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Buy now, pay later: storing up future fiscal challenges in Bangladesh

· Bangladesh,Fiscal,Public expenditure

This Op-Ed discusses how, despite many positive aspects to Bangladesh’s public expenditure management, the country may be storing up risks for the future.

Originally appeared as an Op Ed in the Financial Express on Thursday, October 8, 2015.

Building better infrastructure, providing citizens better services and promising benefits for public servants can make life better today. Some of these things - like new roads and bridges - feed economic growth and opportunity in the future as well as today. Others - like rural grants or benefits for public servants - help to stimulate short term demand and make sure key groups of people feel included or rewarded. But everything needs to be paid for sooner or later. And with fiscal deficits, some of the things bought today will need to be paid for tomorrow, when there will be equally pressing needs.

A recent World Bank Public Expenditure Review (PER) analyzed the major spending trends in Bangladesh over the last decade. As in many developing countries with limited resources, Bangladesh faces an uphill battle meeting the many competing citizens' needs. Yet, those limited resources make it imperative to spend money wisely and be careful about promising goodies today that will need to be paid for tomorrow.

The PER finds many positives in Bangladesh’s fiscal management. Of particular note are Bangladesh’s contained public debt (just 34 percent of GDP in FY14) and public investment growth (from 27 to 33 percent of total public spending between FY10 and FY14). But Bangladesh also appears to be storing up challenges for the future.

Maintaining the shiny new infrastructure

Even through public investment has expanded fast over the last five years, spending on infrastructure maintenance has flat-lined. Over the past decade public spending on maintaining infrastructure has stagnated in real terms even as it increased in almost all other areas. According to a recent World Bank study, improving transport and connectivity within Bangladesh and between Bangladesh and the outside world is one of the keys to unlocking higher economic growth and poverty reduction. Yet, while transport and communication receives the largest share of public investment (and also of infrastructure maintenance), it also bore the brunt of reduced maintenance expenditure over the last decade. As a share of non-interest recurrent spending, maintenance shrunk from 10 to 6 percent between FY06 and FY14.

This trend is worrisome. The benefits people and businesses receive from new investments will be reduced if existing and new infrastructure is allowed to fall into disrepair. In general, it is better value-for-money to maintain existing infrastructure than be faced with a large future bill to repair or rebuild it. Several studies report that for every $1 spent on road maintenance, $3 are saved in repair costs later. To improve maintenance, better connections are needed between the investment and recurrent budgets. When a new road or bridge is being considered, for example, the future costs and administrative procedures required for the maintenance must already be taken into account.

Promising realistic and sustainable pensions

Reforms have temporarily tamed booming pensions spending but an unfunded public service pension scheme may carry heavy future liabilities. After fast growth on pensions spending between FY08 and FY11, the government enacted pension reforms in FY12, increasing the retirement age for public servants from 57 to 59 years of age. With an estimated 40,000 public servants retiring each year the impact was strong. Spending on pensions and gratuities fell by a third (from 9 percent of non-interest recurrent expenditures in FY11 to 6 percent in FY14).

While these reforms helped to address challenges related to the Civil Servant Retirement Scheme, there remain significant challenges with the unfunded General Provident Fund (GPF). Net inflows to the GPF are currently positive and partly used to finance the fiscal deficit, but net inflows risk turning negative in the future as more civil servants retire. In addition, with interest rates of 12 percent per year, liabilities can accrue quickly, and with public servants able to withdraw up to 80 percent of their savings even before retirement, the fund could lose resources quickly. A first step toward containing future pension bills will be to understand better the current liabilities. Second will be the need to take steps both to contain future liabilities and to set aside resources to cover them.

Containing interest costs

Despite reasonably low public debt, Bangladesh is already paying today for past choices. Between FY11 and FY14, non-interest recurrent spending grew by just 3 percent per year – meagre compared to the 10 percent average growth during FY06-11. What happened?

In short, interest costs ballooned, growing at around 14 percent per year over FY11-14. Interest costs increased from a decade low of 1.7 percent of GDP in FY11 to 2.1 percent in FY14, a significant amount in a country where revenue rarely reaches 11 percent of GDP. Worse, interest costs are likely to be crowding out other recurrent expenditure and already dwarf spending on many social sectors. Between FY11 and FY14, interest payments were worth almost the same as was spent on education, or similar to the amount spent on health and social welfare combined. In total, around a quarter of recurrent expenditure was on interest payments in FY15.

Why did interest costs balloon? Not because budget deficit and debt ballooned or external financing plummeted. Interest costs ballooned because the composition of domestic borrowing shifted from low interest sources (bank borrowing) to high interest sources (such as borrowing through National Savings Directorate (NSD) instruments). In FY15 alone, the stock of NSD debt increased by 38.1 percent while the stock of the central government debt to the banking system (including Bangladesh Bank) decreased by nearly 16 percent. The average interest rate on NSD borrowing is about twice the average interest rate on bank borrowing.

Value-for-money when borrowing

Borrowing can be a legitimate way to finance some human and infrastructure investment but it is important to maximize the benefits from such investments (by ensuring they are completed on time, within budget and are properly maintained) and to minimize the interest costs (which crowd out other spending). Reviewing the public debt portfolio to ensure minimal interest costs (for a given level of risk) would help to contain costs and free resources for other important spending.

This op-ed summarizes some of the findings of the recent World Bank Public Expenditure Review Update. The full report is available online: http://goo.gl/3gyjah

Originally appeared as an Op Ed in the Financial Express on Thursday, October 8, 2015.
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