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How sustainable is our external debt?

Hossain Mohammed Omar Khayum | December 11, 2018 00:00:00

Bangladesh seems to be enamoured with continuous budget deficit. Data shows that the average government budget deficit is 5.0 per cent of the GDP. And the practice has got a kind of permanent shape since the days of 2000s. How are we dealing with it in case of financing the deficit? Governments started and continued the practice of borrowing from domestic and foreign sources, which has resulted in inflationary pressure and crowding out of private investments. Now, the public spending is mainly used for two purposes, firstly, provision of public goods and secondly, redistribution of income. Here public debt is used to redistribute the burden of taxation over time and across generations, though it is characterised as an "idle exercise".

Since 1971 we have been concentrating on fiscal policy where the main objective has always been to improve poverty situation and to accelerate the economic growth rate. So, the expenditure of the government, continued to exceed the revenue, which resulted in a common practice of fiscal deficit. The fiscal deficit has increased in recent years and now tends to have an adverse impact on the macroeconomic performance. It has given rise to unplanned and poorly negotiated external debts, which pose a big fiscal threat in the coming years.

For external debt to be sustainable, two conditions are necessary. Firstly, during the projection period balance of payment, equilibrium has to be achieved without opting for exceptional financing such as, debt forgiveness, debt-for-equity swaps, and other types of transactions relating to debt reorganisations. And the level of indebtedness at the end of the projection period must be low enough to make future debt service problem unlikely. This is evaluated using indebtedness indicators, such as, debt-GDP ratio and debt-export ratio. The "rule of thumb warning sign" is that for external debt to be sustainable the debt service-export ratio must be of the order of 200-250 per cent. If the ratio goes beyond this limit, external debt growth should be considered non-sustainable and policy measures have to be undertaken to reduce this ratio.

So, a well-negotiated debt contract is an important factor for these loans where the basic components like, type of loan, interest rate, maturity period along with grace period, repayment modules, procedures, etc. are taken into consideration. Previous debt amount, those contracts, clauses etc. are supposed to be considered too.

According to the IMF's last debt sustainability analysis of Bangladesh in May 2018, Bangladesh seemed to be a sustainable country but the analysis is based on the much-debated government data. Also, risks related to the upcoming national parliamentary elections and Rohingya crisis were identified as events that are supposed to put an extra pressure on the economy. Also, in FY17 there had been a deficit in the balance of payment scenario according to the IMF. Exports and imports of goods and services grew by an estimated 1.7 per cent and 9.0 per cent, respectively, while remittances dropped by 14.7 per cent. The current account deficit was projected to widen in FY18, with strong import demand for capital machinery and industrial raw materials and a temporary need for food imports. For this projection, it was assumed that there would be a rise in investment, which will increase the demand for capital goods.

When it comes to external debt, even the IMF can't ignore the threat posed to Bangladesh due to contracting short term external debts. Because, multiple contracts will reach maturity shortly and that might become a fiscal issue, though these things are kept in the dark, away from public scrutiny. Even the recent budget of FY18 looks for more than 43 per cent of its deficit funding from external sources where the amount is Tk 540.67 billion (54,067 crore). Why is it scary? The following trend will explain better.

The trend shows deficit data from the early 90s to present days. It has been increasing throughout the period along with the increase in external debts. Here one thing should be remembered, deficit should not be certified as bad with black-and-white understanding. It may turn out to be bad for numerous reasons and one of them might be the mode of sourcing funds to cover the deficit. And what we are doing, might backfire when we won't be aware. Evidently, we have already started spending from the reserve, as payments to external sources.

It is worth mentioning that Bangladesh always sets a target of tax to GDP ratio in the budget. Currently, our tax to GDP ratio is 10 to 11 per cent. In FY 17, it was targeted 14 per cent and gradually by 2021 government targets achieving 20 per cent. Habitually, we always fail to realise the given target, though, the target helps as a motivated plan for government and other stakeholders to follow.

In most developed economies, the revenue receipts have the largest share from income tax, and corporate tax or other tax revenue are not as significant as income tax, which means businesses are kept secured. Every fiscal year begins with uproar over revenue target, sources of revenue and tax collection. The focal point of budget discussion remains at revenue collection and percentage of NBR revenue collection. It always happens that NBR and the government try to cover the revenue collection basing on direct tax and indirect tax, which includes corporate tax and VAT, followed by duty imposed on foreign trade. Corporate tax rate escalation and VAT always create diverse challenges for the business community including increasing cost of doing business. Including that, the private sector runs into various external business and market risks including weak infrastructure, inflation, energy insecurity and various policy pressures unfavourable for business, market volatility, political instability and bureaucratic and process delays.

Noting that many local investors are interested in investing abroad, Prime Minister's Economic Affairs Adviser Dr Mashiur Rahman said this is mainly because many local investors' capacity has increased so much that the local market seems not big enough to accommodate them and thus they need bigger markets overseas. No one seems to ask, as the investors are growing, why the market is not growing and getting strengthened simultaneously? Market size is not certainly just the only issue here.

As individuals in an economy differ in abilities and therefore in earnings, and perhaps also in their initial nonhuman wealth, the desire to bequest for future generation varies. Some don't intend to leave positive bequests, some do and some would choose to borrow from future generations. The third group who would choose to leave negative bequests are known as "bequest-constrained individuals". Same goes for nations or regimes, just the process is vast.

Whether the bequest-constrained will succeed even by pushing fiscal policy towards lower taxes for the rich, higher not-very-well-planned debt, increased inequality and higher social security benefits depend on the characteristics of the political process. And given the present condition of the relevant institutions, their governance scenario and the interventions of political regimes in every aspect of policy, process, rules and regulations; we ought to wish good luck to the upcoming finance minister.

Omar is a Research Associate at the Department of Development Studies, University of Dhaka. omar.tamim1993@gmail.com

His Twitter handle is: @omarkhayum

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