Fiscal Policy Of Bangladesh 503r3

Fiscal Policy in Bangladesh

Submitted By:

Md. Sumon Mia ID: 08-040 Department of Management Information system University of Dhaka

Submitted To:

Nymatul Jannat Nipa Lecturer Department of Management Information Systems

University of Dhaka

Submission Date- 12/05/14

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Letter of Transmittal 12 May,2014 Nymatul Jannat Nipa Lecturer Department of Management Information Systems University of Dhaka

Subject: Approval of Report Dear Madam, With due respect i would like to inform you that it’s a great pleasure for me to submit my report “Fiscal Policy In Bangladesh”. Throughout the completion of this report i have earned in depth, knowledge about the Fiscal Policy. i feel this report writing experience will help me to prepare more quality one in future. I would genuinely aspire any corrections and guideline as you feel necessary. Your kind advice will lead me further to the best.

Sincerely yours, Md. Sumon Mia ID: 08-040

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Acknowledgement

At the very beginning we are very pleased to successfully complete my Report writing “Fiscal Policy in Bangladesh”. I would like to express mygratitude to honorable Nymatul Jannat Nipa , Lecturer, Department of Management Information Systems, University of Dhaka,without whose proper supervision the report would have remain incomplete.

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Table of Contents

Contents

Page

Executive summary

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History of Fiscal policy

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Stances of Fiscal policy

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Fiscal policy in Bangladesh

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Conclusion

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Executive summary Fiscal Policy is one more important component of overall economic policy. Its instruments broadly consist of (i) taxes (ii) Public Borrowing (iii) Public Expenditure. The importance of fiscal policy as an instrument of economic development was first envisaged by Keynes in his General Theory wherein he showed that the total national income was an index of economic activity and brought out the relation between economic activity and total spending. The direct and indirect effects of fiscal policy on aggregate spending in the community were clearly established and as a result the budgetary policy of the government as a weapon of economic control and development came into prominence. But the Keynesian analysis of fiscal policy is, applicable to the advanced and industrialized countries and it has little relevance to underdeveloped countries. Let now look at definitions given by different economists. According to Arthur Smithies, fiscal policy means “ a policy under which the government uses its expenditure and revenue programs to produce desirable effects and to avoid undesirable effects on the national income, production and employment” GK Shaw has defined fiscal policy in these words, “We define fiscal policy to encom any decision to change the level, composition or timing of government expenditure or to vary the burden, structure or frequency of the tax payment”. A skilful management of fiscal policy instruments can go long way in maintaining economic stability and ensuring higher rates of economic growth.

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History of fiscal policy

Fiscal policy initiated from the theory propounded by John Maynard Keynes, a British economist popularly known as Keynesian economist. He states that government can influence macroeconomic productivity levels by increasing or decreasing tax level and public spending. The first monetary circular in Nigeria was issued in 1969 while a new comprehensive banking decree was promulgated these a me year, to serve as guideline for establishing and conducting banking business in Nigeria. Later, financial system was comprehensively reviewed in 1979. The review called for an increase in banking supervision and regulation to encourage specialization of financial institutions; a comprehensive compound of training and manpowered development in the banking system, and as part of the effort to improve the monetary management function of CBN, all financial institutions were required to make return on financial statistics to the CBN. The implementation of various recommendations took immediate effect. However, following the collapse of the International Oil Marketing the mild 1981, the Nigerian economy, which was mainly oil dependent, began to nosedive with negative consequences for the fiscal and monetary system.

Apart from the worsening economic condition in the 1980s, there was political in stability in addition to weak socio-cultural relations. By the end of 1985, it became an imperative evident that the economy had to beer structure din order to overcome monumental problems such as those posed by slow economic growth, unemployment, the debt burden and fundamental imbalance in the structure of production and consumption. In response to this difficult circumstance, the Nigerian government undertook a structural adjustment programmed (SAP) with respect to the economy. The financial system for instance, was first to experience radical structural changes following the adoption of the SAP in June 1986. It was aimed at restructuring the production base of the economy and promoting non-inflationary economic growth. The federal ministry of finance advice the federal government on its fiscal operation in collaborates with the central bank of Nigeria on monetary matters. In 1991, the banks and other financial institution act (BOFID) 7

formally was promulgated to replace the CBN act of 1958 and the banking degree of 1969(including later amendments). The policy brought the non-banking financial intermediaries under the supervision of CBN on the debate that such institutions are capable of influencing the monetary policy set and if not properly monitored can altered the financial sector. Since then, the Nigeria banking system has evolved rapidly in a healthy, competitive and regulative prospect till date.

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Stances of fiscal policy The three main stances of fiscal policy are: Neutral fiscal policy is usually undertaken when an economy is in equilibrium. Government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity. Expansionary fiscal policy involves government spending exceeding tax revenue, and is usually undertaken during recessions. Contradictory fiscal policy occurs when government spending is lower than tax revenue, and is usually undertaken to pay down government debt. Methods of funding

Governments spend money on a wide variety of things, from the military and police to services like education and healthcare, as well as transfer payments such as welfare benefits. This expenditure can be funded in a number of different ways: Taxation Seignior age, the benefit from printing money Borrowing money from the population or from abroad Consumption of fiscal reserves Sale of fixed assets (e.g., land)

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Fiscal policy in Bangladesh Fiscal policy in Bangladesh basically comprises activities, which the country carries out to obtain and use resources to provide services while ensuring optimum efficiency of the economic units. Fiscal Policy generally refers to the use of TAXATION and government expenditure to regulate the aggregate level of economic activity in a country. Fiscal policy in Bangladesh basically comprises activities, which the country carries out to obtain and use resources to provide services while ensuring optimum efficiency of the economic units. The policy influences the behaviour of economic forces through public finance. Major objectives of the fiscal policy of Bangladesh are to ensure macroeconomic stability of the country, promote economic growth, and develop a mechanism for equitable distribution of income. The main tools to achieve these objectives are variation in public revenue, variation in public expenditure, and management of public debt. These are reflected in the budgetary operations of the government, prepared and implemented on year-on-year basis. In the initial years of independence, the government of Bangladesh had to spend a large amount of its resources in reconstruction and rehabilitation work. It had negative public savings and limited private investment. Despite large inflows of FOREIGN AID, the increasingly large financing gap became the main concern of the government. The situation was further aggravated by frequent internal and external shocks. Under the circumstances, government fiscal policies during 1970s and 1980s were largely oriented at rehabilitating the war-torn economy as well as stabilising it from various shocks. This had gradually lead to weak fiscal structure and poor fiscal management. The tax structure was such that any increase in taxes due to built-in consequences of economic growth was virtually not possible. This was because of the fact that despite a moderate growth of the economy, INCOME DISTRIBUTION was skewed, and had been pushing more and more people below the POVERTY line each year. As such, the proportion of POPULATION with taxable surplus went down overtime. More than 80% of the total tax revenue came from indirect taxes, amongst which taxes on imports contributed about 60%. Since most imports were in the government sector and basic need-oriented, it was hardly possible to increase import duty. Despite higher production costs, prices of most public goods could not be rationalised due to socio-economic reasons. As such, these were kept lower, which resulted in inadequate cost recovery. 10

Current expenditure had always been underestimated in the country, while current surplus as well as foreign loans and grants were overestimated. Therefore, the overall fiscal deficit experienced a large variability all the time. The whole scenario may be described as such that the fiscal policies of the past could not be used as an adequate tool for 'finetuning' the economy towards achieving macro-economic stability and higher economic growth. Regular deficit financing, normally undertaken through borrowings from abroad, from BANGLADESH BANK, and from scheduled banks, has become a basic feature of the fiscal policy of the country. Opportunity of borrowing from the public by the government for financing BUDGET deficit is very limited in the country as savings capability of the people is very low. Therefore, the opportunity of non-inflationary financing of budget deficit does not exist here. Availability of foreign borrowing depends on the international liquidity situation and the prevailing circumstances in the international capital market, which is always uncertain and volatile for a country like Bangladesh. The commercial banks, because of their potential for central bank refinancing, are also not effective sources of non-inflationary finance. Given the circumstances, whatever is the size of the fiscal deficit in any particular year, a part of it cannot be financed by external borrowing and, therefore, must be financed out of central bank borrowing. As a result, the essential element of fiscal deficit in Bangladesh has become such that once a deficit is incurred, government borrowing from the Bangladesh Bank became inevitable. In the early 1990s, the government of Bangladesh undertook some comprehensive steps towards the improvement of the country's fiscal front. The major objective of the government fiscal policy was to restrict the growth of current expenditure to a level below the growth of the nominal GDP, thereby making more resources available to ANNUAL DEVELOPMENT PROGRAMME (ADP) undertaken in each year. In line with the Enhanced Structural Adjustment Facility (ESAF) of the IMF, a number of reforms were initiated, the most important of which was the introduction of VALUE ADDED TAX (VAT) in July 1991. VAT was introduced at a uniform rate of 15% at the manufacturing-cum-import level. Together with protection-neutral supplementary duties, this system largely replaced the earlier structure of differentiated sales tax on import and excise duties on domestic goods.

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In case of personal income tax, the major reforms involved the inclusion of entertainment allowances in the personal income tax base, deduction of investment in approved assets from the tax base, and an introduction of a withholding tax on dividend with limitation of special expenditure within a reasonable limit. Steps were taken to reduce interest rates on government savings instruments and subsidies for food and jute. A good number of public sector enterprises were denationalised through sales to the private sector. These reform measures resulted in a remarkable improvement in the fiscal situation of Bangladesh after 1990. The growth of current expenditures was contained below the rate of GDP growth. Tax reform led to an increase in government revenues from much below 10% of GDP in fiscal year 1989-90 to 11% in fiscal year 1991-92. This trend continued and revenue collections reached more than 12% of GDP by the FY 1994-95. This trend is continuing, although with minor fluctuations. Moreover, this was accompanied by changes in the tax structure of the country, reflected in the decline of the shares of customs duties and increase in the share of income and profit taxes in the total tax revenues in the subsequent period. As a result, the shortage of local funds that had constrained in the project implementation capacity of the country and had shrunk the country's absorptive capacity for project aid for a long period was largely removed. The improvement of the government's fiscal performance was reflected in the budgetary outcome of the country. The overall budget deficit was 8.4% of GDP during the 1980s and came down to 5.9% in 1991-92 and thus provided a breathing ground for the government. Up to 1997-98, the budget deficit could be successfully contained to less than 6%, helping to stabilise the economy to a great extent. But this could not be maintained in the following year due to the devastating and prolonged floods that occurred in the first half of 1998-99. There was a considerable slippage in the expenditure programme of the government due to floods while revenue collection lagged far behind the target. As a result, the overall budget deficit shot up to 7.8% in the FY 1998-99. Although the government took some steps, the overall deficit remained slightly above 6% in 1999-2000. Up to 1989-90, FOREIGN AID had financed the lion's share of fiscal deficit of Bangladesh. Since then there has been a considerable shift in the sources of funds for financing budget deficit. Domestic sources could provide only 15% of the total deficit during 1989-90. In contrast, in FY 1999-2000, the comparative figures for domestic and 12

foreign sources in funding the budget deficit were 47% and 53% respectively. However, an absolute decline in the flow of external funds on concessionary is also partly attributable to this. Increased dependence on local funds has largely reduced the uncertainties of the implementation of the budgetary programme. But this has also increased the risk of additional burden of higher interest costs from domestic borrowing. Efforts to generate increased domestic resources are generally based on various tax reforms as well as reforms in the financial sector. On the expenditure side, the government has given increased emphasis on human resource development and poverty alleviation programmes. Top priority has been given to improve the quality and coverage of the education system as well as health and family planning services, and social safety net pogrammes to serve vulnerable group. This is demonstrated in the in The policy influences the behavior of economic forces through public finance. Major objectives of the fiscal policy of Bangladesh are to ensure macroeconomic stability of the country, promote economic growth, and develop a mechanism for equitable distribution of income. The main tools to achieve these objectives are variation in public revenue, variation in public expenditure, and management of public debt. These are reflected in the budgetary operations of the government, prepared and implemented on year-on-year basis. In the initial years of independence, the government of Bangladesh had to spend a large amount of its resources in reconstruction and rehabilitation work. It had negative public savings and limited private investment. Despite large inflows of FOREIGN AID, the increasingly large financing gap became the main concern of the government. The situation was further aggravated by frequent internal and external shocks. Under the circumstances, government fiscal policies during 1970s and 1980s were largely oriented at rehabilitating the war-torn economy as well as stabilizing it from various shocks. This had gradually leaded to weak fiscal structure and poor fiscal management. The tax structure was such that any increase in taxes due to built-in consequences of economic growth was virtually not possible. This was because of the fact that despite a moderate growth of the economy, INCOME DISTRIBUTION was skewed, and had been pushing more and more people below the POVERTY line each year. As such, the proportion of POPULATION with taxable surplus went down overtime. More than 80% of the total tax revenue came from indirect taxes, amongst which taxes on imports contributed about 13

60%. Since most imports were in the government sector and basic need-oriented, it was hardly possible to increase import duty. Despite higher production costs, prices of most public goods could not be rationalized due to socio - economic reasons. As such, these were kept lower, which resulted in inadequate cost recovery. Taxation one of the major sources of public revenue to meet a country's revenue and development expenditures with a view to accomplishing some economic and social objectives, such as redistribution of income, price stabilization and discouraging harmful consumption. It supplements other sources of public finance such as issuance of currency notes and coins, charging for public goods and services and borrowings. Bangladesh inherited a system of taxation from its past British and Pakistani rulers. According to Article 152(1) of the Constitution of Bangladesh, taxation includes the imposition of any tax, rate, duty or impost, whether general, local or special, and tax shall be construed accordingly. To develop manpower for efficient tax istration, the government runs two training academies - BCS (Tax) Academy at DHAKA for direct tax training and Customs, Excise and Value Added Tax Training Academy at Chittagong for indirect tax training. The NATIONAL BOARD OF REVENUE (NBR) is the apex tax authority of Bangladesh and it collects around 93% of total taxes or 76% of total public revenues. The NBR portion of total taxes includes CUSTOMS DUTY, VALUE ADDED TAX (VAT), supplementary duty (SD), EXCISE DUTY, income tax, foreign travel tax, electricity duty, wealth tax , turnover tax (TT), air ticket tax, ment tax, gift tax and miscellaneous insignificant taxes. Public revenue also comes from non-tax receipts such as surplus of sector corporations, financial institutions, railways, postal department, telegraph and telephone, judicial stamp, etc, and these non-tax revenues represent around 19% of total revenues. In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services; consequently, annual inflation is also erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of in the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time. Although the present situation of inflation in Bangladesh is not very good, it is better then the previous year.

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The fiscal stance is a term that is used to describe whether fiscal policy is being used to actively expand demand and output in the economy (a reflationary or expansionary fiscal stance) or conversely to take demand out of the circular flow (a deflationary fiscal stance). A neutral fiscal stance might be shown if the government runs with a balanced budget where government spending is equal to tax revenues. Adjusting for where the economy is in the economic cycle, a neutral fiscal stance means that policy has no impact on the level of economic activity. A reflationary fiscal stance happens when the government is running a large deficit budget (i.e. G>T). Loosening the fiscal stance means the government borrows money to inject funds into the economy so as to increase the level of aggregate demand and economic activity. A deflationary fiscal stance happens when the government runs a budget surplus (i.e. G From budget scenario it is seen that government of Bangladesh is running a large budget deficit (i.e. G>T). As a result, the government borrows money to inject funds into the economy so as to increase the level of aggregate demand and economic activity.

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Conclusion Today Bangladesh is exactly 41 years old today. However, even after four decades of her independence Bangladesh still remains as one of the most impoverished countries in the world. Even though from day one of her independence government fiscal policy was targeted to improve the living standard of its people, till today poverty remains as its key challenge as its per capita income is one of the lowest in the world. Adaption of democratic free market policy back in 1990s was seen to be a major breakthrough for Bangladesh towards its economic growth and prosperity as various liberalized economic policies including its fiscal policy changes has been made to achieve the economic objectives. Therefore, this study intends to focus on identifying the impact of various fiscal policy determinants of Bangladeshi economic growth along with drawing a comparative analysis of the impact of fiscal policy variables on the economic growth of Bangladesh during the pre economic liberalization and post economic liberalization periods. Using fiscal policy variables data set from 1972 to 2009, the study concludes that government expenditure, development assistance and export are the most important factors leading to economic growth. Moreover, the study reveals is no significant difference between the economic performances measured by GDP in post liberalization and pre liberalization regime.

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