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The Financial Express

Some thoughts on financing the budget deficit


Some thoughts on financing the budget deficit

Budget deficit is one of the most important macroeconomic issues economists deal with. It has been debated since the 1970s in both academic and political arenas. Because of the structural issues' experience, budget deficit causes more extreme problems in developing nations than in developed ones.

However, in developing countries, budget deficits are likely to happen due to structural and economic factors such as high rates of inflation, a deficit in the balance of payments, extreme level of expenditures against an insufficient level of national income, as well as other political reasons. Conversely, developed nations do not extremely experience the negative impacts of budget deficit on macroeconomic equilibriums, which developing nations do, because they have a positive foreign trade balance, high foreign-exchange reserves and capital stock, and low inflation. Therefore, the government may resort to the sources of deficit financing mostly through borrowing to meet the deficit in the budget and to pulverize the negative effects on the economy.

In general, financing the budget deficit is met by borrowing from other sectors of the economy or international financial market, government borrowing from domestic sources, minting money by the central bank, and it also can be done by issuing government securities. A higher level of domestic loan has a considerable economic expense which leads to slower economic growth. The growth in internal debts prompts an expansion in debt- servicing costs. Internal debt servicing ingests a significant piece of government income. Thus, the government has fewer resources to spend on improvement projects. Additionally, in financial markets, as the internal debt rises, the cost of interest also expands because of holding a lot of loans in short-term instruments.  If the budget deficit is financed by borrowing from the domestic banking system, there will be an increase in the domestic interest rates and the crowding out of private investment. Moreover, monetisation of the deficit brings about an expansion in the supply of money and, hence, the rate of inflation. Also, the exchange rate may appreciate because of adopting deficit budget. The appreciation of the real exchange rate due to the inflow of foreign exchange makes the country's exports less competitive. This will further deteriorate the balance of trade. Again, less-competitive exports may lead to resources moving away from the production of tradable to the production of non-tradable.

However, an excessive budget deficit may result in a debt crisis as it leads to growth in the country's external debt stock. Thus, the budget deficit has a cascading impact on the financial, economic, and political stability of the country.

Since independence, Bangladesh has experienced a gentle increase within the rate of growth of Gross Domestic Product (GDP), accelerating from an average of less than 4.0 per cent per year during 1972-1990 to 6.47 per cent in 2015-21. Though Bangladesh has gained immeasurable attention from all over the world due to its rising economy, it has been experiencing continuous budget deficits and rising levels of debt over the years on account of decline in sources of revenue. The tax-to-GDP ratio is one of the lowest in Bangladesh as compared to other South Asian countries. In the last 10 years, Bangladesh's average tax-GDP ratio is 10.3 per cent, which is 19.6 per cent in India and in Nepal 19.6 per cent. In developed countries, the average tax-to-GDP ratio is 35.8 per cent. Although the economy is developing, there is a logjam within the growth because of increasing government expenditure relative to the revenue income.

According to the Bangladesh Economic Review (2021), the total budget deficit (excluding grants) for FY 2020-21 was projected at Tk 1,900 billion, which is around 6.0 per cent of GDP. The government's domestic borrowing in Bangladesh has been on the increase, rising from Tk 16.5 billion in 1981 to Tk 1099.83 billion in 2021, whereas the government borrowing from external sources rose from Tk 42.5 billion in 1981 to Tk 760.04 billion in 2021. In comparison with domestic debt, the amount of government borrowing from external sources has decreased between 2006 and 2021.

Within the domestic sources, government borrowing from non-bank sources during 2017-2019 had been on the rise mainly due to the expansion in the net sale of national savings directorate (NSD) certificates while borrowing from bank sources is on the decline. After 2019, the government borrowing from banking sources increases compared to non-banking sources in Bangladesh. It is usually contended that a decrease in borrowing from the banking system stimulates investment by the private sector as it reduces the crowding-out effect resulting from government borrowing from banking industries. On the other hand, the fundraising from selling NSD certificates will induce savers by delivering positive real returns as well as ensuring the marginal families' social- safety net, although it has higher-cost implications for government. In any case, when wastefully allotted, the expense of external borrowing can add to macroeconomic-administration problems as severe or yet unreasonable levels of external debt-servicing commitments.

It is true that, for the economic development of our country, deficit budget is important, but there remains a question of how far the maintenance of the amount of 6 per cent of GDP, which is equivalent to almost 32 per cent of the total budget, is reasonable. It will need to keep in mind that budget deficit increases the national debt, more national debts compel the exchequer to pay more interest and more interest cost plays a role in extending the budget deficit. According to the World Bank (2010), the pathway of deficit budgeting states that the fiscal-responsibility-act deficits shouldn't exceed 3 per cent of GDP. According to some scholars, these conditions are gained if the size of the total budget deficit is around 3 per cent of GDP.

The Government of Bangladesh should decrease the size of the budget deficits, mainly by increasing domestic revenue mobilisation through tax-base expansion while lessening foreign and borrowing deficit financing. The tax base can be extended by bringing down the size of the informal sector, battling against corruption and tax avoidance, decreasing unproductive tax exemptions, and overall efficiency improvement in tax organisation. A decrease in the overall recurrent expenditure bill compared to GDP may also assist with relieving the budget- deficit problem that leads to the accumulation of debt in Bangladesh.

As deficit financing through the banking sector crowds out private investment, therefore, the government needs to strengthen policies that reduce the amount of deficit financing through the banking sector to enhance economic growth. Maybe, the public authority should focus on other internal sources like non-bank public, individual investors in the security and bond market, continuing privatisation, managing overabundance in excess money, and so on.  Therefore, it is recommended that the financing of deficit ought to be expanded viably, and that government ought to guarantee a proficient public-expenditure process, fiscal discipline, and maintenance of macroeconomic stability so that Bangladesh's economy can develop. It is suggested that government budget deficit ought to be centred on capital-expenditure use as opposed to recurrent expenditure to guarantee investment in infrastructural facilities that could improve economic development through the upgrade of both domestic and external investment. Foreign debt also ought to be closely observed to guarantee that outside borrowings are not beyond the normal limit which could bring about obligation overhang. Furthermore, the government should enhance moderate levels of domestic and external borrowing and use it in productive and efficient ways to accelerate economic growth in Bangladesh.

 

Dr. Md Nazmus Sadekin is Chairman, Department of Economics, and Dean, Faculty of Social Sciences, Mawlana Bhashani Science and Technology University, Bangladesh.

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