Deficit Budget and interest rate in the economy

Mehedi Hasan | Published: June 29, 2019 21:26:10

One of the major causes of inflation is government's borrowing at high interest rate from the money market. High interest rate certainly sparks inflation in the economy. Government normally borrows to support the deficit budget. Big deficit budget is one of the major impediments of reducing interest rate. It will be very difficult or unrealistic to some extent if we plan to reduce interest rate with a huge revenue shortfall in the budget.

Recently our national budget for FY 2019-20 has been announced. Total revenue target for the upcoming fiscal year has been estimated at Tk 3778.10 billion which is 17.92 per cent higher than the revised target of the outgoing fiscal. As per the proposed budget, projected revenue target of Tk 3.25million will be collected by NBR and Tk 145 billion and Tk 377.10 billion will come from non-NBR and non-tax sources respectively. The revenue growth target of 17.92 per cent appears to be pretty ambitious compared to 7.1 per cent growth in the first nine months of the current fiscal.

Total deficit for the upcoming fiscal year is Tk 1.45 million which is more than 16 per cent of the current fiscal year's. This deficit will be met up mostly from three sources. Tk 265.0 billion, Tk 548.0 billion and Tk 605.0 billion will be sourced from saving tools, bank borrowing and foreign sources respectively. The government is going to borrow Tk 548.0 billion from banks. As we know, the banking industry is facing a very challenging time. Maintaining liquidity and profitability is becoming increasingly difficult with mounting non-performing loans.

The effect of bank borrowing is too heavy for the economy. If banks borrow at double digit, how can they lend at single digit. Moreover, to facilitate large infrastructure and deficit budget, the government has to issue savings certificates and Tk 265.0 billion has been planned to be collected by savings tool in the upcoming fiscal. Interest rate of savings certificates is more than 10 per cent, so how can the depositors be expected to keep their money with banks at 6 per cent interest rate?

Liquidity crisis in banking industry adversely affects private investment and entrepreneurship development. Without boosting private investment, it is not possible to generate higher employment to reach the sustainable growth target. As mentioned earlier, budget deficit causes high interest rate leading to inflation. Certainly, weak participants in economy fail to adjust their income to enhanced price which also creates the inequality as reflected in gini coefficient.

There are multiple effects of budget deficit in the economy, though in countries like ours deficit budget is not unlikely. We have to review who the beneficiaries of deficit budget are as the burden or consequence of deficit budget will fall on the whole nation. 

There are various tools suggested by economists to reduce interest rate by reducing bank rate, bringing reform to the banking industry and stopping issuance of saving certificates at higher rates. Many of us have pointed that interest spread in our country at 4 to 5 per cent is pretty high. It is around 2 to 2.5 per cent in many countries. In fact, bank's profitability is not only dependent on interest spread but is also highly dependent on the quality of assets or good loans. Without reforms in the banking sector (maintaining minimum NPL ratio and using technology in operational process), it will be difficult to reduce interest rate. Higher interest rate in economy also causes fund flow to the money market from capital market which discourages private limited companies getting listed as public limited companies.

It is also high time to rethink on the size of the government as one of the principles of market economy is prudent and small size of government capable of facilitating the private sector.

Mehedi Hasan is Credit Manager at a leading NBFI of Bangladesh.


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