Bangladesh’s economy has been on a downward trend since early 2022, marked by high inflation, declining foreign exchange reserves, depreciation of the taka, poor health of the banking sector, a low and stagnant tax-to-GDP ratio and a reduction in public spending. The GDP growth rate as well as export growth and investment rates have also declined. This decline is the result of economic mismanagement and endemic corruption, including theft in the banking sector and corrupt practices in public procurement.

The decline of the macroeconomy, combined with autocratic and corrupt political governance, increasing income inequality and human rights violations, led to the inevitable fall of the previous government on August 5, 2024. An interim government was established, charged with the responsibility of stabilizing the macroeconomy and reforming the country’s political governance. The most immediate action of this government was to stop the hemorrhaging of the banking sector linked to the thefts by making radical changes in the management of the banks concerned. Second, it completely deregulated interest rate policy and tightened domestic liquidity by increasing the policy rate of the Bangladesh Bank. Third, a broad fight against corruption, including efforts to recover stolen assets, was announced. Several other ongoing reforms include reviewing public spending priorities to reduce waste and leakages, reducing corruption and increasing tax collection through online tax filing, reducing customs duties on imports of essential food products to reduce inflationary pressure and mobilize greater financial assistance from multilateral financial institutions.

Even though the reforms have only just started, some positive results are already visible. Theft-related outflows of bank resources stopped, demand for credit slowed, remittances increased, and deposits increased. The month of October was marked by an encouraging recovery in exports. However, inflation remains stubbornly high, government revenue receipts remain slow, and foreign exchange reserves have fallen to $18.4 billion as of November 14, from $20.4 billion in July. This is partly explained by increased debt repayments and a resumption of imports. In addition, the capital flows expected from multilateral institutions have not yet materialized, pending the review of the current program by the IMF and the delay in negotiating new balance of payments financing from multilateral institutions.

The immediate challenge is to reduce inflation sustainably. And this requires a recovery in imports and production in the manufacturing sector. More generally, with the exception of domestic resource mobilization, demand stabilization measures are generally on track. Political attention must now focus on increasing imports and domestic supply, which is closely linked to the recovery of production, investments and exports.

The supply-side agenda is challenging and involves short-term (one to three years) and medium-term (more than three years) reforms related to skills, technology, domestic investment, foreign direct investment (FDI) and export diversification. These encompass policy reforms in many areas. The most immediate reforms include:

Exchange rate management: Years of controlled exchange rate management have clearly demonstrated the futility of such a system. The strong appreciation of the real effective exchange rate between 2011 and 2022 contributes significantly to the current balance of payments crisis. The exchange rate has been slowly liberalized since May 2024 through the unification of several exchange rates and the adoption of a creeping peg. However, the usefulness of sticking to a crawling peg system is doubtful, and it is preferable to move towards a fully flexible market-based exchange rate. Demand management policies in place will prevent the rate from fluctuating wildly. A market-based exchange rate is the best way to incentivize exporters and remittance issuers.

The Bangladesh Bank should also take a hard look at the outdated foreign exchange regime, riddled with exchange controls and other restrictive practices that impose high transaction costs on exporters and importers, while providing incentives for financial transactions. Services exports can be boosted through a deregulated, exporter-friendly exchange rate regime.

Monetary policy: As noted, monetary policy is fundamentally on track. However, additional work may be needed to carefully examine the functioning of the Treasury market. Even though, in principle, the Treasury bill market is open to the public, it has become an easy option for banks to make profits for themselves instead of engaging in lending operations.

Tax policy: This represents a huge challenge. Corruption, combined with an inefficient tax system, has severely limited Bangladesh’s tax revenue. Overreliance on indirect taxes has fueled inflation while contributing to income inequality. Similarly, due to low revenues, total public expenditure as a percentage of GDP is low by international standards. Yet the effectiveness of this limited spending has been reduced by poor spending priorities and corruption. Public spending on health, education, water resources and social protection has been grossly insufficient, while most spending has focused on civil service salaries and benefits, subsidies, interest charges and major infrastructure projects. The quality of infrastructure spending has been poor due to corruption in public procurement, contributing to delays and cost overruns.

Clearly, overhauling tax and spending systems is a top priority. This is not an easy task and will require several years of sustained effort. The interim government has started to reform both aspects. On the revenue side, he has rightly focused on overhauling the income tax system, where corruption is most endemic. Moving to an online system is a smart policy step. But this will not be enough to produce all the benefits.

To provide incentives to filers, two related reforms are essential. First, tax reporting must be simplified by removing the reconciliation of income, expenses and assets. It is a rent-seeking tool designed to harass taxpayers and its revenue implications are questionable. Taxpayers enter into negotiated deals with NBR staff, and the Treasury loses. Eliminating this requirement would greatly simplify online tax filing and encourage more tax filers to go online.

Second, tax audits should be automated based on pre-selected triggers and be highly selective, primarily focused on large taxpayers. Comprehensive documentation, including reconciliation of income and assets, becomes relevant during an audit review.

When it comes to spending management, one of the top priorities is to reduce fossil fuel subsidies and large infrastructure projects and increase spending on health, education, water resources and social protection. In the current context of high inflation, it is essential to increase social protection spending with a focus on the poor.

A significant property tax: Local government institutions – that is, municipal corporations and municipalities – are inefficient due to severe resource constraints. World experience shows that the best instrument to increase their finances is to establish a meaningful property tax system, based on the market value of properties and a meaningful tax rate. Substantial revenues can be raised through this reform, which will ease pressure on cash transfers to these institutions.

Public Enterprises (SoE): Public enterprises drain scarce budgetary resources from the Treasury with poor financial performance. The total book value of SOE assets in FY2021 was estimated at 16% of GDP, but net fiscal transfers to these SOEs were in the range of 2-3% of GDP. I have prepared a detailed report on how the financial performance of state-owned enterprises can be improved and shared it with the Ministry of Finance in early 2024. The fundamental reforms relate to corporate governance and pricing policy. This is an easy target that the caretaker government may want to focus on.

Commercial policy: A sharp reduction in trade taxes is essential to diversify and boost exports. This would also reduce inflation. Public revenue must be generated by income tax and VAT. Trade policy should focus on supporting the expansion of manufacturing exports and limited support for well-established import substitutes.

Investment climate: Reversing the slowdown in private investment and attracting FDI will require a significant improvement in the investment climate. The establishment of public order, including the protection of private property, is the top priority. Resolving labor disputes is another priority. Restoring the confidence of the domestic private sector is essential to attracting FDI. Easing foreign exchange and import regulations, providing uninterrupted electricity supply, and tax and trade policy reforms will all help improve the investment climate.

Dr Sadiq Ahmed is vice-president of the Policy Research Institute of Bangladesh (PRI). He can be reached at (protected email).

The opinions expressed in this article are those of the author.

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