LDC graduation: Progress brings its own challenges

Image credit: http://www.risingbd.com

by Shamsul Alam | May 30, 2019

The development progress of Bangladesh, measured in terms of income, poverty and human development, is truly impressive, especially after 2009. Between FY1974 and FY 2018, per capita income increased from $90 to $1,752, the incidence of moderate poverty declined from 72 per cent to 22 per cent, average life expectancy climbed from 46 years to 72 years, infant mortality rate fell from 130 per thousand to 32, and adult literacy rate increased from 26 per cent to 73 per cent. In 2015, Bangladesh crossed the threshold of the World Bank-defined lower middle-income country (LMIC). In 2018, it also crossed the threshold for graduation from the United Nations (UN)-defined list of least developed countries (LDC). The presumptive date for formal graduation out of LDC status is January 01, 2024, after going through the standard process of approval and announcement under the UN system.

This progress with development and its international recognition are welcome news.

But progress brings its own challenges as the country aspires to move further forward. The successful move towards LDC graduation implies that the special benefits enjoyed by Bangladesh in its international trade and financial relations with the global community as an LDC will also come to an end after graduation. Some of the LDC benefits have been very helpful for Bangladesh, especially the duty-free access to exports in the European markets. The readymade garments sector (RMG) has prospered in the European Union (EU) country markets with the support of this duty-free access under the ‘Everything But Arms (EBA)’ facility. The Bangladesh Pharmaceutical sector has benefited and flourished into a vibrant industry thanks to the flexibility for LDCs in the application of the World Trade Organisation (WTO) Agreement on Trade Related Intellectual Property Rights (TRIPS). These are the most important benefits. But there are others. Perhaps Bangladesh is the LDC that was able to leverage the International Support Measures (ISM) the most.

In recognition of the importance of the mentioned preferential export market access, the LDC graduation process allows a fair amount of time prior to formal graduation in 2024. The Bangladesh government is keen to utilise this transition period to develop a comprehensive strategy for LDC graduation with a view to ensuring that the graduation costs in terms of loss of benefits are well understood and appropriate strategies and policies are in place to allow a smooth transition from LDC status. As a first step, the government has asked the General Economics Division (GED) of the Planning Commission to conduct an in-depth analysis of the costs and consequences of LDC and suggest appropriate strategies and policies to offset these costs through compensatory domestic policies and reforms. This article aims to provide an analysis of the costs of LDC graduation, suggest strategies and policies to mitigate those costs and move forward along the path of development articulated in the Perspective Plan 2041 (PP2041).

LOSS OF LDC BENEFITS: The International Support Measures Portal for Least Developed Countries of the United Nations Committee for Development Policy lists the ISMs in three categories. These are-(I) General Support related International Support Measures; (II) Development Assistance related International Support Measures; and (III) Trade related International Support Measures.

* General Support- related International Support Measures (ISMs): One of the major components of General Support ISMs for LDCs is the financial support in the form of scholarships and travel grants for research related purposes, which are provided to citizens from this group of countries. The organisations offering such opportunities to citizens from LDCs range from specialised agencies like the United Nations Educational, Scientific and Cultural Organization (UNESCO) to international organisations like the Intergovernmental Panel on Climate Change (IPCC). In addition, academic institutions like the Berkeley Law School and the Leipzig Graduate School of Management also provide scholarships to deserving students.

The most important institutional support is the assistance provided to prepare a strategy for a smooth transition after graduation from LDC status. This smooth transition is of vital importance since a country which is no longer an LDC will stop enjoying trade related support measures like preferential market access.

Another support measure is the cap on the contribution of an LDC member country to the UN’s total budget at 0.01 per cent regardless of the country GNI. For example, in 2015, the amount was capped at $271,356. In 2018, eight LDCs used this measure to determine their contribution to the UN budget, including Bangladesh. At the same time, the countries have to make a minimum contribution of 0.001 per cent to the UN-in 2015, it was $27,136. The LDCs are entitled to a discount of 90 per cent on their contributions to peacekeeping operations.

* Development Assistance-related ISMs: Official Development Assistance, or the ODA is integral component of the special support measures to the LDC economies. Development Assistance Committee (DAC) of the Organisation for Economic Co-operation and Development (OECD) uses the term ODA to measure aid. Since LDCs face numerous structural challenges, their economies are vulnerable and exposed to natural as well as man-made shocks, ODAs provide some degree of secured assistance to these countries. There is a longstanding commitment by developed countries, reiterated in the 2030 Agenda for Sustainable Development, the Addis Ababa Action Agenda of the Third International Conference on Financing for Development and the Programme of Action for the Least Developed Countries for the Decade 2011-2020 (Istanbul Programme of Action), to provide the equivalent of 0.15 to 0.20 per cent of their gross national income (GNI) in the form of ODA to LDCs. This is in parallel to a commitment to provide the equivalent of 0.7 per cent of GNI in ODA to developing countries. Unfortunately, as of 2016, only six countries were able to fulfil their 0.7 per cent ODA/GNI ratio, and 0.15-0.20 per cent GNI/ODA ratio has not been achieved yet.

Another aspect of ODA is that, in 2001, the OECD countries decided to untie aid for LDCs. Apart from South Korea and a few Eastern European countries, 22 DAC members have been able to untie their LDC specific ODA between 90 per cent-100 per cent.

But there are questions regarding transparency of actual untied support measures. Several OECD member countries provide development assistance as grants or on concessional terms to LDCs.

In addition to bilateral assistance by the member countries, assistance is also provided to the LDCs through the UN’s specialised agencies like the United Nations Development Programme (UNDP), United Nations International Children’s Emergency Fund (UNICEF) and the World Food Programme (WFP). The UNDP and UNICEF target provide at least 60 per cent of their regular assistance to the LDCs while the WFP allocates 50 per cent of their funds for the same. At the same time, the World Bank provides loans on concessional terms like lower interest rates and longer grace periods through its International Development Association (IDA) to countries whose per-capita incomes fall below a certain threshold (defined by World Bank as low-income countries).

There are also a number of specialised funds and programmes that seek to support specific aspects of LDC needs or vulnerabilities.

These include: The Least Developed Countries Fund (LDCF) under the United Nations Framework for Climate Challenge (UNFCC) to help fight climate change; the Global Climate Change Alliance (GCCA) of the EU that also supports LDC effort to fight climate change; and the United Nations Capital Development Fund (UNCDF) that seeks to promote small enterprises in LDCs.

* Trade-related ISMs: Most of the International Support Measures for the LDCs are trade related. The trade related ISMs for LDCs are mainly based on three categories: (i) preferential access to markets; (ii) special treatment regarding the World Trade Organisation (WTO) obligations; and (iii) building of trade-related capacities. So far, 16 countries and the European Union have granted LDCs preferential access to their markets: (i) Turkey; (ii) Switzerland; (iii) Japan; (iv) Iceland; (v) Morocco; (vi) China; (vii) Chile; (viii) the European Union; (ix) New Zealand; (x) Norway; (xi) Thailand; (xii) India; (xiii) the Eurasian Customs Union (consisting of Russia, Kazakhstan and Belarus); (xiv) Australia; (xv) Canada; (xvi) the United States; and (xvii) the Republic of Korea. This preferential access is given under two schemes: The Generalised System of Preferences (GSP) – under which the countries benefitting from it are not bound to reciprocate; and (ii) the Global System of Trade Preferences (GSTP) – under which the countries benefitting are supposed to reciprocate. In addition, regional trade agreements like the South Asian Free Trade Area (SAFTA) and the Asia Pacific Trade Agreement (APTA) also provide concessions on access to markets for the LDCs.

In the European Union (EU) countries, Bangladesh enjoys a comprehensive duty-free and quota-free (DFQF) market access for its merchandise exports. This preference is provided to any LDCs under the EU’s “Everything But Arms” (EBA) scheme, which is the most generous among the three different GSP schemes provided by the EU for different groups of developing countries. Bangladesh is the largest beneficiary of the scheme. In 2017-18, it accounted for 64.1 per cent of all EU imports under EBA, and 9.5 per cent of the EU’s total import under preferential treatment. Bangladesh enjoys on average a 9-12 per cent preference margin under the EBA for its exports of apparels to EU. The current EBA scheme is likely to continue for three years after LDC graduation, till 2027.

Apart from the EU, the list of countries providing preferential market access to Bangladesh exports includes Australia, Belarus, Canada (98.6 per cent; except: dairy, eggs and poultry), Liechtenstein, Japan (97.9 per cent; except: rice, sugar, fishery products, articles of leather), New Zealand, Norway, Russian Federation (38.1 per cent), Switzerland, and Turkey (79.7 per cent; except: meat, fish, food, steel etc.). In addition, there are some special and partial DFQF facilities provided by a handful of developing countries including China (61.5 per cent), Chile (99.5 per cent), Korea Republic (90.4 per cent) and Chinese Taipei (31 per cent). It is important to note that Bangladesh does not enjoy any type of GSP facilities in the largest developed economy market of the world, the USA. Bangladesh used to receive some limited US GSP facilities, which remains suspended since 2013, but never had any preferential access for its apparel exports to the U.S. market.

ESTIMATED LOSS FROM LDC GRADUATION: While the access to scholarships and concessional subscription to UN membership has been useful, the financial impact of loss of access to General Support ISMs is not significant. The loss of access to subsidised ODA and grants is important but not a huge source of concern in financial terms presently. At the early stages of development up to the 1990s, like other LDCs, Bangladesh benefitted a lot from concessional ODA. But as development proceeded over 2000-2019, the reliance on ODA as well as the concessional component fell significantly. Post-LDC graduation, this trend will continue especially the stock of concessional aid disbursement will shrink and eventually disappear. Bangladesh will have to increase its reliance on market-based commercial borrowing. So, the average interest cost of foreign borrowing will increase. Simulation exercise done in the report shows this would cause an increase in debt-servicing payment, but debt sustainability will not be threatened if a prudent approach to foreign borrowing is preserved as envisaged under the PP2041 macroeconomic framework.

There will also be some losses of grants post-LDC graduation. These are estimated at around $700 million, of which $400 million goes to the government and an estimated $300 million to non-governmental organisations (NGOs). These grants are not growing much and the losses are very small relative to export earnings during the graduation period (FY24-27).

Similarly, the loss of access to special climate funds for LDCs must not be a worrisome factor. The benefits are small in financial terms. Moreover, Bangladesh will continue to have access to the Green Climate Fund (GCF) which is presently grossly underutilised.

Not surprisingly, the biggest source of loss comes from the withdrawal of trade-related ISMs. The preferential access to markets at zero or very low tariffs has been a big boost for Bangladesh exports. In FY 2017, about 75 per cent of Bangladesh’s total export earnings came from countries that provided some degree of preferential access. Of these, the EU market accounted for 72 per cent. Therefore, the loss of EBA facility will be an important loss. These losses in RMG exports could range from $1.0 billion (low price elasticity) to $4 billion (high price elasticity) in terms of the FY2018 export base. In percentage terms, they amount to a low of 2.8 per cent of total exports in FY2018 to a high of 11.1 per cent. The most likely loss will be about $1.8 billion (price elasticity of 1), which is 5 per cent of export earnings in FY2018. The absolute dollar values will be larger depending upon the timing of LDC graduation. For example, using the PP2041 macroeconomic framework and unitary price elasticity assumptions, the projected loss of RMG exports could be $7.0 billion in FY2027. These are not overwhelming losses compared to the export base but neither are they very small. Also, the losses will be higher if import price elasticity of demand for RMG is higher. So, unless these losses are over-turned with coping policy measures, the cumulative losses over the years could be large. Additionally, there are other adverse implications of LDC graduation related to the end of special treatment under WTO provisions that are not easily quantifiable but can create important challenges.

If the export losses are not countered with timely measures, the estimated socioeconomic impact can be substantial. Simulation results show that the direct and multiplier effects of the export shock can cause an average GDP loss of 1 per cent per year. This will have adverse effects on employment and poverty reduction. Importantly, Bangladesh will go off-track on the PP2041 development path. It will not be able to reach Upper Middle Income Country (UMIC) target by FY2030 and High Income Country (HIC) target by FY2041. The goals of eliminating extreme poverty by FY2030 and reducing moderate poverty to 5 per cent or less by FY2041 will not be possible. Hence, acceleration of policy reforms to counter the potential export losses from LDC graduation is essential.

THE WAY FORWARD: Graduation from LDC is a major milestone and Bangladesh should be justifiably proud of the achievement. The march towards the development goals of PP2041 must continue. The loss of LDC benefits will create important challenges in terms of potential loss of exports and the end of special treatment under WTO that could affect export subsidies, agriculture sector, pharmaceuticals and the services sector. These shocks to the external sector will need to be managed starting from now in order to be well prepared for a smooth transition to post LDC Bangladesh. The PP2041 development strategy and the associated macroeconomic framework and the Delta Plan 2100 are both well-thought out and balanced development strategies. Their solid implementation can help overcome the challenges posed by LDC graduation.

The specific reforms that need to be accelerated to avoid the export shock from LDC graduation include the following:

* Strengthen the implementation of a prudent macroeconomic framework: Bangladesh has generally followed a prudent macroeconomic framework that has served the country well in terms of low inflation, low interest rates, stable balance of payments and exchange rate and comfortable public debt situation. The macro-economy has come under stress recently owing to weak public resource mobilisation, over-valuation of the real exchange rate, and growing non-performing loans (NPLs) of the banking sector. These imbalances must be addressed and removed quickly to put the macro-economy on track as envisaged under the 7th Plan and PP2041. Addressing the public resource mobilisation challenge to sharply increase the tax to GDP ratio from the present 8.7 per cent to at least 10 per cent by FY21 and undertaking banking reforms to lower NPLs in a sustainable manner by addressing the root causes are the two top most macroeconomic priorities for the immediate future. Once the immediate macroeconomic imbalances are reduced, the macroeconomic management must be aligned to the PP2041 macroeconomic framework in order to support the acceleration of the GDP growth rate to 8-9 per cent. Fiscal reforms, especially the tax reforms, will be the most critical challenge.

* Reform trade and exchange rate policies: The best way to counter the export losses from LDC graduation is to increase the rate of growth of exports by diversifying the export base. Diversification of the exports base requires a host of measures, but the two most important reforms are: reducing trade protection and avoiding the over-valuation of the real exchange rate. Exports growth has slowed down considerably in the past 5 years as compared to the growth between FY2000-FY2014. Export concentration on RMG products has also increased. The lack of export diversification has contributed to the slowdown of export growth.

Research shows that export diversification has not happened mainly because the trade regime is biased against exports. Large trade protection through tariffs and para tariffs has provided strong incentives to production for domestic market where rates of return are much higher than exports owing to protection. Additionally, the over-valuation of the real exchange rate since 2008 has hurt exports. The RMG sector has been sheltered through a range of support measures like duty-free imports of inputs through bonded warehouse, export subsidies and income tax break that is not generally available to all exports. A sharp reduction in trade protection along with a supportive real exchange rate will be very important to help export diversification. Moreover, trade protection and export subsidy issues will need to be addressed comprehensively in any case to comply with the WTO rules once the special treatment provisions are eliminated in a post LDC graduation world.

* Address behind-the-border issues: The private sector is the engine of growth for Bangladesh. It has come a long way since the 1990s based on a series of trade and investment deregulation measures. The private investment rate surged from less than 10 per cent of GDP in FY1990 to 22 per cent in FY2010. Since then, however, the private investment rate has stagnated at around 22-23 per cent of GDP. Productivity improvement of private investment has helped boost growth in the interim period along with better capacity utilisation. But export growth of 12 per cent based on diversification and GDP growth in the 9 per cent range as envisaged in PP2041 will not be possible without an increase in the private investment rate to the 27-32 per cent of GDP range over the next 10-12 years. Despite solid progress with development Bangladesh, has not attracted adequate foreign direct investment (FDI).Overall FDI in Bangladesh reached a mere $2.2 billion in 2017, as compared with $134 billion in China, $40 billion in India and $14 billion in Vietnam. Moreover, most FDI investments are outside manufacturing.

A range of behind the border issues will need to be addressed to spur the growth of FDI and domestic private investment. These include: strengthening electricity and transport infrastructure; improving trade logistics focused on enhancing the efficiency and timeliness of port clearances; improving the investment climate by reducing the cost of doing business related to licensing and clearances, access to serviced land, property registration, ease of foreign currency transactions, ease of tax payments, ease of contract enforcements, and bankruptcy laws; improving technology transfer, skills and market access through partnership and joint ventures with FDI; investment in research and development to support innovation and adoption of new production technologies; strengthening labour productivity through investments in human capital; fostering trade facilitation and competitiveness with customs modernisation; and strengthening institutions for trade and industry. Reforms in these areas will also strengthen export competitiveness that is essential to penetrate markets in the post-LDC world.

* Adapt to the world of the Fourth Industrial Revolution (4IR): As Bangladesh is set to graduate out of the LDC status, a global scale fourth industrial revolution powered by cutting-edge technology is also on the horizon. As 21st century world prepares for a new age economic transformation, mechanisation or automation has arrived as a credible problem for job creation that requires preparation. In order to remain competitive in the global market, Bangladesh will also need to adapt to the new production technologies in all spheres of production, especially in manufacturing and modern services. Bangladesh economy is already showing signs of first stage automation. Modernisation of the RMG industry over past several years has increased the capital intensity of production and raised productivity but it has slowed down employment growth.

Despite this employment challenge, automation is inevitable, and there should be no policy hesitancy about promoting competitiveness by supporting technological up-gradation, particularly for export sectors. In some cases, technological advancement can lead to improvements in product quality with prospects for export expansion. Non-export and import-competing sectors also need to embrace more capital-intensive production techniques. Investment in machinery and equipment, as measured by import data, per unit of labour is much lower in Bangladesh, compared to Cambodia, Viet Nam or China. To balance this automation and capital intensity of production trend with job creation, the best response is to promote export growth and diversification that will create more jobs through the scale effects.

Additionally, backward linkages to export-led manufacturing will help create jobs in modern services. This will have to be supported by strong effort to raise labour force education and skills.

Automation will eliminate many jobs now done manually with low skills, but it will also create new jobs that are technical in nature and are skill intensive.

* Trade agreements with regional communities: Bangladesh has been a beneficiary of the multilateral trading system under the auspices of the WTO. While using the special dispensation of LDCs for the remaining few years, it must not lose sight of a long-term strategy of deepening its competitiveness as it prepares to graduate out of its LDC status. At the same time, it should also prepare to follow the new global trend and continue seeking market access under the various bilateral and regional trade and investment arrangements. What is notable is that it might be easier to sign on to South-South regional arrangements, but the greatest gains will come from North-South regional communities. In future, apart from emerging market economies, Bangladesh should be looking forward and preparing to reach trading arrangements with CPTPP, and RCEP (ASEAN+), where the bulk of the country’s future export markets lie. However, to access those communities through potential FTAs will require fulfilment of stringent tariff and non-tariff standards. Unless rationalized, the Bangladesh tariff regime will become the first significant hindrance to such FTAs.

The Government of Bangladesh has received proposals for potential bilateral trade arrangements from several countries including China, Malaysia and Thailand in recent years. Some analysts suggest that under current unorthodox protectionist approaches by US and some European governments to trade negotiations, Bangladesh would be an attractive country for a potential bilateral deal. Post-LDC Bangladesh may have to negotiate a trading arrangement with the EU along with the possibility of an FTA with the post-Brexit United Kingdom. But as it stands today, Bangladesh neither has the adequate capacities or experiences for strong trade negotiations and signing comprehensive FTAs. Urgent attention should be given to enhancing trade policy capacity including negotiating FTAs.

* Preparing the transition strategy for post-LDC full WTO compliance: There are a range of restrictive WTO rules and agreements that have been temporarily waived for LDCs as a special concession. These include: Agreement of Subsidies and Countervailing Measures (SCMs); Agreement on Agriculture (AoA); General Agreement on Trade in Services (GATS); Agreement on Trade Related Investment Measures (TRIMS); and Trade Related Intellectual Property Rights (TRIPS) phase out. Compliance with these agreements will all be obligatory on Bangladesh after the LDC graduation. In particular, compliance with SCMs, AoA, and the TRIPS phase out can be challenging for Bangladesh. Hence, clear understanding of the implications of these agreements and how they might affect Bangladesh is necessary. Early preparation can help phase in compliance with these agreements over a period of time along with implementation of required policy reforms to counter any negative impact on Bangladesh. Of particular importance is to focus on how to deal with export subsidies as an instrument for export promotion in the post LDC graduation world, and on the readiness for the TRIPS phase-out in order to continue to support the growth of the pharmaceutical industry.

[The first of the two-part series, titled LDC graduation: Progress brings its own challenges, was published on Thursday, May 30, 2019]

Dr. Shamsul Alam is Member (Senior Secretary), General Economics Division, Bangladesh Planning Commission. This is adapted from the study GED has undertaken titled ‘Impact Assessment and Coping up Strategies of Graduation from LDC Status for Bangladesh’. The study is under the process of finalization.

The article appeared in the Financial Express on 1 June 2019