The Six Billion Dollar Man

Some simple fiscal arithmetics to show a financing gap in the order of $6 billion from stong dollar and tighter money.

In its latest update on the global economy, the IMF characterises the world economic outlook as 'gloomy and more uncertain'. The world's three largest economies — the United States, euro area, and China — are all slowing, while inflation is unexpectedly higher pretty much everywhere. The global lender has downgraded its forecasts, and still warns of downside risks of a protracted war in Ukraine, stubbornly high and persistent inflation, and socio-political unrest. 

The global slowdown is hitting the emerging and developing countries particularly hard. Whereas during the onset of the pandemic, and in many cases during the Global Financial Crisis of the late 2000s, governments loosened the purse strings to support the private sector, this is neither appropriate nor feasible today. 

In an already inflationary environment, more government spending and tax cuts are likely to worsen the cost of living pressures. And in any case, most countries lack the fiscal space to spend given the sharp rise in debt during the pandemic. 

Indeed, images beaming from Sri Lanka are a stark reminder that the spectre of debt crisis has returned. Citing IMF analysis, the Economist magazine reports that 53 emerging and developing countries might be vulnerable to a debt crisis because they have either unsustainably high debt, defaulted on some debt already, or have bonds trading at distressed levels. 

Considering all that, it shouldn't at all be surprising that Bangladesh is also facing serious economic headwinds. And if these headwinds result in the country approaching multilateral institutions and development partners, well that shouldn't really come as a surprise either. 

In fact, institutions such as the IMF exist for precisely such eventualities. And under certain circumstances, a country approaching these institutions for loans and assistance can in fact boost confidence and avert a worse economic crisis. 

Under certain circumstances, and in some cases — whether Bangladesh is such a case remains to be seen, with a very poor opening to the innings (use your favourite cricketing metaphor here considering the Finance Minister's cricket administrator past). 

First there were media reports of the government approaching the IMF for a $4-5 billion loan, to be supplemented by another billion or so from the World Bank and elsewhere. Then came various reports of a high-profile IMF visiting Dhaka, with updates on its consultations with and counsels to the country's economic policymakers. Then the Finance Minister stated that a loan was neither needed nor sought. The IMF team left without issuing a press release as is customary, but a spokesperson in Washington DC formally stated that Bangladesh has indeed sought a loan, with details to be sorted out over the coming months. 

The Finance Minister has since confirmed that this is indeed the case. Bangladesh has approached the Fund for around $4.5 billion, and more from the World Bank and Japan. Altogether, the government is seeking to borrow around $6 billion. 

While the smoke and mirrors around the loan played out, the country's currency tumbled. This is not surprising either — when a country approaches the IMF only to walk away, it usually means there is more trouble ahead. The Fund (and its traditional development partners) typically lend at a concessional rate, but their money comes with strings attached: conditionalities that require the borrowing government to balance budgets, reform banks, privatise loss making enterprises and so on. 

If a government declines to do these things, it's usually taken as a sign that the country's problems are intractable, that there may be more skeletons in the closet. With everyone acknowledging that loans are very much in play, one certainly hopes that Bangladesh's economy will stabilise over the coming months. 

In the meantime, what might be the reasons behind the government seeking these loans, and what conditions might the lenders ask for? Turns out that based on publicly available information — media reports confirmed by both parties as well as the IMF's latest country report on Bangladesh, the government's Medium Term Macroeconomic Policy Statement, and the Bangladesh Bank's latest Monetary Policy Statement — one can infer a lot to answer these questions.  

Firstly, Bangladesh does not appear to have sought crisis loans. Bangladesh has sought to borrow from the IMF's newly created Resilience and Sustainability Trust. This facility is supposed to help borrowers address longer term challenges such as climate change. 

Bangladesh can, however, borrow only $1 billion against this vehicle. Further, to avail this, a country must also sign up to a more standard, non-emergency, IMF programme where the country receives funds conditional on policy reforms that address structural problems over years. To put it bluntly, this is not what a country in crisis, say Sri Lanka, would be seeking. 

Secondly, Bangladesh is not likely to be in debt distress akin to Sri Lanka. According to the Debt Sustainability Analysis performed by the IMF and the World Bank in February, published as part of the Fund's Article IV report, Bangladesh is 'at a low risk of external and overall debt distress.' According to that analysis, total public debt stood at about 41% of GDP at the end of 2020-21 financial year, with 18 percentage points of that owed to foreigners. 

More than half of the foreign debt owed by the public sector was to multilateral institutions, while less than a third was owed bilaterally, with Japan being the largest creditor. Of $62 billion foreign debt owed by the government as of June 2021, only $4 billion were to China, and only $2 billion were short term. These numbers do not make a debt crisis. 

Of course, these figures are over a year old, and much has happened since. However, the debt sustainability analysis is designed to stress test a country's ability to carry and repay debt by simulating various adverse scenarios. And according to the analysis done by these Washington experts, 'external debt indicators are below their corresponding thresholds under the most extreme shocks.' By way of contrast, similar analysis performed on Sri Lanka (or Zambia, or many other countries), would have been flashing red with debt distress warning well before the pandemic. That is, Bangladesh is not likely to be looking at imminent default. 

Instead, the media reports are that the government is seeking budget support — that is, to finance the deficit. If this is the case, then the odd thing here is the timing. The financial year has just begun. Less than two months ago, the government outlined a strategy for financing the deficit, not just in the 2022-23 financial year, but for the next two years as well. 

The latest Medium Term Macroeconomic Policy Statement projects the budget deficit to narrow from 5.5% of GDP in 2022-23 to 5% in 2024-25. External sources, mainly loans, are expected to finance 2.2-2.3 percentage points of the deficits every year, the rest coming from domestic sources (borrowing from banks and national savings certificates). 

At this point, it is important to recognise the usual pattern in Bangladesh's fiscal performance: every June, an ambitious revenue target and development budget is announced with a lot of publicity; by the end of the calendar year, it becomes clear that revenue is well short of the target; expenditures are constrained accordingly and by the end of the year, the budget deficit is usually smaller than initially projected, with little financing difficulty. As the IMF says in its report, 'Fiscal discipline has kept Bangladesh at a low risk of debt distress.' 

The question then is, why might this pattern not hold currently? Why, for example, can't the government simply cut expenditure in the face of eventual revenue shortfall? And let's not forget, this is way too early in the year to even detect revenue shortfall. 

There might be two possible answers. 

First, as is well appreciated, the taka is facing strong depreciation pressure. Or more accurately, the US dollar has been appreciating strongly against most currencies, taka being no exception. The academic macroeconomic literature as well as the models and toolkits of practitioners are full of failed attempts at forecasting the exchange rate. Therefore, one shouldn't pretend to guess where the taka might settle against the dollar. Some simple arithmetic, however, can tell us how a more expensive dollar would affect the budget.

According to the government's macroeconomic policy report, the budget is predicated on an exchange rate of Tk86 per dollar. The same report projects interest payment of Tk72 billion to foreigners in 2022-23, rising to Tk135 billion in 2024-25. 

At Tk86 per dollar, these translate to around $0.8 billion nearly doubling to $1.6 billion. Suppose the exchange rate were to settle at Tk110 per dollar. This would mechanically raise interest payments to foreigners by Tk20 billion in the current financial year, and by Tk85 billion over the next three years. 

Of course, this is a very simple calculation, with everything else held unchanged. Much is changing as the dollar appreciates. For example, the interest rates are rising around the world. The interest payments mentioned above imply an effective interest rate of 1.3% this year, rising to 1.7% by 2024-25. Suppose the interest rates were to be 1.8% in each of these three years instead. The combined effect of higher interest rates and a more expensive dollar would be over Tk155 billion in extra interest payments to foreigners over the next three years than was projected in June. 

And this leads us to the second, related, explanation behind the government's fiscal recalculations: a slowing economy. 

To stem the rising inflation, central banks around the world are tightening monetary policy. The Bangladesh Bank is no exception. In its latest Monetary Policy Statement, the central bank has articulated a contractionary stance. If the monetary contraction proves effective, the economy will slow.

Instead of the 7.5% growth as projected in the budget, suppose the economy grew by 5% in 2022-23. This would mean the economy — that is, the government's revenue base — will be smaller. Applying the historical revenue-to-GDP ratio to the smaller GDP in this scenario would mean a shortfall in revenue of Tk415 billion this financial year alone, which will of course flow through to next year and beyond. 

That is, by relying on publicly available information and some simple fiscal arithmetic, it is possible to see a financing gap in the order of $6 billion (or Tk660 billion at Tk110 per dollar) over the medium term that arises from a stronger dollar and tighter money. There are far worse ways of meeting this financing gap than approaching the IMF and its traditional lending associates. Abstracting from for the braggadocious approach, let's commend the Finance Minister for shunning options such as domestic banks or other foreign lenders. 

And what might the global creditor ask of the government in return for a loan? 

The conditionalities of any IMF loans will very likely resemble the recommendations of its latest report on the country: raise revenue, make the exchange rate more flexible, clean up the banks and reform the financial sector in the short term, work on export diversification and attract foreign investment in the longer term.

This policy prescription is not particularly controversial from a textbook economic perspective. Whether this is politically palatable is a different matter altogether. And it’s reasonable to assume that the worse the pinch from the exchange and interest rates, the stricter the likely adherence to the lenders’ conditions. That, in turn, means a lot will depend on depend the country’s twin sources of foreign currency: remittance and readymade garments.

The Finance Minister has tried to explain his flip flops as a bargaining strategy, as if a loan negotiation with the IMF is similar to a haggle at the fish market! Let's hope that better sense prevails in the coming months.

A slightly smaller version was first published in The Business Standard. The title refers to the classic 1970s TV show.

Further reading

Debt

• The debt web, Mark De Broeck, March 2018.

• How to prevent the coming sovereign debt crisis, Bill Dudley, 2 February 2022.

• The global interest bill is about to jump, Economist, 5 February 2022.

• Shining a light on debt, Ceyla Pazarbasioglu and Carmen Reinhart, March 2022.

• Deciding when debt becomes unsustainable, Olivier Blanchar, March 2022.

• Steady prices, sustainable debt, Ricardo Reis, March 2022.

• The Global South’s Looming Debt Crisis—and How to Stop It, Mark Malloch-Brown, 16 March 2022.

Argentina

• The IMF bashes the IMF over Argentina, Economist, 8 January 2022.

• The IMF cannot solve Argentina’s dysfunction, Economist, 29 January 2022.

• Argentina’s IMF deal offers a warning on emerging market debt, Gillian Tett, 4 February 2022.

• An Argentinian Haircut for the IMF, Willem H Buiter, 16 February 2022.

Turkey

• Is Recep Tayyip Erdogan’s monetary policy as mad as it seems?, Economist, 27 January 2022.

• Turkey, you were doing so well!, Noah Smith, 5 February 2022.

• Why Turkey’s economic resilience has defied worst fears, Francesc Balcells, 11 February 2022.

• Turkey grapples with triple-digit inflation, Economist, 14 July 2022.

Emerging markets

• Soaring food prices threaten emerging-market currencies, Simon White, 7 March 2022.

• Containing the global shockwave - the real battle to shape the post-crisis world economy, Adam Tooze, 6 April 2022.

Pakistan

• Should IMF define Pakistan’s economic policies?, Ali Salman, 14 February 2022.

• Pakistan’s Strategic Misconceptions: Lesson From The Economic Crisis, Yousuf Nazar, 27 June 2022.

• Pakistan’s rupee falls fast as default fears intensify, Hudson Lockett, Farhan Lokhari and John Reed, 22 July 2022.

Sri Lanka

• Sri Lanka’s excessive govt spending an eye-opener, Ahsan H Mansur, 3 April 2022.

• Sri Lanka: debt default threat strains the string of pearls, Lex, 13 April 2022.

• Sri Lanka’s step towards debt repudiation, Zahid Hussain, 15 April 2022.

• Can Sri Lanka dig itself out of a $50 billion debt?, Natasha Ishak, 30 April 2022.

• China becomes wild card in Sri Lanka's debt crisis, Bharatha Mallawarachi, Krutika Pathi and Joe McDonald, 20 May 2022.

• Why Sri Lanka is having an economic crisis, Noah Smith, 12 July 2022.

Global outlook

• Downside Risks to Global Growth, Stephen S Roach, 25 April 2022.

• The Growing Threat of Global Recession, Kenneth Rogoff, 26 April 2022.

• Good Inflation News from the Bond Market, J Bradford Delong, 11 May 2022.

• Age of inflation in US will last much longer than pandemic spike, Rich Miller, 14 May 2022.

• What drives inflation?, Adam Tooze, 17 May 2022.

• Sonal Desai says the Fed has kept monetary policy too loose for too long, 23 May 2022.

• The Fed must act now to ward off the threat of stagflation, Martin Wold, 25 May 2022.

• Don’t bet on a soft landing, Nouriel Roubini, 26 May 2022.

• The World Bank's global take on the 1970s, stagflation and debt crises, Adam Tooze, 9 June 2022.

• Calibrating the polycrisis - with the help of the Bank of International Settlements, Adam Tooze, 27 June 2022.

• Olivier Blanchard on inflation, 28 June 2022.

• A stronger dollar might hit emerging economies harder this cycle, David Lubin, 28 June 2022.

• Nowcasting - the immediate outlook for the US economy, Adam Tooze, 2 July 2002.

• Brad DeLong asks what America can learn from its past bouts of inflation, 5 July 2022.

Bangladesh

• Could Bangladesh be the next Sri Lanka?, Abdullah Shibli, 8 May 2022.

• Nearly $25.45b govt debt kept out of calculation: Debapriya, 9 May 2022.

• Inflation: Is BB doing enough?, Titu Datta Gupta and Jahidul Islam, 11 May 2022.

• What is going on with Bangladesh’s economy?, Forrest Cookson, 22 May 2022.

• We are not Sri Lanka, but it does not take much to be so, KAS Murshid, 28 May 2022.

• ‘We can’t afford any further depletion of our forex reserves’ - Ahsan H Mansur, 27 July 2022.

Political fallout

• Social Unrest is Rising, Adding to Risks for Global Economy, Philip Barrett, 20 May 2022.

• Costly food and energy are fostering global unrest, Economist, 23 June 2022.