‘Subsidies are facilitating the concentration of exports, not diversification’

Thanks to the Russian invasion of Ukraine and the subsequent supply shock, the import costs of essential raw materials have risen beyond the reach of domestic producers, while the skyrocketing prices of essential commodities have left ordinary consumers distraught.

Understandably, the inflationary pressure on the economy has been a mainstay of national discourse ahead of the FY 2022-23 budget, to be presented on 9 June of this year.

Recent reports surrounding the budget suggest an intent to tame inflation by increasing the disbursement of subsidies to crucial sectors such as agriculture (Tk12,000 crore to Tk15,000 crore), power (Tk12,000 crore to Tk18,000 crore), liquefied natural gas (LNG) (Tk11,300 crore to Tk13,300 crore) and remittance incentives (Tk5,000 crores to Tk6,200 crores) while preventing an upward adjustment of prices. The government will reportedly also devalue the currency even further to make exports more competitive.

The Business Standard spoke to Dr Khondaker Golam Moazzem, Research Director at the Centre for Policy Dialogue (CPD), to discuss the implication and efficacy of increased subsidies for the economy, deficiencies in the subsidy management and pathways to increase foreign reserves.

You have raised questions about the rationalisation of subsidies, subsidy management and the failure of previous subsidies in addressing prevailing market failure and improving equity. What are the problems with the current system? Would you elaborate on this issue?

Firstly, for a least-developed country like Bangladesh, subsidies are an essential tool in addressing market failure, improving efficiency and ensuring equity. However, considering how we disburse subsidies, in terms of their selection, management, and structure, our fiscal expenditure does not uphold those principles.

For instance, we are providing subsidies to export-oriented industries like RMG. But the way these subsidies are distributed across different export-oriented industries implies that resources are being misallocated and will not facilitate the intended outcome of these subsidies.

Secondly, the disbursement of subsidies in Bangladesh is neither time-bound nor target-oriented. In other countries, the allocation of subsidies is time-bound and is specifically mentioned in the annual budget.

More importantly, the allocation of subsidies should be subject to reviews to gauge whether the act of subsidisation produced the intended results or not. However, in Bangladesh, such rigorous review mechanisms are not implemented.

Instead, if a sector receives a subsidy once, it keeps receiving these benefits indefinitely. Because of limited resources, subsidies are also disproportionately and somewhat inequitably distributed across different industrial sectors.

For example, most of the subsidies to export-oriented industries are received by one industry, depriving others in need. As a result, investors are discouraged from investing in sectors less likely to receive subsidies.

In this scenario, subsidies are currently facilitating the concentration of exports, not their diversification. These industries would be better off without any subsidy than a disproportionate disbursement where already matured industries receive more subsidies.

Thirdly, there is a political aspect at work, when it comes to the disbursement of subsidies. More precisely, political leaders of the ruling party can allegedly influence the allocation of subsidies to industries or sectors more concentrated with firms owned by them. Consequently, these firms receive more subsidies, or it is difficult to cut existing subsidies to these sectors.

On the other hand, emerging sectors like agro-processing, ceramic industries, etc., do not receive similar political goodwill and often fail to reap the benefits of subsidies. Even in some cases, it is reported that many subsidies or incentive packages or tariff increase (or decrease) policies are only introduced because of the influence of certain influential individuals or groups of individuals.

As a result, fiscal expenditure in Bangladesh is failing to address market inefficiencies and improve equity in the economy. However, I would also welcome the recent initiatives – although at a smaller scale – to rationalise subsidies and make them time-bound.

Only in FY19, the net loss of four SoEs, BCIC, BTMC, BSFIC, and BJMC, reached Tk24.16 billion. You mentioned that the government should undertake a comprehensive review of SoEs. How is the failure of SoEs affecting subsidy management? What sort of reform would you recommend?

Mismanagement in subsidy allocation is creating problems in achieving proclaimed goals of the government as well. For instance, the government spent around Tk8,730 crores on 12 companies in capacity payment for supplying electricity since we are unable to use the surplus electricity. And Bangladesh Power Development Board (BPDB) cannot pay off these expenses with its revenues.

As a result, they ask the government for subsidies to pay off these costs, which otherwise could have been allocated to other sectors more in need. Such wastage of resources also affects the government's fiscal expenditure pattern.

On the other hand, subsidising surplus fossil-fuel-based energy is syphoning investment away from renewable energy sources. Investors find it more profitable to invest in sectors that receive subsidies. This adversely affects the government's goals to move towards and eventually achieve net-zero emissions.

In the wake of rising prices on the international market due to the Russia-Ukraine war, the amount of subsidies in the agricultural sector is being increased to Tk15,000 crore. Will this be enough to control inflationary pressure?

Because of an increase in the prices of raw materials, transportation costs and relevant commodities, there is already an inflationary pressure on the ordinary people of the country. Since we have no control over the exogenous factors, i.e., the Russia-Ukraine war, subsidising fertilisers and other commodities related to food production can at least prevent prices from rising any further and give a breathing space to the consumers and ensure food security. This is why sector-wise rationalisation of subsidies is critical to determine which sector should receive more subsidies.

It is better for us to disassociate the current inflation rate with the introduction of new subsidies. It is important to understand that introducing agricultural subsidies will not necessarily tame inflation. Instead, they will ensure that the existing inflationary pressure does not deteriorate. More precisely, the objective of these subsidies should be to ensure that domestic factors do not add to the inflationary pressure on top of external factors like the war in Ukraine.

The Ministry of Finances has reportedly decided to devalue the currency further to make exports more competitive. Is this a good decision?

Devaluing currency to make exports competitive is a superfluous argument. Currently, exports from Bangladesh are sufficiently competitive in the international market. There is no necessity to make exports more competitive by further devaluing the currency.

However, there might be the necessity to devalue the currency to prevent the rise in imports. Over the past few months, we have observed a stagnancy in the central bank's foreign reserve. Higher import demands will put more pressure on already dwindling reserves.

So, it would make sense to devalue the currency to make imports more expensive and ease the pressure on the reserve. From this point of view, it makes sense to devalue the currency to decrease imports.

But we should also keep in mind that excessive devaluation of the currency will make the imports of essential raw materials and inputs more expensive. So, we must be careful about devaluing the currency further.

Declining remittances, among other things, may lead to a decrease in foreign reserves. In this regard, the government is thinking of introducing new policies to increase remittance inflow through legal channels. Why are we observing the declining remittance inflow?

The banks in Bangladesh do not have enough foreign currencies in their vaults resulting in a mismatch between the official exchange rate (valued at Tk86.23 per USD) and the kerb market (sometimes valued at Tk90 or even Tk91 per USD).

Moreover, if currencies are not devalued, migrants begin to send money through Hundi (an illegal international market for monetary transactions across borders), and the central bank is deprived of these remittances.

For instance, the difference between bank rate and the kerb market is so high in Sri Lanka that Sri Lankan migrants are using Hundi to send remittances. As a result, their central bank is being deprived of a considerable amount of foreign currency.

A moderate devaluation of the currency would be a reasonable solution as it would encourage migrants to follow the legal channels of sending remittances. Moreover, the existing subsidies should be continued if not expanded.

The foreign exchange reserves are also expected to fall to $42 billion this financial year because of declining remittance inflows and decreasing budget support and vaccine support from development partners in addition to higher import costs than exports, according to the Bangladesh Bank. Dwindling foreign reserves was a severe problem for Sri Lanka. Should Bangladesh be concerned?

While comparing with the Sri Lankan experience, some parts of it, for instance, the immediate spike in energy prices, increase in import payments (because of more expensive inputs), and subsequent pressure on the foreign reserve etc., may be relevant to Bangladesh.

Bangladesh is also facing problems in importing necessary inputs and raw materials. For instance, we are currently failing to import the amount of LNG required to bridge the gap between domestic demand and domestic supply. Consequently, we are forced to ration gas supply in the industrial areas.

However, Bangladesh still needs not to worry about the more sinister aspects of Sri Lanka's failure, such as its failure to pay off an $8 billion debt in FY 2022. Although the cost of debt servicing in Bangladesh in the coming fiscal year will rise from about Tk69,000 crore to Tk81,000 crore in this fiscal year, unlike Sri Lanka, Bangladesh, in the foreseeable future, will not have to pay off the debt on any long-term projects. Bangladesh still boasts a considerably large foreign reserve and can easily take out loans to finance its expenditure.

It was suggested that the government should take short-term loans from multilateral agencies or bilateral sources to pay its energy-related payments. For instance, in 2007, the government took out a loan worth $525 million from the Islamic Development Bank to pay off its energy expenses. In 2018, the government also wanted to take out another $1 billion loan.