A Review of Public Expenditures in Bangladesh: Evidence on Sustainability and Cyclicality

Abstract

Fiscal discipline has been a strength in Bangladesh’s macroeconomic management. Budget deficits have been consistently maintained at prudent levels over time. Consequently, public debt is low, and Bangladesh is assessed to be at low risk of debt distress over the medium to long term. This assumes sustained economic growth at 6.5–7 percent every year for the next 20 years. However, contingent liabilities, particularly those from state-owned financial and non-financial enterprises, risk putting pressure on the fiscal stance. Low revenue mobilization and weak public investment management have limited the growth and equity impact of fiscal policy. Tax revenues and expenditures also appear to be procyclical, implying that fiscal policy does not act as an automatic stabilizer, thus complicating the management of macroeconomic stability challenges.

We would like to acknowledge the research support provided by Afroza Alam, Research Analyst, World Bank Dhaka office.

Annex

1.1 Framework for Long-Run Sustainability Assessment

The following is a reproduction from the World Bank, Public Expenditure and Institutional Review 2010.

The government’s flow budget constraint can be written as

$$ {b}_t=\left(1+r\right){b}_{t-1}-{x}_t-{\sigma}_t, $$

(6.1)

where b_t is the end-of-period stock of real debt, x_t is the real primary balance, and σ_t is the real value of seigniorage revenue.

Forward iteration on this equation combined with the condition

$$ {\displaystyle \begin{array}{l}\lim {\left(1+r\right)}^{-\left(j+1\right)}{b}_{t+j}=0\\ {}j\to \infty \end{array}} $$

(6.2)

implies

$$ {b}_{t-1}=\sum \limits_{i=0}^{\infty }{\left(1+r\right)}^{-\left(i+1\right)}\left({x}_{t+i}+{\sigma}_{t+i}\right) $$

(6.3)

This is the government’s lifetime budget constraint. It states that the government finances its debt at the end of period t − 1 by, from date t forward, raising seigniorage revenue and running primary surpluses with an equal present value.

The most basic tool for fiscal sustainability analysis uses a steady-state version of this lifetime budget constraint. To begin, consistent with the presentation in most World Bank and IMF documents, it is useful to rewrite (6.3) in terms of stocks and flows expressed as fractions of GDP. Let y_t represent real GDP, define ${\overline{b}}_t=\raisebox{1ex}{${b}_t$}\!\left/ \!\raisebox{-1ex}{${y}_t$}\right.,{\overline{x}}_t=\raisebox{1ex}{${x}_t$}\!\left/ \!\raisebox{-1ex}{${y}_t$}\right. and\kern0.24em {\overline{\sigma}}_t=\raisebox{1ex}{${\sigma}_t$}\!\left/ \!\raisebox{-1ex}{${y}_t$}\right.$. Given this notation, Eq. 6.3 can be rewritten as

$$ {\displaystyle \begin{array}{l}{\overline b_{t-1}}{y}_{t-1}=\sum \limits_{i=0}^{\infty}{\left(1+r\right)}^{-\left(i+1\right)}\left({\overline{x}}_{t+i}+{\overline{\sigma}}_{t+i}\right){y}_{t+i}\kern0.24em \mathrm{or}\\ {}\;{\overline b}_{t-1}=\sum \limits_{i=0}^{\infty}{\left(1+r\right)}^{-\left(i+1\right)}\left({{\overline x}}_{t+i}+{{\overline \sigma}}_{t+i}\right)\frac{y_{t+i}}{y_{t-1}}\end{array}}$$

(6.4)

Imagine a steady state in which (i) real GDP grows at a constant rate g, so that $\raisebox{1ex}{${y}_t$}\!\left/ \!\raisebox{-1ex}{${y}_{t-1}$}\right.=1+g$, (ii) the primary surplus as a fraction of GDP is a constant $\overline{x}$, and (iii) seigniorage as a fraction of GDP is a constant $\overline{\sigma}$. In this case, Eq. 6.4 reduces to

$$ {\overline{b}}_{t-1}=\sum \limits_{t=0}^{\infty }{\left(\frac{1+g}{1+r}\right)}^{i+1}\left(\overline{x}+\overline{\sigma}\right) $$

(6.5)

Assuming r > g, (6.5) reduces to

$$ {\overline{b}}_{t-1}=\overline{b}\equiv \left(\overline{x}+\overline{\sigma}\right)/\overline{r} $$

(6.6)

where $\overline{r}=\raisebox{1ex}{$\left(r-g\right)$}\!\left/ \!\raisebox{-1ex}{$\left(1+g\right)$}\right.$.

Equation (6.6) can be used in two ways. First, one could make reasonable assumptions about the values of $\overline{x},\overline{\sigma},r$ and g based on historical trends in the country’s fiscal accounts as well as typical historical values of seigniorage revenue, the real interest rate and the real growth rate. Together these assumptions can be mapped into an estimate of $\overline{b}$ using Eq. 6.6. If the government’s actual stock of debt exceeded this estimate, then the government’s finances could be argued to be unsustainable. Alternatively, Eq. 6.6 can be rewritten as

$$ \overline{x}=r{\overline{b}}_{t-1}-\overline{\sigma}. $$

(6.7)

Given estimates of $\overline{r}$ and $\overline{\sigma}$ and data on the size of the government’s actual debt stock, b_t − 1, Eq. 6.7 can be used to determine the necessary size of the primary balance to ensure fiscal sustainability. That is, rather than setting $\overline{x}$ equal to some historical average, one can determine the value that $\overline{x}$ would need to take in the future to maintain sustainable finances.

A final interpretation of Eq. 6.7 is that if $\overline{x}$ were set consistent with it, then the debt-GDP ratio would remain constant in the steady state. In other words, when $\overline{x}$, $\overline{\sigma}$, r and g are constant and $\overline{x}$ is given by (6.7), not only will the government’s finances be sustainable, but it will also be true that ${\overline{b}}_t$ will be constant and equal to $\overline{b}$.

How to calculate $\overline{\sigma}$? Assume base money is a constant fraction of GDP: $\raisebox{1ex}{${M}_t$}\!\left/ \!\raisebox{-1ex}{${P}_t$}\right.{y}_t=\overline{m}$; inflation is constant at some rate π, and real growth is constant at the rate g, so that

$$ {\displaystyle \begin{array}{c}\overline{\sigma}=\frac{M_t-{M}_{t-1}}{P_t{y}_t}=\frac{M_t}{P_t{y}_t}-\frac{P_{t-1}{y}_{t-1}}{P_t{y}_t}\frac{M_{t-1}}{P_{t-1}{y}_{t-1}}\\ {}=\overline{m}-\frac{1}{\left(1+\pi \right)\left(1+g\right)}\overline{m}=\frac{\pi +g+\pi g}{\left(1+\pi \right)\left(1+g\right)}\overline{m}\equiv \overline{\sigma}.\end{array}} $$

(6.8)

With assumptions and projections regarding inflation, growth and the size of base money, one gets a benchmark value for $\overline{\sigma}$.

Table 6.6 Calculations of sustainable primary balances for a range of real GDP growth and interest rates