Document of

The World Bank

FOR OFICLAL USE ONLY

Report No. 11656

PROJECT COMPLETION REPORT

BANGLADESH

INDUSTRIAL SECTOR CREDIT(CREDIT 1816-BD)

FEBRUARY 12, 1993

Country Operations, Industry and Finance DivisionCountry Department ISouth Asia Regional Office

This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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Currency Equivalents

I Taka - US$0.0325 I Taka - US$O.031030.80 Taka - US$1.00 32.27 Taka - US$1.00

(June 1987) (May 1989)

ABBREVIATIONS

ADB Asian Development Bank IPO Import Policy OrderBB Bangladesh Bank (the Central ISC Industrial Sector Credit

Bank) ISAC-2 Second Industrial SectorBEPZA Bangladesh Export Processing Adjustment Credit

Zone Authority L/C letter of creditBTC Bangladesh Tariff Commission LCA L/C authorizationCCIE Chief Controller of Imports LF LCA and import permit fee

and Exports (MOC) MOC Ministry of CommerceCD customs duty MOI Ministry of IndustryCL Control List (part of IPO) NBR National Board of RevenueCY calendar year NCB nationalized commercial bankDCA Development Credit Agreement NIP New Industrial Policy (1982)DEDO Duty Exemption and Drawback OED Operations Evaluation

Office (in NBR) Department (WB)DFI Development Finance PSIC Private Sector Investment

Institution CreditDS Development Surcharge PRMAC Public Resource ManagementECGD/S Export Credit Guarantee Adjustment Credit

Department (in SBC)/Scheme QR quantitative restriction (onED excise duty imports)EDP Export Development (Credit) RD Regulatory Duty

Project RIP Revised Industrial PolicyEMU Export Monitoring Unit (in (1986)

EPB) SAR staff appraisal reportEPB Export Promotion Bureau SBC Sadharan Bima Corporation

(attached to MOC) SBW special bonded warehouseEPS Effective Protection Studies SEM secondary (foreign) exchange

(unit in BTC) marketEPZ Export Processing Zone SOE statement of expenseFSAC Financial Sector Adjustment ST sales tax

Credit TA-V/VI Fifth/Sixth TechnicalFY Fiscal Year Assistance ProjectGOB Government of Bangladesh TIP Trade and Industry PolicyHS Harmonized Commodity Descrip- (Studies)

tion and Coding System UNDP United Nations DevelopmentIDA International Development Programme

Association USAID United States Agency forIPC Import Program Credit International Development

Fiscal Year (FY) of Borrower

July 1 - June 30

FOR OFFICIAL USE ONLYTHE WORLD BANK

Washington, D.C. 20433U.S.A.

Office of Director-GeneralOperations Evaluation

February 12, 1993

MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT

SUBJECT: Project Completion Report on BangladeshIndustrial Sector Credit (Credit 1816-BD)

Attached is a copy of the report entitled "Project Completion Report on Bangladesh -Industrial Sector Credit (Credit 1816-BD)" prepared by the South Asia Regional Office, with PartII contributed by the Borrower.

The objective of the Industrial Sector Credit was to support industrial growth throughreforms in export policy, trade protection, investment approvals, public enterprise management andindustrial finance. In practice, progress was disappointing. The modest objectives for trade andinvestment reform were not fully achieved on schedule, and the effort to strengthen DFIs was afailure. One tranche release condition (relating to loan collection targets of DFIs) was waived, andseveral follow-up actions were not implemented. Not surprisingly, the real response of the industrialsector has been negligible. Overall, the performance of the operation is rated as unsatisfactory.

The PCR argues that political commitment to reform in Bangladesh improved with thechange of Government in 1991, and that the limited progress achieved under this operation laid thegroundwork for the preparation of the Second Industrial Sector Adjustment Credit. The audit byOED will review the lasting contribution of the Industrial Sector Credit to the process of policyreform and the extent to which the constraints on policy implementation have indeed been relaxed.In the meantime, sustainability is rated as uncertain.

The PCR provides a balanced account of the accomplishments and shortcomings of theoperation. Part II basically agrees with the analysis, except for a few details related to the exportand import trade regime. The PCR was finalized more than three years after project completion;this allowed assessment of follow-up actions after second tranche release and by the newGovernment.

Attachment

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contentsmay not otherwise be disclosed without World Bank authorization.

FOR OFFICIAL USE ONLY

PROJECT COMPLETION REPORT

BANGLADESHINDUSTRIAL SECTOR CREDIT

(CREDIT 1816-BD)

Table of ContentsPage No.

Preface ii

Evaluation Suary ii

Part I PROJECT REVIEW FROM IDA' S PERSPECTIVE

1. Project Idontity 1

2. Background 1

3. Program Objectives and Scope 2

4. Program Design and Organization 3

s. Program Implemontation 3

e Export Policies and Administratlon 4

e Tariff and Import Regime 7e Investment Sanctioning 13e Public Induscrial Enterprlses 14

e Financial Seccor Issues 15i Procurement and Disbursement 17

6. Program Sustainability 18

7. The Borrower and IDA 19

* IDA's Performance 19

Sorrower's Performance 20* Program Relactonship 20

8. Consulting Servicoe 21

9. Program Documentation and Data 21

Part II PROOJECT REVIEW FROM THE BORROWER'S PERSPECTIVE

10. General Commenta 22

11. Agency Commenta 23

Part III STATISTICAL INFORMATION 25

* Related IDA Credics* Projecc Timecable* Credit Disbursemenc* .,issions* Follow-up Adjustment Operations

This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

ii

PROJECT COMPLETION REPORT

BANGLADESHINDUSTRIAL SECTOR CREDIT

(CREDIT 1816-BD)

PREFACE

This is the Project Completion Report (PCR) for the first

Industrial Sector Credit to Bangladesh (Credit 1816-BD) in the amount of SDR

147.8 million (equivalent to US$190.0 million), approved on June 6, 1987. The

Credit was fully disbursed and closed on May 11, 1989, seven months ahead of

the original schedule. Together with a US$2.5 million adjustment to the

Credit amount agreed on March 29, 1989, total disbursements amounted toUS$198.4 million.

The PCR was jointly prepared by IDA (Parts I and III) and the

Borrower (Part II). It was commenced by the former Industry and Energy

Operations Division of the Asia Country Department I, and completed by the

Country Operations, Industry and Finance Division of the reorganized South

Asia Country Department I. The report and evaluation are based on the

President's Report, the Development Credit Agreement, supervision reports,

correspondence, internal IDA memoranda, and discussions with Government

authorities.

Since some actions in the reform program which the Credit

supported were scheduled to occur during three years after release of its

second tranche, a completion mission was not sent to Bangladesh until February

1991. Since then, finalization of the PCR has been delayed further to enable

the evaluation of post-Credit actions resumed by the new Government which took

office in March 1991.

iii

PROJECT COMPLETION REPORT

BANGLADESHINDUSTRIAL SECTOR CREDIT

(CREDIT 1816-BD)

EVALUATION SUMMARY

(i) Prolect Objectives (para. 3.1) The Credit was to support theachievement of high rates of industrial growth to meet domestic demand, expandexports, and create employment outside agriculture through reforms in fiveareas: developing and improving administrative and financial arrangements forexport policy implementation; rationalizing the structure of protection;liberalizing the investment approval system; improving the central monitoringof public enterprise performance, while granting more autonomy and strength-ening PE management; and improving the efficiency of industrial financing.

(ii) Implementation Experience (Section 5) Implementation of a Program

with ambitious compass was affected adversely by (a) insufficient Governmentcommitment to policy reforms in spite of their articulation by prior technicalassistance, (b) delayed TA for the implementation phase, (c) inadequate GOBmonitoring machinery to coordinate the reforms, and (d) failure to makenecessary bureaucratic adjustments and avoid frequent transfers of officials.Only one formal waiver (on the loan collection target for NCBs) was invoked to

enable the second tranche to be released on schedule in June 1988, but several

other conditions were met only after discussion with IDA. The Program calledfor further actions after second tranche, and some of these were notimplemented satisfactorily.

(iii) Results (paras 5.2. 5.7. 5.14, 5.19-20, 5.23. 5.28) The Program

improved some important aspects of the policy and institutional framework forindustrial development, but these improvements have yet to pay off in terms of

increased industrial investment. Bangladesh's manufacturing value added hascontinued to stagnate, accounting for only 10 percent of GDP and 8 percent oftotal employment in spite of the rapid growth in non-traditional exports thathas occurred in recent years. While it is too soon for sector aggregates tobe affected by the Program because of implementation delays in some of itselements, the specific reforms which it initiated represent an important firststep in a process which should enable the industrial sector to grow with a

more efficient structure over the medium term.

(iv) Sustainability (Section 6) Most Program components were designedto represent a gradual reform process and some were implemented even more

slowly than expected. This enabled the limited progress which was achieved tobe sustained -- if not continued -- after the Program in spite of the problems

iv

which beset political commitment, bureaucratic capability and some of theinstitutional developments. The unsuccessful effort to strengthen the DFIsstands out as a notable failure. Quite modest targets were set for the trade

and investment policy reforms, in recognition of the need for a gentle

approach to liberalization in the absence of widespread commitment to market

mechanisms. Although these were not fully achieved on schedule, some further

progress was made over the two years after the Credit was closed and the new

Government in 1991 indicated its intent to regain lost ground as soon as

political circumstances allowed. This has indeed occurred during 1992-93, inpreparation for the Second Industrial Sector Adjustment Credit (ISAC-2).

(v) Findings and Lessons Learned

(a) In the absence of firm commitment to liberalization, the Program

faltered when IDA conditionality was no longer available to support its

implementation. While only one formal waiver was invoked to enable the secondtranche to be released on schedule, some other conditionality in the trade

policy area was met in letter rather than spirit and only after intensive IDAstaff consultations with the Borrower. Tranche release was approved, somewhat

reluctantly, as overall compliance was perceived to be generally satisfactory

-- but that perception rested partly on an expectation that progress would

continue in the third year. In the event, however, several of the essential

actions scheduled to occur after second tranche were not taken satisfactorily

as prescribed in the implementation program (DCA Schedule 4). This may havebeen avoided if the follow-up Credit, ISAC-2, could have commenced in 1990

rather than in 1992.

(b) Apart from the partial and delayed implementation of theprescribed trade policy reforms, those which did occur had less impact than

they should have had on private and public investment/disinvestment decisions

due to the absence of clear articulation of the proposed reform process to the

public. This illustrates the need for firm Government commitment to -- and

announcement to investors of -- a longer term program of reform, with a

clearly specified target structure of protection. Within such a program, the

measures supported under any one IDA two or three year operation can occur as

interim steps.

(c) Few of the institutions targetted for strengthening of staff or

the procedures intended for streamlining became fully operational until

further impetus was provided under other IDA operations well after the Credit

period. This applied to several of the export facilities, to the importclearance procedures, and to the institutionalization of monitoring public

investments. The failures were attributable partly to the Government's

reluctance to accept adequate technical assistance, and partly to delays in

the delivery of the TA which it did accept. It was also due to inadequate

political support to overcome bureaucratic reluctance to internalize the

necessary administrative reforms.

v

(d) The Program's approach of targetting two subsectors -- textile andgarment, and steel and engineering -- for early action in removing importcontrols and lowering the maximum tariff to 125 percent by second tranche andthen to 85 percent was unsuccessful. (Controls still remain in FY93 and the

tariff on many products remained above 100 percent until this year.) This

failure was partly symptomatic of the authorities' general diffidence on trade

policy reform. It might have been avoided, however, if the planned

liberalization and tariff reduction measures had been accompanied by other

types of support for restructuring the subsectors concerned to help them

adjust to the new policy.

(e) The export promotion goal of the Program was temporarilyundermined by appreciation of the real effective exchange rate which occurred

in FY89, just after second tranche release, in spite of the FY87-89 IMF

supported structural adjustment program. This demonstrates the need for

strong, comprehensive conditionality on macroeconomic management, which

occurred when the appreciation was reversed in the context of the following

IMF program.

(f) In spite of serious IDA efforts to supervise the Credit, many ofthe implementation failures were not clearly diagnosed in good time and, when

diagnosed by IDA, were not readily accepted by the Borrower. Much confusion

could have been avoided if (a) baselines had been specified more clearly, and

(b) the Government had put in place its own machinery to monitor progress in

the multi-faceted reform program which the Credit supported. The same problem

appears to have beset the subsequent Export Development Project, and there

still does not appear to be an adequate GOB mechanism to coordinate and

supervise technical and policy aspects of the implementation of ISAC-2.

PROJECT COMPLETION REPORT

BANGLADESHINDUSTRIAL SECTOR (ADJUSTMENT) CREDIT

(CREDIT 1816-BD)

PART I : PROJECT REVIEW FROM IDA'S PERSPECTIVE

1. Proiect Identity

Name Industry Sector (Adjustment) CreditCredit No. 1816-BDRVP Unit South Asia RegionCountry BangladeshSector Industry

2. Background

2.1 Bangladesh is one of the world's poorest countries, with a high anddense population, limited natural resources, and widespread poverty. Its percapita income averaged only $150 at the time the Credit was approved (May1987) and a high rate of population growth imposes a long term constraint ondevelopment. Despite good progress in agriculture, the mainstay of theeconomy, food production remained vulnerable to natural disasters and at thattime the country continued to require imports of about 10 percent of itsfoodgrain consumption. Agriculture could not absorb the rapidly growinglabour force, making the growth of labour-intensive industrial exports animportant development objective. This transition faced serious difficultiesin the forms of a labour force lacking the necessary education, health andnutrition; inadequate power, transport and other infrastructure; apreponderance of inefficient public enterprises (PEs) -- mostly former privatefirms taken over when the country became independent in the early 1970s;highly restrictive trade and payments policies; and an unsound domesticfinancial system. The macroeconomy was characterized by a low savings rateand a large structural payments gap. Remittances accounted for half ofnational savings, which in turn financed less than half of total investment.Export earnings, largely from the vulnerable jute sector, covered only onethird of the import bill. The lack of domestic resources also constrained thefinancing of key public investments as well as the efficient operation ofexisting assets. These conditions persist.

2.2 Nevertheless, and in spite of repeated disruptions by naturaldisasters, considerable economic progress had occurred in the several yearspreceding approval of the Credit. Policies designed to strengthen theagricultural, industrial and export sectors had permitted growth to averageabout 4 percent during the Second Five-year Plan period (FY81-85), includingan increase to 3.5 percent for foodgrains production in spite of adverseweather conditions. Industrial output rebounded from its stagnation in theearly 1980s, mainly on the basis of export oriented, labour intensiveactivities; non-traditional exports (especially garments) had grown by over 20percent a year. In addition, the development of natural gas and other energy

2

supplies had fuelled relatively high growth in the power and fertilizersectors and significant substitution for petroleum product imports.

2.3 Official statistics indicate that industry accounts for only 10percent of GDP and 8 percent of total employment, but these numbers belie bothits potential economic significance and the important role it already plays inexternal trade; about a third of the sector's value added is in exportproduction and it generates over three-fourths of merchandise exports.Initially almost entirely state-owned, the sector can now be characterized asmixed economy with public enterprise (PE) investment reduced to about 40percent by the time the Program commenced, mainly in large units producingbasic steel, cement, fertilizer, sugar, jute, textiles and pharmaceuticals.These and large private units generate 58 percent of the sector's value addedbut account for only 18 percent on the manufacturing labour force, while smalland cottage units are far more significant for employment.

2 .4 The development strategy for which the Government of Bangladesh(GOB) sought donor support during FY87-88 emphasized human resourcedevelopment as an essential long term solution. Seeking to sustain and buildon the recent industrial developments, however, the strategy also included theextension of the process of industrial reform. A New Industrial Policy (NIP)formulated in 1981 had reversed the commitment to social ownership andcontrol. In 1986 the Revised Industrial Policy (RIP) signalled further stepsin deregulating private investment, and GOB declared its aim to continue withtrade liberalization, PE privatization, and non-traditional export promotion.A related aim was to ensure international competitiveness and balance ofpayments stability through flexible exchange rate management and prudentborrowing. Also included in the strategy was an intent to strengthen thefinancial system by rehabilitating the development finance institutions(DFIs), taking stern action against defaulters, and gradually establishing amore autonomous, accountable banking system.

3. Program Objectives and Scope

3.1 The Credit was to support major industrial reforms being undertakenby GOB with the objective of achieving high rates of industrial growth to meetdomestic demand, expand exports, and create employment outside agriculture.The reforms were in five areas:

(a) developing and improving administrative and financial arrangementsfor export Policy implementation.

(b) rationalizing the structure of protection;

(c) liberalizing the investment approval system;

(d) improving the central monitoring of public enterprise performance,while granting more autonomy and strengthening PE management; and

(e) improving the efficiency of industrial financing.

3

3 .2 The Credit of USS190 million equivalent was to comprise 7.9 percentof gross capital inflows over the intended 1987-88 disbursement period,financing about 4.8 percent of merchandise imports.

4. Program Design and Organization

4.1 Policy reforms supported by the Credit were documented in thepolicy matrix and in the Implementation Program which comprised Schedule 4 tothe Development Credit Agreement (DCA). The five reform areas involvedvarious GOB agencies under different organizational arrangements.

(a) Actions on export policies and administration were designed togeneralize the processes and institutional mechanisms which hadbeen successful in promoting strong growth in garment exports.This involved:(l) the Bangladesh Bank (BB) and the Ministry of Finance (MOP) for

flexible management of the exchange rate;(ii) the establishment of a Duty Exemption and Drawback Office

(DEDO) as a department within the National Board of Revenue(NBR) to ensure duty- and tax-free status for imported inputs;

(iii) the Export Promotion Bureau (EPB) for monitoring garmentexports subject to international quota and, with the ChiefController of Imports and Exports (CCIE), for waiving importrestrictions on exporters' inputs; and

(iv) the banking system for strengthening arrangements for theexport credit guarantee scheme, export financing, and theinland back-to-back LIC system.

(b) The tariff and import regime actions were designed to simplfyprocedures, replace direct controls with tariff protection,moderate the latter and find alternative revenue, and free theexchange rate. The agencies involved were NBR (Customs) on tariffand tax rate adjustments and customs procedures, BB on the exchangemarket, and CCIE for Import Policy Orders mandating quantitativerestrictions.

(c) For investment sanctioninR, where the Program actions had beentaken in advance, no institution was required.

(d) Public sector enterprises mainly involved the MOF's AutonomousBodies Wing (ABW), which was being assisted by a UNDP-financedproject to develop monitoring techniques.

(e) For financial sector issues, the organizational units concernedwere BB and the financial institutions to be strengthened.

5. Program Implementation

5.1 The Credit became effective on June 30, 1987, a month earlier thanplanned; the second tranche was released on June 28, 1988; and the Credit wasfully disbursed and closed on May 11, 1989. Except for shortfalls in

4

industrial term loan collections and perhaps also in luxury tariff reductions,fulfillment of second tranche conditions was generally satisfactory, althougha waiver on the NCB loan collections (para. 5.26) was nee-dd to enable thetranche to be released on schedule. Approval of the release was based onoverall satisfactory performance in implementing the Program; it might havebeen withheld under the current practice of requiring compliance with each DCAprovision for release. Actions programed to occur after second tranche, i.e.in FY89, suffered considerable delay but several were taken by the end of FY90and more in the subsequent two years. In a few of the reform areas, progressbeyond the expectations of the Program has been made in the course ofpreparing the Second Industrial Sector Adjustment Credit (ISAC-2).1

5.2 Although the first ISC Program improved some important aspects ofthe policy and institutional framework for industrial development, theseimprovements have yet to pay off in terms of increased industrial investment.Bangladesh's manufacturing value added has continued to stagnate, accountingfor only 10 percent of GDP and 8 percent of total employment in spite of therapid growth in non-traditional exports that has occurred in recent years.While it is too soon for sector aggregates to be affected by the Program

because of implementation delays in some of its elements, the specific reformswhich it initiated represent an important first step in a process which should

enable the industrial sector to grow with a more efficient structure over themedium term.

5.3 The following Subsections outline, for the five Program components:specific actions that had been or were to be taken (intent), together withdetails of their subsequent implementation before and since the second tranchewas released (performance), and IDA's assessment of their impact (results).

5.4 Export Policies and Administration. Prior to the Program, GOB hadalready made significant progress in the development of measures to encourageexport diversification, spurred by the decline of the international jutemarket. These efforts had been rewarded with a breakthrough in readymadegarments, but the international quotas on these made further diversificationessential if the export growth momentum were to be maintained. Programactions were designed to: improve the efficiency of administration and provideinstitutional mechanisms needed to implement announced policies; generalizeproduct- or firm-specific measures to cover all direct or indirect exporters;and improve collaboration between GOB and the export sector to meet externalchallenges. The actions comprised:

(a) Continued management of the exchange rate to avoid a renewedappreciation of the real effective exchange rate (REER).

(b) Provision of free trade status for exports with respect to importedinputs through:(i) improved performance of the exPort processing zone by

increasing the autonomy and streamlining the procedures of the

ISAC-2 was appraised over the year ending march 1992, negotiated in Ohaka on June 8-11, 1992, anrapproved by IDA'S Board on October 27, 1992.

5

Export Processing Zone Authority (BEPZA), authorized prior tothe Credit;

(ii) generalization of the procedure for giving exporters access toinputs restricted or banned for other purposes, and, in themeantime, provision for case-by-ca.. treatment by the CCIE onEPB's recommendation in order to give effect to the waiver ofthe "negative list" authorized in the FY87 Import and ExportPolicy Orders; and

(iii) more general availability of the bonded warehousint systemalready used successfully for 100 percent exporters ofgarments and specialized textiles; to be complemented by

(iv) development of duty drawback facilities, with both of these tobe achieved through the conversion of DEDO into a permanentdepartment and initiation of its activities.

(c) Effective access to pre- and post-shipment working capital forsmall or new export oriented producers (including indirectexporters) through:(i) strengthening the export credit guarantee scheme (ECGS) by

converting it into a department with increased capital andstaff, (undertaken prior to the Credit), and preparing a planand initiating action to further strengthen the scheme;

(ii) implementing a BB taskforce's recommendations on rationalizingthe structure of export financing by modernizing theadministration of pre-shipment financina, creating a foreignexchange revolving fund to finance imports, and establishingan automatic rediscount mechanism for export loans; and

(iii) initiating the implementation of the recommendations of aninter-agency taskforce on making the inland back-to-back L/C(letter of credit) system available to all indirect and directexporters.

(d) Establishment and satisfactory operation of an export monitoringunit (EMU) in the EPB to enable swift response to new internationalquotas, complementing the revised internal allocation policy forquota restrictions announced for FY87 and FY88.

5.5 These intentions were reflected in four provisions of the Program.DEDO would be established as the principal agency responsible for all policy-related and technical tasks pertaining to the duty-free import system, andwould be mandated to prepare guidelines and administrative orders, approveinput coefficients, and monitor its implementation. Measures would be takento rationalize the structure of export finance to give indirect exportersaccess to pre-shipment finance and provide exporters with a choice of paymentmethod for imported inputs; and the ECGS would be modernized and strengthenedthrough the provision of necessary capital, staff and management.Administrative mechanisms satisfactory to IDA would be implemented forapplying export incentives to indirect exporters. Finally, the EMU was to bestaffed and equipped to enable it to monitor the export of items subject toexternal quota in a manner satisfactory to IDA.

6

5 .6 Much of the Program's action in this area occurred before theCredit becama effective. The measures to be takan prior to second tranchewere duly implemented. Some of the initiatives stalled in the following FY89,

however. In particular:

(a) GOB could not prevent REER appreciation, thus eroding the improvedexport environment, until a 4.75 percent devaluation occurred inFebruary 1990 with further action amounting to 6 percent over the

following year.

(b) The bonded warehousing system remained unavailable to some types ofexporter for whom matching inputs with outputs is more complex than

for, say, garments.

(c) DEDO was established but with inadequate authority, premises,budget or specialized staff, requiring technical assistance to beprovided under the the Export Development Project (EDP, Credit2000-BD)2 and other needs which were specified as prior conditionsfor the ISAC-2.

(d) Delays and technical difficulties beset further progress to followup the export finance and credit guarantee actions, requiring suchprogresa to be facilitated by TA under other IDA auspices, notably

the EDP.

(e) The waiver of the "negative list" (renamed as the Control Listunder the 1989-91 Import Policy Order (IPO)), and the back-to-backL/C system for indirect export, though operational, remainedsubject to administrative barriers for some new and potentialexporters until recently.

(f) The quota monitoring unit was established but a significant delayoccurred before it became operational.

5.7 The impact which the Program might have had on export performancewas limited by the problems encountered in operationalizing fully theinstitutions and procedures that were to have been strengthened or

streamlined. However, some improvement in the policy environment facingexporters did take place under the Program -- especially with respect to theChittagong EPZ and access to previously banned imported inputs; thiscontributed to the continued growth that has occurred in non-traditionalexport receipts over the past four years. In addition, the ISC componenttogether with the subsequent EDP helped raise the public profile ofBangladesh's export potential and focus the attention of administrators --including revenue officials -- on exporters' needs and particularly on theissues that must be resolved to liberate export (and other industrial)production from a constraining regulatory framework. At the same time it hasdemonstrated that stronger political support for swift administrative action

I The EDP has itseLf been subject to iiilementation delays, but recent changes to the ruLes and betterpublicity are faciLitating disbursement of the investment funds, and the technicaL assistwce sponsored by theUnited states Agency for internationaL Development (USAID) is now mobilized.

7

and more timely and ambitious technical assistance, preferably in the contextof a comprehensive promotion strategy, would be required to ensure theeffective strengthening of the various institutions concerned. It is now moregenerally recognized that the authorities' limited resources must beconcentrated on the provision of necessary public services rather thanattempting to administer complex control mechanisms. This realization isreflected already -- to the benefit of exporters and other efficient producers-- in the liberalization of credit markets which is occurring under the FSC.More generally, the stage was set for the further streamlining that GOB is nowundertaking with support from ISAC-2, which should facilitate greater growthand diversification.

5.8 Tariff and Import Regime. In the mid-1980s, the structure ofprotection in Bangladesh was characterized by tariff anomalies and extensiveadministrative mechanisms to allocate foreign exchange and restrict imports.

Most final production was protected by outright bans, restrictions or hightariffs. Intermediate products generally carried somewhat lower tariffs, butthe structure contained serious anomalies with many intermediate inputssubject to ban or higher tariffs than the goods they helped produce. Furtheranomalies were created by numerous special exemptions, while effectiveprotection was distorted also by the addition of an import sales tax atvarious rates and, more importantly, by many transactions bypassing officialchannels. In addition, the tariff structure was complicated by a large numberof rate categories and an uncoordinated process for assigning rates inresponse to ad hoc concerns. The practice of granting concessions contrastedsharply with GOB's perception of the tariff as a revenue instruument,providing more than 55 percent of tax revenue in a situation of seriousresource shortage. The medium term strategy for rationalizing the regime,that the Credit was intended to support, comprised:

(a) reducing tariff variation by reducing the number of rates,allocating products to them more consistently, and reducing therange of effective protection among different products;

(b) phasing out quantitative restrictions and streamlining importprocedures; and

(c) accompanying tariff rationalization by tax reforms to generatealternative revenue sources.

A start had been made as the Credit was being prepared in FY86 to take actionon these three fronts; further steps were included in the Program; and moreextensive rationalization was envisaged for support under a second andpossibly third sector adjustment credit(s).

5.9 On the tariff structure, GOB had recategorized 7000 products into11 (rather than 24) customs duty (CD) rate categories with the intent ofrating most raw materials between zero and 20 percent, intermediates at 50percent, consumption goods at 100 percent, and luxuries in a range of 150percent (e.g. washing machines) to 400 percent (cigarettes). "Luxuries" weredefined broadly, hcwever, accounting for about one-sixth of all items in the

8

tariff code. GOB had also, early in FY87, recategorized the sales tax (ST) onimports into three rates (zero, 10 percent and 20 percent) and begun shiftingproducts to the zero category. Meanwhile, it had agreed in principle toliberalize tariffs in the two largest manufacturing subsectors, textiles andsteel/engineering, and started adjusting them in FY86 and FY87. Theseinitiatives provided the basis for a three-year program intended to includethe following FY88-90 actions, which were reflected in Schedule 4 of the DCA:

(a) The tariff rate structure would be revised by the beginning ofFY89. Apart from luxury goods noted as exceptions in (b) below andzero-rated items, it would comprise seven CD rates (2.5, 5, 10, 20,50, 75 and 100 percent, with maxima of 20 percent on raw materials,75 percent on intermediates and 100 percent on final products), andone non-zero ST rate (20 percent). This was agreed prior to theCredit and the details were included as a second tranche conditionin the DCA implementation program. 3 No provision was made forremoving the other import levies: development surcharge (DS, 8percent), regulatory duty (RD), import permit or L/C authorizationfee (LF, 2.5 percent), and advance income tax (AIT, 2.5 percent).

(b) Effective protection for domestic production of most luxury goodswould be lowered by reducing most CD rates above 150 percent tothat rate in FY88 (a second tranche condition) and then to l00percent in FY89. The only exceptions would be five 200 percentgroups (tobacco products, beverage concentrate, furs & fur apparel,precious & semi-precious stones, and perfumes and cosmetics) andtwo 300 percent groups (spirits and luxury motor cars).

(c) For the textiles and steel/en,tineeringc subsectors, nominalprotection provided collectively by CD, ST, development surcharge(DS) and import license fee (LF) was to be reduced over threeyears. The President's Report's policy matrix specified, as asecond tranche condition, that in FY88 the maximum combinedCD/ST/DS/LF rate would be 125 percent with corresponding reductionsfor raw materials and intermediates. During FY89 and FY90,according to the DCA, the maximum rate for final goods in thesesubsectors would be further reduced to 85 percent, with the provisothat any increase by 5 percent or more in domestic excises could bereflected in tariff adjustments.4

5.10 With respect to quantitative restrictions (QRs) and foreignexchange allocation, the Program had three design themes: (a) movingtransactions from the controlled official foreign exchange market to the freersecondary market; (b) making scheduled QRs transparent and monitorable bya.sing a "negative" rather than "positive" list of freely importable products;

' The rates, atthough not the raw materials and intermediates Limits, were given also in the President'sReport (No. P-4558-BD).

in addition, it was envisaged that further tariff rationalization would be carried out in othersuosectors, based on effective protection analysis that was then being financed by the Fourth TechnicaiAssistance Credit (Cr. 1124-SO). Such reform was intended to be supported by future sector credits, however.

9

and (c) reducing such QRs over time so that protection would be provided bytariffs. GOB had taken strong action in all three areas before the Credit wasapproved. The shares of exports and imports utilizing the secondary markethad increased in FY86 and were expected to reach 71 and 42 percent

respectively in FY87 (compared with 27 and 20 percent two years before). Thenegative list had been introduced in FY86. It was supplemented, however, byrestrictions on three other groups of items importable only by: (a) exportersand exchange-earning hotels; (b) registered industrial enterprises up tovalues specified in their passbooks; and (c) importers with prior permission(e.g. seeds, insecticides, explosive ingredients and pharmaceuticals). Boththe negative list and the other restrictions had been liberalized in FY87, the

former by deletion of 68 (18 percent) of its four-digit import trade control(ITC) categories and the latter by removal of 140 more narrowly defined items.Actions to be taken under the Credit to continue such liberalization were:

(a) The negative import list would be reduced by about 20 percent ofits remaining 359 four-digit categories each year, beginning inFY88 as a second tranche condition, and sufficient priority wouldbe given to the textiles and steel and engineering subsectors'items that these would be eliminated at the beginning of FY90.

(b) The restricted list for industrial imports would be phased out inthree approximately equal annual steps (beginning in FY88 beforesecond tranche) to enable commercial import of all items by FY90.

(c) Pursuant to a FY87 announcement, all non-GOB, non-aid, non-barterimports would utilize the secondary market (leaving imported food-grains, fertilizer and equipment for officially sponsored projects,and exported raw jute, tea and leather, at the official rate).

(d) For simplfying import and customs clearance procedures, GOB and IDAwould agree by September 1987 on an action program to adoptproposals that were already specified.

5.11 Finally, to help identify alternative revenue sources, GOB wascollaborating on studies with IDA and the IMP with a view to reducingdependence on trade taxes. It was expected that a comprehensive reformprogram would be agreed on. Implementation would begin in FY88, so that theestimated 1 percent revenue loss for the ISC first-year tariff reductionswould be offset. Continued reform would offset the second- and third-yearcuts (including 2.5 percent of revenue for the textiles and steel andengineering adjustments, without allowing for gains due to QR removal), aswell as the further tariff rationalization intended to occur under a possibleISAC-2 (since approved).

5.12 Most of the Program schedule for QR removal, tariff rateadjustment, and use of the secondary foreign exchange market was implemented,albeit with (i) delays of about a year on some actions; (ii) failure to accordpriority in QRs removal or to fully restructure total tariff protectionaffecting the textiles and steel/engineering subsectors; and (iii) failure toeliminate the restrictions on industrial imports. Specific performance can besummarized as follows:

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(a) The secondary foreign exchange market expansion occurred asplanned, although, as noted above, the official rate was allowed toappreciate for a while.

(b) Few changes in "luxury" tariffs above 100 percent were announced inthe FY88 Budget, and the 150 percent ceiling was waived as a secondtranche release condition against GOB's undertaking that its FY89Budget would authorize the 100 percent ceiling to meet the DCAtarget for that year. Further delays occurred, however, with thereduction to the 150 percent limit being authorized at the end ofFY88, and the 100 percent limit being attained for some items 15months later (as an appraisal condition for ISAC-2). Even then thelist of exceptions was slightly different and longer than had beenenvisaged in the Program, although the FY93 Budget has now reducedthem to four: cars with engines above 1300cc, cigarette paper,firearms, and alcoholic beverages.

(c) For the tariffs affecting textiles and steel/engineering, the FY88Budget authorized CD rate changes which met or improved upon thefirst-year target of a 125 percent ceiling for the majority ofaffected imports. Although some of these even came close toconsistency with the third-year target of a 0-85 percent range ifonly CD were counted, the progress was not maintained and totalnominal protection for many items remained well above that rangeuntil CD for most of them was reduced to 75 percent in FY93.

(d) The process of simplifying the tariff rate structure was advancedto a limited extent. The number of non-zero, non-concessionary,non-luxury CD rates was reduced by FY91 to seven (2.5, 5, 10, 20,30, 50 and 100 percent) with relatively few exceptional rates,5 andthe number of ST rates was reduced to one (20 percent) but withnumerous exceptions (at 10 percent). However, the total tariffstructure remained more complex through (i) the addition of DS andLF, (ii) numerous exemptions from or reductions in these levies, CDand/or ST for selected importers and/or narrowly defined products,(iii) the use of "tariff values" to yield specific rather than advalorem rates of CD for some items, and (iv) the imposition of RDon a few others.

(e) The negative import list is now expected to be phased out overseven rather than five years. The FY88 reduction covered 79 ITCheadings (22 percent) in order to meet the first-year target andenable second tranche release, leaving 280 headings on the list.6

The IPO 1988-89 reduced the list by about 103 headings (29percent), although its reclassification through the introduction ofthe Harmonized System (HS) of tariff coding then yielded 272 HSheadings for FY89.

The 5l rate was retained for a few products, white so retaining 150X are not strictly Luxury products.

Only a few headings were removed from the list by the IPO 1987-88 itself, and 7 codes were added.However, sufficient further deletions occurred through an interim IPO issued in may 1988.

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(f) With respect to intended removal of the 69 ITC headings comprisinggoods restricted to industrial importers over three years, theshortfall from the FY88 target was small so the tranche releasecondition was deemed to have been substantially met. Includingnon-industrial goods as well, deletions and additions caused a netreduction of 50 headings (17 percent) that year.7 In the IPO 1988-89 the resulting list of 239 ITC headings was reduced by 73 (25percent), with the remainder reclassified as 217 HS headings.

(8) A combined Control List published in the IPO 1989-91 contained atotal of 320 HS headings, representing an apparent FY90 reductionof 111 after allowing for duplications in the the FY89 negative andrestricted lists. Progress was continued when the IPO was revisedfor FY91 with the omission of 70 more codes (as an appraisalcondition for ISAC-2).8 The bans that vere removed numbered 81headings in FY90 and 46 headings in FY91, leaving 153 in place. Asthis balance represented about 27 percent of the original baselineafter allowing for the code reclassification, substantial progresstowards the fourth year target occurred for the negative list.Indeed, it was over-achieved if allowance is made for about 54items that could remain banned or restricted indefinitely on suchnon-tradew grounds as religion, safety and health. The followingIPO 1991-93, together with recent rovisions to it, have seen 159more bans or restrictions removed from the CL, leaving fewer than40 headings remaining for removal in FY94.

(h) Unfortunately, the items deleted from the negative and restrictedlist did not adequately reflect the intended removal of ORs ontextiles and steelleniineerint imports. In contrast to theProgram goal of their elimination at the beginning of FY90, morethan 50Z of textile items and about 101 of metal items were stillbanned or restricted through the following year. Even now, 24textile headings remain to be removed early in FY94 under ISAC-2.

(i) Although an action timetable was discussed to meot the trancherelease condition, little progress occurred during the Creditperiod in streamlining import and customs clearance procedures.Since then, however, radical improv _ nts have been initiated andare to be fully implemented during FY93 (under the auspices of theproposed ISAC-2). These include the computerization of ravenuecollections (pending the introduction of ASYCUDA with assistancefrom UNDP/UNCTAD), and the appointment of com_rcial inspectionagents whose functions may include offshore asessment by FY94.

(j) Reform of the indirect tax system, Inter &.Ia to facilitate tariffrationalization by finding alternative revenue sources, w a worked

Only 12 industrial goods headings (17 percent) were raem d initially in the IPO 1967-88, but a furthernine (13 percetnt) were deleted in the interim IPO.

s The resulting 250 headings covered ban or restrictions on 2,216 Ite_ at the 10-digit level -- alost21X of their total.

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out during the Credit period, and legislated by the Value Added TaxAct 1991, with implementation at the beginning of FY92. Thecoverage of VAT and the related Supplementary Excise Duty (SED) isbeing broadened during FY93-94, and revenue should be boostedfurther in FY94 by the above-mentioned import inspection service,notably its assessment function and the associated electronicreconciliation of assessments and collections.

5.13 While the above review shows that some Program targets might nothave been achieved on schedule, it indicates also the desire of the newGovernment to authorize further major changes in the coverage of QRs, thetariff regime, and collection procedures. Actions which have occurred at thebeginning of FY92 and FY93, or are expected in FY94 under the proposed secondISAC, make up most of the ground lost in the FY88-90 Credit period of ISC andgo well beyond that Program's objectives in this area.

5.14 Due to the delays which occurred in implementing the first-stagetariff reform and QR elimination program that the Program was intended tocomprise, these policy changes have not been in place long enough to bereflected in the structure or performance of industrial and other economicactivities. QRs have been removed from some export and other industrialinputs only recently (although they were mainly "restrictions" which favouredindustrial importers, rather than bans), while nominal protection provided bythe tariff structure still remains highly differentiated (although providingsubstantial effective protection for selected existing industries catering tothe domestic market).

5.15 As for other components of the Program, the most important resultof its tariff and import regime changes has been to commence a process whichmust continue in order to have the desired effect of efficiency and growth ofthe industry sector. More in-depth research is required to determine whateffect the changes in effective assistance to industry caused by the tradepolicy reforms -- or the expectation thereof -- already may have had oninvestment decisions that would affect the future structure and performance ofthe sector.9 It is likely, however, in the absence of a more clearlyarticulated trade policy strategy (the ISC-supported Program not having beendetailed in the 1986 RIP), that most investors have been influenced onlymarginally by the reforms actually implemented. Instead, apart from export-oriented garment producers with bond facilities, investors have continued torely on political favor yielding the tailor-made protection which was notprecluded by the implementation of the first-stage reforms. As far as currentand forthcoming investment decision making is concerned, the supply responsewill depend rather on the private sector's (and comercialized PEs')expectation of the outcome of the more definitive trade policy reforms nowbeing undertaken in the second stage, FY93-FY94, with the support of ISAC-2.Since these reforms are being introduced while the Bangladesh economy remainsin recession, their impact on investment will depend also on necessaryconcomitant measures to relax fiscal, monetary and exchange policies and toattract foreign equity investment.

Staff sector work is currently underway to address this question, along with the related issue of e.regulations and policies may still constrain responses to the trade policy changes that have occurred.

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5.16 Investment Sanctioning. Since Independence, private investment inBangladesh had been subject to close public scrutiny, both by limiting theactivities in which it could occur and by requiring official sanctioning forindividual projects. The latter process had been decentralized to manyagencies, including banks and other financial institutions, prior to theCredit, but there were limits on the size of investment that could be approvedby these agencies. These limits were not tackled fully, as that type ofliberalization was assumed to require improvements in lending institutions'appraisal capabilities and elimination of distortions in the incentivesframework. Instead the Program's design in this area emphasized extending therange of "free" activities in which private investors could use their ownfunds to import machinery through the secondary foreign exchange market.

5.17 The liberalization of the investment regime had been reflected inthe RIP which:

(a) gave the priority investment schedule indicative rather thanregulatory status in order to deter bankers from relying on it atthe expense of meaningful project appraisal;

(b) introduced shorter lists of activities in which investment would berestricted to the public sector ("reserved" industries) or requireprior permission ("discouraged" industries), with all otheractivities being "free" for private investment (although subject tothe following other controls);

(c) raised from 20 to 50 percent the proportion of imported inputs thatwould trigger another requirement for investment approval; and

(d) increased the sanctioning limits (without need for GOB approval) toUS$1 million for all commercial banks and $2 million fordevelopment finance institutions (DFIs).

These elements of the Program having been implemented, no second trancherelease conditions or further actions were specified. They were intended,however, to pressage further liberalization which would be coordinated withother Program components: the elimination of distortions in the protectionregime (Section 6) and improvements in DFI's appraisal capability (Section 9).

5.18 The further liberalization commenced in 1990, when increased limitsfor DFI and NCB managements' decision making gave the institutions autonomyfrom BOI oversight with respect to private sector projects worth up to Tk 100million and Tk 60 million respectively, having no more than 49 percent foreignequity, and being outside the discouraged list. Even more freedom occurredwhen domestic entrepreneurs used their own funds and/or borrowed from privatebanks. Larger domestic and all foreign-majority projects financed by DFIs andNCBs remained subject to BOI procedures, however.More progress has occurredsince then. The new Government's Industrg Pollcy 1991 raised the oversightthreshhold to Tk 300 million for both DFIs and NCBs. The IP91 also promisedequal treatment for foreign investment, and discontinued the priorityinvestment schedule and the "discouraged list". The latter had grown sinceits introduction in 1986 and had been treated by the BOI as a prohibited list

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to prevent aeveral proposed investments from occurring. The most recent stepsin these areas have been even more radical, comprising the Government'sOctober 1992 decision to revise the IP91 to: (a) shorten the list ofindustries reserved for public investment to railways, airways, defenceequipment, nuclear energy and security printing; and (b) remove all investmentapproval requirements, including the DFI/NCB sanctioning limits as well as theroles of "sponsoring agencies" other then BOI/BEPZA/BSIC's incentives andassistance functions.

5.19 Since many controls remained in place, private investment did notsurge following the Credit period, and the further liberalization describedabove has been too recent to have promoted a significant investment responseso far, especially in view of the political instability in 1990-91 and thecontinuing recessionary conditions. As conditions improve, however, privateenterprise must be encouraged by the present liberal regime.

5.20 Public Industrial Enterprises. Although GOB had nationalized mostlarge-scale industrial enterprises in 1972, placing them in groups undersector corporations which were supervised in turn by various Ministries, thedecade preceding the Credit witnessed efforts to encourage private enterpriseto take the lead in industrial development while reducing the public rolethrough privatization and improving the public enterprises' performance in themeantime. The 1981 NIP and 1986 RIP had presented a clear strategy forachieving these objectives, and GOB had undertaken several policy measures andimpressive divestiture actions prior to the Credit. Altogether about 650firms had been transferred to the private sector; budgetary allocations to PEshad been mainly for completion, rehabilitiation or modernization of existingunits, and kept within 20 percent of Annual Development Program totals; andthe list of activities reserved for new public investment had been reduced toseven, with gas-based fertilizer the only industry where such investment hadoccurred. These successes reduced the public share of industrial fixed assetsfrom 90 percent in 1972 to about 40 percent by 1986. Efforts to increase theefficiency of PEs had been made too, but with less success.

5.21 Accordingly, the Program design was focussed on supporting theongoing restructuring and performance improvement programs. Its implement-ation program under the DCA required the strengthening of the AutonomousBodies Wing (ABW) of the Ministry of Finance to (a) oversee a contractualsystem of performance indicators for selected PEs and a program for monitoringand evaluating them, and (b) coordinate the setting of perfomance targets byvarious Ministries or agencies. The ABW was to be strengthened satisfactorilyby September 1987; the indicators were to be applied to one PE on a pilotbasis during FY87; and the monitoring and evaluation program was to beextended to three other PEs during FY88. It was envisaged that its furtherextension to all industrial PEs could be supported by a future IDA operation.

5.22 In order to systematically monitor the performance of publicenterprises, the Government has been developing a management inform-ationsystem and expanding performance evaluation for autonomous and semi-autonomousPEs with UNDP assistance. Progress by 1991 was as follows:

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(a) The monitoring cell within the Autonomous Bodies Wing of theMinistry of Finance developed a System for Autonomous BodiesReporting and Evaluation (SABRE) which generates information on PEsthat is used for economic planning, performance evaluation,budgeting and financial control purposes. The cell collects theinformation generated by SABRE in standardized input formats andloads them into a computerized database. With the FY92 budgets ofthe remaining 13 sector corporations being prepared under SABRE,all 38 of them are now included in the system.

(b) The cell has also developed a target-setting and evaluation systembased on performance contracts with the enterprises. This(i) identifies major areas of performance improvement,(ii) assigns weights based on priorities,(iii) sets appropriate targets and monitors their achievement, and(iv) evaluates performance through a composite index.Although the system plans to link bonuses with the evaluation indexit has not yet received the GOB approval to do so. Moreover, thePEs have yet to be given full autonomy to make decisions in orderto help realize their contracts. The first performance contractwas given to a PE in FY87 and four more enterprises were includedthe following year. The number rose to 15 in FY91 and 25 in FY92.

Due to delays in recruiting staff for the ABW, the Government had to rely onthe staff of the UNDP-assisted project to undertake most of the above work. Aproposal to recruit additional professional staff failed to receive President-ial approval in FY88, and project personnel continued on contract.

5.23 The performance contracts established in the Program may havehelped improve the efficiency of a few units somewhat, and has value as aprocess to be replicated. It is labor intensive, however, does not replacethe formal budgetting systems, and probably could not be extended to asignificant proportion of PEs. With bonus payments not linked to theevaluation index, the contracts are currently seen as an additional paperworkexercise rather than a spur to better performance. This is suggested by thevalues of some key indicators for the five enterprises that have used themmore than two years: while production increased in some cases, sales andprofits did not go up correspondingly, and in other cases sales went up butprofits went down. It is evident that the system will not improve thefinancial and economic condition of the PEs unless: (a) performance contractsare linked to a proper incentive system, and focus adequately on the keyissues and problems of the enterprises, and (b) the PE managements haveautonomy to make decisions to realize the goals set. Pendilg such autonomy,the Ministry concerned with each PE should at least review the contract toensure that the key problems are addressed in it. Regarding the ABW staffing,it may now be appropriate for at least some of these experienced personnel tobe absorbed as regular MOP staff to continue the PE monitoring tasks.

5.24 Financial Sector Issues. By the mid-1980s, the country's bankingsystem sufferred from both structural problems involving its legal framework,autonomy, management and supervision, and a short-term credit disciplinary

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crisis with unacceptably low recovery rates. This applied especially for thetwo DFIs, Bangladesh Shilpa Bank (BSB) and Bangladesh Shilpa Rin Sangatha(BSRS), which were the main sources of term finance for industry, but also tothe three nationalized commercial banks (NCBs) which were participating inIDA-financed small industries operations. The poor collections performancehad a number of causes, including weak appraisal capacity, credit targetting,lack of flexibility to restructure loans, large real devaluations, disputesover the portfolios of denationalized PEs, and a weak legal framework. Anaction program had been instituted since 1984 to address these problems, butlittle progress was achieved through FY86. Accordingly, a new action programwas devised with monthly cash collection targets; if these were met, the DFIs'collection ratio would rise from 9 percent in FY86 through 13 percent in FY87to 18 percent (or 50 percent of new amounts coming due) in FY88, while that ofthe NCBs would rise from 19 through 33 to 46 percent.

5.25 The Program activities in this area were designed to increase therecovery rates of the five institutions, as well as increasing the operationalautonomy of the DFIs and strengthening them institutionally and financially:

(a) In pursuit of the recovery rate goal, the DCA required two types ofeffort to enable second tranche release. GOB would:(i) cause and take all necessary measures to enable the institut-

ions to meet FY87 and FY88 collection targets agreed with IDA,i.e. Tk 1370 million by DFIs and Tk 136 million by NCBs; and

(ii) eliminate all PE arrears to BSRS (comprising 18 percent of itstotal arrears) by the end of FY88.

(b) To otherwise improve the BSB and BSRS, the Government would:(i) cause them to increase provisions for bad and doubtful debt in

their FY87 financial statements, reschedule individual loansas appropriate, and selectively write off loans with norealistic prospects of being serviced;

(ii) recapitalize them with a view to maintaining each'sdebt/equity ratio at no more than 3 to 1; and

(iii) provide additional technical assistance to strengthen theirappraisal, loan collection and supervision, and portfoliorehabilitation functions, and accounting and managementsystems, with satisfactory terms of reference and timeframe.

While these steps were being taken, a broader, longer term program offinancial sector reforms would be in preparation for future IDA support.

5.26 During 1987 the Government took additional measures to restorecredit discipline and enable financial institutions to improve their recoveryof industrial term loans, although the collection efforts were adverselyaffected by Bangladesh's worst floods in 40 years and by politicaldisturbances in late 1987. The two DFIs collected 91 percent of the agreedtarget, representing a 34 percent improvement over the correspondingcollection performance in 1986. The three NCBs, which had very smallportfolios of industrial term loans, collected a total of Tk. 64 million, oronly 47 percent of the agreed target, representing a 143 percent increase overthe corresponding collection performance in 1986. This shortfall was deemed

17

insignificant for the purpose of second tranche release. However, both DPIand NCB collections dropped back towards their earlier levels followingtranche release. The Government indicated to IDA its plans to continue itsefforts to restore credit discipline, and a longer-term program of sectorreforms and technical help to NCBs was developed with IDA's assistance. TheFinancial Sector Adjustment Credit (FSAC, Credit No. 2152-BD) became effectivein FY91, and preparation of a second credit to support further adjustment hasbegun. GOB enacted a Loan Courts Law and set up 19 such special courts, whichhave improved significantly the institutions' ability to impose creditdiscipline.

5.27 The DFIs increased provisions for bad and doubtful debts in theirFY87 financial statements and carried out debt reschedulings and write-offs inappropriate cases. The Government completed the recapitalization of the twoDFIs to maintain their debt/equity within the agreed 3 to 1 ratio. In thefirst half of 1988, GOB took action to reduce the public enterprise (PE)arrears to the BSRS by about one-half, and discussions were held amongresponsible Ministries and PEs with the intent of eliminating the remainingarrears in FY89. This did not occur. In order to strengthen the DPIs, theGovernment during 1987 finalized a technical assistance program to be executedby the Asian Development Bank (ADB) and financed by UNDP. Consultants wereselected and the program was initiated in early FY89, shortly after secondtranche release. Unfortunately, the DFIs continued to lose money, andreverted to inadequate accounting policies which understate bad debts.

5.28 The specific institutional results of this Program component thatcan be observed so far are disappointing, although its intensive emphasis oncollections appears to have had a salutary effect on general perceptions aboutthe need to repay loans -- an important factor in Bangladesh. While the useof monthly collection targets for the DPIs did have a modest positive effecton their balance sheets in the short term, the effort did not yield asignificant improvement in these two institutions' longer term capability toraise collection levels. Similarly, the recapitalization was not accompaniedby the other actions necessary to stem their continuing decapitalization. Inany case, failure to eliminate all PE arrears exacer-bated an already serioussituation. Moreover, since acceptable provisioning for bad debts was notsustained, BSB's and BSRS's reported capital soon becme once againoverstated. The technical assistance may have improved their accounting andmanagement operations, but it was undoubtedly been less influential than if itcould have coincided with the "leverage" available from IDA or ADB creditlines. Thus the DFIs remain in a parlous condition, making littlecontribution to industrial development, in spite of the Program. The resultsfor the NCBs were somewhat happier, largely because it was followed quickly bymore comprehensive support for their improvement under the FSAC.

5.29 Procurement and Disbursement. As an adjustment credit, the ISCproceeds were utilized by Bangladesh Bank to fund general imports on areimbursement basis, with the use of a Special Account to facilitate initialpayments. No problems were experienced, although a rather larger share thanexpected was attributed to PE import expenditures.

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6. Program Sustainabilitt

6.1 In spite of some institutional failures, most Program componentswere designed and implemented in such ways that where progress were achievedin the reform process it could be sustained -- with the important provisos ofthe needs for continued political comitment and improved bureaucraticcapability. The unsuccessful effort to strengthen the DFIs stands out as anotable exception. Quite modest targets were set for the trade and investmentpolicy reforms, in recognition of the need to a gradualist approach toliberalization in the absence of widespread commitment to market mechanisms.Although even these were not achieved on schedule, further progress was madeover the two years after the Credit was closed, and the now Government in 1991indicated its intent to regain lost ground as soon as political circumstancespermitted. This has indeed occurred during 1992-93, in preparation for theISAC-2 Program.

6.2 Some of the particular reforms may prove more sustainable thanothers, but they depend heavily on recent and further fresh initiatives, viz:

(a) Those improvements that did get implemented in exPort Dolicies andadministration have been maintained and indeed enhanced duringFY90-91, with further more radical progress occurring under ISAC-2.

(b) Similarly, the rather modest tariff and import retime improvementsprovided a necessary basis for compressing the tariff to anexpected 10-50 percent range (with limited exceptions) andcompleting the elimination of QRs during FY92-94. Although theFY91 and FY92 Budgets announced some tariff increases which wereinconsistent with the Program, these have been remedied in FY93 andfurther progress is expected in the next stage of the reformprocess under ISAC-2, which also emphasizes institutionalstrengthening needed for sustainability.

(c) The progress made on liberalizing investment sanctioning has beencontinued, culminating recently in abolition of intervention.

(d) With respect to public industrial enterprises, the perfomancecontract and management information systems require furtherimprovement in both content and institutionalization before theywill be sufficiently effective to be sustained. Whether the costof such improvements would be justified in view of the Government'sobjective of privatizing many of the PEs remains unclear.

(e) The limited progress made on financial sector issues, at least inthe case of the DFIs which received most of this component'sattention, could not be sustained because of their doubtfulviability. On the other hand, as noted above, the initiativeappears to have established an expectation among industrialiststhat loans from public institutions should be repaid.

6 3 The sustainability of the reform process has been assisted by thecontinuing support provided by the IMF and IDA in the forms of the Fund's

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Stuctural Adjustment Facility (FY87-89), its Enhanced SAY (FY91-93), ISCitself, the above-mentioned FSAC, a FY92 Public Resource Management AdjustmentCredit (PRMAC), and the FY93 ISAC-2. Thesa operations have been closelycoordinated through a series of Policy Framework Papers, with elements of theIDA supported programs serving to implement reforms that comprise performancebenchmarks for the Fund facilities. The process could be strengthened,however, to encourage further GOB efforts to sustain progress on structuralreform without sacrificing stabilization. Particular issues that may requiremore intensive tripartite collaboration to reduce dependence on instrumentswhich inhibit structural change include exchange rate policy and the develop-ment of trade neutral revenue sources; PRMAC and ISAC-2 address these.

6.4 The strengthening of GOB's commitment to the trade and financereform process which the Credit helped initiate has been due partly to itsincreasing recognition that a tightly controlled and overprotected privatesector cannot perform well as the key engine of industrial development. Thisperception has been deepened with the election in February 1991 of ademocratic Government which favours private sector development and hopes toreduce public corruption. So far it has only partly articulated a commitmentto the depth and pace of trade liberalization which the previous administrat-ion appeared to recognize as necessary. On the other hand, it has initiatedsome bold practical steps in the right directions. Their sustainability --and thus that of the earlier ISC Program -- will depend critically on whetherGOB can muster and maintain political support and galvanize the bureaucracyfor the further progress necessary to create a liberal trading environmentsupported by appropriate governance.

7. The Borrower and IDA

7.1 IDA Performance. The Credit followed an extensive program of Tradeand Industry Policy (TIP) studies which GOB undertook with IDA's financial andintellectual support to provide a solid foundation for the comprehensivereforms that were required to redirect the economy. The substantive output ofthe program was lavish, with more than 100 studies produced by 1987. Many ofthese were thorough and helped IDA, as well as GOB, understand the nature anddimensions of the problems with the policy regime. Various industrialsubsectors were studied, protection estimates made, procedures and regulationsanalyzed, and recommendations offered for policy reform. Among therecommendations were detailed proposals for (a) simplifying, compressing andrestructuring the import regime to replace QRs by tariffs at rates which wouldkeep EP within a 30-100 percent range, and (b) using exchange rate policy asfar as possible, supplemented by subsidy and procurement policies, to removethe bias against exports in the protection regime. Proposals were made alsofor (c) eliminating investment controls and biases in lending towards capitalintensive, large scale activities, (d) tax reform to reduce reliance on tradetaxes and distinguish between revenue and protection concerns, and (e) phasingout discriminatory pricing and making subsidies explicit for publicenterprises. Although the reforms implemented under the ISC Program fell farshort of the recommendations, these did make an important contribution to theprogress that occurred, especially in the design of the Program and that ofthe subsequent EDP.

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7.2 As to the Program itself, IDA devoted considerable etaff resourcesto monitoring its implementation. For the import liberalization component,intensive supervision was necessitated partly by a minimalist approach tomeeting some of the targets on the part of the Borrower and partly by thelatter's weak institutional arrangements for analyzing the progress that didoccur. This problem was compounded by the difficulties for monitoringprogress posed by the complex documentation of Bangladesh's trade policyregime and the changes in classification and presentation that occurredconcurrently with the Program's substantive reductions in QRs and tariffrates. Even now it is difficult to chart the course of the FY87-90 revisionsprecisely, underscoring the importance of establishing clear and agreedbaselines for monitoring phased reforms.

7.3 Borrower's Performance. The above-mentioned TIP studies programshould have provided the basis for good performance by GOB in implementing thetrade and investment components of the Program supported by the Credit. Itwas overseen by a large, high-level Govern ent committee, coordinated by amanagement unit in the Planning Commission and comprised work in variousagencies on project planning and identification, the EP structure, industrialinvestment promotion, industrial statistics, investment incentives, and exportpotential. The aims were to (a) analyze the policy structure comprehensivelyin these areas, (b) make concrete recommendations on reforms, and (c)internalize the policy analysis process through appropriate institutionbuilding. Unfortunately for the subsequent Program, TIP's success in thethird respect was limited, with insufficient commitment by both policy makersand officials who required training precluding full advantage being taken ofthe international expertise assembled. in Dhaka for the work during 1983-86.This contributed to both the minimalist approach to implementation and GOB'spoor capability for monitoring it, noted above, so that the Borrower'stechnical performance appeared to weaken rather than strengthen during thecourse of the Program. Organizational problems also beset the export, PE andfinancial components of the Program, with GOB relying to an excessive extenton technical assistance rather than developing the capability within thebureaucracy that is needed to manage and sustain such structural reforms.

7.4 These institutional and personnel issues, at least with respect totrade policy, have been addressed in the design of the follow-up ISAC-2operation. A broader issue to be faced, however, is whether problems ofimplementation are not bound to thwart prograess towards the unshackling ofthe economy, unless GOB could adopt a bold stance on the removal rather thanmodification of official interventions. Lessons should be learned from thefailures to meet some of the first ISC Program's sound goals caused bytraditionalist attitudes to the role of the bureaucracy.

7 .5 Program RelationshiD. IDA and GOB staff collaborated quite well inpreparing and implementing the Program, thus establishing an important basisfor continuing cooperation in the trade and finance reform processes inBangladesh. More progress might have occurred during the Credit period,however, if the relationship had enabled a franker mutual appreciation of theinstitutional weaknesses referred to above.

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8. Consultiut Services

8.1 As noted above, the TIP studies which made an important contrib-ution to the ISC Program design failed to institutionalize effectively theprocess of incentives analysis. Apparently the consultants made seriousefforts to transfer technology in this regard, but the bureaucracy wasunreceptive. Further efforts in this area would need to be designed andclosely monitored with a view to ensuring the paramountcy of the trainingfunction in a suitable institutional environment.

8.2 The Credit itself did not include technical assistance (GOB beingreluctant to use IDA funds for this purpose), but three sets of consultingservices under other auspices proved essential for Program implementation:

(a) The UNDP funded and ADB executed TA for the two DFIs. The consult-ants performed satisfactorily but might have been more effective inthe context of a stronger program to reform the institutions and/oran investment operation that channnelled loan funds through them.

(b) UNDP also financed services to prepare and monitor the performancecontracts for the PEs in the absence of recruited staff for theABW; these have performed well.

(c) The export component of the Program also required TA, but this wasnot arranged until its need was identified during supervision ofISC and the concurrent preparation of the EDP. The latter includedTA funded by the United States Agency for International Development(USAID), comprising consultancy support for flat rates and inlandL/Cs for duty drawback (through DEDO), quota monitoring (throughEPB), and the credit guarantee scheme (ECGS). Unfortunately, theseservices could not be mobilized until late in FY91, causing aserious delay in strengthening these export institutions.

9. Program Documentation and Data

9.1 The President's Report (No. P-4558-BD) and legal agreements for theCredit presented the Program fairly clearly, providing a useful framework forimplementation. However, the baseline and reclassification difficulties notedabove precluded some of the assessments needed for the PCR until the tradepolicy database was improved during preparation for the proposed follow-upCredit supporting further QR and tariff reform.

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PART II: PROJECT REVIEW FROM THE BORROWER'S PERSPECTIVE

10. General Comments

10.1 Established in 1971, Bangladesh is a capital poor economy havingagriculture as both the main contributor to GDP and the provider of employmentto the bulk of its population, although the share of agriculture to GDP hasdecreased in the 1980s and the share of the industrial sector has increased overthe same period. The economy has been performing below its potential, growingat an average rate of less than 4 percent a year in the 1980s. The scarcity ofdomestic savings and consequent low level of investment were the two fundamentalconstraints to growth of the economy. The availability of foreign assistance,however, served both to supplement poor domestic savings and to facilitate thetransformation of savings into investment by the import of capital goods.

10.2 The Industrial Sector Credit, a sectoral adjustment credit signedbetween GOB and IDA in June 1987 was aimed at extending assistance to GOB incorrecting distortions prevalent in the Bangladesh economy and strengtheningprospect for sustainable economic growth by way of achieving high industrialgrowth so as to meet domestic demand, create off-farm employment, and improvebalance of payments position by expanding exports. GOB greatly appreciates theassistance extended by IDA in reinforcing the Government's adjustment efforts bysupporting the policy reform necessary to achieve the above objectives. Thiscredit was a follow-up to a previously concluded series of 13 Import ProgramCredits which also triggered actions to help correct the external balance of theeconomy.

10.3 The ISC Program was implemented during the period when an IMFStructural Adjustment Facility (SAF), with the principal objective ofaccelerating overall economic growth to over 5 percent a year and maintainingmacro-economic stability, was in operation. While the SAF Program aimed atimproving the economic climate of Bangladesh by alleviating key structuralconstraints, the ISC was programmed to support sectoral reforms for industrialdevelopment.

10.4 The main thrust of the Program was to reform industrial and tradepolicies. Significant positive changes took place in the investment approvalsystem which provided more flexibility for private investment (e.g. the limitson the approval of private investment in free sector from own resources wereabolished). The trade regime has also undergone substantial changes.Quantitative restrictions fell, tariffs were reduced and rationalized, andincentives were provided for export.

10.5 The implementation and performance of the credit program have beendiscussed in details in Part I of this report. GOB agrees with the IDA analysisdone in Part I and Part III, subject to the comments made below. Actual economicperformance during the period (FY88-FY89) was significantly less than expected.The rate of growth of the economy was reduced from 4 percent in FY87 (the yearpreceding the start of the credit) to 2.1 percent and 2.3 percent in thesubsequent two years FY88-FY89 respectively during which the Program wasimplemented. Although the gross domestic investment was static during the

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implementation period and thereafter, the exports grew faster than imports, thusreducing fiscal and external deficits and improving balance of payments.However, the policy changes will take some more time to affect the overalleconomic growth, particularly in the area of industrial investment.

11. Agencv Comments

11.1 Commenting on the export policy and administration component, theNational Board of Revenue notes that, as of 1992:

(a) The bonded warehouse system helped Bangladesh to promote garmentsexports, but at the same time there were instances of leakage ofduty free imported fabrics into the domestic market. This not only

deprived the Government of revenue but also exposed domestic textilemanufacturers to unfair competition. Based on the experience withthe garments industry, the Government has been approaching the issuewith caution. In 1991 the Government made a policy decision that inprinciple such facility would be made available to all exporters andstarted selectively extending the facility to exporters other thanthe garments, taking adequate safeguards to protect revenue.

(b) In addition, with the introduction of value added tax (VAT) and zerorated exports associated with it, exporters can claim rebate onimported inputs. Meanwhile DEDO has come a long way in its takes ofgiving refunds of taxes paid by exporters on imports. DEDO has beengiven the authority to write refund cheques, and has announced morethan three hundred flat rates. Further steps are being taken tomake DEDO more effective, particularly in cutting delays inapproving refund application.

11.2 Regarding the import tariff and control regime:

(a) NBR comments that tariff rates were compressed during the Creditperiod and thereafter. Further compression into nine rates; 0, 7.5,20, 30, 40, 50, 75, 100 and a few above 100 percent (with the lastthree rates being temporary) are contemplated by the Governmentunder the ISAC-2. Tariff rates were lowered to 100 percent for allitems except in case of agreed luxury items. Partial or totalexemptions from customs duty given earlier to specific end-use ofimports were withdrawn.

(b) In principle, the Bangladesh Tariff Commission shares IDA's viewscontained in Part I. Regarding program design, organization andimplementation, the Tariff Commission is closely involved in thetariff and import regime reform area (subpara. 4.1 (b)). Since 1987a series of liberalization measures--reduction of the number ofcontrol list items, rationalization of tariff structures, etc.--havebeen taken by the GOB on the basis of examinations andrecommendations of the Tariff Co ission. In addition, recognizingthe need for an institutionalization program and as part of thedevelopment of the Effective Protection Studies (EPS) Unit

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established under the Trade and Industry Policy (TIP) studiesprogram, the Institutional Development of the Tariff Commission(IDTC)TA Project was conceived for a period of two years with effectfrom July 1, 1991 and substantial progress has since been achieved.

(c) The Chief Controller of Imports and Exports clarifies that, when thenegative list was introduced in July 1985 under Import Policy Order1985-86, a restricted list was also introduced then. Bans andrestrictions already in force were included in the negative andrestricted lists respectively. These included the restrictionspertaining to exporters and exchange-earning hotels, industrialenterprises with passbooks, and importers with prior permission(para. 6.3), which had already been in force as per the previousIPO.

11.3 No comments were received from the authorities concerned with PEreform or the finance sector component.

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PART III : STATISTICAL INFORMATION(Amounts in US$ million)

1. Related IDA Credits

Credit No. 1816-BD (C18160, C18161) As of: October 29, 1992Original Disbursed Cancelled Repaid Outstandina

1816-0 190.0 195.94 nil nil nil1816-1 2.5 2.43

2. Proiect TimetableOriginal Credit Dates Actual Credit Dates

Initiating Memorandum 02/25/86 02/25/86Letter of Sector Policy 04/15/87 04/15/87Negotiations (concluded) 04/14/87 04/14/87Board Approval 06/09/87 06/09/87Credit Agreement 06/22/87 06/22/87Effectiveness 06/30/87 06/27/87Tranche Release 06/27/88Amending Agreement 03/29/89Amended Effectiveness 04/25/89Credit Closing 12/31/89 05/11/89Final Disbursement 12/31/89 05/11/89Actual Completion 06/30/89 05/11/89

3. Credit Disbursement (Cumulative)FY87 FY88 FY89 FY90

(i) Planned 15.0 175.0 nil 190.0(ii) Actual nil 105.8 92.5 198.4

(iii) (ii) as percent of (i) __ 60.5 -- 104.4

4. MissionsNo. of No. of Staff Date of

Month, Year Weeks Persons weeks ReportPreparation May 1985 2.5 3 6 6/10/85Appraisal March 1986 3 6 18 4/28/86Supervision I Sept/Oct 87 3 3 17 10/10/87Supervision II February 88 3 4 12 4/06/88Completion February 91 1 1 1 2/11/91

5. Follow-up Adjustment Operations

BANGLADESH: Financial Sector Adjustment Credit, No. 2152-BD, approved inJune 1990 in the amount of US$175 million.

BANGLADESH: Public Resource Management Adjustment Credit, No. 2361-BD,approved in May 1992 in the amount of US$150 million.

BANGLADESH: Second Industrial Sector Adjustment Credit, No. 2427-BD,approved in October 1992 in the amount of US$100 million.