FY2025 proposed budget misses the boat on stabilisation

All eyes were set on this year's budget presentation with the expectation that it would take some tough policy decisions because so much was riding on it. The budget means different things to different stakeholders. 

But there was a consensus that the budget must address the macroeconomic stabilisation agenda. It was particularly important to coordinate fiscal policy to support the good policy decisions adopted on 8 May on interest and exchange rates. 

Political announcements from the government raised the hope that the budget will indeed take steps to lower inflation. Independent researchers also emphasised this point in their opinion pieces published in various newspapers. 

Yet, unfortunately, the FY2025 budget announced on Thursday basically misses the boat on the stabilisation agenda.

The proposed FY2025 budget has some nice features. It makes more realistic assumptions about the target revenue growth. It also seeks to raise revenues by reducing various tax exemptions, and strengthening the implementation of the VAT system. These are welcome steps and will likely have a positive effect on tax revenues. 

But, at the macroeconomic level, the budget proposes a deficit of 4.6% of GDP, which is similar to the estimated deficit of 4.8% of GDP in FY2024. This level of fiscal deficit is inconsistent with the inflation reduction target of monetary policy.

The rationale for this assessment is illustrated in table. Rapid credit growth since FY2020 but especially during FY2022 and FY2023 induced by unprecedented bank borrowings by the Treasury to finance budget deficits spurred domestic inflation. 

To contain inflationary pressure, the Bangladesh Bank tightened domestic credit by increasing interest rates starting in September 2023 and stopped financing Treasury borrowings. 

As a result, total growth of domestic credit has fallen sharply in FY2024 to 11.2% as compared with 16.1% in FY2022 and 15.3% in FY2023.  

Both public and private credit growth rates have come down. On 8 May the Bangladesh Bank deregulated interest rate to be market based with a view to further reducing the growth of domestic credit to contain inflation.

Commensurate with its monetary tightening, total domestic credit growth will likely moderate further to around 10% in FY2025. This amounts to a total credit availability of Tk2,143 billion.  This growth in total credit must be allocated efficiently between the public and private sectors to protect GDP growth, exports and private investments and ensure consistency between stabilisation and growth agenda.  

For the public sector, the main determinant of credit demand is the fiscal deficit. The new FY2025 budget announced on 6 June targets a fiscal deficit of Tk2,560 billion (4.6% of GDP), of which Tk951 billion (1.7% of GDP)  is projected to come from net foreign financing, Tk1,375 billion (2.5% of GDP) from the banking sector and Tk234 billion (0.4% of GDP) from non-bank domestic borrowing. 

If the full Treasury demand for bank credit of Tk1,375 billion were to be accommodated, then it would leave a mere Tk729 billion for the private sector, implying a huge slowdown in private sector credit growth in FY2025 (only 4.4%). Domestic interest rates will skyrocket and there will be  turmoil in the economy. This could easily undermine interest rate deregulation and force credit expansion and interest controls, jeopardising the stabilisation agenda.

From the table, the maximum sustainable bank borrowing by the Treasury in FY2025 is about Tk627 billion (1.1 of GDP).  

Given 1.7% GDP financing availability from foreign sources and another 0.4% of GDP financing from non-banking domestic sources (national savings certificates), a maximum sustainable fiscal deficit that is consistent with inflation reduction targets of monetary policy is 3.2% of GDP. 

Since the FY2025 budget needs to be debated in the parliament, the government is urged to revisit its fiscal deficit target and reconcile this with the inflation reduction target of monetary policy. Without this coordination, the stabilisation agenda faces a serious risk of getting derailed.  

Sadiq Ahmed. TBS Sketch

Dr Sadiq Ahmed is the vice chairman of the Policy Research Institute of Bangladesh.