Whither “7 Percent Club” of Economies - A Review of FY2012 and Outlook for FY2013
Analyst:Sajid Huq Amitsajid.email@example.com(880) 173 072 7939Whither “7 Percent Club” of Economies?A Review of FY2012 and Outlook for FY2013June 19, 2012Part I A ReviewPart II Budget and Macro EstimatesPart III A “Capital Markets Friendly” BudgetA ReviewEarlier this month, a preliminary estimate forBangladesh GDP growth for FY12 was released,which seemed to cause much cheer. Bangla-desh’s FY12 GDP growth was estimated at 6.3%,slightly higher than our Aug’11 forecast of 6.2%.In fact, it surpassed forecasts of more criticalstakeholders, in the backdrop of twin deficits –fiscal and trade. Inflation appeared to be perma-nently lodged in the double digits and a dollarrate in free fall. Hence, the cause for cheer.In the outgoing fiscal, the positives to report aregrowth in construction, small-scale manufactur-ing, transportation and financial intermediation.The negatives are slowing agricultural growth,curbed private investment rate and a dip in thenational savings rate. Private consumption re-mained stable, while large-scale manufacturingexhibited weak growth.On the monetary front, the performance wasmixed. The Bangladesh Bank was rather effec-tive in executing a contractionary monetary policythat arrested a double-digit inflation and broughtit to single-digit levels, reaching 9.15% in May’12(13.16% a year earlier). Since Aug’10 till date, BBraised its repo rate by a cumulative 325 bp,reaching 7.75% in FY12. No surprise then thatbroad money growth fell to 17.6% in March’12from 23.5% a year earlier.As of April’12, tax revenue posted 19.2% growthYoY (27.1% a year earlier). However, despitegrowing revenue collection, a fiscal deficit ofnearly 5% and resultant bank borrowing to fi-nance the deficit, in an environment of monetarytightening and ongoing power crisis, all butchoked private sector lending and investmentgrowth. Private investment growth as of May’12was 19.1%, compared to19.5% a year earlier.This is of course a critical statistic and necessi-tates adequate policy attention.Meanwhile, the external sector, the cause ofmuch concern at the turn of the calendar year2011, yielded mixed results as well. The tradedeficit GR slowed to 9.87% YoY (42% YoY inFY12), as import volume slid 9% in the first threequarters. Trade financing underwent close super-vision such that outflows on account of tradecredit declined 35% YoY.However, on a less cheery note, export volumegrew a meager 8.4% YoY, as of May’12. Conse-quently, the current account surplus fell toUS$456 Mn in the first three quarters of the fis-cal, from US$710 Mn a year earlier. In fact, as ofmid-May’12, international reserves stood atUS$9.5 Bn, equivalent to only 2.8 months of im-ports (in contrast with US$11 Bn a year earlier).In light of the anticipated squeeze in exports,since the onset of the EU sovereign debt crisis, aclearly prudential manifestation of a contraction-ary monetary policy (despite its critics) has beenthe drastic downsizing of imports. In the firstthree quarters of FY12, imports fell 8.35% YoY,reaching US$27.3Bn. To put the GR in context,the average annual import volume GR was22.2% in the last three years: FY’09-11.But in addition to BB’s tightening, it should bementioned that imports also fell on account of areduction in export volume, since with the excep-tion of liquid fuel imports, much of Bangladeshiexports are dependent on imported raw materi-als.To return to a positive note, on April 11, 2012, theIMF approved Bangladesh’s request for a three-year Extended Credit Facility (ECF) ofSDR639.96Mn (~US$1Bn). The ECF is intended
Whither “7 Percent Club” of Economies?A Review of FY2012 and Outlook for FY2013June 19, 20122to provide reprieve to the external sector andbalance-of-payment pressures.Yet another silver lining in FY12’s macro re-view is the 11.6% remittance earnings GR YoYprojected for the outgoing fiscal. In terms ofvolume, that is equivalent to US$13Bn and asof May’12, it stood at US$11.77Bn. Remittancegrowth of FY12 thus defined conventional no-tions that assume it is positively correlated withoil price changes. We, however, anticipated theremittance growth outlook in an earlier reporthere.Budget and Macroeconomic EstimatesOn June 7, 2012, the Finance Minister present-ed the contents of the new budget to the parlia-ment. Subsequently, the policy actions put forthwere discussed and debated far and wide.As expected, FY13’s budget is large and popu-list but not without heed to conditionsstipulated by the ECF. The Annual Develop-ment Program (ADP) component has a 34%larger outlay than in FY2013 and an aggregate1750 projects. Allocation to energy, educationand infrastructure represent ~47% of the ADP(relatively unchanged from FY12).Moreover, the net to be cast on taxable incomeand VAT is significantly wider in the new budg-et and for an overview, our earlier report ishere.Next, there is a reaffirmation implicit and explic-it of monetary tightening and inflation control asbeing central to macro-financial managementin FY13. And last but not least, the new budgetaims to be “capital markets friendly,” which isquite reasonable in its intent, given the centrali-ty of markets in Bangladesh economy-relateddiscussions since late-2009. Therefore, a clos-er assessment of the budget’s capital marketsfriendliness is in order, which is the scope ofthe following section.Also mentionable are the two weak links of theFY12 budget that inhabit the upcoming fiscal’sas well. The first is the existence of a subsidyregime that in FY12 constituted 28% of the na-tion’s tax revenue. While it is of a smaller per-centage in FY13, the Bangladesh govern-ment’s subsidy allocation is still formidablylarge. The second, which flows from the first, is thehigh level of bank borrowing that is planned to meetthe FY13 budget deficit. That said, the targetedlevel of bank borrowing is not significantly largerthan FY12 levels, which, given the larger budget forFY13, equates to a smaller portion of the pie. Thisis an important strategic consideration since theECF stipulates that the government’s subsidy ex-penditure be limited to 2% of the GDP.The net effect of bank borrowing is the crowdingout of private sector loans, and by extension, dimin-ished business growth. Banks meanwhile barelybreak even from increased routing of their depositsto treasury investments while they would much pre-fer making private sector loans. Consequently, theylend at higher rates to push up their spread, raisingtheir cost-of-funds. The aggregate effect of increas-ing interest rates is increasing prices, i.e., higherinflation.We recommend that the subsidy policy be re-assessed in favor of greater nuance in its design.For instance, there could be greater discriminationwith regard to the end-users of the types of liquidfuels that are sold at subsidized prices. After all,certain types of liquid fuels are mostly purchasedby high-end customers, relative to other fuel types.Thus, the government can adopt a sliding pricingscale that adjusts subsidy allocation as per the typeof fuel in question, and the likely affordability of thepredominant end-user of the fuel type. A “slidingscale subsidy” policy would be quite befitting.
Whither “7 Percent Club” of Economies?A Review of FY2012 and Outlook for FY2013June 19, 20123The following table summarizes the budget guidance highlights.Table 1: Budget FY2013BudgetFY 12-13RevisedBudgetFY 11-12YoYChangeParticulars Bn BDT % of budget% of GDP Bn BDT % of budget % of GDPNBR Tax 1,123 59% 11% 924 57% 10% 22%Non-NBR Tax 46 2% 0% 39 2% 0% 17%Non-NBR Revenue 228 12% 2% 186 12% 2% 23%Total Revenue 1,397 73% 13% 1,149 71% 13% 22%Non-development Expenditure 995 52% 10% 918 57% 10% 8%Development Expenditure 601 31% 6% 457 28% 5% 32%-of which ADP 550 29% 5% 411 25% 4% 34%Other Expenditure 321 17% 3% 237 15% 3% 35%Total Expenditure 1,917 100% 18% 1,612 100% 18% 19%Budget Deficit 521 27% 5% 463 29% 5% 12%External 186 10% 2% 119 7% 1% 57%Domestic 335 17% 3% 345 21% 4% -3%Borrowing from Banking Sys-tem 230 12% 2% 291 18% 3% -21%Long-term Debt 184 10% 2% 213 13% 2% -14%Short-term Debt 46 2% 0% 78 5% 1% -41%Non-bank borrowing 105 5% 1% 54 3% 1% 96%National Saving Certificate 74 4% 1% 35 2% 0% 111%Others 31 2% 0% 19 1% 0% 66%Total Financing 521 27% 5% 463 29% 5% 12%GDP 10,414 100% 9,148 100% 14%Source: Ministry of Finance (MoF)Ultimately, the targeted culmination of theFY2013 budget is a 7.2% GDP growth rate andan inflation of 7.5%.We consider the targeted economic growth rateto be rather optimistic, although we can imag-ine the inflation target being logically reacha-ble. Given monetary and fiscal realities, con-trolling inflation is more feasible, both becauseof monetary tightening at home and sustainedlow levels of food, commodity and oil pricesoverseas – as several large economies navi-gate through troubled waters.We, however, welcome the optimism on the taxcollection front and consider the revenuegrowth target 22% feasible, despite the fact thatrevenue growth slowed to 19.2% in FY12 after27.1% GR in FY11. We think that the gamut of ratechanges proposed in the budget, ongoing efforts toexpand the tax net territorially, revision of VAT poli-cy and customs duties, will have a significant posi-tive impact in revenue generation in the next fiscal.Interestingly, the outlook for capital flows, as perthe World Bank, is brighter for emerging and fron-tier economies in the next fiscal. In fact, Bangla-desh should have significantly higher FDI flows inFY13, which given FY12’s low base, will offer greatreprieve to the external sector.Before we move on to the final section on the
Whither “7 Percent Club” of Economies?A Review of FY2012 and Outlook for FY2013June 19, 20124budget’s contribution to capital markets develop-ment, our growth forecasts:Best case: Another strong performance by theremittance sector (~8% growth); uptick in exportson increased US consumer confidence (smallertrade deficit as a result); close-to-target level ofrevenue collection (~20% growth); diversifiedsources of financing deployed by the government(foreign direct investment, savings certificates,capital markets debt instruments, etc); a nuancedsubsidy regime (sliding scale); private investmentand agricultural productivity growth (~24% and3%, respectively), steady manufacturing and do-mestic consumption; and lowered inflation (~8%):may cumulatively actualize a 6.7% GDP growthrate.A Greek sovereign default, ensuing tighter liquidi-ty conditions in the EU, and further decelerationof EU demand for Bangladesh garments couldlower export/ import growth to the ~5-7% range.Moreover, if such a scenario unfolded, EU de-mand slowdown could have second-order effectson Bangladesh. That is to say that the first-ordereffects on countries more exposed to EU eco-nomic outlook, could translate to their own slowergrowth. And in case they happen to be the mar-kets for Bangladesh non-garment exports andmanpower, the external sector would be hard hit.It ought to be mentioned however, that despiteworries about a possible expiration of the Wal-Mart effect, the outlook for H&M and Wal-Mart,both a leading retailer in their respective conti-nents, are quite positive for FY2013. While Wal-Mart benefits from an uptick in US consumer con-fidence but an austerity that prevails and encour-ages shopping in discount retail; H&M has en-tered Asian markets and accessed newer cus-tomer bases. We, therefore, do not foresee amacroeconomic Armageddon letting loose as aresult of a deepening EU crisis.Extreme Case: In the event that the EU crisisworsens, slower inward remittance (~5%), steadyexport and import volumes (both growing at ~5-7%), steady inflation (~9.2%), strong revenuegeneration (we consider this inevitable given lowbase and initiatives adopted by the NBR: ~20%growth); diversified government borrowingsources; steady manufacturing, private invest-ment growth, and consumer economy; and anuptick in agricultural productivity (~2.5% growth):would see Bangladesh grow at 6.3%.Between the best and extreme cases, taking themedian value, we estimate FY13 GDP growthrate at 6.5% and inflation at 8.6%.A “Capital Markets Friendly” BudgetA discussion on the budget necessitates we ad-dress the direct and indirect effects it has on thecapital markets, given the centrality of the mar-kets to a discussion on the Bangladesh economy.Policies advanced by the budget that overtly sup-port the markets include: A waiver of dividend income tax on all divi-dend income up to BDT5,000. Targeted to-wards small investors in order to grow capitalmarkets participation, the 10% tax currentlylevied at source will be waived for small in-vestors earning dividends less than or equalto BDT5,000. Lowering of the effective tax rate for all mer-chant banks, from 42.5% to 37.5%, therebyoffering them a much-needed reprieve. In1Q12, a correcting market saw the portfoliovalues of margin-based investors turn nega-tive, thus undermining merchant bank bottom-lines. Most are yet to recover profits thisyear. A tax rebate of 10%, offered to any companythat issues 20% of paid-up capital via anIPO. Until this point, the supply-side prob-lems behind the stock market correction havenot received adequate policy attention. Freshissuances are clearly the order of the day. Continuation of an existing directive allowingpreviously undisclosed money to be“whitened” by paying 10% tax. However, theefficacy of this policy is questionable as wit-nessed by the outcome it has had in the pastwhen it was promulgated. Each time, the so-called black money to be whitened has beeninsignificant in scale.
Whither “7 Percent Club” of Economies?A Review of FY2012 and Outlook for FY2013June 19, 20125Table 2: Market Impact of FY13 BudgetBefore, we end FY13’s macroeconomic assessment, it is worth considering the otherwise, mostly posi-tive on our top stock picks and the sectors they belong to.Sector Budget Directives Implication for the sector Effect on SecuritiesBanks and NBFIs• 15% tax on interest income for depositors who donot have TIN.• Corporate tax for merchant banks lowered from42.5% to 37.5%.• Detrimental impact on cost ofdeposit or deposit growth.• Banks with merchant banksubsidiaries will have lower effectivetax rate.• Mixed impact on banks.Pharmaceuticals• Establishment of a Pharmaceutical Industrial Park atGazaria, Munshigonj to promote the sector.• Reduced tax burden, from 152% to 3%, onmachinery for pharmaceutical companies, e.g., on airhandling units, heating, ventilation and airconditioning units, etc. Moreover, taxation structurehas been revised, e.g., import duty 25%→3% andsupplementary duty 60%→0%, and VAT 15%→0%).• Reduced Tax Burden on the import of 46 essentialitems for the pharmaceutical sector, from current 38%-59% to 29% (Import Duty 12%-25%→5%).• Completion date of the API Parkhas not been fixed. When thathappens, around 20% value additionis expected as a result of backwardlinkage.• Reduced tax on importedmachineries will decrease CAPEX.• Lower tax on essential items willlower production costs.• Positive impact for SquarePharmaceuticals (DSE:SQURPHARMA) andBeximco Pharmaceuticals(DSE: BXPHARMA).Construction• Increased excise duty on clinker imported by VAT-registered cement manufacturers, from the existingBDT 350 per MT to BDT 500 per MT• Increased excise duty on clinkers imported by othercement manufacturers from BDT 550 per MT to BDT750 per MT• Reduced custom duty on Fly Ash from existing 25%to 12%• Reduced custom duty on Slag, Dross (other thangranulated slag), scaling and other waste from themanufacture of iron or steel, from existing 12% to 5%• Assuming cement to clinker ratio of1.5:1 for cement grinders, cost/50bags will rise BDT 5, which is about1.1% of the retail selling price.• Lower cost of importing Fly Ash formanufacturers that use it as amixture.• Lower cost of importing slag; usageof slag varies among companiesdepending upon their mixture.• The overall impact on the cementindustry is negative as clinker cost isa major component (75% of rawmaterial costs).• Positive impact for LafargeSurma Cement (DSE:LAFARGE) as Lafargeproduces its own clinkerinstead of importing it unlikeits competitors.• Negative impact forHeidelberg Cement (DSE:HEIDELBCEM) as it importsclinker. However, Heidelbergalso uses Iron Slag and FlyAsh in its mixture. Therefore,their import costs (about10% of raw material costs) isset to decrease.Telecommunication • No change in SIM tax, which was reduced last fiscalyear to BDT600 per SIM.• Additional 2% tax at source to be charged for cellphone usage (both for pre- and post-paid customers);Currently 15% VAT is applicable for all customers.• 1% tax at source to be deducted from payment toInternational Gateway (IGW) Services, and 5% forthe amount paid by IGW to other operators forinternational telephone calls.• Additional 2% tax will inhibit cellphone usage among low-end users,thereby curbing penetration of thisfast-expanding sector andtechnology.• Telecom companies already bearSIM tax; they are not in a position toprovide additional subsidy to theconsumers.• IGW license holders will incuradditional cost of doing business.• Marginal negative impacton Grameenphone (DSE:GP), the only listed stock.Operators will pass-throughthis tax to subscribers in theform of higher average priceper minute (APPM) andminutes of use (MOU) mayfall proportionately. But GPhas the lion-share of thepremium subscriber-base–APPM increase will result inrevenue growth for GP.Real Estate • Tax deduction at source @5% and 3% as per thelocation of property at the time of land sale by anyland developer company.• Land developers will pass on highertax to property-buyers. Highertransaction cost will hurt real-estateliquidity and land development.• Negative for EasternHousing Ltd (DSE: EHL).Indirect negative impact oncement companies.Ceramics • Prevailing 15% supplementary duty on domesticallyproduced ceramic products such as bathtub, wash-basin, and commode will be fully withdrawn.• Increase the supplementary duty of tiles andcrockery, and also (ceramic) tableware, kitchenwareand other household articles, from 45% to 60%.• Reduce tax burden on importing several rawmaterials required by the ceramic manufacturers.• Move taken to protect the domesticmanufacturers.• Both ceramics tile manufacturersand ceramics tables aremanufacturers to be benefitted by thedirective.• Ceramic tables that aremanufacturers with more domesticshare in revenue will be benefittedmore than the companies that havehigher export share in their revenue.• All the listed ceramicscompanies will bebenefitted.
Whither “7 Percent Club” of Economies?A Review of FY2012 and Outlook for FY2013June 19, 20126Sector Budget Directives Implication for the sector Effect on SecuritiesConsumerDiscretionary• No change in tax-free income threshold for individualtax payers, which remains at BDT 180,000 (BDT200,000 for women and aged taxpayer and BDT250,000 for physically challenged tax payer)• Minimum tax payable increased from BDT 2,000 toBDT 3,000• With high inflation prevailing inthe economy, no change in tax-free income threshold andincreased minimum tax payablemay lead to lower disposableincome which is likely to reducerevenue for consumerdiscretionary companies• Higher inflation, higherminimum tax together withunchanged minimum taxableincome will hurt all the listedconsumer oriented companies ingeneral e.g. GP, BATASHOE,APEXADELFT, BATBC,GLAXOSMITH, RECKITTBENPower • Power sector has been allocated 16.8% of ADP forFY13• Fresh agreements have been signed to install 52new power plants via public and private companies• A gas development fund has been created todevelop the gas sector• A draft Coal Policy has been framed• Higher investments in powersector will increase electricity andgas generation.• Electricity, gas and fuel priceswill be increased in rounds tominimize subsidy.• Revenue of listed utilities suchas DESCO, POWERGRID andTITASGAS will increase if gasand electricity generationincreases. However increasedcontribution to the gasdevelopment fund may impairmargins for TITASGAS.• If bulk prices of electricity andgas are raised more than that ofretail prices, margins of DESCOand TITASGAS will decrease.Tobacco • An increase in supplementary duty on cigarettepaper has been proposed, excluding those importedby VAT-registered manufacturing industries, from 60%to 100%• A hike in the existing value slabs of cigarettes hasalso been proposed by 10.0% and supplementaryduty from existing 36.0%, 55.0%, 58.0%, and 60.0%percent to 39.0%, 56.0%, 59.0% and 61.0% percentrespectively.• Reduction of tax burden on import of several rawmaterials used by the ceramic manufacturers• Cigarettes export will be hurt.Impact will be more negative forlow-segment-focused cigarettesmanufacturers.• Impact on BATBC will bemixed since they are the leaderin high-end segments whereinsupplementary duty increasewas lower. However the 10%increase of slab-values will helpBATBC to gain more share inthe lower segment.
Whither “7 Percent Club” of Economies?A Review of FY2012 and Outlook for FY2013June 19, 20127IMPORTANT DISCLOSURESAnalyst Certification: Each research analyst and research associate who authored this document andwhose name appears herein certifies that the recommendations and opinions expressed in the researchreport accurately reflect their personal views about any and all of the securities or issuers discussed thereinthat are within the coverage universe.Disclaimer: Estimates and projections herein are our own and are based on assumptions that we believe tobe reasonable. Information presented herein, while obtained from sources we believe to be reliable, is notguaranteed either as to accuracy or completeness. Neither the information nor any opinion expressed hereinconstitutes a solicitation of the purchase or sale of any security. As it acts for public companies from time totime, BRAC-EPL may have a relationship with the above mentioned company(s). This report is intended fordistribution in only those jurisdictions in which BRAC-EPL is registered and any distribution outside thosejurisdictions is strictly prohibited.Compensation of Analysts: The compensation of research analysts is intended to reflect the value of theservices they provide to the clients of BRAC-EPL. As with most other employees, the compensation ofresearch analysts is impacted by the overall profitability of the firm, which may include revenues fromcorporate finance activities of the firms Corporate Finance department. However, Research analystscompensation is not directly related to specific corporate finance transaction.General Risk Factors: BRAC-EPL will conduct a comprehensive risk assessment for each company undercoverage at the time of initiating research coverage and also revisit this assessment when subsequent updatereports are published or material company events occur. Following are some general risks that can impactfuture operational and financial performance: (1) Industry fundamentals with respect to customer demand orproduct / service pricing could change expected revenues and earnings; (2) Issues relating to majorcompetitors or market shares or new product expectations could change investor attitudes; (3) Unforeseendevelopments with respect to the management, financial condition or accounting policies alter the prospectivevaluation; or (4) Interest rates, currency or major segments of the economy could alter investor confidenceand investment prospects.BRAC EPL Researchwww.bracepl.com121/B Gulshan AvenueGulshan-2, DhakaPhone: +880 2 881 9421-5Fax: +880 2 881 9426E-Mail: firstname.lastname@example.orgBRAC EPL Stock Brokerage Capital Markets GroupInstitutional Sales and TradingDelwar Hussain (Del)Head of International Trade& Salesdel.email@example.com 01755 541 252Ali Imam Head of Research firstname.lastname@example.org 01730 357 153Khandakar Safwan Saad Research Associate email@example.com 01730 357 779Farjad Siddiqui Research Associate firstname.lastname@example.org 01730 727 924Kallol Biswas Research Associate email@example.com 01730 727 930Nafees Mohammed Badruddin Research Associate firstname.lastname@example.org 01730 727 931Sajid Huq Amit Head of Strategic Sales email@example.com 0173 0727 939Strategic Sales