Bangladesh is at a turning point, politically, economically and diplomatically. Can Sheikh Hasina Wajed's Awami League produce a stable and effective government which eschews winner-take-all politics?

Can relations with India improve to the point where India becomes a positive factor for Bangladesh? And can the policies and implementation improve to the point where government actions help not hinder private sector development?

Make the right moves now and Bangladesh will not only survive the global economic downturn relatively unscathed but could emerge strong enough to stand a chance of reaching middle income levels within a decade. Fall back into its worst habits and it will drop further behind its giant neighbor and perhaps even become again the aid-reliant basket case which was once deemed to be its fate.

First, the bad news. The dynamics of Bangladesh's economic growth of a respectable 5+ percent a year have been provided primarily by two external factors: the garment export industry and worker remittances. Garment exports grew strongly even in 2008 to around US$16 billion a year, roughly divided between knitwear and woven. Although exports are now falling, Bangladesh is doing a lot better than most Asian exporters as it continues to benefit from rising costs in China, duty free access to Europe and some improvements in its port cargo handling. Its products are mostly at the low end of the quality range so it may eventually gain from the downturn – though not before a sharp fall in orders in the short term. But given likely nil to slow growth in most western import markets over the next few years it seems unlikely that Bangladesh can continue to rely on this sector as a main growth engine.

Likewise, although remittances grew by nearly 30 percent over the past year to almost US$10 billion a decline is now expected. The World Bank expects a drop of at least 10 percent this calendar year given the high proportion of overseas workers in the the Gulf states, where building laborers are being paid off in droves, and in the UK with its devalued currency and worse than average recession.

Between them, these two income sources have sustained both consumer demand and enabled the local savings rate to look healthy by the standards of other low income countries.

Growth has also been underpinned by Bangladesh farmers who continue to overcome natural disasters and maintain food supply increases average 3 percent a year. But they are unlikely to be able to continue to do so if the government cannot make a better job of power supply, irrigation and marketing networks.

Secondly, the social progress which Bangladesh has achieved, in several respects surpassing India, shows signs of stalling. The fertility rate appears to have stopped falling and is above India's and Sri Lanka's, though still far below Pakistan's. Child malnutrition is still widespread and though educational equality is quite impressive general standards are low and school attendance too short. The country relies heavily on NGOs and foreign assistance for social development and improvements in governance are necessary if progress is to be sustained.

Thirdly, there are worrying signs that after the two-year interlude of the army-backed caretaker government, the political parties are now returning to policies of confrontation backed by periodic violence. These may be early days. The election was only seven weeks ago and the incidents of violence, protection racketeering by local politicians etc may prove isolated, at least compared with the past. But there is clearly a danger of a general deterioration in law and order which at some point will lead to another political crisis. Although Hasina has kept some Awami League stalwarts out of the cabinet and brought in new faces, and ones loyal to her, she has also appointed advisers to ministers, not all of whom have clean reputations.

The main burden of meeting public expectations, enhanced by the caretaker era, for improved governance rests primarily with Hasina. But opposition Bangladesh Nationalist Party boss Khaleda Zia must learn to play the game too – which also means keeping her money-oriented sons out of influence and on a tight leash. The omens thus far are mixed.

Against this rather daunting list of negatives, Bangladesh has opportunities which a government with a huge majority in parliament has a chance seizing. But to do so it must overcome both self-defeating economic nationalism and policy immobility produced by layers of official corruption. To confront nationalism it also needs help from its focus, India.

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Bangladesh's failure to develop known massive high grade coal deposits and estimated huge gas deposits has been based on fear it would be mainly for India's benefit. Exploration concessions have been given but little work has been done in recent years though foreign companies are all optimistic. The export markets needed to develop the coal and invest more in gas exploration would lead, say nationalists, to rapid depletion of the resources. Better to keep them underground, saved for Bangladeshis' future use, say the nationalists. As a result Bangladesh now faces shortages of gas and power generating capacity, lack of progress has deterred Indian investment in energy-related industries.

Although corporate India, notably the Tata Group, has been keen to invest in Bangladesh, which badly needs to expand its industrial base, official India's attitudes have contributed to local paranoia. Bangladesh is mostly unfairly blamed for troubles in India's seven troubled northeastern states, and Delhi likes to give the impression that Bangladesh is a breeding ground of Islamic terrorists. While Bangladesh may have been lax in dealing with these issues, Indian attitudes have been unhelpful.

Likewise India's barriers, tariff and non-tariff, to Bangladeshi goods have hurt its industry and contributed to its massive trade deficit with India. These barriers exist more for political reasons than to protect Indian producers. India accounts for 30 percent of Bangladesh imports – and probably more given the volume of smuggling – but sells very little in return. As a result it relies mainly on western markets and now also to some Asian ones such as Korea.

But Bangladesh contributes to its trade problem with India by failing to implement agreements on transit trade. This would improve India's access to the northeast states but horse trading could also give Bangladesh access to that market. Likewise, Bangladesh could benefit financially from transit traffic, which would justify the expansion of Chittagong port to serve Indian as well as local trade. As it is Bangladesh has thwarted developments such as the Pan-Asia highway which would be supported by World Bank and Asian Development Bank money, and stopped Burma from piping its gas to India.

Bangladesh ought to be able to ride on India's growth but having cut itself off in this way it has had to rely on developing trade with more distant partners.

The negative attitude to India extends in a lesser way to other potential foreign investment which hitherto has been small despite the longer-term potential of such a populous, compact and homogenous country. Corruption and the impression of political chaos (though often more sound than action) have nullified the government's very modest efforts to attract investment. However it will come if relations with India improve and policies on resources are positive in practice as well as theory.

A Trade and Investment Framework Agreement with the US may help too. Although such bilateral deals should generally be discouraged as having little practical effect and undermining the principles of multilateralism, in the Bangladesh case the agreement could be a useful statement of intent to foster trade and give comfort to some potential investors. It may also make Dhaka more confident in dealing with India.

The Hasina government should in theory be able to make breakthroughs on several of these fronts. Unlike Khaleda, who has made a career outside of suspicion of India, Hasina has a history of good relations with India and particularly the Gandhi family. Backed by a firmly secular party she can please India by showing a tougher attitude to Islamic extremists. She may be able to break through the obstructionism of rent-seeking bureaucrats and ministers to get projects moving. And she may have the courage, given her majority, to face down the BJP and the combined nationalist and leftist opponents of opening to India and development of gas and coal.

If she does not, Bangladesh's economic performance could go from moderate to poor. And it will have even less chance of coming to agreements with India over vital rivers. At best these could be used both by Nepal and Bhutan for power for India and Bangladesh at the same time as helping flood control and water use in Bangladesh. If India thinks only of its own advantage, Bangladesh, already losing land to rising sea levels and salination, will suffer grievously.

Bangladesh thus has immediate and long term reasons for engaging with India, having enough confidence in its own Bengali identity not to fear being dominated by its neighbor. It has the potential to be as successful as India's best states. If it fails and becomes more like its Indian neighbors Bihar and Assam, it will have itself largely to blame. Given the successes of the past 20 years, that looks unlikely. But the global environment has changed, making it more urgent than ever that a new government chart a new course, one which enables Bangladesh to take advantage of its resources, its geographical position and its human capital.

Bangladesh's Challenge

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