Much ado about deficit financing

A BIG debate is going on following the finance minister’s announcement of the ‘big’ budget for FY2015. The debate is primarily focused on the financing of the big budget. However, there is always a catch in such post-budget reaction — do we only focus on the big targets or on the actual implementation prospect?

Every year, when the finance minister announces budget, he presents past year’s performance along with the fiscal year’s projections. However, we often get carried away by the target figures of expenditure where the finance minister can make it look better on paper.

The difference between target and actual implementation often puts budget analysis in contradiction. For instance, while criticising the size of the budget, many analysts are suggesting that the financing of such a big budget will cause serious pressure on our banking system and crowd out private sector investment. Then again, while reviewing the ADP outlay, major criticisms are focusing on how the ADP will actually not be spent fully. But then again, a lower ADP or total budget implementation will automatically reduce pressure on budget financing, switching the concerns from budget financing to underperforming public investment.

So this time, let’s have a look at how the budget may actually look like once implemented. Revisions in earnings and expenditures of budget have become typical enough to make a good-enough prediction.

From past trend two things are apparent — first, while the government is expected to target its expenditure first based on need and then plan for revenue and borrowings to finance the expenditure, apparently it works the other way round. In Bangladesh, finance ministers have been cutting the coat according to cloths, meaning, downsizing budget expenditure facing revenue or financing shortfalls. This would mean that underperforming ADP is probably not just for the lack of implementation capacity, but to an extent by choice as well.

As it appears, the expenditure side is balanced through a reduced amount over the years compared to the targets. This indicates a planned budget that is bigger in size than the previous year but actually realises much less than the target. Budget planning is thus always done in a way that the target will not be reached but a boost will take place in expenditure. And the same goes for ADP expenditure which keeps on reaching higher digits every year with less amount of actual implementation than planned.

So, if we take the average trends of the past twelve years (FY2003-FY2014), we can already predict that the total budget will fall short of target by 7-10 per cent, while the ADP will experience around 15-19 per cent shortfall. This would mean that the newly announced ADP outlay of Tk 80,315 crore will actually come down to around Tk 70,000 crore (if not less by another Tk 5,000 crore). On the other hand, revenue earnings will see 6 to 7 per cent shortfall from its target, while actual foreign grants and loan will be around 60 per cent of the budget target. So to sum up, the actual budget deficit will be lower than the target by at least 0.5 to 0.8 per cent of the GDP. Past trend also suggest that the government will go over the target by about 10 per cent in domestic borrowing to finance the remaining deficit of the budget.

Budget deficit has now been standardised at a pre-fixed rate of 5 per cent of the GDP, irrespective of revenue earnings or expenditure targets. In fact, budget deficit has been kept invariably at exactly 5 per cent of the GDP during the past few years, including in the budget for FY2015. We can also assume that the government’s revenue generating efforts reflect its fullest competence. That is, the revenue earned in a particular year is the highest it could actually earn with its existing lack of collection capacity, management deficiency and corruption. The finance minister also does not have much control over how much can be borrowed from or granted by foreign sources for budget financing. Meanwhile, the proportion of project aid (foreign finance) in ADP also indicates a declining trend reflecting higher dependency on domestic finance for development expenditures. So, when there is a shortfall in revenue earnings, the finance minister only gets two choices — he can either cut short the budget expenditure, or increase borrowings from domestic sources. Either way, it’s a difficult call. Slowing down of budget expenditure can adversely affect the economy.

Then again, domestic borrowing is done on a very high interest rate, compared to foreign loans. If the government continuously avails higher domestic financing, the domestic banking system would fall into immense pressure and would be left with little finance for the private sector. There are other trade-offs as well including opportunity loss of the government for investment in local industries instead of paying a huge amount of interest at local level. When the government is planning to help bring investors back to the economy after the recent political turmoil, borrowing too much from local banks may not be an option.

So what choice does the finance minister has this time? Low ADP expenditure and low domestic borrowing, or high ADP expenditure and high domestic borrowing?

The government has already increased the rate of interest on debenture and further raise will adversely affect the domestic bank borrowing rate. Revenue expenditure has exceeded ADP expenditure as usual indicating an expensive government that requires more finance for its own management which the government needs to address promptly. The issue with poor ADP implementation also needs a serious alteration through waste reduction, strict monitoring, and corruption attenuation. Thus, a better solution could be a combination of rational reduction in revenue expenditure, and tapping the revenue earnings potentials.

However, this is the best-case scenario assuming that the country has moved on from political violence and heading towards economic revival. But if we do fall back to another political turmoil, private sector investment will not be high and the government can go for domestic borrowing to keep public investment up and running in absence of private investment.