Bangladesh has been going through a period of continuous budget deficits for a considerable period of time. Available data indicate the budget deficit is hovering around 5 per cent of GDP on average. During the same period, the economy has been growing steadily at an annual average rate of 6 per cent which is below the potential as reflected in the output gap. This has been the case since the very early 2000s and is likely to continue in the near future. Now the spread of Covid-19 has become a public health crisis posing a serious risk to the macroeconomic stability of Bangladesh resulting from disruptions in production, transport and supply chains.
The national budget proposal presented on June 11 outlined a budget deficit of TK 1900.00 billion for 2020-21 which is equivalent to 6 per cent of GDP and a forecast growth rate of 8.2 per cent for the fiscal year under consideration. But the World Bank (WB) projected the growth rate to be in the range between 1.2 per cent and 2.9 per cent and fiscal deficit to soar to 7.7 per cent of GDP. This forecast is largely in conformity with the IMF forecast on global output growth indicating that the global economy will contract by US$12 trillion in 2020-21. The divergence in the forecasts is rather surprising given that both the Bangladesh government and the World Bank use the same data base maintained by the Bangladesh Bureau of Statistics (BBS).
The unprecedented global health crisis has created a challenging and an uncertain situation affecting lives and livelihood of millions of people in Bangladesh. Besides the deeply worrying effects of Covid-19 on human life in Bangladesh, it also has the potential to significantly slowdown not only the Bangladesh economy but also the global economy with serious implications for global flows of goods and services. The WTO has provided its trade forecast stating that due to the direct effects of the pandemic, depressing both supply and demand, as well as to a much lesser extent trade measures, global trade in merchandise would decline by 13 to 32 percent in 2020.
The pandemic induced supply shock has morphed into a demand shock creating a recessionary climate. Under such circumstances a sizeable fiscal response regardless of the mode of financing is needed. Also, the fiscal response now under consideration with deficit financing is unlikely to fuel inflation or crowd out private investment.
The term 'deficit spending' often implies a Keynesian approach to economic stimulus in periods of recession. However, economists belonging to the Chicago School contest the idea of deficit spending and argue that such spending will be offset by higher taxes and inflation. The 'Ricardo-Barro effect', also known as the 'Ricardian Equivalence' which postulates that despite efforts to stimulate an economy by increased debt financing by the government, demand will remain unchanged because of the expected rise in taxes in the future.
But the situation on the ground does not always fully follow any one of the theoretical paradigms outlined above. In the post Global Financial Crisis (GFC) period, continuous quantitative easing (QE) did not stimulate consumer spending or economic growth in any meaningful way in the European Union or Japan as was also the case with the US as it recovered from the GFC. This indicates that as the economy starts to move out the recessionary phase, it does so, some times, with some structural overhangs forestalling a full recovery as households' willingness and ability to spend or borrow being structurally impaired. This was equally true of businesses and investment. While theoretically QE is a monetary policy instrument, not a fiscal policy instrument, in reality QE has blurred the borderline between fiscal policy and monetary policy.
But regardless of any theoretical debates surrounding fiscal deficit, in view of the current economic crisis caused by the pandemic, it is necessary to provide economic stimulus. The economic recovery packages in the budget amounting to TK103,117 crore equivalent to 3.7 per cent of GDP are designed to protect jobs, businesses and incomes. In the absence such economic stimulus, hit to the economy from lockdowns would be far greater and a much slower recovery prospect.
The estimated revenue collection for coming fiscal year is TK378,000 crore but the total outlay stands at Tk568,000 crore leaving a budget deficit of TK190,000 crore. This fiscal deficit will now add on to the already accumulated public debt which is now equivalent to 34 per cent of GDP (of which 38 per cent is external debt). The Debt-GDP ratio is likely to rise to 38.3 per cent by 2022-23. This figure is relatively low in comparison with many other comparable countries. However, if the output falls sharply and the deficit grows, debt-GDP ratio will climb up.
We are now living through an extraordinary time that requires extraordinary efforts to face the pandemic crisis. But right now, experts do not seem to expect a rapid rebound from this recession. It is also generally pointed out that as the US, Britain and the Euro-zone countries were starting to show signs of recovery from the GFC, the authorities took fright at their rising levels of public debt. That resulted in switching policies to economic austerity by cutting public expenditure and raising taxes to run budget surplus.
There are lessons to be learnt from the post-GFC response of these countries leading to the adoption of the austerity programmes and the consequences of adopting such policies. The Bangladesh government will now have to borrow to finance the budget deficit. In macroeconomics, the 'twin deficit hypothesis' is the observation that theoretically there is a causal link between a country's budget deficit and its current account deficit. The logic is when a nation runs budget deficit, it often turns to foreign investors as a source of borrowing and also when consumption outstrips income causing dissaving requires foreign borrowing leading to a current account deficit.
However, at times data support the twin deficit hypothesis, other times they do not. That observation is equally true for Bangladesh. This observation has implications for Bangladesh's external sector or more precisely its external balance.
The relationship between the current account and the budget balance is unlikely to be as direct and strong as the twin deficit hypothesis predicts. The saving-investment decision of the private sector may fully or partially adjust to how fiscal policy parameters are adjusted to reduce or increase public borrowing. As such prediction of the effects of increases in budget deficit on external balance should take into account the induced effects on private sector saving and investment decisions.
Under the current situation in Bangladesh, an expansionary fiscal policy is a way of causing private sector saving to be utilised as private sector savings rise due to lack of business confidence. In fact, the government is not preventing private sector spending, but using private sector savings to increase aggregate demand without causing any crowding out.
Bangladesh has a greater reliance on trade relative to the other countries in the region, making the country more exposed to changes in the global economic environment due the current pandemic. The RMG industry and remittances from abroad are two major pillars of the Bangladesh economy. The impact on the Bangladesh economy due to fall in export earnings from RMG and other exports and also fall in remittances is likely to be very significant. Importantly, foreign exchange earnings of the country are expected to drop by about 25 per cent which in monetary terms is estimated at more than US$4 billion in 2020.
Economic slowdown in Europe and North America is of particular concern for Bangladesh as these are the principal markets for Bangladesh's principal export -- ready made garments (RMG). These two regions are also expected to continue to slowdown at least for next six months or more and that has implications for 4 million workers (out of 6 million in the formal sector) in the RMG industry in Bangladesh. The latest IMF forecast growth figure for the advanced economy group is projected at -8 per cent for 2020. Overall, 5 million workers in export oriented industries would be affected due to the decline in exports.
Also, RMG generates close to US$34 billion in exports accounting for 83 per cent of total exports and 14 per cent of GDP. Now the industry is in deep crisis as exports have plummeted due to cancellation of some purchase orders from Europe and North America.
Remittances from Bangladeshi workers accounted for US$17 billion contribution to the national economy in 2019-- 9 per cent of GDP. Now host countries in Europe, North America and the Middle-East are themselves facing economic slowdown causing large-scale layoff of migrant workers. Most of them are now returning home. World Bank estimates now project remittances will fall to US$14 billion this year (2020) from US$17 billion the previous year.
The budget has made a number of provisions to stimulate and to make the export sector competitive, in particular the RMG industry. These include Tk 5000 crore stimulus package for export oriented industries. The specific budgetary measures to stimulate exports include new pre-shipment credit refinance scheme of TK 5000 crore, increased amount for the export development fund from US$3.5 billion to US$5 billion to be allocated at a subsidised interest rate, additional cash incentive for one year and lower corporate tax rate (at 12 per cent) for RMG manufacturers for two years.
While export promoting initiatives could be helpful for exporting firms, it is the price that will ultimately make Bangladeshi goods attractive to foreign buyers. Therefore, the exchange rate is the important determinant of Bangladesh exports (also imports). Movements in the exchange rate affect the relative prices of traded goods and services. That will determine the competitiveness of Bangladesh's exports. The Marshal-Lerner condition, which is an extension of Marshall's theory of the price elasticity of demand, tells us if foreign demand is elastic, the exporter can increase revenue by reducing the price.
Bangladesh maintains a fixed exchange rate regime with the US dollar. Fixed exchange rates require economies to be of similar stage of development and have a similar trade cycle. The Euro for this reason has caused serious problems for many Eurozone countries. Therefore, at this critical point in time, Bangladesh must re-think of its exchange rate policy. Flexibility in the exchange rate will have discernible impact on exports and help improve the current account by reducing deficit. When that occurs, that in turn will help to strengthen the country's fiscal position.
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