Fiscal Discipline For Monetary Targets

Keeping budget deficit below threshold value Saves from danger coming out of the blue.

Govt has presented Tk 7.38 trillion budget before the parliament for FY 2026-27. The size of annual development program is Tk 3 trillion while the budget deficit is Tk 2.43 trillion, 3.47% of GDP.

As govt does not signal any change to policy rate, the sheer size of budget indicating larger govt spending is likely to complicate its monetary goals. Govt aims to contain the inflation at 7.5%,which is higher than 9% at this moment. Earlier govt announced a stimulus package of Tk 600 billion,committing at least Tk 30 billion annual support,which is a monetary expansion amid tighter monetary policy.

Tighter monetary policy requires similar fiscal fine-tuning in order to attain the inflation target. In this light how this budget plus the stimulus package,surprisingly organized by the central bank, will help bringing down the inflation calls for serious explanation.

Luckily, for the govt,ease of tensions in the Middle East means saving the subsidy for extra oil price. But the bad news is NPL is piling up. In three months of this year,NPL increased to 32% and became Tk 5.88 trillion or $48 billion ($1 USD= Tk 122)(See "Defaulted Loans Climb To Tk 588,704cr By March", The Daily Star,June 02,2026,https://www.thedailystar.net/business/news/defaulted-loans-climb-tk-588704cr-march-4188866). When the govt assumed office NPL was $34 billion. First two years for the govt are the right time for reforms if govt is comitted. So far govt stance oscillated between reform commitments and political goals. There is no sign of monetary and fiscal discipline. Sometimes regulatory body is committing blunder. Appointment of a chairman to a trouble-ridden bank and later revoking that decision and dissolution of the board of that bank cost the central bank liquidity support of Tk 25 billion. Govt has to deal with trouble-ridden banks and the NPL. How this can be done depends a lot on regulatory discipline.

Containing the inflation to the desired [level], monetary and fiscal discipline and a low budget deficit can lead to a stable economy. Govt revenue target is Tk 6.95 trillion while revenue deficit widens each year. In this backdrop larger budget deficit means we have to borrow more from abroad and banks. Keeping the budget deficit low should be another major policy criteria. In 2021, budget deficit was 6.2% of GDP. It became 4.6% in 2024. Last year it was 3.6% of GDP. For 2027, it is projected to be 3.7%(Source:Wikipedia, Trading economics, CPD).

Budget Deficit

Year	Deficit (% of GDP)
2021-22	6.2
2022-23	5.5
2023-24	5.2
2024-25	4.6
2025-26	3.6
2026-27	3.7(projected)

Fiscal discipline helps attaining the monetary goals quicker and guarantees macroeconomic stability. Following the 1998 financial disaster, Indonesia literally copied the Maastricht Treaty on budget deficit and made a law to keep the budget deficit below 3%. It enjoys the benefits over the years. The Maastricht Treaty or the Treaty On European Union obliges member countries to keep inflation rate no more than 1.5% higher than the average of three member countries with lowest inflation, to keep budget deficit below 3% of GDP, to keep govt debt below 60% of GDP,to keep the exchange rate of national currency within the margins set by the European Monetary System for 2 years and to keep nominal interest rate no more than 2% higher than in three member countries with lowest inflation(see Maastricht Treaty, Wikipedia,https://en.wikipedia.org/wiki/Maastricht_Treaty).

This kind of fiscal discipline keeps govt spending in check,makes currency stable and helps monetary regulation easier. We need to make similar law in the parliament to keep the budget deficit below 3% of GDP and make sure no govt can change it.

It is interesting that govt embarks on big spending programs while the pace of revenue collection is sluggish and central bank unveils a monetary expansion program while a tighter monetary policy is in action. It is interesting to see how the central bank address the issue in its upcoming Monetary Policy Statement. Point is govt has yet to establish monetary and fiscal discipline. But it is unveiling political programs that have the potentials to prolong the recovery.

Deficit Financing:Road To More Taxes

A tax cut in present day Says in future we have high tax to pay. For the sake of debt stabilization Paying debt interest is the solution.

Government has recently decided to float the exchange rate of Taka against the US dollar. Bangladeshis living abroad now can get the market offered value of their hard-earned remittances. The fall of Taka is an incentive to them. The move is highly appreciating as it will ease of the pressure to some extent on central bank's foreign currency stock. Idea is that such move discourages unnecessary import holding back the import spending. On the other hand, depreciation makes the Bangladeshi export items more competitive at a time when recession like scenario is more credible than before, signalling individual spending cut of Occidental consumers.

But is it enough to improve the current account deficit? Ahead of election, govt has in no mood to follow austerity measures. In the previous post I tried to underscore how growing budget deficit is posing a danger to our economy. Amid this growing budget deficit ,govt mulls reducing corporate tax by 2%.This means to finance deficit we have to borrow more.

Just take a look at the composition of our tax revenue and expenditure.In 2020 government expenditure stood at Tk 4201 billion while it earned a tax revenue of TK 2659.1 billion,leading to a budget deficit of TK 1542.5 billion.Both govt expenditure and tax revenue increased in the subsequent years. But tax receipts never outweighed the spending. In 2021, budget deficit grew to Tk 1874.5 billion. And in 2022 it is projected to be TK 2146.8 billion,6.2% of GDP.Tax revenue only became 10% of GDP in 2021 and projected to be 11% in 2022¹.

Total Revenue & Total Expenditure(In Billion Taka)

	2020	2021	2022
Total Revenue	2659.1	3515.3	3890.0
Total Expenditure	4201.6	5389.8	6036.8
Budget Deficit	1542.5	1874.5	2146.8

Source:Bangladesh Bank

Failure to generate enough tax revenue means we have to borrow more from both internal and external sources to meet the budget deficit.

In 2020,domestic financing accounts for 3.4% of GDP while foreign financing accounts for 1.4% of GDP.In 2022,domestic financing projected to be 3.3% of GDP while foreign financing projected to be 2.9% of GDP¹. As bank borrowing and borrowing through sale of national savings certificates are rising, govt in future has to either print more money or to cut spending in other sectors or has to raise tax levels to pay the interests. Moreover inflationary pressure has already pushed the depositors and investors on national savings certificate on loser's side.

Like domestic borrowing, our external debt is also rising. In 2015-16,our debt was $41.17 billion. In 2020-21,it became $81.57 billion². Our external debt almost doubled in 5 years. As our budget deficit grows,our external debt grows.Now say we want to keep the external debt at this current level. Economist Olivier Blanchard argues that to make it happen, we have to generate enough tax revenue so that tax minus spending equals(primary surplus) the real interest payments to existing debt ³. For the subsequent years, this measure has to be followed in order to stabilize the debt. Otherwise it will add to the past debt, increasing our debt burden.

External Debt(In Billion US Dollar)

	2015-16	2016-17	2017-18	2018-19	2019-20	2020-21
External Debt	41.17	45.81	56.01	62.63	68.59	81.57

Source:Bangladesh Bank

But what is the govt doing?It is considering a tax cut. It means our debt will rise and the govt has to tax more to get rid of those debts. Olivier Blanchard stresses that a tax cut in the present means higher taxes in the future. In that light, our output growth will be lower when we need to grow more to repay our debts and create more jobs³.

More than two-third of our total debt is public debt. Govt took it to finance many infrastructure and development projects. So large part of the debt went to finance politically motivated projects. Some of which were marred by corruption, faced cost overrun and have little or no economic returns.

At a moment when government requires to raise tax,cut spending,govt is mulling populist policies. And the future generation will pay for prices of its populist policies. Stabilizing debt calls for austerity. Free floating of Taka is only a half done job. Raising taxes along with spending cut will complete the task.

Notes And References:

1. Bangladesh Bank Annual Report 2021
2. Bangladesh Bank
3. “Macroeconomics”,Olivier Blanchard,2nd edition, Prentice Hall International, Inc

Growing Budget Deficit: A Looming Danger

Govt borrows more to finance deficit,
Raising debt and curtailing consumption legit.

Govt has decided to peg US dollar at TK 88.And it has instructed banks to enforce it without further delay. The decision came at a moment when US dollar was sold at TK 99 in the open market. In addition, it is implementing the decision when current account deficit reached a record level, $14 billion. Not only that govt is also facing a growing budget deficit. At the start of this year, govt found itself amid controversy after it had disbursed $7 billion of Forex reserve to the banks to contain dollar demand. The matter even prompted IMF to issue serious concern about this unreported incident that had not been reflected in the official reserve figure.

Such pegged US dollar rate may call for more govt intervention. When import expenditure outweighs export earnings and govt expenditure continues to rise, demand for dollar will evidently rise. If there were free fall of Taka against US dollar, then depreciation would work as a mean to curb the growing import expenditure and we would be back on trade surplus. Remittances would rise as a consequence of such depreciation.

Such pegged value of Taka against US dollar may help the govt to go with its development expenditures ahead of election year. However, government finds it difficult to finance its expenditures as trade deficit is rising and remittances keep falling. So we have a growing budget deficit. And to finance the deficit, govt is borrowing right and left.

In 2012-13,our budget balance was -3.7% of GDP. In 2016-17,it reached to -4.8% of GDP. For two consecutive years it remained same. In 2021, it worsened further and became -6.2% of GDP¹.

To meet the deficit, government is borrowing both from foreign govt and domestic source. In 2012-13, Foreign financing accounted 1.4% of GDP while domestic financing accounted for 2.7% of GDP.In 2020-21,foreign financing accounted for 2.3% and domestic financing accounted for 3.8% of GDP. In recent years, government hinged heavily on NSD certificates apart from borrowing from domestic banks to finance the deficit. In 2021,govt set a target of raising TK 200 billion from selling NSD certificates². NSD certificates come with a higher interest rate.

This heavy borrowing in the name of public spending did little help to improve the situation. In this part of the world, culture of accountability is notably absent. We frequently encounter reports of a doomed bridge in the middle of a paddy field or without any approach road. Moreover, corruption and misappropriation of public money rendered the public project a loosing concern. So "public investment" at the end of the day turns out to be public embarrassment and liability. Meanwhile, govt's borrowing from banks and people to finance such “public investment “ projects deprived other private investors to go ahead with viable projects as banks lack fund to finance their projects. Among the private investors those who have close political connection managed to get loan whatever left. Meanwhile, laundering activities put pressure on foreign exchange market. Because of their conducts, export incentives and earnings were misused. So such corrupt and misconceived projects failed to bring return to investment as well as to government coffer. But govt has to pay back the loans along with interest. So the deficit gets bigger and govt has to borrow more. There is some kind of vicious circle. Though there is no clear evidence of a link between budget deficit and current account deficit, a closer look at recent data yields that current account deficit gets bigger with increasing budget deficit. In 2012-13, we had a current account surplus of 1.7% of GDP in spite of having a budget deficit. In 2020-21, current account deficit became 1.1% of GDP. In 2016-17,current account deficit was 0.5% of GDP and rose to 3.6% in 2017-18¹.

Budget Balance & Current Account Balance(% of GDP)

	2016-17	2017-18	2018-19	2019-20	2020-21
Budget Balance	-4.8	-4.8	-4.8	-5.5	-6.1
CA Balance	-0.5	-3.6	-1.7	-1.5	-1.1

Source:Bangladesh Economic Review 2021

The rising inflation and deteriorating trade deficit will further widen this deficit. Meanwhile, govt is reluctant to increase its tax revenue. Rather, it announced corporate tax cut amid rising govt expenditures. Such fiscal expansionary policy hints that it will borrow more from the banks and foreign governments to finance deficits. In the previous post,I discussed how such tax cut may render useless and risk reversing the intended outcome. Furthermore, borrowing to finance deficit will raise our external debt,which will curtail output in the long run when we need to create more job opportunities.Not only that people who are investing in NSD certificates may find themselves on the loser’s side as they may pay more because of rising cost of living and/or increase in taxes and duties to service debt.

In the name of public spending or "public investment" amid a corrupt and opaque atmosphere,debt financing of budget deficit yields little benefits.Course correction measure for the government will be to check its spending, abandon fiscal expansion and let Taka find its true value as signaled by the market.

Notes And References:

1. Bangladesh Economic Review 2021.
2. “Budget FY 22: Deficit Financing And Public Spending”,CPD. For more read at https://cpd.org.bd/budget-fy22-deficit-financing-and-public-spending/