Don’t panic, be vigilant

How worried should one be because of the surge in government bank borrowing? 

In the first two months of the current fiscal year, the government has borrowed Tk 262.48 billion from the banking system, of which 75 percent from scheduled banks and the rest from the Bangladesh Bank. 

The amount borrowed so far constitutes 55.4 percent of the bank borrowing target in the FY20 budget and 34 percent of the domestic financing of the FY20 budget deficit target.  How worrisome, if at all, are these facts depends on what caused it.

Three reasons, according to official sources: reduced sales of National Savings Certificates due to tightening of buying rules; easing of fund release from the development budget to smoothen spending over the entire fiscal year; and shortfall in revenue collection relative to the target. 

If indeed NSC sales have slowed, it is good news for the budget and the private banking system. 

Good news for the budget because NSCs are very expensive. Interest payment on NSCs were 56 percent higher in the FY19 revised budget compared to the FY18 actual.  The former accounted for 66 percent of the estimated interest payment on domestic debt in FY19 revised budget.  Containing the growth of the interest burden on the budget thus required containing the growth of NSC sales. 

Good news for the private banking system because it puts a brake on their loss of deposits.

Spending on account of the Annual Development Program (ADP) in July constituted 1.9 percent of the total FY20 ADP size, compared with 0.5 percent the previous fiscal year. 

If this indicates a real change in the within year pattern of ADP spending, it is good news because it will help tame the wasteful bunching of development spending towards the end of the fiscal year, particularly in June. 

However, it is a little too early to judge whether this indeed will be the case.

What is not good news is the shortfall in revenue collection, although it comes as no surprise. 

Unless the government is able to gear up efforts to expand the tax base and reduce revenue leakage through strengthening revenue administration, a large shortfall is likely to persist throughout the year. 

Consequently, the government will not be able to cutback bank borrowing later to stay within the original budget target.  That will risk crowding out credit to the private sector at a time when liquidity is drying up.

Assume for the sake of optimism that this rise in borrowing is temporary.  Is that still worrisome?

One standard answer is yes. 

Since the debt can be rolled over, nothing obliges government to pay off this extra debt.  The government will still have to pay interest on that debt which requires higher taxes. If the government fails to raise taxes to pay the interest, but instead just borrows more, there is the risk of getting caught in a debt interest spiral, where debt goes only one way--up and up. 

But a slow explosion in debt does not really matter if the economy is growing fast enough. Specifically, if nominal GDP grows faster than the growth in debt.  This will be the case when the real GDP growth rate exceeds the real interest rate, as has been the case in Bangladesh

Does this mean don’t worry, be happy? Yes and no.

Yes, because one of the standard refrain against raising debt is that taxes on the future generations will have to rise to pay the interest.  This does not hold if economic growth exceeds the interest rate.  The government can borrow to pay the interest. The debt to GDP ratio will still gradually fall, because the economy is growing faster than debt.

No, because we cannot be sure this is just a one-off increases in debt. Growth greater than interest rate does not mean we do not need to worry about persistent primary deficits (revenue minus government expenditure not including interest payments) i. e. if spending is permanently higher than taxes. A persistent primary deficit adds to the growth in debt, so the debt to GDP ratio will rise despite the excess of growth over the interest rate. 

A persistent primary deficit can result from persistently low revenue GDP ratio with government expenditure increasing relative to the size of the economy.  It becomes even more worrisome when the latter is driven by rise in recurrent expenditures, as has been the case in recent years.   

Also no, because a significant part of the rise in borrowing is from BB.  This is equivalent to printing of new currency notes.  It is tempting and cheaper―unlike treasury bonds or NSCs, no interest is payable. But beyond prudential limits, It carries inflationary potential that may get out of hand worsening income and wealth inequalities and creating additional pressure on the exchange rate.

What will matter at the end of the day is good fiscal management, one that preserves access to external finance and avoids the crowding out of private investment.  This is one of the strongest arguments for a policy of low and stable fiscal deficit.  While Bangladesh’s fiscal deficit trend warrants no red flags, it is not all green either.  Horror stories on massively wasteful use of public money makes even low and stable deficits appear blazing red.