Fiscal policy is one of the most crucial areas of government economic policy that has the potential of affecting economic stability and boosting growth. With the economy slowed by high inflation and low revenue mobilisation, the impending exit from the LDC club poses major economic challenges for Bangladesh, which need to be addressed immediately and effectively. The interim government is set to unveil a contractionary national budget with the target of reducing spending and implementing reforms to boost domestic revenue to narrow the budget deficit.
Because of low level of revenue mobilisation, the size of Bangladesh's government sector is one of the lowest in the world, at 13-14 per cent of GDP. The tax-GDP ratio which is a key indicator of revenue mobilisation efficiency has remained stagnant at around 8 per cent, which is much lower than neighbouring Nepal-- 23.4 per cent and India-- 20 per cent. Despite this low level of public expenditure, Bangladesh has maintained a budget deficit of approximately 5 per cent of GDP, financed primarily by external and internal borrowings. Growing reliance on borrowing has led to a rising debt burden.
Bangladesh's debt-to-GDP ratio rose to 36.30 per cent in FY2024 from 32.41 per cent in FY2021, due to substantial expansion in both domestic and external borrowing. According to statistics, 14.24 per cent of the national budget for FY25 was allocated solely for interest payments on government debt.
Borrowing from banking sources increased sharply to BDT 5.97 trillion in FY2024, up from BDT 3.34 trillion in FY2021, signaling crowding-out risks. External debt stock surged to BDT 8.12 trillion in FY2024, compared to BDT 4.20 trillion in FY2021. External debt-to-GDP ratio increased to 22.60 per cent in FY2024 raising external vulnerability. A significant portion of the national budget goes to debt servicing to deal with the enormous debt burden causing significant loss of fiscal space on account of mandatory interest payments.
Amid rising repayment obligations and declining foreign exchange reserves, major nondiscretionary expenditures grew faster than the increase in revenue, which caused the fiscal space to shrink. Besides interest payments on foreign and domestic public debt, other major nondiscretionary outlays include pay and allowances for government employees; pensions and gratuities; and subsidy for energy, agriculture and some other sectors.
As per available data, total nondiscretionary spending on pays, allowances, pensions and gratuities accounted for more than 43 per cent of the revenue in FY23. Extensive subsidies allocated to support various sectors account for almost one fourth of the total tax revenue of the government becoming burdensome for the budget.
According to the debt bulletin report of the finance division of the Ministry of Finance, government expenditure on interest payments account for one-sixth of the national budget. Bangladesh's total debt-to-GDP ratio was 33.02 per cent in 2023, with domestic debt at 19.0 per cent and external debt at 14.04 per cent. Total debt-to-GDP ratio rose to 36.30 per cent in FY2024 and is further projected to rise to around 40.26 per cent in 2025, reflecting higher fiscal pressures.
Bangladesh's public debt in terms of GDP is no doubt among the lowest globally. A total debt-to-GDP ratio of more than 40 per cent is significantly lower than the IMF threshold of 55 per cent. However, it is government revenue, and not GDP, that determines the capacity to pay public debt. In terms of debt-to-revenue measure, Bangladesh's public debt is globally one of the highest.
According to estimates, more than Tk. 980 billion of domestic credit was extended by Bangladesh Bank (BB) to the budget in FY2023. This surge in the borrowing from the central bank triggered corresponding surge in inflation to almost 10 per cent in 2023. In FY2024, the BB provided Tk. 36,176.5 crore domestic credit to the budget during the period of July to February.
As significant portion of government expenses is allocated to paying interest on its debts, a major share of public expenditure is consumed for paying interest, putting constraint on fiscal flexibility. This constraint on fiscal flexibility could worsen as tighter monetary policies as a short term measure to curb high inflation would drive up interest rates on treasury bills and bonds.
Enhanced domestic revenue mobilisation is essential for reducing fiscal deficits, providing funds for public investments and ensuring economic resilience. Low tax collection constrains the ability of the government to invest in development projects. As noted, operating expenses dominated budget execution in FY2023, comprising 64 per cent of total actual spending, while development expenditure accounted for only 36 per cent.
To enhance domestic revenue mobilisation for strengthening fiscal foundations and supporting sustainable growth, two major steps have been taken recently by the interim government. The Medium and Long-Term Revenue Strategy (MLTRS) of the National Board of Revenue (NBR) was unveiled in April, setting a target of raising Bangladesh's tax-GDP ratio to 10.5 per cent by FY2034-35.
Defining medium term as the period from FY2025-26 to FY2029-30 and the long term from FY2030-31 to FY2034-35, the MLTRS aims to implement tax administration reforms to enhance efficiency, transparency and accountability in revenue collection. Upcoming reforms include expanding the tax base, simplifying the tax system, modernising tax infrastructure, enhancing voluntary compliance among taxpayers, and implementing structural changes.
In May, the interim government has issued the "Revenue Policy and Revenue Management Ordinance 2025", dissolving the NBR and replacing it with two new divisions under the finance ministry. In a move to modernise tax administration and boost revenue collection, the government will establish separate Revenue Policy Division and Revenue Management Division. The Policy Division will design tax laws, set rates, and oversee international tax treaties, while the Revenue Management Division will handle enforcement, audits, and compliance for income tax, VAT, and customs.
Bangladesh's total tax revenue consists of about two-thirds indirect tax and one-third direct tax. While indirect taxes are easier to collect and contribute significantly to government revenue, these taxes are levied on goods and services consumed by all individuals regardless of income level, which places a disproportionate financial burden on the lower-income households. Proportionately higher dependence on indirect taxes contributes to widening income inequality in the society.
In contrast, direct taxes such as personal income tax and corporate tax play a crucial role in ensuring fairer tax burden distribution. Countries in the Asia region that have successfully increased their overall tax revenue, including India, Thailand, China and South Korea have steadily moved away from dependence on indirect taxes, towards greater reliance on direct taxes.
As Bangladesh stands at a critical juncture in its development trajectory, and strives to attract and retain greater volume of the much required foreign direct investment (FDI), a stable, transparent, and ethical fiscal environment is critical for economic resilience and sustainable growth. A comprehensive approach is required to address structural weaknesses in the taxation system and ensure efficiency in domestic revenue mobilisation. Tax policy changes are an ongoing exercise, for which active and ongoing stakeholder consultations imperative to ensure resilient growth of industries, trade, investment and the national economy.
T.I.M. Nurul Kabir, business, technology and policy analyst, is Executive Director, Foreign Investors Chamber of Commerce and Industries (FICCI)