FY23 budget was a disappointment

The national budget for the current fiscal year has been a disappointment as it did not address the macroeconomic crisis emanating from the joint impacts of global inflationary pressure and Russia's invasion of Ukraine.

"The budget should have adopted an austere stance with an effort to tighten domestic demand through an increase in taxes and the reduction of subsidies and fiscal deficit. The FY2023 budget did not deliver on any of the above," said Sadiq Ahmed, vice-chairman of the Policy Research Institute of Bangladesh, a think-tank.

In an interview with The Daily Star, he said evidence shows that the tax to gross domestic product (GDP) ratio is falling from its already very low levels.

For FY2023, the most likely outcome would be a further reduction in the tax-GDP ratio to a mere 7.1 per cent as compared with 7.6 per cent in FY2021 and 7.7 per cent in FY2019.

"This is hardly surprising as no serious tax reforms have happened since FY2012," Ahmed said.

"Bangladesh has substantial structural and institutional problems with the tax system and unless these are tackled, ad-hoc measures announced during the budget season are not going to work as amply demonstrated by the experiences of past several years."

Subsidies are likely to increase to 2 per cent of GDP in FY2023 mainly triggered by the surge in global energy prices. So, the government will need to find a way to contain subsidies to below 1.5 per cent of GDP, especially when it is unable to increase the tax-GDP ratio.

Ahmed said the government is cutting development and social protection spending to contain the budget deficit. Even so, the fiscal deficit will likely increase from 3.7 per cent of GDP in FY2021 to 5 per cent in FY2023.

"Furthermore, the financing of this deficit has relied substantially on bank financing that is causing an increase in domestic credit growth at a time when credit growth has to fall to reduce demand pressure on inflation."

"Rising fiscal deficit and greater reliance on bank financing are both inconsistent with macroeconomic stability."

The former senior official of the World Bank said the ongoing macroeconomic crisis is of serious concern.

"While the origins of the crisis lay in the heightening of global inflationary pressure that was further accentuated by the Ukraine War, the inadequate policy response has also played a role."

To manage the balance of payments, he said, the government responded by increasing tariffs and adopting a range of import control measures.

These policies drastically reduced the growth of imports and the current account deficit substantially in FY2023 as compared with the outcome in FY2022.

But Ahmed said: "Global experience shows that import controls can at best be a temporary measure and not a sustainable way to manage the balance of payments. So, while imports fell and the current account balance improved, the flip side was a substantial slowdown in GDP growth."

The GDP growth is now estimated at 6.03 per cent for FY2023 against the original target of 7.5 per cent. The economy expanded by 7.1 per cent in FY2022.

"Additionally, these measures could not prevent a substantial worsening on the capital account as foreign direct investments did not expand as projected, short-term trade credit dried up and medium and long-term credit also slowed down," Ahmed said.

"Furthermore, there is evidence of significant capital flight. The signal value of import and exchange controls was highly negative for foreign direct investment, suppliers of trade credit, and the confidence of private investors."

The noted economist cited inflation management by the authorities and said: "The most surprising and negative policy stance was the absence of any demand control measures."

The government's responses to inflation reduction comprised of control over the exchange rate and the use of subsidies to prevent a pass-through of global energy price increases. Contrary to lowering demand, the government policy sought to boost demand by increasing domestic credit through controls over interest rates and a higher fiscal deficit.

"These policies further added to inflationary pressures," said Ahmed.

"Evidence shows that countries that adopted demand reduction policies through hikes in interest rates have all succeeded in reducing inflation substantially."

Inflation in Thailand decelerated from 7.7 per cent in June 2022 to 2.7 per cent in February 2023.

In the US, inflation plunged to 4.9 per cent in April this year from its peak of 9.1 per cent in June last year. India's inflation fell by 40 per cent year-on-year to 4.7 per cent in April.

In Vietnam, the inflation rate spike has been successfully curbed and contained in the 2-3 per cent range, Ahmed said.

"As compared with these successful outcomes of inflation reduction, Bangladesh did not achieve any success with inflation control."

The PRI vice-chairman said the Bangladesh Bank must act fast and with determination to lower the growth of credit by abandoning the 9 per cent interest rate policy and using interest rate flexibly.

The central bank has maintained the lending rate cap since April 2020.

Ahmed recommended the central bank use the interest rate to target domestic credit growth in a way that lowers domestic demand and reduces inflationary pressure.

"The central bank should also fast-track the development of a secondary market for treasury bills to facilitate an interest rate-based monetary policy management."

The economist urged the government to support this inflation control strategy by keeping fiscal deficits below 5 per cent, increasing the tax-GDP ratio, phasing the implementation of large capital-intensive projects, and mobilising low-cost foreign financing.

"It should also reduce bank financing of budget deficit by increasing its reliance on market borrowings using the secondary market for treasury bills."

Ahmed said these demand reduction policies would also help stabilise the balance of payments without the need to resort to import or exchange controls.

"Bangladesh Bank should also swiftly move to a market-determined and uniform exchange rate policy. This will support the growth of exports and remittances while also lowering demand for imports."