Bangladesh had recorded outstanding performance before the Covid-19 pandemic. The economy had grown, gross domestic product per capita had increased, dollar reserves had increased, inflation was low, and poverty levels were falling.
By 2021, Bangladesh’s economy had started to recover well from the pandemic and has gradually returned to its pre-Covid trajectory.
But since mid-2021, global commodity prices, especially oil, have started to rise. This was intensified by the Russian invasion of Ukraine in March.
As a result, Bangladesh, as a major energy importer, faces a number of challenges. Its foreign exchange reserves are dwindling and the value of its currency, the taka, is weakening. Power outages have worsened, adding to the misfortunes of citizens.
What went wrong so quickly? Is Bangladesh headed for a recession or will the economy recover soon?
Economic and political situation
The situation in Bangladesh is largely due to global economic and political crises. Following the economic recovery from Covid-19, the global commodity market had become volatile, but the Russian-Ukrainian war made it worse.
War, trade embargoes and financial sanctions against Russia have disrupted global supply chains and increased the prices of many commodities as well as shipping costs. Food, fuel and animal feed prices have risen dramatically on the world market.
As a result, the cost of imports to Bangladesh has increased significantly even though export earnings have increased only moderately.
In fiscal 2022, import spending increased 36% from 20% in the prior fiscal year. The high cost of imports is partly due to increased demand for imported goods and partly due to higher import prices in the world market.
As a result, the terms of trade have been unfavorable to Bangladesh. During the period 2021-22, the import price index increased by 5.06%, while the export price index increased by 3.23%. This hurt the current account balance.
In fiscal year 2022, the current account balance recorded a deficit of $18.70 billion compared to the deficit of $4.58 billion in the previous year – as shown in Table 1.
The current account deficit in Bangladesh is generally covered by remittances from abroad, which also declined significantly in FY2022. Remittances fell by 14% in FY2022, after a 36% increase in FY2021. This affected the balance of payments, foreign exchange reserves and weakened the taka against the US dollar.
Despite adjusting the exchange rate to meet market demand, the Bangladesh Bank continued to sell dollars from reserves to keep the taka stable. As a result, reserves have further declined.
Foreign exchange reserves fell to $39.77 billion on July 14 from $46.39 billion a year earlier. Although the country received relatively large remittances from expatriates in July due to Eid, the value of the taka against the dollar is deteriorating.
Foreign exchange reserves are not only essential for maintaining the exchange rate of the national currency, but also contribute significantly to increased capital investment and long-term economic growth.
To keep the value of the taka stable, the government of Bangladesh and the Bangladesh Bank have taken measures to reduce imports and increase the flow of dollars. The government discouraged the importation of luxury items. The depreciation of the taka forced the government to seek a loan from the International Monetary Fund. Only a year ago, Bangladesh supported Sri Lanka with $250 million.
The weakening of the taka against the dollar not only makes imports more expensive, but also increases the domestic prices of imported goods and other non-imported goods due to the substitution effect – that is, when sales of a product decrease due to an increase in its price which encourages consumers to turn to cheaper alternatives. This worsens inflation.
Inflation at 9-year high
For the past few years, inflation in Bangladesh was under control, but it started to rise in 2021 and now stands at 7.56% according to official accounts, although the actual rate is believed to be much higher. The prices of rice, wheat, edible oil and other basic products are rising and the inflation rate has reached its highest level in nine years.
Several studies indicate that low-income citizens struggle to cope with high commodity prices and compromise their food and nutrition.
The government has recently increased the prices of urea fertilizers and fuel oil without implementing measures to improve the management of the energy sector and reduce the inefficiency and loss of the system.
When the government is unable to import enough fuel to generate electricity, it has to pay large sums of money as capacity charges to quick-lease power plants while keeping them mostly inactive. The government could have avoided the massive loss if it had planned ahead and canceled some of the contracts earlier.
High fuel prices come at a time when people are already struggling to keep up with rising food prices. This has further increased the cost of transporting goods and fueled a rise in the prices of almost all essential consumer goods. As the price of fuel increases, it contributes to cost inflation, and the cost of everyday basics, including transportation, will increase.
In addition, millions of farmers use diesel for irrigation. The increase in the price of diesel will further increase irrigation costs and could affect food security if the necessary measures to support farmers are not taken.
The rationing of electricity and frequent power cuts have aggravated the suffering of the inhabitants. Electricity is essential for productive activities that support economic growth, but recent frequent power outages have hampered production and businesses.
While large industries have their own generators, most small and micro industries do not have enough capital to purchase backup power infrastructure. Load shedding thus interrupts the operations of small industries, reducing productivity – sometimes even damaging equipment – and degrading the quality of production.
The current situation indicates that if no strategic action is taken, Bangladesh’s economy may suffer from slow economic growth in the coming years and may not be able to return to pre-Covid levels. 19 in the near future. Slower economic growth can shrink the labor market and increase youth unemployment.
Strategic planning and decisive action are needed to secure electricity supply and improve management of the energy sector, eliminate costly electricity rental systems and gradually reduce dependence on external sources.
Energy and food price increases will disproportionately affect low-income households, exacerbating already growing inequalities. To address this, social protection measures need to be further strengthened to protect the poor from high inflation. Exports are crucial for reducing the trade deficit and building foreign exchange reserves, which in turn will help manage exchange rates and the weakening taka.
To cope with the current economic crisis and manage the balance of payments, it is important to maintain the existing restriction on imports of luxury goods and to accelerate the promotion of exports. However, while tightening imports, care must be taken not to restrict the import of raw materials and intermediate goods, as Bangladesh’s exports are highly dependent on imported inputs.
Particular attention should be given to increasing remittances and foreign direct investment and preventing capital flight out of the country.
Golam Rasul is a professor in the Department of Economics at the International University of Business, Agriculture and Technology, Dhaka, Bangladesh.