SITREP | Bangladesh's Fiscal Policy and Inflation

SITREP | Bangladesh's Fiscal Policy and Inflation

By Valerie Mercer-Blackman 
(Additional Contribution: Amador Foronda)
Asian Development Bank

Image Attribute: Dhaka's Mothijheel Business District / Source: The World Bank

Image Attribute: Dhaka's Mothijheel Business District / Source: The World Bank

Bangladesh has one of the lowest tax revenues as a percent of GDP in the world. To create the fiscal space for increased public spending in critical areas, it is necessary to improve tax revenues significantly. The value-add tax (VAT), originally implemented in 1990, has since been riddled with exemptions and loopholes that have reduced its effectiveness. Various technical barriers have delayed intentions to reform the VAT from 2013, which also delayed completion of the Extended Credit Facility Arrangement with the International Monetary Fund. The authorities had aimed to pass new VAT legislation in July 2016 (as of now, it has been postponed to July 2017 due to lack of preparation), which in addition to mobilizing more resources, is designed to protect the poor and small businesses, to make tax administration more transparent, and to reduce taxpayer compliance costs. VAT implementation should be complemented by further strengthening of tax administration, particularly through automation. Further steps to reform inefficient and regressive subsidies would also create room to boost safety nets for the most vulnerable. Greater transparency of state-owned enterprises would also allow a more effective tax administration.

Government spending is also correspondingly low. Central government expenditure to GDP has hovered around 14% in the past few years. More recently, the sharp fall in global oil prices has led to a windfall gain for the fiscal accounts as domestic fuel prices have been unchanged, but escalating electricity demand (See Chapter 4 the Report) has led to higher spending on electricity subsidies. On the other hand, investment expenditure (from the Annual Development Program) has risen slightly from a low base over the past 5 years by about 1 percentage point of GDP. Still, this is not nearly enough to meet Bangladesh’s growing development needs.

Figure 1:  Bangladesh's Fiscal Indicators, 2006-2014 (% of GDP)

Figure 1:  Bangladesh's Fiscal Indicators, 2006-2014 (% of GDP)

Bangladesh pursued a conservative fiscal policy and maintained a modest deficit during 2006–2014 (Figure 1). The deficit remained below 5%, sustaining macroeconomic stability and providing a modest buffer in the event of a crisis. Although fiscal deficits remain within sustainable thresholds, fiscal pressure still exists due to rising subsidies for fuel, electricity, and fertilizer. The government addressed these issues by containing subsidy-related costs and reducing nonrecurring expenses to limit the fiscal deficit. Based on preliminary 2014 data, additional challenges in fiscal management were created by a large shortfall in tax revenue, demand for support from sectors affected by political turmoil, and slower utilization of the Annual Development Program budget. The overall fiscal deficit in 2014 was a modest 3.1% of GDP.

Figure 2:  Inflation, 1991–2015 (percentage points)

Figure 2:  Bangladesh's Inflation, 1991–2015 (percentage points)

Inflation has fluctuated around 6% during 2001–2015. As Figure 2 shows, during 1991–2015, inflation reached its lowest in 2001 at 1.9%, but surged to 9.9% in 2008, and 10.6% in 2012, the highest for Bangladesh in the last 23 years. This scenario necessitated restrained fiscal policies in the following year, coupled with the decision to borrow funds. This led to curtailed monetary expansion, which helped control inflation. It also reflected the declines in both food and nonfood prices, both domestic and international, besides a stable exchange rate and monetary tightening.

More recently, inflation increased in 2014 to 7.4% due to supply disruptions and wage increases in the public sector and garment sector. Inflation would be much higher were it not for stable international commodity prices, weak domestic demand, some appreciation of the nominal exchange rate, and a restrained monetary policy. With these policies in place, inflation slowed in 2015 to 6.4%, compared with 2014.

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Cite this Article:

Valerie Mercer-Blackman 2016. BANGLADESH CONSOLIDATING EXPORT-LED GROWTH COUNTRY DIAGNOSTIC STUDY, Manila, Philippines © ADB. http://www.adb.org/sites/default/files/publication/190610/ban-export-led-growth-cds.pdf, Creative Commons Attribution 3.0 IGO license (CC BY 3.0 IGO)
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