Policy Research Institute - PRI Bangladesh

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IMF's reform recipe to impact new budget

News Published: Friday, May 25, 2012

Eye on Budget
IMF's reform recipe to impact new budget
Economists say the reforms will benefit the economy

Friday, May 25, 2012
Rejaul Karim Byron

IMF conditions will have a sizable impact on the budget for the next fiscal year,

which economists say will boost economic reforms, but will require the government to take a few unpopular decisions just before the polls' year.

The government is going to present its third budget this year after assuming power, accepting some stringent conditions of the International Monetary Fund (IMF).
The economists say if the government can fulfil the conditions, it would create more space for development spending.

In line with the IMF conditions for getting an Extended Credit Facility (ECF) of around $1billion from the lender, the government's subsidy spending in the next budget will have to be contained within 2 percent of GDP. This year the amount of subsidy is more than 4 percent of gross domestic product (GDP) in the revised budget.

To fulfill the IMF conditions, the government will also have to hike the prices of fuel, fertiliser and electricity in the next fiscal year which is very risky for the government just before the national election year.

The IMF conditions also include reducing the government's borrowing from banks; especially borrowing from the central bank has to be kept within 1 percent of GDP; tax-revenue target has to be raised by 0.5 percentage point to 11 percent of GDP in the next fiscal year.

For achieving the targets, two new laws on value added tax and income tax, including various reform programmes, have to be incorporated in the revenue administration.

The government will also have to initiate various fiscal and monetary reform programmes.

Sadiq Ahmed, vice chairman of Policy Research Institute (PRI), said these targets are all feasible and in the right direction.

The targets are consistent with the sixth five-year plan of the government and the directions set in the past two budgets.

"So, it is hard to find fault with these targets. If properly implemented, the overall effect of these policies would be positive for economic growth and poverty reduction.”

World Bank's Senior Economist Zahid Hussain said, “This [ECF reform programme] will create space to boost ADP spending which will benefit further if aid utilisation is improved.”

Ahmed of the PRI said the investment rate in the past few years has been stagnant at 24-25 percent of GDP. To achieve the sixth five-year plan's growth and employment targets, the investment rate has to be raised to around 28 percent of GDP.

He said, though two years of the sixth five-year plan have already gone, the investment rate did not improve.

Ahmed said, “It is looking increasingly difficult that the sixth plan's growth and employment targets will be met unless massive efforts are made in the next three budgets to raise public investment and avoid a crowding out effect on private investment.”

This calls for a much more aggressive drive to raise tax revenues, reduce energy subsidies and mobilise foreign funding for investment, he added.

On whether reducing subsidy and implementing the IMF's reform programmes would put pressure on common people, Ahmed said, “I am not suggesting that all energy subsidies should be abolished. Neither should the subsidy be open-ended as presently.”

He said the government should do a proper analysis of how to limit the subsidy to a manageable amount and target it to the needy. The government should also think of alternative ways to reduce the adverse effects of higher energy prices on the poor.

Giving an example Ahmed said, instead of subsidising diesel across the board, the government could subsidise public transport, including mass transit. Countries globally have found innovative solutions to limit the fiscal cost of energy subsidies while also protecting the needs of the poor. Bangladesh can learn and adopt appropriate energy pricing policy that balances fiscal pressures with the needs of the poor, he added.

Hussain of the WB said, under the IMF's ECF programme the government has committed to moderate fiscal consolidation by narrowing fiscal deficit by one percentage point over the next three years.

The government will do it, primarily by phasing out off-budget financing of energy and fertiliser related state owned enterprises and increasing the revenue/GDP ratio, he added.

He said the next fiscal year's budget is expected to initiate a range of structural reforms that will facilitate fiscal consolidation while putting in place appropriate safeguards for vulnerable groups.

Ahmed of the PRI explained whether the reforms will go against the interest of the common people.

"I have not seen the analysis that claims that the ECF programme will hurt the common man. Most people talk about higher energy prices that are required to reduce subsidies. The fear is that this will fuel inflation and hurt the poor."

This is a hugely populist argument without solid analytical foundations, Ahmed added.

"Let us examine this argument carefully. First, there are many countries where fuel prices are not subsidised. Among them are countries that have large energy taxes and are much more energy intensive than Bangladesh. Yet we do not see inflation rates in these countries that are as high as in Bangladesh, which suggests that the underlying causes of inflation are different than global energy prices."

"Second, suppose the government continues to subsidise energy. In fiscal 2012, the subsidy (on-budget and off-budget) is estimated at around 3 percent of GDP, which is 28 percent of our total tax collection. Given other spending priorities including health, education and infrastructure, the government is forced to borrow from Bangladesh Bank to finance the subsidy. That in turn causes money supply to increase beyond prudent limit, which fuels inflation."

So energy subsidies are contributing to inflationary pressure from the financing side rather than helping control it, Ahmed said.

This is a major reason why Bangladesh has higher inflation than many countries that do not have such subsidy and do not resort to deficit financing from the central bank.

Third, it is important to ask who benefits from energy subsidies, said Ahmed.

"To my knowledge much of the energy subsidy through electricity and CNG goes to the rich. How subsidised power consumed by energy guzzling air conditioners and heavily under-priced CNG fitted in Pajeros contribute to lower inflation or equity is completely baffling to my mind."The government will also have to initiate various fiscal and monetary reform programmes.

Sadiq Ahmed, vice chairman of Policy Research Institute (PRI), said these targets are all feasible and in the right direction.

The targets are consistent with the sixth five-year plan of the government and the directions set in the past two budgets.

"So, it is hard to find fault with these targets. If properly implemented, the overall effect of these policies would be positive for economic growth and poverty reduction.”

World Bank's Senior Economist Zahid Hussain said, “This [ECF reform programme] will create space to boost ADP spending which will benefit further if aid utilisation is improved.”

Ahmed of the PRI said the investment rate in the past few years has been stagnant at 24-25 percent of GDP. To achieve the sixth five-year plan's growth and employment targets, the investment rate has to be raised to around 28 percent of GDP.

He said, though two years of the sixth five-year plan have already gone, the investment rate did not improve.

Ahmed said, “It is looking increasingly difficult that the sixth plan's growth and employment targets will be met unless massive efforts are made in the next three budgets to raise public investment and avoid a crowding out effect on private investment.”

This calls for a much more aggressive drive to raise tax revenues, reduce energy subsidies and mobilise foreign funding for investment, he added.

On whether reducing subsidy and implementing the IMF's reform programmes would put pressure on common people, Ahmed said, “I am not suggesting that all energy subsidies should be abolished. Neither should the subsidy be open-ended as presently.”

He said the government should do a proper analysis of how to limit the subsidy to a manageable amount and target it to the needy. The government should also think of alternative ways to reduce the adverse effects of higher energy prices on the poor.

Giving an example Ahmed said, instead of subsidising diesel across the board, the government could subsidise public transport, including mass transit. Countries globally have found innovative solutions to limit the fiscal cost of energy subsidies while also protecting the needs of the poor. Bangladesh can learn and adopt appropriate energy pricing policy that balances fiscal pressures with the needs of the poor, he added.

Hussain of the WB said, under the IMF's ECF programme the government has committed to moderate fiscal consolidation by narrowing fiscal deficit by one percentage point over the next three years.

The government will do it, primarily by phasing out off-budget financing of energy and fertiliser related state owned enterprises and increasing the revenue/GDP ratio, he added.

He said the next fiscal year's budget is expected to initiate a range of structural reforms that will facilitate fiscal consolidation while putting in place appropriate safeguards for vulnerable groups.

Ahmed of the PRI explained whether the reforms will go against the interest of the common people.

"I have not seen the analysis that claims that the ECF programme will hurt the common man. Most people talk about higher energy prices that are required to reduce subsidies. The fear is that this will fuel inflation and hurt the poor."

This is a hugely populist argument without solid analytical foundations, Ahmed added.

"Let us examine this argument carefully. First, there are many countries where fuel prices are not subsidised. Among them are countries that have large energy taxes and are much more energy intensive than Bangladesh. Yet we do not see inflation rates in these countries that are as high as in Bangladesh, which suggests that the underlying causes of inflation are different than global energy prices."

"Second, suppose the government continues to subsidise energy. In fiscal 2012, the subsidy (on-budget and off-budget) is estimated at around 3 percent of GDP, which is 28 percent of our total tax collection. Given other spending priorities including health, education and infrastructure, the government is forced to borrow from Bangladesh Bank to finance the subsidy. That in turn causes money supply to increase beyond prudent limit, which fuels inflation."

So energy subsidies are contributing to inflationary pressure from the financing side rather than helping control it, Ahmed said.

This is a major reason why Bangladesh has higher inflation than many countries that do not have such subsidy and do not resort to deficit financing from the central bank.

Third, it is important to ask who benefits from energy subsidies, said Ahmed.

"To my knowledge much of the energy subsidy through electricity and CNG goes to the rich. How subsidised power consumed by energy guzzling air conditioners and heavily under-priced CNG fitted in Pajeros contribute to lower inflation or equity is completely baffling to my mind."

 

Speech