ASIAN DEVELOPMENT BANK PPA: BAN 23441

PROGRAM PERFORMANCE AUDIT REPORT

ON THE

SECOND INDUSTRIAL PROGRAM (Loan 1147-BAN[SF])

IN

BANGLADESH

July 2000

CURRENCY EQUIVALENTS Currency Unit – Taka (Tk)

At Appraisal (November 1991)

At Program Completion (April 1994)

At Operations Evaluation (March 2000)

Tk1.00 = $0.027 $0.025 $0.020 $1.00 = Tk37.64 Tk40.13 Tk51.00

ABBREVIATIONS ADB – Asian Development Bank BFIDC – Bangladesh Forest Industries Development Corporation BTMC – Bangladesh Textile Mills Corporation EA – executing agency GDP – gross domestic product ICIR – Interministerial Committee on Industrial Reforms ICP – Interministerial Committee on Privatization MOI – Ministry of Industries PCR – project completion report PME – public manufacturing enterprise PPAR – program performance audit report SDR – special drawing right TA – technical assistance

NOTES (i) The fiscal year (FY) of the Government ends on 30 June. (ii) In this report, “$” refers to US dollars.

Operations Evaluation Office, PE-546

CONTENTS

Page BASIC DATA ii EXECUTIVE SUMMARY iii I. BACKGROUND 1 A. Rationale 1 B. Formulation 1 C. Objectives and Scope at Appraisal 2 D. Financing Arrangements 2 E. Program Completion Report 2 F. Evaluation 3 II. IMPLEMENTATION PERFORMANCE 3 A. Policy Reforms and Institutional Development 3 B. Procurement and Disbursement 6 C. Management of the Program 6 D. Effectiveness of Technical Assistance 6 III. PROGRAM RESULTS 7

A. Achievement of the Objectives 7 B. Sustainability 10 IV. KEY ISSUES FOR THE FUTURE 10 A. Program Formulation 10 B. Ownership and Political Commitment 12 C. Accountability and Governance Structures 13 V. CONCLUSION 14 A. Overall Assessment 14 B. Key Lessons for the Future 14 C. Follow-Up Actions 16 APPENDIXES 17

BASIC PROGRAM DATA Second Industrial Program (Loan 1147-BAN[SF])

PROGRAM PREPARATION/INSTITUTION BUILDING TA No. TA Project Name Type Person-

Months Amount Approval

Date 1635-BAN Strengthening of Institutional Framework for

Restructuring Public Manufacturing Enterprises

AOTA 12 $400,000 2 Jan 1992

1636-BAN Improvement of Labor Productivity in Public Manufacturing Enterprises

AOTA 9 $325,000 2 Jan 1992

1637-BAN Implementation of Privatization Program for Public Manufacturing Enterprises

AOTA 21 $446,000 2 Jan 1992

KEY PROGRAM DATA ($ million)

As Per ADB Loan Documents

Actual

ADB Loan Amount/Utilization–SDR ($ equivalent) 90.5 ($125.0) 45.2 ($62.3)1 ADB Loan Amount/Cancelation–SDR ($ equivalent) 45.2 ($62.7)2 KEY DATES Expected Actual Fact-Finding 10-22 Mar 1990 Appraisal 20 Oct-1 Nov 1990 Loan Negotiations 18-20 Nov 1991 Board Approval 17 Dec 1991 Loan Agreement 24 Dec 1991 Loan Effectiveness 16 Mar 1992 20 Jan 1992 First Disbursement 13 Oct 1992 Program Completion 1 Dec 1993 25 Apr 1994 Loan Closing 30 Jun 1994 Apr 1994 Months (Effectiveness to Completion) 20.50 27.15 BORROWER The People’s Republic of Bangladesh EXECUTING AGENCY Bangladesh Bank and Ministry of Industry MISSION DATA Type of Mission No. of Missions Person-Days Appraisal 1 97 Program Administration Review 5 76 Tripartite Meeting 2 5 Program Completion3 0 0 Operations Evaluation 1 30

ADB = Asian Development Bank, AOTA = advisory and operational technical assistance, BAN = Bangladesh, SDR = special drawing right, TA = technical assistance. 1 As of December 1991. 2 As of April 1994. 3 No program completion review mission was undertaken. The program completion report was prepared based on a

desk study.

EXECUTIVE SUMMARY

Reforms as a process of change -- no blueprints please!

During the early 1990s, the Government of Bangladesh implemented a series of reforms to improve economic performance. The objectives were to (i) create competitive industries, and (ii) enhance private sector development. Complementing the reforms for trade and exchange rate liberalization, the Government began reforms to reduce its presence in manufacturing activities. From 1988 to 1990, the Asian Development Bank provided policy-based loan to introduce policy reforms for the steel and engineering, textiles, and leather industries. The Second Industrial Program (the Program) was expected to continue the process of improving the overall policy environment to promote industrial growth and efficiency. The new Government’s 1991 industrial policy was accompanied by an ambitious agenda of policy reforms; the Program was essentially designed to support implementation of this policy as it related to public manufacturing enterprises (PMEs). The Program was also to implement divestment and privatization measures for selected PMEs.

On 17 December 1991, the Board approved the Program loan for SDR90.456 million (about $125 million). Three technical assistance (TA) grants were provided to assist the Government with program implementation. The TAs supported (i) development of a legal framework for institutional reform of PMEs, (ii) development of modalities and mechanisms for privatization, and (iii) assessment of human resources of PMEs and labor productivity of the manufacturing sector.

The Program focused on seven major areas of reforms: (i) minimizing the Government’s role in the industry sector in general and in manufacturing in particular, (ii) enhancing managerial autonomy and accountability of PMEs, (iii) enhancing financial autonomy and accountability of PMEs, (iv) implementing privatization of PMEs, (v) rationalizing employment, (vi) developing policy actions for the environment, and (vii) supporting institutional reforms to provide better oversight of PMEs.

The first tranche of SDR45.228 million was disbursed in two installments in February and April 1992. Because of the considerable delays in meeting the policy covenants, the second tranche of the loan was canceled on 24 April 1994. The loan was closed in April 1994. The program completion report prepared in December 1997 rated the Program as unsuccessful.

This program performance audit report presents an analysis of the Program’s design and implementation arrangements, an assessment of the Program's effectiveness in initiating and implementing policy reforms, and overall impact on the industrial economy. Although the Government announced the new industrial policy in 1991 and initiated wide ranging policy reforms, overall implementation has been weak and uneven. Several policy covenants remain unfulfilled.

An important impact expected from the Program was the reduction of the role of the Government and particularly PMEs within the overall economy. The PMEs’ share in investment, output, value added, and employment has been reduced substantially.

A major aspect of PME reform was to provide a proper legal framework to enable the PMEs and sector corporations to function as autonomous companies. By June 1992, all of the PMEs were to be incorporated under the Companies Act. This legal change was seen as the

iv

starting point for restructuring, as it freed the existing PMEs from heavily regulated procurement processes, and labor and pricing procedures. It was expected that such autonomy would help to make PMEs commercially viable. The Government did not agree with a crucial policy covenant of giving PMEs the autonomy to allow market wages for their employees. As a result, although most PMEs now exist as companies, overall autonomy of their boards remains weak. The financial performance of PMEs continues to remain an area of concern as PMEs continue to report large losses. The overall financial liabilities of PMEs also remain high. The Program was not successful in reducing negative fiscal burden of PMEs.

While the Program specified various measures for privatization of PMEs, overall implementation has been very slow and remains largely incomplete. Only three units were privatized during program implementation, compared with the target of substantial divestment of 14 units and privatization of 20 textile mills.

This audit report identifies three major issues as determinants of program performance: (i) program formulation and design weaknesses, (ii) ownership and political commitment, and (iii) accountability and governance structure. The Program was complex because it aimed to reform a sector that had chronic performance problems. The Program had several design deficiencies, and did not incorporate in-depth analysis of institutional structures and government processes to identify barriers to reforms.

Policy reforms usually require strong political commitment and ownership. The Program was formulated, processed, and implemented by different governments. While high-ranking officials did exhibit some ownership at times, this ownership was neither widespread nor retained throughout the program. Even for the TAs there was only limited ownership, by the Government and the PMEs. The TAs helped to identify important tasks, but only during implementation. By the time most of TA reports were finalized, the Program had already missed major performance milestones and hence the overall impact of the TAs was limited.

Poor motivation, combined with inadequate skills and little accountability, usually lead to implementation problems. Successful reforms require a strong governance structure with clear and effective accountability. Thus, it is important to address governance and accountability simultaneously with civil service reforms when widespread policy reforms are being introduced at the sector level.

Because the policy reforms identified under the Program remain largely unfulfilled, the Program is rated as unsuccessful. Program implementation provides four important lessons:

(i) Program loans with difficult policy reforms need to build an explicit component aimed at strengthening stakeholder partnership and thus create a demand for the reforms.

(ii) Introducing policy reforms in a developing economy is a complex process and the new lending instrument—program cluster loans—with targeted resource transfer linked to performance seems more appropriate.

(iii) A robust system of monitoring within the Government is very important and needs to be built in explicitly. Resources may be provided for this.

(iv) Privatization and restructuring of PMEs require a high level of political commitment, and hence an in-depth political analysis of the feasibility of the

v

reform programs is an important prerequisite. Because there is residual sympathy for the public sector in Bangladesh, this needs to be targeted at multiple levels if any major change is to be brought about. Only when civil society becomes much more demanding for reforms and modernization in Bangladesh, reforms will take roots.

TAs aimed to support implementation and capacity building must have realistic timetables. Most of the diagnostic analysis pertaining to identifying implementation constraints need to be completed prior to major milestones.

Although the Program has contributed in opening up the economy indirectly, the Government has been unable to remove the structural constraints preventing PMEs from functioning as commercial units. It needs to develop a credible and time-bound action plan to deal with these constraints and accelerate the process of privatization. Improved access to financial resources is crucial for promoting the private sector growth and diversity needed to remove widespread poverty in Bangladesh. Since PMEs continue to account for a large share of nonperforming assets, the Government must address this issue.

I. BACKGROUND

A. Rationale

1. During the early 1990s, the Government of Bangladesh implemented a series of reforms to improve the country’s economic performance. The reforms were an integral part of the medium-term adjustment program supported under an enhanced structural adjustment facility of the International Monetary Fund. The Asian Development Bank (ADB) and the World Bank supported a number of policy-based reform programs1 in industry and trade. Complementing the reforms for trade, exchange rate liberalization, and macroeconomic structural adjustment programs, the Government began reform of public sector enterprises with the goal of reducing Government presence in manufacturing activities. ADB provided its first Industrial Program loan2 to support policy-based reforms in steel and engineering, textiles, and leather industries. The Second Industrial Program (the Program) loan was expected to support the process of improving the overall policy environment to promote industrial growth and efficiency.

2. When the Program was initiated, about 160 public manufacturing enterprises (PMEs) were organized in six sector corporations. Three sector corporations, Bangladesh Chemicals Industries Corporation, Bangladesh Steel and Engineering Corporation, and Bangladesh Sugar and Food Industries Corporation were supervised by the Ministry of Industries (MOI) and comprised a total of 67 PMEs. Bangladesh Textile Mills Corporation (BTMC) was operating 42 units under the oversight of the Ministry of Textiles, while Bangladesh Forest Industries Development Corporation, with 14 units, was under the Ministry of Environment and Forest. Thirty-three enterprises were under the Bangladesh Jute Mills Corporation. One of the most difficult problems facing the Government was to reduce the operating losses of PMEs amounting to Tk1 billion per year. These PMEs also accounted for a large share of the financial resources of the nationalized banks, thus crowding out access of other sectors to these resources.

3. The 1991 industrial policy set an ambitious agenda of policy reforms; the Program was essentially designed to support implementation of this policy as it related to the PMEs. The rationale for the Program is elaborated in the development policy letter of November 1991 (Appendix 1). The ultimate objective of the Program was to assist the Government in improving financial discipline of the PMEs by setting a framework for greater accountability for performance and providing the necessary autonomy. The Program was also to implement selected PME divestment and privatization measures.

B. Formulation

4. The policy reforms were identified and finalized through several internal studies, and a long consultative process3 with the Government. The program period was set at three and half years, from July 1990 to December 1993.

5. Three technical assistance (TA) grants were provided to help the Government implement the Program: Strengthening of Institutional Framework for Restructuring Public Manufacturing Enterprises,4 1 The World Bank processed three loans during the same period: Industrial Sector Adjustment Credit I, approved in 1987, and

a loan of $175 million, approved in June 1990 to address financial sector reforms. The Second Industrial Adjustment Credit was under preparation after its identification in November 1988.

2 Loan 891-BAN(SF): Industrial Program, for SDR46.96 million, approved on 30 June 1988 and closed in April 1990. 3 Given changes in governments, several missions were fielded by ADB during March, May, and June 1990 to identify and

develop areas of policy reforms in consultation with the Government. This process continued even after appraisal with three more missions in May, August, and September 1991.

Appendix 5, page 2

Improvement of Labor Productivity in Public Manufacturing Enterprises,5 and Implementation of Privatization Program for Public Manufacturing Enterprises.6

C. Objectives and Scope at Appraisal

6. The principal objective of the Program was to stimulate growth and efficiency in the industry sector by minimizing the Government’s role in the ownership and management of manufacturing activities. Implementation of the Program was to enhance financial discipline of PMEs and thus free resources to revive private sector activities.

7. The Program included policy reforms in seven areas: (i) minimizing the Government’s role in the industry sector in general and in the manufacturing sector in particular, (ii) enhancing managerial autonomy and accountability of PMEs,7 (iii) enhancing financial autonomy and accountability of PMEs, (iv) implementing privatization of PMEs, (v) measures to address employment issues, (vi) policy actions for the environment, and (vii) supporting institutional reforms to provide better PME oversight.

D. Financing Arrangements

8. On 17 December 1991, the Board approved the Program loan for SDR90.456 million (about $125 million) to support the Government's reform program. The loan became effective on 20 January 1992. The Borrower was the People’s Republic of Bangladesh and the Executing Agencies (EAs) were the Bangladesh Bank for administration and utilization of the ADB loan proceeds, and MOI for program implementation.

9. The loan was to be made available in two equal tranches: the first tranche on loan effectiveness and the second by December 1992. The release of the second tranche depended on compliance with the conditions set out in the policy matrix and the loan document.

10. The counterpart funds generated from the loan proceeds were to be used to finance (i) the local currency cost of ongoing ADB-financed projects, (ii) other development projects, and (iii) the financial restructuring of selected PMEs to be divested during the Program implementation period. In addition, up to Tk900 million was to be used to rationalize employment in the PMEs.

E. Program Completion Report

11. The release of the second tranche was canceled on 25 April 1994 due to delays in meeting important policy covenants. The loan was closed in April 1994, earlier than the target date of June 1994. The program completion report (PCR)8 discusses the scope, implementation, impact of policy reforms, and benefits of the Program. Three TAs supported the program implementation (footnotes 4, 5, and 6). The PCR found that insufficient time given to implementation of the TA recommendations resulted in the TAs not being very effective.

4 TA 1635-BAN: Strengthening of Institutional Framework for Restructuring Public Manufacturing Enterprises, for $400,000,

approved on 2 January 1992. 5 TA 1636-BAN: Improvement of Labor Productivity in Public Manufacturing Enterprises, for $325,000, approved on 2 January

1992. 6 TA 1637-BAN: Implementation of Privatization Program for Public Manufacturing Enterprises, for $446,000, approved on 2

January 1992. 7 Bangladesh Jute Mills Corporation was excluded from the Program as it was to be covered under a separate World Bank

loan. 8 PCR: BAN 23441: Second Industrial Program Loan, December 1997.

Appendix 5, page 3

12. The PCR noted that by opening up the economy to private investment in the key infrastructure sectors under the 1991 industrial policy, the Program paved the way for stimulation of growth and efficiency in the industry sector in the medium to long term. However, in the short term, the impact of the Program policy conditions was minimal due to the slow pace of the privatization program and the inability of the PMEs to operate on commercial terms. Thus, the Program was rated as unsuccessful.

F. Evaluation

13. This program performance audit report (PPAR) focuses on important design aspects of the Program with a view to drawing lessons for future operations. The Operations Evaluation Mission visited the country from 6 to 21 March 2000. The final PPAR is based on a review of the PCR, loan documents, and materials in ADB files; as well as discussions with ADB staff, EAs, other agencies of the Borrower, and the larger development community in the field. The draft PPAR was sent to the Borrower and the EAs with a request for comments. Although the request was followed by faxes, no comments were received; it is therefore assumed that neither the Borrower nor the EAs wish to comment on the PPAR.

14. The PPAR presents an analysis of (i) the Program’s design and implementation arrangements, (ii) its effectiveness in initiating and implementing policy reforms, and (iii) overall impact on the industry sector. The report also presents findings on progress made in an important area of industrial policy, i.e., PME commercialization and privatization. Based on the analysis, the PPAR lists important lessons for future operations.

II. IMPLEMENTATION PERFORMANCE

15. The Program identified over 40 specific policy actions, which were organized in a policy matrix with specific target dates for action. An updated report on the status of compliance is presented in Appendix 2. Many policy covenants remain unfulfilled. Although the Government announced a new industrial policy in 1991 and initiated policy reforms in trade and exchange control liberalization, overall implementation of the Program has been weak and uneven. The following sections provide a summary assessment of the implementation of major policy measures.

A. Policy Reforms and Institutional Development

16. Government Role in the PMEs. The basic objective of the Program was to reorient the existing PMEs to become commercial organizations. Six specific components were identified and incorporated in the 1991 industrial policy. The ultimate goal of establishing fully autonomous commercial organizations has not been fully achieved. While the Government has withdrawn guarantees for PME borrowing, the sector corporations (fully owned by the Government) continue to provide counterguarantees. Output price controls continue for fertilizer, sugar, and paper, and occasionally, the Government exercises price restraints to fulfill other objectives. Overall progress has been very slow in divesting the PMEs. Finally, the Government has yet to set up transparent and commercial procedures for bringing private sector personnel on to the management boards of sector corporations.

17. Improving PME Management Autonomy and Accountability. Prior to the Program, most PMEs operated under Presidential Order 27 issued in 1972. Under this order, the Government could virtually give any instruction to the corporations, which could do the same to the individual PME. The Program planned to amend this framework and establish PMEs as commercial entities, independent of Government. By June 1992, all of the PMEs were to be incorporated under the Companies Act. This legal change was seen as the minimal starting point for restructuring and freeing existing PMEs from heavily regulated procurement processes, and labor and pricing procedures. It was expected that by

Appendix 5, page 4

creating separate companies under the Companies Act, the PMEs would be subjected to the commercial discipline of independent boards and management, external audit, requirements for annual general meetings, and transparent and accountable functioning. In reality, although most PMEs now exist as companies,9 overall autonomy of boards remains weak. Sector corporations were not converted to holding companies,10 they have retained their original form. The Government was to amend the provisions of the Services (Reorganization and Conditions) Act (Act XXXII of 1975) to exclude its application to sector corporations and PMEs. This amendment was to provide the PMEs with the necessary autonomy to set salary and benefits of its employees according to market conditions rather than follow civil service salary scales. The Cabinet rejected this proposal. Thus PME wages and salaries remain tied to Government pay scales.

18. Measures to Improve Financial Autonomy and Accountability. Under the Program, the PMEs were to be subjected to a performance and accountability system with incentive compensation linked to profitability. With salaries tied to civil service rates, the important link between compensation and company performance was not established. Covenants relating to autonomy for the budget and rolling plans, and uniform standards of accounting were not implemented either. While the PMEs and sector corporations are required to prepare external audit reports and publish these annually, these reports continue to be delayed. The criteria for return and payment of dividends by the PMEs to the Government have not been implemented, and the PMEs continue to provide dividends on an ad hoc basis, as per the demands of the Ministry of Finance and the general budget. The Government has withdrawn the guarantees it used to provide for PME borrowing, but the financial discipline and accountability for PMEs and sector corporations remains weak. The program reforms have made the process of interfirm transfer of funds more transparent.

19. Measures to Encourage Privatization. The Program specified various policy measures for PME privatization. As a first step, the Government was to develop a classification system based on financial and economic criteria to select PMEs for divestment, but this was not done. Just prior to the loan negotiations, the Government identified individual units to be privatized under MOI based on the decision of the Disinvestment Board at their October 1991 meeting. Time-bound targets were agreed under the Program for privatization and divestment; five units were to be fully privatized by December 1992 and nine others by December 1993. To increase PME private shareholdings, the Government was to take steps to float shares in five partially privatized PMEs by December 1992, and the remaining nine by December 1993. This was not achieved as per the time schedule. The Government was also to prepare a plan for privatizing the remaining PMEs in forest, engineering, sugar, food, and chemical subsectors, as well as take steps to privatize 20 textile mills in two separate batches of 10 each. In all, the Program aimed to divest 14 units, privatize 10 textile units, and undertake offers of sale for 10 textile units before the release of the second tranche. Only three units were privatized during program implementation. Another two units were approved for privatization, but the process was stalled due to opposition. Privatization of one unit was held up due to legal complications, and the tender response of six units was poor. Overall success of the Program in privatization was rather modest. Appendix 3 provides a comprehensive account of privatization.

20. Measures to Address Employment Issues. The PMEs were to introduce a compulsory retirement age of 60, impose a freeze on new hiring except for identified categories, and offer additional 9 The Operations Evaluation Mission requested the latest annual reports of the sector corporations to determine if the

corporations were operating as commercial entities; however, reports were not readily available. Most audited annual reports are delayed by more than two to three years.

10 There were a few but important discrepancies in the covenants as set out in the policy matrix attached to the development policy letter and the final Loan Agreement. The Loan Agreement specifically provides for incorporation of sector corporations under the Companies Act to enable them to function under the Companies Act, the policy matrix does not specifically require this. As a result of this ambiguity, sector corporations such as Bangladesh Chemical Industries Corporation continued to function under the Presidential Order 27 and not under the Companies Act as was envisaged in the Program. During implementation, a TA consultant noticed this particular discrepancy, but monitoring was continued using the policy matrix.

Appendix 5, page 5

incentives for voluntary separation. These conditions were fully complied with. The Government has reduced staff in the PMEs substantially. During 1990-1999, BTMC laid off nearly 27,904 workers under various voluntary schemes at a cost of Tk2.87 billion. BTMC now has 11,252 employees compared with 42,670 in 1993. Similarly, Bangladesh Steel and Engineering Corporation now has 6,452 employees compared with 13,182 in 1990. An action plan to deal with surplus labor was to be prepared to reduce the number of employees by approximately 3 percent annually during program implementation. Compliance with these conditions cannot be determined due to lack of data.

21. Environment. Three loan covenants relating to environmental improvement of the industry sector were to (i) enact legislation for monitoring pollution control facilities and enforcing environmental standards in industries; (ii) complete reorganization of the Department of Environment to address environmental concerns associated with industrial development; and (iii) formulate and implement pollution control measures for major polluting industries including, at minimum, fertilizer, paper, leather, and chemical industries in the public sector and for privatized PMEs. There was substantial delay in meeting these three covenants. The Environment Conservation Act was passed only in 1995. ADB provided another project preparatory TA in 1992 to assist the Government in formulating and implementing industrial pollution measures.11 This TA prepared an institutional development program for the Department of Environment and identified polluting industries and sources of pollution in PMEs. Progress in actually implementing these recommendations is very slow. The Government did not approve the proposals prepared by the consultant for reorganization of Bangladesh Forest Industries Development Corporation. The corporation’s overall financial performance has improved: it is the only sector corporation involved with manufacturing activities that does not have large losses.

22. Institutional Reforms. Two high-level interministerial committees were to assist the Executive Committee of the National Economic Council, headed by the Prime Minister. The Executive Committee was responsible for restructuring and divestment of PMEs. The Interministerial Committee on Industrial Reforms (ICIR) was set up under the secretary, MOI and the Interministerial Committee on Privatization (ICP) was established, headed by the principal finance secretary and supported by the Autonomous Bodies Wing. A new division, the Industrial Policy Reforms Wing headed by a joint secretary was set up in MOI and the TA on institutional reforms was to assist them with overall program implementation (footnote 4). These institutional arrangements were put in place prior to program loan approval. The other covenants related to rationalizing public investment programs by setting criteria for new investments in the PMEs and for all Government investments. None of these were implemented. The level for private investment requiring government approval was raised from Tk100 million to Tk300 million.

B. Procurement and Disbursement

23. The first tranche, SDR45.228 million, was released in two installments in February and April 1992. It was fully liquidated by October 1992. The proceeds of the loan were utilized to cover the foreign exchange costs of eligible imported items that originated from ADB developing member countries. The largest source, in terms of value, was Singapore accounting for about 32 percent of imports under the loan. Other sources include Japan (13 percent); Hong Kong, China (11 percent); Indonesia (9 percent); and France (about 9 percent). Imports included crude palm olein, B.P. sheet, cement, and high-speed diesel.

24. The Program was to use up to Tk900 million to rationalize employment in the PMEs. The cost of the labor redundancy program has been Tk2.8 billion; this was funded largely from the budget.

11 TA 1769-BAN: Industrial Pollution Control Management, for $600,000, approved on 22 October 1992.

Appendix 5, page 6

C. Management of the Program

25. Monitoring Mechanisms. Various monitoring mechanisms set up under the Program and TAs were not adequate to deal with the basic design deficiencies of the Program. Program monitoring system did not create a permanent group within the Government to support a change process that promised long-term gains, but at the expense of short-term costs. ICP and ICIR could not carry out these functions because they themselves were constantly changing. The Government was to send a trend, progress, and impact report periodically, but most of the monitoring activities were timed around a visit of a mission or a major milestone in TA implementation, such as a tripartite meeting.

26. Procedural Problems. The inadequacies of the privatization modality and institutional weakness also affected program implementation. The Government did not develop criteria for selecting units for privatization. The lack of an adequate number of staff with necessary skills to select and value units to be privatized at different levels adversely affected the preparation and processing of privatization proposals.

27. Clarity of Roles. Similarly, lack of a clear mandate and authority for ICP, and failure to clearly define the responsibilities of relevant line ministries hampered privatization. Units and line ministries perceived divestment as a curtailment of their power. Lack of executive authority for privatization in one central place was largely responsible for delays: even with the formation of the Privatization Board, this constraint has continued to remain binding.

D. Effectiveness of Technical Assistance

28. ADB provided three TAs to assist in implementing the reforms. Discussions indicate that the Government would have liked one comprehensive TA with a much greater role for local expertise. Moreover, because the Government perceived the TAs to be prerequisites for the Program, the TAs were not seen as additional resources available for program implementation. There was a limited ownership of the TAs, by the Government or the PMEs.12 In all, the TAs seem to have assisted the Government, but only in a limited way. An important reason was timing. Most reports were finalized between June 1993 to October 1993. Thus, by the time reports were prepared, the Program had already missed important covenant milestones. The quality of TA reports was average.

29. The TA on strengthening the institutional framework for PME restructuring (footnote 4) was very important for program implementation and sustainability of the program results. The TA was to provide institutional strengthening for MOI and the PMEs, to enable the PMEs to function as separate companies on commercial lines, with corporations supervising their budget and performance. Initially, the TA team helped the Government prepare the relevant draft to amend Presidential Order 27, and prepared draft resolutions at individual company levels. The second phase of the TA was designed to implement the framework, but in reality very little was achieved.13

30. By the time evaluation was undertaken, MOI’s institutional structure had changed significantly. The Privatization Board handles individual cases of privatization, and most ministries have set up a cell dealing with privatization. There was no evidence of institutional knowledge or skill build-up in the areas of these TAs. The overall outcome of the TAs was only their reports.

12 At times, the consultants working on the TAs were not allowed to enter the PME facilities. 13 "It has to be admitted that, during the year of the extended Phase II, virtually no practical implementation has occurred of the

policies and recommendations approved at or before the Tripartite Meeting that ended Phase I, despite countless meetings, decisions, timetables, and assurances from the corporations." TA 1635-BAN: Strengthening of Institutional Framework for Restructuring Public Manufacturing Enterprises, Executive Summary, Phase II Report, October 1993.

Appendix 5, page 7

III. PROGRAM RESULTS

A. Achievement of the Objectives

31. The loan document identified expected effects and ultimate desired impacts of major policy reforms. These effects were to be monitored through trend, progress, and impact reports, which the Government was to periodically send to ADB during implementation. Two years after the end of the Program, the Industrial Policy Reform Wing was to prepare a comprehensive report on the program benefit monitoring and evaluation study. In a separate appendix, the loan document presented a tentative list of impacts, but no specific indicators were identified to measure these impacts. No linkages were indicated between the proposed policy reforms, immediate effects, and the final desired impact. Thus, the task of identifying indicators was implicitly delegated to the Government.

32. In reality, the monitoring was confined to progress with covenant compliance and TA implementation, rather than effects or impacts of the policy reforms. The Government does not seem to have prepared the final program benefit monitoring and evaluation report. The PCR too provided only the immediate effect of the Program and no systematic attempt was made to evaluate the impact of the Program on industrial performance, overall efficiency, or performance of PMEs.

33. The reforms initiated by the Program were an integral part of the overall structural adjustment program aimed at making domestic industries competitive. This required simultaneous liberalization of trade and exchange rate policies. It is, therefore, difficult to isolate the overall impact of the Program on overall industrial performance.

1. Industrial Growth

34. The Program was to improve overall efficiency of the industry sector by (i) making the PMEs more internationally and domestically competitive, (ii) deepening trade-related reforms, and (iii) encouraging the private sector by streamlining the business environment and reducing barriers to new investment. A reduction of the Government’s role in manufacturing activities and reform of the PMEs by imposing greater financial discipline were seen as integral components of the adjustment program to rejuvenate the moribund industry sector. Appendix 4 provides an overall review of the industry sector during last decade.

35. Throughout the 1970s and 1980s, the industry sector stagnated with a growth rate of only 3.2 percent per year compared to the 3.9 percent gross domestic product (GDP) growth rate. Thus, instead of providing a stimulus, manufacturing actually constrained economic growth. Within the manufacturing sector, the performance of small-scale industries remained weak growing at only 1.4 percent per annum. During the first eight years of the 1990s, the performance of the economy improved markedly with GDP growing at nearly 5 percent per annum. Manufacturing expanded to 6.5 percent with large-scale manufacturing faring better (8.4 percent) than small-scale industries (3.9 percent). Although these rates are by no means spectacular, they indicate significantly better performance compared with the past 20 years (Table 1).

Table 1: Annual Growth Rates (percent)

Item 1975 to 1991 1991 to 1999a 1991 to 1995 1995 to 1999a Manufacturing 3.2 6.5 8.2 5.2 Large 5.0 8.4 10.7 5.6 Small 1.4 4.0 3.5 4.4

Appendix 5, page 8

Agriculture 2.3 2.7 0.8 3.7 Gross Domestic Product 3.9 4.9 4.3 5.5

a 1999 figures are provisional. Source: Government of Bangladesh, Economic Survey 1999. Dhaka.

2. Competition and Efficiency

36. In 1993, several industries including jute and cotton textiles, sugar, leather, leather products, and ready-made garments were shielded by effective protection rates of nearly 100 percent or higher; while other goods, particularly agricultural products such as cereals and chemical fertilizers, were subject to negative effective protection. The tariff and quantitative restriction rationalization program of the 1990s substantially reduced the effective protection of all protected industries, except textiles, which continues to enjoy a high level of protection. Overall unweighted tariffs have been reduced from 89 percent in 1991 to about 20 percent in 1999.14

37. During the 1980s, the average growth rate of exports (in nominal dollars) was only about 7 percent per annum. But in the 1990s, it jumped to more than 15 percent. Imports grew at nearly 11 percent. Such rapid rates of growth mean that the share of exports and imports in GDP rose steeply. Compared with 1990, the exports to GDP ratio increased from 6 percent to 15 percent, and imports to GDP from 14 percent to about 20 percent. The share of trade in total GDP is higher at 34 percent now compared with 20 percent in 1990.

38. There is some evidence that dismantling of the negative bias against exports led to the expansion of export-oriented units. Industries that were able to adjust to changing conditions fared better than the units that did not adjust or were slow to adjust. Overall, the industry sector is more competitive now compared with the early 1990s.

3. Performance of the PMEs

39. Role of the PMEs in the Economy. An important impact expected from the Program was a reduction of the role of the Government and particularly the PMEs within the overall economy. The Government’s share of output, value added, and employment has been reduced substantially. From a contribution of almost 30 percent of total output or 1.6 percent of GDP in the early 1970s, the PMEs in 1998 accounted for 9.9 percent of total industrial output or 0.6 percent of GDP. The value added by the PMEs also decreased substantially even in nominal terms. In 1989, the PMEs accounted for about Tk11.4 billion of value added; this declined to Tk7.9 billion in 1999. This decline is largely due to the closure of many PMEs, decrease of new investments, and faster growth of the private sector. The Government reduced investments in the PMEs drastically during this period: from Tk8.4 billion in 1990 to Tk1.7 billion in 1998. Total employment also declined substantially: from 238,908 in 1990 to 149,230 in 1999.

40. Fiscal Impact. Another important program objective was to reduce overall fiscal pressure on government finances. Overall fiscal burden on government finances increased sharply during this period. Despite a reduction of the numbers of PMEs, overall net losses of five PMEs increased from Tk53 million in 1989 to Tk3.8 billion in 1999 (Table 2). Total PME losses continue to account for a substantial share of the overall losses of state-owned enterprises. Detailed performance of individual PMEs is presented in Appendix 5.

Table 2: Profits and Losses of Public Manufacturing Enterprises 14 World Bank. 1999. Bangladesh: Key Challenges for the Next Millenium. Dhaka.

Appendix 5, page 9

(Tk million)

Corporations 1989 1990 1991 1994 1996 1997 1998 1999 BCIC 246 455 (464) 255 (1,214) (2,379) (689) (1,674) BFIDC 8 (39) (57) (51) 30 17 (70) 61 BSEC (78) (358) (856) (1,102) (645) (1,033) (1,124) (978) BSFIC (255) 171 (125) (196) (378) (653) (392) (360) BTMC 25 (170) (629) (1,539) (1,344) (1,633) (927) (887) Total PMEs (53) 59 (2,131) (2,632) (3,551) (5,681) (3,202) (3,838) BCIC = Bangladesh Chemical Industries Corporation, BFIDC = Bangladesh Forest Industries Development Corporation, BSEC = Bangladesh Steel and Engineering Corporation, BSFIC = Bangladesh Sugar and Food Industries Corporation, BTMC = Bangladesh Textile Mills Corporation, PME = public manufacturing enterprise. Source: Monitoring Cell, Ministry of Finance. Budget of Autonomous Enterprises. Various issues.

4. Privatization of PMEs

41. The Program set out an ambitious timetable for reducing Government shareholdings and privatizing the PMEs. Fourteen units with existing private shareholdings were to be substantially divested, whereas 20 other textile units had to be privatized. In addition, the Government was to prepare a privatization plan for the remaining PMEs. In reality, only three units were privatized during the Program.

42. Since loan closure, the Government has privatized 18 units for a total sale price of Tk1.9 billion. In addition, 7 units have been issued letters of intent, and tender processes have been completed for another 4 units. In the textile sector, BTMC has initiated a system of operating leases with the private sector, and as a result, no mills are operated by BTMC directly.

B. Sustainability

43. The Government remains committed to the reforms initiated under the Program. In 1999, the Government announced a new industrial policy15 to achieve the long-term objective of manufacturing contributing at least 25 percent of GDP and 20 percent of overall employment. In this new policy, the Government has retained only four areas (arms and ammunition, security printing, nuclear energy, and forest plantation) under the reserved list for the public sector. The private sector can set up units without any restriction for all other industrial activities. Under the privatization and reform of state-owned enterprises, the Government is contemplating international collaboration and management contracting systems to make these units competitive. The Government is also continuing its efforts for privatization of PMEs. Overall, the existing policy measures are expected to continue the reform process initiated under the Program. The 1999 policy proposes a new scheme, employee-owned stock program, to divest some units. Nine textile mills are being handed back to the workers.

IV. KEY ISSUES FOR THE FUTURE

44. The Program supported diverse policy measures to improve efficiency of and competition in the industry sector, and to rationalize the role of the Government in manufacturing activities. The PMEs continue to report large financial losses: the PMEs’ liabilities continue to account for a large share of nonperforming assets of the nationalized banking sector. Overall resource mobilization for the economy continues to be adversely affected. The program implementation highlights three important issues.

15 Government of Bangladesh. 1999. Industrial Policy 1999. Dhaka.

Appendix 5, page 10

A. Program Formulation

45. Barriers to Policy Reforms. It is essential to identify significant barriers to reforms at the outset. This requires an in-depth analysis of institutional structures and government processes. The Program was an extremely complex program because it aimed to reform a sector that had chronic performance problems. There were several studies during program formulation, but none dealt with the basic question of why the Government was not able to improve the performance of PMEs. Such an analysis should have been an essential first step. Although there was a policy statement indicating political commitment to reforms, the Program was far too demanding for the political system16 given the agenda of reforms and the capacity of the Government.

46. Reforms as Process. It is important to see policy reforms as a long-term process. ADB and most other international financial institutions had extensive experience with project finance that involved limited uncertainty, low risks, and a top-down approach to economic governance. As a result, even programs of reforms were designed using largely the same tools and approaches. Most policy-based reform programs were seen as delivering straightforward policy changes in exchange for aid finance. Participation was defined as explaining the key elements and monitoring of progress. Institutional development was simply management of TAs. The Program (and other similar programs) designed to improve the existing policy environment involve much more than these blueprints. Overall success depends on effectively addressing three factors that contribute to performance: the formal rules or structures, informal norms, and enforcement mechanisms.17 The Program aimed to change the formal PME structure and expected this would automatically lead to commercial viability. It was difficult to succeed without addressing the other two factors. Even with the changed legal status, the PMEs have no real autonomy. Given the weak enforcement structure, the PMEs continued to have soft budget constraints.18 The process approach to reforms required maintaining the focus on organizational change and institutional development, and working with the Government to implement change process. It also needed flexibility during implementation. The program lending instruments in the early 1990s did not provide such flexibility or resources: most program loans normally allowed two tranches, over 12 to 18 months. Overall concern for quality of the country portfolio meant that timing could not be extended without adverse effects on the pipeline of projects.

47. Specificity and Timing of the TAs. It is important to identify individual tasks clearly. Specificity19 was not a strong aspect of the program design; specific tasks were identified and carried out during implementation using the TAs. Although the matrix identified major policy actions, each action required several specific tasks; in many cases these involved other Government agencies. For example, the requirement for the PMEs to be restructured into companies needed legal changes (amendments to existing rules). This required preparing and piloting this amendment in Cabinet and Parliament, changing articles of association of individual companies, passing appropriate board resolutions, and listing with the registrar of companies as a separate company under the Companies Act. Each change involved accomplishing numerous specific tasks. Given the weak institutional capacity of the bureaucracy, work culture, and lack of strong incentives, even simple tasks became long and arduous. It was important to complete the TAs and identify all tasks before the Program began.

16 It is important to recognize that inefficiency in any economic system implies creation of large vested interest groups. Ability

of the existing political system to deal with such interest groups is a very important parameter in implementing reforms. With a new government, this was a major uncertainty and there was no track record of reforms to go by.

17 Douglas North. 1995. The New Institutional Economics and Third World Development in The New Institutional Economics and Third World Development edited by John Harriss, Janet Hunter, and Colin Lewis. London: Routledge.

18 When the Government stopped providing counterguarantees for their borrowings, two other informal structures (in the form of friendly instructions to nationalized commercial banks and counterguarantees from sector corporations) afforded them resources that would not have been available otherwise.

19 Specificity includes the degree to which it is possible to articulate the objectives of a particular activity, the methods for achieving them, and the ways of controlling achievement.

Appendix 5, page 11

48. Institutional and Human Capacity. There was no systematic assessment at the design stage of institutional capacity, existing skills, or human resources for the required tasks. The institutional capacity was perceived as a risk to implementation, but the creation of separate structures in the form of high-level committees and provision of TA was seen as adequate to deal with this risk. In reality, ICP was unable to either remove the existing institutional constraints (lack of skills, motivation, accountability, or continuity), or to create a strong focal interest group within the Government. Uneven political support, combined with weak institutional and human capacity were not explicitly built into the design of the Program. The TAs associated with the Program were not able to remedy these weaknesses.

49. Financial Structure and Labor. Privatization in the Program was seen as a simple exercise of restructuring the PMEs into companies and then off-loading their shares through stock exchange. In reality, the process was much more involved. High debt liability and excess labor were two structural problems, and lack of a systematic approach to deal with the problem of debt meant very slow progress in implementing privatization targets. Enterprise valuation continued to be carried out at book values of fixed and current assets and liabilities. Buyers were expected to assume responsibility for all long-term liabilities making appropriate arrangements with the financial institutions for debt management. For the initial sales, buyers were also to refrain from laying off workers for at least one year. Financial liabilities continue to hamper the privatization process even today.

50. Incentives. In retrospect, the program design points to an inherent mismatch of incentives for different stakeholders. The sector corporations wanted to retain ownership and controls of profitable PMEs and pass on largely loss-making units for privatization. The market was not interested in only loss-making units. Labor largely resisted the changes as alternative employment opportunities in the surplus labor economy were limited. It was not realistic to expect bureaucrats and the politicians who benefited from the PMEs to become agents of change. For the Program to be successful, a large part of MOI’s oversight functioning needed to be eliminated, but the very same officials were given the task of divesting and restructuring the PMEs. Even within ADB, there are strong incentives for the staff to develop a demanding policy reform agenda for program loans because the Board lends its support more easily to difficult reforms to be achieved as quickly as possible.20 Reality checks on risk assessment, if ever carried out, only tend to scratch the surface. The peer review process in this case brought important risks to the forefront, but they were dealt with superficially.

B. Ownership and Political Commitment

51. Policy reforms usually require strong political commitment and ownership. The Program was formulated, processed, and implemented by different governments. The elected government was quite new, and so to a large extent, implementation depended on the ownership and commitment of the bureaucracy to carry the reforms forward. Discussions in the field indicated that though a few high-ranking officials had a high degree of ownership at the time of program formulation, this ownership was neither widespread, nor retained throughout the program period. While there were in-principle agreements over the broad policy changes, there were no specific "buy-ins" at the middle and working levels to push the tasks to adhere to the program timetable. Given the bureaucratic structure, there was only limited continuity in ICP and ICIR, and as a result, no single focal group owned the program reforms.

52. At the macro level, all the loan proceeds were available for general budget purposes and for development projects. MOI had to undertake the difficult task of restructuring units in exchange for the promise of long-term gains. With little motivation and weak institutional structure, the best possible option for the officials was to delay reform implementation. In retrospect, it is safe to conclude that it

20 Review of internal documents, including Board discussions on several program loans, confirms this observation.

Appendix 5, page 12

was not correct to expect commitment from MOI officials or sector corporations, because with reforms their own power base and, at times, even job opportunities were at risk. It was important to devise an institutional framework that enhanced the existing incentives.21 Thus, it is important to look for indicators of political commitment and ownership beyond the mere fact that the Government’s new industrial policy implied a high level of ownership. Greater emphasis needs to be placed on issues such as inherent incentives.

53. It is not just the Program that ran into problems with bureaucratic delay and lack of political will. The World Bank's Industrial Sector Adjustment Credit 2 and the Jute Sector Adjustment Program were not fully disbursed. The self-evaluations for these programs point to lack of commitment and political will for reforms as the key issue.22 The issue of ownership and political commitment goes beyond isolated operations and needs to be dealt with at multiple levels.23

54. The international best practice for privatization indicates different models depending on the local conditions. The most frequently successful practice is to give the privatization responsibility to a third agency. However, it is important to transfer ownership24 to the responsible agency so that sector ministries do not block the process. It may also be useful to reduce the size of the oversight ministry simultaneously. The Government should not transfer all such units to a third agency as it may not have the capacity to deal with so many new responsibilities. An action plan could be used with transfer of ownership staggered so that the agency remains efficient. The process should be made as autonomous and transparent as possible.

C. Accountability and Governance Structures

55. Overall, motivation in many national bureaucracies is quite low; Bangladesh is no exception. Low motivation, combined with inadequate skills and little accountability, usually leads to implementation problems. Most of the program implementation problems arose from incomplete policy, and the poor legal and supervisory environment. Successful privatization requires effective accountability in terms of appropriate standards of law, accounting, disclosure, and governance.

56. Successful reforms require a strong governance structure with effective accountability. Overall institutional structure for accountability in Bangladesh is weak, and as a result, implementation of reforms is slow. Even when reforms are implemented, overall impact may be much lower compared with countries, where there is much greater accountability. It is important to address governance and accountability weaknesses and to work on civil service reform simultaneously when widespread policy reforms are being introduced at sector levels. Clear and effective accountability is a precondition for any reform program to deliver positive impacts.

21 In retrospect, one could say that an independent structure with full authority in the Ministry of Finance might have worked

effectively; or part of the loan proceeds could have been given to MOI as additional resource transfers, but tied to delivery of the desired policy reforms.

22 The implementation completion report for the Adjustment Credit concludes as follows: "even strong political commitment, a few highly competent senior officials, and vigorous Bank support may be unable to prevail in the face of an unsupportive bureaucracy which is at the same time threatened by rapid change and technically weak in some key areas and thus empowered to thwart implementation of policy reforms."

23 For example, country programming needs to keep policy reforms and important milestones on their discussion agenda. Partnership with other parts of civil society can also be used to exert pressure.

24 With full ownership rights, the agency should also have the authority to change management in case the existing management is delaying the process.

Appendix 5, page 13

V. CONCLUSION

A. Overall Assessment

57. The Program was provided when the Government was in need of financial resources. However, the Government was unable to implement most of the reforms as per the agreed timetable. In December 1997, the PCR rated the Program as unsuccessful. To date, the overall performance of the Program in meeting its key objectives and intermediate tasks remains weak. Financial losses of PMEs remain high. Progress with privatization was very slow during program implementation, and although now a few more units are privatized, the Program was unable to enhance domestic resource mobilization in any substantive way through these reforms. Labor rationalization in the PMEs has not led to either improved PME productivity or efficiency. Although the Program was successful in creating appropriate legal framework, most of the PMEs continue to lack market orientation and commercial viability. The Program is, therefore, rated unsuccessful.

58. There are some indirect positive impacts. One positive outcome from the Program is that the Government seems committed to the strategy of private sector-led, export-oriented growth of the economy.25 The desirability of reducing the role of the Government in productive activities outside of some clearly defined areas is now fully established. The Government has ceased setting up new manufacturing units, and new investment in the PMEs (other than fertilizer) has slowed substantially. Manufacturing investment is now mostly private. Similarly, the inevitability of privatization is no longer seriously questioned, although the actual act of privatization of specific units frequently gets caught in procedural and legal problems that stall its progress.

59. At the macro level, the reforms have succeeded in opening up the economy. Public investment was contained at about 6 percent of GDP, while private investment rose from 6 percent to 11 percent during the decade to the late 1990s. The relatively free investment climate seems to have encouraged the increase in private investment. During the 1990s, industrial production increased at more than twice the rate of that in 1980s. Electricity consumption nearly doubled between 1991 and 1997. All these indicators suggest the emergence of a more dynamic industrial economy. Much of this can be attributed to the series of trade and industry reforms implemented in the 1990s.

B. Key Lessons for the Future

1. Stakeholder Partnership

60. Introducing policy reforms in a developing economy is a complex process. Experience with the Program indicates that even Government policy statements are not adequate to ensure the Borrowers' full ownership. Government is not one dimensional; even within government, there are many layers. Although policy reforms maybe owned by some sections, efforts are needed to ensure greater partnership of all. A strong demand for change must be created.

61. Program loans with difficult policy reforms need to build an explicit component aimed at strengthening stakeholder partnerships. Greater awareness of the costs of not undertaking reforms should be systematically and continuously enhanced among larger civil society. With technological advances such as web pages and the expanded role of resident missions, this task is simplified. Such partnerships need to be an integrated part of the implementation strategy and should involve groups of

25 The 1999 Industrial Policy reiterates the Government's commitment.

Appendix 5, page 14

like-minded stakeholders. If possible, independent stakeholders should also be involved in the monitoring process.

2. Reforms as a Process

62. In any bureaucratic system, the introduction of reforms needs to be seen as a long-term process. First the roles of ADB, Government, and consultants need to be clarified. All efforts need to ensure that the Borrower retains ownership and that the Program is not seen as owned by either ADB or the TA consultants. Second, barriers to policy changes must be analyzed. Based on this analysis, an action program must be prepared in consultation with stakeholders, specifying important tasks and monitoring mechanism.

63. Incentives must be aligned with those who deliver the reforms (and thus bear the costs of reforms) and those who receive financial resources. Most program loans seem to be owned only by the Ministry of Finance, because the Ministry receives the additional financial resources that program loans bring. MOI had no financial or other incentive (other than being the reforming sector), but was accountable for undertaking some very difficult tasks such as labor rationalization or closure or privatization of units. In the Program (and in similar program loans), there seems to be thus a mismatch between incentives and accountability. ICP and ICIR were vested with overall responsibility, but they had no authority to make the final decisions. In bureaucratic systems, it is important to aim for better alignment of incentives with accountability for the reforms. In some cases, difficult reforms could also be made the collective responsibility of a few ministers; such groups must be given complete authority to implement the tasks.

64. The new lending instrument, program cluster loans, may be more suitable for correctly aligning incentives with accountability. The overall incentives will be enhanced with targeted resource transfers linked to performance.

3. Monitoring

65. An important lesson is that though loan covenants can supplement the implementation system, they cannot replace broad agreements on ends and means between the Borrower and ADB. It is important to get up-front agreements on all of the specific tasks required for successful program implementation. Covenants can be useful only as monitoring mechanisms; major differences, if any, need to be resolved prior to committing resources.26

66. ICIR and ICP were supposed to monitor the progress, but in reality, ADB and the TA consultants did most of the monitoring. It is important to have an internal system of monitoring that is less vulnerable to bureaucratic transfers. The TA consultants or ADB should supplement internal monitoring, not replace it.

4. Political Feasibility and Governance

67. Most policy reforms and proposals for institutional development impact on the political economy of the countries involved. Reforms in areas such as PME restructuring require economic and institutional analysis of the public enterprise sector, including readiness (capacity) and willingness (ownership) to privatize. An in-depth political analysis of the feasibility of the reform program would be 26 It was brought out in the field that from the point of view of the Government, the costs of not completing reforms are very

large. When international institutions walk away from a sector without completing reforms, overall costs borne by the Government are high, and there is no local constituency to continue reforms under such conditions.

Appendix 5, page 15

an important prerequisite. Such an analysis should also clearly spell out labor market and institutional constraints.

68. If the Borrower is genuinely committed to a task, it will take all the actions needed. ADB or TA consultants cannot make up for a government's lack of commitment to a project or component, or for inadequate implementation capacity, by imposing conditions on its loans. Sometimes, commitment is enhanced if borrowers can anticipate a stream of increasingly larger loans. In a sense, program loans have to have an element of progressive lending if the reform process is to be sustained by greater commitment and political feasibility.

69. Finally, processes of public enterprise reform usually threaten many vested interests and result in resistance in any society. It is important for ADB and other external financiers to make efforts to bring about attitudinal changes within all of civil society. These changes need to be undertaken in partnership with domestic institutions that support the reforms. In economies like Bangladesh, only when the civil society supports reform and modernization much more aggressively, it is possible to implement reforms. There is a residual sympathy for the public sector in this country, and hence, this needs to be targeted if any major change in attitudes is to be brought about.

C. Follow-Up Actions

70. The policy reform agenda of the Program remains largely unfulfilled. The Government has not been able to remove the structural constraints to the functioning of PMEs as commercial entities. The lack of privatization progress reflects deep-seated inefficiencies and governance problems. The PMEs continue to have soft budget constraints with large negative fiscal impacts. Vested interests, lack of political commitment, and trade union opposition continue to delay progress. It is important for the Government to reduce the fiscal burden resulting from the PMEs by divesting the PMEs as quickly as possible. Since the Privatization Board does not have the necessary authority to speed up the process, the Government must develop a time-bound credible action plan to deal with the PME problem.

71. Finally, improved access to financial resources is crucial to promote industrial growth and diversity. Unless there is substantial progress with financial sector and banking reform, growth will not be achieved. Because the PMEs account for a large share of nonperforming banking assets, the Government must urgently address this issue.

Appendix 5, page 16

APPENDIXES

Number Title Page Cited on (page, para.)

1 Development Policy Letter 18 1, 3 2 Industrial Policy Matrix 24 3, 15 3 Privatization in Bangladesh 34 5, 19 4 Industrial Performance 41 8, 34 5 Performance of Public Manufacturing Enterprises 46 9, 40

INDUSTRIAL POLICY MATRIX

AGENDA OF POLICY REFORMS UNDER THE PROGRAM Policy Area/Objective Policy Action Compliance Status Second Tranche Cancellation PCR (Dec 1997) Current Status (Mar 2000) A. POLICY REFORMS 1. Government Role in Public Manufacturing Enterprises Announce overall policy and medium-term strategy to reform the public manufacturing enterprises (PMEs).

The revised industrial policy will state that (i) PMEs will operate on a commercial basis, with full autonomy; (ii) foreign private investment (including joint ventures) to restructure PMEs will be encouraged; (iii) Government guarantees on PME borrowing will be withdrawn; (iv) output price controls would be eliminated, except for monopoly and sensitive items; (v) total disinvestment of up to 100 percent of partially disinvested PMEs will be permitted; and (vi) qualified private sector personnel will be inducted in the management boards of sector corporations and enterprises.

The new Industrial Policy was announced prior to the approval of Program Loan (1991).

Industrial Policy introduced in 1991 and amended in 1992 continues to be in effect. The draft Fifth Five Year Plan identifies private sector as the main engine of industrial growth and aims at facilitation of private sector investments through privatization of state-owned enterprises, liberalization, deregulation of public control, incentives to attract foreign direct investments.

(i) Not implemented. PMEs are neither fully autonomous nor operating on a commercial basis. (ii) A policy for joint investment is now being framed. (iii) The Government is not providing any guarantee but the corporations are providing counterguarantees. (iv) Output price controls have not been fully withdrawn. The Government is exercising a moratorium on paper price increases. (v) Not implemented fully. (vi) Not complied with.

2. Measures to Improve Managerial Autonomy and Accountability Incorporate the sector corporations as holding corporations of the PMEs. Incorporate the PMEs as public limited liability companies.

a) The PMEs will be incorporated as subsidiary companies with limited liability under the Companies Act of 1913 with the shares owned by the sector corporations, while the sector corporations will be designated as holding corporations.

Status of Incorporation Units under Ministry of Industries (MOI) Bangladesh Steel Engineering Corporation (BSEC): All 19 units incorporated.

Most of the PMEs are incorporated under the amended Companies Act of 1992. However, the sector corporations continue to operate under the separate statutory acts.

BSEC: All companies with limited liability. Sector corporations continue to operate under the separate statutory acts.

Appendix 2, page 1

24

Policy Area/Objective Policy Action Compliance Status Second Tranche Cancellation PCR (Dec 1997) Current Status (Mar 2000)

Bangladesh Chemical Industries Corporation (BCIC): Out of 22 units, 21 were incorporated. Bangladesh Sugar and Food Industries Corporation (BSFIC): Out of 19 units, 3 remained to be incorporated. Units Under Ministry of Textile (MOT) Bangladesh Textile Mills Corporation (BTMC): Out of 41 units, 17 were incorporated, and 20 units that were expected to be privatized were not incorporated. However, 4 units remained to be incorporated. Units under Ministry of Environment and Forest (MOEF) Bangladesh Forest Industries Development Corporation (BFIDC): BFIDC rejected recommendations of consultants regarding its reorganization and has undertaken an in-house study to consolidate its units. According to the recommendations of this study, BFIDC was to reorganize its 15 units into 4 by grouping the rubber and timber units and one logging unit was to operate under BFIDC.

BCIC: Only one enterprise remains to be converted into a company with limited liabilities: Tekerhat Limestone Mining Project. BSFIC: All enterprises are limited companies. No further progress. No further progress.

b) The Government will establish a procedure for screening prospective candidates for corporation board appointments drawn from the public and private sectors and from the academic, legal, and accounting professions.

The Government did not establish the required procedures; however, MOI issued instructions to the sector corporations (through notification of 29 Nov 1992) to take steps to appoint directors.

No further progress.

Appendix 2, page 2

25

Policy Area/Objective Policy Action Compliance Status Second Tranche Cancellation PCR (Dec 1997) Current Status (Mar 2000) Strengthen managerial autonomy for PMEs.

c) The PME management will be given the authority to decide on appropriate manning levels, including the right to hire and fire on a commercial basis, subject to total freeze on new hiring except for identifiable categories of skilled or managerial staff.

The Boards of sector corporations and PMEs (excluding BFIDC) adopted the resolutions drafted by the consultants which grant autonomy at corporation and enterprise level and recognize that sector corporations are to operate as holding corporations. However, the effectivity of these resolutions was pending the approval of Presidential Order (PO) 27 by the Parliament. In addition to provision in the resolution regarding manning levels, the sector corporations as well as enterprises initiated the labor rationalization program.

Amendment to PO 27 related to the autonomy of the PMEs has been enacted and gazetted.

The PMEs continue to function with limited autonomy.

Identify and eliminate legal constraints that limit policy implementation.

d) The Government will amend the provisions of the Services (Reorganization and Conditions) Act, (Act 32 of 1975) to exclude its application to PMEs and to enable them to function on a commercial basis and to be incorporated under the Companies Act of 1913. The Government will review and amend those of its directives that affect commercialization of PMEs.

The Cabinet rejected the proposal to amend the Services (Reorganization and Conditions) Act.

No further progress.

3. Measures to Improve Financial Autonomy and Accountability Establish performance objectives, guidelines, and targets between corporation and enterprises.

a) The corporations will set strategic targets for PMEs on the basis of guidelines given by the Government. The PME boards will set qualitative and quantitative targets that will form the basis for management incentive compensation over and above regular compensation.

The resolutions adopted by sector corporations (except BFIDC) and PMEs (except those under BFIDC) provided instructions on these aspects, but their effectivity was pending subject to the approval by the Parliament of PO 27.

Amendment to PO 27 related to the autonomy of the PMEs has been enacted and gazetted. However, the impact of new regulations on the financial performance of PMEs has been negligible. Furthermore, overall financial performance of public enterprises, as shown by the consolidated accounts of BTMC, BSEC, BSFIC, BCIC, and BFIDC, deteriorated, with losses increasing from Tk2.44 billion in 1993/94 to Tk5.15 billion in 1996/97.

No further development.

Redefine the system of budget determination and introduce financial accountability to PMEs.

b) The PME budget will be prepared on a three-year rolling basis with annual update and semiannual review, and will be established as the primary document for determining financial accountability of the enterprise.

Not complied with.

Not implemented.

Appendix 2, page 3

26

Policy Area/Objective Policy Action Compliance Status Second Tranche Cancellation PCR (Dec 1997) Current Status (Mar 2000)

c) The Government will issue new guidelines to all PMEs with regard to uniform standards for financial reporting.

Guidelines were issued in Nov 1992 but compliance is weak.

Compliance with accounting standards continues to be weak.

Guidelines in force but compliance continues to be weak.

d) External audit reports prepared by independent auditors will be published annually.

Not complied with.

Complied with.

e) The PMEs will be given authority, responsibility, and accountability for their finances.

The resolutions adopted by sector corporations (except BFIDC) and PMEs provided instructions on these aspects, but their effectivity was pending subject to the approval by Parliament of PO 27.

Not implemented.

Establish greater transparency in enterprise-Government flows.

f) The Government will establish financial criteria relating to return on investment for payment of dividends from PMEs to the Government.

Guidelines were drafted and were under the Government’s consideration.

The Company Law 1994 has given the directive regarding return on investment. But for the PMEs, the Ministry of Finance (MOF) determines the amount of dividends on an arbitrary basis.

g) The Government will withdraw guarantees given to bank borrowing by PME.

MOI issued a notification in Nov 1993 to reconfirm the decision that the Government will not provide guarantees against any loan by PMEs.

Explicit guarantees have been removed. However, the Government still exercises control over the lending decisions of the nationalized commercial banks and can pressure them to lend to PMEs.

The Government does not give a guarantee, but the corporations do provide counterguarantees.

h) Within a sector corporation, inter-PME transfer of funds from profitable enterprises to loss-making ones will be properly accounted for with a view to eliminating such transfers.

MOI issued instruction in May 1992 to cease inter-enterprises transfer of funds.

Implemented.

Remove price controls on goods manufactured by PMEs, and give management full responsibility and authority for free market operations.

i) The output prices will be determined on an export-parity basis for urea fertilizer, on an import-parity basis for all imported fertilizers.

Subsidies on fertilizer prices were withdrawn in Dec 1992. However, price and export controls on urea remained.

Government resumed subsidization of fertilizer prices with Tk2.1 billion allocated in the budget for 1997/98.

Not complied with.

Improve productive efficiency of PMEs through increased competition.

j) The Government will issue annual performance evaluation of PMEs and rank them according to profitability criteria.

Not yet done.

4. Measures to Encourage Privatization of PMEs

Appendix 2, page 4

27

Policy Area/Objective Policy Action Compliance Status Second Tranche Cancellation PCR (Dec 1997) Current Status (Mar 2000) List PMEs to be phased out and to be privatized.

a) The Government will develop a PME classification to formulate financial and economic criteria to select PMEs for disinvestment, and will make a list of units to be retained or disinvested within a specific time frame in sectors other than jute and textiles.

Privatization of Bangladesh Cycle, Bangladesh Blade, Khulna Hardboard, Deshbandhu Sugar, and Kohinoor Battery was initiated. No response was received to the tender on General Electric. Selection of PMEs for disinvestment was done on an ad hoc basis.

Overall, in the period from 1993 to 1996 only 12 PMEs had been handed over to the private sector. Current Government announced privatization as an essential element of its reform agenda. It currently aims to privatize 224 enterprises mostly in the manufacturing and industry sectors. In 1996/97, share of nine partially state-owned companies were arranged to be offloaded through the Investment Corporation of Bangladesh. In addition, letters of intent to hand over to private sector buyers were issued for eight companies.

There is no set criteria for classifying privatization candidates. It is being done on an arbitrary basis.

b) Steps will be taken to increase private shareholding in 14 partially privatized PMEs.

Of the five units, 3 (Chittagong Cement, Kohinoor Chemical, and Dhaka Vegetable Oil) were privatized. Eagle Box and Shampur Sugar Mill were not privatized. Nine units were at various stages of privatization. For two units, the National Tubes and Metalex, which had been approved for privatization by the Privatization Board (PB) and Cabinet Committee for Finance and Economic Affairs (CCFEA), the process was stalled due to opposition and awaited the Government’s further decision. Privatization of Lira Industries was being held up because of legal problems. The remaining six units were tendered, but the response was poor.

Overall, 82 enterprises are earmarked for privatization in 1997/98 and tenders for their sale have been floated.

Not fully complied with.

c) A plan for privatization of the remaining PMEs in forest, engineering, sugar and food, and chemical subsectors will be formulated and discussed with Asian Development Bank (ADB) prior to its implementation.

Difficulties with privatization of identified units delayed prospects for development of an action plan for privatization of the remaining PMEs.

The World Bank is currently financing a technical assistance project aimed at establishment of the strategy plan and legal framework to govern privatization of PMEs.

Not implemented.

Build upon the successful momentum on the privatization of textile mills to stimulate further privatization in the sector.

d) The remaining audit discrepancies between the BTMC and the privatized textile mills will be resolved.

Audit discrepancies were resolved, and the parties concerned agreed to accept the joint audit report. Guidelines for dealing with outstanding financial liabilities were issued in Dec 1992.

Appendix 2, page 5

28

Policy Area/Objective Policy Action Compliance Status Second Tranche Cancellation PCR (Dec 1997) Current Status (Mar 2000)

e) The Government will develop an action program for the privatization of the entire public sector textile mills.

Difficulties with privatization of identified units delayed prospects for development of an action plan for privatization of the remaining PMEs.

At present, there are 31 textile mills operating in the public sector. Most of them are technologically outdated and all of these mills run at a loss. Government policy as elaborated in the draft Fifth Five Year Plan, is to privatize public sector mills in phases.

Limited progress. (Appendix 3)

f) The Government will take steps to privatize 10 textile mills.

Delay in processing of the tendering of the 10 textile mills occurred because of difficulties in managing labor and debt issues. With the Government’s decision to rationalize the work force in textile sector, the MOT retendered the 10 mills several times. Privatization of the Bangladesh Textile Mill was approved by CCFEA. Four other units, Zofine, Sharmin, Khinoor Spinning, and Madaripur Mills, were to be placed before CCFEA for privatization. Noakhali Mill was to be revalued to determine its realistic indicative price. Barisal and Kishoreganj Mills are to be retendered by PB. Dhaka and Khulna Cotton Mills were not privatized.

Up to 31 textile mills, including Bangladesh Textile Mill, Noakhali Mill, Dhaka and Khulna Cotton Mills, are still to be privatized.

Limited progress. (Appendix 3)

g) The Government will take steps to privatize an additional 10 textile mills.

The list of another 10 textile mills was prepared tentatively, and put up for approval by the Cabinet. In the interim, the MOT was planning retrenchment of another 10,000 workers from these 10 mills to facilitate the process of privatization.

Under the new privatization list, the Government is planning to privatize 17 of the textile mills still under its control. However, the progress to date has been slow due to the resistance of trade unions and poor financial conditions of the mills.

Limited progress. (Appendix 3)

5. Measures to Address Employment Issues

Appendix 2, page 6

29

Policy Area/Objective Policy Action Compliance Status Second Tranche Cancellation PCR (Dec 1997) Current Status (Mar 2000) Implement measures to rationalize PME employment.

a) All PMEs will be committed to (i) introduce fixed compulsory retirement age for workers, (ii) impose a freeze on new hiring except for identifiable categories of skilled or managerial staff, and (iii) offer additional incentives to all workers and employees for voluntary separation from service.

Cabinet approved-corporations/PMEs were in the process of adopting the 60-year retirement age rule. The sector corporations assessed excess labor and started laying off workers. But the bill to fix the retirement age at 60 years, which had been originally planned for presentation to the Parliament for approval, was withdrawn.

Retirement age of employees has been fixed at 60 years.

b) PMEs with unsatisfactory financial performance and with high labor costs will be required to reduce the number of their respective employees in order to achieve more cost-efficient operation, higher productivity, and satisfactory financial performance.

Overemployment was estimated at: 12,654 workers under MOI (including BSEC, BCIC, and BSFIC), of which around 700 were laid off with funds received from MOF 22,768 workers under MOT (BTMC) of which 9,500 were laid off 1,350 workers under MOEF (BFIDC)

The Government introduced a voluntary retirement scheme for PME employees. Under the scheme, 21,100 employees opted for separation. About 14,300 employees actually retired. Further progress is stalled due to the shortage of funds.

27,904 employees were laid off at cost of Tk2.9 billion.

c) The labor rationalization program is to be implemented in accordance with an action plan that reduces workers and employees by approximately 3 percent annually during the program implementation period.

Consultants submitted their recommendation of overemployment.

Overall employment in the public sector enterprises leveled off in recent years at around 260,000 employees, after reduction by close to 20 percent in 1991. Further progress in labor rationalization is being slowed by the lack of funds to finance the separation packages and the resistance from trade unions.

No evidence to sustain this claim.

6. Environment

Address environmental concerns associated with industrial development.

a) The Government will enact legislation to monitor and enforce pollution control facilities and environmental standards in industries.

Draft legislation was prepared and submitted to the Cabinet.

The Environment Conservation Act was passed by the Parliament in 1995. The Act empowers the Department of Environment (DOE) to require conservation-focused, curative, precautionary, and preventive measures. Implementation is however deficient.

Appendix 2, page 7

30

Policy Area/Objective Policy Action Compliance Status Second Tranche Cancellation PCR (Dec 1997) Current Status (Mar 2000)

b) Pollution control measures in major polluting industries (e.g., fertilizer, paper, chemical, leather) in the public sector as well as in privatized PMEs will be formulated and implemented after review by ADB.

The quality standards were drafted.

B. INSTITUTIONAL REFORMS

1. Ministry of Industries

Improve and institutionalize the policy-making role of the Government with a view to controlling indirectly the sector corporations, with an expanded role for the corporations, and greater enterprise autonomy.

a) An Interministerial Committee on Industrial Reforms (ICIR) headed by the secretary, MOI will be set up to support and coordinate with the Executive Committee of the National Economic Council for undertaking industrial policy reforms (including PME reforms) and coordinate with the Interministerial Committee on Privatization (ICP) for undertaking privatization program for PMEs. ICIR will be supported by a secretariat headed by a joint secretary of MOI to formulate and monitor policy measures for managerial and financial autonomy of PMEs and undertake the proposed privatization program in liaison with the Autonomous Bodies Wing in MOF.

In view of the difficulties encountered with the implementation of the privatization program based on the proposed institutional framework that includes ICP and ICIR, ADB recommended establishment of an independent empowered authority to oversee and implement privatization. In response, the Government established in Mar 1993 a PB headed by a chairman and two executive members.

PB is in operation. However, its institutional capacity remains low. It has staff of only seven professional officers. Technical expertise regarding valuation of enterprises, evaluation of bids and offers, and divestment procedures and techniques is limited. Under the recently approved Bangladesh Capital Market Development Program Loan, ADB will provide technical assistance to enhance PB’s capacity to carry out its privatization program.

Limited progress. (Appendix 3)

b) The Secretariat will consist of the staff of the Disinvestment Wing and other relevant MOI staff and is to be made operational.

The Board has no flexibility to take a decision on commercial basis. It is bound by set procedures.

Monitor the impact of policy reforms and improve the planning and policy-making process within MOI.

The Government will prepare and implement a program that will ensure regular feedback and monitoring of ongoing policy reform based on analysis of reliable data by competent professionals.

The Government provided regular feedback on the Program. Monthly reviews to monitor and expedite compliance with the Program were jointly undertaken by the MOI and the Bangladesh Resident Office.

Appendix 2, page 8

31

Policy Area/Objective Policy Action Compliance Status Second Tranche Cancellation PCR (Dec 1997) Current Status (Mar 2000) 2. Department of Environment

Develop the institutional structure for environment management.

The ongoing reorganization of DOE will be completed.

The reorganization and recruitment rules were placed for consideration of MOI.

The recruitment rule for DOE reorganization was approved by the Bangladesh President in Apr 1994. However, implementation is very slow.

No further progress.

C. INVESTMENT PROGRAM

1. Public Sector

Access to Government budgetary funds for public sector development programs of PMEs will be minimized.

a) The public sector development program for the industrial sector, including the three-year (1990/91-1992/93) core rolling investment program, will be discussed with ADB prior to its implementation to ensure that the allocations are in accordance with the priorities and objectives of the industrial reform program.

Not complied with, though the budgetary support for the PME investment program was gradually scaled down. However, MOI was provided an allocation of Tk2.2 billion for the public investment of PMEs in 1993/94.

Public sector investments in industry were further reduced from Tk2.2 billion in 1993/94 to Tk1.1 billion in 1996/97. The share of public sector investment was reduced from 8.26 percent in 1993/94 to 1.87 percent in 1996/97, while the overall investment level, including private sector, increased from Tk2.8 billion to Tk5.8 billion during the same period.

Not complied with.

b) The self-financed investment program of the PMEs will not be undertaken (i) until the PMEs are able to meet their debt-service obligations on schedule and internally generate sufficient cash reserves, (ii) unless the PME is viable without price control or subsidies, and (iii) unless the investment has strong strategic justification and is undertaken in the form of residual equity in joint ventures with the private sector.

Self-financing of PMEs was insignificant.

Operating losses of PMEs continue to be a significant burden on the Government coffers. Operating subsidies estimated at about $600 million per annum (about 2 percent of GDP) continue to be a serious constraint on the budget.

Not implemented.

c) The Government will establish criteria for its public industrial sector investments. As a minimum, the Government will not undertake any further investments in subsectors where there is excess capacity and in units that are nonviable on technical, financial, or economic grounds. Any investment in the industrial sector will have to be supported by strong strategic justification and will be undertaken only on the basis of limited joint venture arrangement in the form of residual equity.

The Government did not establish criteria for public investment in the manufacturing sector. Ad hoc investments continue to be undertaken by the various sector corporations.

Public investments in industrial projects, although at a smaller scale compared to the past, continue in unfocused manner with 65 projects included in the 1996 Annual Development Program.

2. Private Sector

Appendix 2, page 9

32

Policy Area/Objective Policy Action Compliance Status Second Tranche Cancellation PCR (Dec 1997) Current Status (Mar 2000) Increase threshold of projects requiring Government approval to enhance competition.

a) The threshold will be raised from the present level of Tk100 million to Tk300 million, with no restriction on foreign equity participation within the revised threshold.

Complied with.

Under the draft Fifth Five Year Plan, private sector is expected to contribute up to 96 percent of all industrial sector investments over the next five years. All sectors of the economy, except for the five sectors identified in the Industrial Policy, are open to foreign investment. No prior approval or no objection certificate is required for setting up of a joint venture or 100 percent foreign-owned companies.

Fully complied with.

b) The threshold of projects requiring Government approval will be raised to Tk1,000 million.

Complied with.

Fully complied with.

Appendix 2, page 10

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PRIVATIZATION IN BANGLADESH

A. Background

1. Soon after the emergence of Bangladesh as a sovereign country in December 1971, under Presidential Order 1, the Government of Bangladesh nationalized all abandoned properties valued in excess of Tk1.5 million and the entire textiles, jute, and sugar industries irrespective of ownership. The Government decided to restructure the economy and socialize the means of production. The entire formal financial sector comprising banks and insurance companies as well as jute trading were also nationalized. This policy of nationalization suddenly raised the share of public sector assets in modern industry from a modest 34 percent to 92 percent, as the Government acquired full control of 392 substantial industrial and commercial enterprises and numerous smaller units.

2. Although small relative to the total number of business enterprises, these enterprises produced about 7 percent of gross domestic product, 58 percent of manufacturing value added, and 80 percent of exports. It was envisaged at the time that such direct control would help the Government design and implement economic plans to promote rapid industrialization and economic growth of the country within an egalitarian socialist framework. Rigid wage and price controls, and a highly regulated trade regime were put in place. However, the public sector performed poorly and became a serious drag on Government finances. So the Government, in 1974, decided to expand the role of the private sector. Since then, successive governments have emphasized greater reliance on market forces and private initiatives to achieve rapid economic growth. In reality, the legacy of the public sector has remained.

Implementation of Privatization

1. Overall Privatization Experience

3. The first attempts at privatization in Bangladesh began quite early, but very little is known about the institutional arrangements prior to 1982. By 1975, 462 out of a total of 725 mainly small companies were returned to their owners, liquidated, or privatized. Several small industrial units were sold through tenders, using procedures approved by the Cabinet. Implementation was through the Ministry of Industries (MOI). The privatized units did not perform very well and the process was far from transparent. The 1982 new industrial policy represented a major step forward, and a number of jute and textiles industries that were reserved for the public sector until then were partially privatized. Nearly 650 previously nationalized units were returned to the private sector. The Government also initiated steps to improve performance of public manufacturing enterprises (PMEs) by giving greater autonomy, establishing better management information systems, and initiating critical performance evaluation.

4. In one year, the Government denationalized 27 textile mills and 33 jute mills by returning these units to their original owners. This was perhaps the largest and quickest divestment ever done in Bangladesh. The process has slowed considerably since then. The major problem faced by the Government in selling the mills back to the owners was the large cumulative debt liability during the period of public ownership.

5. With the 1986 industrial policy, the Government created two new institutional arrangements to accelerate the privatization program: an executive committee to function as an oversight body for the Disinvestment Board and a working committee to help review and implement divestiture. However, the roles of various agencies were not clearly defined, and as a

3435

result, not a single unit was privatized during 1986-1991. Table A3.1 gives information on the number of units that remained under the sector corporations.

Table A3.1: Number of PMEs under Sector Corporations

Corporations 1976 1986 1991

BCIC 65 23 23 BJMC 78 38 33 BFIDC 20 13 14 BSEC 54 21 21 BSFIC 58 18 20 BTMC 75 48 42

BCIC = Bangladesh Chemical Industries Corporation, BFIDC = Bangladesh Forest Industries Development Corporation, BJMC = Bangladesh Jute Mills Corporation, BSEC = Bangladesh Steel and Engineering Corporation, BSFIC = Bangladesh Sugar and Food Industries Corporation, BTMC = Bangladesh Textile Mills Corporation, PME = public manufacturing enterprise. Source: Consultant's progress reports and Asian Development Bank files.

6. In June 1987, the Government issued a denationalization amendment ordinance whereby 49 percent of shares of profitable PMEs under MOI (Bangladesh Sugar and Food Industries Corporation, Bangladesh Chemical Industries Corporation, and Bangladesh Steel and Engineering Corporation) to be sold to the private sector with 34 percent allotted to the general public and 15 percent to PME employees. Implementation was slow, partly due to inappropriate selection of units. Some of the units that were considered profitable by the Government under trade barriers were very fragile under the liberalized policy environment. The Government seemed to focus only on the current profitability. Thirteen units were partially divested by 1989. Ten more were listed for FY1990.

7. The Government soon realized that partial solutions would not work and therefore in the 1991 new industrial policy, the Government adopted a comprehensive approach to privatize manufacturing units. There were specific commitments relating to privatization under the Second Industrial Program (the Program) loan. A phased program of privatization of 20 units was agreed to. The Government identified 40 units for privatization, and in the April 1992 aid group meeting, the Government made a commitment to privatize a significant share of these enterprises expeditiously.1 The sale of 6 units was completed by mid-1992 through the sale of shares to a wholly state-owned insurance company. In the 1993 aid group meeting, the Government expanded its commitment to privatize additional units.

8. A new privatization board was set up in 1993 to facilitate privatization. However, it managed to sell only 12 units for a total sum of Tk1,869.4 million during 1993-1996. During the tenure of the current Government, the process of privatization has slowed considerably. It sold only 6 units during 1996-1999. These units were mostly small units and the total sale price was only Tk24.8 million. Thus, eight years after the Program was initiated, only 18 PMEs have been fully privatized.

9. Table A3.2 gives the current status of units privatized by the Privatization Board since its inception in 1993. So far, 18 units including 6 very small units have been privatized. In addition, letters of intent have been issued to 7 units for finalization of handing over units to buyers. In 4 cases, the tender process has been completed. The Government is also off-loading shares of 7 additional units through the Board. Two points are worth noting from the data given in Table A3.2. First, overall sale receipts are less than Tk1.2 billion, and in a number of cases, the liabilities are almost twice the tender price. Second, about a third of the units privatized are very small. 1 World Bank. 1994. Bangladesh: Privatization and Adjustment. Report No. 12318-BD. South Asia, Country

Department I, Washington, D.C.

36

TableA3.2: Privatization Efforts Since 1993 (Tk million)

Item Tender Price Liabilities Sale Price

A. List of Units Privatized by the Privatization Board

1. Kohinoor Chemical Company (51% share) 79.7 287.5 367.2 2. Chittagong Cement 335.0 137.9 472.9 3. Eagle Box and Carton Manufacturing (51% share) 20.0 — 20.0 4. Squibb (Bangladesh) Limited (40% share) 1.1 — 1.1 5. Madaripur Textile Mills Limited 80.7 22.1 102.8 6. Sharmin Textile Mills Limited 117.6 115.8 233.4 7. Kishoreganj Textile Mills 95.3 3.8 99.1 8. Kohinoor Spinning Mills 180.5 9.2 189.7 9. Zofine Fabrics Limited 12.5 4.0 165.0 10. Barisal Textile Mills 50.0 16.1 66.1 11. Bangladesh Cycle Industries 22.9 0.9 23.8 12. Dhaka Vegetables Oil Limited 139.4 137.6 276.9 13. Bangladesh Cold Storage 12.5 — 12.5 14. Royal Textile 2.6 — 2.6 15. I.K. Industries 7.0 — 7.0 16. Feroz Ata Dal Mills 0.04 — 0.04 17. National Ice Factory 1.2 — 1.2 18. B.G. Bangla Rice Mills 1.6 — 1.5 Subtotal 1,159.5 754.8 1,894.3 B. List of Units where Letter of Intent for sale is Issued

1. Asrafa Oil Mill 7.7 — 7.7 2. Can Making and Tin Printing 16.0 5.3 21.3 3. Dosha Extruction 13.0 — 13.0 4. Nabarun Jute Mills 44.1 95.5 139.6 5. Kohinoor Battery Manufacturing Company 160.0 19.6 179.6 6. Engineering Industries Limited 35.1 1.7 36.8 7. Deshbandhu Sugar Mills Limited 23.5 153.5 177.0 Subtotal 299.4 275.6 575.0

— = no long-term liabilities. Source: Privatization Board.

Process of Privatization

10. The process of privatization has now become more transparent. The privatization cells in the line ministries finalize a list of enterprises that they wish to sell. The board then obtains approval of the Cabinet Committee for Finance and Economic Affairs (CCFEA) for selling these units. Once the approval is obtained, the board appoints chartered accountant firms or consultants to value the assets and liabilities of the units to be sold. Separate chartered accountant firms or consultants may carry out a revaluation if considered necessary. The present policy is that the buyers have to assume long-term liabilities against the fixed assets and the short-term liabilities are taken over by the Government.

11. The process is time consuming. A meeting of all the concerned parties is held to agree on the final asset value that must correspond closely to what the market will bear. The process of finalization of valuation takes about 3-4 weeks. International or local tenders are floated after the valuation is finalized. The prospective bidders have access to the valuation documents and the

37

units’ commercial performance reports for three years. The Privatization Board scrutinizes the bids and selects the prospective buyer in 3-4 weeks. The whole tender process takes about 45-60 days to be completed. The board then forwards its recommendation to the CCFEA, which takes about 2-3 weeks to give its opinion. If the CCFEA approves the recommendation for sale, it is sent to the Prime Minister who gives a decision usually within a week and routes it to the Cabinet Division, which takes 1-2 weeks to send it back to the Privatization Board. The Privatization Board then sends out a letter of intent and sets up an inventory committee that includes the buyer’s representatives. This committee prepares a report in 2-3 months. Except for the payments on the bid and final handover, there are no time limits imposed on most of these stages. In the assessment of senior official members of the Board, if there are no unusual problems, the process of privatization can be completed within about 30 weeks to seal a deal after the CCFEA has approved the sale of a public enterprise.

Major Constraints

12. The Government has now experimented with numerous institutional arrangements to implement the privatization process. The Interministerial Committee on Privatization set up as the part of the Program was not very successful and so the Government set up an independent board to expedite the work of privatization. It too had limited success in privatizing units as agreed under the loan covenants of the Program loan. While there are some genuine institutional and legal barriers to privatization in the short term, the main barriers to privatization in the longer term are the financial liabilities of the enterprises, a lack of political will, and bureaucratic resistance. The latter shows up in lengthy delays in passing or amending necessary laws and regulations, appointment of incompetent people in crucial positions, and foot dragging in completing the process of privatizing units even after initiating the process. Similarly, lack of competence also sometimes creates serious legal problems in the course of privatizing a unit. For example, the sale of a unit was stalled because the land on which it was situated belonged to another unit that was privatized earlier and no longer belonged to the Government.

13. Some delays and problems also emanate from the structure of the Privatization Board. The board reports to the Economic Affairs Committee of the Cabinet headed by the minister of finance, however, all decisions by cabinet subcommittees have to be approved by the Prime Minister. Thus there is a two-stage process of privatization and the Prime Minister has an effective right of veto.

14. Although the Privatization Board is entrusted with the responsibility of selling public enterprises, it does not have direct control over them. The line ministries exercise the overall control on these units. These ministries were asked to set up privatization cells to identify, prepare, process, implement, and monitor privatization of units under their control. Nine of the 13 ministries that have state-owned enterprises under their control have set up privatization cells. Thus, another major constraint faced by the board is the lack of authority over the units owned by separate ministries. The board has no statutory authority over the ministries; it can only sell the units that are handed over to it by them. Even when these units were slated for privatization, several procedures require reference back and forth to the concerned ministries. While there are no incentives for expediting the process, the board structure and the process gives implicit powers to numerous officials to introduce delays. There is diffused responsibility at all levels.

15. There are also structural barriers to privatization. Most of the units for privatization are not run efficiently, and as a result, there is large debt liability on most of the units. The units are not modern, have outdated technology or declining market shares, and require substantial restructuring and renovations. The financial demands to turn around the units are quite large. Although some progress has been made in dealing with the surplus labor issues, the Government has not, as yet, dealt with the issue of financial liability. There are serious problems of valuation of current assets as well. Given that most units have large current assets and liabilities, actual

38

handing over of the unit gets delayed due to problems of valuation at current prices and that of reconciliation with books of accounts. Many items that are valued at book value have no market value, and usually handover delays of more than a year stem from these problems.

16. By now, the board has also become a large bureaucracy, but continues to lack appropriate skills. For example, there is no in-house expertise for financial analysis and valuation. Overall technical capacity of the board remains weak, and there seems to be no evidence of skill buildup required to carry the process through, in spite of technical assistance by all major financiers, including the Asian Development Bank.

17. Finally, there is a residual public sympathy for the public sector in Bangladesh at all levels. Although there are pronouncements in various policies, the overall commitment to privatization is lacking. It is difficult to locate strong references supporting privatization in the five-year plan 1997-2002. Similarly, privatization does not even find a place in the 17 objectives listed in the 1999 industrial policy. In the subsection dealing with privatization, it contains a fairly standard statement that the present privatization policy will be vigorously pursued. Although there will be no new investments in areas other than reserved sectors, this policy states that public enterprises will be encouraged to supplement and compete with the private sector.

Two Cases of Privatization

a. Success Story

18. The privatization story of Chittagong Cement Clinker Grinding Limited is one of few success stories. The former president of the Bangladesh Federal Chamber of Commerce and Industries bought the unit's majority share of 51 percent. The public holds the other 49 percent. The Government was keen to privatize in the early years, and the owner indicated that even then strong lobbying was necessary to complete the sale of the shares in less than a year. It was necessary to continuously work with the trade unions and erstwhile management of the unit to ensure they did not put up insurmountable obstacles to the transfer.

19. Since privatization, the unit has tripled its capacity from only 1,000 tons per day to 3,000 tons per day. The workforce was reduced immediately after the takeover, but as the business expanded more and more workers were hired. The unit has adopted modern environmental control mechanisms and declared a 50 percent dividend last year. There was also net gain in employment as a result of this expansion. The management has set up a participatory mechanism for workers and they are consulted before important decisions are taken. On the whole, it is a trouble-free enterprise that has recently entered into a joint venture with the world's leading cement producer. In all, a true success story of a privatization implemented speedily!

b. Long Delays

20. The second case relates to a unit whose privatization process has been stalled since the early days of privatization. It took the authorities more than one and half year from the date of scrutinizing the tenders to issuing the letter of intent to sell the unit. More than five and half years after the buyer has fully paid the bid money; the unit has not been transferred. On the contrary, the ministry now wants to cancel the tender. The chronology of main events is given in Table A3.3.

Table A3.3: Chronological Account of a Case Delayed for the Last Five Years

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Date Actions

12 Dec 1992 Tenders invited for the sale of the unit.

22 Mar 1994 The Privatization Board accepted the offer of the highest bidder at its 9th board meeting and sent its recommendation to the Cabinet Committee for Finance and Economic Affairs.

13 Apr 1994 The Cabinet Committee for Finance and Economic Affairs accepted the recommendation for sale of the unit and fixed the liabilities of the unit at Tk81 million. It sent its recommendation to the Prime Minister for approval; it was approved without delays.

26 May 1994 The Privatization Board sent the cabinet recommendation to the secretary, Ministry of Industries (MOI) and the chair, Bangladesh Chemical Industries Corporation, but inserts a new condition for sale. MOI sent two letters to the buyer showing the liabilities to be almost double the original amount approved by the Cabinet Committee. The buyer protested.

31 Aug 1994 Letter of intent issued by MOI showing excessive liabilities.

22 Sep 1994 The buyer accepted the letter of intent with a strong written protest against the additional liabilities and conditions. The buyer paid the bid money on 22 September 1994.

Shares were not transferred. Process is under negotiations.

11 Feb 1998 MOI sought the opinion of the Ministry of Law in this matter.

9 Jul 1998 The Ministry of Law gave its opinion that the decision of the Cabinet Committee approved by the Prime Minister was the final.

24 Sep 1998 MOI sent the opinion to the Privatization Board for comment.

23 Nov 1998 The Privatization Board asked MOI to transfer the share as per the law.

29 Dec 1998 A meeting chaired by the minister of industries and attended by the chair, Bangladesh Chemical Industries Corporation, senior officials of the ministries of Industries and Law, and the Privatization Board was held. The buyer was also invited to attend. The meeting decided to ask the Privatization Board for specific suggestions regarding the handover of the factory to the buyer.

The process continues.

20 Feb 2000 MOI sought the opinion of the Ministry of Law regarding cancellation of the tender and transfer by any other means.

1 Mar 2000 The Ministry of Law informed MOI that the buyer cannot be held responsible for liabilities in excess of Tk81 million approved by the Cabinet Committee and the Prime Minister as the unit was never transferred to them. It also advised that there were no other means to transfer the shares.

Source: Interview and discussions with officials of Privatization Board, the buyer, and MOI officials.

21. The matter remains unresolved. The transfer has not taken place even 5 years after the full payment of the bid money. The tender document stipulates the completion of the transfer within 60 days of the full payment of the bid money.

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INDUSTRIAL PERFORMANCE

A. Macroeconomic Performance

1. Bangladesh’s macroeconomic performance in terms of the major indicators was significantly better in the 1990s than in the earlier decades. The growth rate of real gross domestic product (GDP) was only 3.9 percent per annum during the 1970s and 1980s. The growth rate improved during the first half of the 1990s rising to 4.3 percent and has registered a substantial increase to 5.5 percent during the subsequent years.

2. Macroeconomic measures and reform programs undertaken during the last two decades were successful in other areas too. Conservative monetary management quickly contained the runaway inflation of the early 1970s. Money supply (broad) expanded at the rapid rate of over 20 percent per year during the 1980s, but slowed down to just over 12 percent in the 1990s. This sharp fall in monetary expansion helped to contain inflation in the latter period. The overall budget deficit in recent years was in line with the aid inflow. The current account deficit showed marked improvement (Table A4.1).

3. The favorable trend in these macroeconomic indicators does not suffice to promote rapid advancement of the economy. This ultimately requires a high rate of accumulation of both physical and human capital. The rate of domestic saving is quite low; it stagnated at around only 2 percent during the 1970s and 1980s. It rose in the 1990s, but is still below 8 percent. The low rate of saving was reflected in the low rate of investment of around 12 percent during the 1980s. There was some improvement in the first half of the 1990s; gross domestic investment increased to about 17 percent. Public investment accounted for more than half of the total investment in the 1970s and accounted for about 6 percent throughout the last two decades. Private investment on the other hand rose from about 6 percent in the late 1980s to over 11 percent by the late 1990s. However, most of this increase was achieved during the first half of the 1990s.

TABLE A4.1: MACROECONOMIC VARIABLES (PERCENT OF GDP)

Item FY1991 FY1994 FY1996 FY1998 Real Gross Domestic Investment 11.5 15.4 17.7 17.8 Real Gross Domestic Savings 4.1 7.5 7.5 7.6 Foreign Aid 7.4 6.1 4.5 3.7 Remittances 3.3 4.2 3.8 4.5 Trade Deficit 7.4 6.4 9.5 6.4 Current Account Deficit 0.7 (0.1) 3.3 0.8 Overall Budget Deficit 7.2 6.0 5.7 5.4

GDP = gross domestic product. Source: Government of Bangladesh. Statistical Yearbook, various issues; Economic Survey 1999; and staff estimates.

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Review of the Industrial Economy

1. Industrial Growth

4. The reforms initiated by the Second Industrial Program (the Program) were an integral part of the overall structural adjustment program aimed at the globalization of the economy. The industry sector stagnated throughout the 1970s and 1980s growing at only 3.2 percent per year (Table A4.2). This was less than the growth rate of GDP of 3.9 percent. During the first eight years of the 1990s, the performance of the industrial economy improved markedly.

5. Until 1981, small-scale manufacturing plants produced most of the manufacturing output. Since then, the major part of the output of the manufacturing industries has come from the large-scale manufacturing enterprises; this contribution has increased over time. In 1989, large-scale manufacturing produced 58 percent of the total manufacturing output, but by 1997, its contribution rose to over 66 percent. Within the large-scale manufacturing subsector, textiles (27.2 percent) and tobacco (14 percent) dominate accounting for 41.2 percent of the total production. Chemicals and chemical products (10.1 percent), food manufacturing (10.5 percent), and petroleum and coal products (10.1 percent) contribute another 32.7 percent. Thus, the concentration of industrial production continues to be quite high.

6. Manufacturing did not contribute to large-scale new employment opportunities for the growing labor force. The reduction in the employment of public manufacturing enterprises (PMEs) was not matched by increases in employment in private enterprises; on the contrary, employment in manufacturing actually declined from 5.9 million in 1990 to only 4.1 million in 1995. The service-oriented sectors accommodated most of the increase in the labor force; the employment in this sector rose from 10.9 million to 16 million during the same period.

Table A4.2: Growth Rates of Sectoral GDP at Constant 1984-85 Prices (percent)

Sector 1974-1990 1990-1999a 1990-1994 1994-1999a

Manufacturing 3.2 6.5 8.2 5.2 Large 5.0 8.4 10.7 5.6 Small 1.4 4.0 3.5 4.4 Gross Domestic Product 3.9 4.9 4.3 5.5

a 1998/99 figures are provisional. Source: Government of Bangladesh. 1999. Economic Survey 1999. Dhaka.

Policy Environment and Investment Climate

a. Trade Liberalization

7. The low industrial performance in the 1970s and the 1980s made it clear that privatization alone will not accelerate industrial growth unless it was accompanied by an enabling business environment and removal of other restrictions imposed on trade and

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commerce. The Asian Development Bank and other international organizations, such as the World Bank, worked with the Government to support wide-ranging liberalization of the trade, industry, and finance sectors so as to open the economy to international competition. The trade liberalization policies since the mid-1980s sought to reduce both tariff and nontariff barriers. The ultimate goal was to create a more open economy with domestic relative prices more aligned with the corresponding international prices. The production structure would thus more closely match the comparative advantage of the economy thereby maximizing the gains of specialization.

8. The trade liberalization measures undertaken during the second half of the 1980s consisted essentially of reduction in the number of commodities that attracted Quantitative Restrictions (QRs); 639 commodities in the 4-digit list were subjected to QRs in 1986. The number was sharply reduced to 315 within the next three fiscal years. At present, only 28 items, mostly in the textile industry are subject to QRs. The highest tariff rates were cut sharply from 350 percent in 1991 to 40 percent in 1998. The number of tariff slabs were also reduced from 17 to 6. The unweighted average of custom duty came down from 88.6 percent in 1990 to 20.2 percent in 1998, while import weighted duty fell from 42.1 percent to 14.1 percent during the same period. In the recently announced policy, the number of tariff slabs was further reduced to 4 with the highest duty of 37.5 percent. The unweighted average tariff declined to 16.7 percent in 1999. Despite the large reduction in the average tariff, the dispersion has not declined (Table A4.3).

Table A4.3: Tariff Slabs on Imported Products, 2000

Product Category Rate of Duty (%) Finished consumer goods 37.5 Intermediate goods (semiprocessed) 25.0 Raw materials 15.0 Capital goods 5.0 All products 16.7

Source: Ministry of Finance.

b. Exchange rate

9. Bangladesh has maintained a “strongly managed” flexible exchange rate regime after unifying the multiple exchange rates in 1992. Careful management of the exchange rate has enabled the country to prevent a currency crisis from developing, and thereby avoid any abrupt large changes in the external value of the currency. The fact that there was very little difference between the official and the open market exchange rates suggests that the central bank has been largely successful in steering the exchange rate close to the market rate. Despite management of the exchange rate, Bangladesh had a real appreciation of about 4 percent in the real effective exchange rate from 1990 to 1998, compared with depreciation experienced by its immediate neighbors: Indian currency depreciated 35 percent, Pakistan 19 percent, and Nepal 7 percent during the same period. The taka also appreciated in real terms relative to the competing Southeast Asian countries of Indonesia, the Republic of Korea, Malaysia, and Thailand.

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c. Investment Policy

10. The 1999 industrial policy aimed to liberalize the private investment environment to achieve private sector-led growth of industrial production to at least 25 percent of GDP within a decade. Unlimited private sector investment will be permitted in all industries except for four reserved sectors, namely, armaments and defense equipment, forest plantation and mechanized extraction, production of nuclear energy, and security printing. Foreign investment with up to 100 percent equity will be encouraged in all sectors excluding the reserved sectors, ready-made garments, and the financial sector. Foreign investors will enjoy the same facilities as the domestic entrepreneurs for tax holidays, payment of royalty, technical know-how fees, etc. Full repatriation of profits and dividends as well as the invested capital will be permitted. The Government will play a facilitating role in promoting private investment, and permit public sector involvement only in those activities where it will facilitate private sector growth (and/or where there are overriding social concerns to be addressed). To implement the industrial policy, the Government will enact an investment promotion act to make the 1999 policy enforceable through the court of law. 11. No prior permission from government will be necessary to set up an industry other than those in the reserve list. Permission is also not needed for its subsequent balancing, modernization, rehabilitation, and expansion. However, it will require clearance from appropriate authorities for safety and environmental concerns. Clearance must also be obtained for setting up new units in the ready-made garments and financial sector. All foreign investment must be registered with the concerned promotional body before setting up a unit.

Competition and Efficiency

12. The structure of prereform tariffs and QRs implied a widely varying effective rate of protection for various industries. In 1992, several industries including jute and cotton textiles, sugar, leather and leather products, and ready-made garments were shielded by effective protection rates of nearly 100 percent or higher, while other goods, particularly agricultural products such as cereals and chemical fertilizers were given negative effective protection. The tariff and QR rationalization program of the 1990s substantially reduced the effective protection of all protected industries.1 13. Trade and industrial production increased due to these structural reforms. During the decade of the 1980s, the average growth rate of exports (in nominal dollars) was only about 7 percent per annum: in the 1990s it increased to more than 15 percent. Imports grew at a relatively smaller rate of nearly 11 percent. Such rapid rates of growth meant that the share of exports and imports in GDP rose steeply from only 6 and 14 percent respectively in 1989 to 14.6 and 19.8 percent respectively in 1998. Thus, the overall trade ratio increased from 21 percent to 34 percent during the period. 14. The surge in exports could be attributed to the performance of only one industry: ready-made garments. By 1997 about three quarters of all export earnings and more than 85 percent of the increase in exports (achieved during 1987-1997) was contributed by the ready-made garments industry. There is some concern in the industry and Government that it may not be able to compete successfully against such countries as

1 Textiles continue to enjoy higher protection than any other industry.

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the People’s Republic of China and Viet Nam once the existing quota entitlements are withdrawn in 2005.

Overall Impact Assessment

15. In terms of the objectives of the Program, the Program was judged unsuccessful, and the second tranche of the loan was cancelled. Even today, the PMEs do not function as autonomous commercial units. The various inefficiencies show up in the large financial losses reported every year. Only a handful of PMEs have been privatized and the Government still controls a large portfolio of industries with significant negative fiscal impacts on the budget, contradicting one of the main objectives of the Program. 16. The Program did have some long-term impact that was in conformity with its ultimate goal of achieving an open competitive economy dominated by the private sector. The Program was an integral part of all liberalization programs implemented in the 1990s and so it is difficult to isolate the economy-wide impact of each. One of the most important outcomes of the Program is that the Government is now committed to the strategy of private sector-led, export-oriented growth of the economy. This is enshrined in several important Government documents including the 1999 industrial policy. The desirability of reducing the role of the Government in productive activities outside of some clearly defined areas is fully established. Although the pace of industrial reform leaves much to be desired, it is certainly in the right direction. The Government has ceased setting up new manufacturing units routinely, and new investment in the PMEs have virtually stopped except for the fertilizer subsector. Manufacturing investment is now mostly private as envisaged by the Program. 17. The inevitability of privatization is no longer seriously questioned, although the actual act of privatization of specific units frequently gets caught in procedural and legal problems that stall its progress. The Government has initiated several steps to remove these impediments. An act converting the Privatization Board into a privatization commission and empowering it to directly and independently negotiate the sale of Government stakes in PMEs has been approved by the Cabinet and the President, and is being placed before the Parliament. Many of the privatization bottlenecks will be removed by this act, and the pace of privatization will likely quicken in the near future. This will also make most other objectives, such as autonomy and commercialization of the PMEs redundant. 18. The reforms have undoubtedly succeeded in opening up the economy. Exports increased at a much faster rate in the 1990s than anytime before. Imports also increased rapidly; but the current account deficit, always a cause of worry, showed marked improvement. Public investment was contained at about 6 percent of GDP, while private investment rose from 6 percent to 11 percent during the decade to the late 1990s. The relatively free investment climate contributed to this increase in private investment. During the 1990s, industrial production increased at more than twice that achieved in the 1980s. Electricity consumption nearly doubled between 1991 and 1997. All these indicators suggest the emergence of a more dynamic economy in the 1990s. Much of this dynamism can be attributed to the trade and industrial reforms implemented in the 1990s.

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Appendix 5, page 1

PERFORMANCE OF PUBLIC MANUFACTURING ENTERPRISES

A. Role of the Government in Manufacturing

1. In 1990, public manufacturing enterprises (PMEs) accounted for 30 percent of the value added of large-scale manufacturing and 18 percent of all manufacturing or 1.5 percent of gross domestic product (GDP). By 1999, PMEs’ contribution fell to 8 percent of the value added of large-scale manufacturing and only 5 percent of that of all manufacturing (0.5 percent of GDP). In terms of both output and employment, the PMEs no longer remain important.

2. One of the major thrusts of the Second Industrial Program (the Program) was to minimize the role of the Government in the industry sector. The Government had decided “to focus the role of the Government as a facilitator in creating an enabling environment for expanding private investment”1 by limiting public investment “to only those cases where there is special need to complement private investment or where there is an overriding social and national objective to be achieved.”2 Accordingly, public investment in the PMEs came down from an annual average of over Tk12.5 billion from 1988-1991, immediately before the commencement of the Program, to only Tk1.6 billion per annum from 1996-1999, i.e., a reduction of 87 percent in nominal terms. Given that the price level rose by about 70 percent during this period, the decline in real investment was even larger.

3. The reduction in the role of the Government and the public sector was also reflected in the five-year plans of the country. The plan allocations to the public sector remained unchanged in the second and the third five-year plans at slightly over 64 percent. But there was a reduction in the public sector allocation in the fourth five-year plan to less than 56 percent. The public sector was further trimmed in the fifth five-year plan in which it received an allocation of about 44 percent.

4. The share of the public and the private sector in the total investment of the country were roughly equal in the early 1990s. Private investment grew fairly rapidly in the 1990s. By 1998, real private investment had increased by more than twice its 1990 level. The faster growth of private investment raised the share of the private sector in gross domestic investment from 50 to 63 percent in the last seven years.

Employment

5. One of the reasons identified for the large losses of the PMEs was overemployment. The Program had, therefore, suggested a rationalization of the labor force: mandatory retirement age and voluntary separation. Furthermore, steps were to be taken to reduce the number of employees in the PMEs during program implementation. These measures would, it was anticipated, improve productivity of the workers, reduce costs, and ensure better financial outcomes. Employment in Bangladesh Textile Mills Corporation was reduced by 71 percent during the seven years from 1991-1999. Further reduction have been reportedly made more recently. Most of these reductions were achieved through retirement and voluntary separations. Bangladesh Steel and Engineering Corporation reduced its workforce by 47 percent, while Bangladesh Sugar and Food Industries Corporation achieved a reduction of 27 percent.

1 Government of Bangladesh. 1999. Investing in Bangladesh: A Guide to Opportunities. Board of Investment. Dhaka. 2 Government of Bangladesh. 1999. Industry Policy 1999. Ministry of Industries. Dhaka.

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Appendix 5, page 2 Bangladesh Chemicals and Industries Corporation reduced its workforce by about one-fifth. Bangladesh Forest Industries Development Corporation actually increased employment during the period by 25 percent.

Financial Performance

6. From inception, the nationalized enterprises suffered from serious inefficiencies. At the time, there was a belief that as these enterprises matured, their performance would improve and they would contribute significantly to capital accumulation of the new nation. But this did not happen as PMEs continued to post large losses and required large budgetary transfers or loans from the nationalized banks. The net real losses suffered by both manufacturing and nonmanufacturing are not only enormous, but also increased rapidly during 1988 to 1999. The losses of the PMEs in 1998 amounted to 61.5 percent of their value added and 5.4 percent of the actual total expenditure under the annual development plan. The losses were greater than the total spending of the annual plan on entire agriculture.

7. The substantial reduction in the public enterprise workforce did not improve the financial performance of any of the sector corporations. The real losses (at constant 1985 prices) suffered by all the corporations, except Bangladesh Forest Industries Development Corporation and Bangladesh Steel and Engineering Corporation, increased such that the combined real losses in these PMEs in late 1990s were larger than that in 1991. This would tend to indicate that overemployment was not the main source of the financial losses of the PMEs.

8. There could be several reasons for this outcome. Trade liberalization had reduced protection and monopoly status of many PMEs, such that some of the erstwhile profitable industries have turned unprofitable in the competitive markets. Some units have become obsolete and have not upgraded technology or entered new markets. Nearly 70 percent of the total expenditure of the public enterprises are spent on the purchase of goods and services, and only about 30 percent on employee compensation. It is necessary to carefully scrutinize the procurement procedures to get a better perspective on cost overruns and losses. There is a large debt overhang of nonperforming assets, and as a result, overall liabilities of the PMEs have increased significantly. Finally, the PMEs have very little commercial autonomy.

Performance of Individual PMEs

9. Table A5.1 to A5.5 provide long-term time series data on performance of six PMEs from 1989 to 1998 for four indicators: public sector investments, employment levels, value-added generated by these PMEs, and annual financial losses reported. As can be seen from these graphs, the role of the PMEs has declined in terms of demands for new investments or employment. PME financial performance continues to remain an area of concern.

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