Budget in times of rising inflation

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Last Thursday (June 9), Bangladesh’s Finance Minister presented the budget for the financial year 2022-23 (FY23), at a time of strong inflationary pressures, especially in food and oil prices. energy. The size of the budget stands at Tk 6.78 trillion and is titled “Return to Development Trajectory after Overcoming Covid Shocks”. The Minister assured the nation that the country is firmly on track to achieve GDP growth of 7.5% in the coming fiscal year.

Such a growth projection comes at a time when the World Bank, in its latest “World Economic Outlook” report released last Tuesday (June 7, 2022), warned that the global economy was falling into a prolonged period of stagflation – weaker growth and even outright contraction. sustainable for the foreseeable future.

Stagflation is an economic phenomenon that results in a combination of stagnating growth, rising inflation and high unemployment. Stagflation is worrying for everyone, but for a developing country like Bangladesh, it is even worse because the country depends on exports to wealthy countries and regions like the United States, United Kingdom and India. EU. The economic downturn in these countries will hit Bangladesh hard. It should also be noted that all developing countries, including Bangladesh, are affected by the macroeconomic policies of advanced economies. In fact, there is no indication in the budget document that Bangladesh’s economy might slow down or even run the risk of slipping into recession.

While kick-starting the growth process in the wake of the pandemic, as the budget document claims, there is an implicit message that the benefits of growth would reach the poor and vulnerable sections of the population among the other beneficiaries of growth. in the country. Therefore. the budget will not only continue stimulus programs to accelerate the recovery process, but will also intensify targeted support for marginalized people affected by the rising cost of living. However, the targeted support does not appear to have covered much for lower middle and middle income people who are also facing significant financial hardship. The government will also continue to focus on improving social security, housing the homeless and distributing food to low-income people. The government is also working to launch a national insurance scheme.

The government has also increased expenditure on subsidies to cope with rising oil, gas and fertilizer prices amounting to 571 billion taka. In the current environment, such continued reliance on existing energy and food subsidies will limit domestic price adjustments, which will limit the ability of fiscal measures to respond quickly to more serious economic difficulties that may arise in the months or coming years.

During the presentation of the budget, the Minister of Finance also pointed out that the country faces six major challenges in the coming financial year, 2022-23, of which inflation and increased domestic investment have been identified. as the main challenge. The projected inflation rate is 5.6% for the next fiscal year. According to the BBS, the inflation rate in April was 6.29%. However, the official inflation figure provided by the BBS is considered to be much lower than the actual inflation rate. In fact, the Center for Policy Dialogue (CPD) reported on Sunday June 5 that the inflation rate is well above the official figure (FE, June 6). Various research organizations in Bangladesh estimate the inflation rate to be around 12 percent.

The estimated revenue collection for the coming fiscal year is estimated at 3.70 trillion taka from tax revenue and 450 billion taka from non-tax revenue. Total expenditure of Tk 6.78 trillion leaves a budget deficit of Tk 2.42 trillion, which is 36% of total budget expenditure. This deficit will be financed by internal and external loans. The ratio of foreign debt to domestic debt is about 40:60.

This budget deficit will now be added to the already accumulated public debt (public debt) which now amounts to 38% of GDP (of which around 40% is external debt). The debt-to-GDP ratio is expected to reach 42.1% of GDP at the end of FY 2022-23, with domestic debt representing 25.8% of GDP and external debt 16.2% of GDP. And this is also expected to rise to 42.9% of GDP by the end of FY 2023-24, with domestic debt representing 26.5% of GDP and external debt 16.4% of GDP. Bangladesh’s debt-to-GDP ratio is relatively low compared to the US at 107%, the UK at 81% and Japan at 237%. If output falls sharply and the deficit rises, Bangladesh’s debt-to-GDP ratio will rise further. Only a budget surplus or strong economic growth can help reduce the debt-to-GDP ratio.

In Bangladesh, the budget deficit is financed by borrowing from internal and external sources, grants and foreign bonds. Bangladesh does not have deep and liquid bond markets, which makes it rather inefficient. In such a situation, printing money to maintain liquidity will add to inflation.

Budget expenditures increased by 14% compared to the previous year. In that sense, the budget seems to be slightly expansionary and it feels like the government seems to think that the budget outcome doesn’t really matter because the budget would be in deficit anyway. The budget deficit for 2022-23 stands at TK 2,420 billion, or 5.5% of GDP. Between 1979-80 and 2022-23, Bangladesh has always recorded budget deficits except for four years. This indicates that the budget has a structural rather than a cyclical deficit problem.

A structural deficit problem implies that even taking into account the cyclical fluctuations of the economy, current public expenditure is financed by borrowing. With a structural deficit, therefore, a deficit will be posted regardless of the strength of the economy. A structural deficit problem implies that borrowing will become increasingly unsustainable or more expensive. A structural deficit problem can cause interest payments to rise as a percentage of GDP, which means that an increasing amount of tax revenue would be needed to make interest payments on the debt.

Only spending cuts or revenue increases, or both, are methods that can eliminate structural deficits. But none of these methods please any government and that is why structural deficits persist. More importantly, spending cuts and tax breaks combined can also create a challenge that is more existential than fiscal. Therefore, the government could reform the tax system to solve the structural deficit problem.

Budget deficits mean an accumulation of public debt, which implies higher taxes in the future when the debt will have to be repaid. According to the Ricardian equivalence proposition, households therefore increase their current savings in anticipation of future taxes. Thus, there would be no increase in consumption, therefore no increase in economic activity.

Also, a budget deficit can lead to a current account deficit. This is called the twin deficit hypothesis. The logic behind the assumption is that a budget deficit leads to an increase in consumption. This increase in spending reduces national savings, forcing the country to borrow money from abroad. This borrowed money can also be used to purchase imported goods. But the empirical evidence on the hypothesis is very mixed.

More importantly, fiscal deficits can crowd out private borrowing, manipulate capital structure and interest rates, and reduce net exports. The demand for loanable funds increases when the government seeks funds to borrow to finance its budget deficit. This not only reduces the availability of funds, but also increases the real interest rate and discourages private sector investment.

The budget comes at a time when Bangladesh’s economy is also facing a current account deficit. This deficit largely reflects the increase in international prices of commodities such as food grains and oil and also indicates that the exchange rate transmission is much faster for developing countries like Bangladesh (about 6 months ), which creates a faster increased demand for foreign currency or more specifically the US dollar. import costs for food grains and oil continue to rise, putting pressure on foreign exchange reserves and exchange rates.

For a trade-dependent country like Bangladesh, budget deficit can significantly increase inflation. In addition, fiscal deficits can widen the current account deficit and push up interest rates. An appreciation of the US dollar, as reflected in the BDT/USD exchange rate, will make paying off debt or buying commodities even more expensive. As the US Federal Reserve continues to tighten monetary policy to contain rising prices, at the same time it will further increase the value of the US dollar.

Budget deficits are typically used to expand popular policies such as welfare programs and public works, without having to raise taxes or cut spending elsewhere in the budget. But if paying interest on the debt becomes unsustainable through normal tax revenue or new borrowing flows, the government faces three options. He can cut expenses and sell assets to make payments. It can print money to cover the shortfall, or the country can default on its loan obligations, as happened with oil-rich Mexico in 1982 and Sri Lanka in 2022. If the dynamic economic growth weakens, with rising interest rates in the United States, the debt denominated in the United States dollar will be more difficult to pay. Therefore, the simple math of this is inexorable: the government must identify the spending cuts and the taxes it can raise.

The government faces tough political choices as it tries to shield the population from record food prices and soaring energy costs, pushed further by US sanctions on Russia, Iran and other countries and the Russian-Ukrainian conflict which led Ukraine to exploit its own ports by blocking its own exports of food grains. Additionally, the continued disruption of global supply chains due to the pandemic has resulted in soaring prices for everyday items. There are also national constraints which also contribute to the rising prices in Bangladesh. Therefore, the major fiscal challenge facing Bangladesh should be seen in the context of high and rising inflation. As such, the budget should have a significant impact on inflation. In this context, it should be noted that policies based on inaccurate data on GDP, inflation and other important macroeconomic variables are less likely to succeed.

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