- 1 5900* October 4, 1996

w. " The World Bank

Bangladesh

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TRADE POLICY REFORM m4"

IMPROWING THE INCENTIVE : 1 c-

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BANGLADESH

TRADE POLICY REFORM

FOR IMPROVING THE INCENTIVF, RFGIMF

OCTOBER 4, I '96

Private Sector Development and Finance DivisionCountry Department 1South Asia RegionReport No. 1 5900-BD

LIST OF ACRONYMS

BOP - Balance of PaymentsBSIC - Bangladesh Standard Industrial ClassificationCIF - Cost Insurance FreightCD - Customs DutyCL - Control ListCEM - Country Economic MemorandumCV - Coefficient of VariationDEDO - Duty Exemption and DrawNback OfficeEPB - Export Promotion BureauEPZ - Export Processing ZoneGATT - General Agreement on Tariffs and TradeGDP - Gross Domestic ProductGOB - Government of BangladeshHS - Harmonized SystemIDA - International Development AssociationIPO - [mport Policy OrderNBR - National Board Of RevenueNPR - Nominal Protection RateNT'B - Non-Tariff BarrierL/C - Letter of CreditLF - License F'eeMFA - Multi-Fibre ArrangementOTS - Operative Tariff SchedulePBW - Private Bonded WarehousePSI - Pre-Shipment InspectionQRs - Quantitative RestrictionsRMG - Ready-made GarmentsSBW - Special Bonded WarehouseSD - Supplementary Excise DutySITC - Standard Internationial Trade ClassiFicationSRD - Statutory Rate of DutyTOT - Terms of TradeTV - Tariff ValuesUNCTAD - United Nations Commission for Trade and DevelopmentVAT - Value Added Tax

BANGLADESHTRADE POLICY REFORM FOR IMPROVING THE INCENTIVE REGIME

Table of ContentsPage No.

Executive Summary .................................................................. i-ix

CHAPTER 1. WHY TRADE REFORM? ........................................................................................... 1

CHAPTER II. THE CURRENT TRADE REGIME AND ITS IMPACT

Since 1992 import liberalization has reduced statutory levels of protection ........ ........ 3Efforts to streamnline import clearances have been less successful .... . ........................... 6Despite policy changes, smuggling persists ................................................................. 7High effective protection keeps incentives focused on production

for the domestic market and perpetuates inefficiencies ...................................... ....... 9Export promotion schemes provide an enclave setting for the production of exports.. 11Compared with other reforming countries, trade policy reform

in Bangladesh has a way to go .................................................................. 14

CHAPTER III. THE REMAINING AGENDA

Complete the process of trade liberalization ................................................................. 17The fiscal cost of tariff reform can be mitigated

by improving tax administration ................................................................. 2 1Take advantage of the World Trade Organization Framework ............. ....................... 22Follow an effective export promotion strategy ............................................................. 24Reestablish macroeconomic stability ................................................................. '7

CIIAPTER IV. POLICY RECOMMENDATIONS FOR AN EXPORT - ORIENTED ECONOMY

Import liberalization is the most effective wax to promote trade,especially for cxports ................................................................. 28

Adequate infrastructure facilities must be available to reducethe costs of doing business ................... .............................................. 29

Access to trade finance is crucial to spur export diversification,and increase value added in exports ..................... ............................................ 30

Use the WTO to lock in trade reforms . ................................................................. 30Substantial modification of investment incentives and the regulatory environment

can intensify the effect of trade policy reform ......................................................... 31Bangladesh should act quickly to consolidate the gains from policy reform ........ ....... 31

Page No.ANNEXES

1. Trends in Nominal Protection, 1990/91 to 1995/96 ..................................................... 322. Effective Protection Rates: Corden Method FY95/96 ..................................................... 333. Import Composition FY91/92 to FY95/96 ..................................................... 374. The Uruguay Round Agreement: Main Features and Potential Gains .................................. 385. Bangladesh: Schedule of Commitments for WTO ..................................................... 406. List of Participants in Workshop on the Report ..................................................... 43BIBLIOGRAPHY

List of Tables, Figures and BoxesText Tables

2.1 Trends in Nominal Protection, 1990/91 to 1995/96 ..................................................... 52.2 Main Items in Illegal Cross-Border Trade Between Bangladesh and India ........................... 82.3 Bangladesh: Indicators of Effective Protection, 1992-1996 ................................................ 102.4 Competitiveness of Import-Substituting Industries, 1992/93 .............................................. 112.5 Export Processing Zones at a Glance ..................................................... 122.6 Share of Major Exports and their Contribution to Growth .................................................. 132.7 Nominal Protection in South Asia ..................................................... 152.8 International Comparisons of Tariff Rates ..................................................... 162.9 International Comparisons of Nominal Tariffs in Manufacturing ....................................... 16

3J.1 Bangladesh: Customs Duties ..................................................... 213.2 Share of World Exports, Selected Countries, 1972 and 1994 .............................................. 25

Figures

2.1 The Structure of Tariffs. 42.2 Export Diversification: 1982/83 to 1994/95 .14

Boxes

3.1 The Impact of High Tariffs on Exports .18

3.2 Textiles and Garments: Differing Policy Regimes .20

3.3 Using the World Trade Organization as a Precommitment Device .24

This report was prepared by Sona Vanna (Task Manager). Contributing to the report were Charles Draper(SAIPF), Khurshid Alam (SA1BG), Zaid Bakht, Kamil Yilmaz (Consultants), and Zaidi Sattar (Advisor, NationalBoard of Revenue). Surveys on illegal trade were conducted jointly by the Bangladesh Institute of DevelopmentStudies. Dhaka, and the National Council of Applied Economic Research, New Delhi. Meta de Coquereaumont ofAmerican Writing Corporation was the principal editor. Madeline DeVan (SAIPF) also assisted with editing.Tercan Baysan and Charles J. A. Draper provided valuable comments. The report was processed by AnthonyStanley and Soon-Won Pak. The Director is Mieko Nishimizu and the Division Chief is Marilou Uy. PeerReviewers were Messrs. Bernard Hoekman and Neil Roger. The draft report was discussed in a Workshop held inDhaka on August 29, 1996, participated by GOB and IDA officials, Business Leaders, and Academics (Listattached at Annex 6). The Report was subsequently revised by Tercan Baysan and Khurshid Alam taking intoaccount the some of the recommendations from the Workshop.

Executive Summary

1. Many factors--inadequate infrastructure, a poorly-functioning financial system, lack ofskilled labor, amongst others--constrain efficient allocation of resources and increase the cost ofdoing business in Bangladesh. At the same time, the current trade policy regime, characterizedby a highly-dispersed and anomalous import tariff structure, creates an incentive system that isfar from being neutral. The resulting relative prices still maintain a significant anti-export bias,while providing protection to highly inefficient import-substituting activities. An open traderegime resulting from trade reforms helps enhance domestic market competition, reduces pricedistortions arising from projectionist polices so as to bring the domestic relative prices into closeralignment with the international trend prices, induces resource shifts toward activities that showcomparative advantage efficiency in resource allocation, and encourages innovation anddiversification. It also paves the way for the development of a far more diversified and strongexport-base. In short, the trade policy choices Bangladesh's policymakers make will have animportant influence, along with all other pending economic policy and institutional reforms, onthe success of the country's rapid economic growth strategy.

2. While other important and unfinished structural reforms are not covered in detail in thereport, it should be emphasized up-front that the trade policy reforms alone cannot realize the fullextent of gains expected from improvements in the allocation and use of resources. Tradereforms will help enhance domestic market competition, bring domestic relative prices intocloser alignment with the international trend prices, and induce resource shifts toward activitiesthat show comparative advantage. However, dynamic adjustments will be difficult and costlier ifconstraints on supply response are not addressed. Accordingly, acceleration of reforms in otherkey areas such as infrastructure, banking sector, legal and judicial structure, and public enterprisesector are also very crucial.'

3. This report focuses on Bangladesh's foreign trade policy. It reviews the recent reformactions, evaluates the current trade regime and its impact on the economy, and makesrecommendations for a phased, pre-announced reform strategy to push forward with incompletetrade reform. The remaining trade policy reforms pertain to further liberalization of the importregime, mostly involving the elimination of remaining protection-related non-tariff barriers andfurther rationalization of the tariff structure towards low uniform rates. These steps,accompanied by a flexible exchange rate policy, will help foster domestic competition andstrengthen Bangladesh's export-base. Simplifying and reducing the costs of importing will alsohelp boost the confidence of investors, both domestic and foreign.

A detailed coverage and discussion on the pending economic and institutional reform agenda in Bangladesh's keysectors can be found in the following Bank documents: Bangladesh: An Agenda for Action. June 1996;Bangladesh: Government that Works - Reforming the Public Sector. July 1996; Annual Economic Update:Recent Economic Developments and Mediuim-Term Reform Agenda. July 1996.

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4. Trade reformn has been an important part of the comprehensive stabilization and reformprogram that Bangladesh has been implementing since 1992. In contrast to the piecemealreforms of the 1 980s, significant steps have been taken during the 1 990s to liberalizeBangladesh's trade regime. In the late 1980s, prohibitive tariffs and quantitative restrictionsresulted in underinvoicing and smuggling. Most tariffs were not binding, and there was a highincidence of "water in the tariff' - tariff redundancy which results from smuggling andprohibitively high tariff rates. In some cases, "statutory" levels of protection were higher than theobserved levels of protection, as measured by the difference between world and domestic prices(for most goods, domestic prices were lower than the tariff-adjusted world prices). And in manyothers, competing imports were of higher quality than their domestically manufacturedsubstitutes since domestic producers often compromised or. quality to keep their prices belowthat of competing imports .

What Has Been Done So Far

5. A large part of the trade reform effort so far has resulted in reducing the water in thetariff and bringing statutory levels of protection closer to observed levels.2 It has also reducedthe average tariff burden on imports. Average nominal protection, measured as the average of allimport duties and protective taxes, has fallen from 89 percent in 1990/91 to 25 percent in1995/96 (Table 1). However, nominal protection, as measured by import-weighted averageprotection rates, has declined since 1990/91, but by much less (21 percentage points) than thedecline in unweighted average protection rates (64 percentage points). The practice of grantingtariff concessions and exemptions based on end-use has slowed the move toward simplificationof the tariff schedule.

6. Other reforns have steadily dismantled a complicated structure of import controls,though a crucial industry, textiles, remains protected. A voluntary preshipment inspectionscheme supplements the use of rigid tariff values for import valuation.

7. As a result of such reforms, effective protection has decreased for most industries since1992. But because effective rates of protection for the steel and engineering and food and dairyindustries increased significantly, aggregate effective protection fell only 15 percent between1992 and 1995. When steel and engineering and food and dairy are excluded, the aggregateeffective protection rate shows a 48 percent decline. Observed average effective protection ratesindicate that trade policy reform has not shifted incentives firmly towards the production ofexportables.

2 As indicated by the difference between world and domestic prices.

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8. WVhere export production has succeeded, it has been because a special environment,insulated from the prevailing trade regime, has fostered rapid growth. This enclaveenvironment, created through the use of various export promotion schemes, has assisted inproviding world-priced inputs to exporters in the absence of general trade policies that would dothe same for all would-be exporters. Schemes such as the special bonded warehouses and exportprocessing zones (complemented by other factors, such as quotas under the Multi-FibreArrangement and an innovative financing scheme) have allowed Bangladesh to use its abundantlabor resources to develop an efficient ready-made garments industry, which accounts for over50 percent of gross exports from Bangladesh. This impressive success has yet to be replicated inother industries, however, and Bangladesh's export base remains narrow. More importantly,Bangladesh's share of world exports has declined since 1972 (Table 2).

Table 1: Trends in Nominal Protection, 1990/91 to 1995/96(percentage of assessed value)

Agriculture Mining Manufactures All Tradables

Pre-reform, 1990/91Unweighted 90.5 54.1 89.0 88.6Import-weighted 20.9 24.0 51.8 42.1Dispersion (CV) 63.3 51.7 58.6 59.0

Post Reform, 1995/96Unweighted 26.0 13.6 24.6 24.6Import-weighted 10.1 38.8 21.9 21.0Dispersion (CV) 56.7 82.2 73.5 72.7

a. Import-weighted nominal protection rates for 1990/91 are weighted by import data forthe corresponding year; for 1995/96 they are weighted by 1994/95 imports.

b. CV is the coefficient of variation for the unweighted average.Source: NBR, staff estimates

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Table 2: Falling Behind... Bangladesh's Share in World Exports,Selected Countries (percent)

Country 1972 1994

China 0.95 2.81Indonesia 0.46 0.94Thailand \a 0.28 0.87Mexico 0.43 0.81Turkey \a 0.23 0.36Sri Lanka 0.09 0.08Bangladesh 0.09 0.06Ghana \b 0.11 0,02Kenya 0.09 0.04Nepal'\a 0.01 0.01Philippines 0.28 0.45Vietnam \b 0.00 0.04a\ 1993b\ 1989Source: IMF, International Financial Statistics

9. Despite significant reforms, the current trade regime continues to provide incentives forsmuggling and duty evasion through underinvoicing of imports. In 1994, illegal cross bordertrade was equivalent to about 13 percent of total official trade. The bulk of cross-border tradeconsists of illegal imports, rather than exports; in 1994 illegal imports constituted 18 percent oftotal imports. Most of this illegal trade (83 percent of total unofficial imports and 100 percent oftotal unofficial exports) is with India (Figure 1).

Figure 1. Composition of Illegal Trade between India and Bangladesh

Other14%

Electronics Livestock7 %and related

37%Textiles

Processed Agriculturalfood/tobacco roducts

18% 12%

Source: BIDS/NCAER Cross-Border Survey, 1994.

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10. Compared with other reforming countries, Bangladesh has a long way to go in its tradepolicy reform. In South Asia, Sri Lanka has compressed tariffs into three bands and plans tomove to a low, uniform tariff soon. In Latin America and the Caribbean in 1993, Chile had auniform tariff rate, the Central American countries had only four rates, Jamaica had five, andUruguay had three. Most East Asian economies have also significantly reduced tariffs in an effortto boost exports. In Africa, Ghana adopted a three rate regime in 1993 (Table 3).

Table 3: Many Reformers have Lower Tariffs than Bangladesh(average unweighted tariffs, percent)

Bangladesh (1996) 25Sri Lanka (1995) 10.3 \aArgentina (1992) 12.2Chile (1991) 1 iPeru (1992) 17Malaysia (1993) 14Ghana (1993) 17a\ Denotes tariff collection rateSource: World Bank staff estimates

What To Do Next

11. Bangladesh has made a good start. Significant export and import growth in 1994/95,suggest that trade reforms, coupled with relative macro stability and overall growth in theeconomy, may be evoking a supply response from the private sector (Figure 2). To sustain andstrengthen this response, Bangladesh should complete the crucial remaining items on the tradereform agenda. This agenda should focus on import liberalization, while maintaining theefficiency of current export promotion schemes. To signal private investors of Bangladesh'ssteadfast commitment to a liberalized trade regime, Bangladesh should adopt many provisions ofthe recently concluded Uruguay Round agreement.

12. Import liberalization is the most effective way to promote trade, especially of export, andtariff reform is the most critical element of import liberalization. The Government has madegood progress in reducing tariffs. Now progress is needed in establishing more uniform rates ofprotection, by compressing the number of tariff rates to reduce dispersion and simplify theregime. A major source of tariff dispersion is the continued use of tariff concessions for end-users, which should be phased out.

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Figure 2. Import and Export Growth...

Imports I Exports50- 40SD 1 40

40 t 1- 0 9 j ; 9 ,, 9 9

- ~~~~~~~~~~~~3030 -- 20

20

0 0 1

91/92 91/92 92/93 93/94 94/95 95/96

...And Composition

Imports Exports7 Frozen

Consumer Others Raw jute seafoodGoods ~~~Primary 24% % 9%

Capital J uteGoods sr.cmtap-n cdoa Manuf.21% 5/

¶~~~f ~~Readypdtermrediat T made

liberalization isreco:garmentsLeather ~~~53%

400/ 6%

Note: Growth figures for 1995/96 are estimates.

13. For an open and stable trade regime, that attracts investors and stimulates exportgrowth, the Government should commit to a pre-announced program of across-the-board reformand move away from the made-to-measure approach of special exemptions and compensations.Advanced announcement of tariff reforms is essential to reduce uncertainty for investors andproducers. The Government ought to announce a medium term strategy in its next budget, whichoutlines tariff changes for the next few fiscal years. The following sequence for importliberalization is recommended:

* Alnnounce niow, a low tariff regime, between zero and 20 percent, to be effective in1999/2000.

* Move progressively to a three-rate (10, 20 and 35 percent) tariff schedule in the nextbudget and a two rate schedule (10, 20 percent) in the following budget, keeping thezero rate for imported inputs used by exporters.

* Work towards eliminating all end-user concessions to reduce dispersion. A singletariff rate should be applied to all tariff items under each four digit harmonizedsystem (HS-4) heading (except wvhere very different goods are listed under the sameHS-4 heading).

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Unify the statutory rates of duty and the operative rate to avoid complicating theschedule, and also to avoid any chance of backsliding on the reforrrm process.

14. Fears of large tax revenue losses have been key factors in holding up rapid reductions intariffs. This is an understandable concern in Bangladesh given the importance of tax revenuescollected on imports. Currently, customs duties account for over 33 percent of NBR-administered taxes, with VAT and supplementary duty collected on imports accounting for 23percent and 3 percent, respectively. Obviously, it is important to speed up the unfinisheddomestic tax reform, focusing on the expansion of VAT and income tax nets, while intensifyingefforts aimed at strengthening the NBR. Improvements on the domestic tax front, includingefficiency of the tax machinery, need to be achieved both to pave the way for further importtariff liberalization as well as to strengthen Government's fiscal base. However, it should also beadded that import tax revenue collections also depend, in addition to the tax/duty rates, onshort/long-term price and income elasticities of imports, economic growth and technologychanges - given international prices and abstracting from shocks. All these factors could morethan offset the effect of tariff cuts on tax revenue collections. Indeed, this has been the case inBangladesh in recent years. When tariffs were reduced in 1994-95, imports increased 39 percentin dollar terms, and that import tax revenue increases more than compensated for lower tariffs.And the surge in imports and customs revenue continued into 1995/96, despite congestion at theport of Chittagong and a difficult political situation. As a rough estimate, reducing import-weighted tariffs to half their present level could potentially reduce customs duties by Taka 19billion. If macroeconomic stability is maintained and the economy continues to grow, revenuelosses from further tariff reductions should be offset by increased volume of imports.

15. Quantitative restrictions, especially on textiles, are preventing the development ofbackward linkages with the ready-made garment sector. If these restrictions are removed,protection due to nontariff barriers will virtually disappear in Bangladesh. This would spur thedevelopment of a textile sector that could potentially supply the needs of the ready-made garmentindustry, which now imports more than 90 percent of its textile inputs. Bans on import of sugar,salt, and some other commodities are somewhat meaningless because large amounts of thesecommodities are imported illegally from India. Removing these restrictions would expose theseindustries to greater competition, generate tariff revenues, and benefit consumers by reducingprices.

16. The trade liberalization agenda will not be complete without strengthening importvaluation and clearance. Tariff values, used in import valuation should be phased out; a welldesigned pre-shipment inspection scheme can be used until Bangladesh can rely on invoiceprices as accurate measure of value. Mandatory pre-shipment inspection avoids a number ofproblems being currently faced by the voluntary system. The Govcrnment recently introducedcomputerized customs assessment using the UNCTAD-developed SPEED system at Chittagongport and Dhaka airport, but design and implementation problems have kept the system fromfunctioning smoothly. A review and adjustment of the system, to get it operating correctly, isnecessary to complete computerization of import clearance. The Operative Tariff Scheduleshould be published regularly to ensure transparency of the tariff regime.

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17. The program for import liberalization should take top priority in the Government'sstrategy for trade reforn. Until this liberalization process is complete, however, exportpromotion schemes must be made as effective as possible to reduce disincentives for exporting.The following measures are recommended:

* Overcome the obstacles to making special bonded warehouses available for mosttypes of export industry and further develop the scheme so that it can be used byestablished firms serving both home and domestic markets.

- Consolidate the progress made in developing export processing zones to ease theireventual integration with the regular economy. Private investment in new estates canplay a useful role.

* Resumne improvements in the functioning of the Duty Exemption and DrawbackOffice, produce new and revised flat rates for duty rebates, make partial, occasional,and indirect exporters eligible for duty rebates, and implement the recent decision toinvolve banks in paying the rebates.

* Remove implementation bottlenecks of export promotion schemes reflected ingovernment's policy declaration, e.g. that of allowing export oriented industry to sellpart of their product (I 5-20 percent) in the domestic market after paying of all taxesand duties.

18. Adequate infrastructure facilities should be available to reduce the costs of doingbusiness. Production activities are hampered by Bangladesh's pervasive infrastructurebottlenecks. Unless addressed urgently, these problems will continue to be serious constraint torapid economic growth. Infrastructure facilities are satisfactory only in export processing zones,encouraging export development in enclaves. For sustained growth in exports, all prospectiveexporters must have access to power, telecommunications, and other infrastructure, and toimproved port facilities that expedite the clearance process for both imports and exports. Thefollowing measures are recommended:

* Set up an inland container depot at Chittagong and expand Mongla port. Considerprivate participation in the inland container depots, private container stuffing anddestuffing centers, and the leasing of container berths to private operators.

* Lift the air cargo monopoly currently enjoyed by Biman to bring competition intothe air cargo industry and improve services.

19. Access to trade finance is crucial to spur export diversification, and increase value addedin exports. In the long run, the development of an efficient banking system will relieveconstraints in trade finance. Over the short run, however, a few steps can be taken to increaseexporter's access to trade finance. They are:

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* Discontinue such outdated practices as the compulsory back-to-back usance importletters of credit; let exporters be free to choose between them and other forms offinancing.

* Continue a dollar line of credit at Bangladesh Bank to isolate pre-shipment exportcredit from thc inefficiencies of the banking system.

* Remove the interest rate ceiling on export loans, which have denied small-scaleexporters access to finance.

20. The Government can use the WVorld Trade Organization to facilitate and lock in tradereforms. Bangladesh's commitments at the WTO can serve as a precommitment device for futurepolicy change and will be useful for achieving credibility with investors, both domestic andforeign. To this end, Bangladesh should:

* Bind its tariffs at operative rates.

* Further develop the Tariff Commission as a transparency institution that advises ontariff policy changes.

* Ensure that safeguards mechanisms are designed to minimize the scope for an easyreimposition of protection.

21. Substantial modification of investment incentives and the regulatory environment canintensify the effect of trade policy reform. The current corporate tax system, the remnants of pastcontrols on investment and foreign exchange, and inadequacies in the legal framework increasethe cost of doing business in Bangladesh, and also reduce the incentives for foreign investment.These shortcomings can be remedied relatively quickly, particularly compared with the time itwill take to improve inefficient utility services and inadequate infrastructure. By clearing mostof the policy hurdles the Government will be able to provide incentives for investment that canbalance the additional costs due to the deficiencies in infrastructure.

22. Bangladesh should act quickly to consolidate the gains from policy reform and forgeahead. International experience demonstrates that successful trade reforms proceed on a well-paced, pre-announced schedule, give priority to the reduction of tariff and nontariff barriers toimports, and are accompanied by flexible exchange rate management and prudentmacroeconomic policies. Bangladesh has largely followed this path. While the pace of changehas been slow, policy reform has picked up momentum in the last few years. Early results showthat these changes have elicited a significant supply response. Bangladesh must act quickly toremove the remaining hurdles to trade, in order to move the economy firmly onto the path ofoutward-oriented development and rapid economic growth.

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1. WHY TRADE REFORM?

Trade policy reform is essential for efficient resource allocation and an outward-orienteddevelopment strategy

1.1 Bangladesh has adopted an export-oriented strategy of growth. If implementedsuccessfully, this strategy would increase domestic investment, attract much-needed foreigninvestment, create millions of jobs, and reduce poverty. Many factors--inadequateinfrastructure, a poorly-functioning financial system, lack of skilled labor, amongst others--constrain efficient allocation of resources and increase the cost of doing business in Bangladesh.At the same time, the current trade policy regime, characterized by a highly-dispersed andanomalous import tariff structure, creates an incentive system that is far from being neutral. Theresulting relative prices still maintain a significant anti-export bias, while providing protection tohighly inefficient import-substituting activities. An open trade regime resulting from tradereforms helps enhance domestic market competition, reduces price distortions arising fromprojectionist polices so as to bring the domestic relative prices into closer alignment with theinternational trend prices, induces resource shifts toward activities that show comparativeadvantage efficiency in resource allocation, and encourages innovation and diversification. It alsopaves the way for the development of far more diversified and strong export-base. In short, thetrade policy choices Bangladesh's policy makers make will have an important influence, alongwith all other pending economic policy and institutional reforms, on the success of the country'srapid economic growth strategy.

1.2 While other important and unfinished structural reforms are not covered in detail in thisreport, since focus here is primarily on Bangladesh's foreign trade policy, it should beemphasized up-front that the trade policy reforms alone cannot realize the full extent of gainsexpected from improvements in the allocation and use of resources. However, dynamicadjustments will be difficult and costlier if constraints on supply response are not addressed.Accordingly, acceleration of reforms in other key areas such as infrastructure, banking sector,legal and judicial structure, and public enterprise sector are also very crucial.l

1.3 Trade policy reform has been an important part of the comprehensive stabilization andreform program that Bangladesh has been implementing since 1992. Early reforms resulted incommendable macroeconomic stability and internal and external balance. All macroeconomicindicators showed marked improvement between FY1990 and FY1994: the fiscal deficit wentfrom 7.7 percent in FY1990 to 5.9 percent in FY1994, the current account deficit from 6.9percent of GDP to 1.4 percent, and foreign exchange reserves from 1.9 months of imports to 8.2

A detailed coverage and discussion on the pending economic and institutional reform agenda in Bangladesh's keysectors can be found in the following Bank documents: Bangladesh: An Agenda for Action. June 1996;Bangladesh: Government that Works - Reforming the Public Sector. July 1996; Annual Economic Update:Recent Economic Developments and Medium-Term Reform Agenda, July 1996.

months. There has been some deterioration during FY1995 and FY1996, however, largely due toeconomic disruptions resulting from political tensions.

Macroeconomic stability alone cannot ensure rapid growth

1.4 Though an essential foundation for growth, macroeconomic stability alone will not resultin faster growth, as Bangladesh's recent experience demonstrates. To achieve sustained increasesin economic growth, macroeconomic stability must be complemented by effective structuralreforms in such areas as the financial sector, legal reform, infrastructure, and energy. Most ofthese reforms are difficult and politically sensitive. Trade policy reform, the bulk of whichconsists of liberalizing imports, is perceived to be relatively easier to implement.2 By reducingthe bias against exports, trade policy reform should be very effective in spurring investment, bothdomestic and foreign, in export-oriented sectors. A large share of investment in Bangladesh willcome from foreigners looking to produce exports for the world market. The Government canstrengthen the confidence of these investors by accelerating trade policy reform and announcingin advance the schedule of policy changes so that new investors can select projects sensibly andenterprises can plan any necessary restructuring.

1.5 This report reviews and analyzes trade policy reform in Bangladesh since 1992 andattempts to put into perspective the major policy issues affecting trade. It evaluates the currenttrade regime and its impact on the economy, and makes recommendations for a phased pre-announced near-term reform strategy, to accelerate completion of the remaining trade reformagenda, remove distortions in the import regime, and enhance export competitiveness. Theremaining trade policy reforms pertain to further liberalization of the import regime, mostlyinvolving the elimination of remaining protection-related non-tariff barriers and furtherrationalization of the tariff structure toward a single and low uniform rate. These steps,accompanied by a flexible exchange rate policy, will help foster domestic competition andstrengthen Bangladesh's export-base. Simplifying and reducing the costs of importing will alsohelp boost the confidence of investors, both domestic and foreign.

Though trade reform prescriptions are perceived to be relatively easier to implement, in Bangladesh it may berestrained by the perception prevailing in some quarters of the government and the business community thatBangladesh has already liberalized faster than its neighbors, thereby increasing ratio of risks to returns forindustries here.

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2. THE CURRENT TRADE REGIME AND ITS IMPACT

2.1 By the late 1980s, despite some efforts at reform, Bangladesh's trade policies hadresulted in a trade regime with prohibitively high tariffs and quantitative restrictions that fosteredsmuggling, particularly along the long, porous border with India. As a result, most tariffs werenot binding, as is evidenced by the fact that domestic prices for most goods were lower than thetariff-adjusted world prices.3 A 1992 survey revealed that in some cases "statutory" protection,calculated from the tariff regime, was higher than the observed protection measured by thedifference in world and domestic prices. And in many others, competing imports were of higherquality than their domestically manufactured counterparts since domestic producers oftencompromised on quality to keep their prices below that of competing imports.

Since 1992 import liberalization has reduced statutory levels of protection

2.2 In contrast to the piecemeal and partial reforms of the 1980s, significant steps have beentaken since 1992 to liberalize Bangladesh's trade regime. The reforms have reduced the "water inthe tariffs", bringing statutory levels of protection closer to observed levels. The import-discriminating, multiple rate sales tax was replaced by a 15 percent value added tax levied onboth imports and domestically produced goods. Regulatory duties and surcharges on importswere replaced by a supplementary excise duty, a trade-neutral consumption tax. Tariffs werereduced in each successive budget, and some exemptions based on end-use were eliminated,resulting in some compression of the tariff structure (Figure 2. 1).5

2.3 As a result of these sustained efforts, average nominal protection, including all importduties and protective taxes, fell from 89 percent in 1990/91 to 25 percent in 1995/96, a drop of 64percentage points (Table 2.1). The import-weighted average protection rate, fell by 21 percentagepoints. The import-weighted average protection rate for the manufacturing sector fell even morethan the overall average--about 30 percentage points--the rate rose for mining-- by 15 percentagepoints--mainly because tariffs on petroleum, oil, and lubricants were changed from specific ratesto ad valorem rates in 1993/94. 6 (For a more detailed breakdown of nominal protection rates, seeAnnex 1).

3 See Bakht, 1995.

Tariff redundancy resulting from smuggling and prohibitively high tariff rates.

Unlike many other countries, end-user exemptions are listed in the Bangladesh tariff schedule

6 Prior to 1994195, petroleum, oil and lubricants were taxed at Taka 5,000 per metric ton, in 1993/94, thisspecific rate was replaced by an ad valorem tariff of 45 percent of import value.

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Figure 2.1 The Structure of Tariffs

1991/92 Tariff Rates

30 c=> 25 -

20i-D 15

u 0

IL 0 3 5 10 15 20 30 40 45 50 60 100 150 175 200300 350 400

Tariff Rate

1995d96 Tariff Rates

Source: N 77r77777Data.

20

0 10

0 3 5 8 10 15 20 23 30 40 45 50 60 100 150 175 200 300 350 400

Tariff Rate

Note: Tariff lines denote HS- I 0 digit tariffsSource: NBR Trade Data.

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Table 2.1 Trends in Nominal Protection, 1990/91 to 1995/96(percentage of assessed value)

Agriculture Mining Manufactures All Tradables

Pre-reform, 1990/91Unweighted 90.5 54.1 89.0 88.6Import-weighted /a 20.9 24.0 51.8 42.1Dispersion (CV) /b 63.3 51.7 58.6 59.0

Post Reform, 1995/96Unweighted 26.0 13.6 24.6 24.6Import-weighted /a 10.1 38.8 21.9 21.0Dispersion (CV) /b 56.7 82.2 73.5 72.7

/a Import-weighted nominal protection rates for 1990/91 are weighted by import datafor the corresponding year; for 1995/96 they are weighted by 1994/95 imports.

/b CV is the coefficient of variation for the unweighted average.Source: NBR, staff estimates

2.4 Though tariff reforms have been extensive, little attention has been paid to simplifyingthe tariff schedule by reducing the nurnber of tariff rates applied to a particular product. Theproportion of tariff lines with multiple rates at the four-digit harmonized system (HS-4) level fellfrom 54 percent in 1991/92 to 44 percent in 1995.7 The number of HS-4 headings with five ormore rates first fell from 79 to 21 between 1991/92 and 1994/95, but then increased to 53 in1995/96.

2.5 One reason for the slowdown in the move towards simplification of the tariff schedule isthe continuing proliferation of end-user concessions. The number of concessionary categorieshad been reduced from 20 in 1991/92 to 11 by 1993/1994. Currently, seven concessionarycategories exist, including one for 100 percent export-oriented manufacturers who are exemptedfrom paying duties on capital equipment. Though a useful concession, this has raised thecomplexity of the tariff schedule and increased the number of duty-free items from 300-350during 1989-95 to 1,295 in 1995/96.

The harmonized system (HS) is an internationally accepted system of classification of imports; the greater thenumber of digits, the greater the level of detail in the description of the commodity. HS-4 denotes a fairly broadlevel of disaggregation.

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2.6 Thus tariff dispersion, as measured by the coefficient of variation, has remained high.8 (Ingeneral, the greater the number of tariff rates per item, the higher the coefficient). The majorreduction in import taxes in 1991/92 actually resulted in an increase in the coefficient ofvariation from 59 to 68 percent. In 1992/93 the compression of customs duty rates and theremoval of two concessionary categories reduced the coefficient of variation to 62 percent. By1995/96, however, the coefficient of variation had risen to 74 percent because low tariff rates,rather than high rates, were decreased.

2.7 Progress has also been made in reducing quantitative restrictions. A complicated structureof import controls has been steadily dismantled, although a crucial subsector, textiles, remainsprotected and reductions have occurred unevenly across commodity groups and sectors. Ingeneral, restrictions on domestically produced goods have been removed more slowly than thoseon other goods, and restrictions on manufacturing goods have been lifted more slowly than thoseon agricultural goods. In manufacturing, controls on consumer goods have been more stringentthan those on intermediate and capital goods. Currently, the textiles sector enjoys the heaviestprotection from quantitative restrictions; almost 25 percent of all eight-digit harnonized systemlines in textiles are under quantitative restrictions. By comparison, barely two percent of tarifflines overall are now subject to trade-related quantitative restrictions. Import bans are in place onall woven fabrics, and gray cloth imports are restricted to the ready-made garment industry. Thisprotection has reduced the competitiveness of the local textile industry and has encouragedsmuggling of foreign textiles and domestic leakages of textiles and garments from bondedwarehouses, whose stocks are restricted to be used for ready-made garment exports.

Efforts to streamline import valuation have been less successful

2.8 The Government has set tariff values that are to be used in place of the invoice pricedeclared by the importer in assessing the import value of some imports. In many cases, the tariffvalues are set higher than world prices, thus increasing the protection provided by tariffs. Areview of import transaction data in 1993/94 reveals that tariff values can increase protection byas much as four to seven percent (for basic metal products and textiles). In certain cases, the tariffvalue has inadvertently been set below the CIF invoice price. The recently completed TextilesStudy revealed that the tariff value on a certain quality of polyester yam was below its CIF price,thcrefore actually undercutting the intended protection. 9

2.9 To improve the import valuation system, the Government introduced a voluntary pre-shipment inspection scheme in its 1993/94 budget. In 1994/95 the system was amended to allowpre-shipment inspection values to override fixed tariff values. This improvement increased theusage of the pre-shipment inspection scheme, in 1995/96 it covered approximately 25 percent of

8 The coefficient of variation (CV) is calculated as the ratio of the standard deviation (SD) to the mean,multiplied by 100. The SD has fallen from 54 to 16 percent between 1990/91 and 1995/96. Although the SD iswidely used as a measure of dispersion, it a weaker measure than the CV, since it is scale dependent (depends on thevalue of the mean). The CV rise, despite the fall in SD, occurred because the SD did not fall as much as the meanduring the process of tariff reduction.

See Bangladesh Tariff Commission, Textiles Sector Study Project, Final Report on the Textile Spinning Sub-sector, pp. 16.

all imports. Other improvements in import clearance include publication of the tariff schedule,and installation of a computerized customs appraisal system at Dhaka and Chittagong.

Despite policy changes, smuggling persists.

2.10 Reforms have not eradicated the strong incentives for smuggling, especially across theporous Indian border, and duty evasion continues through under-invoicing of imports. A recentsurvey reveals that illegal cross-border trade, most of it imports, was equivalent to about 13percent of total official trade in 1994. Illegal imports constituted approximately 18 percent of

1(0total imports into Bangladesh. The bulk (83 percent) of unofficial imports are from India. Thistrade has been facilitated by the different pace of trade liberalization in the two countries.Bangladesh has liberalized its import regime faster than India, but border price differentials arestill significant enough to ensure the profitability of illegal trade. The survey found that onaverage, the prices of illegal imports of Indian goods were 31 percent higher in Bangladesh thanin India. While this price differential has fallen since 1990, when it was 74 percent, it is still highenough to make smuggling worthwhile. The onerous import clearance procedures in bothcountries make the use of unofficial channels for trade even more appealing.

2.11 The survey of cross-border flows between India and Bangladesh found that illegalimports from I'dia into Bangladesh ($519 million) greatly exceeded exports from Bangladesh toIndia ($126 alulion). The Indian survey estimated total cross-border trade between the twocountries at a lower $450 million. I l

2.12 Food, agricultural products, and livestock account for the bulk of illegal imports - morethan 70 percent. Cattle alone account for one-third of illegal imports (Table 2.2). 12 Textiles,especially cotton saris, make up another 12 percent, and sugar, pulses, powdered milk, spices,salt, and bicycles are also illegally imported in large volume. Most illegal exports to India arefirst legally imported into Bangladesh, where tariffs are lower, and then exported to India. Thevolume of this "legal import-illegal export" trade has fallen significantly since the tariffdifferentials between India and Bangladesh became smaller, with India's liberalization ofimports. Important items illegally exported to India include copper and brass products, synthetictextiles, VCRs, calculators, and used clothing. Some indigenous items (fish, jute, synthetic fabricwoven of imported yarn) are also exported illegally to India.

0 These estimates are based on a 1994 survey, which estimated the volume of illegal trade between India andBangladesh. All numbers are approximations and should be used with caution.

The field survey was conducted simultaneously at the Indian and Bangladeshi borders, using a commonquestionnaire and methodology. The "Delphi technique" a method of estimation based on successive interviewswith knowledgeable persons, was used to assess the magnitude of the flows.

12 Approximately 1.7 million cows are estimated to cross the border into Bangladesh each year; accounting for20 percent of the hides and skins.

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Table 2.2 Main Items in Illegal Cross-Border Trade Between Bangladesh and India

1994 border prices(US Dollars)

Value Share ofCommodity (US$ million) exports/im Unit India Bangladesh Trade restriction

ports(percent)

IMPORTSLivestock, poultry, 252.0 40.0fish and relatedproducts

Live animals 216.0 34.2 Restricted export(cattle) no. 80.6 164.5 (India), increased

tariff (Bangladesh)Agricultural 78.0 12.4Products

Sugar 35.0 5.6 kg. 0.6 0.97 BannedProcessed food and 114.2 18.1tobaccoTextiles 76.2 12.1 Banned

Saris (cotton) 50.0 7.9 no. 2.4 3.98 BannedOther industrialmanufactures 26.9 4.3

Bicycles andparts 13.9 2.2 no. 25.8 \a 48.4 \a High tariff+ VAT

Other consumer 83.6 13.2goodselectronics 43.1 6.8

no.Total Imports 631.0 \c 100.0

EXPORTScopper, brass and 61.7 58.0 kg 2.7 2.3other metalsfish 35.1 33.0 kg 2.4 1.6synthetic textiles 4.6 4.3 meter 0.47 0.43electronics, spares 5.1 4.8 no. 254.0 \b 225.0 \b lower import duty in

BangladeshTotal Exports 106.0 \c 100.0

Total Illegal Trade 737.0 \c

a\ Price of bicycles b\ Price of video cassette recorders \c These figures have been finalized after reconciling theestimates in the Indian and Bangladeshi surveys. They do not necessarily correspond to the estimates in para 2.11.Note: The border prices are mid-value prices between West Bengal and Bangladesh. Prices are generally higher

in Assam and Tripura.Source: NCAER and BIDSfield survey.

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High effective protection keeps incentives focused on production for the domestic market andperpetuates inefficiencies

2.13 Effective protection, which measures protection to net value added, tends to be a bettermeasure than nominal protection since it takes into account protection on traded inputs.Effective protection rates for domestic sales of manufactured goods demonstrate that industry inBangladesh was highly protected at the start of tariff refonn in 1992 (Table 2.3). 13 Textiles andcertain consumer goods produced mainly for domestic consumption had particularly higheffective rates of protection.

2.14 Sustained trade reform since 1992 has reduced levels of effective protection in mostindustries (Table 2.3), 14 but because effective rates of protection rose significantly for the steeland engineering and food and dairy industries, aggregate rates fell only 15 percent. If theseindustries are excluded, aggregate effective protection declined by 48 percent between 1992/93and 1995/95.

2.15 These trends are corroborated by independent analysis performed by the BangladeshTariff Commission (Annex 2). The analysis showed that effective protection fell from 46 percentin 1992/93 to 24 percent in 1995/96 in agriculture, and from 120 to 49 percent in industry. Theanalysis also found that for certain sub-sectors (edible oils, mill cloth, and wood and woodproducts), effective protection rates are higher than nominal protection.

2.16 Though differences in methodology make it difficult to match up the World Bank resultsin Table 2.3 with those of the Bangladesh Tariff Commission, both studies indicate that tradepolicy reform has not shifted incentives towards the production of exportables. High effectiveprotection has hampered productivity and efficiency growth among import substitutingindustries. Where export production has flourished, as in ready-made garments, its rapid growthhas been fostered not by the overall policy environment, but by a special environment(availability of MFA quotas, an innovative financing scheme, and export promotions schemes)insulated from the prevailing trade regime (paras 2.20 -2.26).

3 Effective protection was calculated using firm-level data on value added. Due to lack of disaggregated worldprice data, the input-output tariff structure was used to estimate world prices. There are problems with this approach,and these results must be treated as approximations. Specifically, most tariffs are not binding, and there is a highincidence of "water in the tariff' in Bangladesh. This is a situation under which protection accorded by the levied tariffsis undermined by smuggling, domestic competition , and related factors. Therefore there may be a significant differencebetween the statutory protection levied by the tariff structure and the "observed" protection that results.

14 Effective rates of protection for 1995/96 have been calculated using the same firm level data but with the1 995i96 tariff rates.

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Table 2.3 Bangladesh: Indicators of Effective Protection, 1992 - 1996(percent, except where indicated otherwise)

1995/96 1992/93 Number ofEnterprises

Sector effective rate of effective rate of Share ofprotection-\a protection \a production Universe Sample

domestic sales domestic sales solddomestically

Tanning and leather 41 127 14 554 54Steel and engineering: 123 86 97 3,090 144Textile 73 105 92 606 58Jute 24 36 29 156 36Dyeing and printing 66 91 92 419 51Knitwear 64 nwva \b 56 517 23Ready-made garments 48 222 3 1,107 133Fish and seafood 12 34 8 134 31Medicine 8 -6 97 339 19Perfumes and toiletries 111 116 82 475 29Food and dairy 123 45 100 4,175 121Food processing 72 139 79 1,941 80Residual A \c 44 238 74 3,935 135Residual B \c 72 237 70 2,616 246Total (weighted by value added) 67 82 57 20,018 1,163Excluding steel and engineering

and food and dairy 45 93 43 12,799 897a\ Calculated as: (value added at domestic price - value added at world price)/ value added at worldprice*100b\ Denotes negative value added at world prices, and implies a high degree of protection.c\ Industries not classified elsewhere (e.g. brick manufacture, locally produced cigarettes, housewares)

Source: Yilmaz (1996), using data from World Bank manufacturing survey, 1992/93

2.17 A recent survey of manufacturing confirms that on average, policy incentives encourageproduction for the domestic market.i In 1992 the manufacturing sector in Bangladesh wasundiversified, with a few sub-sectors -- ready-made garments, food and dairy, bidis, 6 and brickproducts -- accounting for most of employment, value added and investment. Of these, onlyready-made garments were export-oriented.17 The manufacturing sector produced mainly for thedomestic market; barely 35 percent of outpl't was directed to external markets. Large units (morethan 50 workers) dominated the sector, accounting for 80 percent of total capital stock,investment, employment and output. Almost 28 percent of manufacturing operated below itsmaximum capacity, and 24 percent of manufacturing units were considered "sick."

V The Structure and Performance of Bangladesh Manufacturing. 1992, World Bank/USAID, Dhaka

A type of cigarette produced and consumed locally1 Export-oriented subsectors are those that direct over 60 percent of their output to the extemal market

8 Sick units are defined as those earning less than 10 percent return to capital for more than three years.

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2.18 The export-oriented sectors-garments, knitwear, tanning and leather, jute, fish andseafood-performed better than the rest of manufacturing in labor productivity (fish and seafood,tanning and leather), capital productivity (ready-made garments, knitwear, fish and seafood),capacity utilization (knitwear, ready-made garments), and highest returns to capital (ready-madegarments, knitwear, and fish and seafood).

2.19 A number of import substituting industrie-s (except for the bidi industry) were inefficientat current capacity. This is indicated by a domestic resource cost of greater than 1 (Table 2.4).19Profitability was positive, but lower than the manufacturing sector's average of 15 percent (ascalculated in the 1992 survey); the bidi industry was the most profitable in the sample. Theseindustries were more competitive than the tariff structure and resulting statutory levels ofprotection would indicate, however. Observed levels of nominal and effective protection werewell below statutory levels in the soap and detergent industry and the cotton spinning andweaving industry, indicating a high degree of tariff redundancy.

Table 2.4 Competitiveness of Import-Substituting Industries, 1992/93(percent, unless otherwise indicated)

Cotton Soap and Iron and MetalIndicator Bidi spinning and detergent steel re- furniture &

weaving rolling mills fixtures(3143) (3211) (3533) (3713) (3814)

Nominal protectionfrom tariff 51 51 65 66 75observed 41 25 50 n. a. n. a.

Effective protectionfrom tariffs 21 151 110 33 57observed n. a. 52 81 n.a. n.a.

Domestic resource cost (Ratio)at current capacity 0.9l 1.16 - 1.27 1.37 - 1.50 1.00 1.19at full capacity 1.00 1.15 - 1.26 1.34 - 1.47 1.30 1.30

Profit as percent of output 11.7 10.3 8.0 9.9 4.8Note: Numbers in parenthesis are Bangladesh Standard Industrial Classification codes

n.a. denotes not available

Source: Bakht (1995)

Export promotion schemes provide an enclave setting for the production of exports

2.20 Until trade policies can ensure better incentives, export promotion schemes provideexporters with access to world-priced inputs. They have made a significant contribution to theboom in garment exports, particularly the special bonded warehouses and export processingzones.

2.21 Special Bonded Warehouse Scheme. Bonded warehouses allow firms producingexclusively for export to import and stock duty-free inputs. Used mainly by garment exporters,

19Domestic resource cost is the opportunity cost of domestic resources used to save or earn one unit of foreignexchange. DRC calculations use shadow prices, whereas ERP calculations use market prices.

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the scheme is monitored through the use of import and export passbooks and pre-set input-outputcoefficients (for example, the fabric-gannent conversion factor to check inventory of fabric).Special bonded warehouses, which create a free trade environment for these exporters, have beena critical factor in the development of ready-made garments exports, and related intemational anddomestic subcontracting.

2.22 Until 1993, special bonded warehouses were only available to 100-percent exporters inthe garment industries using back-to-back lines of credit, and to suppliers that sell 100 percent oftheir output (e.g. zippers and buttons) to garment exporters.20 In August 1993, special bondedwarehouse status was extended to all 100-percent exporters and "deemed exporters." So far, onlya few leather anid toy exporters have joined the ready-made garments firms that are the main usersof the facility. The National Board of Revenue has not promoted the use of special bondedwarehouses because of the absence of a system for monitoring duty free imports into specialbonded warehouses for industries other than garment firms. The Govemment recently established a

21facility for jewelry exporters. Approximately 2,065 special bonded warehouses are in operation.

2.23 Export Processing Zones are important in Bangladesh for providing a secure foothold forforeign direct investment. In 1984 the Bangladesh Export Processing Zone Authority establishedan export processing zone in Chittagong for both foreign and local enterprises. A second exportprocessing zone was set up at Dhaka in 1993. Both zones are almost full (Table 2.5). Exportprocessing zone producers import raw rnaterials, supplies, and capital goods free of duty, retainforeign currency earnings, operate in a labor market free of unions, and are exempt from incometax for ten years after opening. They also enjoy better infrastructure facilities, includinguninterrupted power and efficient telephone connections.

Table 2.5 Export Processing Zones at a Glance

Chittagong Dhaka

Total investment (US$ million) 150.5 17.5

Exports, US$ million 671 0 46.5share of 194/95 exports 19 1(percent)

Value-Added (percent) 30-35 25

Total Employment (number) 25,111 7,636Women (percent) 80 n.a

Operating projects 52 12wholly foreign-owned 31 12

iVote: n.a. is not availableSource: Export Promotion Bureau, staff estimates

20 Back-to back letters of credit (L/C) consist of import L/Cs for importing inputs, whose primary collateral is theexport L/C. and which is paid out of the proceeds of the exports.

21 Prior to the establishment of special bonded warehouses, non-garment exporters could avail themselves ofprivate bonded warehouses, which were supervised by a customs official. Licenses for these are no longer being issued.

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2.24 Duty Drawback schemes were introduced in 1970 to provide rebates of duties and taxesfor exporters. The Duty Exempticn and Drawback Office, established in 1988, is responsible forhandling import-policy-related and technical tasks affecting the import of inputs used in theproduction of exports. The system is not open to partial and/or occasional exporters. Over theyears the scheme has been modified to require the use of a standard schedule of ilat rates forcertain imports. It has been extended to indirect exporters using the inland let-er of credit system.and now exempts direct and indirect exporters from import restrictions.

2.25 The use of the duty drawback scheme has increased as a result of the application ofstandard rates to a growing number of products and the streamlining of procedures. Leatherexporters use them extensively. Some Taka 1.4 billion (about US$35 million), in dutydrawbacks was paid in 1994/95, but the scheme has not been as successful as the special bondedwarehouses.

2.26 This enclave environment, combined with the avaiability of M-FA quotas, alliovcdBangladesh to use its abundant labor resources to develop an efficient ready-i ade garmer.tsindustry. Garment exports account for over 50 percent of gross exports from Bangladesh. Mostof the 15 percent average annual growth in exports between 1982/83 and 1994/95 was driven lythe growth of ready-made garments (Table 2.6). Other industries have not replica ed thi.simpressive success, however, and Bangladesh's export base remains narrow despite the rapidgrowth in frozen seafood and leather exports (Figure 2.2).22

Table 2.6: Share of Major Exports and their Contribution to Growth. 1987-94(Dercent)

Annual average Share of total Contribution togrowth exports, 1987 - 1994 growth

(1) (2) (3)Raw Jute -2 5 0Jute Goods -2 16 0Leather 3 9 0Tea 4 2 0Frozen Food 8 1i INaptha 5 1 0Garments 24 49 12Total 12 100 12Note: (3) = (1)*(2)Source: Bangladesh Bank export statistics

22 Frozen seafood exports have increased 251 percent over the last decade to USS 306 million in 1994/95;leather exports have increased 189 percent over the iast decade to US$ 202 million in 1994/95. Together theyaccount for 15 percent of total exports, ready-made garment accounts for 53 percent in 1994/95 (Source: ExportPromotion Bureau).

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Figure 2.2 Export Diversification: 1982/83 to 1994/95

1982/83 1994/95Frozen

seafoodLeather &91/ utleather Others Raw jute Othiers Raw jute Manufact

products 19% 16% 24% 2%Frozen Leather & ures

8% ~~~~~~seafood leather M 5Ready 11% productmade 6%

garments2% Jute Ready

Manufact madeures md ur4s garment

44% ~~~~~~~~54%

Note: Numbers represent gross exports.Source: Export Promotion Bureau

2.27 After a surge in merchandise export receipts to US$34.5 billion in 1994/95, a growth of36.5 percent in dollar terms from 1993/94, export performance is expected to be below potentialfor 1995/96. Recent political tensions and frequent strikes have been very damaging for industryin general, and the export sector in particular. Foreign purchasers lost confidence in the ability ofBangladesh's garment exporters to deliver on time and canceled orders. Prospects for otherexports are also bleak. Export growth in 1995/96 is expected to be no more than 10 percent, wellbelow the outstanding performance of 1994/95.

Compared with other reforming countries, trade policy reform in Bangladesh has a way to go

2.28 Comparison with South Asia. A comparison of tariff data for Bangladesh, India, Nepal,Pakistan, and Sri Lanka shows that Bangladesh's maximum tariff is the same as India's, buthigher than Sri Lanka's (Table 2.7). Import-weighted tariffs are, however, higher in Bangladeshthan in India, Nepal, and Sri Lanka. India's trade regime was more protectionist in the past, butsignificant reforms have narrowed the difference between India and Bangladesh. Compared withIndia and Pakistan, Bangladesh has moved faster to reduce quantitative restrictions and exportrestrictions--in India, consumer good imports is still virtually banned, and some 200 agricultural,mineral, and metal items are under export restrictions. However, most South Asian countries aremoving quickly to remove the remaining barriers to trade.

2.29 Sri Lanka is a good comparator for trade reform. Since 1977, Sri Lanka has been steadilyliberalizing its trade regime. Tariffs have been compressed into three bands with standard rates of

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10, 20 and 35 percent. Export taxes have been abolished,23 and quantitative restrictions areapplied primarily for non trade reasons.24 Sri Lanka is also moving away from a reliance onimport duties for revenue: in 1995 custom duties were only 21 percent of total revenue(compared with 33 percent in Bangladesh) and 9.7 percent of imports (23 percent inBangladesh). Although Sri Lanka's trade regime does have some drawbacks (the granting of dutywaivers and exemptions and the application of surcharges and markups in import valuation), themove to the three-band tariff system has made Sri Lanka's economy the most open in SouthAsia. Sri Lanka has announced plans to move to a two- band regime (10 and 20 percent) soon,and to a uniform tariff shortly thereafter.

2.30 Comparison with the Rest of the World. Although Bangladesh's tariffs are low comparedwith those of other South Asian countries, they are higher than the average tariffs prevailing in anumber of countries that have undertaken or are undertaking trade reform in Latin America andEast Asia (Indonesia, Malaysia, South Korea). as well as those in Ghana and Morocco (Table2.8). However, aiter Colombia, Bangladesh has made the largest reductions in average tariffsover its reform period, as measured by the ratio of average tariffs after reform to those beforereform.

2.31 Capital goods enjoy low- protection in Bangladesh (Table 2.9), while consumer goods aresubject to relatively high protection. Protection of capital goods in Bangladesh is similar to thatof countries in Europe, Latin America, and the Middle East. while protection of intermediate andconsumer goods compares with protection of these goods in Africa. These comparisons suggestthat despite significant progress, further tariff reduction is necessary before Bangladesh'seconomy is as open as the economics of rapidly industrializing nations around the world.

Table 2.7: Nominal Protection in South Asia(percent)

Year Maximum tariff Unweighted average Coefficient of Import-weightedvariation average

Bangladesh 1995 50 25 73 211991 509 89 59 42

India 1995 50 41 61 191991 400 128 25 87

Nepal 1994 100 20 n.a. 10

Pakistan 1994 70 50 27 n.a.Sri Lanka 1995 35 n.a. n.a. 10 \aa\ denotes collection rateNote: n.a. is not availableSource: India: Issues in Trade Reform. Volurne 1, 1994, staff estimates

23 Some export cesses and "royalties" remain on items such as coconut products, tea packets and bags, rawhides and skins and rubber.

24 Exception are some agricultural products, certain used transport vehicles, and certain diesel engines.

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Table 2.8: International Comparisons of Tariff Rates

Country Average Before Average After Tariff Ratio \areform reform

Bangladesh (1989, 1995) 94 25 0.27

Cote'd Ivoire (1984, 1989) 26 33 1.27Nigeria (1984, 1990) 35 32.7 0.93Ghana(1983, 1991) 30 17 0.57

Argentina (1988, 1992) 29.4 12.2 0.41Brazil (1987, 1992) 51 21 0.41Chile (1984, 1991,1\b 15 11 0.73Colombia (1984, 1992) 61 12 0.20Costa Rica (1985, 1992) 53 15 0.28Mexico (1986, 1991) 22.6 13.1 0.58Peru (1984, 1992) 27 17 0.63Venezuela (1989, 1991) 37 19 0.51

China (1986, 1992) 38.1 43 1.13Indonesia (1985, 1990) 27 22 0.81South Korea (1984, 1992) 24 10.1 0.42Malaysia (1985, 1993) NA 14

Egypt (1989, 1993) 47 34 0.72Jordan (1987, 1994) 33.4 30.5 0.91Morocco (1983, 1990) 36.1 23.4 0.65Tunisia (1987, 1990) 32.5 28.5 0.88a\ tariff ratio is calculated as post-reform tariff/pre-reform tariff, i.e. Column 2/Column 1b\ denotes uniform tariff after reformsSource: Hoekman 1995b, Dean et al 1994.

Table 2.9: International Comparisons of Nominal Tariffs in Manufacturing

Country/ Region Capital goods Intermediates Consumergoods

Bangladesh 12 19 35Thailand* (1985) 22 14 25Turkey (1988) 31 16 35Philippines (1985) 22 23 38Indonesia* 12 7 27Argentina 24 21 13RegionsAfrica 24 26 50Europe and Central Asia, 19 15 31Middle East and North AfricaLat.n America 19 18 33* denotes il:)ort weighted tariffs, all others are arithmetic averagesSource: India: Issues in Trade Reform, Volume 1, 1994

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3. THE REMAINING AGENDA

3.1 Moves to liberalize the trade regime, coupled with relative macroeconomic stability andoverall growth in the economy, resulted in significant import growth in 1994/95. After years of3-5 percent average import growth, imports grew 39 percent in dollar terns between 1993/94 and1994/95. Primary commodities, the largest component of the increase, grew 60 percent. Capitalgoods, the second largest component, grew 50 percent (Annex 3). There is also evidence of apickup in private sector activity; total credit to the private sector grew 24 percent in 1994/95, amarked increase from the average growth rate of 6 percent between 1990/91 and 1993/94. Thiswould imply that investment activities, including construction, were on the rise in Bangladesh.These major changes in import and credit growth rates indicate that the reform program mayfinally have begun to evoke a supply response.

3.2 Chapter 2 indicates, however, that the present policy regime provides high effectiveprotection to domestic industries, maintains incentives for smuggling, and facilitates exportgrowth only under enclave arrangements. While tariffs have been reduced steadily, there is stillevidence of "water in the tariff'. Such a regime is not conducive to the growth of an efficientmanufacturing sector. Moreover, current incentives focus manufacturing production on thelimited domestic market in Bangladesh and are inconsistent with the Government's export ledgrowth strategy. A significant growth in exports would require a fundamental shift in the currentincentive structure, as well as growth in productivity and efficiency of enterprises. Completingthe remaining agenda for trade liberalization can help shift the incentive structure towards theproduction of exports.

Complete the process of trade liberalization

3.3 The recent growth in trade indicates that trade reforms may be evoking a supply response.To sustain this response, Bangladesh must complete the reforms it has begun. Its reform agendashould focus on import liberalization to remove price distortions, while maintaining theefficiency of its current export promotion regimes. By adopting the provisions of the recentlyconcluded Uruguay Round agreement, Bangladesh could send a strong, positive signal to privateinvestors at home and abroad.

3.4 Tariff reduction. Tariff reform is the most critical element of trade policy reform. Itdeserves top priority in an export-oriented development strategy. Tariffs constitute a hidden taxon exporters, and are an impediment to streamlining trade procedures and increasing backwardlinkages (Box 3.1). All these factors directly affect export competitiveness.

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3.5 The Government has made commendable progress in tariff reduction, but a small,critical part of the agenda remains incomplete. A key objective of tariff rationalization isto move toward uniformity in nominal rates, and thereby in effective protection, whilereducing the average rate. Reducing the maximum tariff rate will not only increasetariff uniformity, but also bring about the largest efficiency gains. A second objective isto reduce tariff dispersion, to reduce the bias implied by different rates. A major source ofdispersion is the continued use of tariff concessions for end users. These concessionalrates of duty should be phased out, and the higher tariff rates should be reduced to bringtariffs closer to neutrality.

Box 3.. The Mpact of Hih Tarffs on Eprt

By raisin gthe price of importables and homfe: goods,: high tariffs result inanti-exportf bias., To offset thisbias, lgovernments:.have set up duty-free access mechanisms, such assdfrawback schemes and special bonded

dwarehouses.0 These schemes impose admrinistrative costs tothe: authorities: and to exporters. .D uty-freeaccess meChanisms are :complext anid do notfalways comp letely offset the bias against6exports.$ And since.no, one system meets the needs :of all exporters, a f 0mechanisms are needed. In Bangladesh, aselsewhere, only free trade zones provide exporters witha neurtral trade environment.

Tariffslare} also an important disincentive dto backward linkages with other domestic iMdustries. Domesticprodciers of:intermediate inputs areiat a competitive disadvantage relative to suppliers, frmo:: 6thercountries since taxes and: duties are levied on import content--osts that foreign products do not carry (lthe.drawback system barely addresses this)i. Mi Moreover, domrestic t suppliers are producing under protectivetariffs and hence are notlJik elyto be as efficient as gforeign exporters who areproducing at world levels.: Alclassic:i example in Bangladesh is the ready-made garments industry, twhere prohibitions and restrictionshavek impeded theiefficiency of domestic textile firrns and prevented backward linkages

Soure:. lUNDP:,"erhnical: Assistanc to PolicyFram!ework" ProjctgN6o. DP/SRL/90/O3D0J1995.

3.6 Import Valuation and Clearance. Tariff values are used reduce revenue losses

from underinvoicing. But in many cases tariff values are set higher than world prices,increasing the nominal protection of domestic industries (para. 2.8). Bangladesh's use oftariff values has to some extent offset the progress made in reducing import tariffs.

3.7 Another drawback of using tariff values is that they need to be updated frequently,to accurately reflect constantly changing CIF prices. In addition, it is impossible for asingle tariff value to reflect differences in CIF prices of items that originate in differentcountries. Currently, the National Board of Revenue is addressing import valuation intwo ways: It has set up a detailed valuation database, which will be updated continuouslyand will eventually replace tariff values. And it has introduced a voluntary preshipmentinspection system (para. 2.9).

3.8 Both measures have problems. It is difficult and time-consuming to constantlyupdate and maintain an accurate valuation database, while the use of voluntaryprehipment inspection is an option mainly for those importers who find the difference invaluation large enough to make the cost of preshipment inspection worthwhile. In

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addition, there have been significant discrepancies recently between the preshipmentinspection value and tariff values, which has caused some conflicts between NationalBoard of Revenue and the preshipment inspection agencies. As a result, the NationalBoard of Revenue has temporarily banned the use of preshipment inspection certificatesfor 12 items.25 The WTO now requires that customs valuation be invoice-based. Tocomply with this, Bangladesh would need to phase out its system of tariff valueseventually.

3.9 In the long run, the best solution to valuation and clearance problems is acomplete reform of customs. As tariff rates are compressed, the incentive to underinvoicewill be reduced, and Bangladesh wvill be able to rely on invoice prices as an accuratemeasure of import value, as many countries now do. Until then, a well-functioning PSIsystem is a useful transitional tool to reduce revenue losses through underinvoicing. Arecent review of such systems found that the "design and content of PSI contracts...merits careful attention if the full benefits of the service are to be realized".26 Wherethey have proved disappointing, especially on the revenue side, it has been largelybecause of the "lack of serious monitoring and follow-up of information generatedthrough pre-shipment inspection and the absence of a satisfactory system for ex-postreconciliation". This finding is particularly relevant to Bangladesh, whose voluntaryscheme cannot deliver the results that could be explicitly mandated in Government-agency contracts, such as accountability to principals, trade facilitation, and routines forconflict resolution. Thus the system needs to be properly designed.

3.10 The trade liberalization agenda will not be complete without improving importclearance procedures. As tariff reform has progressed, the need to improve the efficiencyof import clearances has become even more urgent. The Government recently introducedcomputerized customs assessment using the UNCTAD-developed SPEED system atChittagong port and Dhaka airport. Design and implementation problems have kept theSPEED system from functioning smoothly, however, there are no immediate plans tointroduce it at other customs stations. Review and adjustment of the SPEED system areneeded to complete the process of computerizing the assessment of imports.

3.11 Quantitative Restrictions and Other Barriers. Quantitative restrictions, especiallyon textiles, are preventing the development of backward linkages with the ready-madegarnent sector (Box 3.2). Removing these restrictions would eliminate virtually allremaining protection due to non-tariff barriers in Bangladesh. More important, that wouldprovide an impetus to the development of a textile sector that could potentially supply theneeds of the ready-made garments industry, which now imports over 90 percent of itstextile inputs. Bans on imports of sugar, salt, and some other commodities are virtuallymeaningless because significant amounts of these commodities are imported illegallyfrom India. Removing these restrictions would increase the efficiency in these industries

25 These include cars, dry cell batteries, air conditioners, filament lamps, fluorescent light tubes, GItubes, soda ash and caustic soda, cigarettes, powdered milk, cumin seed and black pepper.

26 See Low , Patrick "Preshipment Inspection Services", World Bank Discussion Paper No. 278.

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by exposing them to competition, generate tariff revenues, and benefit consumers by

reducing prices.

Box 3.2 Textiles ~and Garments: Differing PolicyR,egimes

Vastly ifferen poicy regimes, fort txiles: And ~garments: hAve resuledi ver ifren perfrmance.Whiile textile production has~ largely stagniated, ready-ima de garments iexports have experienced record

The spinnin ad wain (including: hanidloom) industries: have tanditionally enjoye hIghpoeto

through: tariffs ~and ~quantitative restrictions.: Restrictilons oQn iprt o ff yrnhaeirecently been, removed.~Currently, the trade regime affectincotnymsier adbfabic Weavers sa oI

Quantitative Restriction CEustoms.duty.:1 AT (imports) VAT (oetc

Raw cotton Free i i1zeroI zero n.a.Machinery~:~ Free '7.5% :0. 15% 0-5%spares Free 0~-30% >0 15% 15NoCotton yarn Free 7.5% 5% zeroOther inputs Free' 30 -45%. 15%i 15%Gray fabric Restricted :,45% ~ ~ 15% i zero

While thie ~protection: has beeni I 'fted on inputs fabricA imports are still: retrited hshsrslenahg

level of effective,protection of tiheiproduction ~of gray fabrics, aspitot d In th1eTextiles Sector Studyirecently completed by~ the Bangladeshi Tarff Commission.

Consequently, weavngmfills are not compeitifve With: those in nia, Pakitn andiSri Lanka. They~ are:largely domestic: in orienitatioi,~ ~despite ad flouihing downstreamiindustryf (gamens. Poo technology,

historically high prices for yarn, !and a large state presence in textil mills. haecnrbtdo poo quality.of ,outpuit.La,rge quantities of illegal ,imports o~~f fabric and yarnhaveeroe&d protectio to some extent, butnot enough to increase the competitiveness 'of domestically produced textiles.: ii

By contrast,h thrapid grwth ofthei export-orienited :ready-made garment sector was~ facilitated:'by:a:number~ of government incentives. PromTinfent amhong them were4(i)bonded warehouse fcilities:forduty-free impot of inus,() freeimpr of gryclot agi nst bkackt bac lettersfpot inu I IM6 g U a k ofcreit, iin) corporate tax.exemptions ~for five.years, (iv) ~incomie tax re6bates ~of ~up 'to 100::percent o.f export.earnings,~i (iv) cashicompensation of 25i.percent of FOB Value for using lCal fbrics:, and (i) lowrateof ut (now zero)oiports of capital ~machiniery: for. 100 percent export: orieteduit. adition to government. icentives,

(i) quotas unider'the Multi-Fibre Arrangement.provided a guaranteed market in somneiproduct,6- (ii) b ~uyinghouses were~ minlueta in provi din exort orders (amost 90 percent of orders: arei placed. by~ f6reignbuying housesi operating in1 Bangladesh), and: (iii) the back-t back letterof credit: method allowed easy(but expensive) financing through supplier credits.

Few backward linkages have been created between the textile and ready-made garmetnt industries. ltn, 1993,1barely 3''percent of] fabric iused in the: readymad g armenidusr was domesticaly produced. Someintegraton of the industries is presently tAkin paeInthe kniftweari suibsetor, Which represents abouit24percent ofttlgret xors hssbsco is: suported bYa liarge domestiC :knit fabric

manufactring indusr whichihas incereased capacit by16pretanaly bten197 n 199293.: The cah compenisation oni locally proucd Ufabri as also: encouraged d:~omesticiiisourcing~ ofhandlooms, as demonstrated by the: phenomenal growthf of the ~"Gramee Chc,a hanudloom fabric, used

exclusivelyJinthei production of garmentexports.-

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Tle fiscal cost of tariff reform can be mitigated by improvintg tax administration

3.12 Apart from their protective function, import taxes have traditionally been animportant source of tax revenue in Bangladesh. Experience has shown that unless the taxsystem is reformed and reliance on import taxes is reduced, import liberalization will belimited. Fears of large tax revenue losses have been key factors in holding up rapidreductions in tariffs. This is an understandable concern in Bangladesh given theimportance of tax revenues collected on imports. Currently, customs duties accountingfor over 33 percent of NBR-administered taxes, yielded higher revenue than income taxes(Table 3.1), with VAT and supplementary duty collected on imports accounting forfurther 23 percent and 3 percent, respectively. Thus, efforts to improve income taxcollection and to broaden application of the VAT and improve its efficiency will becrucial to providing the fiscal space for trade liberalization by offsetting any relatedrevenue losses.

3.13 Still, the possibility of revenue loss from tariff reduction cannot be ruled out. As arough estimate, reducing import-weighted tariffs by 10 percent (from 21 percent in1995/96) may potentially result in a revenue loss of Taka 19 billion. This loss can bemitigated by simplifying procedures and improving tax administration. Obviously, it isimportant to speed up the unfinished domestic tax reform, focusing on the expansion ofVAT and income tax nets, while intensifying efforts aimed at strengthening the NBR.Improvements in the domestic tax front need to be achieved both to pave the way forfurther import tariff liberalization as well as to strengthen Government's fiscal base.However, it should also be added that import tax revenue collections also depend, inaddition to the tax/duty rates, on short/long-term price and income elasticities of imports,economic growth and technology changes - given international prices and abstractingfrom shocks. All these factors could more than offset the effect of tariff cuts on taxrevenue collections. Indeed, this has been the case in Bangladesh in recent years. Giventhe price elasticity of some imports and continued economic growth, increased importsshould offset some of this loss, as they have done recently. When tariffs were reduced in1994-95 (para. 3.1), imports increased 39 percent in dollar terms, and that import taxrevenue increases more than compensated for lower tariffs. And the surge in imports andcustoms revenue continued into 1995/96, despite congestion at the port of Chittagong anda difficult political situation. If macroeconomic stability is maintained and the economycontinues to grow, revenue losses from further tariff reductions should be offset byincreased volume of imports.

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Table 3.1. Bangladesh: Customs Duties(billion Takas and percents)

1991/92 1992/93 1993/94 1994/95 1995/96 (July- Apr)

Imports 100.8 107.2 112.7 160.3 228.5Total taxes 73.8 85.38 98.18 109.8 86.0Customs duties 27.46 28.8 29.8 36.7 30.3Annual growth (percent) 4.7 3.7 23.2 0 \aPercent of total taxes 37.2 33.7 30.4 33.5 35.2Percent of GDP 2.9 2.8 2.8 3.0 n.a.Percent of imports 27.2 26.8 26.5 22.9 13.3a\ denotes growth over same period in the previous yearn.a is not availableSource: IMF, NBR

Take advantage of the World Trade Organization Framework

3.14 The ratification of the Uruguay Round has changed the world tradingenvironment.2 7 Both developing and industrial countries stand to gain significantly as aresult of increased trade opportunities. For South Asia, the most significant gains willresult from the removal of the Multi-Fibre Arrangement (MFA), which currently governsexports of textiles and apparel from many developing countries to the United States andWestern Europe. Estimates are that South Asia's textile output will increase 17 percent,and textiles exports 26 percent as a result of the phase out of the MFA. Output and

28exports of ready-made garments will increase an estimated 91 percent and 254 percent.This growth is higher than in most comparators in East Asia, because South Asiancountries are among the lowest-cost producers of apparel and the most severelyconstrained under the MFA. The proceeds from increased production and exports arelikely to outweigh the losses from the elimination of quota rents. While estimates ofBangladesh's share in these gains are not available, the estimates for South Asia indicatepotential gains that Bangladesh can achieve in the post-MFA trading environment.

3.15 Bangladesh has made several commitments under the Uruguay Round, which donot entail major liberalization of it's trade regime. It has agreed to impose tariff bindingson some industrial products (Annex 5, Table 1), 29 to eliminate all quantitativerestrictions on agricultural products and replace them with tariffs (Annex 5, Table 2), and

See Annex 4 for a detailed description of the features of the Uruguay Round agreement and anassessment of the resulting gains

28 Hertel et al, 1995.

29 A binding is a ceiling on the tariff applied to a particular commodity. By binding tariffs,Govemment commit that they will not raise a particular tariff above the "binding" or ceiling rate.

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to allow foreign investment in the hotel and lodging industry under the GeneralAgreement on Trade in Services (GATS) (para.3.17 and Annex 5, Table 3).3°

3.16 Bangladesh has set its tariff bindings well above the current operative rates. Bydoing so, Bangladesh has lost an opportunity to lock in its reforms, using the frameworkof the World Trade Organization, and has sent a signal to the world trading communitythat it may backtrack on reform (Box 3.3). Other countries in South Asia have also settheir bindings higher than prevailing tariffs, but they agreed to more extensiveconcessions than did Bangladesh. As a result, Bangladesh will have the highest post-Uruguay Round bound tariff rates in South Asia. Under GATS, on the basis of the ratioof commitments made to the total number of possible commitments (Annex 5, Table 3),Bangladesh has offered the least access among all South Asian countries.

3.17 In the post-WTO era, institutional development and the capacity to conduct policyanalysis will be critical. The restructured Tariff Commission is mandated to act as theapolitical, analytical wing of the tariff regime in Bangladesh. It has been entrusted withresponsibility for analyzing the impact of changes in the tariff structure on effectiveprotection and government revenue. Its role will be crucial in confirning or refutingprotectionist appeals from domestic interest groups and, in designing antidumpingprovisions. Since it is a relatively new institution, recognition by other governmentagencies and the private sector of its central role in determining the tariff regime is ofutmost importance. Once the Tariff Commission develops a reputation for competence,its operations will reduce interest group pressures on trade policy decision making. Torealize its objectives, however, the government will have to make sure that the TariffCommission has access to high-quality staff and computational facilities. Finally, theTariff Commission will become more effective as the data gathering process (bothindustrial and customs data) in Bangladesh improves.

30 As a least developed country, Bangladesh is exempted from the obligations to reduce domestic andexport subsidies in agriculture. For industrial products, the Uruguay Round agreement on subsidies doesnot subject least developed countries such as Bangladesh to the prohibition of export subsidies, but requiresthem to phase out subsidies on the use of domestic goods over imported goods by January 1, 2003.

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Box 3.3. Utsingithe :World Trade Organization as a Precommitment Device

The World TradecOrganization's (WTO) policy disciplines anddinstitutional obligations generally enhanceefficiencyt. Nondiscrimination and transparency provisions.will reduce uncertainty, in the &marketplaceabout which rules and procedures must: be followed0 gin the import procegss. Perhaps the most : important0potential benefit of WTO is that it can gbe used as':a precommitment device eby :governments that seek todenhance the credibility of :a liberal trade policy stance or a reform program:.: Such enhanced credibility isnot an automatic consequen£ce of membershiop of the WTO, but requires unilateral measures.

Bangladesh's status as a least developed. country exempts it froml full implementation of many WTOprovisions and tallows it,a tlonger period to:: imnplement :some6 others. Therefore howv and when the countryimplements: the rules kand priciples of, the WTO remain ilargetlydiscretionary. But it would&be inBangladesh'sti in:terest to implement 0as many WTO pro isiOns as is feasible, to send a: firm signal to itheprivate: sector and the world trading community thatvits trade policy stance is: irreversible. Actions thatBangladesh can take ~in this cOnnection include:-

0 Binding tariffs under the CJATT- at, or0very close to, prevailing rates. A decision to bind tariffs evervtime they aretowered would: signal: thet importance attached to fundkamentally changing0 0the policyregime:

* Making' comprehensive sectoral . commitments: under the GATS which, at a minimum lock in thestatus quo regulatory regime for all:services. Currently, Bangladesh's commitments under the GATS* aethe lowest in South Asia,

* Public disavowal of the:GATT's traditional special and differential treatment provisionsvwitl also helpenhance: credibility.;:: This would imply that Bangladesh Will fully adhere to agreements: onh customsValuations,: standards, investment, and other agreements.

* Developing an institution,thatl has a statutoryj man date to analyze the; economic' effects§ of existing and: tpropXosed trade ptolicles. .Th&e Bangladesh ;Tariff (Commission currently plays this: role to some extent;strengthening itsOinstitutional tcapacity and increasing its autonomy would thelp establish 0its; authority.

* Ensuring that saf6iiards are designeld to limit the scope for easy reimposition of protective measures.Antidumpingiprovisions could pose a major problem along these lines. Experlence in a number ofOECD countries amply illustrates that antidumping measures 0are tdifficultto fcontrol., 0An antidumpingstatute that is not Very carefully designed and administered can substantially reduce the credibility oftrade reform.

Source: Hoekmnan:1995b.'

Follow an effective export promotion strategy

3.18 Despite efforts to increase exports, Bangladesh's share of world exports actuallyfell between 1972 and 1994 (Table 3.2). The success of ready-made garment exports hasnot been replicated by other sectors, which are still subject to the anti-export biases of thecurrent policy regime. The most effective way to increase exports is to complete theprocess of trade liberalization. In the interim, steps should be taken to (a) remove theremaining regulatory impediments to exports-, (b) remove infrastructure constraints; and(c) strengthen the tempor-ary institutions designed to promote exports.

t:00:00rdXeo;0 0:0::::0 0 0400000000000000000000000000000000 000000000000000000000000000000000:000000000

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Table 3.2: Share of World Exports, Selected Countries, 1972 and 1994(percent)

Country 1972 1994

China 0.95 2.81Indonesia 0.46 0.94Thailand \a 0.28 0.87Mexico 0.43 0.81Turkey \a 0.23 0.36Sri Lanka 0.09 0.08Bangladesh 0.09 0.06Ghana \b 0.11 0.02Kenya 0.09 0.04Nepal \a 0.01 0.01Philippines 0.28 0.45Vietnam \b 0.00 0.04

a\ 1993 b\1989Souerce: IMF, International Financial Statistics

3.19 Regulatory/Procedural Issues. Though not discussed explicitly in the report, a

few export controls remain such as the restriction on re-exports. Although recently the

Government has allowed the re-export of goods other than ready-made garments on a

case-by-case basis, a number of conditions remain. Also, a few agricultural commodities

are still subject to export bans.31 Exports of certain manufactured goods are also

restricted. Export bans and restrictions should be avoided, and only used on a

temporary, time-bound basis to address short-tern difficulties.

3.20 Infrastructure Constraints. The Government has assigned high priority to

providing adequate infrastructure for exporters, from adequate port facilities at a

reasonable price to the smooth functioning of export promotion facilities, such as special

bonded warehouses and export processing zones. But present conditions are far from

satisfactory. Adequate infrastructure is available in the export processing zones, but

exporters in the rest of the country are still plagued by energy shortages, poor telephone

connections, and other problems that hamper their activities. 3 3 The lack of phone

connections, for example, has prevented the establishment of a data-processing industry.

While a detailed examination of infrastructure constraints is beyond the scope of this

report, several issues related to infrastructure directly hamper the growth of trade.

3 These include wheat, pulses, onions, jute and sun-hemp seeds, prawns and shrimp (except frozen),and whole bamboo and cane. Exports of molasses, de-oiled rice bran, and wheat bran are restricted

32 These include ferrous and non-ferrous metals, petroleum and petroleum products (except naphtha).gur and khandseri sugar, raw and wet blue leather and urea.

33 Field research in mid 1993 revealed that garment exporters, who apply for electricity connections withsupporting letters from the BOI, experienced indefinite delays unless they make informal payments of 30,000- 40,000 Taka to field staff responsible for actual connection work. Even if a payment is made, it may take 3 -4 months to get a connection. Approximately 66 signatures are required to obtain approval for connection.

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3.21 Transit costs at the ports of Mongla and Chittagong, which handle allBangladesh's sea trade, are high because of inefficient labor management, shortages ofequipment, and the need to stuff/unstuff containers at the ports, due to customsformalities and lack of through-transport facilities for containers.34 Side payments areoften used to speed up the movement of goods. There is currently only one inlandcontainer depot within the country, located in Dhaka. Many manufacturers prefer to shiptheir goods from Dhaka's inland container depot, where they have better control overtheir goods, and there is less risk of pilferage. The depot is operating well above itsmaximum capacity: imports and exports cargo handled there increased by 120 percentbetween 1991 and 1993. Congestion continues to be a problem at Chittagong, especiallyrecently, when both exports and imports hit record levels. Government is consideringgranting of permission to the private sector to start inland container depots in Chittagongwhich would considerably help reduce container congestion and costs. An inland riverport facility for container handling is also being planned in Dhaka.

3.22 Export Promotion Schemes. Export promotion schemes should be viewed as atemporary measure. The schemes impose high administrative costs: a recent studyestimated that the administrative costs of duty-free access mechanisms may be as high as6 percent of the value of total trade (UNDP 1995). Moreover, they favor only certaintypes of exporters and fail to address the fundamental source of anti-export bias. Oncetrade liberalization is complete, exporters will be able to stay competitive withoutrecourse to special bonded warehouses and export processing zones. Until then, suchfacilities must be made to function as efficiently as possible. Leaving these exportincentives in place will not contradict the overall move to reduce the bias againstexporting in Bangladesh.

3.23 Special Bonded Warehouses have brought exporters closest to a free trade regime,but the benefits are often eroded by the costs of exporting under bond. Monitoringmechanisms for special bonded warehouses should be modernized and computerized, andhandling of input-output coefficients should be improved to prevent abuse and enhanceefficiency and speed. The National Board of Revenue should promote the use of specialbonded warehouses, tailoring the system to meet specific exporters' needs, if necessary(this has recently been done for jewelry exports). In its last budget, the Governmentauthorized the levying of duties and taxes when manufactured goods are sold locally fromspecial bonded warehouses. This allows "export-only" firms to sell surplus goods legally inthe domestic market, and may improve the environment for producers serving bothmarkets, who are now dependent on the less satisfactory drawback system. However, therehave been instances when government policy aimed to support export growth could not beimplemented because of conflicting objectives adopted by different governmentdepartments. For example, export oriented leather goods manufacturers have complained

34 Total through-costs for handling a 20- foot container at Chittagong are much higher than for otherAsian ports. Costs for Chittagong are US$ 640, as compared with S214 for Singapore, $220 for Colombo.and $360 for Bangkok. Costs include all handling, stuffing/destuffmg as needed, and clearing costs (includingcustomers and clearing agents' commission, and official and informal payments), but exclude customs dutiesand costs borne by the ship (World Bank, 1995).

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that though the Bangladesh Export Policy, 1995-97, allows for selling upto 20 percent oftheir output (including rejects) in the domestic market after payment of all duties and taxes,they have not been able to receive necessary clearance from NBR. This sort ofbureaucratic bottleneck needs to be removed in order to augment export promotion.

3.24 For all partial and other exporters without access to special bonded warehouses, aduty exemption scheme can be introduced as an alternative to the duty drawback scheme.At the same time, the duty drawback scheme needs to be improved since it is the link thatis required for a fuller integration of export firms with the rest of the economy. A flatrebate system is one way to compensate partial or occasional indirect exporters.

Reestablish macroeconomic stability

3.25 Finally, a stable and consistent macroeconomic framework is essential foreffective trade policy reform. Recent economic developments indicate slippages in themacroeconomic stability achieved in the early 1990s, mainly because of expansionaryfiscal policies and slack monetary policies. The overall fiscal deficit rose from 6 percentof GDP in 1993/94 to 6.8 percent in 1994/95. Inflation peaked at 6 percent in December1995, much higher than the 2 percent rcgistered in 1993/94. Reestablishingmacroeconomic stability will be necessary for the effectiveness of further trade reform.This would entail reducing the fiscal deficit, lowering inflation, and maintaining aflexible exchange rate to prevent overvaluation of the currency.

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4. POLICY RECOMMENDATIONS FOR AN EXPORT-ORIENTED ECONOMY

4.1 For manufacturing production to grow as needed to keep economic growth high,the Government should complete the remaining agenda for trade reform and truly openthe economy and remove the remaining bias against exports. Increasing openness isnecessary not only to reduce distortions within the economy, but to attract much-neededforeign investment.

Import liberalization is the most effective way to promote trade, especiallyfor exports

4.2 The Government should commit to a pre-announced program of across-the-boardreform and move away from a made-to-measure approach of special exemptions andcompensations. Pre-announcement of tariff reforms is essential to reduce uncertainty inthe business community. The Government ought to announce a medium-term strategy inits next budget, outlining tariff changes for the next few fiscal years.

4.3 Announcement of the following pre-announced tariff reform process isrecommended:

D A three-rate schedule of 10, 20, and 35 percent in the next budget, withzero rates only for imported inputs used by exporters (apart from thosealready under export processing zones, special bonded warehouses,diplomatic treaties, and a few other special cases).

* A further compression of rates down to zero (for exporters), 10 and 20percent in the following year, with intensive analysis and input from theTariff Commission.

* Low rates between zero and 20 percent, to be announced now for1999/2000. A maximum rate of 20 percent would retain some protectionfor domestic industry against alleged foreign dumping.

* Additional protection is currently provided through a 2.5 percent importpermit fee (which is being phased out), a 15 percent import VAT ontextiles, and the use of tariff values in duty assessment. These add-onsshould be removed so that nominal protection is provided transparently byscheduled customs duties.

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* To reduce dispersion, a single tariff rate should be applied in the nextbudget to each four digit harmonized system (HS-4) heading (exceptwhere very different goods are listed under the same IIS-4 heading). Thiswould involve eliminating all end-user concessions, except the one forexports.

* Unify the statutory rates of duty and the operative rates to avoidcomplicating the schedule, and also to avoid any chance of backsliding onthe reformn process.

4.4 The program to complete import liberalization outlined above should take toppriority in the Government's strategy for trade reform. Until liberalization is complete,export promotion schemes must do the job of reducing disincentives for exporting. Tomake the schemes function better, the following measures are recommended:

* Overcome the obstacles that have caused customs to delay making specialbonded warehouses available to most types of export industry and furtherdevelop the scheme so that it can be used by established firms serving bothhome and domestic markets.

* Consolidate the progress made in developing export processing zones toease their eventual be integration with the regular economy. Privateinvestment in new estates can play a useful role.

* Resume improvements in the functioning of the Duty Exemption andDrawback Office, produce new and revised flat rates, make partial,occasional, and indirect exporters eligible for the duty rebates, andimplement the recent decision to involve banks in paying rebates.

* Remove implementation bottlenecks of export promotion schemesreflected in goverument's policy declaration; e.g. that of allowing exportoriented industry to sell part of their product (20 percent) in the domesticmarket after paying of all taxes and duties.

Adequate infrastructure facilities should be available to reduce the costs of doingbusiness

4.5 For sustained growth in exports, all prospective exporters must have access toadequate and dependable power, telecommunications, and other infrastructure. Currently,these facilities are satisfactory only in the export processing zones; encouraging exportdevelopment in enclaves. Improved port facilities to speed the clearance process for bothimports and exports are also needed. The following measures are recommended:

* Set up an inland container depot at Chittagong and expand Mongla port.Consider private participation in the inland container depots, private

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provision of container stuffing and destuffing centers, and the leasing ofcontainer berths to private operators

* Lift the air cargo monopoly currently enjoyed by Biman to bringcompetition into the air cargo industry and improve services.

Access to trade finance is crucial to spur export diversification, and increase valueadded in exports

4.6 In the long run, the development of an efficient banking system will relieve theconstraints in trade finance.3 5 In the meantime, however, several steps can be taken toincrease exporters' access to trade finance. They are:

* Discontinue such outdated practices as the compulsory back-to-backusance import letters of credit; let exporters be free to choose betweenthem and other forms of financing.

* Continue a dollar line of credit at Bangladesh Bank to isolate pre-shipmentexport credit from the inefficiencies of the banking system.

* Remove the interest rate ceiling on export loans, which have denied small-scale exporters access to finance.

Use the WTO to lock in trade reforms

4.7 The WTO can facilitate trade reform in Bangladesh by serving as a pre-commitment device for future policy change. Bangladesh's commitments at the WTOwill be uscful for achieving credibility with investors, both domestic and foreign. To thisend. Bangladesh should:

* Bind its tariffs at operative rates.

* Further develop the Tariff Comnmission as a transparent institution thatadvises on tariff policy changes.

* Ensure that safeguards mechanisms are designed to minimize the scope foran easy reimposition of protection.

* The effectiveness of further trade policy reforms cannot be guaranteed.However, the probability of success can be heightened by actingdecisively and communicating the policy agenda to the public at large. Astrong policy stance will send a clear signal to foreign and domestic

35 Trade finance has not been analyzed explicitly in this report.

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investors about the Government's commitment to an export-led growthstrategy.

Substantial modification of investment incentives and thte regulatory environment canintensify the effect of trade policy reform

4.8 The current corporate tax system and the remnants of past controls on investmentand foreign exchange increase the cost of doing business in Bangladesh, and also reducethe incentives for foreign investment. These shortcomings can be remedied relativelyquickly, particularly compared with the time it will take to improve inadequacies in thelegal framework, inefficient utility services and inadequate infrastructure. By clearingmost of the policy hurdles the Government will be able to provide incentives forinvestment that can balance the additional costs due to the deficiencies in infrastructure.

Bangladesh should act quickly to consolidate the gains from policy reform

4.9 International experience demonstrates that successful trade reforms proceed on awell-paced, pre-announced schedule, give priority to the reduction of tariff and non tariffbarriers to imports, and are accompanied by flexible exchange rate management andprudent macroeconomic policies. Bangladesh has largely followed this path. While thepace of change has been slow, policy reforn has picked up momentum in the last fewyears. Early results show that these changes have elicited a significant supply response.Bangladesh must act quickly to remove the remaining hurdles to trade, in order to movethe economy firmly onto the path of export-oriented development.

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ANNEX IPage 1 of I

BANGLADESHTRADE POLICY REFORM FOR IMPROVING THE INCENTIVE REGIME

TRENDS IN NOMINAL PROTECTION(As percent of assessed value)

Unweighted Import-Weighted

1991 1992 1993 1994 1995 1996 1991 1992 1993 1995 1996

The Whole Economy 88.6 58.8 50.3 40.0 30.1 24.8 42.1 39.7 29.6 24.4 21

Coefficicnt ofVariation 59.0 68.1 61.9 68.4 73.8 74.3

Agriculture 90.5 61.6 50.4 41.0 35.9 27.2 20.9 19.2 17.8 17.3 10.1

Mining 54.1 33.5 33.4 25.0 16.9 14.4 24.0 30.6 35.5 40.6 38.8

Manufacturing 89.0 59.1 50.6 40.1 29.8 24.8 51.8 43.1 31.0 26.7 21.9

Consutner Goods 124.4 84.8 70.4 56.0 46.0 38.3 50.0 44.9 49.4 37.8 25.5

Intermediate Goods 79.0 51.7 44.2 35.1 27.0 22.2 55.0 36.5 29.7 33.4 24.9

Capital Goods 72.0 47.0 41.2 30.2 18.1 15.0 47.2 52.0 23.3 18.4 14.2

Food,beverages,tobacco 112.7 79.8 65.7 50.9 38.8 35.7 50.6 48.7 51.3 43.7 27.7

Textiles & Leather 135.3 95.2 79.7 61.0 49.9 39.4 56.6 39.5 39.8 26.8 19.4

Wood, Cork, & Products 105.1 71.8 52.6 42.0 28.6 26.2 40.8 27.3 24.7 16.8 18.2

Paper & Printing 107.8 66.5 54.6 51.4 39.0 27.6 99.0 56.3 49.3 35.9 21.2

Chemicals, Petr, Coal 73.7 46.8 40.1 30.4 26.4 21.9 49.4 25.2 23.1 36.1 24.1

Nonmetallic Minerals 100.6 67.6 56.3 48.5 31.5 27.0 40.8 30.9 23.7 22.3 22.1

Basic Metal Industries 73.3 50.0 47.5 35.4 29.9 24.6 61.3 29.8 33.1 25.2 24.1

Metal Prods, Machinery 78.3 51.4 44.0 34.8 21.4 18.1 51.1 55.8 28.2 22.3 17.9

Other Manufacturing 130.8 86.0 64.3 54.3 41.0 38.1 73.0 49.2 45.4 34.8 33.9

Sub-Sectors:

Food, Beverage, Tobacco

Food Manufacturing 107.3 75.9 62.1 46.9 42.4 35.3 50.4 48.5 51.2 43.7 27.6

Tobacco 219.3 138.3 64.7 79.0 51.1 48.0 104.5 101.2 34.4 50.6 47

Chemicals, Petroleum, Coal

Industrial Chemicals 67.7 42.1 35.9 26.3 23.7 19.5 49.0 28.3 25.6 21.5 14.3

Petroleum Refineries 80.9 36.8 44.5 39.9 51.1 38.6 62.2 8.8 12.9 61.6 45.6

Petroleum and Coal Products 88.0 64.0 57.4 46.9 27.2 22.8 44.2 33.1 28.0 14.5 12.2

Metal Products and Machinery

Nonelectrical Machinery 72.6 47.4 42.3 29.9 17.0 13.9 44.5 57.5 20.6 17.9 12.7

Transport Equipment 93.0 59.8 49.8 37.5 32.4 24.5 78.0 46.4 28.8 25.9 20.9

Note: import-weighted protection rates are calculated using import weights for the corresponding years, except for 1996, which uses 1995 import weight

Data is in fiscal years

Source: National Bureau of Revenue, and staffestimates.

ANNEX 2- 33 - Page 1 of 4

BANGLADESHTRADE POLICY REFORM FOR IMPROVING THE INCENTIVE REGIME

EFFECTIVE PROTECTION RATES: CORDEN METHOD (FY95196)

EFFECTIVE PROTECTION RATES: CORDEN METHOD (FY95196)

Sector No. & Name <ERP%> <V-A DOM> <VA-World> <NRP%>

1. Rice -5.5 0.68504 0.72503 02. Wheat 3 0.61426 0.59622 7,53. Coarse Grains 12.9 0.82986 0.73513 154. Jute 57.9 0.8179 0.51809 505. Sugar cane 15.6 0.60692 0.69814 156. Cotton -1.9 0.83944 0.85551 07. Tobacco 16.2 0.65668 0.56724 158. Potato 47.9 0.84229 0.56941 459. Other Vegetables 32.4 0.81618 0.61667 3010. Pulses 11.5 0.92413 0.82872 12.511. Oil Seeds 16.9 0.87638 0.7493 31.912. Fruits 42 0.97527 0.66699 21.913. Tea 48.7 0.85417 0.57448 4114. Other Crops 26.4 0.89139 0.7051 26.315. Livestock 40.2 0.66308 0.61556 35.816. Fish 28.3 0.84634 0.6599 28.817. Forestry 7 0.92868 0.86632 7.318. Other Food 97.6 0.35504 0.40028 46.519. Edible Oil 139.2 0.28255 0.30842 37.320. Sugar & Gur 50.2 0.4305 0.23016 3021. Salt 27.8 0.67893 0.66787 27.522. Yarn 15.1 0.44658 0.36791 7.523. Cloth Mill 114.2 0.38702 0.16067 39.324. Cloth Handloom 92.5 0.43031 0.22355 39.325. Ready-made Garments 67.2 0.27638 0.16527 44.926. Jute Textile 22 0.4662 0.40028 31.927. Paper 20.8 0.37269 0.30842 21.928. Leather & Leather Products 52.3 0.35044 0.23016 4129. Chemical Fertilizer 15.7 0.54535 0.64697 0.430. Pharmaceutical 0.9 0.47566 0.4716 13.431. Chemicals 33.8 0.35417 0.26479 30.232. Petroleum Products 39.2 0.37213 0.26736 37.433. Cement 22.3 0.50666 0.416 2434. Steel & Basic Metal 25.1 0.40663 0.32516 26.935. Metal Products 43.1 0.51203 0.35782 37.236. Machinery 12.9 0.56528 0.5163 18.437. transport Equipment 39.6 0.59019 0.42269 33.438. Wood and Wood Products 100.8 0.43729 0.21762 38.839. Tobacco Products 81.3 0.52692 0.29176 4540. Other industries 45.6 0.39445 0.27092 35AVERAGE ERP AGRICULTURE 23.50

AVERAGE ERP INDUSTRY 49.03AVERAGE ERP OVERALL 38.18STANDARD DEVIATION 34.16COEFF OF VARIATION 89.45

ANNEX 2-34 - Page 2 of 4

BANGLADESHTRADE POLICY REFORM FOR IMPROVING THE INCENTIVE REGIME

EFFECTIVE PROTECTION RATES: CORDEN METHOD (FY94195)

EFFECTIVE PROTECTION RATES CORDEN METHOD (FY94195)

Sector No. & Name <ERP%> <V-A DOM> <VA-World> <NRP%>

1. Rice 2.9 0.68504 0.66558 7.52. Wheat 12.8 0.61426 0.54477 153. Coarse Grains 12.2 0.82986 0.73963 154. Jute 69.9 0.8179 0.48148 605. Sugar cane 15.2 0.60692 0.7007 156. Cotton -2.2 0.83944 0.85811 07. Tobacco 15 0.65888 0.57304 158. Potato 64.7 0.84229 0.61152 609. Other Vegetables 50.3 0.81618 0.54303 4510. Pulses 13.8 0.92413 0.81184 1511. Oil Seeds 25.3 0.67638 0.69944 23.812. Fruits 45 0.97527 0.6725 44.713. Tea 66 0.85417 0.51448 6014. Other Crops 37.6 0.89139 0.64773 36.815. Livestock 49.4 0.66308 0.57774 44.416. Fish 45 0.64634 0.58379 4417. Forestry 9 0.92868 0.85184 9.418. Other Food 123 0.35504 0.16922 55.119. Edible Oil 100.6 0.28225 0.14071 39.720. Sugar& Gur 47.8 0.4305 0.29124 3021. Salt 32 0.87893 0.66576 32.322. Yarn 14.6 0.44656 0.36962 7.523. Cloth Mill 171.2 0.38702 0.14268 46.524. Cloth Handloom 131.9 0.43031 0.16555 46.525. Ready-made Garments 108.4 0.27636 0.13265 59.926. Jute Textile 26.3 0.4882 0.36639 38.127. Paper 60.6 0.37269 0.23138 39.828. Leather & Leather Products 54.1 0.35044 0.22735 46.329. Chemical Fertilizer 18.5 0.54535 0.66931 030. Pharmaceutical 4.6 0.47566 0.45478 17.231, Chemicals 31.7 0.35417 0.26893 33.532. Petroleum Products 51.2 0.37213 0.24615 48.233. Cement 21.6 0.50866 0.41815 25.534. Steel & Basic Metal 27.7 0.40663 0.31852 30.135. Metal Products 44.9 0.51203 0.35346 40.136. Machinery 14.1 0.56526 0.51285 20.537. transport Equipment 42.3 0.59019 0.41484 36.238. Wood and Wood Products 91.7 0.43729 0.22816 38.839. Tobacco Products 65.6 0.52692 0.28461 47.140, Other Industries 48.7 0.39445 0.26525 38.7

AVERAGE ERP AGRICULTURE 31.29AVERAGE ERP INDUSTRY 57.25AVERAGE ERP OVERALL 46.22STANDARD DEVIATION 39.9COEFF OF VARIATION 86.33

ANNEX 2-35 - Page 3 of 4

BANGLADESHTRADE POLICY REFORM FOR IMPROVING THE iNCENTIVE REGIME

EFFECTIVE PROTECTION RATES: CORDEN METHOD (FY93194)

EFFECTIVE PROTECTION RATES CORDEN METHOD (FY93194)

Sector No. & Name <ERP%> <V-A DOM> <VA-World> <NRP%>

1. Rice 2.1 0.68504 0.67064 7.52. Wheat 11.6 0.61426 0.5504 153. Coarse Grains 4.1 0.82986 0.86533 04. Jute 74.2 0.6179 0.46944 63.85. Sugar cane 74.7 0.80692 0.46185 606. Cotton 5.4 0.83944 0.79647 7.57. Tobacco 3.2 0.65888 0.63819 7.58. Potato 81.4 0.84229 0.46429 759. Other Vegetables 49.2 0.81618 0.54696 4510. Pulses 13.6 0.92413 0.81334 1511. Oil Seeds 31.6 0.87638 0.66604 29.612. Fruits 56.6 0.97527 0.62259 56.113. Tea 86.8 0.65417 0.45721 7514. Other Crops 36.9 0.69139 0.66121 36.315. Livestock 55.7 0.66308 0.55424 50.116. Fish 49.5 0.64634 0.56596 4817. Forestry 17 0.92868 0.79393 17.318. Other Food 89.6 0.35504 0.18729 5519. Edible Oil 111.6 0.28255 0.13354 46.420. Sugar & Gur 70.1 0.4305 0.25307 6021. Salt 38.9 0.87893 0.63272 39.422. Yarn 22.9 0.44656 0.3635 1523. Cloth Mill 194.3 0.38702 0.13151 58.524. Cloth Handloom 148.1 0.43031 0.17343 58.525. Ready-made Garments 150.6 0.27638 0.11028 74.926. Jute Textile 66.2 0.4662 0.29373 60.327. Paper 87.2 0.37269 0.19906 50.728. Leather & Leather Products 78.9 0.35044 0.19586 59.829. Chemical Fertilizer 19.3 0.54535 0.67536 0.330. Pharmaceutical 7.4 0.47566 0.51389 1231. Chemicals 42 0.35417 0.24939 4232. Petroleum Products 29.5 0.37213 0.28738 30.133. Cement 20.9 0.50666 0.42082 2734. Steel & Basic Metal 26.7 0.40683 0.32101 32.235. Metal Products 55.1 0.51203 0.33004 46.636. Machinery 28.6 0.56528 0.45502 32.737. transport Equipment 56 0.59019 0.37831 46.838. Wood and Wood Products 103.4 0.43729 0.21504 4839. Tobacco Products 67.9 0.52692 0.31499 37.540. Other Industries 80.6 0.39445 0.12836 53.6

AVERAGE ERP AGRICULTURE 37.96AVERAGE ERP INDUSTRY 67.06AVERAGE ERP OVERALL 54.7STANDARD DEVIATION 45.52COEFF OF VARIATION 83.22

ANNEX 2

-36 - Page 4 of 4

BANGLADESHTRADE POLICY REFORM FOR IMPROVING THE INCENTIVE REGIME

EFFECTIVE PROTECTION RATES: CORDEN METHOD (FY92193)

EFFECTIVE PROTECTION RATES CORDEN METHOD (FY92193)

Sector No. & Name <ERP%> <V-A DOM> <VA-World> <NRP%>

1. Rice 0.6 0.68504 0.68099 7.52. Wheat 1.2 0.61426 0.62177 7.53. Coarse Grains 4.8 0.82986 0.87194 04. Jute 76.4 0.8179 0.46362 67.55. Sugar cane 72.1 0.80692 0.46884 606. Cotton 4.9 0.83944 0.80028 7.57. Tobacco 35.6 0.65888 0.48573 308. Potato 79.7 0.84229 0.4688 759. Other Vegetables 86 0.81618 0.4387 7510. Pulses 13.1 0.92413 0.81707 1511. Oil Seeds 35.1 0.87638 0.64862 33.112. Fruits 62.5 0.97527 0.60025 62.113. Tea 64.5 0.85417 0.46301 7514. Other Crops 59.7 0.89139 0.55817 57.515. Livestock 73.4 0.86308 0.49765 65.116. Fish 78.6 0.84634 0.47395 73.817. Forestry 20.9 0.92868 0.76838 21.318. Other Food 571.7 0.35504 0.5286 107.719. Edible Oil 205.2 0.28255 0.09259 60.220. Sugar&Gur 124.9 0.4305 0.19141 8021. Salt 51.7 0.67693 0.57939 51.522. Yarn 22 0.44658 0.36617 1523. Cloth Mill 343.1 0.36702 0.08735 73.724. Cloth Handloom 234 0.43031 0.12882 73.725. Ready-made Garments 257.4 0.27636 0.07733 99.926. Jute Textile 66.2 0.4682 0.2937 63.427. Paper 70.2 0.37269 0.21894 50.928. Leather& Leather Products 92.1 0.35044 0.18247 7329. Chemical Fertilizer 21.3 0.54535 0.69272 0.530. Pharmaceutical 9.3 0.47566 0.52449 13.831. Chemicals 51.1 0.35417 0.23444 52.232. Petroleum Products 37.5 0.37213 0.27057 38.633. Cement 63.9 0.50666 0.31025 6234. Steel & Basic Metal 34.2 0.40683 0.30325 41.835. Metal Products 77.5 0.51203 0.28853 63.536. Machinery 43.1 0.58526 0.40894 46.537. Transport Equipment 94.7 0.59019 0.30309 70.738. Wood and Wood Products 123.8 0.43729 0.19539 57.139. Tobacco Products 106.1 0.52892 0.25658 65.740. Other Industries 109.1 0.39445 0.18864 69.8

AVERAGE ERP AGRICULTURE 45.71AVERAGE ERP INDUSTRY 119.52AVERAGE ERP OVERALL 88.15STANDARD DEVIATION 107.73COEFF OF VARIATION 122.22Source: Bangladesh Tariff Commission.

-37- ANNEX 3

BANGLADESHTRADE POLICY REFORM FOR IMPROVING THE INCENTIVE REGIME

IMPORT COMPOSITION FY91/92 TO FY95196(Import figures in Million Taka)

Share Growth Share Share Growth Share Growth FY95-96 Share FY94-95 Share GrowthFY9I-92 % FY92-93 % FY93-94 % FY94-95 % Jul - Nov 95 % Jul - Nov 96 %

1 2 211 3 3/2 4 413 5 6 5/6

1. Primary commodities 24,914.1 2.47% 29,775.7 0.2 27.77% 28,705.7 25.48% -3.59% 46,044.0 28.72% 60.40% 23,677.3 28.51% 13,356.6 25.27% 77.27%

a. Food/vegetable products 10,644.2 10.56% 14,063.8 0.3 13.12% 14,278.4 12.67% 1.53% 25,007.0 15.60% 75.14% 13,568.6 16.34% 5,572.0 10.54% 143.51%

b. Mining products 8,543.7 8.47% 8,545.3 0.0 7.78% 7,332.6 6.51% -14.19% 9,957.3 6.21% 35.79% 2,878.7 3.47% 3,667.0 6.94% -21.50%

c. Animals, forestry, other 5,726.2 5.68% 7,366.5 0.3 6.87% 7,094.7 6.30% -3.69% 11,079.7 6.91% 56.17% 7,230.0 8.71% 4,119.3 7.79% 75.52%

2. Intermediate Inputs 44,559.2 44.20% 45,530.3 0.0 42.46% 49,420.1 43.86% 8.54% 63,913.1 39.87% 29.33% 30,039.8 36.17% 20,945.8 39.63% 43.42%

3. Capital Goods 24,697.5 24.50% 22,504.2 (0.1) 20.99% 22,542.5 20.01% 0.17% 33,744.2 21.05% 49.69% 19,888.7 23.88% 12,296.0 23.27% 61.75%

a. Capital machinery &parts 19,831.0 19.67% 16,663.6 (0.2) 15.54% 15,873.2 14.09% -4.74% 22,712.8 11.17% 43.09% 13,341.3 16.06% 7,979.9 15.10% 67.19%

b. Other capital goods 4,866.5 4.83% 5,840.1 0.2 5.45% 6,669.2 5.92% 14.20% 11,031.4 6.88% 65.41% 6,487.4 7.81% 4,316.1 8.17% 50.31%

4. Final Consumer Goods 6,641.6 6.59% 9,421.1 0.4 8.79% 12,007.1 10.66% 27.45% 16,607.8 10.36% 38.32% 9,503.4 11.44% 6,249.8 11.83% 52.06%

Total 100,812 107,231 0.1 112,675 5.08% 160,309 39.00% 83,049 52,848 57.15%

Note: Data excluding bond, baggage & back-to-back.

Source: ETAC Database, CIS-Cell, NBR

-38- ANNEX 4

BANGLADESHTRADE POLICY REFORM FOR IMPROVING THE INCENTIVE REGIME

THE URUGUAY ROUND AGREEMENT:MAIN FEATURES AND POTENTIAL GAINS

1. The Uruguay Round, completed in 1994, is a complex agreement that includes sub-agreements on the following: (i) tariff reductions in manufacturing products; (ii) tariffication ofnon-tariff barriers in agriculture and binding commitments to reduce the level of agriculturalprotection; (iii) reduction of export and production subsidies in agriculture; (iv) elimination ofVoluntary Export Restraints in textiles and apparel and the elimination of the MFA; (v)institutional and rule changes, such as the creation of the WTO and safeguards, as well asantidumping and countervailing duty measures; (vi) new areas such as Trade -Related InvestmentMeasures (TRIMS), Trade Related Aspects of Intellectual Property Rights (TRIPS), and theGeneral Agreement on Trade in Services (GATS); and (vii) areas receiving greater coverage,such as government procurement.

2. Several studies have attempted to quantify the outcome of the Uruguay Round. Whilethere are differences in these estimates, most differences can be intuitively explained by modelassumptions and coverage. Using a large scale empirical model, Harrison Rutherford and Tarrestimated that the world as a whole will gain substantially from the reforms agreed under the UR;about $ 96 billion annually in the short run, and $171 billion in the long run. The short run gainsare concentrated in developed countries, especially in Japan, the European Union (EU) and theUnited States. The outcome reflects the fact that the industrial countries, especially the US andEU "gave up" the most in the Uruguay Round. These countries are modifying policies which arevery costly in terms of foregone welfare to themselves, most notably distortionary agriculturalpolicies and the import quota protection in textiles and apparel afforded through the MFA, wvhichis to be dismantled. In contrast, under the UR, the developing countries reduce agriculturaldistortions relatively less, (although the reduction of production subsidies is significant in somecases), and do not restrict imports under the MFA. The only general exception is thatdeveloping countries reduce protection in manufactures by more than the OECD countries, sincethe latter now have relatively lower protection, on average, in this area.

3. While some developing countries may lose in the short termn, all of them can improvetheir relative position by limiting the self-inflicted costs, by reducing their trade barriers andother distortions further. South Asia as a whole stands to gain significantly from theimplementation of the UR. Prior to the UR, almost 30 percent of South Asian exports to theOECD faced NTBs with the share of Bangladesh being 48%. The corresponding shares of EastAsian and Chinese exports facing OECD NTBs were around 19 and 17 percent respectively. Inthe case of clothing, 90 percent of Bangladesh's (1988) exports were covered under NTBs(mostly due to the MFA). The gradual removal of these NTBs will significantly increase market

access opportunities and could translate into major gains in export shares for South Asia. In thecase of Bangladesh, NTB coverage of its exports to OECD is estimated to drop to 11 percent.

-39- ANNEX 4

OECD NTB coverage is expected to drop most sharply for exports from Bangladesh and SriLanka, thus giving them a major advantage in market access (Majd, 1995).

4. In particular, the removal of the MFA will be advantageous to South Asia, given thattextiles and clothing make up 45 percent of the region's exports to the OECD. Even though thequota-removal process will be backloaded, it is estimated that South Asia's output and exports oftextiles and clothing are going to be affected drastically. In textiles, South Asia's output will beincreased by 17 percent and exports by 26 percent. In clothing, the effects are much higher, andoutput and exports are estimated to increase by 91 percent and 254 percent respectively. Thesechanges are relatively higher than most comparators in East Asia, and are largely because SouthAsian countries are among the lowest cost producers of apparel, and most severely constrainedunder the MFA. Most likely, South Asia's gains, by being able to increase production andexports, will outweigh the losses from elimination of quota rents.

5. In terms of tariffs facing South Asia's exports, tariff reductions will lower average tariffsby more than 2 percentage points for South Asia's exports to the OECD, and 8.5 percentagepoints on exports to the developing countries, Tariff reductions, however will be much smallerfor manufactured goods, and higher for agricultural goods. For example, the largest cuts in tariffswould be for fertilizers and mineral fuels, commodities that figure less prominently in SouthAsia's basket of exported goods. On the other hand, high post-round tariff rates for manufactureswill adversely affect South Asia as 27 percent of its exports are concentrated in manufacturedproducts. A good strategy in this regard would be to take advantage of market accessopportunities provided by agriculture. The post-Round tariff rates for South Asian exports ofagricultural products to the OECD and developing countries will be around 8 and 15 percentrespectively. Presently agricultural exports account for only 19 percent of the region's totalexports, and - % of Bangladesh's exports. However, given the importance of the sector in termsof output and employment, Bangladesh should not undermine the prospects in exploiting themarket access opportunities created in agriculture, especially in the industrial countries.

6. The post-Uruguay Round world presents a more open global trading environment.Unilateral tariff reductions or the reduction in other distortions in developing countries will leadto a change in developing countries' production and exports based on comparative advantage,and the exports expansion that follows is less likely to be impeded by global protectionism.Moreover, in the long run, higher income levels are expected to result in gains for almost allcountries that lose in the short run. This suggests that all countries atleast have the potential togain from the IJruguay Round.

Souirce: Harrison, Glen, Thomas Rutherford and David Tarr, "Quantifying the Outcome of theUruguay Round" Finance and Development, December 1995

-40- ANNEX 5

BANGLADESHTRADE POLICY REFORM FOR IMPROVING THE INCENTIVE REGIME

BANGLADESH: SCHEDULE OF COMMITMENT TO WTO

Table 1. Bangladesh - Schedule of Commitments for Industrial Products

Pre-Uruguay Post -Uruguay Post-Uruguay RoundRound Round Bound Rate ofApplied Bond "Other

H.S. Code Brief Description of Products Rate of Duty 1/ Rate of Duty Duties and Charges"

(%) (%) (%)

0306.13 & 23 Shrimps and prawns 45 50 302523.10 Cement clinkers 7.5 50 303006.60.90 Chemical contraceptive preparations 0 50 303103.10 Superphosphates (fertilizers) 0 50 305303.10 Rawvjute 30 50 306305.10.10 Sacks and bags ofjute 60 50 307201.10 Non-alloy pig iron 7.5 50 307302.10 Rails 15 50 308401.10 Nuclear reactors 30 50 308402.00 Steam or vapor boilers & boiler parts 0; 7.5; 30 50 308403.00 Central heating boilers & boiler parts 0; 30 50 308407.10 Aircraft engines 7.5 50 308410.11 Hydraulic turbines of power n/exceeding 30 50 30

1,000 KW8410.12 Hydraulic turbines of power exceeding 1,000 30 50 30

KW8410.13 Hydraulic turbines of power n/exceeding

1,000 KW, but not exceeding 10,000 KW 30 50 308411.91 Parts of turbo-jets 30 50 308411.99 Parts of gas turbines 30 50 308434.10 Milking machines 7.5 50 308434.20 Dairy machinery 7.5 50 308439.90 Machinery for making paper or paper board 15 50 308571.20 Digital automatic data processing machines 7.5 50 308471.91 Other digital processing units, whether 7.5 50 30

or not with system8471.92 Imput or output units, whether or not with 7.5 50 30

system8473.30 Parts and accessories of machines of 7.5 50 30

heading No. 84.718525.20 Transmission apparatus incorporating reception 0; 7.5; 15 50 30

apparatus8601.10 Rail locomotives-powered from an 15 50 30

external source of electricity8601.20 Rail locomotives-powered by electric 15

accumulators8602.10 Diesel electric locomotives 15 50 308603.10 Self-propelled railway or tramay coaches, vans 50 30

and trucks powered froun an external source 15 50 309020.00.10 Gas masks and similar respirators 7.5 50 309021.40 Hearing aids, excluding parts and accessories 7.5 50 30

As per the 1994/95 operative tariff schedule. In case of multiple rates, these correspond to those applying to the differentsub-headings at an eight-digit H.S. code.

Source: WTO

-41- ANNEX 5

Table 2. Bangladesh: Schedule of Commitments for Agricultural Products

Post-UruguayPost-Urugay Post-Uruguay Bond Rate of

Brief Round Applied Round Applied "Other DutiesDescription Rate of Duty 2/ Rate of Duty 2 & Charges" Implementation

H.S. Code of Products (%) (%) (%) Period

0101.11 Live horses 7.5 50 30 1995

0104.10 Live sheep 7.5 50 30 1995

0105.11 Live fows 30.0 50 30 1995

0208.20 Frog legs 45.0 50 30 2004

0501.00 Human hair 30.0 50 30 1995

0701.10 Sweet potatoes 7.5 50 30 2004

0902.10 Green tea 60.0 50 30 2004(non-fermented)

0902.30 Black tea 60.0 50 30 2004

1006.10 Rice in the husk 7.5 50 30 1995

1008.30 Canary seeds 15.0 50 30 1995

1201.00 Soybeans (seeds) 15.0 50 30 1995

1207.20 Cotton seeds 15.0 50 30 1995

1703.10 Molasses 45.0 50 30 2004

]/ For all agricultural products not included in this table, tariffs and "other duties and charges" are bound at rates of200 percent and 30 percent, respectively.

_/ As per the 1994/95 operative tariff schedule.Source: WTO

-42- ANNEX 5

Table 3. GATS Members: Number of Sectors Scheduled at the Mode of Supply

Percentage ofNumber of Possible

Commitment Commitments

India 132 21.3%Pakistan 108 17.4%Bangladesh 4 0.7%Sri Lanka 8 1.29%

Memo Items:China 196 31.6%Korea, Rep. of 311 50.2%Malaysia 256 41.3%Thailand 260 41.9%OECD countries 330 53.3%

Note: maximum number = 620, i.e., 155 activities times 4 modes of supply.Source: Ibrahim (1995), Hoekman and Braga (1994).

-43-

ANNEX - 6

List of Participants at the Workshop, on the Report, held in Dhaka on August 29, 1996

1. Mr. S.M. Akram, Honorable Member of Parliament2. Mr. Syed Manzur Elahi, Industrialist & former Advisor, Caretaker Government3. Mr. M.A.M. Ziauddin, Chairman, Bangladesh Tariff Commission4. Mr. M.I. Talukder, Division Chief, Planning Commission5. Mr. Faisal Ahmed Chowdhury, Vice-Chairman, Export Promotion Bureau6. Ms. Joslin Landell-Mills, IMF/Bangladesh Bank7. Mr. Kabir U. Ahmed, Economist8. Mr. Mazharul Karim, Joint Secretary, Ministry of Commerce9. Mr. Fouzul Kabir Khan, First Secretary, National Board of Revenue10. Mr. Abdur Rab, Consultant, Ministry of Finance11. Mr. Zaidi Sattar, Economist, Planning Commission12. Mr. Zahid Hossain, Consultant, Ministry of Finance13. Mr. Zaid Bakth, Sr. Research Fellow, BIDS14. Mr. Shahab Sattar, Industrialist15. Mr. Pierre Landell-Mills, Chief of Mission, The World Bank16. Ms. Marilou Uy, Division Chief, The World Bank17. Ms. Lorene Yap, Division Chief, The World Bank18. Mr. Owaise Saadat, Manager, PSD&F Unit, The World Bank19. Mr. Tercan Baysan. Manager, Economics Unit, The World Bank20. Mr. Syed Nizamuddin, Sr. Program Officer, The World Bank21. Mr. Zahid Hussain, Program Officer, The World Bank22. Mr. G.M. Khurshid Alam, Private Sector Development Officer, The World Bank

BIBLIOGRAPHY

Bakht, Zaid. 1995. "An Analysis of Assistance and Efficiency in Bangladesh Industry."

Bangladesh Institute of Development Studies. 1995. "Cross-Border Trade between Indiaand Bangladesh." A Bangladesh Perspective, Dhaka. Processed.

Bangladesh Tariff Commission. 1995. Textiles Sector Study (draft). Dhaka.

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