FY23 fiscal policy shies away from prioritising macroeconomic stability

The fiscal policy adopted in the ongoing fiscal year has shied away from prioritising macroeconomic stability although several key indicators have come under serious stress owing to internal and external factors, said a noted economist.

Zahid Hussain, a former lead economist of the World Bank's Dhaka office, says the budget deficit widened in the first eight months of FY23, with domestic financing, largely monetised, on course to overshooting the budget target.

"External stabilisation is in dire need of course correction. The fiscal measure that matters directly for external balance is public expenditure on imports not financed externally. The promised effort to cut import-intensive domestically financed projects is awaiting visibility in the fiscal outturn data."

"The fiscal policy in FY23 so far has shied away from prioritising macroeconomic stability," he said.

According to the economist, the FY23 budget faced several challenges in adapting to macroeconomic stress amidst post-pandemic recovery, global supply chain disruptions and a deeply uncertain external outlook.

The budget makers sought to expand the fiscal deficit hoping global headwinds will fade, thus allowing the FY23 fiscal measures to catalyse investment, growth, employment, disinflation, and building up foreign exchange reserves.

"The outturns on all the above so far have not been the desired direction, only partly due to tight external financing conditions, a strong dollar, and elevated international commodity prices," Hussain said.

Despite significant corrections in the corporate tax regime for three years in a row and an expanding fiscal regime incentivising import substitution through higher tariffs and subsidising exports, the private investment rate, export growth and employment have declined.

GDP growth is projected by the Bangladesh Bureau of Statistics to fall to around 6 per cent and inflation is running above 9 per cent.

Productivity growth slowed. Foreign exchange reserve depletion is still looking for a bottom, tax revenue growth slumped and borrowing from the Bangladesh Bank ballooned.

Hussain thinks lower growth with higher inflation is symptomatic of the predominance of supply shocks caused by foreign exchange rationing, gas shortage and a proliferation of economic management by command and control.

"Public policy response to the external shocks lacked fitness for purpose."

A stronger motivation for investment induced by lower tax rates does not translate into action when inflation is rising, the pass-through from the statutory rate reduction to the effective rates is mediated by complicated eligibility conditions, and the foreign exchange constraint is too tight too long.

Deeper investment climate reforms, given the usual speech service, predictably remained sloth, according to Hussain.

He says the elephant in the room on reforming the deployment of public resources this year was the subsidy regime broadly defined to include incentives and loans.

Despite a significant increase in the administered prices of oil, gas, electricity, and fertiliser, the subsidy bill in the first eight months of FY23 was twice the subsidies during the same period last fiscal year, allegedly due to "arrears" and import price increases still exceeding the domestic pass-through.

"Both explanations warrant deeper digging," he said.

Revenue mobilisation has been most disappointing. Betting on higher buoyancy parameters, through better tax compliance, has not paid off. The revenue gains from base expansion and several indirect tax rate increases have failed to outweigh the revenue losses from the direct and indirect tax decreases.

The revenue growth target was at the mercy of growth in the nominal value of international trade, domestic manufacturing, and formal sector services. All of these are far short of projections. The lack of progress in reducing the cost of tax compliance did not help.

Hussain said a significant legal measure to boost revenue and reverse illicit capital outflows was the rolling out of special privileges to money-holders offshore.

"It has so far failed to deliver any revenue, not to speak of getting back money laundered abroad."

Social assistance to the poor and the vulnerable did not get the attention it deserved. The family cards programme, introduced in March 2022, continued this fiscal year to help 10 million poor and ultra-poor families combat the price hike of selected essentials.

"It looked promising at the start, notwithstanding unanswered questions on why food was preferred over an equivalent amount of cash," he said.

He said administrative costs of food transfer programmes typically are almost 2.5 times higher than those of cash transfer programmes. The dealers demand bribes, cheat on weight, and supply rotten or below-standard products. The beneficiaries wait for hours in the queue.

"Enhancing support to programmes such as stipends, old age pensions, and cash transfers, where implementation capacity can be presumed to have improved, would have helped deliver more social assistance at a lower cost. Not surprisingly, the Family Card initiative got tainted by internal corruption and irregularities."

HOW TO ADDRESS INFLATION AND EXTERNAL IMBALANCE

Hussain said outsiders don't have the benefit of feeling the fiscal pulse as intimately as the insiders.

"So, we can, therefore, only seek to sketch solutions applying the operating principles we believe are pertinent to the state of the economy and the near-term outlook."

Disinflation and stabilisation of foreign exchange reserves are macroeconomic imperatives. This warrants fiscal consolidation meaning a declining path of primary fiscal deficit (i.e. deficit not including interest payments) and shunning (if not reversing) the monetisation of the government's domestic borrowing.

On revenue mobilisation, raising Tk 30,000 crore to Tk 40,000 crore from the reduction in tax expenditures by prioritising tax concessions expiring this fiscal year and going beyond to the extent needed looks in the realm of the possible, given the gigantic size of the tax expenditures, according to Hussain.

"Tax policy (VAT, Income Tax) and administration reforms can add some more. These must build on the work already done on the related legislations and the various projects in place for automation of tax services."

"We must walk the talk on expenditure allocations."

He says the expenditure shares of the top ten economic sectors have to square with the priorities deserved by the agriculture and social sectors and thinks expenditure rationalisation is needed to expand funding for these sectors.

"The elephant in the room here is reprioritising the mega projects and prioritising maintenance in infrastructure in general and transportation in particular. Adequate funding for road maintenance with close attention to fiduciary risks is a high priority."

The former World Bank economist called for direct generosity where it is needed the most as inflation has damaged the real income, food security, and essential expenditures of households in heterogenous ways.

"Inflation is an annoyance for the rich, a drag on savings for the middle class, and a livelihood crisis for the poor and the vulnerable. The social assistance to cope with inflation has to be targeted to those struggling to manage their livelihood beyond what is already in place."

He says the FY23 budget missed an opportunity to use the education budget for fighting inflation as well as making up lost learnings.

"This needs correction. Making up the lost 1.5 years of schooling due to Covid-19 and reducing disparities are big challenges. Innovative approaches geared to meet these challenges head-on needs embracing partnership with non-state actors."

The economist thinks several structural reforms need immediate execution.

These include bringing market-driven flexibility back into the interest rate and the exchange rate regime, finishing the work in progress on several financial sector legislations, putting in place a transparent regime of energy pricing, injecting functionality into the shops set up to provide services in one stop, and several key reforms in trade and human development policies.