IMF's conditions: A possible chance for longer-term reforms

Once upon a time, long before the days of the internet, telegram involved wiring short messages across far-flung places. Telegram cables were the worldwide web of the 19th and 20th centuries. Telegram messages were colloquially called wires. 'Condition critical come immediately' was a particularly ominous wire as it informed the recipient that a close family member was on a deathbed. 

The IMF's recent assessment of the Bangladesh economy does not appear to contain anything that dramatic. The economy has been hit with a serious shock and needs external support, the authorities have responded but could do better, including by enacting specific measures that are conditions for the Fund's support. Further, these conditions do not require large and abrupt adjustments to the economy or policy settings. To use medical analogies, this is akin to telling a middle-aged overweight person to cut down on sugar and cholesterol and be more physically active, and not a case where double bypass surgery is required immediately lest the condition becomes critical. 

Let's unpack this by discussing first the programs Bangladesh has signed up for and then the conditions the IMF has asked for before ending with some tentative remarks.     

Bangladesh is borrowing $3.3 billion under an Extended Credit Facility / Extended Fund Facility program over the next 42 months, while another $1.4 billion will be borrowed concurrently under the Resilience and Sustainability Facility. It is important to note that the ECF/EFF arrangements are different from the IMF's Stand-By Arrangements that are deployed when a country is in an economic crisis. The ECF/EFF programs provide financial support to facilitate longer-term reforms that can help an economy avoid a crisis, with the ECF usually used for low-income countries. The RSF is a relatively new facility that is designed to help low and vulnerable middle-income countries address long-term challenges such as climate change.

That is, the IMF program that Bangladesh has entered into is not one of immediate crisis management, but one that, if properly implemented, should help the country avoid a crisis. Particularly, an ECF/EFF program is usually designed when there are issues in the fiscal and external sectors that, if left unaddressed, could metastasize into a crisis. And that is the IMF's latest assessment of the Bangladesh economy. 

According to their assessment, the economy was hit in 2022 with external shocks. Strong export growth was more than offset by stronger import growth, while remittances were yet to recover. Rising global commodity prices drove domestic inflation to a multi-year high and widened the current account deficit (the difference between how much a country saves compared with how much it invests —a deficit meaning it needs to borrow externally to finance its investment needs). This had put significant pressure on the taka, and central bank interventions to prevent further depreciation resulted in the loss of foreign reserves. With the central bank selling dollars in exchange for taka, banks faced a liquidity shortage and yields on government securities rose. While the cost of financing the budget deficit increased, revenues declined. The government responded by cutting expenditures to keep the deficit and public debt manageable. Banks were already vulnerable because of high levels of non-performing loans, particularly among the state-owned commercial banks. The cap on lending rates resulted in private-sector credit growth outpacing deposit growth.     

The IMF characterises the government's responses —the raising of the prices of fuel, fertilizer, gas and electricity, restrictions on imports, slowing the implementation of import-intensive development projects, the closing of diesel-fuelled power plants, rolling blackouts, reduced offices hours and school weeks and so on — as 'stringent demand management' that 'could prolong the ongoing hardship and will likely hurt both near-term growth and medium-term economic potential'.

Crucially, the IMF's assessment is that the current responses 'are unsustainable, as they would severely suppress domestic demand to curtail imports, thus leading to disruptive macroeconomic adjustments …. are disproportionately affecting the poor and vulnerable …. and would drag medium-term growth prospects'. And in spite of all that hardship, the country would still have an external financing gap of over $2 billion in the 2022-23 fiscal year —the current account deficit for the year is projected to be over $15 billion, with only $13 billion of financing sources identified. By 2025-26, the accumulated financing gap is projected to be around $9 billion, with the country's foreign reserve falling to levels that could cover only around 2½ months of imports.

That is, while the economy might not be in crisis currently, according to the IMF, the current path is not sustainable as it leaves the country acutely vulnerable to a crisis.

The $4.7 billion programs, however, are expected to catalyse funds from other development partners —including the World Bank, Asian Development Bank, Japan International Cooperation Agency, and the Asian Infrastructure Investment Bank —to close the $9 billion external financing gap. 

The IMF finance is contingent on the policymakers meeting a set of specific quantitative performance criteria —floors on foreign reserves and government's primary deficit and no external payments arrears —and indicative targets —ceiling on reserve money and floors on tax revenue,  priority social spending and capital expenditure —over the coming years, with instalments released only after periodic reviews.

A number of measures — conditionalities — are prescribed to meet the criteria and targets. What are these conditions? What are they supposed to achieve? Can the authorities meet them? Will they meet them?

The conditions under the ECF/EFF are called 'structural benchmarks'. One set of structural benchmarks calls for targeting additional revenue of 0.5% of GDP in the 2023-24 and 2024-25 fiscal years, rising to 0.7% of GDP in 2025-26. Policy measures that shift the tax burden from trade-related ones towards income and value-added taxes are prescribed, to be supported by tax administration reforms and capacity building, are prescribed to meet the revenue targets. The additional revenue is supposed to create fiscal space for supporting the vulnerable as well as spending that raises future growth potentials. 

Also with the objective of creating fiscal space is the expenditure measure to rationalize energy subsidies. There are three separate issues here. 

First, the current energy subsidy regime is opaque and arbitrary —the government has the discretion to change the prices of petroleum and related products including electricity. The IMF calls for a formula-based, transparent regime by the end of 2023 such that the prices faced by the consumers reflect global energy market conditions. 

Secondly, notwithstanding the recent price hikes, gas and electricity subsidies remain extensive at 0.9% of GDP in 2023-24. The IMF has asked the authorities to explore a gradual reduction of the subsidy bill. 

Thirdly, recognising the needs of the vulnerable, the program explicitly asks for additional social and development capital spending.

In addition, the Ministry of Finance is asked to improve cash management practices and develop a strategy that limits the reliance on National Savings Certificates for financing the budget deficit. Technical assistance from the IMF will be available to meet both structural benchmarks, which aim to reduce interest bills. 

Of course, interest rates are also affected by the monetary policy framework. The IMF calls the current monetary policy framework of interest rate caps, non-market NSC pricing mechanism, and the absence of a well-functioning government securities market 'eclectic' with 'opaque objectives, a multitude of policy instruments and weak communication strategy'. 

The program has asked for gradual modernization of the monetary policy framework and operations, with the aim of removal of all interest rate caps and enhanced communication and transparency by the end of the program period. Modernisation of the monetary policy framework would also require the Bangladesh Bank to focus on containing inflation and stemming reserve losses. The central bank has been asked to unify the multiple exchange rates and allow greater flexibility. 

The IMF asks the central bank to publish banks' distressed assets in the annual financial stability report by June 2023 and the Ministry of Finance to submit before parliament by September 2023 draft amendment to legislation governing banks and financial institutions to upgrade the regulatory framework to international best practices. Further, the Bangladesh Bureau of Statistics has been asked to begin publishing quarterly national accounts by the end of 2023. These measures are aimed at enhancing transparency which ought to improve economic governance. 

Finally, a number of 'reform measures' are called for as part of the RSF program that aim to build the authorities' capacity to address economic challenges emanating from climate change. The timeframe for implementing these measures are over the next few years. 

All of the above benchmarks, targets and the policy measures are sensible, and should be feasible. There is, of course, a non-trivial difference between should be feasible and will be implemented. 

For example, since other countries at similar stages of development can mobilise more revenue relative to their GDP, one might expect Bangladesh to meet the target. Against that, one might remember similar sentiments expressed by the late AMA Muhith in his first budget speech in June 2009. What makes one confident about the government's willingness to do something in the next three years what wasn't done in the last 14?      

One can pose similar questions about subsidies, banks, and all the other conditions. Perhaps the government will indeed address them because they see what has happened to Sri Lanka or Pakistan as they let problems fester for too long. But if the global economic conditions improve and the IMF financing is no longer needed, will the government remain committed to these steps?

Of course, this is something that will be answered only in future. For now, let's return to the IMF's assessment of the economy as it reels from the shock and how it is expected to recover if its lending conditions are met. 

In its last Article IV assessment of the country, published in March 2022, the IMF expected the country to run a current account deficit of 2.4 percent of GDP in 2021-22 fiscal year. Against that, the current account deficit turned out to be 4.1 percent of GDP. Even with all reform measures, targets, and benchmarks met, the current account deficit is expected to be wider than was expected last year (Chart 1). Chart 2 shows the depletion of foreign reserves, measured in months of imports, and its gradual improvement. 

Inflation of 7.6 percent was recorded in the year to June 2022, compared with 5.9 percent expected last year. Inflation is now expected to remain elevated in the year to June 2023 before easing to the previous trajectory (Chart 3). As a result of the external shocks and current policy settings, economic growth is expected to slow to 5.5 percent in 2022-23 fiscal year, but a stronger growth rate is projected towards the end of the projection period if the lending conditions are met (Chart 4). 

With the additional revenue and savings from the rationalisation of energy prices redirected to social programs, medium-term budget deficit and debt-to-GDP ratio are expected to remain similar to the trajectory projected in March 2022 (Charts 5 and 6).

Of course, there are risks to the outlook even if program conditions are fully implemented. Failure to effectively address the problems in the banking system, including high non-performing loans, is characterised as a risk with medium likelihood that, if materialised, could have a medium-to-high impact in short-to-medium term. When juxtaposed against the risks from the banking sector, the structural benchmarks for the sector appear to be rather tepid. One wonders if the risks are so significant, why not ask for more stringent mitigation measures? 

Other downside risks include intensifying spillovers from the war in Ukraine, commodity price spikes, abrupt global recession, further Covid-19 outbreaks, natural disasters, or weakened donor support to manage the Rohingya refugee crisis. Curiously absent is any mention of discrete fiscal risks from power purchasing agreements and state-owned enterprises. For example, media reports abound about the government's contractual obligations to the controversial Adani Group of India. Are there more skeletons in the fiscal closet? We don't know. Is that a major risk? Not according to the IMF it would appear. 

One hopes that they are right, but what if they aren't? 

Jyoti Rahman is an applied macroeconomist. His analyses are available at: https://jrahman.substack.com/