Structural reforms through fiscal measures

The recently announced national budget has sparked considerable debate among economists, business leaders and the general public. Barely a few weeks have passed since the Finance Minister's speech, and it is widely considered that neither a 23 per cent growth in expenditure nor a 27 per cent growth in revenue collection is realistic. The bottom line is an unlikely GDP growth of seven per cent given the fundamental constraints in the economy.
These constraints not only include inefficiencies in the tax system which has received overwhelming attention in the media, but several other structural issues. Such issues require reforms aimed at reducing market distortion and inefficiency, ensuring fair production of goods and services and generating higher productivity. We outline six structural reforms for Bangladesh to break the current six-per cent growth trap.
INSTITUTIONAL CAPACITY: International experience shows that quality of fiscal spending is largely determined by efficiency of institutions. We focus on two specific instances where institutions in Bangladesh need drastic reform.
First, the new budget outlines an Annual Development Programme (ADP) almost 30 per cent bigger than last year's revised ADP. But the budget does not clearly delineate a time-bound and transparent plan to ensure that respective ministries can actually achieve these targets. As is well known, below-par efficiency in individual ministries is one major reason behind downward revision of ADP every year - naturally policies aimed at tackling such bottlenecks have to be mainstreamed.   
Second, the government's decision to allocate BDT 50 billion in the new budget to recapitalise the state-owned banks is nothing but a very short-term solution to institutions which need longer-term diagnosis. If the government really wants to bring about structural change in this aspect, privatisation of these banks need to be seriously considered.
BUSINESS REGULATION: It is generally accepted that Bangladesh's 28 per cent investment-to-GDP ratio is not enough to fuel seven per cent growth. Generating sustained private investments is now of utmost priority which in turn hinges on business-conducive regulations. The budget speech does point out steps to improve access to electricity and gas to encourage investments. Modernisation of land management, record and registration is also mentioned, though without a phase-by-phase timeline to achieve these targets.
But issues such as getting construction permits, protecting minority investors, trading across borders, enforcing contracts and resolving insolvency are left largely unaddressed. These are critical areas which also need to be looked at if Bangladesh is to be viewed as a business-friendly economy.  
DEFICIT FINANCING: The current budget proposes to finance 65 per cent of deficit from domestic sources. While issues of "crowding out" private investment is not relevant this year due to subdued aggregate demand, relying on domestic sources to finance budget deficit is not a prudent practice, especially since Bangladesh qualifies for highly concessional loans from external lenders because of its developing-country status. This has to be pursued more rigorously from both bilateral and multilateral donors.
One might argue about increasing external debt. This is logical since Bangladesh has one of the lowest external debt-to-GNI ratio in the region, at 19.5 per cent. This means the country has room to increase external debt, to at least the average of 23.2 per cent in South Asia (Source: World Bank), as long as income-generating investments are waiting in the pipeline.
Another option is to expedite the process of issuing sovereign bonds. The recent idea of a dollar-denominated bond is quite promising but care must be taken to raise the money only when plans for growth-enhancing public projects are laid out and prepared to be initialised.  
ENERGY SUBSIDY: It is encouraging to see that overall subsidy allocation has been reduced by about 10 per cent in the new budget and is now about 8.3 per cent of total expenditure. However, a structural shift would entail a clear strategy aimed at eliminating the highly distortive energy subsidy entirely from the budget in a specified time frame. This is especially relevant now that international oil price is subdued. But subsidies continue to both Bangladesh Petroleum Corporation (BPC) and Bangladesh Power Development Board (BPDB).
It is high-time for a comprehensive subsidy policy, which not only phases out energy subsidy but ensures that the gain is permanent. This can be achieved only if government discretion in setting energy prices is removed and replaced with an automated energy pricing mechanism based on market fundamentals. To protect against shocks, short-term price smoothing can be introduced into such a system. Finally, subsidy policy in Bangladesh has to be independent from the financial distress of politicized institutions like BPC and BPDB. These entities require management oriented reforms. So, there is no economic rationale for tagging subsidy policy with their financial state.    
TRADE POLICY: The new budget outlines major changes in duty structure. Both customs duty (CD) and supplementary duty (SD) have been changed for a large number of products. However, while CD for most products has been decreased, SD has actually been increased for more products than it has been reduced. At a net level, there is limited evidence of a push towards full-fledged trade liberalisation despite overwhelming empirical proof of the benefits of trade openness.
This practice of protecting domestic import substituting industries is a classical approach by developing countries to let its infant industries burgeon. But is Bangladesh still in that stage where almost all industries (apart from garments) are still at their infancy? If the answer is no, then the government needs to significantly reduce protection to improve exports of non-garment products. Another argument against tariff reduction is the government's high revenue collection target. But once the 'VAT and SD Act 2012' is completely operational, shifting away from tariff-based revenue may become a more viable option.
Labour Market: Empirical evidences as well as growth accounting models prove that achieving higher real income growth hinges on higher productivity of labour. Bangladesh needs to implement strong policies aimed at producing skilled labour. This has to start with higher budget allocation in education and health. Regrettably, the share of education and health sector in total expenditure has actually decreased this year to 11.6 and 4.3 per cent from 13.1 and 4.8 per cent respectively compared to last year's budget allocation. The trend should have been the other way round given that Bangladesh has historically spent least in these two vital sectors compared to the regional counterparts.
Reforms in labour market cannot stop at simply raising allocation in these sectors. More micro-level education reforms have to be put in place to improve quality and ultimately the returns to schooling. Additionally, greater availability of vocational education and on-the-job training needs to be made to improve long-term labour productivity.
As Bangladesh approaches the terminal phase of 'Vision 2021' to reach Middle Income Status, the government needs to accept that the conventional model of an expansionary fiscal policy is insufficient to attain the seven per cent target. More fundamental and long-term oriented structural policies need to be designed to root out persisting roadblocks prohibiting higher growth.
Sharjil M Haque ([email protected]) is a macroeconomic analyst based in Washington D.C. USA; and Sabrina Afroz ([email protected]) is an analyst at a multinational asset management
company in Dhaka, Bangladesh.