Should Bangladesh be worried about debt servicing?

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Debt servicing has become a growing concern for developing countries in recent times. With slow global growth, the devastation wrought by Covid-19 over the past three years, and global economic instability due to the ongoing war in Ukraine, the revenues of governments in developing countries are shrinking and their need to borrow increased. . As a result, debt repayment (principal and interest), as a ratio of income or gross national income (GNI), becomes increasingly difficult. For example, with the advent of Covid, the average external debt-to-GNI ratio of developing economies (excluding China) jumped 13 percentage points to 44% in 2020, following which developing countries have had to struggle to retain their pre-Covid human development spending.

The concern for debt service has also found an echo in the case of Bangladesh. Over the past fiscal year, the debt service-to-revenue ratio in Bangladesh has climbed to 81% from 56% in the pre-pandemic year. The increase in the debt service to revenue ratio means that today, if the government earns 100 Tk in taxes, it has to spend more than 81 Tk to repay loans, compared to 56 Tk in 2019. This simply implies that ‘Due to debt service payments, there would be fewer resources available for development and other priority spending, including those needed for post-pandemic economic recovery. This will put pressure on public finances. Resources that could have been devoted to essential sectors such as health, education or public investment are now devoted to the payment of interest.

Reimbursement of the debt must relate to the internal debt as well as to the external debt. In this context, three points are important. First, while domestic debt can be paid in terms of domestic revenue, external debt must be paid in terms of foreign currency accrued from export earnings. Second, due to its nature, the government can have more flexibility in managing domestic debt service compared to external debt service. And third, sometimes governments put more emphasis on external debt than domestic debt, even though domestic debt can be substantial. In Bangladesh, total public debt stood at $148 billion in FY2021, or about 41% of GDP. Of this amount, the external debt represented USD 62 billion, or 18% of GDP.

A close examination of Bangladesh’s debt service raises some structural problems of public debt. First, interest payments on debts remain high due to higher rates on national savings certificates, expensive bank loans, delays in project execution, as well as irrelevance and overvaluation of projects. For example, the government offers higher interest rates on national savings certificates due to the fact that people have limited sources to invest their hard-earned money. As a result, they choose to invest in risk-free national savings certificates, leading to increased government borrowing from expensive sources.

Second, due to revenue constraints, the government has opted to borrow more in recent years, including through non-concessional and firm-term loans from foreign lenders, resulting in higher repayments. Borrowings were contracted to finance current expenditure, but also to service existing debts, which represent the bulk of expenditure. Sometimes, the government has to borrow to finance big projects, the repayment of the debt of which is also consequent.

Third, in many cases, some multilateral and bilateral donors have increased their interest rates and service charges, but have reduced grace periods. For example, the World Bank, Bangladesh’s largest multilateral donor, reduced the maturity period of its loans from 40 years to 30 years and the grace period from 10 years to five to seven years, respectively. The government has also taken firm loans from bilateral donors such as China and Russia. Overall, the country had to repay its interest and principal simultaneously, which resulted in increasing repayment amounts from year to year.

Fourth, with Bangladesh graduating from the list of Least Developed Countries (LDCs), borrowing and debt repayment would become more difficult for Bangladesh in the future. In fact, since 2016 when Bangladesh upgraded to lower-middle-income (LMIC) country, loans started to get more expensive. For example, the Asian Development Bank (AfDB), Bangladesh’s second largest multilateral donor, has increased lending from its non-concessional window. Since Bangladesh became an LMIC, lending from the AfDB’s soft window, the Asian Development Fund, has declined year on year. Japan, Bangladesh’s largest bilateral donor, has also tightened its lending terms, charging an interest rate of 0.10% in recent years compared to 0.01% a few years ago.

Fifth, average revenue mobilization is quite low in Bangladesh. In FY2021, revenue mobilization in Bangladesh was around 10% of its GDP. It is less than half of that of 25% in emerging and developing Asia. The revenue to GDP ratio in Nepal is 22%, in India it is 20% and in Pakistan it is 15%. Therefore, Bangladesh has a lot of catching up to do.

In the context of the previous discussion, a crucial question is: is debt servicing under threat in Bangladesh? The answer is no.” Bangladesh’s public debt, at 41% of its GDP, is well below the 70% risk threshold estimated by the International Monetary Fund (IMF). The country’s external debt service-to-revenue ratio reached 10% in 2020, but is still below the 23% risk threshold In Bangladesh, all external debt indicators are below their corresponding risk thresholds under the most extreme shock scenario, and risks over-indebtedness remain low.

But there is no room for complacency. Bangladesh needs to be careful about its debt and debt service. Even though the amount of external debt is still well below the risk threshold, Prime Minister Sheikh Hasina recently ordered all the authorities concerned to take the necessary measures to ensure the maintenance of the country’s current position in the future. on external debt.

Measures need to be taken on both the revenue side and the debt side. On the revenue side, Bangladesh’s tax base needs to be broadened. The government had set an annual revenue collection target of 13.5% of GDP in 2020. Yet last year Bangladesh’s actual revenue collection was 9.4% of GDP. The government is committed to automating revenue administration and streamlining tax expenditures. Thus, broadening the tax base would require the use of technology for tax enforcement, while reducing spending on loss-making public enterprises. The issue of export diversification is a long-standing problem in Bangladesh. With global growth slow, this is extremely important for Bangladesh if foreign exchange earnings are to be improved.

On the debt side, Bangladesh should continue to seek concessional financing wherever possible, although with the graduation of LDCs, this could prove to be a major challenge for the country. After graduation, Bangladesh would have to borrow loans at higher rates, which would further increase the amount of its debt repayments in the near future. In this context, the country should also seek to attract non-debt-creating financial flows, such as foreign direct investment (FDI). In addition, Bangladesh should ensure optimal use of expensive loans through quality project implementation as well as verification of misuse and leakage of funds. Domestic borrowing should be given more scrutiny as it costs the economy more due to borrowing at higher commercial rates.

When it comes to servicing Bangladesh’s debt, right now no one needs to panic. However, the country must be careful so that unforeseen future shocks do not create over-indebtedness.

Selim Jahan is a former director of the Human Development Report Office and the Poverty Division at UNDP.

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