The budget may exacerbate macroeconomic stress

The government will continue treading the same risky path on the fiscal front as the outgoing year. Ambitious targets lack back-up measures with sufficient traction. The nominal size of the FY24 budget, at Tk7.6 lakh crore, is 15.3% higher than the revised FY23 budget, which in turn is 2.6% short of the original FY23 budget. Inflation is targeted to fall to 6% and GDP growth to rise to 7.5%. Investment is projected to rise in both public and private sector. Achieving these will be challenged by global headwinds, the foreign exchange constraint, and policy and institutional drags.

No matter how one looks at it, the budgetary stance is expansionary. The FY24 budget deficit, projected at Tk2.60 lakh crore, is 15% higher than the revised FY23 budget deficit. Equivalent to 5.2% of GDP, the projected deficit nearly equals the planned size of the FY24 Annual Development Programme. The deficit target is 0.1 percentage point of GDP higher than the ongoing year's revised target, an indication of policy inclination towards a mild fiscal expansion. The government will borrow 14.7% more from the banking system, Tk1.32 lakh crore, than the revised target of the current fiscal year. The latter is 8.5% higher than the original budget target.

Is the planned expansion of budget deficit consistent with disinflation, easing external imbalance, and a steep (investment fuelled) growth recovery? Increased budget deficit is, in theory, incongruent with reduction in inflation and external imbalance, other things equal. In practice, other things are never equal. The extent to which a fiscal expansion makes fighting inflation and dollar shortage more difficult depends on the composition of deficit financing. If the excess of government savings and government investment (which is what deficit is) is largely monetised, like it was this year, inflation and external imbalance could linger.

Relying more on the commercial banks risks crowding out private credit, thus adversely affecting growth. However, as several bankers have pointed out, the crowding out risk is relatively low because private demand for credit is currently weak. With increasing non-performing loans, weak deposit growth, and continued dollar sales by the Bangladesh Bank, the banking system is not riding a mountain of excess liquidity either. Crowding out therefore cannot entirely be ruled out but, under the prevailing macroeconomic stress, monetisation of government borrowing could be toxic for inflation, adding to the impact of a myriad of higher indirect taxes on prices.

Nonbank borrowing, which probably is the least inflationary, is projected to decline, driven entirely by reduced use of national savings certificates to Tk18,000 crore, 10% less than the FY23 revised target which in turn recognises 43% undershooting of the original FY23 budget target.  Reduced reliance on NSCs is understandable to rein in future growth in the largest single interest payment item in the budget.

The impact of fiscal expansion on aggregate demand and reserves is immediate while that on supply, if any, comes with lags. Impact on the demand for foreign exchange risks crowding out private sector imports. This in turn would further exacerbate inflationary pressures both directly, as supply of imported consumption good shrinks and indirectly, as domestic production is constrained by the inability to procure raw materials, intermediate inputs, and spare parts.

Bangladesh at this crunch time needs to create fiscal space for sustainable increases in social spending and public investment complementing private investment. The probability of impacting growth hinges on the initial economic slack, which currently is constricted by severe foreign exchange and energy shortages. Expanding fiscal deficit spillover will increase pressure on foreign exchange reserves, something Bangladesh can ill afford in the midst of large declines in reserves two years in a row.

Macroeconomic stability could be made more resilient to fiscal expansion if deficit is financed from cheaper foreign financing. Net foreign borrowing, targeted at around Tk1.02 lakh crore (nearly $10 billion at the Bangladesh Bank's Tk104.5 per $ exchange rate), is Tk18,671 crore ($1.8 billion) more than the revised target for the current fiscal year. The latter, as is usually the case, is 12.1% lower than the original FY23 budget target, indicating the authorities are not good at utilising external financing opportunities.

Achieving the FY24 net foreign financing target would require unprecedented agility in implementing externally funded projects and impactful structural reforms. The opening project loan pipeline this year is around $50 billion and a variety of budget support from the multilateral and bilateral funding agencies are on offer. Relatively cheaper and longer maturity foreign funding can help ease the tradeoffs between inflation, external stability and GDP growth created by fiscal expansion.

Even a mild doze of fiscal consolidation often entails difficult policy choices. International evidence shows inflation rises more when fiscal expansion is driven by expansion in public spending rather than revenue shortfall. Austerity is therefore the first line of defence to preserve macroeconomic stability. The government has reportedly saved Tk34,000 crore this fiscal year which is twice the Tk17,557 crore decline in total government expenditure in the revised FY23 relative to the original FY23 budget. Thus, a large part of austerity appears to have atrophied. Tougher efforts will be needed going forward.

The FY24 budget envisages stronger tax revenue mobilisation efforts, higher social spending, and public investment on a trajectory to keep debt below 45% of GDP. The mild fiscal expansion, however, could easily turn into a relatively large fiscal one with even modest underperformance in revenues and less than usual underperformance in expenditures because of the increasing nondiscretionary parts such as interest, employee compensation, sticky subsidies, and mega projects, not to speak of political contingencies such as the impending election. The expansionary fiscal stance may be larger than it looks.

The government will not just have to walk but run the talk on revenue mobilisation, expenditure rationalisation.

Zahid Hussain is former lead economist of the World Bank Dhaka office.