On Public Indebtedness

Jyoti Rahman

Published in the Daily Star Forum on 5 September 2011.

This piece asks whether Bangladesh could have done better.

To a casual observer, the $1 billion loan from India to Bangladesh agreed by the countries’ prime ministers in January 2010 might appear to be a major issue. If the observer is sympathetic to the government’s India policy, or has a favourable view of India, this loan is likely to be seen as the latest evidence of Indian beneficence to Bangladesh. To those more sceptic of the government, or India, there are all sorts of cynical suggestions about this being a debt trap, the latest in a long line of perfidious attempts to subjugate Bangladesh.

How big a deal is this billion, really?

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One way to answer that question is to consider the amount. This is quite easy, and the answer is — the loan is probably not as big a deal as one might think. In 2010, Bangladesh’s economy was measured at about $105 billion. And that economy is growing by 6-7% a year.

Meanwhile, in 2009, the outstanding stock of Bangladesh government’s foreign debt amounted to about $22 billion.

To put it simply, suppose you had a daily income of 105 taka (rising steadily over time), stock of debt of 22 taka, and someone lent you another taka — would you be excited? No, I didn’t think so either.

But beyond the amount, we should consider the nature of this loan — what is the loan for, what are the terms and conditions, the fine prints?

The actual agreement signed with the Exim Bank of India allows Bangladesh to borrow the $1 billion with a fixed interest of 1.8%. The loan is repayable in 20 years, with a grace period of another five years. Insofar as the interest and repayment time is concerned, this is rather pedestrian — not as concessionary as loans from multilateral development banks, but on better terms than what prevails in the global money markets.

But there is more. The loan comes with strings attached to how the money is to be spent. It is to be spent on projects related to ‘connectivity’. The primary source of procurement has to be Indian businesses. And any unutilised amount will attract a commitment fee at a rate of 0.5% a year.

This piece is not about the connectivity issue. The relevant point here is that this kind of loan — suppliers’ credit — is not usually considered the most flexible option that a country like Bangladesh can avail. In the development literature, this kind of loan is criticised as favouring the lender in terms of procurement conditions and repayment schedule.

As of 2008-09, only about $2 billion were disbursed under suppliers’ credit. However, since the current government came to power, as much as $7 billion of suppliers’ credit has been agreed with, not just India but also China, Korea and Turkey. Whereas traditionally this kind of loan was only considered for priority projects where other options were not available, the current government has sought these loans for 45 infrastructure, power and water projects.

One cannot help but wonder whether easier options were sought? Multilateral development banks would definitely not have discriminatory procurement conditions, even though they might have insisted on tougher transparency requirement. One cannot help but wonder about the political economy why these suppliers’ credits were negotiated.

Thus, the issue is not whether the $1 billion borrowed from India is a big deal. It isn’t. It’s not particularly generous. It’s not special — other countries are also lending Bangladesh. And they are not lending in any more deleterious manner than the Indians.

The issue really is, could Bangladesh have done better?

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Let’s leave the reader to ponder that question and consider something else. Is the government saddling the country with a high debt burden? Are we falling into a debt trap?

One way to answer this question is to compare Bangladesh’s debt burden with our neighbours.

Chart 1 shows that the stock of external debt, expressed as a percentage of gross national income, has been low and falling in Bangladesh during the past decade relative to our neighbours. Chart 1, showing debt service as a percentage of gross national income, paints an even more favourable picture.

Does Bangladesh face an external debt problem? It would appear not.

And this informal conclusion is actually backed up by a 2009 joint analysis by the IMF and the World Bank. Their analysis suggests that external debt is likely to decline from about 20% to less than 10% in the next couple of decades — a ratio of about 40% is considered alarming. Debt service ratio is slated to halve from current 6 per cent — 20 per cent is the threshold.

That Bangladesh is reasonably creditworthy given its non-economic (that is, political and environmental) circumstances is further evidenced by the credit ratings accorded by Moody’s Investors Service and Standard & Poor.

The apparent creditworthiness, however, only deepens the puzzle about the government’s preference for unfavourable loans such as suppliers’ credit.

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Since we can’t really explain why the government prefers suppliers’ credit, let’s consider a different issue. The government doesn’t have an external debt problem, but what about domestic debt? The government consistently runs budget deficits, so public debt must be going up. Who finances this deficit, and what are the consequences?

If the deficit is financed primarily by the Bangladesh Bank, then the result is an acceleration in money supply growth, which eventually fuels inflation. Fortunately, the stock of government debt owed to the Bangladesh Bank has remained broadly unchanged between 100 and 300 billion taka in the past decade.

A different picture emerges when we consider the stock of debt owed to the banking sector. During the third BNP government, the stock averaged around 100 billion taka. The 1/11 regime saw the stock rising to over 250 billion taka. Under the current government, public debt to the banking sector has topped 400 billion taka.

Not only does excessive borrowing from the banking sector crowd out loans to private entrepreneurs, but the rising interest burden crowds out the government’s ability to spend on development programmes. In 2000-01, the government spent 42 billion taka on interest payments, about a fifth of the amount spent on development programmes. A decade later, about 146 billion taka was paid on interest, which was two-fifths of the development expenditure in 2010-11.

 
 

The government has been very vocal about the debt trap that microcredit can impose on poor households. Ironic that the government may be imposing a debt trap on the entire nation through its macroeconomic mismanagement.

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Contrary to the hypes, the $1 billion that Bangladesh has borrowed from India is not particularly special. And excessive focus on that loan crowds out two other important issues: the government has an unhealthy preference for suppliers’ credit; and its borrowing too much from domestic banks.

Neither a borrower nor a lender be,
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.

Lord Polonius thus counsels his son Laertes in Hamlet. Well, modern economists would disagree. Loans are perfectly fine if they are obtained from the best available source with the best possible term, and used for purposes with the highest pay offs.

It’s not at all clear that the government is meeting any of the criteria that would meet with the economists’ approval. As such, might we be better off heeding Polonius?

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