Low external debt-to-GDP ratio no insurance against debt distress

The already contracted external debt, whose servicing is scheduled to start beyond 2025, is likely to increase total external public debt service payments (principal plus interest) to $5-6 billion annually. 

The Economic Relations Division (ERD) probably has more precise estimates. 

Repayments on several externally funded projects such as the Rooppur Nuclear Power Plant, Dhaka Metro, Elevated Expressway, Karnaphuli Tunnel, Rampal Power Plant, etc., will start from 2026 onwards.

The repayment burden may not look concerning as a ratio of GDP or annual earnings from exports and remittances. Indeed, the Debt Sustainability Analysis (DSA) by the IMF and the World Bank has consistently assessed the risk of external debt distress as low under their standard stress tests. 

These assume favourable debt dynamics in the medium term, driven by real GDP growth exceeding the effective real interest rate on external debt and a modest primary deficit-to-GDP ratio. As far as I could comprehend, their analysis does not account for tail risks from idiosyncratic shocks such as LDC graduation.

Yet they caution about several downside risks. These include persistent inflation, a rising interest burden, low revenue mobilisation, an export slowdown, spikes in import payments, financial system distress, and snail-paced macro-critical structural reforms. The banking sector is a ticking time bomb of fiscal risk, as are the loss-making state-owned enterprises.

The warnings would multiply if the possible adverse impact of LDC graduation on external market access and ever-increasing corruption in fiscal management were factored in. A low external debt-to-GDP ratio is no insurance against debt distress.

A very recent case is Ethiopia. Even though its external debt-to-GDP ratio was only 18% in 2023, persistent shocks and inadequate policy responses triggered a debt default in late 2023 despite GDP growth being above 6%. The Ethiopian government had to tighten already onerous current account and financial sector restrictions to manage foreign exchange pressures. With a low tax-to-GDP ratio (7-8%), it had to cut spending and severely limit increases in wage and social safety net payments at a time of dire need.

Don't the above Ethiopian numbers look familiar?

Dr Zahid Hussain (Economist). Sketch: TBS

Coping with debt pressure

A billion-dollar question is whether policymakers recognise the impending pressure. Even now, after all that has happened in the last two years, there is a belief that all our macroeconomic woes are attributable to external factors. 

Even Ukraine, where the war is being fought, has managed the macroeconomic effects of the war better than we have. Their growth outturns have improved, sharp disinflation has continued, and the foreign exchange market has been stable after exiting from a fixed exchange rate in October 2023.

Rising interest payments are rapidly squeezing fiscal space. The budget deficit, particularly the expensive domestic financing of the deficit, must shrink to stop the squeeze from getting worse. This requires increased revenue mobilisation and decreased "wasteful" expenditures.

A very strong political commitment is needed to increase revenues without hurting growth and exacerbating inflation. One of our fiscal regularities is that wasteful expenditures tend to become necessities and spawn new obligations. These have to stop.

Reduced fiscal deficit is necessary, not sufficient. The composition of deficit financing needs serious attention to containing interest costs without resorting to the monetisation of domestic borrowing. We have to do a lot better in utilising the existing pipeline of concessional foreign financing and accessing the ones on offer. 

In the current high-interest environment, reliance on expensive bills and bonds could lead to further spiralling of interest on domestic public debt.

Foreign exchange buffers need to improve substantially. Fitch has just downgraded Bangladesh's sovereign rating because of a secular foreign exchange reserve decline. The recent introduction of a "crawling peg" regime looks more like a crawl back to a rigid rather than flexible exchange rate. This is unlikely to help rebuild reserves, reduce capital outflows, and discourage the use of informal channels for remittances.

Whatever path the budget takes, the first step is to acknowledge the complexity of the dilemmas and to accept that attributing everything simplistically to external forces will not make the problems less pressing, nor will it help the credibility of the diagnostic. 

We have neither formulated nor implemented tight budgets in the past few years. It is about time to start doing so by cutting waste, of which there is plenty.

Dr Zahid Hussain is a former lead economist of the World Bank's Dhaka office.