Summary of Recent Economic Developments
In the report, the World Bank has commended the steps the new government has taken to maintain fiscal prudence in a “difficult economic and security environment”, as well as its efforts to broaden the national ceasefire agreement into a national dialogue to resolve underlying grievances. At the same time, however, it notes that the fiscal deficit has widened to 3.2% of GDP (and is likely to widen further to 4.5% of GDP in the current year), and comments that recent intensified violence has underlined the political difficulties that lie ahead.
It expects economic growth to slow from 7.3% in 2015-16 to 6.5% in 2016-17. Agricultural productivity issues have hampered the pace of recovery from last year’s floods, and industrial activity—especially in food processing (about 2/3 of manufacturing output), gas production (28%) and construction (18%)—has slowed. Food processing has been feeling spillover effects from the slow recovery in agriculture, whilst exchange rate volatility has impacted the cost of imported inputs, on which Myanmar has a high dependence.
The World Bank sees the merit of improving construction regulation but cautions the sector is important for employment (c.5% of the workforce) and bank credit (c.30%, if construction and real estate are combined.) It therefore suggests a phased approach that is predictable and transparent is critical to avoid big shocks.
With gas and agricultural products representing c.60% of the merchandise export basket, weaker commodity prices have dented export performance, causing the current account deficit to widen to 4.8% of GDP in 2015/16. With slower foreign investment flows, Myanmar’s balance of payments produced a deficit equivalent to 0.7% of GDP. FX reserves are estimates at around 2.5 months of imports. Although the World Bank has no immediate concerns over external sustainability, as a good share of the deficit is financed by non-debt creating flows and is going to productive foreign investments, it advocates a need for fiscal and monetary discipline to contain vulnerabilities.
The garments sector (around 10% of exports) is emerging as a potential source for non-commodity export growth. In H1 2016/17, their value and volume rose by 120% and 174% respectively YoY, albeit from a low base. There are also some encouraging signs that foreign investment commitments in non-commodity sectors have been growing, with those to manufacturing up by 77% and to communications by 275% between June 2014 and November 2017.
Partly as a result of a rebasing of the basket to reflect current consumption patterns, inflation has moderated to 3.5% YoY by October 2016. However, whilst the World Bank accepts the lingering effects of Cyclone Komen have continued to be felt, it notes that the growth in the money supply has remained high (at 23% YoY) in 2015-16, as a result of the monetization of the fiscal deficit. It also suggests that the strength of credit growth to the private sector (+34% YoY) needs watching, especially as the sector and borrower concentration of lending has been on the rise.
Lending to wholesale and retail trade has averaged around 43% of the total in the last 3 years; agriculture, manufacturing and construction have represented around 15% each. The pattern reflects a limited range of lending products (mostly of 1-year maturity), which creates a maturity mismatch in sectors such as construction and manufacturing—both of which, the World Bank notes, have experienced strong credit growth, despite slowing or even contracting output.
A general strengthening of the Dollar and the increasing current account deficit have put downward pressure on the Kyat since the end of 2016. The Central Bank has maintained exchange rate flexibility, albeit adjusting the reference rate to the market rate with a slight lag, which has posed some challenges for the official market. As a result of high inflation in the first half of the year, the real effective exchange rate is estimated to have risen by c.11.5% in the first half of 2016, although it has dropped back a little since then.
Declining commodity revenues, exchange rate depreciation, unexpected expenditures for food and disaster relief and a higher wage bill have all contributed to an expansion in the fiscal deficit, which is expected to rise further to 4.5% of GDP in 2016/17. Noting that monetization of the deficit by the Central Bank was a high 5% of GDP in 2015-16, the World Bank has welcomed recent decisions to limit CBM lending to 40% of gross financing needs and to make the costs more market-oriented, as well as efforts to develop the domestic debt market. On the expenditure side, it suggests spending on social protection and capital spending (especially in energy and transport) have been feeling the effects of fiscal constraints most.
Medium-Term Outloook
Looking ahead, the World Bank projects an acceleration of public and private investment to drive average GDP growth of 7.1% in the coming 3 years. With slower growth in demand and reduced fiscal monetization, inflation is forecast to ease to 8.9% on average in 2016-17, but the current account deficit is expected to widen further as gas exports moderate, demand in China slows, and investment-related imports remain strong. Gas production is expected to maintain a declining trend until new gas fields come on stream. However, FDI is expected to pick up and, as a result, the size of the balance of payments deficit should diminish.
In conclusion, the World Bank thinks the risk of external debt distress remains low. Key longer-term risks include Myanmar’s narrow production base, its dependence on primary commodities, and its vulnerability to natural disasters.
Policy Priorities
The World Bank broadly endorses the government’s economic agenda which, it feels, “provide a very good basis for prioritizing reforms that could promote inclusive growth and poverty reduction in Myanmar.” It also endorses its adoption of fiscally prudent budgets, the expansion of the domestic debt market, broadly maintaining exchange rate flexibility, and the adoption of the new Investment Law.
However, it suggests that it would help stability if the government were to communicate its vision (eg. expected sources of growth, enabling policies) and the economy’s performance relative to its objectives, more clearly.
It suggests that, in its Medium Term Fiscal Framework, the government should target a fiscal deficit of less than 5% of GDP, with gradual consolidation over the medium term. The deficit target could be complemented with a clear statement on revenue and expenditure plans—eg. tax policy and administrative reforms to offset declining gas income on the revenue side, and reallocations from lower to higher priority areas on the side of expenditure.
It also sees a need to align borrowing more to longer-term investment needs, and away from inflationary CBM financing, and specifically suggests the Central Bank needs to accept higher interest rates in its T-Bill auctions, and to tighten liquidity in the face of strong FDI flows and bank deposit growth. It says the phased relaxation of interest rate caps would help to encourage medium and longer-term deposits, which would be better matched to longer-term commercial loans. It also suggests a rebalancing towards longer-term concessional finance, which is currently below the average share in Low Income Countries, could help to lower the cost and risk of Myanmar’s public debt portfolio, whilst helping to address weaknesses in public investment capacity through external technical assistance.
In the medium term, as monetary policy capacity develops, the World Bank thinks the Central Bank may need to think about gradually relaxing the current regime of administratively fixed lending rates for the banks. Whilst there is a case for having these at a time when credit and risk management skills are weak, they can impede the development of a healthy credit market in the long term, as lending tends to shift to lower risk activities, to the detriment of SMEs, and it can increase the concentration of lenders’ portfolios.
The implementation of the new Financial Institutions Law (2016), with new regulations on capital governance, exposures, loan classification and provisioning, is seen as important for financial sector stability as, without them, it will be difficult to judge the health of the banking system. The World Bank looks forward to the issuance of the regulations on credit reporting, which is expected soon, with at least one credit bureau expected to start operations by mid-2017.
Lastly, the World Bank returns to the topic of revising tax incentives policy, suggesting four issues that need consideration: – replacing blanket tax holidays with incentives linked to investment (investment allowances, accelerated depreciation, training)
– targeting incentives more towards export-oriented investors, or highly mobile investors (eg. in garments)
– focusing more on projects that have high economic (social) returns, but lower financial returns (eg. education, or investments directed to disadvantaged areas)
– increasing the transparency around the impact of tax incentives on revenue forgone
Special Topics
At the end of its report, the World Bank concludes with some comments on three areas of special interest to it:
Firm survival and employment in a period of high growth
The rate of firm exit in Myanmar continues to be high at around 17% annually. Most exits are of micro or small enterprises, which tend to be less productive than larger; survivors tend to be less credit constrained and have more experienced managers. Net job creation has been around 13%. The high rate of exit underlines the need to improve the business environment, particularly access to credit, and to maintain economic stability.
Policies for managing informal border trade
Informal imports may be being under-reported by as much as 40%-60% and there are concerns over the quality of imported goods, the loss of government revenue, and unfair competition for domestic operators. The World Bank suggests consideration should be given to simplifying border processes, building greater trust between traders and officials, promoting consumer awareness, and tightening surveillance.
Protecting priority public spending from gas revenue volatility
Gas revenues are conservatively estimated at between 15% and 20% of government revenue. Optimistic estimates can create unfunded commitments, whilst revenue windfalls can spur unsustainable spending. To protect against revenue volatility, the World Bank advocates integrating forecasts into the Medium-Term Fiscal Framework and adopting fiscal benchmarks to stabilize spending over the resource cycle.
A summary table of the World Bank’s expectations for the Myanmar economy is shown below:
