Not enough innovation to deal with old and new challenges

Finance Minister AHM Mustafa Kamal’s fourth successive budget, placed in Parliament (Jatiya Sangsad) on Thursday last, has rightly identified the key macroeconomic challenges, but actions incorporated into it may not be enough to deal with those. The minister has struck the right chord when it comes to the challenges—taming the soaring inflation, keeping imports at a reasonable level while maintaining the foreign exchange reserve at a stable level and protecting the poor from soaring prices. He has proposed a strategy to ‘enhance supply while cutting demand growth’. The objective behind such a strategy, understandably, is to contain inflation and stabilise the value of taka and the reserve. How far the strategy will work remains to be seen since any cut in demand through measures, fiscal or otherwise, has some negative implications on the economy and people’s livelihoods.

Undeniably, the last two financial years were different from the previous ones when the incumbent finance minister crafted his budget documents. The onslaught of the Covid-19 pandemic made all the difference. The time turned out to be very difficult for him. Millions lost jobs and sources of income and toiled hard to get both ends met. The government’s primary concern was to save lives in the face of a deadly and widespread outbreak of a hitherto unknown virus and keep the economy going. As the country along with other nations resumed economic activities full throttle in the last quarter of 2021, a surge in demand also pushed up the commodity prices and shipping costs. As if, that was not enough. The world got a severe jolt when Russia invaded its neighbour Ukraine, resulting in a further hike in prices of commodities, fuel oil, cereals, fertilisers and edible oils in particular.

Bangladesh, a large importer of items like fuel oils, LNG, cereals, sugar and fertiliser, is bearing the main brunt, as it is spending a substantial amount of foreign exchange. The finance minister his estimated that the country will have to spend an extra amount of $8.2 billion on the import of those items in 2022 over that of 2021. Such spending, coupled with a drop in the inward remittance inflow, has been eroding the reserve, despite a healthy growth in export proceeds in recent months. To deal with the situation, the central bank, on the one hand, has imposed curbs on certain high-end and non-essential imports and introduced floating exchange rate. The market-based exchange rate has been long overdue to enable the Bangladesh currency to get its real effective exchange rate (REER). However, the import curbs are unlikely to reduce the pressure on the reserve to any notable extent, as Bangladesh will have to continue importing fossil fuels, fertilisers and food, which make up the bulk of its import basket.

That the finance minister is eager to maintain the growth trajectory even during a crunch time is evident from the budget size and GDP growth target for the upcoming fiscal year. Such an urge is understandable. But the situation on the ground is a bit hostile. Given the tax revenue growth during the current financial year, the target set for the next fiscal year might appear ambitious. Under the prevailing circumstances, the government should have reduced the size of the budget. Besides, the growth projection contradicts the strategy of reducing ‘demand growth’.

Businesses would welcome the proposed budget with their arms wide open, because of the tax sops the finance minister has offered to them. The budget has made a big step forward in rationalising the corporate tax. It has tried to make non-RMG exports competitive by reducing the corporate tax levied on them.  The proposed tax measures are likely to give a big boost to non-RMG export industries that have been demanding such a fiscal action for years. This particular step might help attract new investment in non-RMG export-oriented industries also. The budget contains some other tax measures that would help the domestic industries grow better and prepare themselves to face competition from imports following the country’s graduation, scheduled for 2026, and capture the export market better. But such protection by a big measure has a few downsides. Industries become inward-looking. They focus more on accessing the domestic market, as it is easy and involves the least cost.

Borrowing by the government to finance the deficit is an age-old practice. But what matters here is the source and cost of such financing. The government borrowing as earmarked in the proposed budget is bigger than that of the last year and most of it would come from the domestic banks—Tk.1063.34 billion, which is 225 per cent more than that of the outgoing fiscal. Such a large borrowing from banks that are amid a liquidity crunch will lead to a crowding-out effect on the private sector lending. The demand for credit from the private sector also has been growing in recent months as the economy is almost back to normal. Non-availability of enough funds from formal sources would hurt private investment, which has been more or less stagnant in recent years, and also employment generation. The government needs to try to ensure budgetary support from multilateral sources to relieve the pressure on banks. The central bank, for the sake of fairness, needs to leave the deposit and lending rates at the mercy of market forces, as with the exchange rate. Market-based rates are likely to draw more deposits.

Given the high inflationary pressure on the economy, the finance minister needs to search his soul whether he has done enough in the proposed budget to make the life of poor and low-income people a bit more comfortable. The minister, quoting a World Bank report, has mentioned in his budget speech the improvement in the poverty situation in the outgoing fiscal year. But there has been a change in the situation lately, as some people failing to cope with the soaring prices of essentials have again gone below the poverty line. Expansion of the safety net along with the countrywide sale of rice and some other essentials at subsidised prices is necessary to help these people.

One particular issue that has drawn widespread attention is the opportunity proposed in the budget to legalise laundered assets, movable and immovable, by paying penal taxes ranging between 7.0 per cent and 15 per cent. And no question would be asked about the assets thus legalised. An interesting part of the proposal is that owners of such assets would not have to repatriate their assets. The proposed provision has all the ingredients to hurt the sentiment of genuine taxpayers and encourage people to transfer funds abroad and legalise the same by paying nominal tax. Besides, the government is unlikely to net anything big from the move that, if implemented, is certain to arouse suspicion. The government needs a sufficient volume of revenue in such a difficult time. The demand needs to be met through an effective widening of the tax net and reforming the tax administration. In sum, it will be a tightrope walk for the finance minister. He will have to watch his every footstep.