Students' World: Crowding out effect of public borrowing in private investment (Evidence from Bangladesh)

Chapter

One

Introduct

1.0 Origin of the Report

For ensuring quality education in the BBA programme we need to know the application of theoretical knowledge in practical field. So, in order to identify the consistencies and inconsistencies of theoretical knowledge learnt in BBA programme with the practical condition of our country’s economy we have made an empirical analysis on the crowding out effect of public borrowing on private investment as a partial requirement of our “Government Finance”. We have prepared the report for meeting the requirement of completing the course “Government Finance” under department of X, Faculty of business studies, university of Dhaka. This report is assigned to us by our honorable course teacher,

1.1 Objectives of the Report

Though the report is prepared as a partial requirement for the completion of the BBA programme, this is not the prime concern to make this report. The main intention of the study is to investigate whether there is any significant evidence of the crowding-out effect of public borrowing on private investment in the Bangladesh context. The supplementary objectives of the report are to meet up the following queries:

v Rationales for public borrowing by the government.

v What are the sectors in which Bangladesh government disburse the fund collected through public borrowing.

v Relative importance of both public borrowing and private investment.

v The impact of public borrowing on the private investment.

1.2 Methodology & Data Collection

1.2.1 Data collection:

The nature of the present study does not necessarily require the use of primary sources for data series. Therefore, the data are collected from secondary sources. The main sources forms where we have collected the information are as follows:

a) Various issues of National Accounts Statistics published by BBS provide GDP and private investment data.

b) Public borrowing figures are derived by using data collected from various issues of Economic Trends published by Bangladesh Bank, Various issues of Bangladesh Economic Review published by Ministry of Finance and documents supplied by National Saving Directorate to Bangladesh Bank.

c) On the other hand, interest rate data are easily picked up from various issues of Economic Trends.

1.2.2. Nature of the variables:

The variables used in this study can be defined as follows:

a) Private Investment: means investment made by private entrepreneurs, no matter whether they are domestic or from abroad.

b) Public Borrowing: refers to that part of total borrowing by public authorities, i.e., government itself and other public sector corporations which are sourced from domestic lenders except Bangladesh Bank. In other words, public borrowing figures show how much money is siphoned off from the funds available for potential private use.

c) GDP: conveys its usual meaning that is, value of all goods and services produced domestically.

d) Interest Rate: stands for weighted average of interest rates on advances charged by different banks. In order to escape the influences of inflation, data for all the variables except for the interest rate are taken in real terms.

1.2.3. Approach:

In this report we used four distinct approaches in addressing the crowding-out versus crowding-in issue. They are as follows:

i. The computable general equilibrium (CGE) model,

ii. IS-LM model,

iii. Model of the impact on supply side, and

iv. Estimation of the investment function.

In view of the relative advantages and higher relevance of the investment function approach, it has been employed in the current study. Accordingly a private investment demand function in Bangladesh is estimated in the present study considering domestic public borrowing from sources other than Bangladesh Bank, weighted average interest rate on advances and GDP as explanatory variables. Theory suggests that while the coefficients of GDP and the interest rate are expected to assume respectively positive and negative signs, that of public borrowing may be either positive or negative depending upon the liquidity position in the economic system, the nature of the loan backed public expenditure, psychological impact on private investors and the like.

1.3 Limitations of the Report

In every aspects of life we have to face some common contingencies, which are termed as our limitations that reduce our expected level of outcome. Thus, while preparing this report we have to encounter with some contingencies which are as follows:

First, of all, we are not enough capable of being speculative in analyzing the broad picture of the government, its functions, its structures and the relationship of it’s with the macro-economy. Thus the contents here is presented may not be able to meet up all the requirement of a prudent reader. But at the same time we confessed our intellectual incapability in some respect and give an assurance that this report will at least make some of the quests of the readers.

Time is another constraint to us which limited our effort to gather vast information regarding our report. Not only that there is a time limitation in respects to some of the data presented throughout this report which are not of most recent figures.

The basic problem we have faced to prepare this report is that we have to rely on secondary data most of the cases. As a student we can’t get the easiest access to the primary data and it is quite tough for us to collect the overall economic data.

Chapter Two

Literature Review

2.0 Definition of Government Finance:

Government Finance is the study of the role of the government in the economy. The purview of Government Finance is considered to be threefold: governmental effects on

i. efficient allocation of resources,

ii. distribution of income, and

iii. Macroeconomic stabilization.

As government is the ultimate responsible authority for the accomplishment of these tasks, it takes budgetary decisions. And very often government faces problems in the aspect of implementation of its budgetary programs. There are two possible sources open to the government to finance it activities, one is it may collect fund from foreign sources i.e. by the issuance of sovereign bonds, loans from different international lending authorities like World Bank, IMF etc. and the other one is that it can borrow from its internal sources. So, there may raise the basic question that is why government needs to borrow?

2.1 Public Borrowing:

Public borrowing or government debt or public debt or national debt, in which name it is called refers to the activities of any government to collect intended fund to finance its activities from various sources whether it may be taken domestically or internationally. It is a part of the monetary policy taken by any government.

The issue of public borrowing is an issue of much debate and historical division between the two main schools of economic thought, namely, classical and Keynesian. While classical economists take a much conservative stance on public borrowing, the Keynesians are extremely flexible towards the same. One may have the clear idea about the position of the classical regarding public borrowing from their basic belief “that government is the best which governs the least”. The classical economists suggest keeping public undertakings such as borrowing as minimum as possible.

2.2 Rationale to Public Borrowing:

As we stated earlier that the main intention of public borrowing is to finance its budgetary activities, it is not the whole scenario that is depicted. There are other reasons in support of the public borrowing, such as:

· Governments may borrow to meet temporary needs, as when estimated revenue falls below or is exceeded by estimated expenditures. Short-term treasury notes, payable by increased taxes or by greater economizing, may be issued, but such a debt should not become permanent.

· Nonetheless, many national governments incur such debt because of an unwillingness to limit spending or increase taxes for fear of the political consequences.

· Borrowing to finance public works, especially when widespread unemployment exists, is another source of public debt and is justified in part by their long-term social utility.

· The largest public debts are incurred to meet emergencies, such as war debts that arise when it is difficult to finance the extended activities of the government by new or increased taxes, or when the government must borrow abroad to finance the war effort.

2.3 Importance of Private Investment:

Private investment refers to the investment that has been made by the institutions or individuals of a country. The importance of private investment is undisputed in the economic development of a country. And once again we know that private sector is much more efficient than that of public or government sector. So, for the efficient functioning of any economy as well as a country the private sectors importance is undeniable.

2.4 Crowding-out:

In economics, crowding out is a phenomenon occurring when expansionary fiscal policy causes interest rates to rise, thereby reducing investment spending. That means increase in government spending crowds out investment spending. The following picture shows the crowding-out effect:

Figure 1: IS-LM curve & Crowding-out

The IS curve moves to the right, causing higher interest rates (i) and expansion in the "real" economy (real GDP, or Y).

Theoretically, the process of crowding-out generally works as follows: once public authorities borrow from the domestic market, there emerges a fund crisis (due to excess demand) which raises interest rate leading to the reduction of private investment. Apart from this, there are some other channels, indicated in the words of Adam Smith, through which crowding-out can occur. For example, the type of public expenditure has important bearing on private investment. If the borrowed fund is spent to produce goods and services which are considered a substitute for privately produced goods and services, the confidence in the private investors is eroded, resulting in reduced private investment. On the other hand, in the case where the public entity borrows to provide something which complements private sector products, the borrowing might have every possibility to be followed by a crowding-in effect rather than crowding-out effect even in a tight money market environment. Public borrowing can be seen by private investors as a warning signal of the government becoming bankrupt within the foreseeable future. They may also fear that government will impose higher taxes in future in order to facilitate the repayment and servicing of the loan. In that case private investors will become less enthusiastic to invest. However, policy makers have to know whether public borrowing is followed by any crowding-out effect on investment, through whatever channel, and to what extent and whether the detrimental effect of such actions outweighs the benefit coming from the use of borrowed money.

2.5 Determinant Factors of Crowding-out:

The extent to which interest rate adjustments dampen the output expansion induced by increased government spending is determined by:

§ Income increases more; interest rates increase less, the flatter LM curve.

§ Income increases less; interest rates increase less, the flatter IS curve.

§ Income and interest rates increase more the larger the multiplier, thus, the larger the horizontal shift in the IS curve.

In each case, the extent of crowding out is greater the more interest rate increases when government spending rises.

Chapter Three

Rationales of Public Borrowing by Bangladesh Government

3.0 Rationales of Public Borrowing by Bangladesh Government:

Bangladesh has a commendable record in maintaining fiscal discipline despite poor initial

Conditions and constant pressures placed on public resources by recurring natural disasters and widespread poverty reduction and social needs. The country has managed to stabilize its fiscal deficit, modestly improve revenue mobilization, lower spending, and reduce reliance on the central bank to finance public spending, stabilize the debt situation, and undertake significant reforms to improve its public financial management institutions. Despite all the positive gains, the quality of the fiscal performance remains far from satisfactory. In view of a stagnant and narrow tax base, Bangladesh’s economy is characterized by poor growth of revenue income which in turn forces the government to rely on continuous borrowing from both internal and external sources to finance the budgetary deficit. Besides, the other public sector corporations, owing to relatively weak financial position, also borrow from different sources. There are so many reasons for which Bangladesh government is engaged in public borrowing. The rationales behind public borrowing are as follows:

The prime reason for which our government is engaging in borrowing is to finance the deficit which has been prevailing in our budget. As our country is a developing country, there is a huge amount of budget deficit in our national budget every year. At the same time sources of fund to reduce this budget deficit is limited to some specific sources. That’s why our government needs to borrow.

As we all know that the main sources of revenue for a government come from tax revenue. And here in this perspective our government faces difficulties. Since our tax system is so much regressive and our tax base is narrow, it can’t generate adequate revenue that each year our government expects to do so. These contingencies forced our government to borrow from the domestic source.

Each and every year there is a huge amount of external borrowing that has been made by our government. The debt which has been taken outside form the country must be paid in future, and every year our government has to make interest payment against those foreign debts.

Social security is one of the most important concerns of any government. The government is the sole authority to ensure this facility towards every citizen of the country. Hence, government has to collect funds for running those programs.

The success of any government relies on the implementation and completion of its Annual Development Programs (ADP). There is much evidence in the past that many of our ADPs taken by those governments, has not been completed in due time period for the shortage of fund. And the funding of those programs is also a part of government policy.

Nothing is expectable, whether it is too excessive or too low. Extreme inflation and deflation is not welcome to any economy. And government is under pressure, when there is inflation or deflation over the economy and it spread out throughout the whole country. As a tool via monetary policy government introduce different policy regarding borrowing from public sector.

Chapter Four

Utilization of Public Borrowing by Bangladesh Government

4.0 Utilization of Public Borrowing:

As noted earlier that government of Bangladesh takes loan from the domestic sector that we termed as public borrowing with a view to accomplishing its manifold objectives. Thus the utilization of public borrowing is described below:

Government Budget deficit:

As a developing country we have deficit in our budget in every year. So, government needs to finance this deficit by implementing various monetary or fiscal policies. And as a tool of monetary policy it does public borrowing. During the FY 2011-12, the total revenue collection of the government is estimated at Tk. 1,18,385 crore against Tk. 95,187 crore in revised budget of FY 2010-11. The tax collection from NBR is estimated for FY 2011-12 is Tk. 91,870 crore which was Tk. 75,600 crore in FY 2010-11 that is about 21.52 percent higher than that of the previous fiscal year. The revenue expenditure in FY 2011-12 is estimated at Tk. 1,63,589 crore. In FY 2011-12, the total expenditure for development sectors is estimated at Tk. 46,000 crore and Tk. 1,02,903 crore for non-development sectors.

Figure 2: Budget Deficit as percentage of GDP

Source: Bangladesh Economic Review 2011

Accordingly, in FY 2011-12, the overall budget deficit is estimated at Tk. 45,204 crore which is 5 percent of GDP and is 0.6 percent higher than that of the previous year. In FY 2007-08, it has reached at the peak but after that deficit has turned around to five percent.

One of the prime tasks of the fiscal policy of the government is to continue endeavoring for narrowing the gap between expenditure and income in order to offset the budget deficit or to maintain it at a tolerable level. Over the past few years, the overall budget deficit registers an increasing trend that puts serious pressures on the total debt of the country.

Government Expenditure and GDP Ratio:

Though the prime objective of public borrowing is to meet up the deficit in the budget, government may borrow to make financing for its expenditures. As our economy is growing over the time government expenditures is also increasing from what it was in the past. In FY 2012-13, the government expenditure and GDP ratio might be 15.38 and it might reach to15.46 in FY 2014-15, if the current trend prevails. However, in FY 2000-01, the government expenditure and GDP ratio was 15.5 while in FY 2007-08 it has risen to 16.5. Government expenditure and GDP ratio stays between 14 to 17 percent of its GDP earnings over the years. Government expenditure and GDP ratio (in percent) is much higher than that of the government revenue and GDP ratio that keeps on increasing the deficit in successive years. Combining the government revenue and GDP ratio and government expenditure and GDP ratio, it is seen that over the time the trend of deficits might increase and it might stay around four to five percent of GDP earnings.

Figure 3: Government Expenditure and GDP Ratio (percentage)

Source: Bangladesh Bureau of Statistics (BBS)

And we are very well known that our government expenditure will increase in future also. The following table shows the probable increase of government expenditure in our country in the upcoming years:

Table 1: Government Expenditure and GDP Ratio (percentage) in upcoming years

Fiscal Year	Government expenditure-GDP ratio (percentage)
2011-12*	15.34
2012-13*	15.38
2013-14*	15.42
2014-15*	15.46

Source: Bangladesh Bureau of Statistics (BBS)

Furthermore, the total government expenditure can be split into two major types:

a. Development expenditure

b. Non-development Expenditure

Development and Non-development Expenditure:

Each year the government has to borrow from domestic and external sources to cover the budget deficit, and each year a major portion of its budget expenditure gets expanded on interest payment. It is seen that in FY 2006-07, 11 percent of the total development and non-development expenditure has been paid on interest payment while payment on social security and welfare was only 4.9 percent and payment on subsidies was 2.5 percent.

Over the time, the portions of this expenditure are increasing. In FY 2009-10, the interest payment has risen to 13.9 percent while social security and welfare and subsidies were 7.3 and 6.1 percent respectively.

Figure 4: Development and Non-development Expenditure (Interest, Social Security and Welfare and Subsidies)

Source: Bangladesh Bureau of Statistics (BBS)

Non-development Expenditure:

In case of non-development expenditure, usually the highest allocation goes to interest payment. It is seen that in FY 2006-07, the interest payment has been 17 percent of its total non-development expenditure while social security and welfare and subsidies have got an allocation of only four and 5.4 percent of its non-development expenditure respectively. In FY 2009-10, a record 19.2 percent of total non-development expenditure has been allocated as interest payment while social security and welfare and subsidies jointly have got an allocation of 16.5 percent of total non-development expenditure.

Figure 5: Non-development Expenditure (Interest, Social Security and Welfare and Subsidies)

Source: Bangladesh Bureau of Statistics (BBS)

In FY 2011-12, the interest payment has been estimated at 15.5 percent of total non-development expenditure, while the share of social security and welfare and subsidies has been reduced and estimated at eight and 5.5 percent of total non-development expenditure respectively.

Chapter Five

Public Borrowing and the Private Investment Scenario in Bangladesh

5.0 Public Borrowing Scenario in Bangladesh:

The government mainly borrows both from the Bangladesh Bank and the commercial ones. In FY 2010-11, the government has borrowed 4.43 times higher from banking sectors (BDT 11,240.5 crore) in comparison to that of FY 2001-02 indicating a sharp crowding out effect which has dampen private investments. In FY 2001-02, government has borrowed an amount of Tk. 2,534.9 crore from banking sector whereas Tk. 4,711.47 crore has been borrowed from non-banking sectors. The government has become more dependent on banking sectors other than non-banking ones for domestic financing over the time.

Figure 6: Total Public Borrowing

Source: Bangladesh Bank

The borrowing from banks as percentage of GDP has been increasing over the time. In FY 2010-11, the government borrowing from banking sector is 1.43 percent of GDP while it is 0.45 percent from non-banking sectors. However, in FY 2001-02, the government borrowing from banking sector amounts 0.93 percent of GDP while from non-banking sector it totals 1.72 percent.

In FY 2001-02, total domestic debt as percentage of GDP was 2.65 percent while in FY2010-11, it became 1.88 percent. Total domestic borrowing as percentage of GDP remains 1.5 to 3.0 percent of GDP over the last ten years.

Figure 7: Total domestic borrowing as percentage of GDP

Source: Bangladesh Bank

Continuation of current trend will result into an increasing movement in domestic debt. In FY 2013-14, the government may have to borrow Tk. 16,254.42 crore from domestic sources while it might increase to Tk. 17,755.76 crore in FY 2014-15.

Table 2: Future Domestic Borrowing

Fiscal year	Total Domestic Borrowing (in crore taka)
2011-12*	15503.751
2012-13*	16254.421
2013-14*	17005.09
2014-15*	17755.761

5.1 National savings & Investment Scenario:

It is well known to all that there is an association between savings and investment. Savings and investments are interdependent. As a developing nation we haven’t a huge amount of savings in our country but what we have is not also poor. In comparison to our savings there is a notable discrepancy between savings and investment. In FY 2014-15, the national savings might be 30.58 percent of GDP, investment 25.45 percent and gap between national savings and investment might be 5.13 percentage of GDP. The gap between national savings and investment as percentage of GDP increases over the time and makes a potential loss of output. The worrying factor in the saving investment scenario is the fact that gross national savings exceeded gross investment on a regular basis, particularly during the first half of the decade. This might indicate an existing shortfall of investment demand.

The budget for FY 2011-12 targeted a growth rate of 7 percent which requires about 30 to 35 percent investment share in GDP. Achieving this targeted rate of investment might be a challenge for the government as investment rate is around 25 percent. However, investment has traditionally been low in Bangladesh and is still far below than the required level

Figure 8: National Savings and Investment Scenario

Source: Bangladesh Bureau of Statistics, Bangladesh Bank and Finance Division

Table 3: Future Scenario of National Savings and Investment

Fiscal Year	National Savings as the percentage of GDP	Investment as the percentage of GDP	Gap between National Savings & Investment
2011-12*	28.94	24.96	4
2012-13*	29.49	25.12	4.37
2013-14*	30	25.28	4.72
2014-15*	30.58	25.45	5.13

Source: Bangladesh Bureau of Statistics, Bangladesh Bank and Finance Division

5.1.1 Public and Private Investment Scenario in Bangladesh:

There is a significant change in the pattern of public investment that has been made by our government through its various development organizations, programs and the investment different non-government organizations that means the private sector. And there is an upward trend in this respect.

Figure 9: Public and Private Investment as percentage of GDP

Source: Bangladesh Bureau of Statistics, Bangladesh Bank and Finance Division

In FY 2010-11, public investment totals Tk. 415.8 billion which is 5.3 percent of GDP and private investment amounts Tk. 1,532 billion which is 19.5 percent of GDP. In this fiscal year, the total amount of investment is Tk. 1947.9 billion. However, in FY 2001-02, public investment was 7.2 percent of GDP (Tk. 183.8 billion) and private investment was 15.8 percent of GDP (Tk. 401.5 billion). The total amount of investment in FY 2001-02 was Tk. 585.5 billion.

Figure 10: Private and Public Investment over the year

Source: Accounts & Budgeting Department, Bangladesh Bank

Chapter Six

Evidence of Crowding-out effect of Public Borrowing in Bangladesh

6.0 Crowding-out Evidence:

A careful look into factors catalyzing the public borrowing-crowding-out nexus leads to the following arguments.

6.0.1 Excess liquidity in the banking system:

As mentioned earlier, crowding-out effect of public borrowing arises due mainly to the fund scarcity in the system. The banking system of Bangladesh has long been characterized by substantial amount of excess liquidity.

Table 4: Excess liquidity scenario in the banking system over the last 16 years

Liquidity position (outstanding) in the Banking System (in billion BDT)
Period	Total Liquid Assets	Required Liquid Assets	Excess Liquidity	Excess Liquidity as % of total liquid asset	Excess Liquidity as % of GDP
Average (1990-91 to 1994-95)	70.79	58.77	12.02	16.98	0.93
Average (1995-96 to 1999-00)	126.6	99.21	27.39	21.64	1.36
2000-01	188.75	144.13	44.62	23.64	1.76
2001-02	228.28	162.41	65.87	28.85	2.41
2002-03	266.56	186.85	79.79	29.90	2.65
2003-04	286.90	169.36	117.54	40.97	3.53
2004-05	305.71	196.29	109.42	35.79	2.95
Average (2000-01 to 2004-05)	255.24	171.80	83.43	32.69	2.72
2005-06	351.47	255.56	95.91	27.29	2.30

Excess liquidity as a percentage of total liquid asset and GDP is seen to be significant every year. It is quite reasonable to view this steady overflow of liquidity as an endorsement of the fact that fund crisis channel of crowding-out effect does not work in Bangladesh. In other words, public borrowing from domestic sources other than Bangladesh Bank does not appear to exert any deterring impact on private investment by creating or exacerbating a fund crisis.

6.0.2 Private sector encounters only benign competition from the public sector:

Pursuant to a private sector development policy, Bangladesh government took gradual steps to denationalize a large part of the economy since late 70s onward. This effort began to receive huge momentum during the 90s following the adoption of Structural Adjustment Program (SAP) under the auspices of the World Bank and the IMF in the 80s. The economy’s movement towards a market based structure is still continuing. Due to such a market oriented approach to industrialization, no perceptible competition on the part of the public sector on the private investment is observed during the period under study. It is, indeed, not deniable that private goods are produced by several state owned enterprises (SOEs); and the SOEs often resort to borrowing for operating their businesses. For example, private sector is yet to invest in the production of sugar, paper, newsprint, fertilizer etc. Consequently, it is futile to say that public borrowing undertaken for public production of such goods gives rise to any crowding-out of private investment. Public production of other goods such as cosmetics, transport services, yarn, cloth etc., which are produced in the private sector as well, is also believed to exert only a minimal competition upon the private sector because public production of these goods is insignificant as compared to the national demand for these goods.

Table 5: Evidence of narrow competition offered by SOEs in the textile sector

Yarn and Cloth Production: Public versus Private Sector
Fiscal Year	Yarn Production (in million kg.)			Cloth Production ( in million meter)
Fiscal Year	Public Sector	Private Sector	Total	Public Sector	Private Sector	Total
1993-94	18.23	121.91	140.14	12.73	1035.27	1048.00
1994-95	18.13	135.24	153.37	4.65	1130.35	1135.00
1995-96	15.90	157.01	172.91	2.79	1262.43	1265.22
1996-97	7.39	186.76	194.15	0.78	1324.23	1325.01
1997-98	8.64	204.81	213.45	0.17	1394.83	1395.00
1998-99	10.02	186.76	228.84	-	1451.00	1451.00
1999-2000	13.12	240.81	251.46	-	1630.00	1630.00
2000-01	15.81	186.76	271.57	-	1845.00	1845.00
2001-02	15.39	204.81	298.50	-	2050.00	2050.00
2002-03	9.35	330.65	340.00	-	2200.00	2200.00
2003-04	9.70	370.30	380.00	-	2750.00	2750.00
2004-05*	9.48	440.52	450.00	-	3100.00	3100.00

Source: Bangladesh Economic Review (2006). * Provisional

Public sector production of yarn and cloth seems to have steadily declined to a negligible status vis-à-vis private sector production, thus creating virtually no crowding-out effect associated with competition.

6.0.3 Public borrowing is still at a sustainable level:

Although borrowing from BB has risen in the recent past, the overall debt scenario of the Bangladesh public sector is still better than many of the neighboring countries.

Table 6: Trends in Debt- GDP Ratio for some selected Asian Countries (%)

Trends in Debt- GDP Ratio for some selected Asian Countries (%)
Year	Bangladesh	India	Pakistan	Srilanka
1993	54.23	53.71	79.43	96.80
1994	57.37	55.63	-	94.86
1995	55.68	53.18	-	94.65
1996	49.68	51.03	-	92.34
1997	48.67	49.38	-	85.82
1998	45.66	51.12	79.08	90.84
1999	46.68	51.22	-	95.06
2000	50.51	52.72	74.67	96.90
2001	50.43	55.92	-	103.20
2002	53.85	60.14	-	105.54
2003	52.47	63.30	59.88	105.83
2004	52.26	62.92	67.90	98.82
2005	50.88	64.22	54.30	98.50
2006	50.86	62.17	55.00	90.60

Source: Bangladesh Economic Review (2006). * Provisional

As observed in the Table 6, while the outstanding debt-GDP ratio of Bangladesh remained stable around 50 percent over the past decade, that of Sri Lanka ranged from 85.82 to 105.83 followed by Pakistan and India ranging from 54.3 to 79.43 and 49.38 to 64.22 respectively. The debt-GDP ratio in Bangladesh has been found empirically sustainable by Islam and Biswas (2006). Despite the prevalence of default behavior on the part of SOEs, as a whole Bangladesh has earned good creditworthiness by virtue of the decent record of regularity in debt servicing.

6.1 Crowding-in Evidence:

On the other hand, the observed crowding-in effect may be interpreted from the following

Angles:

6.1.1 Transfer and subsidy programs of the government:

A good chunk of money from the government exchequer is spent each year as transfer payments for promoting private sector investment and agricultural sector and elevating the living standard of the relatively poorer segment of the society. According to official statistics, roughly BDT 117 billion was spent as subsidy and other transfer payments in FY06. Private investment in particular areas enjoys tax exemption for 5 to 7 years. The exempted period is 15 years for power generation companies. Some selected agro-based industries are allowed to receive interest rate subsidy under Equity and Entrepreneurship Fund (EEF) arrangement. The same facility is allowed for farmers under agricultural credit arrangement. Farmers are also getting subsidy in the form of reduced price of agricultural inputs. Most attractive facilities are rationed for export oriented industries. Cash incentives ranging from 5 to 30 percent are offered. Apart from cash incentives other facilities in the form of income tax exemption, tax holiday, duty-draw-back, duty free import and exemption of insurance premium are also given for those industries. On the consumption side, a significant amount of government fund flows routinely towards the hands of poor people as relief.

Table 7: Transfer program taken by the government

Government Expenditure on Subsidy and Other Transfer Payment Program (SOTP)
Fiscal Year	SOTP in billion BDT	SOTP as a % of revenue expenditure	Fiscal Year	SOTP in billion BDT	SOTP as a % of revenue expenditure
1990-91	23.92	32.72	1998-99	48.50	28.93
1991-92	22.48	28.46	1999-2000	48.46	26.27
1992-93	22.31	26.22	2000-01	55.78	27.00
1993-94	23.31	25.48	2001-02	59.15	26.07
1994-95	27.28	26.49	2002-03	70.84	27.99
1995-96	31.78	26.90	2003-04	81.86	28.83
1996-97	34.80	27.76	2004-05	104.37	31.32
1997-98	38.29	26.41	2005-06	117.05	31.35

Source: Bangladesh Economic Review 2006.

A closer look at the table suggests that about one fourth of revenue expenditure is allocated for subsidy and other transfer payments (SOTP). It can, however, be inferred that private investment is induced directly by SOTP to the industrial sector (including agro-based industries) and indirectly by the same to poor people through the consumption channel (SOTP? Consumption demand? Investment demand? Private investment?). Obviously, the fund government uses for SOTP purpose has important bearing on its borrowing decisions. It is, thus, logical to relate domestic public borrowing from sources other than Bangladesh Bank to the enhanced investment in the private sector resulting from SOTP.

6.1.2 Development expenditure:

In general, revenue budget shows a surplus balance. The overall budgetary balance becomes negative due to the Annual Development Program (ADP) component of the budget. The government has to borrow to finance that part of ADP which is not covered by surplus revenue balance. Thus, public borrowing may be thought to be linked with development expenditures. It is important to note that by definition most outcome of ADP expenditure, by means of positive externalities, would be seen as complementary to the private economic activities. Some of the sectors under ADP such as water resources, electricity, oil and gas etc. make for direct and significant external economies.

Table 8: ADP Expenditures

ADP Expenditures on Sectors Directly Complementing Private Sector (in billion BDT)
Sectors	FY99	FY00	FY01	FY02	FY03	FY04	FY05	FY06*
a. Water resource	8.77	10.66	9.83	7.6	7.33	6.79	9.13	11.12
b. Electricity	14.97	19.95	19.72	17.00	23.52	29.03	31.88	31.20
c. Oil, gas & natural resources	5.84	6.58	4.00	4.31	6.85	8.59	8.45	10.00
d. Transport	22.45	26.90	32.99	28.00	29.12	30.34	30.31	30.40
e.Communication	3.44	4.79	4.58	8.59	6.21	3.74	10.50	7.36
f. Industry	.98	2.56	5.41	2.66	1.95	4.61	5.4	4.46
g. Physical infrastructure, supply & Housing	6.70	10.83	12.12	9.31	9.60	9.74	13.60	12.16
h. Total (a-g)	63.15	82.27	88.65	77.47	84.58	92.84	108.98	107.50
Total ADP	125.09	154.17	162.40	140.90	154.34	168.17	187.70	245.00
(h) As% of total GDP	50.48	53.18	54.59	54.98	54.80	55.21	58.06	43.88

Source: Bangladesh Economic Review 2006.

As projected in Table 8, around half of the ADP budget is engaged in producing those goods and services which are postulated to directly stimulate private investment. Thus considering the structure of development expenditure and associated government borrowing it may be summed up that the crowding-in is a natural consequence of public borrowing.

6.1.3 Government microcredit program:

Alongside the SOTP and development expenditure, Bangladesh government is reported to disburse a substantial amount of microcredit every year through its different ministries and other organizations. Available statistics suggests that about BDT 10 billion out of government fund was disbursed as microcredit in the last fiscal year (BB 2006). Such microcredit programs of the government, which have bearing on public borrowing, also contribute to the crowding-in effect as recipients of microcredit add to mainly private investment from their borrowed funds.

6.1.4 ADP-black money linkage:

One explanation of crowding-in effect in Bangladesh may proceed as follows: If in a system of ‘public expenditure’, a sizeable fraction of funds are not spent on the provision of public projects but are instead pumped back into the private sector by the contractors, politicians, bureaucrats and others who conspire to fraud the public, black-money based underground economy has every likelihood to be fortified. Excess billing for services provided by contractors is believed to be a major conduit for such leakages of funds. The diversion of allocated expenditure (financed say by public borrowing) to personal use mainly by the recipient of ADP contracts form the basis of additional spending in the domestic economy into consumption or, of course, investment, especially in the construction sector. As argued frequently by knowledgeable persons and printing media, the above mentioned situation is inherent in Bangladesh economy.

Possible corruption via misappropriation of ADP funds is also argued to lead to greater private investment in selected area, and hence, again supportive of the crowding-in argument. However, just because public expenditure has positive externalities for the private economy, does not imply that these expenditures are at the optimal level or that the public expenditure programs are efficiently run.

Chapter Seven

Conclusion, Findings

The results of the study have important implications for the fiscal management. Existence

Of excess liquidity and possibility of crowding-in effect together put the fiscal authority in a position to foster private investment and hence economic growth through expanding

Borrowing backed public expenditure. However, the overall criteria that public expenditure authority ought to ensure are the transparency and efficiency in its programs. Moreover, government can avoid unnecessary inflation and external indebtedness by reducing reliance for funds on Bangladesh Bank and foreign sources as long as excess liquidity in the banking system prevails.