How worrisome is the surge in government borrowing?

Government borrowing is spiraling up. Borrowing from the banking system zoomed to Tk 471.4 billion as of December 9, constituting 99.5 percent of the target for FY20 and over 2.8 times the amount borrowed from the banks last fiscal year. Yes, non-bank borrowing, mostly through sale of the National Saving Certificates (NSC), has declined significantly but net sale was still positive, amounting to Tk 5.5 billion during July-October of the current fiscal year. 

If the increased bank borrowing were just a switch from costly NSCs, it would have constituted an unambiguous positive development. The size of interest payments in the budget has increased 57.4 percent since FY15 due to excessive reliance on NSCs. However, the surge in government's bank borrowing so far this year is much more a result of an unusually large increase in budget deficit rather than a shift in the composition of domestic financing of deficit.

The budget deficit target for this year is Tk 1453 billion. The government intended to finance this gap between its outlays and revenue by borrowing 53 percent of deficit from the external sources and the rest from domestic sources.  Absent any significant mid-year course correction on the revenue and expenditure sides, the deficit is most likely to miss the 5 percent of GDP target, a rarity in Bangladesh's recent fiscal history.  domestic financing would most likely have to carry the larger part of the financing burden since net foreign official borrowing in July-October has already declined by 7.8 percent. In an emerging economy such as Bangladesh, budget deficits in normal times do not create major fiscal risks as long as the government debt does not grow faster than the size of the economy.  Bangladesh has been on such a stable path until FY17, but the trend has changed recently with the debt/GDP ratio rising from 30.8 percent in FY17 to 32.8 percent in FY19.

Bangladesh's public debt-to-GDP ratio is not high by any standard. The risk of debt distress continues to be assessed as low by the joint World Bank-IMF Debt Sustainability Assessments (DSA 2019).  The main anchors of the low risk are the projected rapid growth of nominal GDP, stable nominal interest rates and sustainable primary deficits.  When the nominal interest rates that the government must pay on its debt are less than the growth rate of nominal GDP, an economy can run deficits small enough to ensure that the ratio of debt to GDP is not increasing over time. An important part of the deficit is the government's interest payments on the national debt. Interest payments are projected to account for nearly 40 percent of the entire deficit in the current year. The noninterest portion of the budget deficit relative to GDP needs to be on a declining path from FY20 onwards to keep debt stable.

The noninterest part of the budget deficit is currently (3.1 percent of GDP in FY19) larger than the sustainability limit of 2.3 percent (defined as the level of primary deficit that keeps the total debt to GDP ratio stable). In fact, the debt-to-GDP ratio is projected to continue to creep up, reaching 40 percent by 2039 (DSA 2019). Current laws governing taxes, policies governing entitlements (such as grants-in-aid, social protection, pensions) and rapidly expanding development expenditures leave a large budgetary gap. This is exacerbated by tax waivers and concessions that depress tax revenues.

Any government that issues debt far in excess of what it could collect in taxes has to pay increasingly higher interest rates. Thus, a government's fiscal policy has definite market constraints. History is replete with episodes in which governments spend freely, accumulating massive debt, only to find that their behavior led to a crisis of investor confidence and sharply rising inflation as well as interest rates. Such experiences highlight the risk in taking what economist Gregory Mankiw described as a "deficit gamble". The bet fails exactly when the economy is weak.

There are several signs of economic weakness currently in Bangladesh. Exports declined by 7.6 percent (July-November), consumer and intermediate goods imports fell 4.5 percent (July-October), capital goods and other imports declined by 3.2 percent (July-October), private credit growth at a recent historic low of 10 percent (end October), non-performing loans at a recent high of 12 percent (end-September) and growth in revenue collections down to 4.3 percent (July-October).  The one strong indicator -- 22.7 percent growth in remittances (July-November) -- if sustained during the rest of the year, would mean exceeding the Tk 30 billion provision for cash subsidy to remittances in the FY20 budget. With ADP spending growth of 18 percent (July-November) before the start of the dry season, accounting for 19.9 percent of the total FY20 ADP, expenditure shortfall is less likely to buffer the deficit from exceeding the original budget target, as has usually been the case.  Banks' commercial lending rates are already high. Inflation rate is also edging upwards. High interest and inflation rates offer policymakers very little space to pursue some positive actions that lower rates allow.

What then are the policy options for containing government's domestic borrowing?

Containing the deficit is the first priority because the expansion is driven largely by revenue shortfall and increased subsidies, not growth enhancing public investments. Policymakers rely on fiscal deficits to expand popular policies. This way, fiscal deficits also encourage rent-seeking and politically motivated appropriations. Many businesses implicitly support fiscal deficits as evident from their propensity to ask for expensive cash support (the latest being the Tk 100 billion loan sought by the stock brokers) and low taxes (vested business interests successfully torpedoed the revenue yielding features of the 2012 VAT law this year) simultaneously.

A combination of tax increases and spending cuts are needed to bend the borrowing curve.  Fiscal austerity, such as higher taxes and lower spending, when the economy is already weak, is never painless. However, rising debt could gradually squeeze discretionary spending and deny the country the tools needed for growth and economic stability.  Mid-year course corrections must seek to raise tax revenue, whether by eliminating deductions and other tax subsidies, or introducing new taxes, such as a carbon tax. The automation agenda promises some quick gains by expanding the number of tax payers and reducing leakage. On expenditures, the government needs to be penny wise and pound smart. There is concern over the spiraling and wasteful recurrent expenditures where the government needs to be penny-wise. Being pound smart requires a review of the policy regime governing subsidies, recapitalization of banks, loans to state-owned non-financial enterprises and prioritization of ADP expenditures.  Growth in the discretionary budget, which includes spending on programs ranging from social sectors to transportation and research, may require restraints.

Government has so far relied largely on Treasury bills (Tk 188.4 billion) and bonds (Tk 146.8 billion) sold to scheduled banks and on monetization by the Bangladesh Bank through Ways and Means Advances (Tk 45.8 billion) and devolvement of T-bills and bonds (Tk 25.7 billion). By reducing the pool of available funds to be lent to businesses, government borrowing from banks has a direct impact on interest rates. The interest rate paid on loans to the government represent risk-free investments against which nearly all other borrowings must compete. If 364 days T-bills are paying 7.6 – 7.9 percent interest, other types of financial assets must pay a rate high enough to entice buyers away from T-bills. The interest rates the government pays on its domestic debt are already high (10.6 percent of total domestic debt in FY19).  The gap between the 5-year NSC and 5-year government bond declined from 5 to 3 percent due to sharp increase in yields of government bonds and T-bills in the last one year. 

Monetization of debt alleviates the pressure on interest rates, but the risk with the monetization option is inflation rather than crowding out of private credit. BB's share in the government bills and bonds portfolio increased from 6 percent to 14.5 percent within last one year. Providing short term advances to smooth out tax revenues fluctuations or sterilize the foreign exchange interventions is not an issue, but government cannot depend on structural liquidity injection, such as BB devolvement, to fund their operations. Also, continual financing of fiscal deficits by BB may further undermine whatever is left of its operational autonomy.

Deficits invoke risks.  Over the medium-term, debt created to finance tax cuts and bailouts for the wealthy or vanity projects create downside risk. Investments in anti-poverty programs, productivity-enhancing human and physical capital and well-designed social protection create upside risk. The macro risks that come with higher interest and inflation rates are immediate. These require stronger fiscal prudence.  Bangladesh does not have to look too far back in its recent fiscal history to know what such prudence looks like in the fiscal bottom lines.  

Recent (2018) work by Paul Beaudry (University of British Columbia) and Tim Willems (IMF), using data from all IMF member states, show that more optimistic growth projections typically induce countries to accumulate more debt. They find that countries for which growth estimates and forecasts have been overly optimistic are more likely to develop debt crises. Overborrowing induced by too much optimism ends in tears when growth disappoints. Further, large upward bias in estimates of actual growth not only lull the policymakers into dangerous complacence but also contribute to closing the windows of concessional finance linked inversely with GNI per capita.  

The surge in government borrowing is a serious worry. A low risk of debt distress does not imply low liquidity or rollover risk as well. A perfectly solvent government can have liquidity crisis and an insolvent government can go on for a long time before hitting illiquidity. The way out is to be smarter about what the borrowed money is spent on and how the financing is managed.  

The author is an economist.