Can spending cuts cool inflation?

The proposed national budget for the 2025-26 fiscal year is shaped by a strong resolve to tackle the long-standing and urgent problem of inflation. Although numerous aspects of the budget adhere to established trends, there is a clear trend towards contractionary policies, which means the government is trying to cut back on expenditure. Set at Tk 7.9 trillion, this budget is Tk 70 billion lower than the original outlay for the current 2024-25 fiscal year. This reflects a rare reversal in the usual pattern of expanding government budgets. Given that this budget was presented by an interim administration, with national elections scheduled for first half of 2026, this approach was perhaps inevitable. The public largely perceives this administration as a caretaker government, responsible only for essential reforms and election preparations. As such, the government has refrained from allocating funds for big-ticket infrastructure projects typically pursued by elected governments.

A large portion of the budget is driven by a basic fiscal reality in which mandatory expenditures take up most the government's resources. A massive Tk 1.13 trillion has been allocated solely for interest payments on existing debt. This number is almost one-seventh of the entire budget, but the public receives no real benefit from it. With the overall amount of the government's domestic and foreign debt approaching $100 billion, it simply represents the weight of prior borrowings. That means a significant portion of the budget is already spoken for before a single new policy initiative is implemented. The estimated Tk 820 billion in core revenue expenses involving salaries and benefits is another fixed cost. Apparently, the budgetary priorities are wildly out of balance. The amount set aside for interest payments is more than what is to be spent on either education and technology or transport and communication, which are both very important for the long-term economic growth and development. It's no surprise that inflation gets harder to control in a country that spends more on paying off its debt than on building up its people or its assets.

However, the government's allocations in sectors outside these mandatory expenditures show a clear intention to bring inflation under control. This is no easy task for an interim administration, especially at a time when falling foreign exchange reserves and strict IMF loan conditions are creating added pressure. When the interim government took office about ten months ago, inflation was spiraling, reaching 11.66 per cent in July 2024, which is one of the highest rates in recent memory. Since then, the government has managed to marginally ease inflation into 10.89 per cent in December 2024 and further to 9.17 per cent in April 2025. The finance adviser is optimistic that inflation could fall to 8 per cent by the end of the current fiscal year and to 6.5 per cent by the close of FY 2026. However, whether these targets are achievable will depend on a combination of factors.

One such factor is the stability of the newly adopted floating exchange rate. Bangladesh switched to this system last month and the exchange rate hasremained stable since then. In the short term, this stability grants the Bangladesh Bank greater control over monetary policy, allowing it to focus on domestic inflation without the burden of defending a fixed exchange rate. However, Bangladesh's economy is heavily import-dependent. If the Taka depreciates significantly, import costs will rise, pushing up prices for essential goods and raw materials. This pass-through impact has potential to reignite inflation. Moreover, a fluctuating exchange rate could create business uncertainty, reduce investor confidence, and instill inflationary expectations in the public's mind. If these risks materialize, the progress made so far in controlling inflation could be undone rapidly.

Another critical area is revenue collection. The proposed budget sets an ambitious target of Tk 5.64 trillion in revenue, with Tk 4.99 trillion expected to come via NBR. This goal is equal to roughly 9 per cent of the country's GDP, and is, by most standards, highly optimistic. Historically, Bangladesh has struggled to meet its revenue targets. In FY 2023-24, the highest-ever revenue collection was only Tk 3.82 trillion. Given the current slowdown in economic activity, rising unemployment, and subdued investment climate, it is difficult to see how this year's revenue target will be met without resorting to desperate measures.

If revenue collection falls short, as it likely will, the resulting budget deficit will compel the government to borrow more, both domestically and from foreign sources. Domestic borrowing, especially from the banking sector, poses its own inflationary risks. If the government turns to the central bank for financing, it would be tantamount to printing new money, increasing the money supply without a corresponding increase in goods and services. This scenario is a textbook recipe for inflation. Even borrowing from commercial banks could lead to credit expansion, which would further fuel inflationary pressure.

The government has so far pursued a contractionary monetary policy, raising the policy interest rate by 150 basis points to 10 per cent. However, there is only so much that monetary tightening can achieve on its own in curbing inflation. When inflation is also fueled by structural inefficiencies, supply chain disruptions, and lax fiscal discipline, monetary policy alone cannot offer a comprehensive solution.

To its credit, the budget does make provisions for protecting the most vulnerable segments of society. Food subsidies are set to rise by nearly 20 percent and the number of low-income families receiving food assistance will also grow. These measures are necessary, but they must be implemented efficiently to ensure that relief reaches those who need it most.

If the government stays committed to aligning fiscal and monetary policies, stabilizing the exchange rate, boosting production and protecting the livelihoods of low-income groups, there is a genuine possibility of bringing inflation under control. It remains uncertain whether the interim administration will have the time or political inclination to implement these reforms fully, but the groundwork, at the very least, seems to be in place.

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