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    What an Indian Recession Could Mean for Bangladesh?

    LightCastle Analytics Wing

    Regional economic power in South Asia has primarily been concentrated in India. However, with Bangladesh’s meteoric rise to regional prominence–owing to its booming economy–the economic balance of power in the region is beginning to show the first signs of a paradigm shift. India was the strongest regional economy over the 40 years between 1970 and 2010, with an Annualized GDP growth rate of 8.7 percent in contrast to Bangladesh’s 7.6 percent and Pakistan’s 6.7 percent. However, in the three years since 2016, Bangladesh’s GDP–at current prices in dollar terms–grew at a Compounded Annual Rate (CAR) of 12.9 percent, which is more than twice that of India’s 5.6 percent.[4]

    With India’s economy beginning to slow down, analysts believe India is in the middle of a quasi-recession.[6] If current trends persist, Bangladesh could surpass India’s per capita income by the year 2020.[4]

    What’s Causing India’s Economic Slowdown?

    A recession is defined as three consecutive quarters of contraction in GDP. In India’s case, the GDP growth rate has fallen to the 5 percent region in the first quarter of FY20, the lowest in over six years–continuing a trend of dipping growth rates for five consecutive quarters.[5][6] This indicates that “Asia’s No.3 economy” is headed towards tougher times. The generally accepted consensus–as things stand now–points towards a complex set of factors driving the current economic slowdown. Chief amongst these are India’s policy failures.[9]

    Among the leading drivers behind the slowdown was the rising incidence of non-performing assets in India. In the first half of 2019, new banking credit plummeted by a mighty 88 percent, resulting in growth falling from 8 percent in 2018 to just 5 percent this year.[9] This suggests a virtual “freeze on lending”. Due to growing demographic pressure, India needs to maintain a growth rate of 7.5 percent to keep the level of unemployment constant. Under the influence of methodologically unsound forecasts and cronyism, the state banks under the previous government (2009-2014) let non-performing loans inflate to a $200 billion bubble.[9] This period was plagued by numerous scandals, amongst which were the cases of misallocation of resources.[10]

    India’s labor and land acquisition laws also impede investment and a pro-growth climate. Current labor laws make hiring and firing workers very expensive–this is a stumbling block for economic growth.[10] Similarly, land acquisition is also very cumbersome. For example, to acquire a piece of land, one would have to get the approval of two-thirds of the people who have a part of that land.10 This poses a threat to infrastructure development. The state of infrastructure is a key area of concern for Chinese investors. The government also failed to adequately support new and small businesses. Instead of providing a robust policy framework that made it easy for small businesses to operate, the government introduced its highly controversial demonetization scheme which hurt many small businesses.[10]

    Another key driver behind India’s economic downturn is investment. Both private and government investment has been a key driver of GDP growth since the liberalization of 1991.[5] Gross Fixed Capital Formation (GFCF) has been the main component of investment, and–despite increasing–its contribution to the economy fell by 6.2 percent in the period 2014-2019 than in 2011-2014.[5] This is largely a result of the government’s lethargy in reforming many of the laws surrounding land acquisition.[10] Decreasing levels of investment prevent infrastructure development, creates impediments in establishing small businesses, prevents entrepreneurs from investing in research and development (R&D) and results in technological stagnation. High levels of investment in the economy creates long term profitability for many years, enhancing operational efficiency and raising the level of innovation.[5]

    One of the foremost effects of this slowdown has been the sudden spike in job losses arising from the automobile sector and FMCG industry. The growth of the Indian economy has been dominated by consumption, including both Private Final Consumption Expenditure (PFCE) and Government Final Consumption Expenditure (GFCE).[5] In the last five years, consumption expenditure by Indian households accelerated with an average growth rate of 7.8 percent. However, the sharp fall in PCFE to 3.1 percent in the June quarter significantly contributed to the economic slowdown.

    Any large enough fall in consumption expenditure will initiate a chain of events that will prolong the recession even further. A fall in consumption spending leads to lower levels of employment and output as consumption directly affects the two. This results in macroeconomic price deflation. Consequently, the lower level of prices prevents firms from recovering production costs, forcing them to halt operations. This further initiates a layoff process, reducing earnings even further. Eventually, the economy finds itself in a vicious cycle, sinking deeper and deeper into a state of shock.

    Bangladesh Fares Better than India

    Bangladesh’s GDP in dollar terms has grown by 12.9 percent, more than twice that of India’s.4 Consequently, per capita income in Bangladesh has grown at three times the pace of India’s income growth. According to the United Nations Conference on Trade and Development, while India’s per capita income increased by 13.8 percent between 2013 and 2016, Bangladesh’s per capita income grew 39%. According to certain estimates, if Bangladesh manages to keep Gross National Income (GNI) and GDP growth rates up, the country’s per capita income will overtake that of India’s by 2020.[3]

    Source: United Nations Conference on Trade and Development (UNCTAD), UN Stats, World Bank, Data for 2016

    Bangladesh is performing better than India across a host of different human and social development indicators. Two of these important indicators include infant mortality and life expectancy. A newborn in Bangladesh is more likely to live to the age of five as opposed to infants in India and Pakistan. As of data from 2016, infant mortality stands at 28.2 percent in Bangladesh, 34.6 percent in India and 64.2 percent in Pakistan. In addition, life expectancy is also higher in Bangladesh at 72.5 years with India and Pakistan trailing behind at 68.6 years and 66.5 years respectively.[4]

    India vs Bangladesh in the Race for Development

    Bangladesh’s economy differs structurally from that of India’s. The service sector has the lion’s share in terms of its contribution to India’s growth whereas its industrial sector’s contribution is lower than desired. In contrast, Bangladesh has a booming industrial sector responsible for its rise to economic prominence.[1] This has serious ramifications for job creation and employment in both countries.

    Bangladesh’s booming industrial sector allows it to create jobs. As countries move from agrarian production towards manufacturing, this very same industrial sector absorbs the bulk of the excess labor, creating employment in the process. This increases the overall spending power of the populace and helps boost consumption, thereby promoting growth. On the other hand, most of the Indian population is still stuck in agriculture, which contributes the least to Indian GDP.[1] India’s industrial sector is struggling to grow fast enough to absorb the excess labor transitioning out of agriculture.

    Bangladesh’s great success lies in its being able to fill the gap left by Chinese exporters of RMG products as policy-makers in Beijing shift their focus towards increasing domestic consumption and investment, and away from exports. China’s total exports declined from a record high of $2.35 trillion in 2013 to $2.2 trillion in 2016, creating space for other exports of consumer goods to absorb this unmet demand.[4] The strength of Bangladesh’s domestic industries have enabled the country to increase exports from 6.7 percent in 2018 to 10.1 percent in 2019, despite the escalating trade war between the U.S. and China.[1]

    According to a report by the Asian Development Bank, “Growth in garment exports rose from 8.8% to 11.5%, reflecting strong demand from the US and newer markets for Bangladesh like Australia, Canada, India, Japan, the People’s Republic of China (PRC), and the Republic of Korea.” India failed to capitalize on China’s shifting focus during this same time period, as evidenced by its contracting export revenue–falling from a record-high $488 billion in 2013 to $433 billion in 2016.[4]

    Despite having a limited basket of export products against a backdrop diminishing export demand, Bangladesh has successfully increased exports by finding new markets and edging out other garment exporters such as India. In contrast, India’s export earnings limped forward at an average rate of 1.5 percent per annum since 2012-2013.

    What Lies Ahead

    Bangladeshis are expected to become richer than Indians by 2030, with per capita income projected increase by 4 times the current amount throughout the 2020s.7 Standard Chartered India states that Bangladesh’s per capita income will rise $5,734.6 in 2030 while India’s will reach $5,423.[4] In 2018, Bangladesh’s per capita income stood at $1,599.8 while India’s stood at $1,913.2.7 On the back of healthy domestic consumption, a good demographic dividend, rising investment, and strong export-led growth, Bangladesh will be part of what Standard Chartered is calling the “7% club”–a list of nations expected to grow at levels above 7 percent.[7]

    If India’s economy does find itself in a full-fledged recession, and Bangladesh continues its stellar track record of consistent high levels of growth on the back of its export revenues and migrant remittances, the forecast that predicts that per capita income in Bangladesh will exceed that of India’s will in all likelihood hold true.

    However, with the advent of increased automation in textiles in destination markets, the RMG sector is at risk. It can be argued that India–which relies more heavily on the service sector–has stumbled upon a new model of development that discards the traditional model of manufacturing. In most years, India is growing strongly, despite the recent dip in growth rate. The force behind this growth is India’s service sector.[2] The famous Indian outsourcing companies represent a facet of this service industry. Other examples of the industry include software, finance, logistics, tourism, online services, and health care.[2]

    As increasing automation starts to dominate, textile manufacturing is becoming less labor-intensive. There is a risk that the apparel industry could migrate back to the developed world, where labor is expensive but capital is cheap. This implies that the developing world is at risk of premature deindustrialization. Essentially, this means that if the Bangladeshi RMG industry cannot compete with rich-world robots, then the sector can no longer create mass urban employment.[2]

    Some of this reverse migration may already be underway. If this is the case, then poor countries such as Ethiopia will face a hard time escaping poverty. In the wake of this development, some analysts argue that the only path towards development left for poor countries would India’s service-centric model discussed earlier.[2]

    Other economists are not so pessimistic, however, and argue that there is still plenty of work left for industrious people in developing countries. In Bangladesh’s case, it appears as though policymakers anticipate this looming threat of automation and hence there is an attempt being made to move towards export diversification in the form of automobiles and electronics.[2]

    The Possible Impact of India’s Recession on Bangladesh

    Bilateral trade between India and Bangladesh is strong. In Fiscal Year (FY) 2017-18 bilateral trade stood at $9.5 billion. That figure rose to $9.85 billion in fiscal year 2019. The World Bank estimates that bilateral trade potential between the two nations is actually $16.4 billion. However, for Bangladesh, bilateral trade with India essentially means a trade deficit. As of 2019, the deficit stood at $7.35 billion. This sum is only projected to increase moving into the future.[11]

    The reason behind this deficit lies chiefly in Bangladesh’s import of raw materials from India. This is of strategic importance, as these raw material imports are principally for the apparel or ready-made garments (RMG) sector, which happens to be the most crucial driver for Bangladesh’s economic growth. 87 percent of Bangladesh’s exports to the U.S. include RMG items. These are in part made from cotton, yarn and other fabrics imported from India. Therefore, Indian raw material imports are of vital importance to the country’s RMG sector.[11]

    India’s economic slowdown can have a number of effects on bilateral trade between the 2 nations. India’s exports exceeded $400 billion in 2018. As India’s economy is slowing down, output is declining and with it, income. Bangladesh has not been able to capture India’s import market. India is importing a plethora of items from the global market but not from Bangladesh. Similarly, Bangladesh exports these very same items but not to India. With the recession in India, Bangladesh is likely to face increased protectionist trade policies from India in an effort to keep imports low and net exports high, thereby preventing aggregate expenditure from falling further.

    Indian businesses are also likely to lobby for more protection against Bangladeshi imports to limit competition and protect their own interests domestically, especially if Bangladeshi products are cheaper. Additionally, many Indian products will not be moving “off the shelves” due to the slowdown. This raises Indian businesses’ inventory costs. If there exists no feasible way to clear inventories in the event of a stronger recession, there may be a possibility Indian products will be “dumped” in the Bangladeshi market. This would further hurt Bangladesh’s trade deficit with India.

    Bangladesh’s decision to devalue its currency in the face of increasing competitive pressure from competitor exporting nations such as India and Vietnam brings with it another slew of problems. As a devalued currency raises import costs, the Bangladeshi RMG sector’s raw material import costs may rise, which would further hurt the sector’s global competitiveness. Much of the capital equipment required for industry in Bangladesh is imported, many of it from India and China. The devalued currency in this wake would further hurt investment in Bangladesh.

    The actual manner in which India’s recession may affect is a broad issue. However, the above talking points are a start to further exploring this issue and devising appropriate strategies to tackle this situation.

    Conclusion

    While Bangladesh’s booming economy is the talk of a great many economic conferences, India’s economic slowdown is also dominating headlines. A robust external profile characterized by a competitive garment sector and large migrant remittances has paved the way for Bangladesh to boast impressive GDP growth rates year after year. Conversely, the fall in consumption expenditure in India along with stagnating levels of investment have been the premier driving forces behind India’s economic slowdown. Despite this, India still has a strong service sector capable of sustaining the economy during difficult periods and will continue to grow in prominence as the threat of automation looms over the horizon.

    India’s economic slowdown, however, may prevent Bangladesh from fully benefiting from regional trade, who may be facing greater protectionism from India, an ever-increasing trade deficit, and the possibility of “dumping” by India. However, if current trends persist, Bangladesh is well-poised to breeze past India on the front of per capita income by the year 2030. Building on its key strengths, anticipating future threats, and focusing on a holistic and comprehensive view of development will enable Bangladesh to pave the way towards the future it always desired.

    Shahreem Ahsan, Trainee Consultant at LightCastle Partners, has prepared the write-up. For further clarifications, contact here: [email protected]

    LightCastle Analytics Wing is the research division of LightCastle Partners. It is tasked with producing periodic reports on the different sectors of the economy, analyzing trends in markets and making methodical, thorough and intelligent analysis to improve strategy and drive business growth.