist, one statistician and three statistical inves-tigators and has a micro-computer. The data base used by the LocalGovernment Division is the monthly expenditure statements prepared at theUpazila level. The monitoring unit has so far only been abLe to compile afew basic statistics on expenditures under the program, i.e., totalallocations, total expenditures and the sectoral allocations. A completelisting of projects is available in files maintained by WPW. Not all theUpazilas have submitted their end of the fiscal year reports (less than 20%are outstanding) so that the data are not yet fully compiled.

6.21 A pol_cy of enforcing adherence to rigid guidelines uniformly acrossthe country would have some serious drawbacks. It would make local adapta-tion and responses extremely difficult, causing unnecessary delays in plan-ning and implementation; it would not be able to conform to local needs andpotential and would discourage local initiative and drive which are so essen-tial for solving local problems. Issuance of guidelines on sectoral alloca-tions and general instructions on project preparation cannot be sufficient tobuild the necessary capacity for identification of locally beneficialprojects; such capacity can only be created by well-designed trainingefforts. An attempt to provide formal training courses to staff for 460Upazilas in different sectors would be a massive undertaking which the meagernational institutional resources may not be able to accomplish. Rather thanrelying on formal training, it may be preferable to set up a mechanism whichwould not only impart skills and knowledge to officials working in the

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Upazilas, but would also be designed to create commitment to developingprojects which would benefit the majority of the population.

6.22 Many Upazilas need assistance in initiating ideas for local develop-ment programs as well as in formulating and designing specific programsrelated to local problems and resources. It would therefore be highlydesirable that the Central Government play a leadership role in problemidentification and consensus building on the issues and areas of interventionand setting priorities. Such a positive role, rather than a potentiallynegative policy of monitoring adherence to detailed guidelines, would seemmore appropriate under the current circumstances. This means that theprescription of uniform guidelines and monitoring on paper could usefully bereplaced by a system under which carefully selected and well-trained teams ofcentral government officials would visit Upazilas regularly and would assistthem to formulate programs, design projects and to train local level staffthrough this process. These visits would also provide an opportunity tomonitor and evaluate local programs and to transfer knowledge and experiencefrom one Upazila to another. This mechanism of regular visits could be builtaround the present practice of occasional field visits by senior officialsfrom the Government who could lead these visiting teams.

6.23 The teams should include 2-3 local level planning experts. In thefirst instance, the visits would be designed to assist Upazilas in identify-ing local problems and potential and in setting priorities. The local levelofficials would then propose and design their own program to deal with theproblem areas identified. During subsequent visits, the teams would beavailabl! to work with Upazila officials on the detailed design of programthereby training them in the technical, organizational and economic aspectsof local Level planning and project implementation. In this way, differentprograms may emerge in different Upazilas rather than a single uniformnational portfolio. This outcome would, however, be more realistic since itwould be based on local needs and potential.

6.24 The Upazilas will differ in the degree of such assistance which theymay require. About 20 local level planning teams could cover the wholecountry on a two-years cycle of visits. This will, however, mean additionalresponsibility and more active participation by the senior officials of theGovernment. This is important in the Bangladesh context as only the seniorofficials can influence the local leadership and officials to work towardsthe national objective of popular participation and programs which wouldbenefit the majority of the population.

Project Implementation

6.25 GOB has continued its efforts to speed up the process of projectimplementation along the lines discussed in last year's economic report. Thenumber of projects in the ADP has been reduced further, progressively greaterautonomy has been given to agencies directly responsible for projectimplementation and improving customs and fund release procedures. However,

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these measures have not been sufficient to avoid a deterioration of proiectimplementation performance. As noted in Chapter 2, actual expenditure onthe FY84 ADP was around Tk 30 billion compared to the original estimate ofTk 34.8 billion. Disbursements of project aid for the FY84 ADP are estimatedto be about Tk 12.2 billion compared tu the Budget estimate of Tk 15.2billion. The limited figures available for the first half of FY85 suggestthat a significant shortfall of expenditure is also likely to be recorded inFY85.

6.26 This experience suggests the need for more realism in the setting ofADP targets and the need for closer monitoring of imDlementaticn performanceduring each fiscal year. As late as April 1984, ADP expenditures for FY84were expected to be above, rather than below, the original budget target dueto the lack of accurate and timely data on actual expenditures. The finaloutcome of the ADP was not determined by a decision to cut back expenditureson non-core projects but by unpredicted slippages in general implementation.The concept of a core program within the ADP can serve a useful purpose onlyif decision-makers are well informed of the progress of implementation inboth the core and non-core portions of the ADP. The lack of accuracy in theFY84 mid-term review may also have contributed to the over-estimate ofimplementation capacity for FY85.

6.27 The recent performance in terms of project implementation has beeninadequate in absolute terms as well as in relation to budget targets. Totalproject aid disbursements (including disbursements outside the budget) inFY84 were estimated at $552 million, which is lower than the correspondingFY81 figure of $560 million. In the meantime, the closing pipeline ofproject aid has grown from $2.6 billion for FY81 to around $4 billion at theend of FY84. Project aid disbursements have not kept pace with growing needsnor with the increased availability of committed resources. This issue needsmore serious and urgent attention if additional commitments of project aidare to be justified. With the expected tight constraints on the availabilityof local currency during the Third Five Year Plan Deriod, more effectiveactions will need to be taken to ensure that administrative constraints donot act as a further impediment to project implementation.

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Chapter 7: MEDIUM-TERM PROSPECTS AND ISSUES FOR THE THIRD FIVE YEAR PLAN

7.01 This Chapter deals with prospects for the period of the proposedThird Five Year Plan (FY86 to FY90), with particular emphasis on the balanceof payments and budgetary outlook. The main conclusion is that the capacityfor economic growth will be severely constrained by the availability offoreign exchange for essential imports, especially during the next two years,FY86 and FY87. Section B, which deals with the likely prospects for externalresources, stresses that in the present climate for concessional aid flows,increases in the real value of aid commitments cannot be expected over thecoming years. Some real increases in aid disbursements may, nevertheless, befeasible provided that GOB is able to take effective actions to acceleratedisbursements from commitments already made and there is some shift in the"mix" of new comitments in favor of rapidly disbursing commodity assistance.However, real increases in commodity aid commitments will continue to bejustified only if GOB, on its part, makes more concerted efforts in terms ofdomestic resource mobilization. Section E discusses some possible optionsfor resource mobilization which could be considered in order to increase thescope for public expenditure over the period of the Third Five Year Plan(3FYP). Within the limits of total budgetary resources (domestic as well asexternal), greater emphasis will need to be given to operation and main-tenance of existing assets and the completion of ongoing projects, even ifthis is at the expense of some new public investment initiatives within the3FYP. As discussed in Section F, development cannot be promoted effectivelyby adding to capital assets if their expected benefits cannot be realizedbecause of inadequate funding for staffing, operation and maintenance. Thefinal section of the Chapter sets out aid recommendations for FY86 in themedium-term context of prospects for the next five years.

A. PREPARING FOR THE THIRD FIVE YEAR PLAN

7.02 The preparation of the 3FYP provides an important opportunity forclarifying GOB's priorities and re-examining sectoral strategies and invest-ment programs to ensure the efficient utilization of very scarce resourcesover the rest of this decade. A carefully prepared plan, set in a longerterm perspective for development, could play an extremely valuable role instrengthening domestic consensus to support the broad thrust of the nation'sdevelopment strategy as well as reinforcing international support for theseefforts.

7.03 The design of the forthcoming plan also entails some risks: forexample, it will be difficult to strike the correct balance between thedesire to attain ambitious targets and the need to acknowledge the very reallimits of resources and capacity for implementation. It has to be recognizedthat Bangladesh will remain a very poor country in twenty, let alone in fiveyears' time, but it may not be easy to win acceptance for a plan documentwhich faces this reality. On the other hand, if the 3FYP document becomes astatement of hopes rather than a pragmatic blueprint for action, it will not

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serve its important objectives of clarifying policies and priorities to guidethe management of the development process. A careful and realistic projec-tion of the resources likely to be available for the next Plan period will bean essential step in the preparation of a consistent macro-economic frameworkfor the Plan: in this context, it is hoped that the scenarios presented inthis chapter may be of some help during the finalization of the 3FYP.

7.04 Starting from the present ve.-, low level of income per head (about$130/head in 1983) and an inadequate coverage and quality of physical andsocial infrastructure, the Government of Bangladesh and the internationalcommunity would certainly hope to promote a significant increase in incomesper head over the next five years, based on a rapid increase in both publicand private investment. Nevertheless, such hopes may not be realized becauseof the expected limits on resources. Constraints on the availability of bothdomestic and external resources may make it difficult even to maintain the3.5Z p.a. average rate of economic growth recorded during the last 4-5 years.

7.05 Bangladesh is heavily dependent on external assistance; moreover,given the already high burden of debt service and limited export prospects(discussed in more detail below), the country can afford to absorb aid onlyon grant or highly concessional lending terms. In view of the expectedlimits on such highly concessional assistance to all developing countries,including severe limits on IDA resources, it would not be realistic to expectany real increase in the value of aid commitments to Bangladesh during thenext five years; the most which can be expected is that the value of aidcommitments can keep pace with the projected rate of inflation in the pricesof manufactured exports to developing countries. In these circumstances, thechallenge facing Bangladesh is to seek to maintain at least a modest realgrowth in investment and GDP without reliance on a continuing increase in aidcommitments.

7.06 The projections presented in this chapter suggest that a continuationof a GDP growth trend of around 3-4Z p.a. could be sustained over the nextfive years, provided that the Government is able to maintain progress interms of export promotion, import replacement, is able to improve the rateof utilization of the large, already committed pipeline of project assistanceand there is, at the same time, some shift in the composition of new commit-ments of aid in favor of rapidly disbursing forms.

7.07 Over the next few years, it will be essential for Bangladesh tomaintain the welcome pace of growth of exports recorded over the past threeyears, particularly the increase in non-traditional manufactured exports suchas ready-made garments. Aid donors, on their part, could assist this processby minimizing the restrictions placed on such exports to their countries fromBangladesh. It will also be necessary to continue the drive for importreplacement in three major areas. Firstly, it will be imperative to increasefoodgrain production in order to achieve a steady reduction in foodgrainimport requirements over time. Secondly, it should be possible to makefurther headway in import substitution of petroleum products by the continued

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development of natural gas resources and thirdly, increased domestic produc-tion of of nitrogenous fertilizers can be promoted by bringing additionaldomestic gas-based capacity on stream.

7.08 To support these efforts to narrow the large trade deficit, thecapital account of the balance of payments could be strengthened by fasterproject implementation which would, in turn, improve the base of infrastruc-ture for future economic growth. As discussed in Chapter 6, projectimplementation performance has been disappointing in recent years. Withlittle prospect of increasing the real value of new aid commitments, theGovernment will certainly need to intensify its efforts to make more effec-tive use of commitments already made. Provided this effort is successful, itwill be possible to maintain some real increases in disbursements of externalassistance even if commitments do not increase faster than inflation duringthe next five years. Finally, as discussed below, it is recommended that themix of aid commitments over the next five years be shifted to some extent infavor of commodity and/or program type assistance in order to facilitate anincrease in the pace of disbursements from limited commitments of externalassistance. Such a shift towards commodity assistance would be justifiedprovided it was matched by a serious and sustained effort by GOB to raiseadditional domestic resources.

7.09 The expected limits on che availability of external resources willalso constrain the growth of public expenditure during the next plan period.There is considerable scope for improving the effective utilization of exist-ing assets, but there is also a need for new investments in publicinfrastructure, ranging from power generation to improved communications. Inboth cases, additional resources will be required and will need to begenerated, to an increasing extent, from domestic sources. While a morevigorous domestic resource mobilization effort is clearly desirable, expecta-tions should again be tempered by realism. Over the past decade, factorssuch as the very low incomes per head and weaknesses in the administrativestructure have precluded significant improvements in the rate of domesticsavings and have limited increases in domestically generated Governmentrevenues. Even with a strong commitment by GOB to achieve better resultsduring the 3FYP period, these limitations cannot be remot.!d overnight.Therefore, overall investment plans based on an assumption of sharplyimproved marginal rates of savings out of very modest increases in incomesper head will prove unrealistic. Similarly, public investment plans whichassume a greatly increased capacity for domestic revenue generation will notbe possible to implement within the available limits of resources.

7.10 The experience of the First and Second Five Year Plans has alsoindicated the limits of the financial and managerial capacity of the publicsectar to promote development. There are a large number of sectors where thebulk of expenditures will continue to have to be undertaken by the publicsecror since the needs for strengthening the nation's economic and socialinfrastructure remain immense. For example, much of the investments neededto facilitate future urban development as well as to expand the coverage of

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basic education health services to cope with the pressure created by theinexorably rising population (described in Volume III of this report) willremain the responsibility of the public sector. Recognizing the limitedcapacity of the public sector, GOB has assigned a substantially increasedrole for private enterprise in sectors where a choice can be made betweenfinancing production and investment from public or private sources.Consistent with this new strategy, the 3FYP should not emphasize detailedinvestment and production targets for all sectors. While figures onestimated output by broad categories can be useful indicators of how theGovernment expects to see the economy develop, detailed planning outside theareas that are the direct responsibiiity of the government is neither neces-sary nor feasible. Plan preparatiol2 should, instead, focus on the design ofan appropriate policy framework wittin which the private sector can expand aswell as on the reduction of the past emphasis on detailed investmentschedules and regulations.

7.11 Planning the allocation of public expenditures is a very importantfacet of national planning. In previous plans, there has been much greateremphasis on the planning of public investment as against recurrent expendi-tures. When resources have fallen short of expectations, planned investmentshave been adjusted, but only after important recurrent expenditures had alsobeen severely squeezed. Consequently, there is increasing evidence that thesevere reduction in public servants' compensation since independence hasadversely affected the capacity of the administration, while the relativeneglect of operation and maintenance (O&M) expenditures has resulted in adeterioration of the nation's physical assets. This imbalance should beginto be redressed in the Third Five Year Plan. Within the constraints ofavailable resources, priority should be given to essenatial recurrent expendi-tures as well as to the completion of ongoing projects in order to define thescope for undertaking new initiatives.

7.12 Public investment plans should also take stock of the limitedcapacity for project implementation. Achievement has fallen well short ofthe implementation objectives of the FY84 ADP and the same problem is likelyto recur in FY85. The perpetuation of this pattern would weaken the effec-tiveness of the AD? as a management tool and would gradually undermine thecase for additional commitments of project aid. For the 3FYP, it may be moreappropriate to limit ambitions for public investments to be consistent withthe recent evidence of limits of implementation capacity as well as ofresources. New project starts should be limited to those that are clearlywithin the financial and implementation capacity of the authorities, afteradequate allocations have been assured for the completion of ongoing projectsand for the efficient operation and maintenance of infrastructure and otherassets created by projects already completed.

7.13 To sum up, the prospects for the next five years indicate a period oftightly constrained resources, especially for new public investment. Itwould be appropriate to emphasize the need for very careful selection andevaluation of new projects and to stress the need for consolidation to ensure

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the completion of initiatives already made and to maximize the potentialbenefits to be gained from past investments.

7.14 The following sections of this chapter present some alternativeresource projections for the FY86 to FY90 period within a consistent macro-economic framework. The projections have been generated by a simple macro-economic model which projects:

(i) Balance of payments prospects, which are based, in turn, on:

(a) the expected availability of external assistance; and

(b) expected trends in domestic foodgrain production andfoodgrain import requirements; and

(ii) Resources to support the growth of public expenditure fromexternal and domestic sources and the allocation of theseresources.

The key assumptions used to derive these projections are discussed below,together with some important implications for the remainder of the 1980s.

B. PROSPECTS FOR EXTERNAL ASSISTANCE

1.15 Bangladesh has been highly dependent on external assistancethroughout its brief history, with foreign aid disbursements accounting for401 of total Government resources,l/ about 50% of total investment and closeto 55% of import payments in FY84. Even under the most optimistic assump-tions regarding the growth of exports and of national savings, a substantialdegree of dependence on aid will persist 'or the foreseeable future.Accordingly, the prospects for economic growth over the next five years willdepend crucially on the likely availability of external assistance.

7.16 Table 7.1 below sets out the historical trends in aid commitments toBangladesh since FY74, adjusted for the changing purchasing value of these

1/ The balance of Government resources are generated from domestic sources(including tax and non-tax revenues and receipts for the sale of foodthrough the Public Food Distribution System) as shown in Table 7.9.Comparing total aid disbursements to total resources is considered to bea more relevant measure of external dependence than the proportion of theADP financed by project aid, commodity aid disbursements and PL-480counterpart funds. The latter ratio not only tends to overstate theimportance of aid relative to domestic resource mobilization efforts, butalso tends, implicitly, to understate the relative importance of recur-rent to investment outlays.

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aid commitments in terms of manufactured imports.l/ It may be seer thatwhile aid commitments increased substantially during the first ten years ofIndependence to FY82, there is no discernible upward trend over the past 3-4years. In view of the tight constraints on highly concessional sources ofassistance, such as IDA, it would not be realistic to base medium-termresource projections on an increase in the real value of commitments over thelevel reached in FY84, which is also close to the average of the three yearsfrom FY83 to FY85. This is the basic assumption used to project the realvalue of aid coumitments to FY90 as shown in Table 7.1. Within these totals,the volume of food aid is assumed to decline from the high levels which areneeded in FY85 and FY86 to help rebuild foodgrain socks after the recentfloods.2/ Project aid commitments are assumed to increase by 5-6Z in nominalterms, which is slightly less than the anticipated rate of internationalinflation, resulting in a modest (1% p.a.) decline of project aid commitmentsin real terms over the next few years. This would permit a modest 2% p.a.trend of real increases in commodity aid commitments which would lead to anincrease in the share of commodity aid commitments from 32% in FY84 towards36% in FY90, as shown in Table 7.1.3/ These recommendations are consistentwith (i) the need for rapidly disbursing forms of assistance to help overcomethe balance of payments problems foreseen for FY86 and FY87; and (ii) theperceived difficulties in utilizing the recent rapid increase in project aidcommitments.

I/ The deflator used to adjust aid commitments is the MUV; the unit valueindex of manufactured exports from developed to developing countries.

2/ The foodgrain outlook and food aid requirements are discussed in moredetail in Section C below.

3/ The recommended trends in aid commitments over the next five years arebased an FY84 actual commitments, rather than FY85 estimates for tworeasons: firstly, information about aid commitments for FY85 is not yetcomplete; secondly, and more importantly, preliminary estimates suggestthat, rather than increasing, the share of commodity aid commitmentsdeclined from FY84 to FY85. Details of aid requirements for FY8E arediscussed in Section C below.

Tible 7.1: CoMit.ents of External Assistance in Constant US*(US$ million, FY84 prices)LI

Actual Estimates ProlectedType of Commitments FY74 FY77 FY80 FY81 FY82 FY83 FY84 FY55 /c FY86 FY87 FY88 FY89 FY90

Food aid 273.5 186.9 247.3 183,2 203.9 239.4 284.0 303.0 289.6 254.9 259.2 263.7 268.9Couodity aid 303.3 397.1 261.3 320.4 460.2 467.2 546.0 480.0 535.4 561.8 584.0 600.0 610.0Project aid 395.4 388.5 570.7 976.5 1,154.4 971.0 882.0 1,050,0 931.1 907.5 882.4 857.8 834.0

Total coit ent 972.3 92.-6 1.079.3 1.480.1 1.818.5 1.677.6 1.712.0 1.833.0 1.756.1 1.724.3 1.724.8 1.720.7 1.712.6(of vhich)Grants Lk 437.1 590.2 909.5 981.9 881.6 975.9 934.9 918.0 918.3 916.1 911.3Concessional loans /b 642.2 899.9 909.0 696.0 830.4 857.1 821.2 806.3 806.5 804.( 900.8

Multilateral 449.6 479.2 592.2 530.7 523.0 604.4 579.1 568.6 568.7 567.3 564.7Bilateral 192.6 410.7 316.8 165.3 236.0 252.7 242.1 237.7 237.7 237.2 236.1

Index of comitaents(n84 - 100)

Food aid 96.3 65.8 87.1 64.5 71.8 84.3 100.0 106.7 102.0 89.8 91.3 92.9 94.7Coinodity aid 55.5 72.7 47.9 58.7 84.3 85.6 100.0 87.9 98.1 102.9 107.0 109.9 111.7Project aid 44.8 44.0 64.7 110.7 130.9 110.1 100.0 119.0 105.6 102.9 100.0 97.3 94.6

Total comitments 56.8 56.8 63.0 57.0 106.2 98.0 100.0 107.1 102.6 100.7 100.7 100,5 100.0

Comiposition of comitments (2)

Food aid 28.1 19.2 22.9 12.4 11.2 14.3 16.6 16.5 16.5 14.8 15.0 15.3 15.7Comodity aid 31.2 40.8 24.2 21.6 25.3 27.8 31.9 26.2 30.5 32.6 33.9 34.9 35.6Project aid 40.7 40.0 52.9 66.0 63.5 57.9 51.5 57.3 53.0 52.6 51.2 49.9 48.7

Total commitments 100.0 100,00 jQ± 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 ii9 Liu

/a The deflator used in this table is the HUV, the unit value index of manufactured exports from developed to developing countries on a c.i.f. basisand expressed in US dollar terms.

1k The estimated composition of commitments by source (grants, multilateral and bilateral loans) for subsequent years is based on the averagecomposition of comitments from nY82 to FY84.

1k Comitszne for FY85 are estimates which are still subject to change, for example the Einal figures may be affected by the timing of thenext imp',rt credit from IDA.

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7.17 Disbursements which would follow from such an assumed voluoe andpattern of new aid coumitments to Bangladesh will also depend, to a con-siderable extent, on the ability of the Government to improve the pace ofdisbursements out of the aid pipeline. For the "high case" of Table 7.2, itis assumed that the rate of project aid disbursements out of the openingpipeline for each year can be increased gradually from just over 16X atpresent to 20: by FY90. It is also assumed that the disbursement of com-modity assistance will revert back to the recent average of 75Z of the open-ing pipeline plus 25% of new commitments in each year, compared to the lowerratios for FY84 and for FY85. Under these assumptions of an improved disbur-sement performance and some shift in the "tmie of external assistance infavor of commodity aid, there could be a continuation of real increases inthe value of aid disbursements during the 3FYP even if total aid commitmentslevel off in real terms over the coming years: as shown in Table 7.2 thereal value of total disbursements is projected to increase by an average of3X p.a. between FY84 and FY90.

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tabe 7.2: Coit to and Diru_e of Extenal Aa.imtnce- 1TW-1MO(1ss millioms. currnt prices -leas otherwise slated)

TsAL. Uutinate Prosetdn83 F284 nsIs Fr86 ns87 nss ns89 MO

'KI CASE' - corruaIoeda to the r _comuded pattern of ce_iteta eat ant in Table 7.1:i.e.. a gradual increasing abare of codity aid comitmente; andinreasing rates of project aid dimb.rseannts.

*eed Aid

Opening Pipeline 46 60 47 47 49 54 59 65Comitments 248 286 303 311 295 324 356 392Disbueaneata 255 277 303 30Y9 2 319 350 3s5Clsing Pipeline 40 47 47 49 54 59 65 71

Ceo~dit~ -id-

Opeing I ipeLi- '28 460 567 572 6i 642 708 784Coeitueu 486 546 480 575 650 730 810 890Dib t-rsewsrats *52 439 475 530 626 664 733 81lCloesig Pipline 460 567 572 617 64 708 784 864

Priect AidOpenin Pipeline 3.2B3 3.373 3,703 4.153 4.447 4.708 4,339 5 158Commints 1.006 882 1. 50 1.000 1.050 1.103 1.58 1.216Disbursements 638 552 600 706 789 371 938 12032Cle ing Pipeline 3,373 3.703 4.15J 4.447 4.708 4.939 5.158 5.342

Total Aid

Opening Pipeline 3,757 3.873 4.317 4.772 5.114 5.403 5.706 6,008Com-ita 1.738 1.712 1.833 1,S86 1.995 2.156 2,323 2.497Di. uumat. 1.345 1.268 1.378 1.54 1.705 1.S53 2.022 2.228Cloieng Pipeline 3,873 4.317 4,772 5.114 5,403 5.70s 6.008 6.277

Memoradum I tenProject aid disbursets

as 3 of opening pipeline 19.4 16.4 16.2 17.0 17.8 1S.5 19.0 20.0Co_dity aid di abreemta

e 2 of opening pipeline 75.0 75.0 75.0 75.0 75.0 75_0 75.0 75.0.1.. 1 of nam coitments 27.1 17.2 10.0 17.5 25.0 25.0 25.0 25.0

Cmdity aid cmit-metsa of total comitmeute 28 32 26 31 33 34 35 36

Total aid disbursents inco0ent S84 V0s3 1.326 1.268 1,364 1.438 1.474 1.4S2 1.497 1.528

"CAIUEM E A - no increase in the share of coindity aid comitmate;disbursewnts ratios as for "bigh came."

e-wdie 4id

.omitnats 480 546 480 510 550 594 641 693Dishurmenmts 452 439 475 518 560 564 59 643

Pr ect Aid

C<_ini t. 1,006 882 1,050 1.115 1.203 1,299 1.403 1.515Disbursemet. 638 552 600 706 810 917 1.014 1,145

Total AidCoitmnts 1.738 1.12 1,833 1,937 2,048 2.217 2,400 2.600Diebureemasta 1,345 1.265 1.378 1.533 1.660 1.799 1,963 2,174

Comodity aid comituntsas 2 of total coisitamt 28 32 26 26 26 26 26 26

Total dieer eenets inConstant nu IS5 1,326 1.268 1,364 1,427 1,435 1.439 1,454 1.491

"A=h1l34T! *' - comitnentm as for hiz,h case';lower ra tee of project aid dishursemets.

Proreict Aid

Opeing pipelin- 3,283 3.373 3.703 4*153 4.468 4,781 5.094 5.411Ce_itnete 1,006 882 1.050 1.000 1,050 1,103 1,158 1,216Disbcrumate 638 552 600 685 737 789 841 893Cloeing pipelixe 3,373 3,703 4,153 4.468 4.781 5.094 5,411 Ii,734

Total AidDisbureenata 1,345 1.268 1,378 1.524 1,653 1.?71 1,924 .089

Project aid disaureentsas Z of opeing pipeline 19.4 16.4 16.2 16.5 16.5 16.5 16.5 16.5

Total *Ad dishzee-t in

£mNtAt 1TB M 1.326 1.268 1.364 1.419 1.429 1.417 1.425 1.432

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7.18 It must be stressed, however, that the projected pattern of disburse-ments shown in the "higb case" of Table 7.2 may be difficult to realize,since it may not prove possible to expand commoditylprogram type assistanceat the recommended average increases of around $60 million per year over thesix years from FY84 to FY90. The case for increasing the share of commodityor program type assistance to Bangladesh has been stressed repeatedly inrecent economic memorandr. The reasons for such a shift in the compositionof aid flows include:

(i) project aid disbursements already account for around 50% of theAnnual Development Programs: recognizing the limited scope forincreasing domestic resource mobilization, increased counterpartfunds generated by commodity/program type assistance will beneeded in the foreseeable future to facilitate a faster pace ofproject implementation;

(ii) higher commodity assistance is also desirable for increasing,together with an intensified domestic resource mobilizationeffort, the resources available for essential operation andmaintenance (O&M) expenditures: it is extremely important thatthe form in which external resources are made available shouldsupport a more appropriate balance between new investments andO&M expenditures; and

(iii) rapidly disbursing coiodity or program assistance can help tominimize the need for disruptive restrictions in essentialimports caused by sudden shortages of foreign exchange.

7.19 Although the importance of comodity assistance is recognized by theaid community, there has been a substantially more rapid increase in projectaid commitments in zecent years, as shown in Table 7.1. Moreover, the rela-tive shift towards project aid appears to have continued during FY85. Theimportance of seeking to reverse this trend is illustrated by Table 7.2.Alternative A shows that the volume of disbursements would be substantiallyreduced if the mix of aid could not be altered in favor of slightly morerapid increases in commodity aid relative to project aid during the next fiveyears.

7.20 Alternative B of Table 7.2 underlines the importance of achieving afaster pace of project implementation: it shows the extent to which aiddisbursements would be reduced if the ratio of project aid disbursements fromthe opening pipeline remained at 16.5% throughout, rather than increasing to20% as assumed in the "high case" scenario. Since neither an improvement inthe rate of project implementation, nor a change in-the "mix" of aid commit-ments towards more rapidly disbursing forms can be taken for granted, the"high case" should be regarded as a somewhat optimistic projection of theexpected trend of aid disbursements to FY90. Although it has been used toproject gross aid inflows in the balance of payments analysis which follows,its realization will require intensive efforts by GOB as well as a favorable

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response to the recommendation for increased commodity or program assistancefrom the donor community.

C. THE AVAILABILITY AND DISTRIBUTION OF FOODCRAINS

7.21 The economy of Bangladesh continues to be dominated by agricultureand, within agriculture, by the production of foodgrains. Notwithstandingthe increases in foodgrain production which have taken place, substantialfoodgrain imports continue to be required, which will have a significanteffect on the likely balance of payments as well as the budgetary outlook forthe foreseeable future. Consequently, the abiLity to maintain a steady paceof increase in foodgrain production ahead of the rate of growth of populationwill be an important strategic issue for the 3FYP period. As noted inChapter 10 of Volume III, although most of the additions to the work forceduring the 3FYP and beyond should, ideally, be absorbed in non-agriculturalactivities, agriculture will remain by far the biggest employer. Withoutvigorous growth in agriculture, there would be very little scope for increas-ing productive employment opportunities in other sectors. Moreover, thenation's balance of payments would be undermined in the absence of continuedprogress towards self-sufficiency in foodgrains.

7.22 As discussed in the sections of this report which deal with povertyand nutrition, progress towards self-sufficiency (defined in terms of produc-ing all the foodgrain requirements for meeting a target availability offoodgrains per head of population) will not be enough in itself because ofthe difference between potential and effective demand. Improvements willalso be needed in the system for distribution of foodgrains in order to tryto improve the access of the most vainerable groups of the population to thetotal supply of foodgrains available in the country. Such an im-rovement inaccess to adequate nutrition will, above all, require accelerated employmentgeneration; it will also require the effective stabilization of market pricesso that in times of scarcity the worst-off as well as those employed in theformal urban sectors can be protected against sharp upward swings in foodprices. To a l&rge extent, as discussed in Chapter 4, the achievement ofthese important objectives will depend on the targeting and management of thePublic Food Distribution System (PFDS).

7.23 Policies with respect to the management of the PFDS will also haveimportant implications for fiscal management, while the future of food aidwill remain a crucial determinant of both fiscal and balance of paymentsprospects. It would be unfortunate if progress towards foodgrain self-sufficiency resulted simply in a reduction of food aid which was not compen-sated by other forms of commodity or program assistance at the same time asGOB was making serious efforts to redirect food distribution to those groupswho cannot be reached through the ration system. Such a redirection of thePFDS towards those who lack the purchasing power to secure their nutritionaLneeds from the market is to be welcomed in terms of equity and nutritionalobjectives; however, it should be recognized that it will result inevitablyin the reduction of "counterpart fund' generation. For all of these reasons,

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the analysis of prospects for the 3FYP should be based on a careful projec-tion of the feasible increases in agricultural production and assessing theimpact of policies for the management and financing of the PFDS.

7.24 For the projections presented, it has been assumed that agriculturalGDP and foodgrain production can increase at an average rate of 4Z p.a. up toFY90. In the light of recent experience, such a rate of growth should notprove impossible, but at the same time it is the maximum average rate ofgrowth which can be assumed to be sustainable over an extended period.1/Table 7.3 sets out the rate of increase in foodgrain production which wouldbe consistent with the assumed growth of the agricultural sector as awhole.2/ The total requirement for foodgrain imports is projected as thebalance between total foodgraiu requirements (based on a quite minimal targetfor per capita per day availability rising to 16 oz. per head by FY90) andthe expected growth of domestic production. For FY86, it is recomended thatthe volume of food aid should rise to 1.7 million tons (including 1.55 mil-lion tons of wheat) to assist COB in the urgent task of rebuilding foodstocks which have been depleted in the aftermath of the 1984 floods. For theremainder of the 3FYP period food aid is assumed to remain constant at 1.5million tons, based on the FY84 aid volumes of wheat and rice.3/ Table 7.3also shows that the remaining import requirements, which take into accountthe need to replenish public foodgrain stocks during FY86, are projected tobe met from GOB's own resources.4/

1/ Agricultural GDP increased at an average rate of 4.4% p.a. from FY73 toFY79, but at only 2.2% p.a. from FY80 to FY84.

21 It is highly likely that the pattern of foodgrain production willinclude fluctuations due to weather conditions (droughts or floods)during the 3FYP period. As in 1984, such circumstances will requireflexibility in the management of the PFDS as well as in the volume andtiming of food aid. In this Chapter, however, the concern is withassessment of medium-term prospects rather than the forecasting of tem-porary production shortfalls whose timing and seriousness cannot beforecast.

31 Although the volume of aided shipments of foodgrain are assumed to beconstant beyond FY86 at 1.5 million tons, the US$ value of aid disburse-ments would increase slightly over time, in line with projected changesin world prices of wheat and rice (see Table 7.2).

4/ Tables 7.3 to 7.5 describe the foodgrain outlook for rice and wheattaken together: the model used to generate these tables projects theoutlook for both grains separately.

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Table 7.3: Foodarain Reauirements and Sugslies. 1Y84-1Y90(000 tons)

Actual Estimated ProiectedFY84 FYf 85 FY86 FY87 FrY88 FY89 FY9

Consuption requirements / 15,677 16,795 16,778 17,307 17,852 18,143 18,992

Domestic production (gross) 15,842 15.770 16,700 17,368 18,063 18,786 19,537Domestic supply (uet) /b 13,894 14,161 14,956 15.773 16,194 16,841 17,513

Losses frm stocks 103 124 105 105 105 105 105Chu4e in stocks /C 170 129 321 0 0 0 0

loort leauireints 2.057 287 2,248 1.840 1,763 1,677 1 583Food aid 1,488 1,652 1,700 1,500 1,500 1.500 1.500G08 resaorces 569 1.235 548 340 263 177 83

Cash imports 231 265 548 340 263 177 83Deferred payments 338 970 - - - - _

nemrandu Item:Rate of growth of foodgrain

production (Zp a.) 2.2 1.6 5.9 4.0 4.0 4.0 4.03 of total requirements

met from imports 13.1 17.2 13.4 10.6 9.9 9.1 8.3

& Derived from population growth and an assumed gradual increase in foodgrain availability per heed from 15.7 ozldayin FY84 to 16.1 oz/day over the pro,ection period.

Lk Allows for wastage and use for seed.LI Foodgrain stocks are assumed to be built up to 1.25 million tons during FY86, then mintained at that level.

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7.25 Table 7.4 shows the projected sources of supply and the pattern ofofftake from the PFDS. Domestic procurement has been projected to be in therange of 300,000 to 400,000 tons per year. Domestic procurement policies areexpected to be geared, appropriately, to ensuring an adequate "floor price"to producers, rather than to achieve high volumes of domestic procurement forthe PFDS. The balance of the needs of the PFDS are projected to be suppliedfrom imports.l/ The pattern of offtake from the PFDS is projected to be inline with the continuation of recent policy directions; these reflect GOB'spolicy of shifting the emphasis of the PFDS gradually towards expanding thescope of the FFW program, reaching vulnerable groups together with the con-duct of a more effective program of open market sales (ONS) in order toachieve a higher degree of price stability. Such a transformation in thepattern of offtake from the PFDS will be possible only if there is a substan-tial reduction in the allocations for the ration system during the 3FYPperiod.

1/ It may be noted that import requirements are independent of the volumeof domestic procurement for the PFDS. If the maintenance of targetlevels of foodgrain available for consumption is an objective of thePFDS, then domestic procurement which, in the first instance, reducesfoodgrain available for consumption cannot be a substitute for imports.In other words, relative increases in domestic procurement simultaneouslyact (i) to make it possible and (ii) to necessitate higher offtake fromthe PFDS in order to maintain a target volume of foodgrain available forconsumption.

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Table 7.4: Peblic Poodarsin Distribution Systeu Ooerations. n84nFY90(t000 tons)

Actual Estimated ProiectedFY84 FM85 FY86 FY87 Pf88 FT89 1190

Opening Stocks 630 800 929 1,250 1,250 1,250 1,250

hualies 2.324 3.035 2.571 2.181 2,123 2.058 1.986Imports 2,057 2,887 2,248 1,840 1,763 1,677 1,583Domestic procurement 267 148 323 341 360 381 403

Distribution 2.051 2.782 2.145 2.076 2.018 1.953 1.881Ration sales 1,333 1,676 1,240 1,055 891 743 607Open market sales 157 255 255 302 338 348 33)Food-for-Work 441 494 500 550 600 650 700Relief and lCF LI 120 357 151 169 189 212 238

Losses frm stocks 103 124 105 105 105 105 105

Closing Stocks 800 929 1.250 1.250 1.250 1.250 1.250

- Soroudum Item:Comosition of distribution (Z)

Ration sales 65.0 60.2 57.8 50.8 44.2 38.0 32.3Open market sales 7.7 9.2 11.9 14.5 16.7 17.8 17.8

Bob-total 72.6 69.4 69.7 65.4 60.9 55. 50.1

Food-for-Work 21.5 17.8 23.3 26.5 29.7 33.3 37.2Relief and ICG 5.9 12.8 7.0 8.1 9.4 10.9 12.7

Sub-total 27.4 30.6 30.3 34.6 39.1 44.1

Public Distrib.tion asI of total consumption 13.1 16.6 12.3 12.0 11.3 10.6 9.9

L& luF - Vblnerable Group Feeding.

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7.26 The implications of the above assumptions on the food budget arepresented in Table 7.5, showing that cash deficits are expected in the foodbudget for the next two years. The subsidy element of ration sales isprojected to be eliminated over the period. On the other hand, the counter-part funds generated by the resale of some of the aid-financed food importsthrough the ration system or open market sales (OHS) are projected to be morethan offset in these years by the cost of imports from GOB's own resourcestogether with the burden of servicing the substantial debt incurred for foodpurchases during FY84 and FY85. Once the recently incurred debts for foodhave been repaid, the food budget should again generate cash surpluses,provided that food aid levels are maintained. The desirable switching ofofftake away from the ration system in favor of FFW will have important shortand long-term benefits, but there is a clear short-term cost in terms offoregone revenue from saLes of foodgrains from the PFDS. If the donor com-munity favors increasing the share of foodgrain allocation towards suchemployment, nutrition and relief objectives, then it would be important toavoid a decline in food aid even as the total ,-equirements for foodgrainimports is reduced through higher domestic production. If food aid were todecline to 1 million tons by FY90, compared to the steady level of 1.5 mil-lion tons for FY87 to FY90 assumed in Tables 7.4 and 7.5, then the cashdeficit of the food budget would widen again to about Tk 1.5 billion by theend of the 3FYP, unless the FFW and VGF feeding programs were correspondinglycurtailed.

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Table 7.5: Public Foodarain Distribution System. Sources and Uses of Funds. 84-7Y90(Tk billions)

PreliminaryActual Zctimates ProiectedFl84 FY85 FY86 FY87 FY88 FY89 F 90

USES OF FUNDS

Aided Imports (c.i.f.) 7.6 8.9 10.1 10.4 11.6 13.0 14.5

COB Laports 2.3 6.4 2.9 2.2 1.7 1.1 0.6Cash 0.9 1.5 2.9 2.2 1.7 1.1 0.6Deferred Payment 1.4 4.9 - _- - -

Domestic Procurement 1.4 0.8 2.1 2.4 2.9 3.6 4.4

Other Costs 5.5 7.0 4.0 4.8 5.2 5.4 5.5Handling and Overheads 2.2 2.9 2.7 2.5 2.7 2.9 3.1Interest on Food Loans 0.3 0.4 0.7 0.5 0.2 - -Amortization of Food Loans 1.5 1.1 2.0 2.9 0.7 - -PL-480 Deposits to ADP 1.0 0.9 0.8 0.8 0.8 0.8 0.8Other Transfers to ADP Is 0.5 1.6 -2.3 -1.9 0.8 1.7 1.5

Total Outlsas 16.9 23.1 19.1 19.8 21.4 23.1 25.0

SOURCES OF FUNDS

Revenue from Sales 7.2 9.8 9.3 10.2 10.9 11.5 12.2Ration System 6.3 8.2 7.3 7.2 7.2 7.1 6.8Open Market Sales 0.9 1.7 2.1 2.9 3.7 4.5 5.3

Subsidy from Revenue Budget 1.6 1.1 0.8 0.5 0.3 0.1 -

Food Aid Beceipts /b 6.9 7.9 9.0 9.1 10.2 11.4 12.8

GOB Borrowing for Food Imports Ic 1.2 4.3 - - - - -

Total Receipts 16.9 23.1 19.1 19.8 21.4 23.1 25.0

Menorandum Item

Cash Surplus ILd -0.1 1.5 -2.3 -1.6 1.3 2.4 2.3

l/ These transfers are derived as a residual after accounting for all other sources and uses of funds. Thetable is on a cash flow basis, so no imputations are made are for the valustion of Food-for-Work or reliefprograms.

lb Food aid receipts represent the c.i.f. valuation of aided food shipments, less any costs (freight or otherhandling) met by COB.

/c This item represents the value of food purchased on deferred payments terms. less the cost of freight anddownpayments (if any) met by COB in the year of purchase.

/d Megative sign indicates a cash deficit. The cash surplus, or deficit, is total transfers to ADP (includingPL-480 deposits) less subsidy from the revenue budget.

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D. BALANCE OF PAYMENTS PROSPECTS

7.27 Based on the foregoing projections and assumptions regarding externalassistance and foodgrain import requirements, the following paragraphs drawtogether the balance of payments outlook for Bangladesh up to FY90. Thescenario which is described in the following paragraphs (and presented inTable 7.6) is based on optimistic, yet not implausible, assumptions regardingkey balance of payments variables such as exports, foodgrain imports, remit-tances of foreign exchange by Bangladesh citizens employed abroad and disbur-sements of external assistance. This projection, which can be designated asthe "high case," indicates that even under a rather optimistic set ofassumptions, there will be a very tight constraint on the capacity for non-food imports throughout the 3FYP, with a particularly difficult situationforeseen for the next two years, FY86 and FY87. Over the period from FY84 toFY90, total imports are not expected to grow by more than 2.5% in real terms,with non-food imports increasing only slightly faster at between 3Z and 3.5%p.a. in real terms. Given the very limited natural resource base ofBangladesh, investment and growth prospects (especially in the non-agricultural sectors) will always be highly dependent on the capacity forimports. Therefore, the "high case" scenario suggests that the capacity forgrowth during the 3FYP will be restricted by the limited capacity forimports, as it has been for many of the years since LIdependence. The "lowcase" projection in Table 7.7 shows that under a somewhat pessimistic, thoughno less plausible, set of assumptions the capacity for imports and hence forgrowth could be very restricted indeed during the next few years.

7.28 The following paragraphs set out the detailed assumrtions underlyingthe "high case" balance of payments prospects presented in Table 7.6.Starting with exports, it is assumed that following some fluctuations in FY85and FY86 due to the effects of the 1984 floods, the volume of jute exportscan increase at a trend of 2.5% from their FY84 level. Given the difficul-ties facing jute production and limited world market prospects, such anexpectation must be regarded as difficult to fulfill, especially in view ofthe declines which have taken place during the past 10 to 15 years. It mustalso be recognized that with world market jute prices expected to declinesubstantially from their present peak, there will be a corresponding reduc-tion in the value of jute exports even if some increases in volume can beachieved durLig the next few years.l/

1/ Projections of world prices for all export and import commodities aretaken from commodity price forecast as updated by the World Bank inJanuary 1985. In the case of jute, the price projections are not inde-pendent of the expected volume of exports from Bangladesh, so that anymore optimistic forecasts of export volumes would not necessarily lead toany increase in the value of exports.

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7.29 Exports of other primary production-based commodities (tea, leatherand marine products) are assumed to continue to grow at 3-5% in voLume termsover the projection period. A more ambitious assumption has been made forthe exports of non-traditional manufactured exports (presently mostly con-sisting of garments) which are projected to increase by around 18% p.a. inreal terms over the next five years. This is a very ambitious target:nevertheless, since the present base of such exports is still extremely smallin world market terms it may be possible to continue the rapid pace of growthwhich has taken place over the past two to three years. However, such astrong performance of non-traditional exports cannot be taken for granted:it will require a continuous process of diversification as market restric-tions are encountered for certain items. It will also be essential for GOBto assure adequate incentives to exporters, inter alia, through therationalization of the incentive structure and flexible exchange ratemanagement. At the same time, it must be recognized that even a rapid growthof non-traditional exports such as garments or electronics can have only alimited positive impact on the balance of payments in the next few years,since such exports are growing from a small base and the growth of suchexports will also require corresponding increases in the imports of necessaryraw materials.

7.30 Turning to imports, the projected imports of foodgrains are based onthe volumes shown in Table 7.3 above. Fertilizer imports are projected asthe difference between expected demand and domestic production, while projec-tions of petroleum imports allow for the expected further substitution ofpetroleum by natural gas in selected uses. Capital goods imports areprojected to increase in line with disbursements of project aid and a modestincrease in private sector investments. Imports of other intermediate andfinal goods are then projected as a residual which is determined by thecapacity to import, consistent with the need to maintain at least a minimallevel of foreign exchange reserves.

1.31 The projection of remittances, which have become an important com-ponent of the current account in the balance of payments, is very difficult.Remittances rose from about US$200 million in FY80 to over US$600 million inFY83 before declining to US$552 million in FY84 and are projected to be loweragain at around US$450 million for FY85. As discussed in Chapter 5, theimport liberalization which was made possible by the channeling of anincreasing flow of remittances through a secondary (WES) foreign exchangemarket has made an vital contribution to the revival of the industrialsector. This improved access to imports would be difficult to maintain ifremittances were to decline further: for the "high case" it has been assumedthat remittances would be maintained in real terms, so that they rise (innominal terms) from $450 million in FY85 to around $650 million by FY90.

7.32 Debt service obligations with respect to past foreign assistance,food loans and IMF purchases are projected on the basis of available debtdata, with an allowance for additional obligations on debt incurred duringthe projection period. It may be seen from Table 7.6 that debt service

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obligations are already quite high, with debt-service ratios of 20X to 25Zbetween FY85 and FY87 because of substantial obligations to the IMF onaccount of past purchases and the burden of repayment of recent short-termborrowing for foodgrains. For the foreseeable future, there will be verystrict limits on the country's creditworthiness due to the low volume and thehigh concentration of the composition of exports, the relatively uncertainfuture of remittances and the already relatively high debt service obliga-tions in relation to the sum of exports and remittances. Accordingly, noallowance has been made for any net commercial borrowings during the nextfive years.l/ Moreover, because of the rising burden of repayments on pastconcessional medium and long-term (MaLT) aid loans, all future aid commit-ments should be on highly concessional or grant terms. The projections ofaid disbursements shown in Table 7.6 correspond to the "high case" for futureexternal assistance described in Section B above.

1/ Some modest amounts of suppliers' credit could be associated with somedevelopment projects, but no explicit allowance has been made for thesein the projections. Some borrowing on more commercial-type terms couldalso be envisaged for specific large scale (possible gas-based) exportprojects. However, due to the long lead terms required before suchprojects would generate any net contribution to the balance of paymentsor to government revenues, no such projects are considered in the follow-ing projections to FY90.

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Table 7.6: Iflnte- of rav a.. 4 ns9(0S$ million. carrait prices)

Averag iereausActual Zetiuted Proreiced .C. i real term (21) LAf64 FlU5 "as6 nsV nui wg 1790 ns64-s0o wts5go

emmn f.e.1b) QE MR 2M 970 1.09 I" 1j1 Li laaw jute & jute good. 473 506 470 430 456 464 514 -4.6 -6.9

Tea, leather, fisb 249 254 270 298 341 390 446 3.5 4.0N.e-traditional export.. n.e.i. 100 138 198 242 299 370 461 21.2 1ao

1mrt (e.i.f.) I,=5 2.800 2,735 2 U87 3.15 3.U7 3.91 la O.JFoodgraie 39S 591 451 398 415 432 455 -4.0 -11.8Petrols_m 355 332 355 379 423 470 523 0.2 1.6lertili_re 74 115 122 130 137 172 217 12.4 5.5Capital goode 606 700 74 F26 910 995 1.104 3.7 1.8Otbhr iwosrt 918 1.062 1.060 1.154 1,271 1.428 1.612 3.2 1.0

(All imorte otber then foodgraina) (1.955) (2,209) (2,284) (2.49) (2.741) (3,065) (3.456) (3.3) (1.6)

zSa. Balanu -Ic31 -1.n -i79 -1.917 -2.060 -2.253 -2.490

services (net) 519 375 419 470 528 563 642(of which remittances) (552) (450) (478) (516) (557) (601) (6502 (-3.5) (0.0)

orret Account aance -L -1.25 -1.378 -1.A5l72 I't -1.12 -IE.

Aid diaberate 1.26e 1.378 1J544 1705 1.853 2.022 2L22 ILI LIFood Aid 277 303 309 290 319 350 385 -0.8 -2.5Project Aid 552 600 706 789 671 939 1.032 4.2 3.6Comodity Aid 439 475 530 626 664 734 Ul 4.0 3.4

HLS Amrtiati. -71 -90 -107 -133 -150 -:70 -190 10.7 7.9

Deferred paymnts food imports 44 165 - - - - -

Tood lee amortizatien -60 -44 -69 -91 -23SoDrt-ten ad other borrwing 7 -30 - - - - -

Cb-e in other wet liabilitias Ls -12 -11 14 -64 -78 - -9

Chane is reserve assets(- i iscreae) -166 157 -4 30 -70 -101 -92

Bod-year gros reserves 516 359 363 333 403 504 596(as umoth of imports) (2.6) 1.5) (1.6) (1.4) (1.5) (1.7) (1.8)

Debt-eervic ratio /d 1l8 20.5 23.0 25.8 I6 16.4 16.2

Curret account balaceas I of CDP 8.4 11.2 9.7 9.8 9.3 9.1 L9

La Deflated in each case by the idz of increasoe Is avrage prices of mnufactured exports from all developedta deeloping coentrie. (wN).

& Other imports Ibclude all inter_diate and final goods not elsewhere indicated./c Includes speial balance of paywmots assistance of $10431 for FIN6 ad $1St for n87./d Debt-serice ratio ie calculated as (interest and mwrti.ation On on MALT liane, food 1ano and DV obligationa)

divided by (merchadis eports plus non-factor cervices receipts).

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7.33 Table 7.6, which brings together the implications of all of the aboveassumptionm, demonstrates the very limited capacity for imports projected forthe next five years, despite the relatively optimistic assumptions which havebeen made regarding increases in commodity assistance, remittances andexports. Total merchandise imports for FY85 are expected to be around $2,800million, including capital goods imports of $700 million and imports ofintermediate and other final goods of over $1,050 million. These high importlevels were made possible in part by a drawdown of reserves, substantial debtincurred for foodgrain imports as well as balance of payments support from aCompensatory Financing Facility purchase of SDR 55 million from the IMF.However, further significant net drawdowns of reserves will not be possibleover the coming years, so that in the absence of further special balance ofpayments assistance total imports would need to decline to around$2,600-$2,650 million in FY86. In real terms, this would represent a declineof almost 12x. Even with a substantial decline in food imports, the foreignexchange available for imports of non-food imports would decline sharply, byabout 8Z in real terms from their FY85 level. Such a disruption to the flowof imports in the initial year of the Third Five Year Plan wouLd beundesirable, suggesting the need to obtain additional balance of paymentssupport. The scenario presented in Table 7.6 therefore assumes additionalbalance of payments support of $100 million in FY86 and $50 miLlion in FY87,in addition to the recommended coammitments for conventional developmentassistance. Such additional support would serve to increase the capacity forimports to between $2,700 and $2,750 million.

7.34 Despite the assumption of such additional support in FY86 and FY87,it may be seen from Tables 7.6 and 7.7 that the car:city for imports willremain v-ry limited, even in this "high caset' scenario. Total imports arenot projected to recover to their FY85 levels in nominal terms until FY87 andwould still be lower in real terms in FY90 than tb-;y were in FY85. Althoughthe value of food imports is projected to decline, the capacity for non-foodimports will still be strictly limited: the averege rate of growth of suchimports from FY85 to FY90 would be around 1.5% in real terms. Even from thevery depressed import base of FY84, the real growth of non-food imports wouldbe less than 3.5% p.a.

7.35 Such a severe constraint on the capacity to import will, in turn,limit the scope for increasing non-agricultural GDP over the 3FYP period.The linkage between imports of capital and intermediate goods and non-agricultural value added is not fixed in the short term; for example,increased use of existing industrial capacity and improvements in produc-tivity which could result from the speedy completion and effective operationof development projects could permit non-agricultural value added to increasemore rapidly than the scope for increasing imports. However, given theabsence of most raw materials required for non-agricultural production, itwould not be realistic to expect a sustained growth of such production andvalue added which is consistently and substr.cially less dependent on importsfor an extended period of time. It is, therefore, not likely that a negli-gible real growth in imports of capital goods, intermediate goods and other

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imports and an average growth of around 1.5Z p.a. in all non-food importsduring the FY85-FY90 period would be compatible with a growth trend on non-agricultural GDP significantly in excess of 3Z p.a. during the 3FYP. Such amodest growth in noi-agricultural GDP dne to a tightly constrained capacityfor essential imports would, in turn, imply limits on the likely growth ofnon-Agricultural employment. It would also mean very little improvement inincomes per head during the 3FYP. The Government and the aid communityshould, rightly, be reluctant to settle for suca modest goals. Nonetheless,a better result may not be feasible.

7.36 There are a number of reasons why even such modest growth may not beattainable; potential risks include the following:

(i) Remittances: Following the declines of the past two years,there may be a further decline in remittances in real terms;

(ii) Non-traditional exports: Due to a combination of supply dif-ficulties or market restrictions imposed by developed countries,the growth of non-traditional imports could be somewhat lowerthan the 18% p.a. real growth assumed in Table 7.6; even a10-12% real annual growth could not be taken for granted;

(iii) Foodgrain production: The 4Z p.a. increase in foodgrain produc-tion is higher than the rate which has been sustained in thepast. There could be setbacks due to droughts or floods or by aslowe- than expected spread of improved technologies;l/ and

(iv) Lower non-project assistance: The experience of recent yearsindicates some risk that the recommnended levels of food andcommodity assistance may not become available.

7.37 The scope for non-food imports and, consequently, for non-agricultural growth could be seriously depressed in comparison to the "highcase" scenario of Table 7.6, for any one of, or a combination of, the abovereasons. The sensitivity analysis of Table 7.7 sets out a "low case", whichindicates the degree to which the capacity for imports would be reduced ifless optimistic assumptions were made regarding some of the possible risks

1/ It should also hap noted that if non-agricultural growth is limited to3% p.a. or less, then over the coming years there will be an increasingdanger of "demand-side" limits on the growth of agriculture. If theiicomes of the growing numbers who cannot be employed in crop productionLo not rise sufficiently, the limits on effective demand for agriculturecould constrain the future growth of that sector, which would then bereflected in a relatively depressed demand for industry.

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cited above.l/ In the "low case", the level of non-food imports vould remainconstrained at or below their FY85 level throughout the next five years.Non-food imports would increase by an average of only 2% p.a. in real terms,even from the extremely depressed base of non-food imports of FY84. Such asensitivity analysis underlines the vulnerability of growth prospects forBangladesh during the next plan period. Given the existing very large gapbetween imports and exports, relatively minor changes in the assumptionsabout future trends in the "balancing items" of remittances and aid disburse-ments can have a significant impact on the medium-cernm balance of paymentsoutlook for Bangladesh.

1/ The "low case" could follow from a combination of the followingassumptions: lower aid disbursements due to a relatively lower shareof non-project assistance, a slight decline of remittances in real termsover time or a slower growth of non-traditional exports than assumed inthe "high case."

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TSble 7.7: S.citivitry ssly of te Cmeit, fr imorts f(us$ UiiliM)

Avwra. incress,Actual Katinted froiected .n. in real ten (2)

a 85 n86 rr87 nus n89 nso nYSa-9 785-90

imoort in currt Pricey 2.353 2 U1 35 A.fZ 7 334 9 3.911.grai 398 591 451 398 415 432 455

Otbir 1.955 2.209 2.284 2.489 2,741 3,065 3.456

Imsoft in coeta_t 1164 upice- LL 2,353 2277 2. 2 495 2.5Z4 L.22. 2.618 2.2 - OZ.Vaoadgaina 398 585 420 344 332 320 312 4.0 -11.8Otber 1.955 2.157 2.127 2.151 2.193 2.271 2.371 3.3 1.6

nMC

I="rt in c2rr3t price 2 2J 2 715 2.8S1 3.W6 3.353 3.669?ondgraina 398 591 451 398 415 432 *55Other 1.955 2.209 2.264 2.453 2.671 2.921 3.214

Lnorec is contat r284 orice LE 2.353 2.77Z Z.9 2.464 2" 2L& 2.517 sL -LIlaomr ain 398 585 420 344 332 320 312 -4.0 -11.8Other 1.955 2.18 2.109 2.120 2.137 2.164 2.206 2.0 0.2

LS The deflator used is the WmV inde of inflation in tbe prices of manfactured exports Fr all dew loped and de1lqpin countriia-

Source: Staff projection; the "high came' correpouda to Table 7.6. wbile the Ola case' assumee a reel decline in rmittances(-3.52 V.&.) and a slower grwth of non-traditional exporta (at 1;: p.a. in real tes).

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E. DOMESTIC RESOURCE MOBILIZATION

7.38 In addition to maintaining a viable balance on the foreign account,economic management during the 3FYP will also need to assure that governmentexpenditures remain in line with total available resources. In combinationwith external assistance, the total resources available to support governmentexpenditures during the 3FYP will also depend crucially on the ability of GOBto mobilize additional domestic resources. Rather than setting undulyambitious expectations for domestic resources in order to bridge the gapbetween a desired growth of expenditures and the expected availability ofexternal resources, it will be more appropriate to make a realistic assess-ment of the scope for mobilizing domestic resources and to adjust expendituretargets to be consistent with the social, political and administrative con-straints on revenue generation.

7.39 Revenue prospects for the 3FYP, presented in Table 7.8, are based onthe assumptions described below. Customs duties and sales taxes (CDST) takentogether,l/ are the largest component of revenues and are projected in linewith the growth of imports in the balance of payments "high case" scenarioset out in Table 7.6: the ratios of dutiable content and average total rateof CDST are based on those of recent years. Revenue prospects from thesesources would be enhanced if these ratios were increased, but this would alsolead to an even higher reliance on import related taxes which would not bedesirable for several reasons. The importance of import-based revenuesalready renders the budget vulnerable to periodic fluctuations in imports.Moreover, increasing the rates or coverage of import duties could lead toexcessive rates of protection, creating a risk of inefficiency in some domes-tic sectors, while the anti-export bias of the incentive system would beexacerbated.

7.40 Turning to direct taxes, while the base for income tax is small andnot expected to widen significantly in the near future due to the limitedprospects for growth, the scope for increasing taxes on property isconsiderable. In Bangladesh the distribution of wealth and income is almostcertainly correlated with the ownership of land, especially in urban areas.Given the inexorable concentration of land ownership as the proportion oflandless grows, appropriate taxation of such assets would be certainlyequitable. However, the assessment and collection of such levies requires ahigh degree of administrative coffitment and competence - the disappointingrecent record of collection of land taxes suggests that, in spite ofincreased efforts, a dramatic gain in revenue cannot be readily expected fromthis source in the near future.

1/ Sales taxes are presently levied only on imports so the two types oftaxes can be treated together for analytical purposes.

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7.41 In addition to the above sources, there is considerable potentialfor mobilizing domestic resources for financing additional essential publicexpenditures through a combination of:

- increasing the rate of cost recovery for selected Governmentservices;

- increasing the proportion of essential investments by publicutilities which is finAnced from internal cash generation;

- improving the profitability of public enterprises in theinduXrial sector; and

- reducing subsidies for certain kinds of consumption or investment.

None of these can be regarded as easy options for resource mobilization, butthere is room for improvement in all cases. Given the enormous needs forimproving the standard and coverage of almost all of the services presentlyprovided by the public sector, there is a compelling case for making moreeffort than in the past.

7.42 In many countries, services such as health and education are providedfree of charge, especially at the basic levels. In view of the ve:y lowstandards of such services presently available in Bangladesh and theextremely low incomes of many of the beneficiaries of such services it maynot seem appropriate to suggest that there should be a higher degree of costrecovery for such services. However, as discussed in Volume III of thisreport, decisions on the provision of almost all of the public servicesprovided in Bangladesh involve a clear and necessar; trade-off between theobjectives of improving the quality of services, extending ,ider access tothese services and the degree of (explicit or implicit) subsidizationinvolved in their provision. Moreover, it is generally the relativeLybetter-off sections of Bangladesh society who benefit most from any degree ofsubsidy involved in the delivery of public services. Even for the poorestgroups, it is often the lack ef facilities -ather than the cost of serviceswhich is the real barrier to access to services such as health and education.Accordingly, it would be reasonable to investigate more actively the scopefor a gradual improvement of cost recovery for selected Goverrment services.

7.43 The investments of the major public utilities (such as BPDB, BWDB,BIWTA, etc.) were carefully screened by the Planning Comission and by aiddonors involved in these investments in order to ensure that they werecapable of generating a high economic rate of return. However, partly due tocost overruns and to delays in construction, but substantially due toGovernment-determined pricing decisions, these expected economic rates ofreturn are rarely reflected by actual financial rates of return. As aresult, many of these enterprises operate at a loss, necessitating supplemen-tal injections of government equity, or make very small contributions toessential further investments from internal cash generation. In addition tomaking greater efforts to improve the efficiency of project implementation,GOB should examine closely why the purchasers or beneficiaries of the serv-

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ices provided by the public utilities should not pay a price reflecting thelong-run marginal cost of delivery of such services to them. In many cases,very large adjustments in prices and levies would be required and would haveto be phased carefully, but it is highly desirable that steady progress bemade. Policies aimed at improving the self-financing capacity of thenatural gas and electric power generating utilities which are expected tomake very substantial investments during the 3FYP and beyond are urgentlyneeded: Bangladesh cannot afford a development strategy under which Dnturalgas, its only significant, but exhaustible, natural resource is sold at belowits economic value.

7.44 At the time of independence, it was hoped that the large number ofindustrial enterprises acquired by the state would continue to generateprofits to help finance essential development expenditures through the ADP.For a number of reasons, such hopes have not been realized and for almost allpast years the nationalized units (together with other public and enterprisesconstructed subsequently) have been a drain on, rather than contributors tothe budget, as well as pre-empting a significant share of available domesticbank credit. Over the last two years, there has been a substantial improve-ment in the financial situation of these enterprises, largely due to relaxa-tion of controls over prices of their outputs. GOB is aware that priceadjustments cannot be a long-term substitute for improved efficiency.Accordingly, increasingly determined efforts are being made, commencing withthe implementation of a system for monitoring the performance of publicindustrial enterprises, to achieve further improvements in the profitabilityof public enterprises through improved efficiency rather than through higherprices.

7.45 There is also scope for reducing the explicit subsidies on some ofthe goods supplied by public agencies (such as fertilizer sales by BADC andthe ration component of the PFDS). GOB is committed to a gradual eliminationof such subsidies and a series of price increases already implemented haveresulted in considerable reduction in the share of explicit subsidies withinthe budget over recent years. In addition to the progressive elimination ofthese budgeting subsidies, there is also considerable scope for the reductionof the significant implicit subsidies in the delivery of public goods andservices as discussed in the preceding paragraphs.

7.46 To an important extent, improvements in the mobilization of domesticresources during the 3FYP period will depend on the capacity of theGovernment to make progress toward the reduction of the range and extent ofsuch implicit and explicit subsidies. The difficulty of making significantgains should not be underestimated, but some improvement is essential. Theprojection of domestic resources shown in Table 7.8 assumes that the gain indomestic resources from all such sources taken together would contribute anaverage of 0.4% of GDP per year during the 3FYP.

7.47 A particularly strong domestic revenue mobilization effort will beneeded for FY86 for the following reasons:

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(a) the food component of the budget is expected to have a cashsurplus in FY85 due to the deferral of payments for a substan-tial part of commercial food imports; in contrast, funds will beneeded for additional commercial imports together with substan-tial repayments on past food borrowings during FY86 (and FY87).As shown in Table 7.5, a sizable food budget deficit isprojected for next year;

(b) unlike in FY85, significant increases in customs duties andsales taxes (CDST) cannot be expected for FY86 due to theprojected constraint on dutiable (non-food) imports; and

(c) recurrent budget expenditures will need to be higher than inFY85 if any progress is to be made towards correcting the ero-sion of salaries and allocations for operations and maintenanceduring the past years.

Based on the above considerations, preliminary calculations suggest that anabove average revenue mobilization effort in the order of 1% of CDP is likelyto be required in FY86 to avoid a decline in the real value of resourcesavailable for financing the ADP.

7.48 The external resource contributions to the budget (from a combinationof food, commodity and project aid disbursements) are taken from the "highcase" balance of payments projections, converted to domestic currency at anexchange rate which is assumed to be periodically adjusted to maintain aconstant real effective exchange rate during the 3FYP period.

7.49 Under this combination of assumptions regarding domestic resourcemobilization and external assistance, the share of total COB resourcesprovided by aid disbursements would initially rise from 40% in FY84 to around42% in FY87 as aid disbursements increased while domestic resources wereconstrained by the reduced capacity for imports. The aid financed share oftotal GOB resources would then decline to 39% as import duties recovered andadditional revenue measures were introduced.l/ The importance of a domesticresource mobilizatiou averaging 0.4% of GDP per annum can be illustrated asfollows: if no new revenue measures were taken, the total resources avail-able to GOB in FY90 would be reduced by 9% and the share accounted for by aidwould remain over 42% through the 3FYP period. On the other hand, if newrevenue measures averaged around 0.6% of GDP in each year of the 3FYP, thenthe total resources available in FY90 would be 3% higher, with the share offoreign aid declining to about 37.5% by FY90.

1/ These proportions are based on the projection of GOB's consolidatedbudget shown in Table 7.9. Table 7.9 is a consolidation of Tables 7.5and 7.8 setting out the overall macro-economic impact of all governmentoperations, including the food budget, over the next plan period.

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Table 7.8: CoG_vera ladfb Budget(Take billion, current prices)

Actual Isti ated Proiecteder84 Fn85 1T86 FY87 FY88 FY89 FY90

Recrrent Revenue "Al 3L 1, ALI 56.3 66.2 77.9

Tax revee 24.0 28L. 33.3 38.6 44.0 51.1 59.7Indirect taxes 19.0 22.5 24.8 28.8 32.4 36.9 42.3

CDST La 13.1 15.4 16.6 19.7 22.0 25.1 28.8Excise 6.0 7.1 L81 9.2 10.3 11.8 13.5Direct taxes 4.9 5.9 L5 9.8 11.7 14.3 17.4

Nn-tax revenue 5.6 6.4 9.0 10.3 12.3 15.0 18.2

Recurrent Uxuenjiture 24.5 2 M.A R 49.0 58 69.

Current Budtet Surp lus 5. 5A 7.4 7. 9 8.6

Trnsfer from food budget 0.5 1.6 -2.3 -1.9 0.7 1.7 1.5Otber domastic resources /b 1.5 0.4 0.9 0.5 0.7 1.1 1.9

Total Doyestic Resources 7.0 .a - 6 8. 10.7 12.0

External Assistance 23.1 26.6 3Z 9 ALI 49.7 55 6

Food Aid Le 1.0 0. 9 0.8 0. 8 0.8 0.8 0.8Project Aid Ld 12.2 14.6 18.3 22.2 25.0 27.4 30.5Comodity Aid 9.9 11.1 13.8 17.7 19.2 21.6 24.3

Am-al Developmnt Progr Le 30L1 34.0 31L7 4L68 53.7 60.4 67.6

AverageAnualIncrease

Utinated Pro iected Fr 85-90Memrandu its n8s f FU89 FZ90 (2 p-2

Indices of growth in real term(FY85 - 1. 00) II

ecurrent expenditure 1.00 1.07 1.14 1.23 1.33 1.38 (7.5Z)AD? 1.00 1.02 1.12 1.17 1.19 1.21 (3.9Z)Recurrent revenues plus

self-financing by publicenterpriseo 1.00 1.10 1.16 1.22 1.31 1.41 (7M1M)

Revenues as Z of GDP

Recurrent revemue andself-financing 10.2 10.9 11.1 11.4 11.; 12.1of which:Custom duties andmales taxes 4.3 4.0 4.2 4.2 4.2 4.2Otber 5.9 6.9 6.9 7.2 7.5 7.9

,g CDST: customs duties and sales taxes levied on imports.& Includes aortization of external and domestic debt. self-finacing by public sector corporations and any

dometic bank fi1UDCing./e PL48D deposits only.Li Total project aid disbursements less disbursements outside the budget (e.g. through development finance

institutions).Le The size of the Amual Developmet Program (AD?) is set to be qual to the total resources available, i.e.. total

domestic resources plus external assistanc-.LL Deflated by the projected rate of demtic inflation.

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F. THE SCOPE FOR PUBLIC EXPENDITURE

7.50 The budget projections in Table 7.8 allow for an expansion of recur-rent budget expenditures over the next five years. This growth is due partlyto the rising interest obligations on domestic and foreign debt, but largelydue to the need to begin to make good the drastic erosion of civil servicesalaries in recent years and the increasing gap between desirable and actualO&I provisions. Operation and maintenance expenditures have accordingly beenassumed to increase at an average annual rate of IOZ in excess of domesticinflation. The salary components of the recurrent budget (and of the ADP)are also assumed to increase by lOZ p.a. in real terms during the planperiod. As discussed in Chapter 6, such increases in public salaries couldbe justified, provided that they were made carefully and selectively so as toassure a corresponding improvement in efficiency and were accompanied by someoffsetting reductions in the explicit and implicit subsidies in the provisionof services (such as food rations, housing, etc.) provided to civil servantsand other (largely middle class) recipients of such services.

7.51 The projected growth of recurrent expenditure would mean that,despite the assumed vigorous resource mobilization effort, there would bevery little increase in the "revenue surplus" as shown in Table 7.8. Asnoted in Chapter 2, this should not be viewed necessarily as an adversedevelopment. The extent to which GOB is making a serious, sustained effectto mobilize domestic resources should be measured directly by the growth ofthose resources, rather than by whether recurrent expenditures have been heldto lower amounts which are well below actual requirements. Moreover, to theextent that O&M represents (gross) investment by avoiding the prematuredepreciation of existing national assets, the "revenue surplus" as it ispresently defined, is not a meaningful measure of public savings. If GOB isto be encouraged to devote additional resources to O&M as against newcapital, then it follows that changes in the "revenue surplus" or in theratio of external financing of the ADP will not provide a fair assessme"t ofCOB's resource mobilization efforts. This effort should, instead, bemeasured by comparing the shares of aid and domestic resources in overallreceipts and outlays (including those for OEM), as shown in the consolidatedbudget presentation presented in Table 7.9.1/

7.52 Following an extended period of relative neglect of operations andmaintenance, there is reason to believe that during the next few years the

1/ For example, although Table 7.8 shows that aid disbursements throughthe budget account for an increasing share of ADP expenditures, Table 7.9shows that this does not reflect a correspondingly declining share ofdomestic to total resources over the 3FYP period. This consolidatedpresentation, shows, inter alia, the relatively increasing share ofresources projected to be devoted to essential recurrent expenditureswhich then require a higher share of increasing domestic resources.

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marginal rates of return to incremental public expenditures will be highestfor outlays to improve the condition of existing infrastructure (for assetssuch as roads and irrigation works) or to improve effectiveness of facilitiessuch as health centers through a more adequate supply of essential drugs etc.Accordingly, in the mediumrterm budget projections, the size of the ADP hasbeen derived as the residual between the projection of available resourcesand the increasing resources required for essential recurrent expendituresand debt service obligations. This would reverse the past pattern when O&Mexpenditures tended to be squeezed in order to protect the size of the ADPfrom constraints in total available resources. Table 7.8 indicates that,under this combination of assumptions, the ADP is projected to increase ataround 4% p.a. in real terms over the 3FYP.1/ The consolidated budgetpresentation in Table 7.9(B) shows that the share of recurrent expendituresis projected to rise gradually from 32% to 40Z of total expenditures.

1/ It should be noted that this is an average rate of increase. As shownin Table 7.8, no real increase in the size of the ADP can be expectedin FY86 despite an assumed domestic resource mobilization effort of 1%of GDP. Some real increases in the ADP should be possible in subsequentyears provided that some revenue mobilization effort is sustained overthe 3FYP period.

-142-Table 7.9(A)

BANGLADESH: Budget OverviewSources of Funds(millions of Taka :n current prices)

kctual Estimated Projected Prj;ected Projected Projected ProjectedFY1983194 FY1984185 FY1995/86 FY19C6bl7 FY1997/8e FY19f8189 FY1989190

GENERAL REVElUES 30329.0 36210.0 44767.3 51767.8 59989.7 70660.9 93642.8

Taxes 23954.0 29400.0 33273.5 38570.2 44036.0 51145.5 59689.1indirect taxes 19030.0 22450.0 24752.3 2806.7 32377.6 36892.7 42300.2

C3ST 13070.0 15400.0 16609.1 19653.7 22039.5 25107.2 2993.1Excise 5960.0 7050.0 8143.2 9153.0 10339.1 11795.5 ;3466.1

Direct taxes 4924.0 5950.0 9521.1 9763.5 11658.4 14252.9 17319.9Other receipts 6375.0 7910.Q 1 4 93.9 e 3197.6 15952.6 19515.3 23953.6

Non-tax recurrent revenue 5575.0 6400.0 9040.9 10347.7 12319.3 15005.1 19248.5Extra-budg. resources (net) 500.0 1410.0 2452.9 2949.9 3534.3 4510.2 5705.2

AID DISIURSENENTS 28988.2 33556.5 41075.2 49145.4 54418.1 60362.0 67650.2

Food 6911.2 181.5 8952.7 !i36.2 10215.3 !1437.6 128;20.5Project 12198.0 14560.0 18299.3 22293.f 25045.6 .'7365.5 30554.Comodity 9870.0 11115.0 13923.2 17725.6 !9157.3 2158.9 24274.9

FDOD REVENUES 9410.7 14342.9 14101.2 14469.5 16504.9 19784.5 21549.0

Revenue from sales - 7186.9 9943.9 ?s37.8 10173.7 10904.4 11519.5 12162.4Ration system 6287.9 3193.3 7253.5 7242.5 7192.2 7066.7 60.8Open market sales 899.1 li50.6 2064.3 2931.1 3712.3 4452.8 5341.6

Imputed value of oth.food dist. 2224.8 4499.0 4783.4 4295.8 5600.5 7265.0 9385.6Fgl l857.E 2084.2 _505.3 3272.7 4240.0 5455.0 6976.6Y3F 1 Relief 500.2 151.2 769.7 IC2Z.0 1360.5 I81b.0 2409.0Increase in stocks -134.2 ?03.6 1508.5 0.0 0.0 0.0 0.0.

5OR°0MIN6 3:27.3 5280.4 1071.7 1146.8 :233.7 1327.1 1429.8

Domestic 2171.0 989.0 10-1.7 1148.3 1 3 .7 1327.1 1429.8Def.pmt. food impcrts !'56.2 4291.4 0.0 0.0 0.0 0.0 0.0

sOTAL S0URCES '205F.1 9359.D lOlVS.9 !1i531.5 !:2045.5 151134.5 174270.9

.ENO ITEKSPeercenta;e of Total Sources from:G60 Sources 55.: 56.6 58.3 56.9 57.9 59.2 60.4Aid9isburseeents '0.2 5 40.7 42.A 4.2 39.9 38.8Other Borroming 4.6 5.C 1.1 1.0 .9 .9 .8

______~~ ~ ~ ~ ~ ~ ~ ~ ~ ~~~~~~~~~~~~~~ .9__ _ _ ___ __ __ _ _ __ _ _ __ _ ___ __ _ _ _ _ _ _ __ _ _ _ _ _

-143-Table 7.9(B)

BANGLADESH: Budget OverviewUses of Funds(million of Take in currnt pricn)

Actual Estimated Projected Projected Projected Projected ProjectedFY1983/94 FYV'8/05 FYIMS/66 FY199687 FYI97166 FY1998189 FY!969190

PECURRENT EIPITUTES 23244.4 29706.0 35061.4 41514.7 46960.3 5a119.7 19297.4

Interet 1968.0 2639.0 3511.0 3654.2 3527.7 3600.5 3864.4Food loans 324.4 390.0 723.0 545.0 179.0 0.0 0.0Other 1643.7 2449.0 2763.0 3109.2 33!8.7 3600.5 3864.4

Othe recurrent 21276.3 25861.0 31550.4 37860.5 45432.6 54519.1 65423.0

ADP 30079. 34043.0 38696.4 46B15.9 322.9 iO445.2 67595.9

FMD EXPENDITURE 15729.9 23516.7 22631.0 21766.6 24546.2 27150.4 32025.6

BEI Imports 2307.4 6425.5 2937.4 2466.7 1723.5 1124.1 582.2Cash 947.1 1514.2 2°37.4 2166.7 1723.5 1124.6 592.2Deferred payent 1360.3 4911.3 0.0 0.0 0.0 0.0 0.0

Aided Imports (CIF) 7631.6 8929.7 10143.8 10357.7 11584.1 12974.0 .14547.1Doestic Procurement 1366.3 900.5 2051.1 2413.0 2925.1 3593.7 4439.9Food Investomnts 1723.6 2987.8 4013.8 3272.7 4240.0 5455.0 6976.6

FF3 1157.J 2084.2 2505.3 3272.7 4240.0 5455.0 6976.6Increase in stocks -134.2 903.6 1S09.5 0.0 0.0 0.0 0.0

Other food distributionVEF & Relief 500.' 1511.2 -69.7 1023.0 1360.5 1810.0 2409.0

Handling & Other Overhead 2200.0 2e62.0 2715.3 2523.4 2712.9 2B93.2 3070.1

AMORTIZATIN 3002.7 3130.0 4626.6 6434.4 4916.0 4719.2 5372.0

Feod loans 14ri.0 1141.0 1989.0 2875.0 728.0 0.0 0.0Jther M&LT debt 1505.7 1;89.0 2637.6 3559.4 4098.0 4719.2 5372.0

-OTAL USES 72055.1 89389.9 a 01015.4 115S1.5 1320345.5 151134.5 174270.9

IENO ITEMSPercentage -f Total 5ses

Recorrent 32.3 32.1 4. 7 S .. S 9.5 i?.3ADP 41.7 38.! 3a.3 40.2 40.7, 0.0 38.8Food Expenditures 21-.E 26.3 22.4 187 15.6 18.4 1N.4Anort:a-ticn 1.2 3.5 4.i 5.5 3.6 3.1 3.11-terest+Ascrtizatimn c. 6.7 8.1 8.7 b.3 -5.5 5.3Recurrent les5 Interest :?.5 29.9 31.2 32.5 34.4 36.1 37.5

_ _ ~-_ _ _ ----- __-_ __-__--_ __ _ _ _ __-

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7.53 The projected growth of the ADP is very modest when juxtaposed withthe desire to accelerate the creation of new infrastructure and to improvethe quality and coverage of social services to a fast-growing population.The scope for public investment could be enhanced to some extent if fasterprogress could be made in terms of domestic resource mobiLization. If thegains from a broad range of "cost recovery" measures could be accelerated toan average of 0.6% of GDP per year (compared to 0.4X of GDP per year assumedin Tables 7.8 and 7.9), then, provided implementation capacity was adequate,the additional resources mobilized could finance a 6% p.a. growth in ADPexpenditures during the 3FYP period, without any cutbacks in the growth ofO&M expenditures. In contrast, if there were no new revenue measures duringthe 3FYP period, then there would be no scope at all for real increases inthe ADP without a continued underfunding of essential recurrent expenditures.

7.54 If, as recommended above, commodity aid commitments increased morerapidly than project aid commitments, then it would be possible to maintain arelatively stable ratio between the local currency contribution to the totalcost of aided projects and project aid disbursements themselves. Under theseconditions, it may be expected that project aid disbursements would not bedelayed or disrupted by a shortage of local cu-rency. On the other hand, ifthe proportion of commodity aid to project aid disbursements remained thesame from FY85 to FY90, then the ratio of local currency contributions to thetotal cost of aided projects wouLd decline from about 35% to 20% despite theproject vigorous resource mobilization effort by GOB. Such a decline in therelative availability of locaL currency would tend to undercut efforts aimedat faster project implementation. As the experience of the early 1980s hasshown, a shortage of local currency resources (generated by a combination ofdomestic revenues and counterpart funds from commodity/program assistance)can be a serious impediment to project implementation. For these reasons,the projected modest growth of the ADP will be manageable only if there is ashift in the ratio of aid disbursements in favor CiA commodity/programassistance, or an increase in the share of total project costs financed byaid, or a combination of both.l/ It must be recognized, however, that suchincreases in the share of aid financing in total project costs would bepossible only if GOB, on its part, was able to demonstrate clearly that areduction in its financial contribution did not result in any correspondingreduction in its commitment to implement the projects concerned. Similarly,a case for increased commitments of commodity assistance will be justified

11 In the absence of such changes in the "mix" of assistance, project aiddisbursements could onLy be maintained at their projected pace by cuts insome other parts of the budget. In view ef the importance of achievingreal increases in the allocations of funds for operation and maintenance,a reaLlocation of funds away from recurrent expenditures would not bedesirable, underlining the importance of changing the present compositionof assistance to GOB.

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onLy if GOB is able to demonstrate its own commitment to improved domesticresource mobilization.

7.55 Within the total resources available for financing a modest growthof the size of the ADP during the 3FYP period, alLocations will need to bemade for ongoing projects as well as for new initiatives. The extent offorward commitments for ongoing projects is indicated, in broad terms, by the$4 billion pipeline of undisbursed project aid which has built up over time.Given the urgency of completing projects already commenced, it should berecognized that significant scope for decision making regarding new projectstarts will not open up until the latter part of the plan period. Sincealmost all resources for the initial years are already committed and thereis an increasing degree of uncertainty concerning the resources likely to beavailable at the end of the period, it would appear to be appropriate toadopt a rolling two to three year time horizon for effective decision makingregarding new project starts. Such decisions would make it possible toreflect GOB's priorities within the framework of successive five year plansand to communicate these decisions in a timely manner to potential aiddonors.

7.56 The limited room for maneuver in terms of initiating new investmentsalso underscores the need for very careful project selection as well asefFiciency in the use of scarce capital. Bangladesh clearly cannot afford-rinecessary or low-return projects. In the case of economically justifiableprojects, very carefui evaluation and deliberations will still be neededbefore comitments are made to any large indivisible investments (e.g. theproposed multi-purpose crossing of the Jamuna River). Since none of thetrends projected to FY90 can be expected to be markedly different for thesubsequent five years, caution should be exercised before a long-term coumit-ment is made to any massive or indivisible project which could pre-emp. alarge volume of resources which would otherwise be available for initiatingother high priority investments during the period of the Third and FourthFive Year Plans.

7.57 The limits on resources which will be available to support publicexpenditure place a greater responsibility on the private sector to promoteeconomic growth in Bangladesh. This will need, as discussed in Chapter 5, afurther improvement of policies to create an environment within which privateentrepreneurs can take decisions with limited need for Government approvals;can expect to benefit from the consequence of such decisions; bur should beprepared to face the obligations and risks inherent in those decisions.Bangladesh cannot afford a private sector which is only willing to operateunder explicit or implicit government guarantees of survival irrespective ofefficiency. The creation of such an environment over time will requireskill, patience and consistency on the part of policy makers: much of theeffort towards Plan formulation should be devoted to the design of animproved, consistent and durable policy framework for a "mixed economy."

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7.58 A Third Five Year Plan which was set in a consistent and realisticmacro-economic frame-work as well as in the context of a longer-term develop-ment perspective for Bangladesh, contained a carefully thought out program ofpublic investments and dealt seriously and effectively with issues rangingwell beyond the allocation of new public investment would be a major con-tribution to the future of Bangladesh. At the same time as the Plan is to befinalized, GOB policy-makers wilL also need to focus on the short-termbalance of payments management problems anticipated during FY86 and FY87, thefirst two years of the next planning pcriod. These pressing problems,together with the mediumrterm prospects for the five-year period as a whole,should form the backdrop for decisions concerning the volume and compositionof aid commitments for the coming year.

C. RECOMMENDED AID COMMITMENTS FOR FY86

7.59 Bangladesh's balance of payments has deteriorated in FY85; theforecast rundown of reserves is due to a number of factors discussed inChapter 2, including the crop losses due to ;he 1984 floods which neces-sitated record foodgrain imports of close to 3 million tons. The response ofthe donor community to the situation was prompt, but limited, so that aver1.2 million tons of foodgrains had to be purchased from GOB's own resourcesat an estimated cost of around $250 million. About 20% of these imports werepurchased for cash, leading to a loss of reserves of about $60 million, whilethe repayments for the remainder will add to balance of payment pressuresduring the next three years.

7.60 The welcome recovery of Lhe industrial sector contributed to anincrease in non-food imports which are estimated to increase by about $250million between FY84 and FY85. In addition, thc- demand for imports was alsoboosted by the substantial expansion of private credit during the 18 monthsto the end of 1984, as well as an appreciation of the effective exchange rateduring the same period.l/ At the same time, remittances declined from over$552 million in FY84 to an estimated $450 million in FY85. These factorswere more than sufficient to offset an improvement in export performance aswell as the estimated increase in foreign aid disbursements, SG that thelevel of foreign exchange reservt at the end of FY85 is forecast to bereduced to a minimal level of around 1.5 months' coverage of imports.

7.61 As discussed in Chapter 2, GOB has begun to take corrective measuresfrom late 1984. Considerably tighter ceilings have been imposed on creditexpansion. The ceiling on the premium in the secondary exchange market hasbeen allowed to widen from the 10% limit imposed in mid-1984 to about 14Z by

1/ Since domestic inflation in Bangladesh was faster than those of itstrading partners, while the nominal exchange rate was depreciated by only6Z during the 18 months ending December 1984, the real effective exchangerate appreciated by well over 10%.

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January 1985 and a number of small adjustments in the official exchange ratehave begun to reverse the appreciation of the rate which had taken placeduring 1984. A continuation of sound macro-economic policies by GQB wilLl beneeded to support balance of payments management, with particular attentionpaid to export promotion and demand management. It will be essential to setand adhere to cautious limits on domestic credit expansion so as to avoidadding further to the pressure on prices and the balance of payments. COBshould also continue to avoid any domestic bank-financing of its own opera-tions by setting realistic targets for its expenditures which are commen-surate with an enhanced resource mobili-ation effort. As discussed above(see also Table 7.8), resources available for ADP financing will be par-ticularly cunstrained in FY86, partly due to the reduction in revenuesresulting from the reduced capacity for imports. At Least 1% of CDP willneed to be mobilized through a combination of new revenue measures (whichcould include the reduction of explicit or impLicit subsidies) in the FY86Budget, in order to help ensure that the resources available for ADP financ-ing can be increased at least in line with domestic inflation.

7.62 Important as they are, even suck sound macro-economic policies on thepart of GOB will not be sufficient to avoid a seriously constrained balanceof payments situation during FY86. Since reserves of foreign exchange havebeen considerably depleted, there is no scope for any further significantdrawdown of reserves during FY86. Moreover, as shown in Table 7.5, thedebt-service ratio is already forecast to be over 20% for the next two years,due to the combination of payments due on past aid loans, obligations to theIMF as well as repayment of debt incurred for foodgrain purchases. Theseobligations will not only add to balance of payments pressures during FY86and FY87, but aLso preclude the option of any significant resort to short-term commercial borrowing to ease balance of payments pressures during thenext two years.

7.63 Earnings from non-traditional exports are projected to increase onceagain during FY86 following the sound performance of the last two years. Onthe other hand, the value of traditional exports is expected to decline nextyear as both jute and tea prices are projected to fall substantially fromtheir presently high levels. Accordingly, only a modest $40 million netincrease in export earnings is projected for next year. The future of remit-tances is uncertain following the sharp decline which took place during 1984;even if the real value of remittances was maintained, they would increaseonly marginally to around $480 million in FY86.

7.64 As a result of the accelerated food distribution necessitated by the1984 floods, food stocks are still at a unsatisfactorily Low level and shouldbe built up to a level of 1.25 million tons during FY86. Therefore, evenwith an anticipated increase in foodgrain production, foodgrain importrequirements for FY86 are estimated to be around 2.25 million tons, costingaround $450 million. This requirement could, of course, be substantiallyincreased if there are any further serious weather-related disruptions toproduction. With some scope remaining for import substitution only modest

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increases are projected in petroleum and fertilizer imports, but an increasein capital goods imports is projected in line with expected increases inproject aid disbursements. All of the above factors, taken together, implythat unless there is a substantial increase in the inflow of capital nextyear, the capacity for imports of other intermediate and final goods will beseriously disrupted in FY86.

7.65 Table 7.10 brings together the factors listed above to show theexpected requirements and sources of foreign exchange during the next twoyears. Although such forecasts are inevitably subject to some degree ofuncertainty, the projections indicate that capital inflows will need to risesubstantially in both FY86 and FY87 if a serious disruption to the flow ofnecessary imports are to be avoided.

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Table 7.10: Foreinn Zxchanze Reauirementg and Sourceg. FY85-FY87(US$ millions, current prices)

Y 85 FY86 Y 87

A. FOREIGN EXCHANGE RN)UIR}UKTS

Ci) CUnENT PAYMENISMercbandise ixports 2 800 2,735 2. 887Food 591 451 398Non-food 2,209 2,284 2,489

Interest 142 141 139Food loans 15 25 17nW service charges 37 24 27Other M&LT loans la 90 92 95

Other service payments 283 284 302

Sub-total 3.225 3.160 3.328

tii) CAPITAL PAYMENTSAmortization 200 262 338

Food loans 44 69 91INF repurchases 66 86 114Other M&LT loans 90 107 133

Increase in gross reserves -157 4 -30

Sub-total 43 266 307

TOTAL FOREIGN EXCHANGE RNOUIREKE1IS 3,268 3,426 3.635

B. SOURCES OF FOREIGN EXCHANGE

U) CURRE INFLOWSMerchandice exports 900 93 970Traditional Lb 762 740 728Son-traditional 138 198 242

Private remittances 450 478 516Other service receipts 350 365 394

Sub-total 1.700 1.781 1 880

(ii) CAPITAL INFLOWSAid disbursements Ic 1.378 1.544 1.705Food aid 303 309 290Commodity aid 475 530 626Bilateral 355 380 460Multilateral 120 150 165

Project aid 600 706 789Bilateral 230 300 330Multi7steral 370 405 460

Deferred payment food imports /d 165 - -Other capital inflovw e 25 100 50

Sub-total 1.568 1.644 1.755

TOTAL SOURCES OF FOREIGN EXCHANGE 3.268 3426 3,635

L/ MiLT: medium and long-term loans.Lb Traditional exports include raw jute and jute goods, tea. leather and

marine products./c The allocation of commodity and project aid between bilateral and

uultilateral sources is for indicative purposes only./d Gross value of debt incurred lems freight and cash dorn paymaets made

by GOB during FY85.Li Includes net abrwt-term borrowing, net purchases from the IMY and any

other balance of payments support.

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7.66 It should not be expected that new commitments of development assis-tance can be adjusted to meet all of the required increases in capitalinflows in the short-term; it should be recognized that dealing with short-term balance of payments problems is not the primary objective of developmentassistance. Although the recommendations which folLow for FY86 are higherthan those for previous years, they are designed primarily to set a trendwhich, if sustained, would permit at least some prospects for growth ofincomes per head during the 3FYP period, rather than to fill a short-term"financing gap". Even if next years' capital requirements are forecastaccurately, it would not be realistic to expect aid disbursements whichfollow largely from earlier commitments (with variable lags even in the caseof commodity aid) to be adjusted precisely to fill these gaps. Other formsof balance of payment support (rather than deveLopment assistance) are moreappropriate means of reacting to short-term balance of payments problems,while commitments of development assistance should be set with a view to thenation's medium-term prospects and long-term needs. Accordingly, it isrecommended that GOB should seek to supplement development assistance withspecial balance of payments support during the next two years; a total of$150 million of such support has been assumed in Table 7.10 during FY86 andFY87. It may be seen that, even with such support, aid disbursements willneed to increase substantially in both FY86 and FY87 to avoid an undersirabledecline in the capacity for imports. A substantial share of these disburse-ments would be generated from the existing pipeline of project aidcommitments, but an increase in disbursements will also depend on newcommitments, particuLarly of non-project assistance for FY86.

7.67 In view of the constrained balance of payments situation forecast forthe next year, it is vital that aid commitments, particularly commitments offood and commodity assistance do not fall below the recommended medium-termtrend from FY84 to FY90. The recommendations for FY86, which are set out inTable 7.11, are based on the FY84 commitments for two reasons: firstly,information concerning FY85 is not yet complete; secondly, and moreimportantly, preliminary estimates suggest that commodity aid commitmentsdecline while project aid commitments increased again in FY85. For thereasons discussed above, this pattern will need to be reversed next year. Ifserious balance of payments problems are to be avoided next year, commodityaid commitments should be equal to, or higher than, the $546 million com-mitted in FY84. The recommended commitments of aid are presented in detailin the following paragraphs.

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Table 7.11: External Assistance. Commituents. Disbursements and Pieline. FY84-FY86(USS million, current prices)

Non-Droiect AidProject Food Non-food Sub-total TOTAL

Aid (Commodity) (Non-project)

Uhdisbursed balance on July 1. 1983 3.373 40 460 500 3.873Aid conmitments FY84 882 284 546 830 1,712

Disbursements FY84 552 277 439 716 1.268From pipeline 552 40 345 385 937From new co,mitments - 237 94 331 331

Undisbursed balance on July 1. 1984 3,703 47 567 614 4.317

Aid commitments FY85 1,050 303 480 783 1,833

Disbursements FY85 600 303 475 778 1-378From pipeline 600 47 425 472 1,072From new commitments - 256 50 306 306

Undisbursed balance on July 1. 1985 4,153 47 572 619 4,772Aid commitments FY86 1,000 311 575 886 1,886

Disbursements FY86 706 309 530 839 1-544From pipeline 706 47 429 476 1,182From new co mitments - 262 101 363 363

Undisbursed balance on July 1. 1986 4.47 49 617 666 5.114

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7.68 Food aid: As already noted above, due to the need to build up ade-quate foodgrain security stocks, total foodgrain import requirements willremain high in FY86, at around 2.25 million tons. Given the expected tightbalance of payments situation, it would not be desirable for COB to have tofinance a high proportion of these imports. It should also be noted that,with an already high debt service ratio projected for FY86 and FY87, thescope for further food borrowing is strictly limited. Accordingly, it isrecommended that the volume of food aid be increased to 1.7 million tons(comprised of 1.55 million tons of wheat and 0.15 million tons of rice),valued at a total of about $350 million based on projected c.i.f. worldprices. Of this value, aid is expected to finance approximately $310 withthe balance of the value of aided shipments being financed by payments fromCOB's resources (for freight, etc.) The volume of food aid recommended wouldbe the highest since the difficult year of FY80, but would certainly bejustified in view of COB's efficient handling of the flood situation in 1984and the need to replenish foodgrain stocks. In order to provide a cushionagainst a possible disruption in food production during FY86, it would bedesirable for a high proportion of aided food imports to be scheduled forarrival early in the financial year. The events of the past year haveunderlined, once again, the need for careful monitoring of the food situationand flexibility on the part of donors to respond promptly to unexpected cropshortfalls.

7.69 Project aid: The availability of project aid has grown substantiallyover recent years as commitments have grown by about 9% p.a., leading to aclosing pipeline of project aid for FY85 estimated at around $4 billion. Forthe coming years, provided that the rate of disbursement from the availablepipeline is improved, an average of 5-6Z p.a. increase in project aid commit-ments from FY84 to FY90 should be sufficient to lead to a 9-10% p.a. increasein project aid disbursements. There would be some decline in the real valueof project aid commitments, but this would permit a gradual increase in thereal value of commodity aid commitments to Bangladesh while keeping overallcommitments constant in real terms. To be consistent with this medium-term-trend, it is recommended that project aid commitments should be around $1,000million for FY86.

7.70 Commodity aid: As emphasized above, there is a need for at least amodest shift in the "mix" of assistance to Bangladesh in favor of commodityaid. It is therefore recommended that commodity aid commitments should riseby 2% p.a. in real terms during the 3FYP period, so as to maintain a trend oftotal aid commitments which would be constant in real terms. This recommen-dation would imply an annual increase of around $60 million per year incommodity aid commitments, which is comparable to the average annualincreases of around $65 million per year between FY80 and FY84. However,given the unwelcome decline in commodity aid commitments which appears tohave taken place between FY84 and FY85, a substantial recovery in the Levelof commodity aid commitments will be needed between FY85 and FY86. It isrecommended that, rather than using the reduced level of FY85, the referencepoiiit or base for the growth trend in commodity aid commitments over the 3FYP

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period should be the $546 million in new commitments which were made avail-able during FY84. In view of the severe balance of payments pressuresexpected during next year, it would be important that commodity aid commit-ments should be at least in line with this trend for the first year of theproposed period of the Third Five Year Plan. Accordingly, it is recommendedthat commodity aid commitments should be not less than $575 million forFY86.1/

7.71 Table 7.11 shows that, on the basis of these recommendations, totalaid commitments for FY86 would amount to around $1,900 million. Commitmentsof this order should permit total disbursements of aid to increase from about$1,375 million in FY85 to around $1,550 million in FY86, provided that GOB isable to take affective steps to improve the pace of disbursements from theexisting pipeline. If these disbursements of development assistance werecombined with special balance of payments support of around $100 millionduring FY86, then it should be possible to minimize the decline in thenominal value of imports of non-food items from their expected peak levels ofFY85. However, following the drawdown of reserves during FY85, it wilL beextremely difficult to avoid some decline in the capacity for imports in realterms during FY86. Therefore, the aid recommendations set out above repre-sent no more than minimum requirements for the coming year.

1/ Table 7.4 shows that commodity aid disbursements are projected toincrease somewhat more rapidly than commitments in FY86. This estimateof disbursements is based on the assumption that disbursements willaccount for two-thirds of the opening pipeline and just under 20% of newcommitments. These ratios are slightly lower than those of the early1980s (namely, 75% of opening pipeline plus 25% of new commitments).However, they are in line with the estimates of the pipeline, commitmentsand disbursements for FY84 and FY85. There may be scope for increasingthese disbursement ratios, provided that the type of goods made availableunder commodity aid are carefully matched to the import needs ofBangladesh.