The FY24 Budget: The macroeconomic and structural imperatives

Deep global and local headwinds face the FY24 budget. It will do itself better justice by recognising these realities, including the difference between adapting to what it cannot change and capitalising on what it can. Macroeconomic stabilisation and prioritisation of reforms in taxation, expenditures, deficit financing, and several structural areas are the key imperatives for the FY24 budget. 

These are testing times for fiscal policymakers.  I cannot recall a three-year-long period in the last three decades when budgets had to be prepared under more stressful conditions. We lived through business-as-usual budgets, ones very stingy on structural reforms, in the past two years. Now that local and global macro-financial conditions are tighter, only structural reforms can ease policy tradeoffs facing the fiscal and monetary managers of the economy.   

Slower growth, rising inflation

There is evidence-based consensus that growth this fiscal year will be lower and inflation way higher. GDP growth is projected by all, including the government, to fall in FY23 from the officially reported 7.1% in FY22. The growth projections range from 5.2% by the World Bank to 6.5% by the government. Headline inflation persisted close to double digits since August 2022, reaching an eleven-year high of 9.3% in March 2023. It is projected at around 9% for the fiscal year both by the WB and IMF. 

Slower growth with rising inflation typically happens under rising cost and demand conditions. Increased domestic prices of energy and electricity; currency depreciation; and energy and foreign exchange shortages added to the usual high cost of doing business causing supply to compress. Slower export, remittance, and private sector credit growth through February balanced aggregate demand growth stimulated by a significant expansion in credit to the public sector, including money pumped in by the Bangladesh Bank.

Inflation eroded real incomes as wages across several lower skills groups did not keep pace with prices. A steep rise in food inflation from April to August 2022 and then again in February-March hurt poor families disproportionately. International evidence shows, given a higher share of food in total expenditure in low-income families, even temporary food price inflation increases food insecurity with lasting long-term, irreversible intergenerational damage, especially to children. The link between food price inflation and its long-run effects was a public policy concern even before the cascading crises from 2020 onwards. 

A large expansion of domestic credit fed the persistence of non-food inflation at close to double digits since August 2022. A decline in BB held foreign exchange reserves dried excess liquidity in the banking system. However, the impact of falling liquidity on bank advances is attenuated by BB's liquidity support and refinancing schemes. Not surprisingly, data so far do not show a discernible impact of lower excess liquidity on bank advances.

A growth recovery with disinflation is projected by most for FY24 conditional on tapering of global headwinds, macroeconomic stabilisation, and structural reforms. Market-based monetary, fiscal, and structural policy reforms can mitigate risks even if interest rates, commodity prices and the price of the US dollar remain elevated at their current levels in the global markets.

Multiple external headwinds  

The macroeconomic and structural policy stance in the budget will have to factor in multiple external challenges. A slow global recovery in trade, higher borrowing costs, limited fiscal space in donor countries, and heightened geopolitical gymnastics present more than a bucket full. Trends in goods and services trade point to a slowdown of globalisation. FDI and migrant flows suggest the opposite. Overall, there is no hard evidence to date that deglobalisation has started. However, a structural growth slowdown is underway across the world (WB book on Potential Growth 2023). The growth rates of investment and total factor productivity are declining. The ageing global labour force is expanding more slowly.

We may be entering an era where the future of trade and globalisation is shaped more by political motivations rather than market forces (World Bank Policy Research Working Paper, April 2023). The policy environment and public attitudes towards trade with other countries are changing. The latest is the mood swing that trade should be promoted only between "friends." Geopolitics, more than economics, accounts for such rethinking on reshoring. This is distinct from the more traditional motivation for reshoring based on the impact of globalisation on low-skill workers in advanced economies.  

The upshot from above is that getting the desired economic outcomes from the FY24 budget and beyond can use some help from a prudent foreign policy. The new policies in advanced economies could open doors for Bangladesh if the US and perhaps Europe decide to aggressively pursue avenues for reducing dependence on China. Trade and investment reforms in the FY24 budget geared to integrating better in the global supply chain of goods and services could yield additional dividends if Bangladesh can navigate through the narrow corridor of geopolitics, where business talks, with foreign policy providing the cover for sailing through unperturbed.  

Foreign exchange shortage

Private sector activity has been heavily impacted by import and controls on dollar outflow forced by foreign exchange shortage. Reserve depletion was driven by the current account deficit in FY22 and the financial account deficit in FY23. BB interventions in the foreign exchange market were the main channel of official reserve depletion. Domestic banks' foreign exchange liquidity has been precariously low, and often negative, for a fairly long period now. 

A complex multiple exchange rate regime exacerbated the foreign exchange shortage. The cap on rates has incentivised the use of informal channels offering higher rates. Exporters receiving lower-than-market exchange rates have deferred repatriation of export proceeds. Incentives for both import under-invoicing and over-invoicing imports have risen. Firms are unable to obtain foreign exchange for imports or dividend repatriation. A wide gap between official and parallel rates persists. 

A market-determined flexible exchange rate would reduce distortions and rebuild reserves. The multiple-rate regime offers windfall profits from privileged foreign exchange access at the suppressed exchange rates. A uniform set of market clearing buying and selling rates would eliminate these distortions. 

Getting fiscal policy on track  

The fiscal balance is headed in the wrong direction. After widening to an estimated 4.3% of GDP in FY22, the budget deficit in the first six months of FY23 reached Tk 101.8 billion, compared to Tk 30 billion in the first half of FY22, driven by revenue shortfall and tapering of fiscal austerity measures.  The revenue to GDP ratio maintained a declining trend from 8.7% in FY17 to 8.4% in FY22. This has probably worsened in FY23. Bank borrowing, mostly from BB, more than doubled over the first half of FY23.  

Reduced foreign financing is perpetuating the shortage of dollars. Net medium- and long-term borrowing declined to $3.6 billion over the first eight months of FY23, from $4.8 billion during the same period the previous year as authorities sought to limit borrowing at higher interest rates. The FY23 foreign financing target has been revised down. 

Financing needs and availability depend heavily on policy frameworks. The development outcomes that public expenditures and investments seek to generate can be improved when sensible policies are put in place. Budget support from the multilateral, enhanced utilisation of the project aid pipeline, and fully accessing the resource envelope notionally allocated for Bangladesh by multilateral and bilateral donors need to be prioritised over domestic financing of the budget deficit. 

Greater agility on the part of the development partners will help. Enhancing efforts to scale up implementation of the aid effectiveness agenda, including improved coordination and a focus on results, could help address key challenges, such as inadequate quality and coverage of public services, and limited fiscal space, not to speak of inflation and foreign exchange shortage. 

The world still has trillions of dollars to invest. The question is if Bangladesh can get organised to get its share. Efforts to expand the flow of concessional resources could yield much better results if combined with replicating some of our best policy efforts of past decades in taxation, trade, finance, energy, education, health, and social protection with a major investment push grounded in a robust macroeconomic framework. 

IMF won't do it for us

A better quality of macroeconomic than microeconomic policies is a distinctive feature of Bangladesh. Several countries in Asia have slipped on the macroeconomic front big time, Sri Lanka and Pakistan being the most recent notables in South Asia. Bangladesh's macroeconomy is currently stressed, albeit not yet in a full-blown crisis. 

Fiscal policy needs adjustments to support macroeconomic stabilisation and protect the vulnerable. Macro vulnerabilities have increased. The monetisation of domestic financing of the deficit is incompatible with inflation reduction and exchange rate stability. 

The IMF program per se is not going to bring lasting respite. The floor on reserves and the primary fiscal balance set the parameters for the exchange rate and fiscal policies while public social and investment spending are given some protection through the Indicative Targets. They are helpful but by no means a panacea. IMF's core programme aspires to correct the ailments without game changers in domestic policy propagators of the crisis and administrative dominance in structural, fiscal, monetary, and financial policy. However, nothing but domestic political-economy dynamics prevents the government from doing the needful in time. 

The government must remain on track with stabilisation, move structural reforms forward, and secure external financing from development partners. The imperatives of a stronger competition policy are pressing. Arguably, concentration and the dominance of the business-politics nexus, favouring the status quo, have become more egregious over time. It can no longer be assumed that economic growth will inexorably create shared gains. Ad hoc administrative measures without rethinking some of the key pillars of our regulatory regimes to address the systematic distortions in our market and political processes are unlikely to kindle path-changing investor and consumer confidence.

Zahid Hussain is a former lead economist of The World Bank, Dhaka office.