Fiscal policy says spend, monetary policy says stop: Can investment gain pace amid this policy standoff?

Highlights:

• Expansionary fiscal policy clashes with tight monetary policy, creating conflicting signals for businesses
• High interest rates keep borrowing expensive, discouraging private investment despite tax incentives
• Private sector credit growth remains below 5%, reflecting weak lending and banking sector stress
• Economists urge productive public spending and reduced corruption to maximise the budget's impact
• Revenue shortfalls could force higher government borrowing, crowding out private sector credit
• ADB forecasts 4.5% GDP growth in FY27, far below the government's 6.5% target

Think of it like driving with one foot on the accelerator and the other pulling the handbrake. All you get is burnt tyres, a damaged engine, and no movement at all.

That's the direction Bangladesh's economic policy is heading. The government has announced an expansionary budget designed to jumpstart a sluggish economy, while the central bank holds the line on a bruising 10% policy rate to fight stubbornly high inflation. It's a classic macroeconomic standoff and in this collision, it is the private sector, the engine of growth, that takes the hit.

Economists say that when fiscal policy is expansionary and monetary policy is contractionary at the same time, the typical outcome is predictable: interest rates stay high, suppressing private investment; government spending crowds out private spending through the credit channel; inflation moderates, but at the cost of weaker growth than the fiscal expansion intended.

The newly elected government's first budget took an expansionary stance - cutting taxes, protecting local industries, boosting investment incentives, raising the development outlay, deregulating business processes, and expanding social protection. The message to businesses and investors: the cost of operating is lower, the environment more supportive, now is the time to invest and hire.

The central bank's contractionary stance sends the opposite signal: borrowing is expensive, credit is constrained, conditions are tight.

The million-dollar question is whether businesses will invest when lending rates sit at 12-14%. Businesses say they need 15-18% operating profit just to service debt but profits remain thin or nonexistent. Without that margin, investment stalls.

The numbers bear this out. Private sector credit growth has stayed below 5% for months, down from the usual double digits. Many mills are shutting down for want of working capital and energy supply. Private investment as a share of GDP sits at around 21% and, per the government's own medium-term macroeconomic outlook, will stay there for the next two fiscal years. Against this backdrop, absorbing the roughly 25 lakh people entering the job market each year looks increasingly difficult.

Two legitimate priorities, one policy clash

This mismatch isn't accidental or irrational, according to Dr Fahmida Khatun, executive director of the Centre for Policy Dialogue (CPD). It reflects two genuinely competing priorities that are both legitimate given Bangladesh's current conditions: the government needs to stimulate growth through investment, while also reining in inflation.

"It's a double whammy for the government," she said. It creates a problem of policy coherence, yet an expansionary monetary policy now could have been more devastating.

Even with an expansionary fiscal stance, she said, the government must be disciplined about how public money is spent - earning real returns on that spending, and plugging leakages and corruption so investment actually pays off. She hopes fiscal and monetary policy will eventually align, and that the central bank may review its tightened stance within six to twelve months.

Dr Mustafa K Mujeri, former chief economist of Bangladesh Bank, agreed the two policies appear mismatched on the surface. But he argued that contractionary monetary policy has limited real impact on inflation in Bangladesh, since price pressures stem largely from market management and supply chain issues rather than credit conditions alone.

Still, he said the expansionary budget could work if the government channels spending into productive activity while controlling leakage and corruption. "If the government can do this, then there will be no mismatch visible but that is a tough task," he said.

How the mismatch plays out in practice

Tax cuts lower businesses' operating costs, but the interest rate environment determines the cost of the capital they need to expand. A factory owner who saves Tk50 lakh in annual taxes gains little if his working capital loan costs 14-15% and term loan repayments are eating into cash flow. For most businesses in Bangladesh right now, financing cost, not the tax rate, is the binding constraint.

The credit channel itself is broken. Private credit growth at 4.7% isn't primarily a function of high interest rates; it reflects a banking system stressed by over 32% classified loans, wary of borrower quality, and hoarding liquidity overnight rather than lending term. Bangladesh Bank's stance doesn't fix this structural problem - keeping interbank liquidity costly potentially makes it worse by discouraging lending further.

An investor weighing a new project looks at the whole environment: tax rates, energy supply reliability, regulatory ease, political stability, financing cost, and expected demand. The budget improves some of these variables; monetary policy worsens ao critical one. Whether the net effect is positive depends on which factor binds for that particular investor.

For many factories - from spinning, weaving, ceramics - energy supply is the constraint, and neither fiscal nor monetary policy touches it. For domestic-market businesses, weak consumer demand, itself partly a legacy of four years of inflation eroding real incomes - is the constraint. For new investment projects, financing cost and banking sector health are critical. The budget helps with some of these; monetary policy helps with none.

Rising government borrowing compounds the problem. The budget's NBR revenue target of Tk6.04 lakh crore is, by any honest assessment, unlikely to be met given the NBR's recent track record. When revenue falls short, as it has for years, the government borrows more from the domestic banking system to cover the gap and that borrowing competes directly with private credit for the same pool of funds. Every Tk1,000 crore the government borrows is Tk1,000 crore unavailable for private sector loans. With Bangladesh Bank keeping rates high and liquidity tight, that crowding-out effect is even larger than it would be in a looser monetary environment.

The United States in the early 1980s offers the textbook parallel: Reagan's expansionary fiscal policy - tax cuts, defence spending - collided with Paul Volcker's Federal Reserve holding extremely tight monetary policy. The result was high real interest rates, a strong dollar, a recession, and eventually lower inflation but the growth benefits of the fiscal expansion were significantly delayed and diluted.

Bangladesh's financial system is far less developed, its monetary transmission mechanism weaker, and its fiscal capacity more constrained than the US in the 1980s. But the directional logic holds. Perhaps Bangladesh's development partners have already priced this in as the ADB projected on Thursday that GDP will grow just 4.5% in FY27, well below the government's 6.5% target.