A fork in the path: growth or contraction?by Rashed Al Mahmud Titumir
‘Macroeconomic pressures have intensified over the past 18 months,’ so says the government in the Memorandum of Economic and Financial Policies for accessing loan from the International Monetary Fund’s Extended Credit Facility. The three-year reform programme, articulated in the memo, embodies nothing but orthodox contractionary fiscal and monetary policies, for an economy which has been growing at an average rate of six per cent until the recent pressures of its own making, ensued by wrong choices of policies, stemming from chaotic management of the economy and pursuance of policy conditionalities in order to be eligible for the IMF’s credit facility.
Bangladesh has been on the growth track, as evidenced in the rise of the gross domestic product to a decadal average of six per cent. The country has also advanced in the realm of social indicators, despite one in every three persons living below the so-called poverty line. However, wilfully disarrayed fiscal management of the government and the investment-thwarting monetary policy prescribed by the IMF have been dragging the processes of such advancement.
Impunity of fiscal disorder has warranted ever-increasing domestic and foreign borrowing, mainly to feed in subsidy-guzzling quick rental power plants, which have proved to be the Achilles’ heel for the public but is a deliberate choice by the government enjoying indemnity under a controversial indemnity bill for managing power and energy sector contract awards on unsolicited offers. With the flows of foreign aid drying up and a lack of aid commitments at the desired level on the horizon, the government has resorted to domestic borrowing from banking sector to make up the gap. Domestic borrowing and low foreign exchange reserves owing to mounting petroleum import bills have, thus, resulted in a crowding-out effect that has been squeezing out domestic investment and public expenditure.
The central bank has been following the diktat of the IMF in its monetary policy, failing to contain inflationary pressure, which even climbed to double digits, unprecedented in the national economic history. Again, the wrong policy of raise in the rate of interest to curb inflation, because of the wrong diagnosis of the causes of inflation and the lack of liquidity in the banking system due to excessive government borrowing, has resulted in a slump in investment. The growth in manufacturing has been further squeezed by the shortage of supply of electricity, power and gas. The country has been experiencing pressure on the balance of payment since the rate of growth in export has started decelerating while the growth in import has been on the rise, mainly to foot import bills of petroleum products to meet the demands of quick rental power plants. The declining import of capital machineries and intermediate goods has further worsened the growth prospects. As a sequel to the balance of payment situation, the taka has drastically depreciated vis-à-vis the US dollar, and the foreign exchange reserve dwindled. Thus, all projection made earlier on the growth of economy has been lowered. This means reduction in productive capacity, squeeze in social expenditure, fall in public expenditure and decline in infrastructural development. This amounts to lesser investment to create the required employment and hence, threaten sustainable reduction in poverty and inequality.
Against this backdrop, the key question is: will the three-year IMF– MEFP programme — a programme of lower spending, deficit-pruning, reduction in the public services and increased rate of interest — be able to arrest the process of deceleration and lead the economy to a sustainable growth path required to create gainful employment, reduce poverty and shrink inequality?
Austerity versus growth
THE IMF-MEFP is nothing new, and its variants have been prescribed in many countries by the dogmatic establishment, though it has failed to bring results and its faulty theoretical foundation has been reasoned by heterodox economists. What, however, is new is that even the mainstream economists are questioning the feasibility of austerity-led retrieval of an economy, particularly in the backdrop of the current crisis in certain Eurozone economies. These economists argue that austerity may lead to minimisation of debt but in return slow down economic growth.
The Eurozone is facing a contagious debt crisis over the last two years, mainly because of the economic crisis in Portugal, Ireland, Italy, Spain and Greece. The sovereign debt crisis in three Eurozone countries Greece, Ireland and Portugal led them to accept the EU-IMF programmes in order to put their finances back on track and to attain sustainable growth by slashing public debt.
The argument in favour of austerity is that most of the European economies are built on the shaky foundations of property, asset or construction bubbles. There is no possibility for an economic recovery unless these EU countries get their finances in order and trim down their deficits. Austerity and economic reforms will leave European economies to hold on their own in a globalised economy. Therefore, austerity is necessary for recovering from the debt crisis.
The anti-austerity camp argues that the economic crisis and recession in Europe was caused by problems in the financial sector, and not from excessive state spending. Austerity policies will be destructive as incentives are withdrawn from the economy during the recession following the credit crisis. Austerity policies in Greece, Portugal, Spain and Italy threaten to kill, not cure, the pace of sustained growth. The contractionary monetary policy would dampen investment and squeeze the scope for employment generation, which, in turn, would stagnate economic growth. The ‘death spiral’ of austerity, contracted growth, increased debt burden fuelled borrowing in Greece. According to them, austerity has a human cost as well — the destruction of the fabric of society.
The newly elected president of France, Francois Hollande, refuses to accept the logic of austerity that is embedded in the EU fiscal treaty. He argues that austerity cannot lead to economic growth; rather, it contracts the overall economy. He therefore, placed his four proposals in place of austerity: employment generation and growth sustainability by adopting a financial transactions tax, use of EU structural funds, expansion of the resources of the European Investment Bank, and ‘project bonds’ for promoting infrastructural development.
In most cases, the orthodoxy has been focusing numerators, i.e. fiscal deficit, inflation, etc, of an economy by overlooking the denominators, i.e. growth and employment generation, for which economic sustainability depend. Moreover, numerators cannot be addressed unless economic denominators are properly taken care of.
THE GDP in terms of volume is increasing over the years while the overall growth in the GDP is increasing at a decreasing rate in recent past and might eventually bottom out in the coming years. The initial projections by the IMF-MEFP of the GDP (volume) are overambitious and the growth rate could be lower than that of the medium term macro framework of the government. At the same time, savings as a percentage of the GDP is following a downward trend and investment as a percentage of the GDP is at stuck because of the spiralling inflation. One of the critical factors behind this declining GDP growth rate is weaker net exports compared to increasing import payments. Although the revenue from value-added tax is increasing but the escalating trend of imports, debt and deficit, especially the borrowing from banking sector, is ultimately shrinking the foreign exchange reserve.
In FY2010-11, the GDP stood at Tk 7,874.95 billion (at current market price) of which Tk 1,403.81 billion came from the agricultural sector, Tk 2,174.88 billion from the industrial sector and Tk 4037.92 billion from the service sector. The GDP target for FY2011-12 is set at Tk 8,996.70 billion. The agricultural sector is targeted to contribute Tk 1,506.87 billion; the industrial sector Tk 2,351.10 billion; and the service sector Tk 4,360.64 billion to the overall figure. The GDP growth rate was 6.63 per cent in FY2005-06. This declined to 5.74 per cent in FY2008-09 and again increased to 6.66 per cent in the previous fiscal year.
The GDP projections of the government in the MTMF and the IMF-MEFP are Tk 8,834.4 billion and Tk 9,207 billion respectively. The gap between the projections of the IMF-MEFP and the MTMF on GDP projections might be Tk 372.6 billion, Tk. 682.3 billion and Tk. 942.1 billion in FY2011-12, FY2012-13 and FY2013-14 respectively. Meanwhile, the projections for real growth rate by the IMF-MEFP, the Asian Development Bank and the MTMF are at 5.5 per cent, 6.2 per cent and 7 per cent respectively.
A decomposition of GDP shows that the share of consumption is increasing sharply over the years. The share of consumption is higher compared to investment and the government expenditure. In FY2010-11, consumption accounted for Tk 6,332.15 billion which was Tk 4,384.29 billion and Tk 5,033.39 billion higher than those of investment and the government expenditure.
Savings and investment volume is going up, but at a slower rate over the years. Meanwhile, savings as a percentage of GDP is declining and investment as a per cent of the GDP is flattening. In FY2010-11 national savings and investment stood at Tk 2,236.5 billion and Tk 1,947.9 billion respectively which were 7.32 per cent and 14.91 per cent higher than that of FY2009-10. National savings as a percentage of the GDP dropped in FY2010-11 to 28.4 per cent while it was 30 per cent in the previous fiscal year. The main reason behind the decline was a reduction in private savings due to the higher rate of inflation, especially food inflation which makes people save less. Investment as a percent of the GDP increased slightly from 24.4 per cent in FY2009-10 to 24.7 per cent in FY2010-11.
The contribution of the industrial sector to the overall GDP registered a slower declining trend as businesses face shortages of power, inadequate inflow of FDI, and most importantly, failure to implement an adequate industrial policy. The contribution of the agricultural sector to the GDP is also declining. In FY2010-11 the share of agricultural, industrial and service sectors in the GDP were 19.95 per cent, 30.33 per cent and 49.72 per cent respectively. This was 9.26 per cent lower, 9.19 per cent higher and 1 percentage point lower respectively than FY1990-91.
Export earnings and import payments are going up. However, a matter of concern is the fact that imports payments surpasses export earnings, especially in the recent fiscal years. This is due to the increased payments for petroleum imports for power generation. In FY2010-11 export earning was $22,928.2 million which was 41.49 per cent higher than that of FY2009-10. According to the commerce ministry, in FY2011-12 export earnings are estimated to be Tk 26,500 million, which is 15.58 per cent higher than that of the actual earnings of the previous fiscal year. During the last nine months of the current fiscal year, export earnings have remained far from the targeted level of exports. Although it has increased in volume, it is lower than that of the same period last year. Import payments (c & f) have increased by 12.22 per cent over the same period. The increasing trend of import payments exerts a pressure on the foreign exchange reserves of the country. In terms of foreign currency inflow, the contribution of foreign aid is negligible compared to the contribution of export earnings and remittance.
Financing the mounting deficit is mainly dependent on borrowing, both domestic and foreign. In FY2011-12 the overall public debt has been estimated at Tk 402.66 billion, which is 31.59 per cent higher than that of the revised budget of FY2010-11. The share of domestic borrowing and foreign borrowing has been estimated at Tk 272.08 billion and Tk 130.58 billion respectively in the current fiscal year, which is 67.57 and 32.43 per cent of the total debt. Moreover, in FY2011-12, net foreign and domestic debt has been projected at Tk 130.58 billion and Tk 272.08 billion respectively which are 125.79 and 9.63 per cent higher than FY2010-11.
Excessive borrowing from the banking sector for financing, the deficit in the current fiscal year suggests a crowding out effect which might dampen private investment. Even the IMF-MEFP assessment on net borrowing from the banking system is more ambitious and it may trim down the opportunity of other investments as well as the production capacity of the country. Moreover, the target to attract foreign financing in the MTMF projection is also short-sighted.
Implementation of the annual development programme is much lower than the allocation. The ADP for FY2011-12 has been projected at Tk 460 billion as 5.1 per cent of the GDP. This is 19.48 per cent higher than the proposed ADP and 28.21 per cent higher than the revised ADP for FY2010-11. Continuation of the yearly data trend suggests that about 89.37 percent of the RADP might be implemented by the end of the current fiscal year whereas the monthly implementation status of the ADP suggests that only 67.16 per cent might be implemented in this fiscal year.
To be continued
Rashed Al Mahmud Titumir is chairperson of Unnayan Onneshan, a multidisciplinary think-tank based in Dhaka. This is the first chapter of the book titled, Growth or Contraction? State of Bangladesh Economy and Development, 2011–2012, published ahead of the declaration of the national budget for the coming fiscal year by Shrabon Prokashoni, Dhaka.
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