Reforms needed to achieve budget targets

Fiscal policy, embodied in the government's national budget, is an important determinant of macroeconomic stability, growth and equity.  The FY20 budget maintains the usual prudence we have gotten used to with a 5 percent of GDP overall deficit target of which 2.7 percentage point is projected to be financed from domestic sources and the rest from foreign sources.

Given a low public debt to GDP ratio and some increase in the cost of external finance, this does not create any additional risk of debt distress if economic growth continues to be 7 percent or above and the gross external financing target of about $8.9 billion is achieved. The latter is ambitious but achievable given that the size of the aid pipeline stood at over $48 billion as of November 2018, thus requiring slightly nearly 19 percent utilisation rate to achieve the target.

Target underachievement is still likely.  Although the revenue and expenditure growth targets in the FY20 budget are more realistic relative to previous budgets, it is still likely that both will be underachieved. Under-achievement of the expenditure target may as usual exceed the underachievement of the revenue target, thus resulting in undershooting of the deficit target. However, deficit is likely to increase relative to the actuals in the recent past because the difference between the expenditure and revenue under-shootings is likely to shrink. Expenditure undershooting is likely to be driven by underutilization of the ADP which in turn may lead to underutilisation of the external financing target.  This means reliance on domestic financing may not necessarily be reduced correspondingly even if deficit is below target.

There is a double whammy on domestic financing. The budget aims to reduce dependence on National Savings Certificates (NSCs) and increase reliance on bank borrowing.  Unfortunately, this desirable shift in the composition of domestic financing has come not just a little late but also probably at the wrong time. Excess liquidity in the banking system has shrunk considerably due to rising non-performing loans, dollar sales by the Bangladesh Bank and weak deposit growth.  As a result, private sector credit growth dipped to a 52-month low in April.  Increased bank borrowing by the government in such a situation will increase the risk of crowding out bank credit to the private sector with adverse effects on private investments.  This can be avoided by ensuring increased use of concessional external financing and, more importantly, resolving the non-performing loan problem in the banking system.  Some increase in the monetisation of deficit (that is borrowing from the Bangladesh Bank) is also an option, but it should be used only as a last resort because it may elevate the inflation risk.

NBR tax revenue growth is not beyond achievability, judging from experience.  However, 14.2 percent nominal GDP growth will not be enough to yield this result. The revenue impact of the new VAT law is uncertain since multiple rates are back and several other loopholes that the original new law, as passed in 2012, intended to close are now likely to have been restored. Corporate tax rate reduction and structure simplification has not been addressed while tax holidays have been extended. 

There are some potentially revenue increasing tax proposals, but they may not suffice for achieving the target even if they survive the post budget review before the budget is approved by the parliament. Achieving the revenue target will depend critically on the planned expansion of the income tax base from the current 1.5 million people to nearly 10 million which in turn will depend on progress in tax administration reforms, particularly in automation.

The budget promises to simplify the customs and income tax laws to make them business friendly, which is great. However, scanning all import and export consignments may undermine the intention to simplify.  A risk-based scanning approach may be more efficient.

Recurrent expenditures continue to dominate total expenditure.  With increase in pay and allowances, pensions and gratuities, and grants-in-aid outpacing revenue growth, some of the proposed increases in subsidies risk reducing fiscal space because of their stickiness or irreversibility. The economic justification for some of the new ones or expansion of the existing subsidies is not immediately obvious since there is no pressing case for a fiscal stimulus or mitigation of negative externalities. Some (such as agricultural subsidies targeted to small and marginal farmers), certainly not all, may be justified on grounds of inclusion.

As usual, the allocation of development expenditures by sectors is generally consistent with the country's development priorities. Adequate provisions for transformative projects such as the Padma bridge and Dhaka Metro Rail Transit are indeed reassuring. Increased spending on the development of rural infrastructure will help stem the tide of internal migration from rural areas to the mega cities. Making cities livable require, among others, making villages livable as well. Implementation speed and efficiency are the key challenges here. 

The ADP continues to be overloaded with too many projects and the operational inefficiency manifested in time and cost overruns remain ubiquitous. The implementing agencies need to be held more accountable for delivering completed projects.

More budgetary effort needed on human development and inclusion. Bangladesh has lagged peers in three equity-promoting fiscal expenditures: education, health care, and social protection. Expenditure on education as a share of GDP was only 2.1 percent in FY19. The FY20 budget proposes to raise it to 2.75 percent.  Expenditures on health has consistently been below 1 percent of GDP and will continue to be so in FY20 (0.9 percent of GDP). Social safety net expenditures, excluding pension for public sector was only 1.6 percent of GDP in FY19. Bangladesh needs to do more to foster inclusive growth by steering fiscal policy towards spending a lot more on education, health and social protection than proposed in the FY20 budget while strengthening the capacity to spend.  Increased budgetary allocations of course must come with enhanced quality assurance.

Also, the budget has provisions for some unproductive and non-transparent "capital" expenditures for supporting loss-making state-owned enterprises and recapitalising the state-owned banks.  Innovative schemes such as a pilot (one district) insurance project for farmers and migrant workers, startup funds for the unemployed youth and expansion of safety net beneficiaries by 1.3 million are great ideas.  But the devil lies in the details of their implementation.

Transformative structural reforms could make the difference between success and failure. Key reforms needed to achieve the budget targets with the desired stability, growth, job creation and equity effects must include: (i) the resolution of the NPL problem so that government bank borrowing does not crowd out private credit flows; (ii) rationalisation of interest rates on NSCs so as to discourage excessive demand for NSCs; (iii) making tax administration friendlier to taxpayers to incentivize tax compliance by reducing the direct and indirect cost of paying taxes; (iv) smarter management of subsidies and transfers to ensure that these reach the intended targets; (v) improving public investment management processes to the time and cost over-runs in development project implementation and (vi) reducing regulatory hassles and unpredictability to enable increased private investments.

The writer is lead economist at the World Bank Bangladesh.