Is Bangladesh Rolling towards Debt Stress? An Exploration of Debt Sustainability in the Context of Recent External Financial Flows

Background

Public debt sustainability is an important characteristic of a country’s macroeconomic stability. Countries saddled with high debt burdens have to allocate significant shares of their resources to servicing debt instead of investment that can lead to economic growth and employment generation. Given unserviceable and rising debt, countries start experiencing debt distress and tend to seek bailout assistance from international creditors. Bailouts usually entail fiscal consolidation and austerity measures, such as decreased government expenditure and increased tax collection. A bailout in the face of debt distress is usually precipitous, leading to increases in unemployment and underemployment, decreases in wages and living standards, and a dip in the economic growth.

Recent economic history is replete with the fallouts of unsustainable debts across a wide variety of developed and developing countries. The European sovereign debt crisis, which took place in the late 2000s, and the Latin American debt crisis, which occurred in the early 1980s, are two notable cases in point. The debt-distressed countries required massive bailout assistance, in which they had to undertake severe austerity measures, from international creditors to recover from these debt crises. Due to adopting drastic austerity measures, those countries had to slash public expenditure, which lead to higher unemployment, lower income and depressed economic growth.

Historically, Bangladesh has experienced very few problems in managing its public debt. The country’s debt situation—considering both external and domestic components—has been under control when measured using conventional debt sustainability indicators. Currently, the ratio of total debt to gross domestic product (GDP) is at a reasonable level. The risk of Bangladesh falling into public debt distress is low (International Monetary Fund & International Development Association, 2016). Notably, the country has never defaulted on its external debt obligations, making it a star performer among low-income countries.

Although Bangladesh has been in a comfortable position to manage public debt, the issue of debt sustainability has assumed heightened urgency in the wake of recent developments. Since graduating to lower middle-income status in 2015, and consequently no longer being able to access loans from foreign sources at concessional interest rates, Bangladesh has been borrowing at steeper interest rates with more stringent conditionalities. The country has energetically engaged itself in securing financial assistance from Southern countries such as China, India and Russia, which entails relatively higher interest rates along with shorter repayment periods. With a view to underwrite fiscal deficits, Bangladesh has increased its reliance on sales of publicly guaranteed savings bonds (known as National Savings Certificates) that bear high interest rates, but such reliance will contribute to rising debt service obligations. Interest payments on public debt already constitute one of the largest shares of Bangladesh’s recurrent budget. Due to allocating high level of financial resources to servicing debt, the country is endowed with lower level of financial resources for allocating to other sectors, such as investment in infrastructure, health and education, which are essential for fostering its economic growth. Greater investment in infrastructure is critical for Bangladesh for attracting higher private investment, which is necessary for both generating adequate employment opportunities in the job market and fostering economic growth, and is presently in a poor condition in the country. On the other hand, Bangladesh is required to make higher investment in these social services sector to develop skilled workforce, which is essential for accomplishing higher economic growth. However, the country under-invests in the aforementioned growth-enhancing sectors while allocating substantial share of its GDP towards servicing debt. Higher levels of debt in coming years would force Bangladesh to allocate a greater share of its revenue to servicing debt, thereby shrinking the country’s capacity further to invest in those growth-promoting sectors.

If Bangladesh accumulates unsustainable levels of debt, economic growth figures projected under the Seventh Five-Year Plan (2016–2021) will be jeopardized. Less investment in growth-stimulating sectors would lead to reduced job generation, wages and subsequently, government revenue. Debt stress has often left low-income countries in medium-term vicious cycles of stunted investment, low employment, diminished well-being and increased poverty. Pre-emptive policy measures are key to avoiding such situations.

Design of the Article

This article studies Bangladesh’s emerging debt scenario by answering the following research questions: (a) What are recent trends in Bangladesh’s total public debt and external public debt? (b) Will Bangladesh be able to sustain its total and external public debt in the near future? (c) What policies need to be adopted if Bangladesh increasingly accumulates debt?

This article focuses on Bangladesh’s total public debt and external public debt. Although the country has been rapidly accumulating public domestic debt, the article does not cover it, because no reliable methodology has been devised to evaluate domestic debt sustainability. Moreover, the article does not assess Bangladesh’s private debt because there is no methodology to evaluate private debt sustainability, and there is a paucity of literature on private debt in Bangladesh.

The article adopts the debt-stabilizing primary balance approach (DSPBA) and the IMF/World Bank Debt Sustainability Framework (DSF), to respectively assess total public debt sustainability and external debt sustainability in Bangladesh. Under these two methodologies, the article undertakes simulation exercises that develop low-case alternative scenarios, which are the worst-case scenarios where the estimates of economic correlates are not realized as per predictions of the baseline scenario. These exercises examine whether Bangladesh will be able to sustain public debt in the medium and long term in alternative scenarios. The scenario building process allows the incorporation of probable external financial flows in the medium and long term, rise in the interest rate payable on debt originating from Bangladesh’s recent move to borrow from more expensive sources of finance and the incidence of the country’s inability to attain its revenue collection target in the analysis of debt sustainability. Data for economic correlates that are relevant to debt sustainability, such as total public debt, external debt, GDP and government revenue, come from national sources.

The article contributes to a large body of literature analysing debt sustainability in a number of ways. This article presents a classic case of a new class of borrowers, Bangladesh, which has always managed to sustain its debt liabilities but will face a stern test in maintaining that acclaim on the eve of large volume of external financial flows, bearing significantly higher interest rates, in the future. In addition, the article introduces newness in methodology of examining debt sustainability in which it first adopts simulation exercises to develop future scenarios of debt situation in Bangladesh, before undertaking assessment of debt sustainability in the coming years. Moreover, the article is the first study, to the authors’ knowledge, that aims to provide a comprehensive policy prescription, based on the authors’ analyses and other literatures, to manage public debt in the medium term.

Following this introduction, the second section undertakes a review of literature on public debt. The third section depicts recent trends in Bangladesh’s public debt. The next section outlines the adopted methodologies for the analysis of the sustainability of Bangladesh’s total and external public debt. The fifth section presents findings based on the adopted methodologies and simulation exercises that provide alternative scenarios. The article concludes with policy perspectives on effectively managing public debt in the medium and long terms.

Origins of Debt Stress

A country will experience debt stress when it is unable to increase its primary budget balance, which is the difference between government revenue and expenditure barring interest payments on debt, in response to a rise in its debt-to-GDP ratio. According to Cecchetti, Mohanty, and Zampolli (2010), in the years leading up to the Greek government- debt crisis, Greece accumulated unsustainable level of public debt as it borrowed massively to finance its public expenditure, which was significantly higher than the low revenue collection of its government. Moreover, Greece failed to increase its primary balance in response to the rise in its debt. As a result of perennially amassing unsustainable level of public debt without commensurate increase in the primary budget balance, Greece finally experienced the sovereign debt crisis in 2009.

Episodes of debt distress can also unfold when countries permit unregulated and excessive external financial flows without assessing their implications for macroeconomic stability. Creditors are equally responsible for these episodes when they provide loans to countries without evaluating the debt-repayment capacities of those countries. According to Delvin and Ffrench-Davis (1995), the origin of the Latin American debt crisis of the 1980s can be traced back to the actions of the three actors in the 1970s. First of all, governments of Latin American countries, such as Argentina, Brazil and Mexico, who accumulated unsustainable levels of debt rapidly by pursuing inward-looking development strategies to accomplish higher economic growth based on debt-financed infrastructure spending. Second, foreign private creditors were responsible for the precipitation of the debt crisis as they willingly lent to those countries without inspecting creditworthiness and debt-repayment capacities. Moreover, international financial institutions, such as the IMF and World Bank, were not alarmed by increasing indebtedness of these Latin American countries and did not advocate for restricting flows of external capital into those countries.

Debt distress is also observed in a country when debt-financed investments fail to generate expected returns that would be used to repay the principal plus interest on loans. Fonseka and Ranasinghe (2007) found that Sri Lanka, a developing country, experienced debt stress when its projects, funded by foreign borrowing, failed to deliver the expected returns. Presbitero (2012) found that despite having high debt-to-GDP ratios, developed countries were better able to service debt than developing countries as they were able to utilize domestic and foreign borrowings better than developing countries due to having better economic management and institutions.

Modes of Transmission of Debt Stress

Debt stress can spread to create crises when several countries obtain loans from common bank creditors. In this situation, if one country begins to experience problems in managing debt, the common creditor may call loans from other countries, which are not at risk of experiencing debt distress, in that region and reduce the availability of credit to those financially solvent countries to reduce risk in their investment portfolios and recapitalize themselves after they experience initial losses. However, those economies with low probability of accumulating unsustainable debt, in the wake of reduced credit, experience difficulty in repaying their debt obligations immediately. According to Kaminsky and Reinhart (2000), Indonesia, Malaysia, the Philippines and Thailand received loans from Japanese commercial banks before the incidence of the Thai financial crisis in 1997. Afterwards, the banks began to call loans from these East Asian countries due to which commercial bank credit in the financially solvent countries, such as Indonesia and Malaysia, reversed from an inflow of USD 50 billion to an outflow of USD 21 billion the following year. A liquidity and debt crisis known as the 1997–1998 Asian financial crisis ensued in the region. Similarly, when US banks reduced their lending to debt-distressed Latin American countries, which relied mostly on external capital from US banks to finance their expenditure programmes, and demanded that they service their debt obligations at once, the debt-ridden countries and the fiscally solvent countries faced liquidity shortfalls, which precipitated the Latin American debt crisis.

Debt stress can propagate through an economy if the central bank does not swiftly adopt appropriate monetary policy measures. Konstantakis and Michaelides (2014) found that the Federal Reserve of the United States managed to stem the transmission of the global financial crisis by quickly undertaking necessary monetary policies. On the other hand, the European Central Bank was unable to obtain the required unanimous consensus in due time to adopt appropriate monetary policies to prevent the transmission of the debt crisis in Greece, which caused the debt crisis to spread to Italy and Spain.

International portfolio investors also act as a transmission channel for debt stress when they engage in rapid sell-offs. Investors, who hold stocks and bonds of countries in the same region and with similar macroeconomic fundamentals as the debt-distressed country, will sell them off immediately by assuming that these countries will also experience debt stress. Constâncio (2012) observed that investors rapidly sold off Italian and Spanish government bonds following the incidence of debt distress in Greece. The prices of these bonds plummeted, which adversely impacted the capacity of Italy and Spain to manage public debt and eventually led them to experience debt stress. Falling bond prices, tied to both demand by investors and liquidity available to countries, substantiated investors’ suspicion that Italy and Spain would be unable to repay their debt obligations in a self-fulfilling prophecy.

Fallout of Debt Stress

Following a debt crisis, many banks are unable to recoup bad debts, their balance sheets deteriorate and they adopt a conservative stance in lending practices that shrink the availability of credit for investment in public and private sector, and subsequently lead to lower job creation and economic growth. According to Acharya, Eisert, Eufinger, and Hirsch (2014), a contraction of lending by banks after the European debt crisis led to lower investment, job generation and economic growth in euro area countries affected by the crisis.

In order to receive bailout assistance from international creditors, debt-distressed countries are required to undertake rapid fiscal consolidation measures, which includes lashing government spending and increasing tax collection. Reinhart and Rogoff (2013) asserted that reduced government spending and higher taxes in countries impacted by the European debt crisis was responsible for lower public investment, employment generation and economic growth. Also, DeLong and Summers (2012) found that decreased investment led to a spike in unemployment and massive erosion of human capital in euro area countries.

Moreover, wages and living standards deteriorate due to depreciation of the currencies of debt-distressed countries. According to Ocampo (2013), Latin American countries, which relied on external capital to finance government expenditure programmes, could not obtain external finance after the debt crisis, and had to undertake devaluation of their respective currencies and to reduce spending, which culminated into a ‘lost decade’ of depressed economic growth, high unemployment, low productivity, and falls in wages and living standards.

Policy Responses to Debt Stress

As mentioned in the subsection on origin of debt crisis, countries undergo episode of debt distress, when they are unable to increase their primary budget balance following increase in their debt-to-GDP ratio. Hence, countries can stem incidence of debt distress by raising their primary budget balance in the aftermath of an increase in debt-to-GDP ratio. According to Fincke and Greiner (2011), Germany and France, the two largest economies in the euro area, did not experience the European sovereign debt crisis as they managed to comfortably sustain public debt in the years preceding the occurrence of the debt crisis through attaining primary budget surpluses following increases in their debt-to-GDP ratios.

A country needs to adopt a conservative policy and regulatory stance regarding the new inflows of external finance. According to Delvin and Ffrench-Davis (1995), one of the lessons from the Latin American debt crisis is that countries need to properly oversee and manage inflows of external finance and regulate financial markets to simultaneously reach macroeconomic equilibrium, enhance domestic savings and boost investment performances. Countries should also be cautious in receiving external finance for ensuring macroeconomic stability. Similarly, Prizzon and Mustapha (2014) showed that inflows of less traditional official development finance, such as Eurobonds and Chinese financial assistance, into African countries must be properly managed to prevent them from falling into debt distress.

Given unfavourable external shocks, countries can sustain public debt by properly adjusting the value of their currencies if they have that option. According to Evgeny (2012), Brazil and India did not suffer the adverse consequences of the global financial crisis and accumulate unsustainable levels of debt despite being closely integrated into the global financial system. India managed public debt by undertaking devaluation of their currency, Rupee, while Brazil sustained debt by adopting a floating exchange rate, moderate inflation target rate and strict fiscal policy to rein in the amount of borrowing.

Instead of relying solely on a favourable real interest rate and economic growth rate differential, a country needs to improve its current account balance through structural change in production and export diversification to be in a comfortable position for sustaining external debt when domestic and external environments become unfavourable. According to Vaggi and Prizzon (2013), although a negative interest rate-growth differential, which occurs when the economic growth rate exceeds the real interest rate, is a necessary condition for sustaining debt, an improvement in the non-income current account (the current account balance of a country barring interest payments on external debt obligations) to be either balanced or positive is a sufficient condition for sustaining debt in low-income countries. Export diversification would benefit these countries in terms of higher foreign exchange earnings from a greater number of exports and increased resilience, linked to a larger export basket, to external shocks.

As mentioned, low-income countries can sustain debt as long as they maintain an economic growth rate that is higher than the real interest rate payable on external debt. Islam (2007) stressed that public debt was sustainable in Bangladesh from fiscal year ¹ FY1981–FY2006 due to attaining an improving primary deficit and having economic growth higher than the real interest rate. Moreover, Baduel and Price (2012) stated that external debt burden was low in low-income countries, such as Bolivia, Cameroon and Tanzania, favourably as the economic growth rates of those countries were higher than the real interest rates on debt.

Besides keeping external debt ratios at sustainable levels, countries need to enhance their revenue collection and foreign exchange earnings from exports as these income-generating sources provide countries with the resources of servicing external debt. Bangladesh needs to boost revenue collection to bring its public debt-to-revenue collection ratio to a sustainable level since a significant share of resources for servicing external debt is also obtained from tax revenue (International Monetary Fund & International Development Association, 2016). On the other hand, Islam and Faisal (2012) stressed that Bangladesh attains the financial resources for servicing external debt from its export earnings. Failure to enhance revenue collection would create a trade-off between allocating resources for servicing debt and growth-oriented sectors. Further, Islam and Faisal (2012) demonstrated that Bangladesh allocated a greater share of its export earnings to servicing debt. Therefore, the country is required to improve its export earnings to have adequate financial resources to service its impending rising debt obligations in the future.

Lessons Relevant for the Study

The literature review provides key lessons that are relevant to the study of Bangladesh’s debt sustainability. First, countries that permit excessive and unchecked flows of external finance without assessing their implications for macroeconomic stability, usually experience debt stress. Bangladesh is expected to pursue external financial flows in coming years and may risk accumulating an unsustainable level of debt if they are not managed properly. Moreover, the inability of external debt-financed projects to realize anticipated gains may push countries towards debt stress. Bangladesh could be pushed towards debt distress if external debt-financed projects fail to generate expected returns.

Second, fallout of debt stress may be transmitted throughout a country’s economy if its government and central bank are unable to deploy necessary fiscal and monetary policies at the appropriate time. In Bangladesh, debt distress can spread if the Government of Bangladesh and Bangladesh Bank fail to undertake timely policy and institutional measures to contain unsustainable debt accumulation in the wake of external financial flows.

Third, debt stress often leads to erosion of credit for investment, a spike in unemployment, declines in both income and standard of living, and deterioration of economic growth. Bangladesh’s economic advancement may be severely hampered if it begins to experience episodes of debt distress due to liquidity shortfalls that adversely affect private investment and economic growth.

Fourth, a conservative stance on external financial flows may be useful in preventing debt stress. Bangladesh would be in the advantageous position to sustain public debt if it manages inflows by properly assessing their implications for macroeconomic stability as well as the country’s ability to service debt obligations.

Recent Trends in Bangladesh’s Public Debt

From Table 1, it is evident that Bangladesh has managed to sustain public debt according to various metrics of debt sustainability in recent years. According to column 1, the average of total public debt-to-GDP ratios decreased from 41.43 per cent in FY2006–FY2010 to 34.33 per cent in FY2011–FY2015. Growth of GDP had been outpacing growth of total public debt, due to which public debt constitutes a decreasing share of GDP. However, column 2 of Table 1 depicts that share of domestic debt in total public debt increased from 45.52 per cent in FY2006–FY2010 to 57.18 per cent in FY2011–FY2015, while column 3 of Table 1 highlights that share of external debt in total public debt declined from 54.48 per cent in FY2006–FY2010 to 42.82 per cent in FY2011–FY2015. Hence, the Bangladesh government is increasing its reliance on domestic debt, entailing higher interest rates, while curbing its dependence, which bears lower interest rate, for financing its deficit. The rapid accumulation of domestic debt, which bears a higher interest rate, flags the concern that Bangladesh is accruing higher interest payments on its borrowing.

On the other hand, column 4 of Table 1 highlights that the average of shares of supplier’s credit in external debt decreased from 4.15 per cent in FY2006–FY2010 to 2.35 per cent in FY2011–FY2015. Contrariwise, column 4 of Table 1 states that average of shares of direct loans in external debt increased from 95.85 per cent to 97.65 per cent. Hence, Bangladesh has been increasing its dependence on direct loans to obtain foreign borrowing, which carry lower interest rates compared to supplier’s credit, while decreasing its reliance on supplier’s credit owing to which the interest rate payable on external debt has declined in recent years.

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Table 1.

Share and Components of Domestic Debt and External Debt (%)

	Total Public Debt			External Debt
	(1)	(2)	(3)	(4)	(5)
	Total Public Debt-to-GDP Ratio	Share of Domestic Debt in Total Public Debt	Share of External Debt in Total Public Debt	Share of Supplier’s Credit in External Debt	Share of Direct Loan in External Debt
Average for the period of FY2006–FY2010	41.43	45.52	54.48	4.15	95.85
Average for the period of FY2011–FY2015	34.33	57.18	42.82	2.35	97.65

Sources: Ministry of Finance (2015a, 2015b, 2016a), Bangladesh Bank (n.d.a, n.d.c, 2016) and Economic Relations Division (n.d.).

According to Table 2, which presents average estimates of different debt-burden indicators of DSF in the period of FY2006–FY2010 and FY2011–FY2015 for Bangladesh, the average values of ratios of external public debt to other economic correlates were considerably below their respective thresholds in the DSF, which reveals that Bangladesh has been able to sustain external debt till present. ² These averages declined considerably from FY2006–FY2010 to FY2011–FY2015. In the DSF, a country has to maintain an external debt-to-GDP ratio of 40 per cent to sustain external debt. Column 1 of Table 2 shows that the average value of external debt-to-GDP ratios declined from 22.57 per cent in FY2006–FY2010 to 14.70 per cent in FY2011–FY2015 in Bangladesh. The declining value of this ratio indicates that Bangladesh’s economic growth has outstripped accumulation of external debt.

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Table 2.

Average Values of External Debt Ratios in Debt Sustainability Framework (%)

	(1)	(2)	(3)	(4)	(5)
	Ratio of External Debt-to-GDP (Threshold = 40 %)	Ratio of External Debt-to-Revenue Collection (Threshold = 250 %)	Ratio of External Debt-to-Exports (Threshold = 150 %)	Ratio of External Debt Service-to-Revenue Collection (Threshold = 20 %)	Ratio of External Debt-to-Exports (Threshold = 20 %)
Average for the period of FY2006–FY2010	22.57	224.54	205.71	19.00	17.41
Average for the period of FY2011–FY2015	14.70	132.30	103.94	16.17	12.70

Sources: Ministry of Finance (2015a, 2015b, 2016a), Bangladesh Bank (n.d.a, n.d.c, 2016) and Economic Relations Division (n.d.).

Moreover, column 2 of Table 2 reveals that the average value of ratio of external debt to both revenue collection nearly halved from 224.54 per cent in FY2006–FY2010 to 132.30 per cent in FY2011–FY2015, which signifies that revenue collection outperformed external debt in terms of growth. On the contrary, column 3 of Table 2 shows that average value of ratio of external debt to exports decreased from 205.71 per cent in FY2006–FY2010 to 103.94 per cent in FY2011–FY2015. The decline in the average value of ratio of external debt to exports stresses that growth of exports have been higher compared to growth of external debt in Bangladesh. According to column 4 of Table 2, the average of ratios of external debt service to revenue collection plummeted from 19 per cent in FY2006–FY2010 to 16.17 per cent in FY2011–FY2015, thereby indicating that growth of revenue collection in Bangladesh has outdone growth of external debt service. The decline in values of these debt ratios reveal that Bangladesh has been in a favourable position to sustain external debt.

From column 1 of Table 3, it is evident that the average of shares of budget deficit in GDP increased from 3.54 per cent in FY2006–FY2010 to 4.36 per cent in FY2011–FY2015, which depicts that Bangladesh has managed to keep budget deficit within the desired level of 5 per cent of GDP. However, column 2 of Table 3 stresses that the average of shares of external financing in total financing decreased from 43.72 per cent to 29.68 per cent over the same periods, while column 3 of Table 3 highlights that the average of shares of domestic financing in total financing increased from 56.28 per cent to 70.32 per cent. Therefore, these estimates of budget deficit indicate that Bangladesh has been increasing its reliance on domestic sources to finance its budget deficits. Borrowing from domestic sources entails higher interest rates than borrowing from foreign sources, due to which, the Government of Bangladesh has been accumulating higher levels of debt.

On the contrary, column 4 of Table 3 denotes that the average of shares of bank loans in domestic financing of budget deficit increased from 63.86 per cent in FY2006–FY2010 to 73.45 per cent in FY2011–FY2015. In addition, column 5 of Table 3 signifies that the average of shares of non-bank loans in domestic financing of budget deficit decreased from 36.14 per cent in FY2006–FY2010 to 26.55 per cent in FY2011–FY2015. As Bangladesh has been increasing its reliance on borrowing from banks to finance its budget deficits, it has been decreasing the availability of credit for investment in the banking system, thereby crowding out private investment. Weak private investment is one of the major challenges that Bangladesh needs to address in order to attain the growth target in its Seventh Five-Year Plan, but its increasing reliance on borrowing from banks has been aggravating that challenge.

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Table 3.

Share of Sources of Budget Deficit Financing (%)

	(1)	Total Budget Deficit Financing		Domestic Financing
		(2)	(3)	(4)	(5)
	Share of Budget Deficit in GDP	Share of External Financing in Total Financing	Share of Domestic Financing in Total Financing	Share of Bank Loans in Domestic Financing	Share of Non-bank Loans in Domestic Financing
Average for the period of FY2006–FY2010	3.54	43.72	56.28	63.86	36.14
Average for the period of FY2011–FY2015	4.36	29.68	70.32	73.45	26.55

Source: Ministry of Finance (n.d.a., n.d.b., 2016b).

As it has registered robust economic growth in recent years, Bangladesh has been in a favourable position to manage public debt, maintain a relatively low real interest rate payable on debt, and improve its primary budget balance. Nonetheless, it has been increasing its reliance on domestic loans with higher interest rates compared to foreign loans, owing to which the interest rate on public debt has been increasing. Similarly, it has been increasingly resorting to domestic sources of borrowing with higher interest rates to finance its budget deficits instead of foreign sources. Further, it has been obtaining a major share of its domestic borrowing for financing budget deficits from banks which crowds out private investment that is essential for stimulating Bangladesh’s economic development.

Compared to other South Asian countries, Bangladesh is in a comfortable position to sustain debt in the medium term. Mahmood, Abby, and Sherazi (2014) marked that a necessary condition for ensuring debt sustainability is to register economic growth higher than real interest rate payable on debt. South Asian countries, such as Bangladesh and India, have fulfilled the necessary condition and have managed to sustain public debt in the process, while other South Asian countries, such as Sri Lanka and Pakistan, have been unable to fulfil the necessary condition of debt sustainability and thus have experienced problems of unsustainable debt. Moreover, the level of public debt is lowest in Bangladesh among all South Asian countries. In fact, the interest payment as a share of GDP is lower in Bangladesh compared to other South Asian countries, which signifies that Bangladesh has to apportion the lowest share of GDP in debt servicing in the region of South Asia. From estimates of debt- burden indicators of DSF, it is evident that Bangladesh is in an auspicious position to keep debt at sustainable level in the future. However, Siddiqui and Malik (2001) focused that debt-burden indicators of DSF has reached alarming levels in both Pakistan and Sri Lanka. As a matter of fact, perennial accumulation of unsustainable debt has led Sri Lanka to experience a debt crisis of sort (Foneska & Ranasinghe, 2007). On the other hand, Siddiqui and Malik (2001) stated that Pakistan has relegated from a ‘moderately indebted country’ to a ‘severely indebted country’ on account of amassing high level of debt for many years. Contrarily, other countries in the South Asia region, such as Bangladesh and India, have always managed to service their debt obligations properly. However, recent inflows of massive level of foreign loans, which entail higher interest rates, to Bangladesh can provide a stern test to its capacity of managing debt in the medium term and long term.

Methodologies to Assess Debt Sustainability

This article adopts the DSPBA to examine Bangladesh’s debt sustainability under the baseline scenario, which uses the estimates of national sources as well as the projections of this study. The rationale for selecting this methodology is that it enables us to assess sustainability of public debt in Bangladesh by focusing on economic growth, real interest rate payable on debt, revenue and government expenditure. Blanchard, Chouraqui, Hagemann, and Sartor (1991) and Buiter (1985) explained that the DSPBA involves first deriving the primary budget balance (the difference between government revenue and expenditure barring interest payments on debt) that will stabilize the total public debt-to-GDP ratio at its current level over time given an economic growth rate and real interest rate. ³ It then takes the difference between the debt-stabilizing primary budget balance and actual primary budget balance to identify the ‘primary balance gap’. A positive gap signifies that the debt-to-GDP ratio will increase in the absence of fiscal consolidation measures in a country due to which public debt will reach unsustainable levels. A negative gap indicates that debt-to-GDP ratio will decrease even if fiscal consolidation measures are not undertaken.

The article also adopts the DSF, which looks at the ratio of both external debt and debt service to other economic variables, to assess whether Bangladesh’s external debt is sustainable according to other indicators of debt sustainability. ⁴ As noted by Hjertholm (2001) and the International Monetary Fund and International Development Association (2004), one of the primary reasons for using this methodology is that it assesses the accumulation of external debt with indicators of external debt-servicing capacity—government revenue and exports.

In addition to assessing debt with the variables of the DSPBA and DSF, the article also examines Bangladesh’s debt sustainability under different scenarios by first developing its own projections for different economic correlates under the baseline scenario for the period of FY2017–FY2026, and then undertaking simulation exercises for the alternative scenarios by introducing shocks to various economic correlates. These exercises involve scenario building with various possible values of nominal GDP, real GDP growth, total public debt, external financial flows, external debt repayment, exchange rate of Taka, nominal interest rate, real interest rate, revenue collection and export earnings. The aim is to test whether Bangladesh will be able to maintain debt sustainability if the values of these economic correlates deviate from the projections of the article under the baseline scenario. This article also contemplated the possibility of adopting Stochastic Frontier Analysis (SFA) for assessing Bangladesh’s capacity to sustain debt in the future. However, this article has been unable to deploy SFA for several reasons. ⁵

Forecasting Methodology

This article analyses the sustainability of public debt in Bangladesh from FY2017 to FY2026 by using the adopted methodologies. However, there is a paucity of data on projections of economic correlates that are relevant for sustaining debt for that period. The Seventh Five-Year Plan contains projections of economic correlates included in the adopted methodologies of debt sustainability. However, this study does not use them to analyse sustainability of debt in Bangladesh, as they only cover the period from FY2016 to FY2020, and projections of economic correlates in previous five-year plans diverged significantly from their actual figures. Hence, this article devised its own forecasting methodology to estimate different economic correlates from FY2017 to FY2026. It adopted the trend line option in Microsoft Excel for generating projections. First, data for the economic correlates were obtained for the FY2001–FY2016 period, with the exception of data on interest payments on total public debt and real GDP growth which were obtained for the FY2007–FY2016 period. Then trend lines of different shapes, such as linear, exponential, logarithmic and polynomial, were generated in Microsoft Excel to assess which trend line most closely captured the movement of a specific economic correlate over the past 16 fiscal years and, as such, had the highest R2 (goodness of fit). The trend line with the highest R2 was used to forecast the future values of that variable (see Tables A1 and A2).

An example can illustrate the methodology in more detail. To project the future values of nominal GDP, trend lines of various shapes were created to imitate movements of nominal GDP from FY2001 to FY2016 in Microsoft Excel. The polynomial trend line of order two had the highest goodness of fit (R2 = 0.9988) and was selected for forecasting the value of nominal GDP for the next 10 fiscal years. In making projections of nominal GDP, the equation corresponding to the polynomial trend line of order two was used to forecast the numerical values of nominal GDP.

y(1)xx

(where y = nominal GDP and x = sequence of the fiscal year).

In the dataset, FY2001is the first fiscal year and the value of corresponding x-variable in Equation (1) for FY2001is 1. Similarly, FY2017 is the seventeenth fiscal year in the dataset and its corresponding x-variables in Equation (1) has a value of 17. Therefore, to forecast the value of nominal GDP in FY2017 using Equation (1), the value of x was set equal to 17 in that equation, which yielded a value of Taka 19.1 trillion for nominal GDP (the y-variable in the equation) in FY2017. A similar approach to trend lines and corresponding equations was deployed to forecast the values of other economic correlates with the exception of real GDP growth. Values of real interest rate were derived from the values of interest payment on public debt that was computed using the trend lines.

This article used the average value of real GDP growth for the last 10 fiscal years—from FY2007 to FY2016—to forecast the value of this correlate for the period of FY2017 to FY2026. The rationale behind using this approach to predict future values of real GDP growth is that it yields reliable, credible estimates. Other approaches performed poorly. The trend lines in Microsoft Excel failed to capture the movement of real GDP growth over the past 16 years, in which they had low goodness of fit, and predicted that real GDP growth will reach double digits by FY2026. Taking the average of real GDP growth for other durations, such as five or fifteen fiscal years, to forecast this correlate also resulted in imprecise and unfeasible values.

The real interest rate was calculated by first deriving the projections of interest payment on total debt and projections of total public debt using trend lines and corresponding equations in Microsoft Excel. Then, the projections of interest payment on total debt were divided by projections of total public debt for a given fiscal year and the resulting interest rate was converted into real terms.

Sources of Data

This article developed its own projections of economic correlates based on previous estimates of these variables that were obtained from various national sources of data. Data on nominal GDP, nominal GDP growth, real GDP growth, total revenue, total expenditure and export earnings from FY2001 to FY2016 were obtained from Bangladesh Bank’s Monthly Economic Trends (Bangladesh Bank, 2016) and the Ministry of Finance’s Bangladesh Economic Review (Ministry of Finance, 2015a, 2015b, 2016a). Data on public domestic debt for the FY2007–FY2016 period were obtained from Bangladesh Bank’s Annual Reports (Bangladesh Bank, n.d.a), Quarterly Volumes (Bangladesh Bank, n.d.c) and Monthly Report on Government Borrowing from Domestic Sources (Bangladesh Bank, n.d.b). Figures for external debt and external debt service from FY2001 to FY2016 were obtained from various volumes of the Economic Relations Division’s Flow of External Resources into Bangladesh, which encompassed the period from 2005–2006 to 2015–2016 (Economic Relations Division, n.d.). Data for real interest rates on both public domestic debt and public external debt for FY2016 were taken from the Economic Relation Division’s Flow of External Resources into Bangladesh for 2014–2015 (Economic Relations Division, n.d.), the Ministry of Finance’s Bangladesh Economic Review (Ministry of Finance, 2015a, 2015b, 2016a), Bangladesh Bank’s Annual Reports (Bangladesh Bank, n.d.a), Bangladesh Bank’s Quarterly Volumes (Bangladesh Bank, n.d.c) and Monthly Report on Government Borrowing from Domestic Sources (Bangladesh Bank, n.d.b). Data on sources of budget deficit financing for the period of FY2006 to FY2015 were obtained from the Monthly Report on Fiscal-Macro Position (Ministry of Finance, n.d.a), Monthly Report on Fiscal Position (Ministry of Finance, n.d.b) and Medium Term Macroeconomic Policy Statement 2016–17 to 2018–19 (Ministry of Finance, 2016b). In generating the projections of the correlates, the article did not experience the problem of missing data since local sources of data contained figures for all the economic correlates for the whole period.

Debt Sustainability under the Baseline Scenario

First, this article undertakes an analysis of Bangladesh’s debt sustainability under the baseline scenario using the DSPBA, DSF and projections of various economic correlates. In FY2016, the public debt-to-GDP ratio was 34 per cent and considered sustainable (International Monetary Fund & International Development Association, 2016). The DSPBA identifies the primary budget balance that will stabilize the debt-to-GDP ratio at 34 per cent for the next 10 fiscal years. Table 4 shows that under the baseline scenario, the real GDP growth rate is greater than the real interest rate on account of which Bangladesh will manage to sustain debt-to-GDP ratios at 34 per cent if it obtains primary budget deficits for the whole period from FY2017 to FY2026. Every fiscal year, the debt-to-GDP ratio will remain at 34 per cent if the projected primary budget deficit does not exceed the corresponding debt-stabilizing primary budget deficit. However, the projected actual primary budget deficits will be higher than debt-stabilizing primary budget deficits from FY2019 onwards, due to which the primary balance gap will be positive, which indicates that debt-to-GDP ratios will exceed 34 per cent from FY2019, and persistently increase afterwards unless fiscal consolidation measures are undertaken to improve the primary budget balance. Adopting fiscal consolidation measures will require curbing government expenditure, which will result in higher unemployment, lower income and stunted economic growth.

According to the DSF, a country’s public external debt will be considered unsustainable if the ratios of external debt to different economic correlates exceed their respective threshold levels. Table 4, which represents the baseline scenario, shows that all of Bangladesh’s external debt ratios will remain significantly below their thresholds for all fiscal years for the FY2017–FY2026 period barring the external debt service-revenue collection ratios from FY2024 to FY2026, which increasingly exceed the threshold value of 20 per cent. These rising ratios of external debt service with revenue and export earnings flag the concern that Bangladesh will have to continually allocate an increasing share of its revenue to servicing external debt in the future, while concurrently reducing its allocation of financial resources to other sectors, such as health, education and infrastructure, which are indispensable for fostering economic growth.

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Table 4.

Findings of the DSPBA and DSF in Baseline Scenario

IMF/World Bank Debt Sustainability Framework						Debt-Stabilizing Primary Balance Approach
FY	Present Value of External Debt-to- GDP Ratio (Threshold = 40 %)	Present Value of External Debt-to- Revenue Ratio (Threshold = 250 %)	Present Value of External Debt- to- Export Earnings Ratio Threshold = 150 %)	External Debt Service-to- Revenue Collection Ratio (Threshold = 20 %)	External Debt Service-to- Export Earnings Ratio (Threshold = 20 %)	Debt- Stabilizing Primary Balance	Actual Primary Balance	Primary Balance Gap
2017	9.77	94.68	66.58	16.36	11.50	–3.61	–2.92	–0.68
2018	8.29	83.98	58.10	16.67	11.54	–3.22	–2.93	0.29
2019	7.05	74.74	50.97	17.08	11.65	–2.88	–2.90	0.02
2020	6.00	66.71	44.92	17.56	11.83	–2.59	–2.87	0.28
2021	5.12	59.72	39.76	18.14	12.07	–2.34	–2.84	0.50
2022	4.39	53.61	35.32	18.80	12.39	–2.13	–2.80	0.66
2023	3.78	48.23	31.49	19.55	12.77	–1.97	–2.73	0.76
2024	3.27	43.50	28.16	20.40	13.21	–1.84	–2.59	0.75
2025	2.78	39.31	25.25	21.36	13.72	–1.75	–2.42	0.66
2026	2.36	35.59	22.71	22.41	14.30	–1.71	–2.69	0.99

Sources: Bangladesh Bank (n.d.a, n.d.c, 2016), Economic Relations Division (n.d.), Ministry of Finance (2015a, 2015b, 2016a) and authors’ projections.

Note: Bold figures represent problems in sustaining debt.

Simulation Exercises

The simulation exercises present low-case alternative scenarios where the projections of the economic correlates under the baseline scenario are not realized. These scenarios are built by introducing shocks to various economic correlates. Rationales for the introduction of each shock are included in the simulation exercises.

Two alternative scenarios of the simulation exercise under the DSPBA were developed by lowering the values of the economic correlates compared to the baseline scenario:

The simulation exercise lowered the value of the real GDP growth rate in scenario one to account for the possibility that Bangladesh’s real GDP growth will be negatively affected by adverse shocks. The value of the real GDP growth rate was held constant at 7.11 per cent (its value for FY2016) in scenario two to test whether Bangladesh will sustain public debt if real GDP growth remains stagnant due to unfavourable shocks.

In Table 5 in scenario one, reflecting the first alternative scenario under the DSPBA, it is evident that if the real GDP growth rate decreases by 0.5 percentage points, the real interest rate increases by 0.5 percentage points, and revenue collection decreases annually by Taka 100 billion compared to the baseline scenario, then the real interest rate becomes higher than the real GDP growth rate in every fiscal year from FY2017 to FY2026. If real interest rate exceeds real GDP growth, then Bangladesh will begin experiencing debt distress. Moreover, the primary balance gap, which is the difference between the debt-stabilizing primary balance and the actual primary balance, will remain positive through the period of FY2017–FY2026. A positive primary balance gap in an economy indicates that debt-to-GDP ratio will increase in that country in the absence of fiscal consolidation measures. In this scenario of continually experiencing positive primary balance gap from FY2017 to FY2026, Bangladesh will be required to attain primary budget surpluses in that period through undertaking fiscal consolidation measures and stabilize the debt-to-GDP ratio at 34 per cent from FY2017 to FY2026 unless it intends to have perennially increasing values of debt-to-GDP ratios, which can push Bangladesh towards accumulating unsustainable level of debt.

Table 5 also shows that findings of scenario two of DSPBA, in which the real GDP growth rate remains stagnant at 7.11 per cent in the entire period, the real interest rate increases annually by 0.5 per cent and revenue decreases annually by Taka 200 billion compared to the baseline scenario. In this scenario, Bangladesh will manage to sustain debt-to-GDP ratio at 34 per cent in FY2017 and FY2018 since the real GDP growth rate will be higher than the real interest rate in those two fiscal years. From FY2019, however, the real interest rate will exceed the real GDP growth rate of 7.11 per cent, thereby stressing that Bangladesh will have to attain primary budget surpluses to stabilize the debt-to-GDP ratio at 34 per cent. Notably, Bangladesh failed to obtain primary budget surpluses during the past two decades, so it is unlikely that the country will register primary budget surpluses in the near future. Moreover, the primary balance gap remains positive with a higher value during the whole period than scenario one, due to which public debt-to-GDP ratio will persistently increase by a greater magnitude from FY2017 to FY2026, which will exacerbate the debt-servicing liabilities of Bangladesh. Moreover, this estimates of scenario two reveal that debt-to-GDP will continually rise in the presence of stagnating economic growth, which bears the threat of leading Bangladesh towards experiencing the problem of debt distress.

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Table 5.

Alternative Scenarios under the DSPBA (% of GDP)

Scenario One Real GDP growth decreases annually by 0.5%, interest rate increases annually by 0.5% and revenue collection decreases by Taka 100 billion compared to the baseline scenario				Scenario Two Real GDP stagnates at 7.11%, interest rate increases annually by 0.5% and revenue collection decreases by Taka 200 billion compared to the baseline scenario
FY	Debt-Stabilizing Primary Balance	Actual Primary Balance	Primary Balance Gap	Debt-Stabilizing Primary Balance	Actual Primary Balance	Primary Balance Gap
2017	0.32	–3.30	3.62	–1.34	–3.80	2.46
2018	0.69	–3.26	3.94	–0.65	–3.71	3.06
2019	1.00	–3.17	4.18	0.00	–3.58	3.59
2020	1.27	–3.10	4.37	0.62	–3.47	4.09
2021	1.50	–3.03	4.52	1.20	–3.37	4.57
2022	1.68	–2.95	4.63	1.75	–3.26	5.01
2023	1.81	–2.85	4.66	2.25	–3.13	5.39
2024	1.90	–2.67	4.57	2.73	–2.94	5.66
2025	1.95	–2.47	4.42	3.16	–2.71	5.88
2026	1.96	–2.75	4.71	3.56	–2.97	6.53

Sources: Bangladesh Bank (n.d.a, n.d.c, 2016), Ministry of Finance (2015a, 2015b, 2016a) and authors’ projections.

These two alternative scenarios under DSPBA indicate that given external financial flows that bear relatively high interest rates, if the real interest rate increases above the real GDP growth rate, Bangladesh will face problems in stabilizing its debt-to-GDP ratio. Rising values of this ratio are an issue of anxiety for Bangladesh because they indicate that the country will accumulate higher levels of public debt, and thus higher debt servicing obligations. The Government of Bangladesh has been already allocating a significant share of its resources to servicing debt. In this situation, it will be required to improve its primary budget balance by implementing fiscal consolidation measures, which will necessitate enhancing revenue collection and reducing government expenditures.

For the two alternative scenarios of the simulation exercise under the DSF, values of different variables were altered compared to those under the baseline scenario to reflect shocks to economic correlates:

The simulation exercise lowered the values of nominal GDP growth in both to capture the situation in which Bangladesh’s GDP growth may be adversely impacted by shocks. The values of external debt were increased to reflect the expected rise in borrowing from China, India and Russia.

In Table 6, which reflects scenario three, all the ratios of external debt to other correlates are significantly below their respective threshold levels, with the exception of the external debt service-to-revenue ratio in the DSF. That ratio is considerably higher than the threshold value of 20 per cent in every fiscal year from FY2017 to FY2026, indicating that Bangladesh will have to allocate more than one-fourth of its revenue to service external debt. Allocating such a significant share of revenue to external debt repayment impedes Bangladesh’s ability to allocate revenue to other growth-oriented sectors, such as health, education and infrastructure, which are essential for fostering economic growth.

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Table 6.

Scenario Three (DSF)

Scenario Three 5% annual decrease in nominal GDP growth, annual USD 2 billion increase in external debt, annual USD 1 billion increase in external debt service, annual 2% depreciation against US Dollar, annual 2% increase in nominal interest rate, Taka 300 billion annual decline in revenue collection and USD 2 billion decline in export earnings compared to the baseline scenario
FY	Present Value of External Debt- to-GDP Ratio (Threshold = 40 %)	Present Value of External Debt-to-Revenue Ratio (Threshold = 250 %)	Present Value of External Debt-to- Export Earnings Ratio (Threshold = 150 %)	External Debt Service-to- Revenue Ratio (Threshold = 20 %)	External Debt Service-to-Export Earnings Ratio (Threshold = 20 %)
2017	10.62	107.40	76.12	27.59	19.56
2018	8.99	94.61	65.90	26.89	18.73
2019	7.63	83.69	57.40	26.40	18.11
2020	6.49	74.30	50.28	26.12	17.67
2021	5.53	66.18	44.25	26.00	17.38
2022	4.73	59.14	39.11	26.04	17.22
2023	4.06	52.99	34.70	26.24	17.19
2024	3.51	47.60	30.90	26.62	17.28
2025	2.98	42.87	27.60	27.16	17.49
2026	2.53	38.68	24.73	27.84	17.80

Sources: Bangladesh Bank (2016), Economic Relations Division (n.d.), Ministry of Finance (2015a, 2015b, 2016a) and authors’ projections.

In Table 7, that depicts scenario four, it is evident that most of the ratios of external debt to other correlates are considerably lower than their respective thresholds for every fiscal year in the FY2017–FY2026 period. The value of external debt service-to-revenue ratio is significantly higher than its threshold value of 20 per cent for the entire period. Moreover, the external debt service-to-export earnings ratio surpasses its threshold value of 20 per cent from FY2017 to FY2020 and remains very close to that threshold value for the remainder of the period if export earnings decline on account of external shocks. These ratios flag the concern that Bangladesh can amass high level of debt in the low-case scenarios, in which estimates of economic correlates are under-realized compared to the predictions of the baseline scenario. Because of this, the country will inherit high level of debt-servicing obligations, which will force the country to apportion higher level of financial resources for servicing its debt liabilities and further shed its allocation of financial resources to other growth-enhancing sectors, such as health and education. This will of course impede the country’s ability to sustain high level of economic growth in the medium and long term.

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Table 7.

Scenario Four (DSF)

Scenario Four 10% annual decrease in nominal GDP growth, annual USD 5 billion increase in external debt, annual USD 2 billion increase in external debt service, annual 5% depreciation against US Dollar annual 4% rise in nominal interest rate, Taka 500 billion annual decline in revenue collection and USD 4 billion decline in export earnings compared to the baseline scenario
FY	Present Value of External Debt-to- GDP Ratio (Threshold = 40%)	Present Value of External Debt-to-Revenue Ratio (Threshold = 250%)	Present Value of External Debt-to- Export Earnings Ratio (Threshold = 150%)	External Debt Service-to- Revenue Ratio (Threshold = 20 %)	External Debt Service-to- Export Earnings Ratio (Threshold = 20%)
2017	11.94	126.30	90.67	31.95	22.94
2018	10.09	110.39	77.74	30.84	21.72
2019	8.54	96.96	67.14	30.01	20.78
2020	7.24	85.54	58.36	29.43	20.08
2021	6.15	75.76	51.01	29.04	19.56
2022	5.25	67.34	44.81	28.86	19.21
2023	4.50	60.04	39.54	28.85	19.00
2024	3.88	53.70	35.03	29.07	18.96
2025	3.29	48.15	31.14	29.50	19.08
2026	2.79	43.28	27.77	30.08	19.30

Sources: Bangladesh Bank (2016), Economic Relations Division (n.d.), Ministry of Finance (2015a, 2015b, 2016a) and authors’ projections.

Note: Bold figures represent problems in sustaining debt.

In the analysis of debt sustainability in Bangladesh, the findings of the DSPBA and DSF share some commonalities. Both methodologies stress that since a significant share of Bangladesh’s resources for servicing debt has been attained from revenue collection, revenue collection should be improved to properly service public debt, including its external component, in the short and medium term. Moreover, Bangladesh will face difficulty in sustaining public debt if there is a considerable increase in the interest rate payable on debt, which will magnify its debt-servicing liabilities. There were also divergences, however. An adverse shock to real GDP growth has significant effects on Bangladesh’s debt sustainability in the scenario one under the DSPBA, while such shocks on economic growth, where it was lowered exert an inconsequential influence on the country’s capacity to manage debt in the alternative scenarios under the DSF. Shocks of different magnitudes were administered in the simulation exercises of DSF and DSPBA. In the alternative scenarios of DSF, nominal GDP growth was reduced by 5 per cent and 10 per cent compared to the predictions of the baseline scenario, while in the alternative scenarios of DSPBA, real GDP growth was curbed by 0.5 per cent compared to the baseline scenario. The two methodologies assessed debt sustainability based on different set of economic correlates. DSF considered the variables nominal GDP, external debt, export earnings, external debt service and revenue collection in its formula whereas DSPBA included real GDP growth, real interest rate and primary budget balance in its estimation. The DSPBA predicts that Bangladesh’s debt-to-GDP ratios will continually increase if economic growth or GDP growth experiences adverse shocks, whereas the DSF indicates that they will decline even if economic growth or GDP growth is affected by such shocks. Apart from that, the DSPBA stresses the need for curbing unnecessary government expenditure to ensure debt sustainability in Bangladesh, while the DSF does not deem restraining government expenditure to be a necessary condition for managing debt in the country.