With the highest ever Foreign Exchange Reserve (FER) of 43 billion USD (end 2020), Bangladesh faces a dilemma – should it continue accumulating the reserve or invest the surplus reserve on large-scale public sector projects?
The government seems to be staking in favour of development projects. A write-up in the Daily Star reported that “The Bangladesh government has decided to use the country’s ballooning foreign exchange reserves to implement development projects” (Byron and Uddin, The Daily Star, 12 October 2020). If this is true, it is a momentous but risky decision for Bangladesh.
The FER in developing countries are mostly used for self-insurance: to acquire the ability to pay for imports, service external loans, maintain a stable currency exchange rate, and competitively priced exports. A good reserve spares a country from kowtowing to donors and preserve its dignity.
But maintaining a reserve beyond what is necessary for self-insurance also involves a cost; the cost is the spread between current earnings (which is zero or near zero) and potential return. Safety considerations may dictate maintaining a high reserve for rainy days; on the other hand, investments in high yield projects could generate a handsome dividend.
There is therefore a temptation to use the surplus reserves for large scale investments, and get a handsome return.
Such investments would be welcome if they can be invested in high yield sectors, and the reserves could be made to increase at its historic rate to provide self-insurance for the country. If these two requirements are not met, the country can be in financial peril in the longer run. Examples abound in the world on large publicly financed investments not delivering the right returns at the right time.
At this time of covid-19 related uncertainties, the risk arising from the volatility of the global economic situation can be quite large. Today, most countries in the world, impacted by covid-19, have slumped. Small and big businesses, especially those related to tourism, travel, and those requiring close human contacts have suffered. And so far, recovery has been erratic. Even with the roll out of vaccines, the recovery remains uncertain.
The prospects of investment in these circumstances vary widely across countries. The opportunities for successes and the risks for failures, both can be high depending on how well businesses click with evolving economic opportunities, public health and financial support scenarios. Well placed, they can succeed (like Amazon, communication like Zoom, and not the least the medical equipment suppliers and covid-19 vaccine producers); if not, they can limp on and even fail (like tourism, airline industry and other forms of public transport). Huge public investments can fail to deliver, not only because of bad choice of projects but also due to adverse local and global economic circumstances, bad management and the risk of time and cost overruns.
China’s trillion dollar ‘One Belt One Road’ project financed out of its huge reserve is a long-term initiative to project China’s global reach and its economic and political intentions. It is a high-stake investment which is expected to over a number of years. The country has enough economic prowess, well recognized management capacity and political influence to pull it up. Even if it does not fire initially, the Chinese juggernaut support structure and financial capacity can pull it up.
Similarly, examples of sovereign funds of many petroleum rich countries and rich developed countries can succeed as they have large resource base to back them up, tide over bad patches and come out successful at the end. Such examples of investments using sovereign fund are not of much relevance to Bangladesh given the country’s smallish surplus reserve and limited capacity to take up large projects on its own.
The debate in India on the choice between self-insurance and public investment in large infrastructure projects could be more pertinent to Bangladesh. India today boasts of having a very high FER of about 585 billion USD, but compared proportionately with Bangladesh, the difference is not enormously high. What makes it more comparable to Bangladesh is its socioeconomic environment and the governance structure, in which these two countries are not too far apart.
India too called for investing the surplus FER for infrastructure projects and public sector investments for industrial development. But it attracted flaks from financial analysts, independent reviewers and economists. The government’s policy to invest in large scale publicly financed projects was criticised on the grounds that such investments could very well crowd out private investments, that investment in the industrial sector could be boosted by cutting tariffs instead of creating facilities for the potential investors to borrow funds. Moreover, it was argued that big public sector investments could create monopolies, which is considered to be an unwelcome outcome where anti-monopoly and anti-trust legislations are not well developed. A better policy would be to support the domestic economy through market stabilization scheme rather than investing in infrastructure projects.
While the above provide some indications of what could possibly be the direction and modality of utilizing surplus reserve in a situation similar to that of Bangladesh, the answer to the dilemma facing Bangladesh has to be sought and resolved in the specific Bangladesh context.
Apart from the issues raised in the context of India, for Bangladesh, one has to consider the constraints on project implementation due to the evolving covid-19 situation, the usual drama of not so infrequent changes in project designs and management inefficiencies leading to time and cost overruns, and therefore delays in profiting from the returns on investments. The government currently has its hands full with (more than a dozen) large scale development projects, financed by foreign loans as well as by the country’s own resources. These mega projects are at various stages of completion, and some are suffering from significant time and cost overruns. The projected returns are expected to be delayed, and therefore low at current prices. Even though Bangladesh is projected to do well in terms of recovery from covid-19 slump, thanks to the pick-up of the vibrant garment sector and minor damage, if any, to the agricultural sector, the longer term prospects of recovery and growth would depend on how quickly the covid-19 pandemic is tamed.
And it will also depend crucially on how quickly the remittance income of the country, the main driver behind the growth of FER, picks up. It is hard to make a projection; much of the pickup will depend on the growth of the host economies of Bangladeshi migrant workers. It will also depend on whether the economies which traditionally absorbed Bangladeshi workers will continue their dependence on unskilled and semi-skilled workers or move towards automation, use of robot technology, and highly skilled workers.
The flow of remittances can probably increase over the short term, but in the longer term, it may as well decline.
The country’s FER therefore may even go up the in the near future, but whether it will return to the current high level is questionable. In this scenario, it would be wise for the country to focus on completing more than a dozen on-going large scale infrastructure projects (financed through local funding and donor assistance). It would be wise to take a step back from taking on more large scale investment projects, assess the situation, local and global, and not throw precaution out of the window in a hurry to minimize the opportunity cost of surplus FER.
This does not mean that the purpose of holding on to the reserve fund is to keep the surplus fund idle. Given the time and cost overruns of the on-going projects, much of the surplus fund may be needed for successful completion of the on-going projects. Besides, the government could focus, in the short and medium term, on supporting (through subsidized loans) the small and medium industries in the private sector to strengthen the industrial base of the country, finance advanced research and capitalization of agriculture, develop the IT sector, and improve manpower skills so that expatriate workers can move up the ladder of income scale when they get employed abroad.
As the global economy recovers and the country begins to build up its reserve fund, it would be time for the country to be ambitious again. Until then, the government has to be cautious with people centric approach for consolidating growth. The country is doing fine, and the mega projects awaiting completion will keep the country engaged for some time. Hurried approach and high ambition with more large scale projects can overheat the economy and jeopardies the stable and good progress the country made so far.
Dr Atiqur Rahman is an economist and ex-Lead Strategist of IFAD, Rome.