Seventh Plan fiscal policy: Setting the tone

The Sixth Five Year Plan is coming to a close on June 30, 2015. The Sixth Plan is the first medium-term government strategy for implementing Vision 2021 and the Perspective Plan 2010-2021. The implementation of the Sixth Plan has important implications for defining the goals, targets and strategy of the Seventh Five Year Plan scheduled to start from July 01, 2015. The upcoming FY2015/16 Budget is the first national budget under the Seventh Plan.

In a market economy like Bangladesh where over 90% of the economy is owned and managed by the private sector and it accounts for 80% of total investment, government regulatory policies and the annual National Budgets are the two key instruments for implementing the five year plans. The annual Budget for the first year of a new five-year plan not only defines the government's current economic and social policies but also provides the most explicit statement of the government's medium-term strategic directions. In that regard, the forthcoming FY2015/16 National Budget is of paramount importance to setting the tone and directions of the fiscal policy for the 7th Plan.

This paper looks at expenditure management aspects of the Seventh Plan and the implications for the FY2015/16 Budget.  The main objective of this paper is to provide some constructive inputs to the Finance Minister as he prepares to present the FY2015/16 Budget next month. The inputs are evidence-based, drawing from the lessons of experience of implementation of the annual expenditure programmes over the five years of the Sixth Plan (FY2010/11-FY2014/15).  

RESOURCE AVAILABILITY AND BUDGET SPENDING: The trend in actual budget spending as compared with the budgeted level and the level projected in the Sixth Plan is shown in Figure 1. It is important to note that the GDP (gross domestic product) was revised upwards by about 15% by the Bangladesh Bureau of Statistics (BBS) in 2014 due to the rebasing of GDP estimates.  As such, to enable a meaningful comparison, the government spending as a share of GDP that was projected in the Sixth Plan is adjusted with the revised GDP base.  

The comparison shows some interesting results:

1) Total budget spending during the Sixth Plan more than doubled in nominal terms, growing from Taka 1015 billion in FY2009/10 to taka 2309 billion in FY2014/15, which suggests  an average annual growth rate of 18% in nominal terms and 10% growth in real terms. As a share of GDP, spending grew from 12.7% to 15.1% over the same periods.

2) Actual budget spending was in line with the Sixth Plan and the Budget target for the first three years of the plan period.

3) The Budget and Sixth Plan targets were consistent with each other in FY2013/14, but actual spending fell way short.

4) The Budget target and actual spending are both considerably below the Sixth Plan target for FY2014/15.

5) Actual spending is significantly below the Budget and the Sixth Plan for both of the last two years of FY2013/14 and FY2014/15.      

 Source: Ministry of Finance

In addition to implementation constraints, a major reason for the expenditure shortfalls in the last two years is the inadequacy of available resources (Table 1). Total budget resources grew by 2.4% of GDP between FY2009/10 (base year of the Sixth Plan) and FY2014/15 (final year of the Sixth Plan).  As compared with this, the Sixth Plan projected an increase by 4.4% of GDP, which is 2% higher than actual. The shortfall happened owing to the inability to increase tax revenues to the extent necessary.

From the macroeconomic stability point of view, it is to the government's credit that they maintained fiscal discipline by adjusting expenditures to the revenue shortfalls. Fiscal deficit increased modestly and the sustainability of public debt is not an issue in Bangladesh (Figure 2). This contribution of fiscal policy to macroeconomic stability is a huge plus that must be acknowledged and celebrated.  South Asian countries (Pakistan mainly but also India and Sri Lanka) have suffered considerably from long episodes of macroeconomic instability owing to lack of fiscal discipline and a growing burden of public debt.

Source: Ministry of Finance

Yet, the shortfall in budget spending is a part of the reason for the shortfall in the actual growth rate of GDP over the Sixth Plan target. Much of the spending shortfall happened in the area of development spending (Figure 3).   While the Sixth Plan aimed at expanding the development spending by 2.7% of GDP (from 4.1% of GDP in FY2009/10 to 6.8% of GDP in FY2014/15, actual development spending increased by only 1.1% of GDP over the five year period of the Sixth Plan.

Sixth Plan and Annual Budgets

Another important issue on the financing side is the declining contribution of foreign financing along with growing volume of unused foreign aid pipeline (Figure 4) at a time when there are domestic revenue constraints to the expansion of the development spending. The more rapid use of the aid pipeline can help finance core public investments without creating inflationary pressure or crowding out effects of budget deficit.

Source: Ministry of Finance

SPENDING PRIORITIES: Along with the size of development spending and the way that public investment is financed, the composition of government spending and how well it is implemented are important determinants of the effectiveness of public spending on economic growth and poverty reduction. While development spending helps economic growth as well as human development through supportive public investments in physical infrastructure and human capital, current public spending on teachers, medical personnel and social security transfers can all have major positive impact as well. In this sense, the distinction between development and current spending is often not helpful. Yet, it is also recognised that some areas of public spending such as interest cost, general purpose subsidies, transfers to finance the deficits of state-owned enterprises and transfers to cover the non-performing loans of state-owned commercial banks do not normally contribute to long-term development.  These spending trade-offs can be specially challenging in an environment of resource constraints.

ECONOMIC COMPOSITION OF GOVERNMENT BUDGET: The economic composition of budget spending during the Sixth Plan is shown in Table 2.

* On the positive side, the wage bill and interest costs have basically remained under control, although a wage surge is expected in FY2015/16 with the implementation of the new wage award. Since this will add 1.3% of GDP, its management will present a challenge in the coming Budget.

* The subsidy budget has grown over the years. Much of the subsidy is on account of energy sector, fuel oil and electricity. At its peak energy subsidies reached 1.8% of GDP in FY2012/13. Price adjustments brought it down in later years. The recent large decline in international oil prices has given the budget a boon and oil subsidies have turned into a sizeable surplus for the Bangladesh Petroleum Corporation (BPC). The government has rightly decided to use the surplus for retirement of the large outstanding deficits of BPC. A major policy challenge for the 7th Plan will be to convert this into an opportunity to depoliticise oil prices and move to a market-driven pricing mechanism along with a competitive market for oil supply over the longer term.

*  The financing of state-owned enterprise (SOE) deficits and budget transfers to cover the non-performing loans and thefts from public banks is taking a sizeable amount of budget resources (included in others and net lending component). This is a major policy challenge for the Seventh Plan. The government has invested a lot of money in SOEs.  It is high time that a hard budget constraint was imposed on these enterprises and the government should require these enterprises to earn a positive rate of return on investment. Similarly, banking is a profitable enterprise and there is no reason why public banks should require transfers from the budget to stay afloat. The government can either require them to operate as commercial enterprises and be financially solvent or privatise them.

SECTORAL COMPOSITION: From a development perspective, the sectoral composition of government spending provides important insights about the likely development impact of the budget.  The main sectoral priorities of the expenditure programmes during the Sixth Plan in terms of actual implementation are indicated in Table 3.

Table 3 is a powerful indicator of the government's spending priorities reflected in the actual pattern of spending.  It conveys a number of important messages:

*  On the whole, actual public spending during the Sixth Plan was broadly focused on sectors that are likely to have the most impact on growth, human development and poverty reduction.  Thus, on average, the expenditure share of these sectors was around 70% of the total budget.  This is reassuring.

*  Government spending on infrastructure has grown significantly from a low of 1.2% of GDP in FY2009/10 to 2.1% of GDP in FY2014/15.  This is a positive development and reflects the high priority accorded to infrastructure.  Yet, this is very inadequate compared to needs. The ability to increase GDP growth rate from the present 6.0 per cent level to 7-8 per cent range in the Seventh Plan will critically depend upon the ability of the government to increase development spending on infrastructure as a share of GDP.

*  Notwithstanding the priority given to human development, government spending on human development is very low and falling as a share of GDP.  Instead of growing, spending on human development has fallen from 2.8% of GDP in FY2009/10 to 2.4% of GDP in FY2014/15. Education spending has fallen from 2.0% of GDP to 1.7% and health spending remains less than 1.0% of GDP.  This compares rather unfavourably with other Asian developing countries like Vietnam, India, Philippines and Indonesia and quite poorly with advanced Asian countries like Korea, Malaysia and Thailand (Figure 5).

*  Spending on social protection increased during the 2000s from the low levels of the 1990s. But it stagnated at around 2% of GDP during the Sixth Plan, with a slight downward trends (1.7% of GDP in FY2014/15), as compared with the Plan target of raising it to 3.0% of GDP by FY2014/15. If the spending on civil service pensions is excluded, which is not really social protection spending for the poor and vulnerable, social protection spending declined to only 1.3% of GDP in FY2014/15.  This is rather low for a country with an estimated poverty rate of 24.9% (39 million people) and extreme poverty rate of 12.6% (20 million people) in FY2014/15.

*  The main reason for these low levels of spending in priority sectors is the inadequacy of revenue resources. Under a tight resource situation, expenditure trade-offs become a real challenge. The policy choices can be illustrated from the experience of FY2012/13, when the spending on fuel subsidies soared to Taka 204 billion while spending on education was Taka 182 billion and health spending was a mere Taka 88 billion. Should the government spend scarce resources on oil subsidies that benefit the rich more than the poor or on health and education? Similarly, transfers to cover deficits of state-owned enterprises and public banks divert resources from expanding spending on education, health and infrastructure.  

*  The expenditure challenge for the Seventh Plan is obvious.

Source: World Bank Database and Ministry of Finance

Dr Sadiq Ahmed is Vice Chairman of the Policy

Research Institute (PRI).

[email protected]