Public Expenditure and deficit financing in the Covid-19 era
Public expenditure and deficit financing have come to the forefront of discussion in the context of Covid-19 pandemic. It has become difficult for the fiscal authority to maintain usual fiscal balance. The sustainability of fiscal position is an important dimension of fiscal policy. Can the current and projected level of fiscal deficit be sustained without exploding debt?
While Bangladesh has long been maintaining a healthy fiscal balance amid its rising public expenditures (around 8 percent during 2010-2018) and higher GDP growth (7-8 percent during 2015-2018), the Covid-19 crisis puts fiscal balance under pressure with a substantial decrease in revenue collection and increased pressure on expenditures.
Development expenditure increased as a share of total expenditure from 33 to 40 percent over time. The focus has now shifted to Covid-19 crisis management with higher allocation to public health expenditures and increased demand for social safety net programmes, implying that the government has to revisit the balance between its regular development expenditure and emerging expenditure in regard to Covid-19 crisis management for the next few years.
Notwithstanding low revenue mobilisation (tax-GDP ratio below 10 percent), the government was able to achieve average fiscal deficits ranging from 2.2 to 4 percent of GDP, with an average of 3.1 percent, in recent years. The deficit was well below the South Asia average of 3.7 percent.
Due to controlled deficits and strong economic growth, public debt has been low and declining as a share of GDP until recently. Public debt declined steadily from 37 percent of GDP in FY08 to 31 percent of GDP at the end of FY18, which was the lowest in South Asia. Bangladesh's low level of public debt has provided cushion against fiscal unsustainability over medium-to-longer term, which is commendable.
However, public expenditure has been contained at the expense of lower spending in some key areas of development, such as health, education, social safety net etc. These deserve more spending in order to achieve inclusive and sustainable growth. Similar budgetary allocations in FY2020-21 will have dire consequences on the recovery as well as growth trajectories of the economy.
Bangladesh's public expenditure to GDP ratio, which falls short of what is typically observed in other countries at Bangladesh's income levels, represents a leaner government that avoids the efficiency and welfare costs of bloated state bureaucracies and overextended government programs. This situation poses concerns pertaining to the effectiveness of public functions, limited coverage of public goods and services, inadequate manpower utilization, the sizeable share of wage bill broadly defined vis-à-vis budgetary funding and competing demands for non-wage inputs on government's limited budgetary resources from priority sources.
The ongoing Covid-19 pandemic has painfully unravelled public health mismanagement, which are largely attributable to the inadequacies of health infrastructure, manpower, skill-mix and inefficiencies in service delivery.
The current economic downturn in the face of Covid-19 crisis is not the Keynesian type recession that can be mitigated immediately with fiscal stimulus. Such stimulus cannot revive the suppressed aggregate demand, as a result of government-imposed lockdown and people's apprehension in joining usual activities due to fear of contracting the virus.
Fiscal support is currently needed to maintain livelihoods of the people and Covid crisis management through improvement of the public health care system. Once the Covid-19 crisis is contained, in the recovery phase of the economy, perhaps latter in the year, demand stimulation would be needed to accelerate economic recovery.
According to various estimates, to provide livelihood (or entitlement) support to half of the population, who are now around the poverty line, for about six months with a reasonable amount and improvement of public health care facilities would require almost 50 percent of the total current budget, which is almost equivalent to annual development expenditures of the previous year. Some allocations would also be needed to provide working capital support to industries, waiver of interest payments etc.
We also understand that some allocations would be required for the ongoing mega infrastructure projects along with operations and maintenance of other infrastructure projects. We therefore anticipate that with all these necessary allocations, the budget deficit might exceed all previous heights this fiscal year. Given low public debt to GDP ratio, such a fiscal expansion would not undermine fiscal sustainability in the medium to long term if fiscal consolidation measures are adopted after the emergence of a new normal.
The main concern currently is how to finance the deficit. The space for borrowing from the banking system is limited considering that banks bear the brunt of implementing all credit-based stimulus packages. Given the shrinking income of the people, non-bank borrowing through NSD certificates is expected to fall. Remittances and export earnings are declining.
Against this backdrop, the WB and the ADB have committed to provide some budgetary support (about $1 billion), and the IMF will provide $730 million to boost foreign exchange reserves. The expected level of external financing is unlikely to be adequate to cover the fiscal deficit.
Therefore, given the space available for increasing public debt without risking sustainability, as evident from the sustainability analysis of the World Bank and IMF, the government should explore all possibilities to ensure low-cost borrowing from multilateral donor agencies in order to finance budget deficits. To meet the remaining financing gap, one possible option would be to monetize a part of the budget deficit given that monetisation would not fuel inflation in this suppressed demand situation.
However, at the recovery stage, monetisation would likely to be counterproductive and the fiscal authority will need to harness alternative options like foreign sources, increasing tax and non-tax revenues, limiting unnecessary expenditures, bringing discipline in public-sector operations, including those of several large state-owned enterprises (SOEs), prudent subsidy management, prioritising public investment projects etc. The irony of the fiscal management is that having fiscal sustainability in place, our fiscal authority is not able to enhance public expenditures in order to expedite the development process.
Finally, we would like to highlight that the budgetary allocations and priorities in the face of Covid-19 crisis should be different than the previous years in order to manage the crisis. Anecdotal evidence on wasteful use of public funds are aplenty. If this is not the time to clamp down on such expenditures, when will it be? It is possible to increase the budget deficit from the usual trend in the pandemic context, which can be financed through pragmatic resource mobilization (both domestic and foreign) efforts.
Monzur Hossain is Senior Research Fellow at BIDS, and Zahid Hussain is former lead economist at World Bank, Dhaka office. The authors drew some results from the book "Bangladesh's Macroeconomic Policy" (Chapter 6; Palgrave Macmillan) in this article.
