Deficit financing and fiscal transparency in budget FY21

Lower subsidy demand for some cash incentives and lower utilisation of project aid in mega projects could help lower the overall expenditure at the end of FY20. However, a significant revenue shortfall and expected rise in the public expenditure depending on the extent of Covid-19 and associated costs and implementation of policy measures, may result in even higher overall deficit financing by the end of FY20 compared to FY19 (5.50 per cent of Gross Domestic Product or GDP). In the backdrop of subdued revenue mobilisation, the possibility of pushing the budget deficit beyond the traditional cap of 5.0 per cent of the GDP may be a necessity in view of the upcoming FY21.

Given that Bangladesh currently enjoys a robust debt sustainability index (public-debt-to-GDP ratio is around 34.0 per cent), the country could afford a couple of additional percentage of fiscal deficit (perhaps up to 7-8 per cent of GDP). However, this increased budget deficit should be managed through appropriate diversion of available resources, proper sourcing and prudent use of resources.

EXTERNAL SOURCES' OPPORTUNITIES NEED TO BE UTILISED: It is critically important to give heightened attention to seek and utilise new funding opportunities available from external sources. Particularly those from multilateral and bilateral sources must be mobilised to the fullest to combat the Covid-19 pandemic. Deterioration in the utilisation of foreign resources in FY19 was a worrying sign, which has also continued in FY20, and may further exacerbate due to Covid-19. Net foreign borrowing registered 22.10 per cent growth in FY19 (119.8 per cent in FY2018). It recorded (-) 0.5 per cent growth during July-February of FY2020. The government has already approached a number of development partners in this regard. Reportedly, the government is seeking US$ 2.60 billion worth of budget support from various international financial institutions (IFIs) including the World Bank, the International Monetary Fund (IMF) and the Asian Development Bank (ADB). ADB has already signed an agreement to provide $100 million loan for buying equipments and testing kits and for development of health infrastructures to fight Covid-19. The bank is also likely to approve $500 million worth of credit support for Bangladesh to help meet its budget deficit during FY20. The World Bank has approved a fast-track $100 million financing to help Bangladesh prevent, detect, and respond to the Covid-19 pandemic and strengthen its national systems for public health emergencies. The IMF has sanctioned a total of $732 million for the country - with $244 million at zero interest rate under the Rapid Credit Facility and $488 million at below one per cent interest rate under the Rapid Financing instrument.  Such efforts should be intensified and every available opportunity should be exploited.

Given the higher cost of borrowing and stringent terms and conditions set by IFIs in the coming days, GoB should actively seek budgetary support from potential external sources which allows more flexibility in terms of spending. Bangladesh should take advantage of the decision of the G-20 as regards providing low income countries with funds at zero or low interest to combat Covid-19 pandemic. There may also be opportunities for suspension of debt service payments and debt cancellation not only from traditional OECD development partners but also from southern countries which are members of G-20. These should be proactively explored and pursued.

SALE OF NSD CERTIFICATES TARGET MAY BE DIFFICULT TO ATTAIN: Sale of National Savings Directorate (NSD) certificates has already come down by a significant degree. Automation and regulatory deterrents (e.g. making mandatory the submission of e-TIN, national identity cards, bank accounts, mobile numbers and cheque transaction, 10.0 per cent tax at source on total amount of yields) and high repayment rate (55.10 per cent) have contributed to a drastic fall in net sale of NSD certificates (-48.7 per cent growth) during July-February of FY20. This has led the savers to shift their investment from NSD to long term bank deposits. According to Bangladesh Bank (2020), time deposits registered a net growth of 61.1 per cent during July-December of FY20 over the corresponding period of FY19.) However, the recent interest rate cap on bank deposits may change depositors' behaviour in favour of investment in NSD certificates. It would be prudent to continue with the current regulations pertaining to NSD certificates and properly enforce those. Overall, since the people are likely to have lower levels of savings in view of Covid-19, net sales of NSD certificates is likely to be low in any case.

BURDEN TO BE BORNE BY BORROWING FROM THE BANKING SYSTEM: Within domestic financing structure, high bank borrowing has been the key contributor in FY20 unlike the previous fiscal years. According to MoF, net borrowings from banking sources registered 1,631 per cent growth during July-February of FY20 compared to corresponding period of FY2019; this is already 218 per cent of the annual target for FY20. Since a large share of the financing has already been secured from bank borrowing, the need for non-bank borrowing was rather limited. As the budget deficit is projected to go much beyond the programmed level, it is likely that the overwhelming majority of the budget deficit in FY21 will need to be financed with borrowings from the banking sources. However, there has already been signs of deposit slowdown from January 20 due to recent interest rate cap on deposits by the central bank. Time deposits registered a growth of 0.6 per cent in January 2020 over December of 2020 which was the lowest month-on-month growth since April 2019.   It may force the time depositors to re-shift their funds from banks to NSD certificates creating another possible liquidity crunch in the banks. In the face of the rising demand of bank borrowing by the government to finance its deficit, this will result in further shrinking of private sector credit growth which is already in a dire situation. Private sector credit registered the slowest growth (9.2 per cent) at least since FY12 during July-January period of FY20. In fact, the criticality of plugging fiscal space became evident, when the government, quite early in the process, resorted to seignior age (printing of money). Bangladesh Bank on May 4, 2020 released new cash amounting more than Tk. 700.0 billion, which is almost one-third of the Annual Development Programme (ADP) outlay. With the bulk of the stimulus package to be implemented through the commercial banks and, in view of prevailing weaknesses in the banking sector, overreliance on the banking sector to finance the widened budget deficit may put the macroeconomic management in a challenging state.

Mobilisation of idle funds lying with state owned entities could be accelerated to finance the increased deficit in view of the added expenditure required to tackle the ongoing pandemic. For example, windfall gains of the BPC in the backdrop of lower oil prices should be channelled towards resource mobilisation.  GoB may also look for the option to borrow short term loans from international money markets. As of May 2020, the 12 months US Dollar London Inter-Bank Offered Rate (LIBOR) interest rate is 0.7 per cent. (This is the average interest rate at which a selection of banks in London are prepared to lend to one another in US dollars with a maturity of 12 months). The Financial Institutions Division also has a plan to make it mandatory for insurance companies to invest a certain part of their investible funds in government securities and allow investment of undisclosed income in the capital market. However, such black money whitening facility through voluntary disclosure of undisclosed income and investment in capital market discourages honest taxpayers while tax evaders are encouraged. It has also failed to register any notable response). This provision should not be continued from the next fiscal year.

TIME TO ENSURE TRANSPARENCY IN FISCAL AND BUDGETARY PROCESSES: More transparency in fiscal and budgetary processes should be one of the key areas of economic reforms in Bangladesh. In this connection, particular focus is required to be put on implementing 'second generation' reforms to ensure higher levels of transparency and independence of regulatory bodies in order to raise efficiency, enhance competitiveness and guarantee distributive justice. In successive Independent Review of Bangladesh Development (IRBD) reports, CPD has strongly suggested in favour of undertaking a number of needed reform measures to improve macroeconomic and sectoral performance. The issue of transparency has become ever more important in the current context. In view of these, the budget for next fiscal year needs to be initiate the following transparency agenda: (I) Establish a Public Expenditure Review Commission (PERC); (II) Make a detailed reporting in the budget speech, with adequate follow-up measures as regards issues related to demand assessment, beneficiary selection process, fiscal tool to increase allocation etc., as identified in the sectoral priorities; (III) Formulate appropriate follow up mechanism for monitoring government tax incentives; (IV) Take steps to ensure disclosure of financial accounts of state-owned enterprises including the BPC

KEY CONSIDERATIONS FOR FISCAL POLICY STANCE: In view of the ongoing crisis originating from the Covid-19 pandemic, CPD urges for pursuing a set of expansionary counter cyclical policy measures to offset the adverse impacts of the pandemic. This could be achieved through fiscal policy tools by the government supported by the needed monetary policy actions by the central bank. The government has already responded by announcing four key elements in this connection: (i) increasing public expenditures, (ii) incentivising economic activities, (iii) broadening social protection and (iv) enhancing money supply. However, sequencing of the application of the aforesaid policy instruments has been quite interesting.

As was observed, majority of the proposed measures to confront the attendant crisis has come from the monetary side of the policy spectrum. These included liquidity enhancing measures such as lowering of repo rate, reduction of cash reserve ratio (CRR), deferment of loan repayments, buying back of treasury bonds, increasing allocation to the Export Development Fund (EDF). At the same time, the announced economic recovery packages also centred around lowering interest rates. Only a handful of measures were taken from the fiscal side which included added allocation to the Ministry of Health and Family Welfare and removal of duties and taxes on imports required to fight Covid-19.

The precedence of monetary policy tools over fiscal measures was perhaps dictated by the aspiration of transmitting market signal and the comparative ease of implementation. Nonetheless, it might also be attributed to the deteriorating fiscal framework of the economy. It can be argued that the government went for this because it did not have fiscal space in FY20, and also it lacked the required administrative capacity to pursue an expansionary fiscal policy.

Drawing on insights from the discussion so far, four key considerations as regards the public finance framework may guide formulation of the FY2021 budget in view of the COVID-19 pandemic.

These include: (I) Designing a credible fiscal framework based on reliable and realistic income-expenditure figures so that proper planning and effective implementation is possible in a crisis-ridden year; (II) Addressing the redistribution issue in a judicious manner using instruments from both the income side (e.g., raising the personal income tax threshold) and expenditure side (e.g., redirecting the savings from oil import at lower price and reprioritisation of public expenditure to health sector and social protection to the poor); (III) Enhancing the budget delivery capacity in terms of revenue mobilisation, public expenditure and deficit management by undertaking a number of much needed reform measures linking the short-term measures to medium-term recovery strategy while being cognisant of the implications for the eighth five-year plan (which will be launched with the FY21 budget) and the aspirations of the SDGs deliverables. 

Dr Fahmida Khatun, Executive Director, Centre for Policy Dialogue (CPD);

Professor Mustafizur Rahman, Distinguished Fellow, CPD;

Dr Khondaker Golam Moazzem, Research Director, CPD;

and Towfiqul Islam Khan, Senior Research Fellow, CPD.

[email protected]; www.cpd.org.bd

[The article is based on CPD IRBD 2020 (fifth periodic review of FY20). Research support was received from CPD IRBD team

members including Md Zafar Sadique, Mostafa Amir Sabbih, Muntaseer Kamal, Md. Al-Hasan, Syed Yusuf Saadat, Abu Saleh Md. Shamim Alam Shibly, Nawshin Nawar, Tamim Ahmed, Md Jahurul Islam, Iqra Labiba Qamari, Fariha Islam Munia and Taslima Taznur]