Living with donor conditions

Complaints about donor conditionality are a staple of political conversation in Bangladesh. The common argument is that foreign lenders use their money to impose their preferences, attaching conditions to loan disbursements that do not always match the country's needs or ambitions.  This concern is not without basis, yet successive governments have shown scant hesitation in seeking external financing and accepting their terms. The reason is not difficult to fathom. Government expenditure continues to rise while revenue collection remains weak, creating a persistent financing gap that the government has little option but to fill through borrowing.

The ongoing loan programme with the International Monetary Fund is a fitting case in point. This programme began in January 2023 with a commitment of $4.7 billion and was later expanded under the interim government led by Professor Muhammad Yunus to $5.5 billion. Bangladesh has so far received $3.64 billion across five tranches, though the sixth expected in last December was not released. The incumbent government remains keen to maintain continuity with the programme and is working to satisfy the outstanding requirements. While some programme conditions have been met, progress in other areas such as separating revenue policy and administration, reducing subsidies and improving revenue generation has only been partial. The government is nonetheless hopeful of receiving the sixth tranche by June. Just last Wednesday, Prime Minister Tarique Rahman also sought an additional $2.0 billion from development partners to help cover rising fuel import costs. Whatever reservations exist about the terms of external financing and their match with national priorities, the pressure on public finances leaves the government with limited scope to disengage.

The size of the forthcoming national budget makes this dependence even harder to overlook. The budget for the next fiscal year is being planned at around Tk 9.0 trillion, an increase of more than Tk 1.0 trillion over the previous year. Expenditure of this scale will inevitably boost domestic demand. A significant portion of that demand will be met through imports given the economy's reliance on imported fuel, machinery and a wide range of consumer goods. Higher public spending also tends to add inflationary pressure, raising production costs and making exports less competitive in international markets. When import demand rises while exports lose ground, the country ends up spending more foreign exchange than it earns, thus producing current account deficit.  Bridging that deficit means turning to external financing, which means the country's economic stability rests, to some extent, on the willingness of the outside world to keep lending.

The preference for foreign over domestic borrowing follows its own logic. Governments can and do borrow from domestic sources, whether through bank lending, non-bank instruments or the sale of savings certificates. But heavy reliance on domestic borrowing risks displacing private investment, as the government ends up competing with businesses for the same pool of available capital. Foreign borrowing, by contrast, adds to that pool rather than depleting it, helping sustain private investment alongside public spending.

Foreign loans are most commonly directed at development spending, and the composition of national budget shows how precariously that spending is positioned. In the first six months of the current fiscal year, over 85 per cent of government expenditure went to the operational budget alone, covering civil service salaries, pensions, subsidies and interest payments on existing debt. These are obligations that cannot be deferred or reduced at will and they consume the bulk of what domestic revenues bring in. That leaves development spending, which stood at just over 12 per cent of total expenditure over the same period, almost entirely dependent on external financing. It is through this relatively thin slice of the budget that the government builds roads, bridges, schools and hospitals, creates employment and draws in private investment. The returns from such spending ripple across the broader economy in ways that far exceed the initial investment. To walk away from external financing on grounds of principle would be to cut off the very investment that the domestic budget cannot provide.

That said, borrowing for investment is not without its complications. Debt repayment is a fixed component of the operational budget, and an excessive debt burden can place the broader economy under strain. The imperative is therefore to borrow at the lowest available cost and to ensure that capital expenditure is managed with an efficiency that has always been conspicuously absent. For Bangladesh, infrastructure development remains the most reliably productive destination for development investment and is also the area where external lenders show the greatest willingness to engage.

Much of what is pushing up the cost of borrowing stems from the government's own decisions. Projects are often approved without proper feasibility studies, so costs and returns are never carefully examined at the outset. Funds are then released slowly and unpredictably, delaying progress and adding to expenses. Weak oversight during implementation also allows inefficiencies and waste to accumulate unchecked. None of this is, of course, beyond remedy. Correcting these failures would allow the government to achieve considerably more with less borrowing, gradually reducing its dependence on external financing without compromising its developmental ambitions.

The more concerning development is that the terms on which Bangladesh borrows from external sources have been moving in an unfavourable direction. Since the World Bank reclassified Bangladesh from low-income to lower-middle-income status in 2015, the average interest rate on foreign borrowing has risen and repayment periods have shortened. Concessional financing, once the dominant form of external assistance available to the country, is gradually becoming a smaller share of the total. Each new loan must therefore be evaluated with greater rigour than before, with the expected economic return weighed carefully against the cost of borrowing. A loan should only be contracted where the long-term benefit is clearly positive. Borrowing as a reflex, simply because funds are available or because a programme must be sustained, is a habit the country can no longer afford. 

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