Slow Alignment Costs Investment

Slow policy alignment Only shelves investment.

Recently, the World Bank has downsized Bangladesh growth forecast. It also predicts that inflation in the next fiscal year will be hovering around 8.5%. Earlier IMF in its economic outlook said that it would take at least 2/3 years for Bangladesh to stabilize its economy.

Bangladesh Bank has already said that it has no intention to change its monetary policy before the next general election. This means easing of inflationary pressure may take some time.[However,on October 04,2023,Bangladesh Bank has raised the policy rate/repo rate by 75 basis points.*]

Meanwhile, soaring inflation dents in the pockets of lower income group and casts shadow over the investment projects outside the economic zones. If there were several raises in policy rates in one/two quarters( that I argued in a previous piece,see "Could Bangladesh Get The Second Credit Pack?" ), things might have improved one/two quarter later. Now, real interest rate is negative, meaning nominal interest rate is still below the inflation rate. Notion such as this misalignment will be addressed future—interest rate will rise further ---will hold back investors to go ahead with investment projects. Why?

Answer lies on how big investors make their decision. If you look at the discounting criteria then it is not a wise idea to implement a project when interest rate is likely to rise further. Because net present value of cash inflow decreases as interest rate increases. Moreover,cost of capital goes up further,raising the cost of doing business in the country. For FDI project or investors investing in economic zones,this may not be a big issue as they have access to cheap foreign credit/financing. But interest rate could become a factor when their local vendors try to purchase things from local market. Not only the interest rate, the rigid exchange rate may also increase their cost of doing business.

While inflation may continue to dominate interest rate, interest rate may vary in future. In such case, internal rate of return (IRR) based decision becomes untenable as interest rate varies in short period.

Tribal nature of our politics plays a conducive role in mingling business with politics. In such case, investment projects associated with ruling regime with payback period longer than 5 years will go abroad. Investment with higher cash inflows and payback period less than 5 years may see the light. Now guess what businesses will offer you high cash inflows in the face of overwhelming odds! Meanwhile, investment projects associated with opposition creed may go abroad as they may find it difficult to operate here.

Failure of MPS to contain inflation casts shadow over the economy. Interest rate policy chases the inflation at slow pace, sending wrong signal to investors. Political impasse and US Visa restrictions complicated the matter. Amid high inflation we need investment projects to create jobs and generate optimism in the economy. Yet the current policy shelves those projects at a later date or pushes them abroad.

[*Updates: this piece has been updated by me on October 06,2023 at 14:33 PM Bangladesh Standard Time. Updates include mention of Bangladesh Bank's increase of policy rate and link to the previous post.]

Decoding Our FDI

A debate has often been waged that we are not getting enough foreign investment. However, many statistics provided by various government agencies say Bangladesh has bagged lots of investments over the years. Many will put up opposition to such claim by citing figures of neighboring countries. Breakdown of those investments will offer a different picture than what we have in our minds.

In terms of reporting investment figures, there are differences. Many government organizations have predilection for  proposed investment projects to show them as investment figure. Meanwhile, others report inflows of foreign investment as real investment. It is obvious that what has been pledged at a certain point is not often matched by what has been implemented at a later date. This mismatch writs large on the following graph. In 2017, foreign investors pledged to invest $10756 millions. But the real foreign investment was $3038 million. (Source: BIDA and Bangladesh Bank) Obviously, bigger the number bigger the projection of success.

(Data Source: Bangladesh Bank and BIDA)

True debate may revolve around whether $3038 million is enough for a country like Bangladesh. Compared to our GDP, should we be contend to this amount of investment? Our investment-GDP ratio has been increasing since 2005-06. Back in 2005-06, it was  26.14% and it has increased to 32.04% at the end of 2015-16. What will attract more investment is a matter that we are less concerned. If we empathize an investor, we will see discounted cash flows of a project, marginal product of output against rental cost, inventory-to-sales ratio , inventory management etc are very dear to him. Some may argue that political stability is also important for  attracting investment. To what extent it is true that needs to be examined. For instance, many authoritarian countries bag huge amount of investment. In these countries, there is political stability and concerns crucial to an investor are also being addressed in these countries.

I did a little analysis on the victims of political instability and FDI. First I ran a Vector Autoregressive (VAR) model on victims of political violence and foreign investment that took place between 2002 and 2018. Then I ran a causality test between the two. Despite the ups and downs in the number of victims in the said period and a steady rise of FDI , statistical results show neither political stability causes more FDI, nor more FDI causes a stable political environment. There is no causal relationship between the two. Certainly, it does not mean that descamidos will dominate the street and strikes and siege will cripple the country. The bigger truth is political instability hurts the economy. Political stability helps to maintain homeostasis of a state that is conducive to bring more investment by sowing trust among the investors.

(Data Source: Bangladesh Bank and Odhikar)

Trust of an investors hinges on lots of factors.World Bank in its "Doing Business 2019" report ranked Bangladesh 176 among 190 countries. Though the country did well in getting electricity and registering property, it scored bad in starting a business, getting credit, protecting minority shareholders, dealing with construction permits and trading across borders. Perhaps better governance at home could secure Bangladesh an improved position by signalling positive things to a foreign investors.

Now what kind of investment we are getting and its sector wise composition call for a closer scrutiny. Bangladesh Bank survey for July-Dec 2018 says that both reinvested earnings and intra-company loans account for 64% of net FDI inflows in the given period. Equity capital accounts for the rest 36%. Bangladesh Bank defines reinvested earnings as amount of profit shelved for reinvestment , intra-company loans as borrowing and lending between parent companies and subsidiaries, and equity capital as ordinary shares,capital reserves, share money deposits and other reserves. At first glance it appears that all the reinvestment of profits and intra-company loans are good things. It sounds good when it means production capacity will be increased, expansion of operation, automation, backward linkage, forward linkage, introduction of new technology and managerial services etc. However, how transparently they are being done that has never been taken into account. Because the reinvested amount and the loans will go back to the investors later. And we may end up paying more if the calculation is overestimated. And another note of caution is like our public external debt , our private external debt is also increasing.

Sector wise composition reveals that in 2018 Power attracted more investment(28.01%) ,followed by Food(20.19%) and Textile and Wearing(11.29%). According to a monthly report by BIDA,  in 2012-13 the Service sector accounts for 92.76% of the proposed foreign investment. It is more or less clear that the  Power, Telecommunications and Services sectors led the way in terms of getting FDI. Apart from Textile and Wearing, these sectors are heavily capital intensive and employment generation in these sectors is infinitesimal. So $1012.01 million of  investment in Power sector may obviate the shortcomings of Power sector but did little to create employment opportunities in this sector.

To see FDI as a real game changer for our economy, we should focus on sectors that are labor-intensive and where there is more room for value addition. For instance, tourism and agroprocessing industry could be potential destinations for FDI. Unlike Power and Telecommunications sectors, the two do not require astronomical amount of investment. Every penny invested will fetch benefits worth couple of times more than the amount invested. It is high time that our policy makers seriously ponder  about where we truly need FDI.