Bangladesh’s post pandemic recovery faces continued headwinds in FY24. Economic conditions worsened in FY23 as inflation increased and the balance of payments deficit widened. The introduction of a multiple exchange rate regime in September 2022 disincentivized foreign exchange inflows, leading to a financial account deficit. Foreign exchange rationing measures were implemented to restrict imports, which resulted in shortages of key intermediate goods, capital goods, gas and energy.

Real GDP growth slowed significantly to 5.8 percent in FY23 from 7.1 percent in FY22, due to weakening private consumption and investment. Persistent inflation eroded consumer purchasing power. Tight liquidity conditions, rising interest rates, import restrictions, and increasing input costs stemming from upward revisions in the administered energy prices hampered investment activity. The contribution of net exports to growth increased, led by a sharp contraction in intermediate and capital goods imports. Industrial and services growth moderated on the supply side. Industrial sector weakness continued in FY24, with a manufacturing-driven 3.7 percent decline in the index of industrial production (IIP) year-on-year.

To rein in inflation, Bangladesh Bank (BB) continued to tighten monetary policy in early FY24. BB introduced an interest targeting framework in FY23 to better signal its policy stance. However, monetary transmission remains weak due to a variable cap on lending rates, and the real policy rate remains negative. The banking system continues to face tight liquidity conditions due to unsterilized BB foreign exchange sales and weak deposit growth. Private sector credit growth slowed further in FY24, reflecting a broader slowdown in investment. The nonperforming loan (NPL) ratio in the banking sector remains elevated, and even this elevated ratio understates banking sector stress due to lax definitions and reporting standards, forbearance measures, and weak regulatory enforcement. BB has proposed bank mergers and introduced a Prompt Corrective Action (PCA) framework to address the vulnerabilities in the banking sector.

The decline in foreign exchange reserves has moderated. The BoP deficit moderated during the first half of FY24 driven by a surplus in the current account. However, the financial account deficit has widened further. Expanding net outflows on account of net trade credit reflected increased divergence between export shipments and receipts, the slowdown in trade flows and private sector credit. A decline of Medium and Long Term (MLT) loans added to the financial account deficit. The interbank exchange rate was inadequate to clear the forex market, leading to a severe shortage of dollars. Continued interventions by BB in the forex market led to a depletion in official gross international reserves from US$ 24.8 billion to US$ 20.8 billion in the first eight months of FY24.

The fiscal deficit moderated marginally to 4.4 percent of GDP in FY23 from 4.6 percent in FY22. Subdued revenue growth was offset by deferred capital investment and limited public sector wage growth. The public debt-to-GDP ratio increased to 35.0 percent but remained sustainable, with a low risk of debt distress. To contain subsidies, the government cut export subsidies to almost all sectors, increased electricity prices, and adopted a marketbased pricing formula for liquid fuels, linked with global prices. Net borrowing from the banking sector declined in the first three quarters of FY24.

Real GDP growth is projected to remain relatively subdued at 5.6 percent in FY24, compared to the average annual growth rate of 6.6 percent over the decade preceding the COVID-19 pandemic. Persistent inflation is expected to weigh on private consumption growth, and shortages of energy and imported inputs combined with rising interest rates and financial sector vulnerabilities are expected to dampen investor sentiment. Relatively slower growth is projected to persist in FY25, at 5.7 percent, driven by a modest recovery in private consumption supported by a moderation in inflation. Investment recovery will need support from improved implementation of large public 7 investment projects. On the supply side, this will be reflected in higher industrial growth, even though services growth is expected to remain subdued. Growth is expected to increase gradually over the medium-term as monetary, exchange rate, financial and structural reforms are implemented.

Even though political uncertainty has diminished with a new cabinet taking oath after the national elections held in January 2024, downside risks to the outlook are significant. Inadequate progress in monetary and exchange rate reforms may result in a further decline in foreign exchange reserves and persistent inflationary pressure. Tighter liquidity conditions could exacerbate vulnerabilities in the banking sector. Fiscal risks include a revenue shortfall, potential financial sector fiscal liabilities, and deficit monetization.

Expediting structural reforms are needed to promote economic diversification and integration into Global Value Chains (GVCs) and strengthen resilience over the medium to long term. Critical reforms include developing the intellectual property rights (IPR) regime and strengthening the framework for foreign direct investment. An efficient resolution framework for NPLs is urgently needed. In this regard, conducting a comprehensive Asset Quality Review of the largest banks, establishing legal frameworks for the creation of an NPL market, strengthening corporate governance of the state-owned commercial banks and efficiently implementing regulations such as the Prompt Corrective Action framework for weak banks are crucial steps. Moving forward with forced bank mergers may be counterproductive without a thorough assessment of asset quality. A consolidation process will require careful assessment and prudent implementation of procedures to avoid weakening good banks acquiring bad banks, and an assessment of the asset quality of weak banks will be required.

The special focus section of this report discusses how domestic revenue mobilization can be strengthened to support Bangladesh’s development strategy. Bangladesh’s revenue as a share of GDP is currently 8.2 percent of GDP (FY23), among the lowest in the world and significantly below peers. Critical public investments in energy, transportation, municipal infrastructure, and human capital development are significantly constrained by the very low levels of government revenues. Reforms to increase domestic revenue generation will be critical for sustaining future economic growth. There is potential to collect three times more VAT if policy and compliance gaps can be reduced. The recently updated Income Tax Act (2023) is an opportunity to increase income tax collection by expanding the tax base through improved compliance and tax services. Administrative reforms could modernize manual and paper-based processes and enhance transparency. Policy reform will be required to transition from trade-based taxes to income and consumption taxes.

Bangladesh remains highly reliant on trade-related taxes, more so than peer countries. The country is preparing to graduate from LDC status in 2026. Through its National Tariff Policy (2023), it has committed to reducing the current high levels of protectionist tariffs and para-tariffs, which will promote international trade but can reduce trade-related taxes in the short term. This is an opportunity to move towards a tax structure consistent with an upper middle-income country, by reducing the current reliance on indirect taxes and expanding direct taxes. A tax structure aligned with that of competitors, coupled with an improved business climate, can gradually reduce the necessity of maintaining large tax expenditures to attract investment.