Fiscal Policy
Fiscal Policy in Bangladesh basically comprises activities, which the country carries out to obtain and use resources to provide services while ensuring optimum efficiency of the economic units. The policy influences the behaviour of economic forces through public financing. Major objectives of the fiscal policy of Bangladesh are to ensure macroeconomic stability of the country, promote economic growth, and develop a mechanism for equitable distribution of income. The main tools to achieve these objectives are variation in public revenue, variation in public expenditure, and management of public debt. These are reflected in the budgetary operations of the government, prepared and implemented on year-on-year basis.
Following the independence of Bangladesh, the government had to spend a large amount of its resources in reconstruction and rehabilitation work. It had negative public savings and limited private investment. Despite large inflows of foreign aid, the increasingly large financing gap was the main concern of the government. The situation was further aggravated by frequent internal and external circumstances. Thus the government fiscal policies during 1970s and 1980s were largely oriented to rehabilitating the war-torn economy as well as stabilising it from various other shocks. This had gradually led to weak fiscal structure and poor fiscal management. The tax structure was such that any increase in taxes due to built-in consequences of economic growth was virtually not possible. This was because of the fact that despite a moderate growth of the economy, income distribution was skewed, and had been pushing more and more people below the poverty line each year. As such, the proportion of population with taxable surplus went down overtime. More than 80% of the total tax revenue came from indirect taxes, amongst which taxes on imports contributed about 60%. Since most imports were in the government sector and basic need-oriented, it was hardly possible to increase import duty. Despite higher production costs, prices of most public goods could not be rationalised due to socio-economic reasons. As such, these were kept lower, which resulted in inadequate cost recovery.
Current expenditure had almost always been underestimated, while current surplus as well as foreign loans and grants were overestimated. Therefore, the overall fiscal deficit experienced a large variability all the time. The whole scenario may be described as such that the fiscal policies of the past could not be used as an adequate tool for 'fine-tuning; the economy towards achieving macro-economic stability and higher economic growth.
Regular deficit financing, normally undertaken through borrowings from abroad, from bangladesh bank, and from scheduled banks, has become a basic feature of the fiscal policy of the country. Opportunity of borrowing from the public by the government for financing budget deficit is very limited in the country as savings capability of the people is very low. Therefore, the opportunity of non-inflationary financing of budget deficit does not exist here. Availability of foreign borrowing depends on the international liquidity situation and the prevailing circumstances in the international capital market, which is always uncertain and volatile for a country like Bangladesh.
The commercial banks, because of their potential for central bank refinancing, are also not effective sources of non-inflationary finance. Given the circumstances, whatever is the size of the fiscal deficit in any particular year, a part of it cannot be financed by external borrowing and, therefore, must be financed out of central bank borrowing. As a result, the essential element of fiscal deficit in Bangladesh has become such that once a deficit is incurred, government borrowing from the Bangladesh Bank became inevitable.
In the early 1990s, the government of Bangladesh undertook some comprehensive steps towards the improvement of the country's fiscal front. The major objective of the government fiscal policy was to restrict the growth of current expenditure to a level below the growth of the nominal GDP, thereby making more resources available to support annual development programme (ADP) undertaken in each year. In line with the Enhanced Structural Adjustment Facility (ESAF) of the IMF, a number of reforms were initiated, the most important of which was the introduction of value added tax (VAT) in July 1991.
VAT was introduced at a uniform rate of 15% at the manufacturing-cum-import level. Together with protection-neutral supplementary duties, this system largely replaced the earlier structure of differentiated sales tax on import and excise duties on domestic goods. In case of personal income tax, the major reforms involved the inclusion of entertainment allowances in the personal income tax base, deduction of investment in approved assets from the tax base, and an introduction of a withholding tax on dividend with limitation of special expenditure within a reasonable limit. Steps were taken to reduce interest rates on government savings instruments and subsidies for food and jute. A good number of public sector enterprises were denationalised through sales to the private sector.
These reform measures resulted in a remarkable improvement in the fiscal situation of Bangladesh after 1990. The growth of current expenditures was contained below the rate of GDP growth. Tax reform led to an increase in government revenues from much below 10% of GDP in fiscal year 1989-90 to 11% in fiscal year 1991-92. This trend continued and revenue collections reached more than 12% of GDP by the FY 1994-95. This trend is continuing, although with minor fluctuations. Moreover, this was accompanied by changes in the tax structure of the country, reflected in the decline of the shares of customs duties and increase in the share of income and profit taxes in the total tax revenues in the subsequent period. As a result, the shortage of local funds that had constrained in the project implementation capacity of the country and had shrunk the country's absorptive capacity for project aid for a long period was largely removed.
The improvement of the government's fiscal performance was reflected in the budgetary outcome of the country. The overall budget deficit was 8.4% of GDP during the 1980s and came down to 5.9% in 1991-92 and thus provided a breathing ground for the government. Up to 1997-98, the budget deficit could be successfully contained to less than 6%, helping to stabilise the economy to a great extent. But this could not be maintained in the following year due to the devastating and prolonged floods that occurred in the first half of 1998-99. There was a considerable slippage in the expenditure programme of the government due to floods while revenue collection lagged far behind the target. As a result, the overall budget deficit shot up to 7.8% in the FY 1998-99. Although the government took some steps, the overall deficit remained slightly above 6% in 1999-2000.
Up to 1989-90, foreign aid had financed the lion's share of fiscal deficit of Bangladesh. Since then there has been a considerable shift in the sources of funds for financing budget deficit. Domestic sources could provide only 15% of the total deficit during 1989-90. In contrast, in FY 1999-2000, the comparative figures for domestic and foreign sources in funding the budget deficit were 47% and 53% respectively. However, an absolute decline in the flow of external funds on concessionary terms is also partly attributable to this. Increased dependence on local funds has largely reduced the uncertainties of the implementation of the budgetary programme. But this has also increased the risk of additional burden of higher interest costs from domestic borrowing.
Steps have been taken to mobilise domestic resources by promoting fiscal and financial reforms. During the last fiscal years, budgetary allocations have been increased emphasising the human resource development, poverty alleviation, improvement of the quality of education, health and family planning services as well as increase of the network of social safety-net.
Fiscal policy was aimed at ensuring macroeconomic stability and attaining rapid economic growth by maintaining a balance between revenue earning and spending. With a view to modernise and standardise the implementation process, Mid Term budget at the macro-level was launched and steps have been taken to implement it. It has been termed as Mid Term Budgetary Framework (MTDF). In order to strengthen the whole management system of government's revenue expenditure, a five-year project financed by World Bank is being implemented. With the completion of this project it is expected that significant changes will come in the fiscal policy and improvement will occur in the revenue management. These reform measurers have started giving positive result. Tax network has been expanded, revenue system strengthened, new sources of revenues were identified. All these steps have augmented the tax collection. As a result, tax-GDP ratio rose from 8.47% in 1999-2000 to 11.5% in 2009-2010. Similar progress has also been made in un-tax revenue earning which rose from 1.80% in 1999-2000 to 2.20% in 2009-10. This has been reflected in the budgetary allocation, which shows that even in the backdrop of increasing allocation in the annual development, a balance between allocation and expenditure has been maintained. It is interesting to note here that until 2010 of the last decade, except 2008, the fiscal deficit remained below 5%.
At present government's debt obligations remain at a tolerable level. Due to various changes at the global level, scope of financial support in the form of loan and grant from external sources has been diminishing. So, in order to make up the deficit financing, the government has taken steps to mobilise resources from domestic sources. As a result, deficit financing from external sources came down from 2.50% of GDP in 1999-2000 to 2.0% in 2009-10, and the same time the mobilisation of finances from local sources has increased from 1.9% to 2.5%. This shows a positive sign of our fiscal management. [Syed A Khan and A Samad Sarker]
