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Bangladesh’s economy has been experiencing a number of headwinds, both from global and domestic sources. The global recession, exchange rate volatility, and supply chain disruptions are exacerbating internal structural issues such as a weakened banking sector, inflationary pressure, and bureaucratic inefficiencies.
The balance of payments has deteriorated over the past couple of years due to rising commodity prices, a global economic downturn impacting exports, and geopolitical instability. The depreciating currency has further increased the cost of imported essential goods, worsening the balance of payments situation, with the current account deficit reaching USD 4.9 billion in July 2023. To mitigate this, the government informally restricted the opening of LCs for non-essential imports, resulting in a current account surplus of USD 1.927 billion in FY23-24.
However, the financial account deficit soared to USD 7.3 billion between July 2023 and January 2024, nine times higher than the previous year. This spike was driven by increased interest rates on foreign loans and a depreciated domestic currency, leading businesses to start repaying foreign currency loans. Consequently, foreign exchange reserves have dwindled to below USD 20 billion over the past six months. IMF’s assistance through two payment tranches has provided some stability, but the implementation of IMF’s policy recommendations will have medium-term implications, as reflected in this year’s budget.
The proposed budget for FY2024-25 has increased marginally by 4.6% compared to the previous year, acknowledging the economic downturn. The government has realistically assumed that the tax base will not broaden significantly, despite IMF pressure to increase the tax-to-GDP ratio above 10%. Various tax benefits and waivers in sectors like consumer durables are being withdrawn, and tax holidays for companies in EZs and hi-tech parks are being phased out.
The budget deficit of 4.6% is expected to be financed primarily through international borrowing and the banking sector. While foreign borrowing provides immediate funds, it increases future repayment obligations and exposes the economy to currency risks. Domestic government borrowing mobilizes internal resources and could stimulate government investment, but heavy borrowing from domestic banks might crowd out private sector investments, making credit more difficult and expensive to obtain. The recent removal of the interest rate cap has already resulted in higher lending rates and decreased private investment.
Low-income groups have been significantly affected by the economic downturn, necessitating increased social safety net (SSN) payments from the government. However, SSN payments only increased marginally from 17% to 17.1%, insufficient to meet the needs of the economically vulnerable population. Alarmingly, allocations for Open Market Sales (OMS) have been slashed by 64%, from BDT 54,910 million to BDT 20,040 million.
Revenue projections indicate that indirect taxes, such as VAT, are expected to contribute 33.8% to the budget. This will disproportionately impact the poor and lead to further inflationary pressure. Corporate taxes have been increased by 2.5%, with incentives to encourage bank-based transactions. Companies that exclusively use bank transfers for transactions exceeding BDT 500,000 per transaction and BDT 3.6 million annually will benefit from a 25% tax rate, while others will face a 27.5% rate. However, companies may struggle to comply with these requirements due to practical challenges.
The next fiscal year will be challenging for both businesses and citizens, as inflation is unlikely to be stemmed and employment generation might stagnate due to lower private sector investments. Higher interest rates, combined with lower consumer and government spending, will discourage private investors from making fresh investments. Additionally, international investors might reconsider their plans in light of the ratification of the withdrawal of tax holidays in economic zones (EZs).
This article was authored by Zahedul Amin , Director at LightCastle Partners. For further clarifications, contact here: [email protected]
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