Published in the Forum on 6 July 2009.
This piece gives a macroeconomic analysis of the Budget.
On June 11, Mr. A.M.A. Muhith submitted the third Awami League government’s first budget. In the weeks since, the budget has been much parsed and analysed. As such, there may not be much in this piece that is particularly novel.1 A review, nonetheless, is attempted, focussing on three issues.
First discussed are the economic growth projections. Contrary to some commentary that the budget forecasts are “not ambitious enough,” 5.5 percent is, on balance, a prudent growth forecast for 2009-10.
Then the fiscal outlook is discussed. While much is said about the implementation of the government’s development expenditure targets, implementation of its medium term revenue enhancement measures deserves greater attention.
The final section analyses a few medium term growth issues that are alluded to in the budget. How these issues are resolved will perhaps prove lot more important than any specific measures announced on June 11.
A steady boat
Buffeted by a number of shocks — political uncertainty, natural disasters, global commodity price spike, and now the global recession — Bangladesh’s economy has proved surprisingly resilient in recent years, and the budget forecasts only a modest easing in growth in 2009-10 (Chart 1).
On a sectoral basis, agriculture is forecast to contribute about 1 percentage point to forecast growth. Agriculture makes up slightly over a fifth of GDP. To contribute 1 percentage point to 5.5 percent growth, agriculture will need to grow by about 4.8 percent in 2009-10.
Let’s put this in context. Agriculture is a volatile sector, with annual growth in the past couple of decades ranging from 0.3 percent to 7.4 percent. In the past four years, the sector has grown at an annual rate of 4.3 percent, while it grew at 4.9 percent a year under the second Awami League government.
This suggests that a 4.8 percent growth rate for agriculture may not be unreasonable. Of course, there are risks — natural disaster being the most obvious one. The forecast explicitly assumes improved agricultural productivity, diversification of crop production, and improved disaster management capacity.
The industry sector is expected to contribute about 1.75 percentage points to 2009-10 GDP growth. This translates into a forecast of about 5.9 percent growth for the sector, the same rate achieved in 2008-09, but slower than 7.8 percent achieved annually in the past half decade. Indeed, if realised, this will be the most prolonged slowdown in industry growth since the early 1990s.
It’s obvious that the slowdown in the industry sector has its roots in the global recession.2
About three-fifths of the industry sector is manufacturing, which grew by 5.9 percent in 2007-08 — a sharp slowdown from the 8.6 percent a year achieved in the previous half decade. Undoubtedly, through an export slump, it is manufacturing that has borne the brunt of the global recession. But, compared with sharp falls in industrial production witnessed around the world — the biggest contractions since the 1930s in many countries — our manufacturing sector seems to have held up reasonably well.
If the rest of the industry sector (30 percent construction, the rest nearly evenly split between mining and utilities) grows at the average rates recorded in the past two decades, manufacturing will need to grow by about 5 percent for the whole sector to achieve budget forecast. Given the severity of the global recession, risks to the manufacturing sector seem to be firmly weighed to the downside.
On the other hand, there may well be upside to construction, which has grown at 5.7 percent a year since 2006-07, compared with an annual growth of 8.4 percent in the previous decade. The recent construction slowdown has been attributed to political uncertainty and associated low confidence, as well as high costs of building materials. To the extent that both these factors have dissipated, a construction boom may well be on the cards. Construction could get further fillip from various infrastructure investments being unrolled.
Finally, the services sector is forecast to contribute about 2.75 percentage points to economic growth. This translates to an implied sectoral growth forecast of 5.5 percent in 2009-10 — a percentage point slowdown from the average over the past half decade, but on par with what was achieved in the previous half decade.
Retail and wholesale trade, as well as transport and communication services, have driven the services boom during the past half decade. These services, indeed the entire services sector, have benefited from high remittance inflows over this period. Defying expectations, remittance inflows have held up thus far into the recession. While the budget forecasts assume renewed remittance inflows, should remittances dip, the service sectors will be hurt (a remittance slowdown could hurt construction too).
Social services — health, education, community services — have also contributed to the services boom. With a favourable business environment and various government programs supporting them, these services should see robust growth, partly off-setting potential negative impacts of the global recession.
From the GDP (expenditure) perspective, the economic slowdown is driven by an investment downturn. Investment-to-GDP ratio is forecast to dip in 2009-10, implying investment growth will be at half the rate recorded in 2008-09. The forecasted investment slowdown has been questioned by some commentators. However, such a slowdown would hardly be unusual in the current global economic climate.
Possibly more at risk are the export forecasts. Exports are estimated to have grown by 12 percent in 2008-09, down from nearly 16 percent the previous year. Exports are projected to grow by 12.5 percent in 2009-10, and then by 18 percent a year in the following two years. As discussed in the final section below, there is reason to be sceptical about this medium-term outlook for exports.
In summary then, the forecast slowdown in growth in 2009-10 is, on balance, prudent.
There are, of course, risks around this forecast.3 In addition to the global recession, the most significant economy-wide risk to the forecast is perhaps energy shortage. The budget explicitly assumes “increased private sector investment in response to measures to eliminate power and gas shortage…”
This assumption, plus in election pledges for the energy sector, provides benchmarks against which the government’s performance should be assessed.
A budget deficit of 5 percent of GDP is forecast for 2009-10. To put this in context, the budget deficit is estimated to have been 4.1 percent of GDP in 2008-09, while in the previous year, the army-backed regime presided over a deficit of 5.1 percent of GDP. At 4.7 percent of GDP in 2011-12, the deficit is expected to continue to exceed the government’s target of 4 percent of GDP over the forecasting horizon.
Higher development expenditure appears to be the major reason why budget deficit is rising. In 2008-09, development expenditure is estimated to have been 3.7 percent of GDP. This is projected to rise by a percentage point by 2011-12. Non-development expenditure, on the other hand, is expected to dip by 0.4 of a percentage point relative to GDP over the same period.
Much has been said about the failure to implement ambitious budget targets. Particularly, development programs seem to repeatedly miss the target. Two points need to be made here.
First, a major impediment to full implementation of development programs is the lack of local government authority over, and responsibility for, development work.4 The government seems to betray a degree of bipolarity when it comes to local empowerment. On the one hand, lofty promises reiterate its commitment to strong local government. On the other hand, its actions — power grabbing by the MPs in local affairs — belie that commitment. Failure to resolve this internal contradiction will not only affect development expenditure, but in time could also engulf the government in a political crisis.
Second, it was not always the case that development expenditure missed targets. Indeed, under the stewardship of S.A.M.S. Kibria, development programmes were implemented in a better manner than has been the case since.
Moving from implementation to financing, how does the government propose to pay for the additional development expenditure?
Revenues have been marked down in the budget because of slower GDP, imports, and remittance growth. Nonetheless, at around 11.5 percent, revenue-to-GDP ratio is projected to be higher throughout the forecast years than in the recent past — in 2006-07 revenues were only 10.2 percent of GDP.
Again, there are implementation concerns — it’s easier to promise that revenue collection will rise than to implement it. Nonetheless, it is possible to increase revenue collection. Tax revenue relative to GDP has already risen by 1 percentage point since 2006-07. Potentially bigger risks to revenue growth are from slower GDP, import, and remittances growth.
Even if revenue were to grow as forecast, it will still not be enough to arrest the rise in budget deficit. Two-fifths of the deficit is expected to be financed from foreign borrowing in 2009-10, rising to over half by 2011-12. The concern over the foreign borrowing is not so much about the cost of debt-servicing, which appears to be modest by international standards. Rather, it is the strings and conditionalities that may come with the debt that should worry us.
To be sure, conditionalities suggested by donors and international agencies can anchor credibility of commitments to difficult but needed reforms. However, for this to happen, such conditionalities have to be carefully negotiated. And therein lies the test of leadership for the finance minister and his officials.
Should foreign borrowing prove too dear — whether in financial terms or in terms of political economic costs — the deficit will have to be financed from domestic sources. As it is, the budget forecasts that nearly half of the deficit will be financed by bank borrowing in 2009-10. Bangladesh Bank will have to be extremely careful in the coming period about not monetising the deficit, fuelling inflation in the process.
The appointment of someone closely linked to the political side of the ruling party’s election campaign to the governorship of the central bank does not bode well for the autonomy of that institution. Governor Atiur Rahman will have an opportunity to prove the sceptics wrong if he can resist printing money to pay for the debt (as an aside, a more immediate risk of inflation may well be commodity prices, which could start rising rapidly as the Chinese economy recovers).
Continued budget deficit is, of course, not sustainable over the long term, and there is no alternative to raising revenue. The government seems well aware of this. The budget acknowledges that revenue-to-GDP ratio is much lower in Bangladesh than in neighbouring countries. Over the medium term, the government plans to raise revenue by a combination of: expanding tax coverage; rationalising the tax system; decentralising the collection operations; and institutional reforms separating tax policy from tax administration.
These ideas may not have political glamour but, if properly followed through, they could significantly boost public finances and our ability to invest for growth and development. As such, the government’s performance on this front should be closely monitored. Of course, “political compromises” such as the “black money deal” raise concerns about the credibility of the government’s commitment on tax reform.
To recap then, the economic growth forecasts underpinning the budget are rather prudent. While there are serious concerns about implementation of various expenditure and revenue measures, these challenges are not insurmountable. And finally, the government should be held to account for its promise to reform the tax system over the medium term so that ambitious development programs can become sustainable. It is the medium term growth prospects that this section focuses on.
Recall from above that an export boom is forecast for 2010-11 and 2011-12.
Is this sensible?
This forecast appears to be rather rosy if one considers that Bangladesh’s major export markets — the United States, the United Kingdom, the euro area — are likely to remain mired in a sluggish recovery over these years. True, our ready-made garments and knitwear, servicing the budget end of the market, have proved resilient going into the recession. However, there is no reason to think that the so-called Wal-Mart effect will underpin an exports boom.
However, there is an interesting assumption that may explain the forecast export revival. The economic growth, and by extension fiscal, forecasts rest on a number of medium term assumptions. One of them is: “sustained high growth rates in exports through exploitation of new market opportunities and export market diversification.”
It’s not clear what exactly “new market opportunities” and “export market diversification” refer to.
However, the giant economies of China and India — among the first to recover from the global slump — appear to be natural candidates. Rightly or not, there is a perception that the government enjoys a special relationship with India, while the Chinese alliance has been a constant in our foreign policy since the 1970s. It is about time that the government cashes in those friendship chips so that Bangladeshi goods can enter these massive markets.
In addition to exports diversification, there is a lot of emphasis on small- and medium-sized enterprises being an engine of economic activities. While this is a welcome focus, many impediments — from infrastructure bottleneck at the broadest level to access to finance, market, business skills, and supply network at the micro level — need to be addressed for the SMEs to be serious driver of sustainable growth.
And, finally, the budget assumes “greater efficiency and technological progress across the economy, partly driven by increased investment in information and communication technology.”
Political gimmickry such as the term “Digital Bangladesh” notwithstanding, a lot could be done to streamline service provision and reduce transaction costs, thereby enhancing economy-wide productivity growth that could sustain a growth pick up into the next decade. However, measures such as digitising the land records that could underpin this growth spur will require significant political courage.
In the long term, how the government steps up to these challenges will prove lot more important than any specific measures contained in this budget. As they put the budget behind them and start working on the five-year plan, Mr. Muhith, the planning minister, and their officials, should keep that in mind.
1. For a broad initial coverage, see: S Ahamed, Budget for recession and recovery, the Daily Star, 15 June 2009. Available at: http://www. thedailystar.net/newDesign/news-details.php?nid=92579.
2. For a discussion on how the crisis has been affecting Bangladesh, see J Rahman, Surviving the great recession, Forum, June 2009. Available at: http:// http://www.thedailystar.net/ forum/2009/june/surviving.htm.
3. For a discussion on some of the risks, see J Rahman, Risks to the economic outlook, The Daily Star, 14 June 2009. Available at: http://www.thedailystar.net/newDesign/news-details.php?nid=92408.
4. For a discussion on the governance challenges, see A Saleh, The devil is in implementation, The Daily Star, 12 June 2009. Available at: http://www.thedailystar.net/newDesign/news-details.php?nid=92177.