‘Second generation’ economic reforms: Should the wait be too long?

Khondaker Golam Moazzem

Published in The Financial Express on November 23, 2017

Photo: The Financial Express

Over the last few years, Bangladesh economy has been experiencing a number of interesting changes which would have far-reaching impact on country’s long term economic growth. First, private sector investment is increasingly being concentrated to large scale enterprises and more specifically to limited number of large group of companies. Second, few large business groups are taking control of a number of local commercial banks where processes are not so transparent and regulators are silent. Third, despite the huge amount of debt-default by a quarter of ‘habitual defaulters’ especially from state owned commercial banks and partly from private commercial banks, no visible progress in repayment of those debt has been made which rather encouraging others to do the same. Fourth, local consumer markets both for essential goods and services have experienced emergence of ‘dominant’ market players who appear to violate the competition rules and thereby deprives the consumers and producers. Fifth, cost of doing business in the country is heavily burdened by almost no progress with regard to corruption in public offices which adversely affect the private sector particularly small and medium scale enterprises. Sixth, entry barriers for new businesses are becoming high due to bureaucratic and administrative hassles in the process of taking licenses, registration, getting the clearances, securing utility connections etc. bottlenecks Seventh, lack of skilled workers and professionals has become increasingly a major business concern particularly for export-oriented businesses which is forcing firms to recruit foreign professionals in order to retain their competitive edge in the global market. Eighth, increasing administrative control at the centre and more specifically to a particular office has been dislocating the key role to be played by different offices, which may favour some but may deprive many others. Ninth, despite the poor performance of public sector enterprises, government’s continuous fiscal and financial support have not only depleted domestic resources but also dampened the competitive environment both at local and global markets. Overall, such examples portray an uncompetitive, inefficient and inequitable business environment in the country which would slow down return from private investment and would ultimately weaken the economy and may entrap the economy into lower-middle income status.

There are the symptoms of lack of proper reform with regard to rules and regulations, their enforcement and public institutions usually those are part of ‘second generation reform’. The emergent need of the ‘second generation reform’ usually felt in an economy when the payback period of the ‘first generation reform’ is getting over; perhaps Bangladesh economy has been passing the last phase of the first generation reform under which the economy got the benefit of liberalizing the major economic activities. Besides, the incremental benefit of ongoing initiatives for significant infrastructure development undertaken by the government would be rather low unless the concerns with regard to second generational reform are addressed. Given the diminishing returns of the ‘First Generation Reform’, it’s time to put focus on ‘Second Generation Reform’ which indicate ‘rules’ and ‘institutions’ .Unfortunately, government is ignoring the importance of undertaking necessary reforms.

Second generation economic reforms: Case of Bangladesh

The key objective of the second generation reform is to improve overall efficiency and productivity of the economy which will contribute to overall competitiveness, social conditions and macroeconomic stability of the country. The second generation reform focuses on institutionalization both through creation and rehabilitation, boosting competitiveness of the private sector, reforming health, education and other public services and build new economic integration. In the context of Bangladesh, major economic reforms should target financial sector, public sector, policy related to industry, trade and investment, education and health sector, technologies and labour market.

Financial sector reform

Banking sector is facing multifaceted challenges which include large amount of defaulted loan mainly from the SCBs, continuous injection of capital in debt-ridden SCBs, overexposure of bank borrowing by limited number of large scale borrowers, high lending rates particularly for SMEs, excessive number of banks competing for limited financial assets, strengthened family ownership in the Board of Directors of private commercial banks and for a longer period time by amending the law and gradual taken over of private commercial banks by few large group of companies and in a non-transparent manner. Besides, non-bank financial institutions particularly insurance companies are also in trouble – allegations of improper functioning of insurance companies particularly transfer of fund in non-productive activities, non-compliance with regard to meeting the demand of the policy holders etc. Besides, new types of financial services offered by mobile phone based financial services and off-shore e-financial services pose new challenge to the banks which have reduced the flow of remittance from abroad through banking channel. However, these newer forms of financial services need to be accommodated under necessary legal structure. The capital market, on the other hand, has yet to get ready to function as an alternate source of finance for the businesses. Despite repeated market crush (in 1996 and 2010) the regulators have yet to build their strength to make the market viable. Most local companies have limited interest to raise fund from the capital market; more importantly, small and medium scale entrepreneurs have limited scope to comply with the cumbersome requirement for enlistment in the capital market. Moreover, the market is yet to be checked from manipulation and interferences of vested quarters despite undertaking various steps and legal measures. The capital market has yet to build the confidence among the shareholders mainly due to problem of governance and lack of market depth.

In this backdrop, reform of the financial sector should be the top-most priority of the government, which is mentioned by Centre for Policy Dialogue (CPD) over the last several years. First, the role of the banking division as the authority of the SCBs should be fully handed over to the Central Bank which would include selection of Board of Directors, selection of MDs and other senior level positions, recruitment and influence in management and administrative decisions etc. The Ministry of Finance and the Central Bank should work together to make necessary amendment in the laws and rules in order to ensure that. Given the poor performance of the SCBs as well as availability of alternate sources (such as NGOs and other organizations) to provide the social services to different quarters of the society, there is very little justification of so many SCBs with large number of branches to be in operation but incurring constant losses. Gradual downsizing of the operation of SCBs by merging loss-making branches and finally merging a number of SCBs should be the long term agenda of the government. Second, the ‘ArthaRinAdalat 2003’ or ‘Money Loan Court Act 2003’ needs to be amended with a view to quick enforcement of the law to repay back the defaulted loan. The recent amendment of the Bank Company Act (May, 2017) which allows number of members in a family to be the directors of commercial bank at a stress of nine years, is a major setback towards ensuring corporate governance in the banking sector. Third, the presence of excessive number of commercial banks in a small economy like Bangladesh as well as weaknesses in loan disbursement by few banks, necessitates revisiting the logic of providing licenses to nine new banks two years bank. Given the situation, there needs to have merger/acquisition of a number of commercial banks in order to strengthen the banking sector of the country. Fourth, in case of the non-bank financial institutions the regulatory role of the Insurance Development and Regulatory Authority (IDRA) to be strengthened particularly in monitoring the activities of insurance companies. Securities and Exchange Commission (SEC), Dhaka Stock Exchange and Chittagong Stock Exchange have been better equipped to facilitate the businesses. As a regulator, the SEC needs to strengthen its monitoring and enforcement system in order to identify the malpractices as well as taking actions. SEC needs to make transparent of personal information of large number of BO account holders. Without proper monitoring of the transaction made through different BO accounts and their ‘actual’ holders, it is difficult to reduce the transaction related malpractices in the stock exchanges. SMEs should be encouraged to raise their capital through the capital market. Bangladesh should introduce the bond market for the public sector.

Public sector reform

With the growing demand of the economy, the role of the public sector has widened. Over the period, public sector has undertaken various measures in order to improve their efficiency, accountability and overall performance. Despite those measures, bureaucratic bottlenecks and inefficiency are considered to be one of the top most important bottlenecks for doing business in the country. According to the World Economic Forum (2017), major challenges include difficulty of the private sector in challenging government actions and regulations, difficulty in getting access to information of government policy changes that have direct relationship with their activities, favouritism of the government officials and politicians to favour well-connected firms and individuals when deciding upon policies, burdensome of the private sector to comply with administrative requirements, lack of functioning of the legislative process. There is problem of illegal diversion of public funds to companies, individuals or groups, bribes are not uncommon to export and import, as well as to public utilities and tax departments. The role of the private sector is also not out of question- corporate ethics of companies are poor. The concentration of authority and power by the bureaucrats at the centre has weakened the local government institutions which adversely affect the businesses to get the necessary approval and required facilities at the local level quickly. Besides, the competitive environment in few sectors have been adversely affected due to uncompetitive business practices by the public sector enterprises. The huge debt of public enterprises has already a burden for the government and has serious adverse impact in the discipline of the budget. Public sector is still behind in using latest available technologies although a number of positive development happened through the announcement of creating ‘Digital Bangladesh’. Although public procurement guidelines have been streamlined, e-procurement system has been introduced, the government offices are still shy off using latest IT based technologies. Despite having the political commitment of the government for creating a digital society by introducing IT based communication and other activities, the technology has yet to get prominence as business enhancing technology. Uses of ICTs by government rarely improve the quality of government services to citizen (59%; bad).Bangladesh is still at the nascent stage in case of creating IT-enabled business environment.

The public sector needs overhauling in terms of regulations, management and operations, transparency and accountability and productivity and efficiency. First, the Public Services Act which is at draft stage needs to highlight a number of above-mentioned issues. Second, devolution of power by delegating more authorities to local government institutions is essential to get better services by the businesses at the local level. Third, government should reconsider its policy towards operating state owned enterprises which have been increasing the debt burden because of incurring losses over the years. Squeezing the operation of these enterprises by handing over the facility to the private sector for setting up new and modern industries may be more socially desirable. Fourth, given the changing demand of the economy, the number of public sector organizations needs to be reduced; at the same time, a new set of organisations are required to cater the new demand. Fifth, public offices should be enabled into use of IT based services. Public investment should focus on developing IT-enabled infrastructures in the country. Quick implementation of some of the important ICT projects is urgently needed such as Kalikoir high tech-park, Bangabandhu high tech park, IT training and incubation centre and innovation and entrepreneurship development project.

Policy reform

Since Bangladesh has set its ambitions to be a competitive higher middle income economy within the next decade, current policy regime particularly related to industry, trade and investment would need major overhauling in order to meet that level of ambition. First, the country should increasingly put its focus on sectoral policies instead of generic form of industrial and trade policies. For example, policies need to be sought for key and potential industries such as RMG and textiles, light engineering, plastic and rubber, light engineering, ship building, machineries and electronics. Although FDI policy regime is mentioned as ‘open’, in reality it is only in paper. FDI Act should be made clear which sectors are open for investment and what level of investment is allowed. There is no scope to play ‘hide and seek’ in terms of providing access to FDI in different sectors. FDI related incentives and facilities should cover pre-establishment phase which include providing support for market research which include major market players, market size, and major suppliers of raw materials. The FDI Act needs to be revised accordingly. In this context, recently set-up BIDA is a positive development and BIDA’s ‘one stop service act’ is expected to make positive contribution in ensuring effective services.

Industry related policies are often criticized for ‘full of commitment’ only. Because of non-binding nature, most of the policies could not ensure required level of services to the private sector. Rather, most cases government decisions have been influenced by short term official decisions instead of long term ones. For example, national budget is the most important policy document of government. There is doubt about how the national budget consult government’s long term policies such as Industrial Policy, Export Policy, Import Policy Order and Policy Strategy for SME Development etc. Because of the short term nature of government’s policy decisions, often entrepreneurs fear about lack of continuity and predictability of government’s policies. Moreover, various fiscal and monetary measures taken through the national budget do not follow proper assessment mechanism. Afterwards a mid-term review of implemented policy would be necessary – whether the implemented measure actually contributed or not. There is allegation that formulation of national budget is not out of influence of different influential quarters. Such influence of different quarters may have adverse effect in creating equal policy environment for all sections of the economy.

Government’s role as a monitoring and enforcement of rules are being increasingly important. The rise of big group of companies in the private sector and their dominance in different sectors raise question about the ability to maintain competitive environment in the market. More specifically, there is an increasing tendency that such groups have tended to play the role of ‘dominant market player’ and tried to influence market supply and market price through different kinds of malpractices. In this context, the role of the Competition Commission is being strongly felt; the Commission needs to develop its instruments in order to trace the malpractices by the dominant players and will take actions accordingly. Otherwise, the small and medium scale enterprises would not be able to grow in different sectors. On the other hand, with the rise of businesses, it is important to make the business operation transparent and accountable to proper authority. The recently enacted Financial Reporting Act (FRA) needs to develop the infrastructure with a view to guide the business to ensure financial transparency.

Domestic resource mobilisation reform

Reform of the domestic resource mobilization is needed in order to generate adequate resources to meet the resource requirement. The recent reforms of VAT and Supplementary Duties Act 2012 and Income Tax Ordinance are two important milestone in this context. In case of VAT, the concerns raised by the business groups need to be taken into account which include introduction of multiple rates, highest rate and waiver. Besides, impact of the new VAT Act on consumers, needs to be assessed properly. Since Bangladesh is comprised of diverse categories of producers, retailers and consumers, the impact of new VAT act without addressing the impact and implications, would cause large adverse impact particularly on SMEs and low-income consumers. Similarly, income tax act needs to be amended in order to increase the coverage of income tax net as well as collection of tax. According to the estimates, only 15 per cent of the eligible Bangladeshis provide income tax. Thus, there is a huge untapped segment of eligible potential tax payers who needs to be included in the tax net. Besides, the tendency of tax avoidance need to identify which will increase collection of taxes. In this context, an integrated financial system needs to be implemented in order to track all kinds of financial transactions under personal and business accounts through different sources which include transactions through commercial banks, government bonds, stock exchanges, land offices, forex dealers and other important sources. Such an integrated system would help to improve financial reporting of individual and corporate bodies and significantly improve collection of taxes.

Education and health sectors reform

Country’s education system is by and large weak in terms of meeting the demand of the private sector. Despite achieving higher literacy rate with primary education, the share of people with secondary, higher secondary and tertiary levels are still very low. Hence, more resources should be allocated for attaining higher levels of secondary and above level students through low-cost public and private educational institutes. Taking the precedence of other developing economies (such as Philippines and Sri Lanka) vocational education should be promoted at the secondary level both in the general and technical education systems. Private business bodies should set up their own technical training centres as par their requirements. The collaborative arrangement between government and BGMEA and BKMEA to provide training newly entrant garment workers found to be successful. Professional degrees provided by large number of private universities are of poor quality. A major challenge is – most of the degree holders do not comply with the minimum required standard. Because of the skill gap, entrepreneurs tend to recruit professionals from abroad. A number of export-oriented industries recruit professionals like managers, industrial engineers, fashion designers, merchandisers from abroad. It is important to invite internationally reputed management schools to set up branches in Bangladesh and government should provide necessary support for that.

Public health care system is still poor and is not adequately available in industrial areas. Because of absence of low cost health insurance facility, poor workers have to bear the expensive medical treatment costs from local private clinics. Lack of awareness of health related matters as well as absence of workplace safety and security affect workers’ health. Raising awareness about health and other safety related issues among the workers are urgently needed.

Technological reform

Bangladesh is one of the least prepared considering the future technological reform. The fourth industrial revolution (4R) which will be driven by IT based technologies will make a major change in the working process, employment structure and use of artificial engineering etc. However, Bangladesh’s preparedness in terms of using ICT is backward although government’s political commitment towards transforming the country into a ‘digital Bangladesh’ is quite clear. ICT use in the government offices and dealing with private sector are quite rare. Private sector has yet to use ICT as business development tool. Workers are not ready in ICT based professional works. Government has yet to grasp the major employment challenge with regard to technological upgradation which perhaps weaken employment opportunity not only in high-tech jobs but also in manual jobs. Government need to take employment policy taking into account the future demand of the industry as well as addressing the future challenges.

Labour market reform

Informal nature of job contract is one of the major drawbacks of Bangladesh’s labour market. A major drive should be given towards ensuring formalization of jobs in all industries. Public offices particularly the Ministry of Labour and Employment (MoLE) and Ministry of Expatriate’ Welfare and Overseas Employment (MoEWOE) should take necessary steps to monitor the nature of job contract of Bangladeshi nationals both at home and abroad. On the other hand, labour market is relatively flexible in terms of hiring and firing of workers, setting workers’ wages and other benefits etc. Out of 137 manufacturing sub-sectors, only 42 sectors have mandatory minimum wage related rules. Hence, rest of the sectors need to be covered under the minimum wage rules. There is scope for amendment of rules related to minimum wages by including definition and measurement related issues in respective provisions. There should have standard operating procedure for registering trade unions and should create equal access of trade union rights in the Export processing zones (EPZs). The recent initiatives undertaken by the government is expected to meet the requirement of need of the workers. Moreover, proper enforcement of labour related rules is another important aspects which include ensuring sufficient compensation for workers’ injury at the workplace, provision of health insurance for workers, sharing the stipulated amount of profit for the welfare of the workers as par law etc.

Challenges for undertaking economic reforms

It is well understood that all the above-mentioned reforms have substantive positive impact on industrial growth and overall economic development in the next decades. However, government needs to priorities areas of reform based on their level of importance, difficulty in the process of implementation, impact of producers and consumers in short, medium and long term, level of resources required to implement the reform and availability of the required amount of resources etc. Reforms are always painful. Hence for the sake of great cause, government should accept the importance of those reforms and should take time bound measures. However, government needs to handle the political pressure and pressure from other influential quarters not to take reform measures. It is important to understand that reform initiatives have their uniqueness and there is no ‘one size fits all’ measure. Government along with other stakeholders needs to be innovative in finding out proper solutions which will be sustainable and ensure long term benefit for the country. Since reform is a major agenda for any political party, it should be vetted for the public. There is no scope to avoid implementing such long list of reform related issues. In this backdrop, Bangladesh’s political parties must include reform agenda in their election manifesto for the upcoming election. It is expected that the party who would be in power in 2019 will take the reform measures seriously in order to move the economy forward.