The FY26 budget is the first and perhaps the only budget that the interim government will prepare. One would hope that it has the following characteristics:
- The macro-economic framework establishes or leads to a reasonable balance among revenues, budget deficit, development expenditures, and recurrent expenditures. Related to this is the need to avoid driving out private investment as is now the case, and to contain inflation.
- There is a strong program to develop exports, particularly the RMG sector.
- Key issues that can best be decided by the interim government are disposed of in a satisfactory way.
This article discusses some of the items I believe should be included in the budget.
Macro-economic impact
A good rule of thumb is that the revenues less the revenue budget should finance half of the development budget. The rest of the development budget is financed by domestic and foreign borrowing. This rule of thumb, assuming net foreign borrowing is $3.5 billion, suggests a smaller budget than what is proposed.
The FY26 budget is the first and perhaps the only budget that the interim government will prepare
The current budget essentially has revenue budget expenditures equal to revenue so that all of the development budget is borrowed. The result is too much borrowing by the government, crowding out private investment and driving up interest rates to attract domestic borrowing.
The budget has declined substantially in real terms, but this is not enough. By my suggested rules of thumb, the budget is too large relative to the revenue earnings. The rising interest rates imply that the resources available for running the government are increasingly inadequate.
For many years, the government has tried to obtain low-cost money to help cover the deficit; this is getting more and more difficult. The elected government is going to find it necessary to slow the increase in the budget while trying to increase the revenue. But the basic conclusion is that the budget is too large, with the result that there is increasing foreign debt to excessive levels, crowding out private sector investment. While the numbers are different, the principle is the same -- one should have some equity in an investment. The government has none in its development program.
Inflation
Fighting inflation is a combination of fiscal and monetary policy. Economists are divided as to which is more important. At present in Bangladesh, the monetary policy is very tight with high interest rates and very low private investment.
The high interest rates for government securities attracts bank funds, enabling banks to make reasonable returns with little support for the private sector.
Fiscal policy is essentially expansionary. Revenue collections are very low compared to the GDP. Expenditures are too high, very little effort is made to reduce the size of the government.
The new budget programs a reduced deficit, increasing fiscal policy’s contribution to controlling inflation. But this is not really enough; greater reductions in expenditures would enable an easier monetary policy and greater investment by the private sector.
Trade
We do not know the impact of the budget on exports. The subsidies will probably be reduced or removed. The tax regime on the RMG sector is confusing and there has been some talk of raising their taxes. The finance adviser observed that the sector has been an infant industry for 40 years.
The most powerful instrument for supporting exports is the exchange rate. The rate remains overvalued; forget the theoretical stuff about the real effective exchange rate. The true test is whether exports are increasing over a range of items. They are not.
There are many serious problems in the RMG sector. But the most serious are the problems arising from the wild and volatile trade policy of the United States. The future of the industry is now very uncertain. Everyone has their guesses about this. Mine is that it will work out well for the Bangladesh factories, but not without much grief.
The uncertainty will do much good by driving out weak factories and making room for the strong factories to expand. What is essential is not crying about the abuse by the Americans but getting down to strengthen the industry and dealing with the major changes in the sector.
These are the declining participation of the Chinese, the increasing demands by buyers for high environmental standards, and the changing technologies, particularly artificial intelligence (AI). There are many actions that the government can take to improve the prospects for exports but there is a stubborn refusal to deal with these issues.
Private investment
The impact on private investment from the budget will largely rest with the prospects for lowering interest rates and increasing the flow of bank funds to the private sector. There are essential improvements to the capital market needed. At present the capital market hardly exists. The long sad development from its start in the early 1990s to its near demise is well known.
Is it possible to develop an effective market? Will the budget take up this serious matter? There will be some changes in the tax rates to encourage listed companies but this is not enough to improve the capital market.
The penultimate point relevant to increasing investment is the improvement of the legal system to recover loans. Loan recovery is a tortured long process that is so weak that it is the main cause of the large volume of non-performing loans.
Finally on this point, will the budget provide increased funding for the program of computerization of land ownership documents and modernize the records enabling an improved land market? This is an essential element of the management of collateral for bank loans and important for managing private investment.
Revenue
The development of the revenue system is always a fundamental part of the budget. There are a host of recommendations on this matter. There are two important points one should look for.
First is whether total taxes on imports go up or down. The actual tax on an import includes a variety of items: VAT, duty, advanced income tax, and supplementary duties. The budget should make major steps towards lowering the total amounts charged to the importer. The interim government’s financial leadership fully understands the anti-export bias in the high level of protection of domestic industry. Will they do anything to start the process of reducing this distortion?
The second point is to move strongly to a uniform VAT rate and build more towards a proper system of no exemptions and proper calculation of the amount due, building on the self-enforcement nature of the system.
Expenditures
There are endless arguments on the question of how the government should spend its money. Everyone has their own favourite topic. In a democratic system, the discussion of revenues changes and the direction of expenditures are the main issues revolving around the budget.
There is no parliament to discuss the budget and make recommendations. There will be many post-budget discussions, and the sponsors of these discussions should be encouraged to submit a written report on what changes were recommended by the participants.
Employment
The employment situation is dire. The interim government wants to do something about this. One should look at the programs that are proposed to lower unemployment. The labour law should be signed. A revised procedure for the determination of the RMG wages should be established. But employment grows with the private sector and prospects for growth are modest.
Helping the poor
The government will expand the program for distribution for the poor. One hopes that these programs move towards distribution of cash rather than actual food prices.
Transition issues
These are important issues that the interim government should do:
- Lower protection levels sharply.
- Stop all subsidies to exporters.
- Establish a privatization commission and privatize Biman, the Power Grid Company, and Titas Gas.
- Reduce the subsidies to electricity and gas but reduce application of VAT and AIT except at retail level.
- Execute the actions to deal with bad banks and ensure the funds are appropriated to achieve this.
- Strengthen the Competition Commission by authorizing a greater staff, funds for serious foreign training, and funds for technical assistance from other countries. As a rule of thumb they should have a staff of 25% of Bangladesh Bank.
Forrest Cookson is Research Adviser to the Centre for Research and Development. In Bangladesh, he led the central bank component of the Financial Sector Reforms; was the Team Leader of the study of Northwest Area Development of Bangladesh; and served as the Statistical Advisor of the Legal and Judicial Capacity Building Project.