Foreign aid declining, debt servicing rising – how it's affecting economy

Infographic: TBS

Foreign loan disbursements and commitments contracted significantly during the first 11 months (July-May) of the current fiscal year, while debt repayment obligations continued to rise as a result, allocating resources to development, social safety and public services is getting constrained.

According to a report released by the Economic Relations Division (ERD) today (23 June), foreign loan disbursements fell by more than $1 billion during July-May compared with the same period of the previous fiscal year. Commitments from development partners also declined by $1.26 billion year-on-year.

The report further noted that Bangladesh repaid a total of $4.13 billion in foreign loans during the period, the highest debt repayment on record.

Economists say the decline in foreign assistance is creating some pressure on Bangladesh's macroeconomic management.

"A situation has now emerged where foreign loan disbursements (the amount of money coming in) and repayments (the amount going out) have become almost equal. In other words, nearly the same amount of foreign financing that Bangladesh is receiving is being paid out in debt servicing. This signals a significant source of pressure on the economy," Dr Mustafa K Mujeri, executive director of the Institute for Inclusive Finance and Development (InM), told The Business Standard.

The first and most direct impact is on the government's fiscal policy and budget management, he said.

"Foreign debt repayment obligations are rising rapidly, forcing the government to allocate a growing share of its revenue expenditure to debt servicing. As a result, the government's ability to allocate resources to other areas – such as development, social protection and public services – is becoming increasingly constrained. In effect, this is placing clear pressure on the national budget," Mujeri said.

"Secondly, the situation is also creating pressure on foreign exchange reserves and the broader macroeconomy. Foreign loans must be repaid in US dollars or other foreign currencies, which increases the burden on the country's foreign exchange reserves," Mujeri added.

This can tighten the supply of dollars, create exchange-rate volatility and negatively affect overall economic stability, he further said. "Therefore, the challenge is not merely fiscal; it has broader macroeconomic implications."

Explaining the decline in foreign loan commitments and disbursements, Mujeri said one major reason is the political context. "In the absence of a fully elected government for an extended period, development partners were cautious about making large new loan commitments. With nearly eight months of political and electoral uncertainty, it was natural for commitments to decline."

Another important factor was the low rate of project implementation, he said. "During this period, project execution fell to one of the lowest levels in recent history, particularly up to February and March. Since disbursements depend on project progress, slower implementation inevitably led to lower disbursements."

Mujeri said there are reasons to expect improvement in the future. A democratically elected government is now in office and needs to implement its election manifesto. This could accelerate development activities. As the government's economic and development policies become clearer, development partners may also be more willing to make new commitments. Therefore, commitments and disbursements may increase again in the future, and there is no reason for excessive concern at this stage.

"The most important issue, however, is the country's future borrowing strategy. Over the next several years, Bangladesh will need to be far more cautious and selective in taking on foreign debt. The country should not borrow simply because financing is available or because commitments have been offered. Debt-servicing pressures have already risen substantially," Mujeri warned.

He opined that future foreign borrowing should be limited to projects that are genuinely critical and capable of generating high economic returns. Priority should be given to projects that increase productivity, accelerate economic growth and strengthen the country's long-term capacity to repay debt.

Ahsan H Mansur, former Bangladesh Bank governor, described the situation by saying that the country is now essentially "spending to survive" rather than investing enough to support growth, development and a more comfortable economic position.

One major challenge under these circumstances is increasing foreign financial inflows, he said. However, he noted that significantly raising such inflows through the government is neither realistic nor always desirable. "Bangladesh's tax-to-GDP ratio remains very low, meaning government revenues are limited. Governments repay debt from revenue – not from GDP. Therefore, weak revenue collection undermines debt-servicing capacity."

From a policy perspective, he argued that Bangladesh should gradually reduce its dependence on foreign borrowing in the public sector. Instead, greater foreign financing should be channelled to the private sector. At the same time, domestic borrowing should increase so that the government can meet more of its financing needs from within the country.

"The practical challenge, however, is that Bangladesh's banking sector remains relatively small and weak. As a result, when the government borrows more from domestic sources, less credit becomes available for the private sector. This has contributed to a significant slowdown in private-sector credit growth, which is not a positive sign for the economy."

In this context, Mansur cited India as an example. India relies less on foreign borrowing because its stronger banking system allows the government to raise substantial resources domestically. As a result, it does not need to depend on foreign budget-support loans.

Bangladesh faces a different reality, the economist noted. "On the one hand, it needs to reduce dependence on foreign borrowing. On the other hand, it lacks sufficient capacity to mobilise adequate resources domestically. Compounding the problem is weak revenue collection, which makes debt repayment more difficult. Consequently, the government remains under pressure and is still compelled to rely on foreign loans and budget-support financing."

Mansur concluded that the sustainable solution lies in increasing government revenue and strengthening the banking sector. Without progress in these two areas, it will be difficult to ensure long-term stability in budget financing and debt management.

ERD data show that foreign loan disbursements during July-May of the current fiscal year stood at $4.57 billion, down 18.3% from $5.48 billion in the corresponding period of the previous fiscal year.

ERD officials said the disbursement target for the current fiscal year was set at $7.86 billion. However, only 58% of the target had been achieved in the first 11 months.

Meanwhile, according to the ERD report, total foreign assistance commitments between July 2025 and May 2026 amounted to $4.22 billion, compared with $5.48 billion during the same period of FY25, representing a 23% decline.

ERD data show that the target for securing foreign loan commitments from development partners during the current fiscal year was $6.71 billion. However, only 55.48% of the target had been achieved by May.

While commitments and disbursements declined, foreign debt repayments continued to rise. Bangladesh repaid $3.78 billion to development partners during July-May of the previous fiscal year. During the same period of the current fiscal year, repayments increased to $4.13 billion, the highest ever.

Previously, Bangladesh repaid $4.08 billion to development partners during the full July–June period of the last fiscal year.