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The annual income and expenditure of a nation rarely match. If income exceeds expenditure the nation lends out the surplus, and when expenditure exceeds income, the country has to borrow from overseas to pay for the deficit.

Foreign lending is usually regarded as a good thing for the nation, but foreign borrowing is often looked with some anxiety. Foreign lending builds up foreign assets and earns interest income which adds to the purchasing power of the people. On the other hand, if foreign debt increases, the nation has to pay out more in debt service payments.

Consequently, it has less to spend for itself.

Spending borrowed money prudently:

However, if funds borrowed from overseas are invested judiciously to earn in excess of the debt servicing liabilities, the purchasing power of the country increases. In this case, foreign borrowing is advisable.

But when the return from foreign borrowing falls short of debt service obligations, the purchasing power actually declines below what it would have been without the borrowing.  If the growth of foreign debt is not arrested, the debt service liabilities can grow to a level that reduces the net purchasing power of the country.

If such a situation continues, the health of the economy worsens progressively and, at some point in time, it runs into a debt crisis, which may impose enormous costs on the country.

Whether such a situation could arise will be determined by mainly three factors: (1) the terms (interest rate etc.) at which the funds are borrowed, (2) exchange rate fluctuations and (3) productivity of the investment made with borrowed funds.

Any country or enterprise borrowing from overseas must weigh these factors very carefully to determine if the net return of the investment would be positive. If not, foreign borrowing should be shunned to prevent the possible development of a crisis.

Though Bangladesh is still out of the crisis zone:

Over the last quarter of a century, Bangladesh has achieved a fairly comfortable foreign debt position. The outstanding stock of foreign debt, including private debt, stood at $39 billion in 2015-16 (World Bank). This was a moderate 18.6 percent of the GDP of the country. The debt service liabilities amounted to less than 3 percent of the foreign exchange earnings of the country. Such a situation was brought about by the prudent policies of successive governments after the overthrow of the military regime of General Ershad.

During the Ershad period, the debt service payments for the foreign debt of the government was mostly well above 10 percent of the foreign exchange earnings, but by 2015-16, this was brought down to 2.2 percent.  An important factor behind the low debt service payments was the fact that Bangladesh as a least developed and low income country received loans on concessional terms, sometime at zero interest.

The relatively large stock of foreign reserves and the comfortable foreign debt situation seem to have encouraged the government to borrow more aggressively from overseas to fund mega projects, and even allow private business enterprises to borrow from overseas.

Since Bangladesh has an excellent foreign debt repayment record, several countries with surplus savings are keen to invest here. China has recently offered $24.5 billion, India $8 billion and Japan $4.5 billion in loans to fund various development projects.

The traditional lenders are also offering more loans. It is likely that more loan offers will be forthcoming.

The additional loans will entail larger debt service payments since the loans will have to be negotiated at relatively high interest rates and shorter repayment periods since Bangladesh will be no longer eligible for the concessional loans given to low income countries.

(Compare the most concessionary 20-year Indian loans at 1 percent to the normal 40-year IDA loans at 0.75 percent service charge).

If the stock of debt piles up, at some stage, the debt service liability will rise to a level that will be difficult to repay.

Therefore, it’s prudent not to borrow excessively.

Election strategy with the development pivot:

Bangladesh is currently passing through the phase in its political business cycle when the government tends to be a little profligate.

The present government will have to garner the support of the majority of the population in order to return to office in the forthcoming general election, assuming that it will be free, fair and participatory.

It may try to increase its popular support by increasing both current and development spending which may temporarily raise employment and income. The development spending is also a major source of income for party cadres including businesspeople.

Part of this income could be channelled back to electioneering to influence voting.  The government will also be reluctant to raise taxes before the election, fearing a voter backlash. It may be recalled that despite all the efforts of the Finance Minister, the Parliament did not allow the uniform VAT law to be passed.

A pre-election interlude on taxation:

The government may even reduce its effort to enforce existing tax rates. The prospect of greater desired spending financed by higher taxes at this time appears dim.

Therefore, a large gap may develop between the desired spending and the actual revenue of the government, leading to a large budget deficit on the eve of the election. The government may be tempted to borrow from overseas to fund the deficit since domestic borrowing could set it on a collision course with domestic borrowers by crowding out the credit market.

There are ample indications that the government has developed a penchant for foreign borrowing, especially when it is being flooded with credit offers from various sources, no doubt due partly to our excellent loan repayment record.

It could also get cocky and attempt to use the foreign credit offers for strategic advantages. This will not bode well for the economy in the long run.

If the government decides to accept most of the offers and signs loan deals with the countries mentioned above, the debt stock will double in a few years moving Bangladesh toward a tighter foreign debt situation. What is of real concern is that once the government gets addicted to foreign loans, it may overlook the future dangers immanent in debts and continue its borrowing spree until a debt crisis erupts.

Keeping the Sri Lankan lesson in mind:

The problem may be further compounded by private sector borrowings even though these did not have sovereign guarantees.  While this might seem to be a distant possibility now, the dynamics of the situation could push the country in that direction.

If this happens, the current authority will have left a bad legacy for successive governments.

It is advisable that the government should shun this path and maintain the current comfortable foreign debt situation.

This requires carefully vetting of foreign loan offers to ensure that the net productivity of the additional loans is greater than the additional debt service liabilities. In this event, a higher debt stock will not raise any problem for the country, on the contrary, it will add to the welfare of the people. Obviously, this requires government selecting investment projects that have high net returns.

This is not as easy as it may seem. Sri Lanka had borrowed extravagantly from China to finance such infrastructure projects as a deep sea port, coal power plant, and highways. Unfortunately, some of these projects turned out to be much less productive than what the previous government of Sri Lanka, which did the loan deals, had thought.

When debt service payments became increasingly difficult to bear, the current government was forced to lease out the sea port for 99 years to China. Incidentally, the investment projects chosen by Bangladesh government for funding by foreign loans are very similar to the investment projects of Sri Lanka.

The moral of the story: Bangladesh should do the maths very carefully before venturing into ambitious projects.

M A Taslimis a Professor of Economics of the Department of Economics, University of Dhaka, and a former Chairman of Bangladesh Tariff Commission and was a government negotiator at WTO talks.

One Response to “Genie, maybe I don’t want a foreign loan!”

  1. Eric

    Thank you for a no-nonsense down-to-earth article.
    Some creditors notably China have a propensity to overburden smaller countries with loan, especially countries it deems have long term strategic interests. Sri Lanka is not the only country that fell prey to Chinese; CPEC in Pakistan is another case in point. India though a smaller, lender by design or otherwise, tends to follow the Chinese model.
    Our growing economy will need credit for worthwhile proejcts, and good debt is good for the economy. Problem with loans for mega projects, and specially some with suppliers’ credit is that the cost of credit and other terms are more onerous making the benefit of these projects questionable. Further, cost blow out , sometimes many tiems of orginal estimates, is almost guranateed in such projects, forcing the borrower to seek more credit.
    Bangladesh’s fiscal responsibily for overseas borrowing so far has been credible and one hopes this won’t be compromised by political expediency.

    Reply

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