Risks everywhere

Posted in economics by jrahman on July 2, 2011

Sadiq Ahmed of the Policy Research Institute has written recently on the Fy12 Budget.  The first one, titled A high reward high risk budget is available here.  The money quote:

Indeed, there is a serious risk that the recent policy actions to curb the growth of money supply in order to reduce inflationary pressures might get compromised by the increasing budgetary demand for bank financing.  In the past two years monetary growth much exceeded prudent limits even with limited pressure from the fiscal front. With pressure now being built up from the fiscal side, the ability to keep monetary expansion within prudent limits to prevent inflation and contain the balance of payments pressure will again become a substantial macroeconomic policy challenge in FY2012.

In English: the government will ask the Bangladesh Bank to print money to pay for various programmes, the pro-poor governor of the Bangladesh Bank will oblige (just as he did the last time the government needed some help), there will be too much cash chasing too few goods, and prices will go up even more quickly. 

His second piece, titled What makes FY’12 budget susceptible to serious downside risks? is here.  He concludes with a laundry list of things (see below) that are, frankly, too hard to do.  Will this government do it?  I don’t know.  What will happen if it doesn’t?  See the above para.

The downside of the budget is that it falls short on the policy front in a number of ways that makes the budget susceptible to serious downside risks and could also compromise the Sixth Plan’s objectives to improve the composition and efficiency of private investment. These include: (a) clarity about energy price adjustments that are essential to contain the subsidy bill; (b) policies for strengthening public sector implementation capacity; (c) policies for reducing corruption and leakages; (d) broadening of tax base by introducing a broad-based property tax system; (f) reform of trade taxes, especially the phasing away of supplementary duties; (g) bringing capital gains from real estate and stocks into the income tax net in line with treatment of income from other sources; (h) strategies for mobilizing flexible budget financing from donors; and (i) a comprehensive domestic debt financing strategy that minimizes reliance on bank borrowings to avoid a conflict with monetary policy.

Shahidul Islam also discusses deficits, but of a different kind:

This new reality with existing fiscal deficits mean increasing domestic and foreign debt that could shoot-up interest rates, put pressure on exchange rates and increase inflation leading to a slower economic growth. If the commodity prices do not deflate markedly (oil prices may not drop much due to the uprisings in the Middle East) and remittance growth does not elevate substantially, the macroeconomic stability could face a severe test.

One may argue that most South Asian economies — India, Pakistan and Sri Lanka — are running the twin deficits (current account and budget deficits) for many years. But unlike India, Bangladesh does not have a sophisticated financial system that could channel external money to finance its saving-investment gap. Deficits in India’s current accounts is largely offset by surpluses in its financial and capital accounts. Pakistan and Sri Lanka’s twin deficits slowed down their growth significantly in the past few years (bar this year in Sri Lanka) and both have experienced a much higher level of inflation than that of Bangladesh.

While the import of short-term hot money (portfolio investment) is not feasible given the autarkic nature of the financial system, FDI could bridge the financing needs theoretically. This can only be done if a visionary government does the required reforms by easing the FDI rules, appointing the right personnel in the Board of Investment (BoI) and allowing a level-playing field for both foreign and local investors. Unfortunately, it cannot be done overnightly.

Moreover, economics is also a function of politics. Given the deteriorating political scenarios in the country, the flow of foreign investment may not be adequate to offset the adverse developments in the BoP. The government seems to have little choice but to accept an International Monetary Fund (IMF) bail-out.

In English: what we owe foreigners (import bills) are going to be bigger than what we get from abroad (exports earnings and remittances), and we don’t have sophisticated banks and investors like India, so we will have to go begging to those IMF guys, who will ask us to cut subsidies and do hard things that Sadiq Ahmed says we should do. 

But the government will not want to do those because they are, well, difficult.  So what will happen?  Back to Sadiq Ahmed’s first point?

Okay, if you’re depressed at this point, and thank your stars that you live in, say, USA and don’t have to worry about the mess in Bangladesh, I give you the kabuki theatre that is the debt ceiling negotiation in the US (no links — switch on the CNN). 

(Cross-posted in UV.  Read the coming Forum for further Budget analysis.)


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