Seldom do the annual income and expenditure of a nation match exactly. If income exceeds expenditure the nation lends out the surplus, and when expenditure exceeds income it has to borrow from overseas to pay for the deficit. When a nation lends out it accumulates international reserves (foreign assets) and when it borrows its foreign debt increases. Foreign lending is usually regarded as a good thing for the nation, but foreign borrowing is often looked upon with some anxiety. Foreign lending builds up foreign assets and earns interest income which adds to the purchasing power of the people. On the other hand, if foreign debt increases the nation has to pay out more in debt service payments. Consequently it has less to spend for itself.
However, if the funds borrowed from overseas are invested judiciously to earn in excess of the debt servicing liabilities, the purchasing power of the country increases. In this case foreign borrowing is advisable. But when the return from foreign borrowing falls short of debt service obligations, the purchasing power actually declines below what it would have been without the borrowing. If the growth of foreign debt is not arrested, the debt service liabilities can grow to a level that reduces the net purchasing power of the country. The longer such a situation continues, the health of the economy worsens progressively and at some point in time it runs into a debt crisis, which may impose enormous costs on the country.
Whether such a situation could arise will be determined by mainly three factors: (a) the terms (interest rate etc.) at which the funds are borrowed, (2) exchange rate fluctuations and (3) productivity of the investment made with borrowed funds. Any country or enterprise borrowing from overseas must weigh these factors very carefully to determine if the net return of the investment would be positive. If not, foreign borrowing should be shunned to prevent the possible development of a crisis.
Over the last quarter of a century Bangladesh has achieved a fairly comfortable foreign debt position. The outstanding stock of foreign debt, including private debt, stood at $39 billion in 2015-16 (World Bank). This was a moderate 18.6 per cent of the GDP of the country. The debt service liabilities amounted to less than 3 per cent of the foreign exchange earnings of the country. Such a situation was brought about by the prudent policies of successive governments after the overthrow of the military regime of General Ershad. During the Ershad period the debt service payments for the foreign debt of the government was mostly well above 10 per cent of the foreign exchange earnings, but by 2015-16 this was brought down to 2.2 per cent. An important factor behind the low debt service payments was the fact that Bangladesh as a least developed and low income country received loans on concessional terms, sometime at zero interest.
The relatively large stock of foreign reserves and the comfortable foreign debt situation seem to have encouraged the government to borrow more aggressively from overseas to fund mega projects, and even allow the private business enterprises to borrow overseas. Since Bangladesh has an excellent foreign debt repayment record several countries with surplus savings are keen to invest here. China has recently offered US$24.5 billion, India US$8 billion and Japan US$4.5 billion in loans to fund various development projects. The traditional lenders are also offering more loans. It is likely that more loan offers will be forthcoming.
The additional loans will entail larger debt service payments since the loans will have to be negotiated at relatively high interest rates and shorter repayment periods since Bangladesh will be no longer eligible for the concessional loans given to low income countries. (Compare the most concessionary 20-year Indian loans at 1.0 per cent to the normal 40-year IDA loans at 0.75 per cent service charge). If the stock of debt piles up, at some stage the debt service liability will rise to a level that will be difficult to repay. It is prudent not to borrow excessively such that the debt stock does not rise to that level.
Bangladesh is currently passing through the phase in its political business cycle when the government tends to be profligate. The present government will have to garner the support of the majority of the population in order to be returned to office in the forthcoming general election assuming that it will be free, fair and participatory. It may try to increase its popular support by increasing both current and development spending which may temporarily raise employment and income. The development spending is also a major source of income for party cadres including businesspeople. Part of this income could be ploughed back to electioneering to influence voting. The government will also be reluctant to raise taxes before the election fearing a voter backlash. It may be recalled that despite all the efforts of the Finance Minister, the Parliament did not allow the uniform VAT law to be passed. The government may even reduce its effort to enforce the existing tax rates. The prospect of greater desired spending financed by higher taxes at this time appears dim.
Therefore, a large gap may develop between the desired spending and the actual revenue of the government leading to a large budget deficit on the eve of the election. The government may be tempted to borrow overseas to fund the deficit since domestic borrowing could set it on a collision course with domestic borrowers by crowding out the credit market. There are ample indications that the government has developed a penchant for foreign borrowing, especially when it is being flooded with credit offers from various sources, no doubt due partly to our excellent loan repayment record. It could also get cocky and attempt to use the foreign credit offers for strategic advantages. This will not bode well for the economy in the long run.
If the government decides to accept most of the offers and signs loan deals with the countries mentioned above, the debt stock will double in a few years moving Bangladesh toward a tighter foreign debt situation. What is of real concern is that once the government gets addicted to foreign loans it may overlook the future dangers imminent in debts and continue its borrowing spree until a debt crisis erupts. The problem may be further compounded by private sector borrowings even though these did not have sovereign guarantees. While this might seem to be a distant possibility now, the dynamics of the situation could push the country in that direction. The current government will have left a bad legacy for the future governments.
It is advisable that the government should shun this path and maintain the current comfortable foreign debt situation. This requires carefully vetting foreign loan offers to ensure that the net productivity of the additional loans is greater than the additional debt service liabilities. In this event a higher debt stock will not raise any problem for the country, on the contrary it will add to the welfare of the people. Obviously this requires government choosing investment projects that have high net returns.
This is not as easy as it may seem. Sri Lanka had borrowed extravagantly from China to finance such infrastructure projects as a deep sea port, coal power plant, and high ways. Unfortunately some of these projects turned out to be much less productive than what the previous government of Sri Lanka, which did the loan deals, had thought. When debt service payments became increasingly difficult to bear the current government was forced to lease out the sea port for 99 years to China. Incidentally the investment projects chosen by Bangladesh government for funding by foreign loans are very similar to the investment projects of Sri Lanka. Bangladesh should do the math very carefully.
The writer is Professor of Economics, University of Dhaka.
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