Budget and some missed opportunities

Posted by BankInfo on Sun, Jun 17 2012 08:07 am

The national budget arguably is the most important instrument for the implementation of the sixth five-year plan. Two budgets (FY11 and FY12) have gone by and the third one (FY13) has just been presented to parliament and will likely be approved with minimal changes. These three budgets send important signal about the government's thinking and economic policy management. The consistency between the annual budgets and the sixth plan also provides valuable insights regarding the gaps between intentions/plans and realism/implementation.

The sixth plan set ambitious targets for the five-year period starting in F11 and ending in FY15 (Table 1). The sixth plan is the first of the two medium-term plans aimed at implementing 'Vision 2021'. At the macroeconomic level, the main targets are: (i) increasing GDP growth rate from 6.1 percent in FY10 to 8 percent by FY15; (ii) reducing poverty rate from 31.5 percent in FY10 to 22.5 percent by FY15; (iii) lowering yearly average inflation rate from 7.3 percent in FY10 to 7 percent in FY13 and 6 percent in FY15; (iv) increasing the share of manufacturing employment from 11.2 percent in FY10 to 15.2 percent by FY15; and (v) reducing income inequality.

To achieve these targets, the plan makes a number of assumptions about the macroeconomic policy framework. The key policy targets are: the investment rate is to increase from 24.4 percent of GDP in FY10 to 32.5 percent by FY15; exports are to increase by 15 percent annually during FY12-FY15 ; tax to GDP ratio is to increase from 9 percent of GDP in FY10 to 12.4 percent by FY15; prudent macroeconomic policies would be maintained to keep inflation low and preserve the stability of the exchange rate; role of the private sector would be bolstered to play a bigger role in infrastructure financing; public investment will emphasise infrastructure, human development, agriculture and social protection; and income inequality will be reduced by improving the equity of the budget.

The actual results of the first two years under the sixth plan are summarised in Table 1. The data on outcomes of the first two years of the sixth plan suggest serious shortfall in GDP growth, investment, export and inflation targets of the sixth plan. If corrective actions are not taken quickly, it will be near impossible to achieve the sixth plan's GDP and exports growth targets, which in turn will jeopardise the employment and poverty targets. There are also serious issues regarding the equity aspects of the budget, including pressure on inflation, which raises concerns about the plan's realism in achieving an improvement in income distribution.

Against the backdrop of the above, the targets and policies underlying the FY13 budget gain added significance. This mid-term budget of the sixth plan needs to tackle forcefully the gaps in economic performance in order to put the economy on the path of the sixth plan and Vision 2021.

Table 2 summarises the FY11 and FY12 budget outcomes and the FY13 budget target. There are a number of positive aspects of budgetary management of the past two years. The fiscal deficit has been contained at around 5 percent of GDP; the tax to GDP ratio has been growing as planned; public investment spending has been rising; and budget spending has been focused in priority areas of infrastructure, education, agriculture and health. These have had a positive effect on economic growth and human development. But the efforts, although in the right direction, fall short of what is needed to achieve the sixth plan targets.

While the tax to GDP ratio has been increasing, the overall tax performance remains weak by international standards and available resources fall far short of what are needed to achieve the targets of the sixth plan. The budget continues to rely heavily on trade taxes including supplementary duties. This has contributed to unintended trade protection that has hurt exports. High trade protection is a major reason for the inability of Bangladesh to diversify the export base.

On the spending front, a major budgetary problem is the inability to curb large subsidies in energy that has caused the current spending to swell. The fiscal deficit targets have been achieved by curbing public investment spending in both FY11 and FY12. As a result, the public investment rate is significantly below the rate needed to achieve the growth targets of the sixth plan. In particular, the FY11 and FY12 budgets have both failed to implement the planned investments in infrastructure. The much heralded public-private partnership (PPP) initiative for infrastructure did not take off in a significant way. Shortage of foreign financing has caused excessive reliance on borrowings from the Bangladesh Bank that has contributed to inflationary pressures. Budget borrowing has also constrained the availability of credit for the private sector.

Improvement in income equality requires policies to improve the equity of both taxes and public spending. Heavy reliance on inflationary financing has had adverse consequences for poverty and income distribution. There is plenty of empirical evidence that inflation hurts the poor and low income groups more than the better off. On top, there are considerable loopholes in the tax net that allow the rich to escape a substantial amount of their income and wealth from the tax net. These include capital gains on real estate transactions and from stockmarkets and property taxes. Personal income tax collection remains woefully low at around 1 percent of GDP even though the top 10 percent of the population accounts for a whopping 35 percent of the national income. This indicates that the effective income tax rate, which is supposed to be the most progressive tax instrument, is a mere 3 percent as opposed to an inflation tax rate of 10 percent which is highly regressive in nature.

On the spending side, although the government has put priority on health, education, agriculture and social protection, weak implementation and inadequate availability of funding limits the positive effects of this policy. For example, Bangladesh spends only 2.4 percent of GDP on education and 1 percent of GDP on health as compared with 4.8 percent and 3.5 percent respectively in Korea. The 2 percent of GDP spending on social protection is similarly inadequate compared to the needs of the population. There are also substantial issues regarding the quality of these spending.

The policy gaps in the last two budgets suggest the need for an aggressive and tough budget stance in FY13 in order to recover the lost ground from the last two budgets. How adequately does the draft FY13 budget presently debated in parliament meet this challenge?

On the growth front, the main budget instruments are public investment, exports and deficit financing. The FY13 budget continues to keep the fiscal deficit under control at below 5 percent of GDP, which is a positive development. It also targets a 0.8 percent of GDP increase in public investment. A key question is how will the increase in investment be financed? Taxes are projected to grow by 0.2 percent of GDP, which still leaves a financing gap of 0.6 percent of GDP. Unless corrective actions are taken to reduce subsidies, it is very unlikely that the investment target will be met. The cumulative shortfall in public investment over the three-year period of FY11-13 would be in the range of 2 percent of GDP, which is a serious shortfall.

Regarding exports, the FY13 budget continues to rely heavily on trade taxes and has introduced some further anti-export measures. So, the ability to achieve a 15 percent growth in exports in FY13 in an environment of European debt crisis looks very difficult. Similarly, the continued strong reliance on bank borrowing for budget financing will imply a likely adverse effect on credit availability for private finance that could hurt private activities. In this environment of both investment rate and exports growth being substantially off-track, the sixth plan GDP growth target will not be met.

The projected reduction in poverty incidence and the increase in employment share in manufacturing in Table 2 are both predicated on achieving the GDP and export growth targets of the sixth plan. A shortfall in the GDP growth target or the export growth target will naturally imply an inability to achieve these outcomes.

Regarding inflation, the result will depend upon the budget's ability to keep the lid on subsidies. The level of deficit financing through the banking system, which is already on the high side, especially in the context of the restrained monetary policy required for inflation control, is predicated on that. The targets for subsidies and bank borrowings were both bust successively in the last two budgets, which leaves an uneasy feeling that the FY13 budget continues to walk on a tight rope.

Concerning income distribution, the budget does not come close to taking any significant measure to improve this. The loopholes in the income tax net remain, largely owing to the absence of effective capital gains and property taxes. On the expenditure side, the tight resource situation and continued strong pressure from subsidy limit the ability of the government to expand the required programmes in the areas of safety net, rural infrastructure, health and education.

These aspects of the FY13 budget lead to the natural conclusion that it does not make any significant effort to catch up with the lost momentum on investment, exports and income distribution from the first two budgets of the sixth plan. This is a missed opportunity. With elections still some 18 months away, the government could take tougher actions on the income tax and subsidy front to release resources for funding higher public investment and social programmes. Trade protection should be reduced to boost exports. The government could also mobilise higher levels of foreign funding to finance much needed investments in infrastructure. These policies would also allow the government to reduce reliance on bank borrowing, thereby freeing up more credit for the private sector while also lowering the pressure on the creation of high-powered money.

The author is vice chairman of Policy Research Institute of Bangladesh. He can be reached at sahmed1952@live.com.

The Daily Star/Bangladesh/ 17th June 2012

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