Some positive policy signals

The government decisions to suspend all new and replacement vehicle purchase under both the operating and development budgets till December 31 and close chronically loss-making public jute mills are well timed. These decisions are hopefully part of a larger expenditure austerity program the government should be working on. The decisions have come early enough to close the gates before the horse has left the barn. They target low value for money expenditures rather than cutting indiscriminately across the board without any attention to welfare and development priorities.

The limits of public financing

The overarching economic justification for belt tightening comes from the financing tradeoffs the government faces at any given time. No government can live beyond its means forever. There is no free lunch even for a government. The means available to a government in any given year are mainly taxation, borrowing and monetization. Bangladesh government is currently constrained in each of these financial policy spaces.

The pandemic has aggravated the pre-exiting policy and administrative challenges in revenue mobilization. It has hit hard production, consumption, investments, exports and imports. NBR revenue collection in FY20 dropped by nearly 4 percent over last year, with a deficit of Tk 850 billion relative to the revised FY20 budget target. With the virus rampaging the economy at will, revenue collection is unlikely to grow at a rate even close to the (over 50 percent) growth target envisaged in the FY21 budget. The erosion of the tax base accelerated by the onslaught of the virus do not seem to have bottomed out yet.

Borrowing is limited by access to international finance and the availability of loanable funds in domestic markets. Bangladesh has already obtained nearly $2 billion from the new external financing windows opened by the pandemic. The budget has set an ambitious $9.4 billion net external financing target that will require considerable structural reform and a significant boost in the implementation of aided development projects.

Domestic borrowing will exceed the Tk840 billion projected in the budget even if the FY21 external financing target is met. The latter is unlikely. The pandemic has reduced national savings. The government will be competing for these reduced savings in an environment where lending to the private sector has become riskier. Increased bank borrowing by the government may be good news for the bankers, but not necessarily for the economy.

Monetization, the extent to which the Bangladesh Bank (BB) helps the government's borrowing program, is limited by macroeconomic risks. Together with refinancing of financial support packages, the money supply in the economy has started to increase, reaching 12.2 percent in May 2020 from 9.9 percent in June 2019. Unlike countries that can issue internationally tradable currency, the monetization option in Bangladesh is limited by the macroeconomic risks it creates as confidence on the currency wanes when too much of them are circulating within the economy.

Monetary space depends on the rate of nominal GDP growth and changes in the rate at which money changes hands in the economy (velocity). The budget targets 13 percent nominal GDP growth. There is evidence that velocity has declined because of increased demand for "mattress money", allowing more space for expansion than otherwise. Yet monetary growth exceeding 18 to 20 percent will raise red flags. Additional monetary expansion through bank credit under the stimulus package for the private sector will shrink the 6 to 8 percentage points of remaining monetary space now available. Note that the Tk737.5 billion committed so far by the BB to refinancing packages constitutes 5.4 percent of broad money at end-May 2020. A large part of it is waiting to be pumped into the economy.

Early actions were warranted 

Looking for expenditure efficiency is the best way to avoid wasteful build-up of public debt and excessive expansion of money supply. The choice for the policy practitioners often is not between contractionary and expansionary expenditure stance. The choice is between alternative ways of prioritizing expenditures under hard budget constraints.

Early use of austerity measures allows the government to avoid measures forced by the prerogatives of crisis management. Impossible to avert pressures emerge when cashflows dry out to levels below operating expenditures. Such a contingency cannot be ruled out in the current fiscal year. The operating expenditure target is Tk3,122 billion, nearly 29 percent higher than the total revenues collected in FY20.

A 15 percent revenue growth over the estimated FY20 actual implies a 3.1 percent of GDP shortfall relative to the target. This could drive fiscal deficit to 9.1 percent if the projected level of expenditures does not adjust. Expenditures do adjust by default. An unintended 10 percent implementation shortfall will save 1.8 percent of GDP.

Domestic financing is projected at 3.5 percent of GDP in the budget. If external financing falls short by say 0.5 percent of GDP, domestic financing will have to rise to 5.3 percent, amounting to over Tk 1681 billion. This is larger than the Tk1,670.8 billion stock of central government debt to the monetary system at end-April 2020 and 1.5 times the domestic financing target. Assuming such exceptionally large volume of public borrowing will do no harm to the rest of the economy may be a stretch.

The government is not taking no harm for granted. Quick and decisive actions within the first two weeks of the fiscal year such as suspension of vehicle purchases and closure of loss-making public enterprises augur well.

How much savings can be expected?

Savings from suspension of vehicles purchases can be significant. The suspension applies to all public sector institutions, not just the central government. According to a TBS report (July 10), most cars are bought for development projects. The big development projects buy as many as 40-50 cars. Small projects buy 2 or 3 per project. Average cars per project is 10. About 1,600 to 1,650 new cars are bought every six months for various development projects in normal times. Assuming Tk 1 crore per car, this alone will save Tk1600 to 1650 crores if the purchases are not reinstated in the last half of the fiscal year. This is over three times the allocation for cash support for the informal sector poor in the FY21 Budget.

The efficiency gains from closing the jute mills are not so straightforward. Their production costs exceeded sales by 54 percent in FY19 and 66.3 percent in FY20. Closing enterprises with negative value-added removes a drag on economic growth. The nearly 25,000 labour unemployed due to closure will be compensated directly into their accounts from a Tk5,000 crore separation package. The fiscal gains will not accrue until deciding how to utilize the mills' infrastructure and machinery with a book value of Tk16,619 crores. To make the adjustments smooth, the unemployed workers will need technical support in reintegrating with the labour market.

Why keep the Bangladesh Jute Mills Corporation (BJMC) as is? What will the head office do with all enterprises closed? BJMC head office lived entirely on levies from the enterprises. The latter paid the salaries, pensions and other benefits of the head office employees. Except in FY11, the jute mills BJMC has overseen were in red every year during FY09-19. Their cumulative financial loss during this period amounted to Tk4,096.8 crores. Has BJMC not outlived its usefulness?

Deeper digging into the budget can find more avenues for expenditure savings. For instance, limiting expenditures on training, buildings, equity and reserves to the FY19 level will save Tk45,142 crores, equivalent to over 50 percent of the bank borrowing target. More clarity is needed to assess savings from the suspension of funding for low priority old and new development projects.

Possible to build on

All loss-making state-owned non-financial and financial enterprises need transformative reforms. The state-owned non-financial sector had an estimated negative value added of Tk8.27 crores in FY20. The resources deployed in this sector, with a book value of Tk142,311 crores, can surely be used more productively. The SOEs, financial and non-financial, rely on government for capital injections, direct subsidies, soft loans, grants, and loan guarantees. They pose potentially large fiscal risks for the government. 

Tax reforms are overdue. The decline in revenue collection in FY20 relative to FY19 was not all due to the virus. Reform reversals and inertia in a moth-eaten revenue governance structure had been holding revenue behind growth in the size of the economy for years. Revenue reforms in the recent past often reshuffled revenues from regressive goods and services taxes. Success in expanding the tax net have been few and far between. Reducing the explicit and implicit costs of paying taxes, leakages and evasion has notable revenue yielding promise if the existing public financial management reform programs and the tax administration modernization projects can be expeditiously and efficiently executed.

Pitching for more aid to combat the pandemic can help get close to the budget target. Covid-19 related new funding windows are intended to enable an effective crisis response. The government must commit to use the resources to increase social, health, or economic spending in response to the crisis. The government should use the Tk10,000 crore block allocation in the FY21 budget for pandemic response to catalyse funding from these windows.

Bangladesh has not opted for the OECD Debt Service Suspension Initiative in which over 46 countries are already participating, including countries at low risk of external debt distress such as Nepal, Myanmar, Tanzania and Uganda. This could have deferred amortization payment of about $320 million in 2020 and spread it over 3 years from 2022 onwards. The requirement to disclose all public sector financial commitments involving debt and debt-like instruments could contribute to increased fiscal transparency.