Acknowledging Defeat?

Tax cut and relaxing duties on oil May worsen the economic turmoil. Ensuing debt and high tax in future New government has less for expenditure.

Last week Bangladesh Bank held press conference to convince clients that there is no liquidity crisis. In fact, there is a liquidity of TK 169 trillions in Bangladeshi banks. The announcement came in the wake of many banks' inability to open LCs as per govts' instruction to curb import(Source: “Bank e Takar Sonkot Holey Debe Kendriyo Bank(In Case Of Liquidity Crisis Central Bank Will Pay)”, Daily Prothom Alo,November 15,2022,p-1).

Meanwhile, import is still higher than export,which witnessed fall in the two consecutive months. Traditional sources of remittances like UAE,Saudi Arabia also witnessed negative growth.Current account balance and overall balance is still negative (till September). Taka is hovering around Tk 102/USD as per official figure. But market rate is a bit higher. Government is however optimistic that by the end of January there will be no dearth of US dollar.

But we have to acknowledge that before and after election years big depreciation/fall of Taka against US dollar was observed in the past.In 1990-91,rate of taka was Tk 35.67/USD . In 1991-92,it was Tk 38.14/USD.In 1996-97, it was Tk 42.70/USD. In 1997-98,it was Tk 45.46/USD. In 2000-2001,it became Tk 53.95/USD. In 2001-02,it was Tk 57.43/USD. In 2005-06, it was Tk 67.07/USD. In 2007-08,it became Tk 68.60/USD.Biggest depreciation came this year. Now in the open market Taka is being sold at Tk 106/USD.

Year	Exch.Rate(TK/$)
1990-91	35.67
1991-92	38.15
1995-96	40.84
1996-97	42.70
2000-01	53.96
2001-02	57.44
2008-09	68.80
2009-10	69.18

Source:Bangladesh Economic Review 2019

To finance the budget deficit and prop up the forex reserve, govt is heavily relying on borrowing. Govt is inclining more and more towards banks for domestic borrowing as sales of national savings certificates hit the nadir this year. This year only Tk 7.32 billions worth of NSD certificates have been sold after govt made tax return mandatory for purchase of NSD certificates worth more than Tk 500,000(Source: “Sanchaypatra Bikri Komechhey,Sudo Komtey Parry(NSD Sale Lowers,Interest Rate May Follow Suits)”,Daily Prothom Alo,November 13,20222,p-11).

Pledged budget support from multinational donor may assuage the problem temporarily but raises the total debt stock. It is highly unlikely there will be 180 degree change in the governance,which led to this situation,during the rest of the tenure.

Meanwhile, govt did little to raise the revenue. Surprisingly,it reduced corporate tax from 22% to 21%. And special duty on diesel and gas was also lifted. Yet Non Performing Loan (NPL) keeps rising. A tax cut in the present means more taxes in the future as argued by Olivier Blanchard.

I put forward some observations that hint some important change in the future:

1. A managed floating exchange rate discouraging exporters to bring exports and encouraging importers.
2. Corporate tax cut, removing duties from oil and gas,relieving bureaucrats from submitting tax returns.
3. Releasing forex reserve money to stabilize dollar market.
4. Holding back data on balance of payment, inflation,NPL that is costly for the govt.

This growing budget deficit and revenue fall also curb future govt's ability to spend more. Guido Tabellini and Alberto Alesina in an article titled “Voting On The Budget Deficit “,published on American Economic Review (1990) argue that how one group of policy makers' belief about future govt and its policy leads to inefficient outcome like high debt. More generally, if the current govt thinks future govt may be run by the opposition then it causes the current govt to borrow more now so that future govt may not spend more in the wake of high debt.In that light govt itself is acknowledging its defeat in the next election scheduled to be held by the end of 2023! It is indeed interesting how the govt responds to the reform works it pledged to the creditors.

Could There Be A Recovery?

Tax cut and high govt spending
Will do little in situation improving.

Taka depreciated to TK 102 against US dollar last week. The record depreciation took everyone off guard. As government is pursuing a managed floating exchange rate, it pegged the rate at TK 87.50. Now at the exchange rate market US dollar is sold at TK 95. Net difference, TK 8,remains same as before. There will be some appreciation when Bangladesh will receive $250 million budgetary support from ADB.

Meanwhile, balance of payments causes lots of worries. There is widening deficit in current account balance. It stands at $14 billion right now.

Remittances keep falling. Though export earnings have increased and show signs of achieving this years target, growth forecast about key export markets throw a wrench into similar growth expectations in the future.International Monetary Fund revised down its growth forecast for 2023 to 3.6%¹.Bloomberg Market recently conducted a survey where a little less than half of the investors apprehended a recession in US economy for 2023. Deutch Bank echoed similar concern. According to a news report, UK inflation reached 9% and 25% of the British find it difficult to get 3-meal per day^2&3.

If we take a look at the country wise export,then we will notice USA,UK,Germany and France constitute our key export destinations. We remember that in 2008-09 Housing Bubble led to recession in the USA. The following year, Bangladesh’s export to USA,Germany,France and Belgium declined ⁵.But Bangladesh got back on track in the subsequent years.Reasons will be explained few para later.

With the rising price level and uncertainty, demand for Bangladeshi goods will be lower in these countries. Though import will be costlier, import of raw-materials and other essential items like oil,foodgrains may lead us to another current account deficit next year.

However, it is not clear what impact the inflation will make on oil revenue even if there is an output contraction in the developed economies. If there is indeed an oil revenue boom in the Middle East,key source of Bangladeshi remittances, then growth in remittances may end up in a current account surplus. However, inflation may cast a shadow over remittances coming from USA and UK. In 2009-10,year after the beginning of the financial crisis,remittances from USA declined to $1.4 billion. Another bout of geopolitical tension will hurt the remittances flow surely.

It is highly likely that government will increase spending as election will be held by the end of 2023. It has to make happy thr grassroot workforce. In addition,govt mulls corporate tax cut from 22% to 21% in the next budget⁴. Such fiscal policy may increase the output but will do little in the end. Why?

• First,such tax cut will do little in bringing new investment. Existing groups close to ruling party will take full benefits of such tax cut
.
• Second, investment spending in a corruption-stricken country hardly translates into new job creation or an increase in output. Rather,in the name of investment spending we may witness opening up of LCs to import capital machinery,raw-materials etc ,making alley of laundering money abroad
.
• Third,for the foreign investors there are already various kinds of tax incentives, so tax cut will do little to bring new FDI
.
• Fourth, in a country where tax-GDP ratio is still below two-digits such fiscal expansion is not a wise move especially when government is taking assistance from others as budgetary support
.
• Fifth, such fiscal expansion will raise the interest rate and Taka will appreciate, making our goods less competitive in the future. Look at the level of depreciation in Pakistan and Cambodia
.
• Sixth, when exchange rate is pegged at some value, now it is at TK 87.50, such fiscal expansion may contract our output more than it is under a free floating exchange rate.

It is indeed interesting to see how the government manages the challenges of inflation and current account deficit in an election year when populist government generally spends more and is shy to reduce interest rate.

I am optimistic about the current account balance. Because our export items to the West are mostly lower-end items. Consumers will purchase trousers, sweat shirt,T-shirts,undergarments, sweaters no matter what their income is.Their demand is inelastic.Despite the long bad spell in the US and Europe,Bangladeshi export took a little hit and did remarkably well. I anticipate the same thing this time. Moreover, we have to make liability into opportunity. As from the next year,we have to start paying an annual obligation of $565 for Rooppur nuclear power plant⁶[*]. However, if we could manage to convince Russia, we could pay it partly as RMG items/ship and partly as agricultural items. Moreover, we have to urge Russia to export wheat and oil to Bangladesh as part of its moral obligation for starting a war.In such case, burden to our US dollar stock will be significantly reduced.

Another thing the government should do is to let Taka lose its value. Now at the open market, exchange rate for a US dollar is TK 95. Government rate should reflect it. If the Taka depreciates further (to TK 120 or somewhere there), then our exportable item will be more competitive and output contraction will not be severe in the wake of a growth cut.

Like the populist regime,government embarked upon taking expansionary fiscal policy ahead of election year. No course correction is in sight. But further depreciation and reduction in interest rate would be more welcoming.

Notes And References:

1. “IMF Cuts Global Growth Outlook, Here Are The Warning Signs”, Reshma Kapadia,Barrons,April 19,2022. For more read at https://www.google.com/amp/s/www.barrons.com/amp/articles/imf-global-growth-outlook-warning-signs-51650326199
2. “Investors Predict US Recession 2023-Here Are The Facts”,Felix Richter,Statista,April 12,2022.For more read at https://www.weforum.org/agenda/2022/04/recession-investor-bank-pandemic-united-states/
3. “Teen Bela Khabar Pacchey Na 25% British;Mullosphitete Navishash(25% British Do Not Get 3-meal A Day; Awful Inflation)”,Jamuna Television, April 19,2022. For more watch https://m.youtube.com/watch?v=dNkAqd3C-4w
4. “Corporate Kor Abar Komchhey”,Daily Prothom Alo(p-12),May 21,2022.
5. Bangladesh Economic Review 2019,2020.
6. "Rooppur Ki Shethosti?(Is Rooppur A White Elephant?)", Bangladesh Military News,Facebook,May 13,2022. For more read at https://bit.ly/3LBCVOULBCVOU

[*Note:This piece has been updated at 21:15 PM BST on May 22,2022.The update includes link to annual repayment of Rooppur Nuclear Power Plant.]

The Woe Called Current Account Deficit

A virus called Corona
Sweeps across China.
Damage to trade cannot be seen,
People want to know what it means
For economy, commerce and culture.
So the business as usual does not rupture.
The woe called current account deficit,
Lacking enough forex receipt,
Keeps growing bigger,
For the last three years.
Exports fall short
Of meeting the gap.
Even the forex warriors fail
To bring another feather to their cap.

 Another pandemic has brought the world to a standstill. Fear looms large that it may badly hit Bangladesh economy. News reports indicate that ongoing development projects (infrastructure) will be delayed several weeks as many China-financed projects witness their workers on leave are being stranded back home. In addition, many exporters and importers are also worried about their goods from China, one of the biggest trading partners of Bangladesh. Port operations and export and import operations are also crippled by flu pandemic.However, a closer look at the external trade data for the last one decade will reveal that things are already in bad shape for our external sector.Bangladesh Bank data on Balance of Payments say that for the last three years current account has experienced deficit. More worryingly, it has been growing since 2017.

Current account deficit is not a good sign for the economy as gap in trade deficit is no longer offset by remittances. Remittances, in the past,came as a savior to help Bangladesh's dire economy. Things have changed as many traditional destinations shut its door to Bangladeshi workers. Despite the surge in remittances in last couple of months, overseas employment market may take a hit in South East Asia. The region is close to the epicenter of flu outbreak and several Bangladeshis have been identified with the symptoms of having the flu with no cure.

Source:Bangladesh Economic Review 2018, BBS Pocket Book 2012,2018,Bangladesh Bank.

The risk is there that trade and overseas employment market of Bangladesh may be badly affected by the flu outbreak.

External trade is already in trouble before flu pandemic. Balance of payments data in the period between 2010 and 2018 say that there has always been trade deficit and it has been growing for the last one decade. It only underscores the role of remittances in our external sector. However, since 2017 we have been witnessing a current account deficit and it shows no sign to dissipate soon. Rather it is growing at an alarming rate. In 2019, our current account deficit stood at $15.49 billion. Though export has been growing steadily over the last one decade, import has outperformed it.

I ran a logit model to get an idea how the export increase raises the odds of having a current account surplus, analyzing data for the  period 2010-2019. For each export earnings level, I fetched the corresponding data for GDP and current account balance. Now the probability of a positive current account balance is current account balance for the corresponding export level divided by corresponding GDP. The odds ratio,P_i/(1-P_i) in favor of a positive current account balance is the ratio of the probability that there will be a current account surplus to the probability that there will be no current account surplus. Then I took the natural log of the odds ratio to  make it linear in parameters.

Now the logit model becomes
L_i=ln(P_i/1-P_i)= b₁+b₂X_i
where X_i is export earnings in million US $.
To get rid of heteroscedasticity, I transformed the model  as follows:
sqrtw_i L_i= b₁sqrtw_i+ b₂sqrtw_iX_i+sqrtw_iu_i.

Or

L*_i=b₁sqrtw_i+ b₂X*_i+v_i
where L*_i=sqrtw_i L_i,X*_i=sqrtw_iX_i  , v_i= sqrtw_iu_i  , w_i= GDP_iP_i(1-P_i)

Then I carried out the OLS regression on the transformed equation.The model appeared to be significant (F=253.21, p=0.0000002436,df=1,8). Both the intercept,b₁sqrtw_i,(t= -14.41, p=0.0000005241) and the slope coefficient, b₂, (t= -15.912, p=0.0000002436) turned out to be significant. The slope coefficient is -0.0000644841. Taking the antilog of slope coefficient yielded 0.999935. So for a unit increase in the weighted export earnings, X_i, the weighted odds in favor of a current account surplus increase by -0.00645 percent. So analyzing given data , the odds for a current account surplus in response to an increase in export earnings are minuscule. This underscores role of remittances in current account balance. Despite the fact that exports have grown remarkably, it does not play a dominant role in lifting up the current account deficit to a surplus level. Acceleration in export earnings is expected. For that, diverse bucket of goods and new destinations are must.

These stuffs have been chewed so much that they now sound cliché. But we still depend heavily on our remittance warriors to  fill up the gaps in current account. But the last three years, as the data show, increasing current account deficit should be a cause of concern. It is in fact pushed the overall balance negative in 2018.

Bad news keeps coming from the overseas employment market. Several traditional recruiting countries impose new restrictions, limiting further prospect of recruiting more Bangladeshi workers. Recent flu pandemic will further aggravate the problem. There is little room for optimism that remittances continue to play the role of savior in future.

Similarly, no good news surfaces for country's apparel sector.EU parliament has nodded affirmatively to a free-trade agreement with Vietnam, allowing the country to export duty-free apparel items to EU countries. This augurs ill for Bangladeshi apparel sector as its apparel items will face stiff competition in that market. Instead of widening the market, Bangladesh witnesses losing of its existing ones.

Overseas employment market and apparel export jointly fill up the forex reserve of the country. Government response to address the woes prevailing in these two sectors is not adequate. This is often manifested in the inhuman suffering of the remittance warriors and lack of policy support for apparel sector. Before the current account deficit turns worse, government should mobilize efforts to avoid a catastrophic situation.

Indebted Indeed

As a nation, our debts are piling up. We need to grow worried. However, it has never been reached to  worrying level. Government always feels complacent by citing our debt-GDP ratio, which is much lower and declining as per official statistics. Many are not happy the way they are being calculated. Just take a look at the level of our outstanding external debt stock, In 2012, it was $22.095 billion. In 2017, it became $ 28.33 billion. And last year it increased to $33.11 billion. Our outstanding debt as percentage of GDP in 2012 was 16.6. In 2017, it declined to 11.3. But in 2018, it increased to 12.1. (Source: Bangladesh Bank)

Many of our development and infrastructure projects are being financed by foreign credits. In FY2016-17, we took a $3.21 billion worth of medium and long term loans. In FY2017-18, the amount rose to $5.78 billion.

[Data Source: Bangladesh Bank]

Our repayment record is pretty good. In 2014, repayments of MLT were $1.2 billion. In 2017, we paid back $1.1 billion of MLT loans with interest. In 2018, we paid back even more: $ 1.4 billion. Eventually we have to make adjustments in our expenditures to do this kind of payments. For instance, we could have spent this money on education, health and social safety net programs.

Perhaps as a country our earnings are not enough to meet our spending. Current account captures economic activity of a country with the rest of the world and its ability to pay spending on foreign goods.

A closer look at the Balance of Payments reveals that our overall balance is negative in 2017-18. Moreover, our current account balance has been negative since 2016-17. Last year ,I wrote an analytical piece on our negative overall balance, titled "Address The Imbalance". Data published by Bangladesh Bank and Bangladesh Economic Survey insinuate that we have a current account deficit of $1.3 billion in FY 2016-17. This deficit has grown to $ 9.7 billion in FY2017-18.

[Data Source: Bangladesh Bank. Numbers are in million USD.]

Our trade balance has always been negative. It has always been a one sided story: import dominates export. In 2017-18, our export grew by 6.43%. Private transfers, which incorporated remittances sent by workers, grew by 16.28%. Meanwhile, import grew by 16.28% during the same period. So, two major sources of receipt did not jointly outweigh the major source of payments. Import spending is growing at a greater pace. A regression run on trade data collected in the periods between 2004-05 and 2017-18 revealed that a 1 percent increase in export decreases the trade imbalance by 3.12 percent whereas a 1 percent increase in import increases the trade imbalance by 4.1 percent.

Remittances popped up the current account balance, which was positive till 2016-17. In fact the deficit in CA in 2016-17 is largely attributed to fall in remittances in that period.In 2015-16, we received $14.72 as remittances. In 2016-17, it declined to 12.76 billion. In 2017-18, it increased to $ 14. 7 billion. Despite the increase in remittances, we incurred a current account deficit due to large import expenditure in 2017-18. Many of the recruiting countries have already stopped hiring Bangladeshi workers or started sending back the laid-off workers. There has been no rapid increase in remittances. What role remittances could play to improve our current account deficit and the overall balance that is about to see.

A positive overall balance withered away the worries in all these years. Balance of Payments say along with FDI, medium and long term loans have kept the overall balance positive all these years. It is anticipated that the medium and long term loans will grow more as we are implementing a greater number of projects with foreign loan. And we have to pay them back along with interest. As I said earlier we have to slash somewhere else to repay those loans. What rings the alarm bell is a negative overall balance in 2017-18.

Growing current account deficit, rising foreign debt and a diminishing reserve remain genuine cause for concern. In 2017-18(Jul-Feb) we received $3.1 billion MLT loans and in 2018-19(Jul-Feb) it increased to $ $3.9 billion, a 21.30 percent increase. During the same period, our reserve declined from $33.0 billion to $32.3 billion.

Remedial measures include pursuing an expansionary monetary policy, which will increase output and depreciate Taka. Thereby our competitiveness in export market will grow resulting in improved current account balance.

Things are complicated in reality.Any depreciation of local currency deteriorates the current account balance in the short run but it eventually improves it in the long run. Because market responds slowly to such changes.

As our imports and MLT loan payments are growing , any depreciation of local currency has adverse impact on current account deficit and overall balance.

So far domestic investment remains sluggish and export growth does not hint that it will surpass import in future. So there is no reason to be optimistic about current account deficit and overall balance.

And it is the time we become serious about our external debt. Unless it is absolutely necessary, we should abstain ourselves from taking foreign loans. There are ample of examples how bad foreign debt not only drove wedge in relations between countries but precipitated political crisis at home.

Many at home often put forward our debt-to-GDP ratio as a reason to borrow more from abroad. Wise people say austerity is good when the economy is in good shape.