What has happened to investment?

For Bangladesh to achieve rapid economic growth the level of investment must be greatly increased. At present, investment is about 24% of GDP; in contrast with China where investment is 45% of GDP. Of the investment in Bangladesh about one fourth is made by the Government and the rest by the private sector. Perhaps 5% of private investment is financed by foreign investors; some 50% of government investment is financed by foreign funds. What are these private sector investments? Most of such investment is in residential housing, followed by commercial real estate development such as office buildings, hotels, restaurants, etc. Finally, there are the factories both plant and equipment that produce the goods that the society exports or consumes; water pumps that irrigate the fields, cultivators that power the plows, trucks and buses, computers used in business, etc.
Good data on investment is hard to come by. The best data available arises from information on imports of goods that are used for investment. The first Figure presents data on monthly imports of capital machinery over the past three years through July 2009. This graph gives the value in US dollars of the monthly imports of such capital machinery. Without making things complicated we see immediately that over the past three years this part of investment has declined. It is even worse; dollar prices of many capital goods have risen in the past three years so that in terms of actual machines the trend is even more downward. It is still worse. Most of the machines imported come from countries whose currency has revalued against the dollar and hence the dollar value overstates the number of machines. The underlying price increases in the country of origin of the machine and the appreciation of the currency of the country supplying the machinery both increase the price of machines in dollars. Examining this graph one sees that investment was fairly strong during the last months of the BNP Government and the first few months of the caretaker government. [These were imports of machines ordered before the caretaker government took power.] For about one year the imports of capital goods were lower, then rose in the middle of 2008 only to be followed by a decline to very low levels since about September 2008. There is no sign yet of any improvement of these machinery imports. The decline has been quite dramatic---from an average monthly import of $130 million to $100 million; taking account of the price changes and the currency appreciations the decline in imports of capital machinery is of the order of 30%. Investment in machinery for factories has been declining at almost 10% per annum! This is a really serious finding and indicates deep problems within the economy. The machinery applies to both Government and private investment, but it is largely private. The factories that are needed to generate jobs in manufacturing are not being built. The second Figure covers the imports of machinery of various sorts that is not directly used in factories. This includes automobiles, computers, trucks, electronic equipment, buses etc. A large part of this is consumption expenditures by individuals. For example electronic equipment, telephone, refrigerators, computers and automobiles are largely for households. But still a substantial share of this category is equipment that is used for production of goods and services-computers used by banks, buses used for transporting people, etc. Much of this category is purchased by the Government. What does Figure 2 tell us? Imports have increased steadily over the past three years, from a level of about $100 million per month to about $140 million. Taking account of price changes and exchange rates, in real terms there is about a 25% increase over these three years. A great deal of this is coming for households for telephone, computers, and automobiles. The increase in telephones is very substantial with the growth of mobile services; the increase in automobiles and computers has been supported by the consumer lending increases by commercial banks. We conclude that in this category of machinery the part used for investment has shown some increase over the past three years, perhaps of the order of 5% per annum, not even keeping up with the growth of GDP. The goods in this category used for consumption have increased more rapidly than GDP. Motor vehicles is the most dramatic. Most of these investment are not in manufacturing, but support the service sector (e.g. banking or transport).
The third Figure deals with the intermediate goods most of which go into the construction business or are used to make other capital goods. These intermediate good imports were stable at about $125 million per month from July 2006 until March 2008; then these increased sharply largely due to dollar price increases, stabilising at about $190 million per month and then declining steadily to July 2009. The price fluctuations are a good part of these changes. In real terms there is little sign of any growth of imports of these materials. The implication is that much of the construction sector has been stagnant in real terms over these three years. The picture is very clear; during the caretaker government investment in the economy stagnated and probably declined. Through July 2009 the data shows no signs of investment recovering. The import data is the basis for the estimates of investment and provides the only really accurate information available. Let us turn to what has caused this stagnation over the past three years.
Frightening the private sector
The first point is that the take over of the country by the caretaker government and the anti-corruption programme that then started sharply reduced private investment. This was clear to all observers, although lots of words were expended arguing that the investment situation was improving, etc. The donors seemed to want to believe that investment was doing all right. The caretaker established a Better Business Forum trying to increase confidence. But all of this hype was incorrect; investment had been strong under the BNP government but after March 2007 began to decline and has not yet recovered. What happened?
Many leading businessmen were put in jail or fled the country. The community felt that there were no rules. The actions of the anti-corruption teams were arbitrary and increasingly unprincipled and themselves became corrupt! Eventually it was realised that this was having a terrible impact on the private sector. The consequences of disruption of private sector are still with us. Much of the business community is closer to the BNP that the AL and are uncertain about the future. Another part of the business community identified with the caretaker government and also uncertain about the future. The confidence in the economy is slowly rebuilding but there is some way to go. However, one has to look further to understand the decline and stagnation of private investment. It is more than a hesitant private sector. There are five factors that are adversely affecting the decisions to invest leading the business community to repeatedly conclude - it is better to "wait and see" rather than, "invest now".
1. Markets: Investors want to find large markets to sell their products. The world economy is not helping: For the export markets there is not much that anyone can do. Part of the slow down in investment is the market condition in the garment and textile sectors, where demand growth is modest. For domestic markets all depends on the rate of economic growth! Economic growth has slowed down since 2007; when growth accelerates the domestic markets will emerge that the investors need. Investors will follow not lead market expansion.
2. Finance: Finance is a complicated factor in investment. First, in 2009 real interest rates have been very high. [The real rate of interest is the nominal rate less the inflation rate] With inflation dropping to 1 or 2% per annum, real interest rates are 11-12% up from 6-7% two year ago. Naturally investors face much greater problems at such high interest rates. Indeed most manufacturing enterprise cannot be successful at such high rates of interest on loans. These are the highest real rates of interest the economy has experienced. The sharp drop in inflation was not recognised by the authorities and the magnitude of the high real interest not perceived. The high real rates over the past year have certainly discouraged investment. The second financial factor is availability; will banks make the loans to business? The short answer is "yes" for many banks! There are a lot of funds available for lending. In late 2009 the banks have large loanable funds available. It is the business community that is not interested. The central bank finds itself in the unhappy position where (a) The inflation is very low, there is a lot of bank liquidity but nominal interest rates are not declining; (b) It is unable or unwilling to force down the nominal rates. High real interest rates will always inhibit private investment; so long as these high real rates continue investment will be limited.
3. Energy: The problems in the electricity and gas sector are well known. Investors are faced with greater uncertainty in the government's power supply and to accept the high cost of standby power. Improving the supply of power and gas for industry will take several years and during that time establishing new factories will not be very attractive. Investment in the energy sector itself is held up by an inability of government to rapidly push through a programme. The unwillingness to confer with prospective investors and understand their viewpoint leads to starting procurements that then must be reversed, delaying decisions. Over the years arrogance and incompetence of the energy authorities had led the nation to the present breakdown of energy infrastructure and a failure to meet the needs of the economy. A more collaborative approach is badly needed. The recent back and forth on the terms and conditions of eligibility for the rental power units illustrates the decisions. Error after error has been made in this sector and continues to be made. Although the energy supply situation will improve slowly, the cost of the energy will be much higher. For the next three years availability will limit interest in investment.
4. Governance: The linkage between governance and investment is immensely complicated. Everyone has a view. The problem here is easy to formulate but difficult to solve: It is to balance between the "pure" views of the donors, IFIs, Transparency International, on one hand; and the uncontrolled, corrupt, crony capitalism on the other! The one thing that always comes through when one studies this issue is that procedures should be simple; policy should stay the same for long periods of time; fees, side payments etc. should be modest and easy to manage; and clear dispute resolution mechanisms must be available. In 2009 the courts are not up to the task of supporting a modern economy.
5. Uncertainty: The prospective investor faces all sorts of uncertainties. The government frequently changes its rules, introducing new ideas and considerations that were not previously on the table. The introduction of a new scheme of Special Economic Zones is one of the more spectacular examples of this. With a successful working programme of Export Processing Zones, ignoring what had been accomplished and the investment made in learning to develop and manage the EPZs, someone wanted to start Special Economic Zones for which there is neither experience, nor demonstrated need! Should I invest in an EPZ or would I wait for the SEZ to come along sometime in the distant future? Another example: there have been land allocations to investors construction starts and then allocations were withdrawn by government, leaving a lasting sense of uncertainty. A final example of uncertainly deals with reversal of rules with respect to sugar; investments made on one set of rules were threatened when the rules were changed. The business community wants calm, predictability, and simplicity.



Source: Forrest Cookson, The Independent.