March 23, 2020
COVID-19 and Bangladesh’s macroeconomic challenges
The world economy is now on lockdown because of the global coronavirus pandemic. Governments and their central banks around the world are wasting no time in dealing with the health and economic implications of this crisis.
It is surprising that the Bangladesh government has seemingly accepted the effects of the outbreak on our economy. The real economy is facing unforeseen crises—slump in both aggregate supply and demand. An obvious consequence is contraction in value added and output across industries.
On the supply side, every economic activity will surely contract more or less. This is because supply chain of every product including access to raw materials and intermediate inputs has been substantially disrupted. Labour mobility too has been seriously impeded as physical isolation is one key measure of minimising the health risks. On the demand side, exporters who are left with diminished production capacities will also see markets for their final goods shrink. Local industries that cater to domestic residents are also experiencing rapid decline in the demand for their goods and services. Small and medium enterprises (SMEs) which employ millions of workers and constitute the backbone of the economy appear to be more vulnerable. As SMEs face massive slump in demand, their existential challenge is to remain financially viable.
This unforeseen but truly exogenous COVID-19 shock is now interacting with many prevailing economic woes of Bangladesh. Those include stagnant tax revenue, widening fiscal deficits, prohibitive liquidity and solvency crisis in the country’s financial system, a long-depressed stock market, an overvalued exchange rate, and persistent and unsustainable current account deficits in the last few years. How do we deal with these complex economic challenges?
Firstly, businesses faced with falling demand and broken supply chain will find no option but to lay off workers. That will be destabilising and chaotic. The government must try to prevent this using several mechanisms. Given that government borrowing from banks have surged in order to support widening fiscal deficits in recent times, liquidity crisis has become prohibitive in our financial system. We therefore expect no big room for increased budgetary support. The best course of action for Bangladesh will be an unprecedented monetary expansion targeting lending rate to be in the range of 5-8 percent. To this end, the Bangladesh Bank (BB) can immediately start buying government bonds and treasury bills held by the banks and financial institutions. Other policy options include reduction in cash reserve requirements (CRR) and statutory liquidity ratios (SLRs). BB can also direct cash-rich state-owned banks to increase their advance-deposit ratio (ADR) to an enhanced target level. BB should target repo rate to go down from current 6 percent to 4 percent. Excess liquidity is already evident in the financial system and lending to private sector would pick up once interest rates subside further.
The central bank can make a number of interventions targeting industries that are worst hit by the coronavirus pandemic. One key policy directive can be to extend working capital loans at the lowest possible interest rate (or even zero) to industries on the condition that they keep their workers on payroll regardless of their work for at least three months. The assumption is that effective drugs (or vaccination programme) will roll out and normalcy will return by this time. BB can also negotiate with multilateral organisations for floating a Special Fund of Tk 100,000 crore to this end.
Banks and financial institutions can access this low-cost fund and start lending to businesses provided that they meet a few conditions including retaining workers on payroll. Secondly, BB can issue a directive asking lenders to extend a 12-month moratorium on their loans and advances that will fall due in a year. This will provide cushion to firms and corporations to avoid imminent bankruptcy. Thirdly, the stock market has long been depressed for a variety of reasons. The outbreak of COVID-19 is now causing another round of panic sale and stock prices have collapsed. A policy guideline of BB is already there whereby a commercial bank can access a five-year Tk 2 billion fund from the central bank to invest in stocks and securities. I will advise the central bank to further lower this borrowing cost to less than 5 percent and let the scheme go into effect without delay.
Providing liquidity to households and micro, small and medium enterprises (MSMEs) is a critical challenge. To this end, BB can work via microfinance institutions (MFIs). The nationwide network of state-owned and private commercial banks can also be utilised for channelling low-cost loans to households and MSMEs. Brac Bank for example has credible experience of managing large portfolios of loans to MSMEs. Their experience and infrastructure can be of high value.
The government seems to be in deep trouble. Tax revenue is contracting. But the need for giving budgetary support to many sectors is now manifold. Government will have to redouble its spending on public health and medical infrastructure. A public-private partnership can be started incorporating private hospitals and medical colleges. The partnership can involve measures including paying for testing, supplying more test kits and emergency gear to frontline health workers, staffing and providing uninterrupted supplies to health centres.
Food security is an emerging concern around the world as job losses are mounting. The government will have to increase its budgetary allocation for improving food security for vulnerable people. Millions of households and elderly people live on the financial edge and will require income support through social safety nets to avert falling back into extreme poverty. Government may collaborate with bKash or similar mobile payment systems to provide income support to poor and ultra-poor households. It will have to restate its annual budget discarding avoidable spending plans including developmental projects that are yet to take off.
National Board of Revenue (NBR) may defer collection of taxes for one or two quarters. Household and firms will further demand the lowering of tax rates and a new set of tax incentives. NBR can provide tax relief to firms based on the number of employees working at least 20 hours a week. Indiscriminate use of account freezing of firms may force them to go bankrupt. Tax relief of a certain amount may be granted to firms employing up to 50 workers and on condition that workers continue to be employed during this downturn. Ministry of Finance (MOF) must revisit its tax policy to save our businesses.
The COVID-19 outbreak will further worsen current account imbalance in Bangladesh. As tax revenue will contract this year, we expect government spending to increase faster and fiscal deficits to rapidly widen. On the other hand, net private sector saving will also deteriorate for a variety of reasons. That essentially means we expect doubling of our current account deficit in 2020-21.
That will prove dangerous because it may lead to a crisis in the foreign exchange market. If BB keeps selling its foreign exchange reserves to support an overvalued exchange rate of taka per USD, it will significantly erode monetary policy effectiveness. Liquidity crisis will return to the financial system. We can avoid such a scenario by orchestrating a gradual devaluation of taka against the US dollar. Finally, we must reorganise key state institutions that are governing the financial sector and capital markets. An expansionary monetary policy, as envisaged in this note, will require careful planning, intense monitoring and prudent supervision at every stage.
Dr Mizanur Rahman is a professor of Department of Accounting & Information Systems at the University of Dhaka. He is an EducationUSA Fellow.