What is Fiscal Policy? Fiscal Policy is the decision of the government about: How to earn revenue and gather resources from various sources For what to spend those earnings and resources How much to spend and When to spend 2

There are two sides of fiscal policy 3 Inflow of money into the govt.’s pocket: earning Outflow of money from the govt.’s pocket: spending

Earnings: Revenue and Resources 4

Why does the government need revenue? To maintain its daily activities, i.e. to run the government To ensure protection for the helpless To provide necessary services to people that otherwise nobody would provide (Market failure) To ensure development of the country To build buffer against risk! 5

Where does the revenue come from? Tax revenue Direct: income tax, wealth tax etc. Indirect: VAT, tariff, excise duty etc. Non-Tax revenue Fees & charges: registration, sales of forms, stamps etc. Fines: mobile court fines, police fines etc. Printing of money 6

Where does the government keep its revenue? The government’s account is maintained by the Treasury which is located at Bangladesh Bank The “account” in which all these revenues are deposited is called the “Consolidated Fund” Consolidated Fund was created under Article 84 of our constitution 7

Resources from other sources Grants Loans from Domestic sources Treasury bills/bonds savings schemes borrowing from the banks Foreign sources Bilateral Multilateral 8

Revenue trend in Bangladesh Revenue as percent of GDP is increasing Around 80 percent of public revenue in Bangladesh is derived from tax sources. 9

Revenue trend in Bangladesh (crore taka) 10 FY FY FY FY FY FY FY FY FY FY FY Total Revenue Tax Revenue Non-Tax Revenue As percentage of GDP Total Revenue Tax Revenue Non-Tax Revenue

Spending 11

How does spending help? Theoretical framework How much spending will affect depends on two factors-  The multiplier effect and  The crowding-out effect The multiplier effect denotes that a certain amount of spending will have bigger impact than the size of the spending. The crowding-out effect arises out of a mechanism that offsets the increase in AD. 12

The multiplier effect The MPC helps the money spent rolling from hand to hand in an infinite chain of successive rounds of spending. Suppose, the MPC in Bangladesh is 0.75 and govt. increases spending by Tk. 20 billion for social safety net. The rounds of spending are as below: Govt. spending = Tk. 20 billion First change in consumption (C) = (MPC X Tk. 20 billion) Second change in C = (MPC X MPC X Tk. 20 billion) Third change in C= (MPC X MPC X MPC X Tk. 20 billion) … … … … … Total change in C = (1 + MPC + MPC 2 + MPC 3 + …….) X Tk. 20 billion = Tk. 20 billion /(1 – MPC) = Tk. 80 billion. 13

The Crowding-out effect 14 MD1 MD2 AD1 AD3 AD2 r1 r2 r M Y P 1. An increase in G increases AD 2. This increases money demand 3. As a result r increases 4. And AD falls back

How does spending help? If the government wants to increase GDP… 15 Government increases spending that increases demand for goods and services As a result, producers produce more goods GDP increases

How does spending help? If the government wants to check inflation… 16 The government reduces spending Demand for goods and services fall Price of goods fall in the short run and as a result reduces inflation

For what to spend? Through spending the government tries to affect: Macroeconomic stabilization Equity: horizontal and vertical Efficiency in resource allocation: Provision of public goods Check market failure 17

Macroeconomic Stabilization To stabilize price To raise growth rate To raise employment level To reduce deficit 18

How government spending helps keep macroeconomic stabilization? 19 Subsidy for food production Food production increases Food price stabilizes

How government spending helps keep macroeconomic stabilization? 20 Introduction of employment generating activities Allocation and disbursement of funds Employment level raised

Equity Inequality prevails in all societies. Government tries to reduce the gap between the rich and the poor For this, the government collects taxes from the rich and spends it for the poor 21

Efficiency of resource allocation Private entrepreneurs may not be interested in investments where return of investment is not good for him but good for the country In this case, the government may step ahead and supply resources for such investments Example: building roads and highways, Public-Private Partnership (PPP) 22

Is government spending always good? Government spending is necessary to keep the economy on track. However, if the spending is not in line with the economic objective then it may be detrimental Example: Suppose a country is facing high inflation. Price is increasing very rapidly. But as the national election is close the government decides to spend more on social safety net programs and development activities to win popularity. What will be its impact on the economy? 23

Public Expenditure: Types Government spending may be broadly classified into two categories- Revenue expenditure Development expenditure Revenue expenditure mainly includes government employees salary, benefits and establishment costs. Development expenditure mainly includes money spent on development activities. Is revenue expenditure good or bad? 24

In which way public expenditure of Bangladesh moving?  The government spends huge amounts of money on  building socio-economic and physical infrastructure  human resource development and  poverty alleviation.  Besides, the government has to incur expenditure for:  Administrative  welfare and  other service oriented activities. 25

Recent trend of public expenditure in Bangladesh 26 FY FY FY FY FY FY FY FY FY FY FY (up to February) Public Exp (a+b) a) Rev Exp b) Dev Exp Percentage of GDP Public Exp (a+b) a) Rev Exp b) Dev Exp

Recent trend of public expenditure % of GDP 27

Economic structure of revenue expenditure % share of major economic categories 28 ParticularsFY 03-04FY 04-05FY 05-06FY 06-07FY 07-08FY (up to February) Pay and allowances Pay of officers Pay of staff Allowances Goods and services Supply and services Repair and maintenance Payment of interest Domestic Foreign Subsidies and current transfers Subsidies Grants-in-aid Subscription to the international organizations Write-off of loan advances Pension and gratuity Block Unexpected Other Procurement of assets & public works Procurement of assets Purchase of land Construction and works Gross total Deduction recovery Total- Non-development revenue expenditure

Is the government fulfilling its welfare commitment? Public Expenditure By Social Sectors: The Social Sectors are getting increasing prominence day by day 29

Annual Development Program expenditure for social sectors (crore taka) 30 SectorFY FY FY FY FY FY FY FY FY FY FY Education & Religion Sports and Culture Health & Family Welfare Labor & Manpower Social Welfare, Women & Youth Dev Sub-total ( ) As % of Total ADP Exp (6/8*100) Total ADP Allocation

Revenue expenditure for social sector (crore taka) 31 SectorFY 98-99FY FY FY FY FY FY FY FY FY FY Education & Religion Health & Family Planning Youth, Sports & Cultural Affairs Labor & Manpower Social Welfare & Women Affairs Sub-total ( ) As % of Total Rev Exp (14/19*100) Total (ADP+Rev) (6+14) As % of total Pub Exp (16/(8+19)*100) As % of GDP (16/20*100) Total Revenue Allocation GDP at Market Prices

What is the balance in the government’s pocket? If revenue earning is higher than expenditure, the government has surplus If revenue earning is lower than expenditure, the government faces deficit In Bangladesh the government maintains a deficit budget 32

How the deficit is met Deficit means that spending is more than earning Therefore, additional money is needed for filling out the gap between spending and earning This additional money is called “financing” Financing may be either from domestic or foreign sources From foreign sources financing may come as bilateral or multilateral loans Financing from domestic sources comes from borrowing from banks, issuance of savings schemes and bonds… and if needed from printing money. Which one would you prefer for deficit financing- domestic or foreign? 33

Trend of deficit financing in Bangladesh 34

Implications of budget deficit High budget deficit means government is spending more than its ability And in doing so it is borrowing from various sources If the borrowing comes from domestic sources it means less money is available for the private sector. This may hinder private sector development initiatives. If the borrowing comes from foreign sources it means the country is exposed to foreign currency risk (for example- speculative attack, current account deficit) Increased amount of borrowing increases interest rate and, therefore, debt liabilities. High interest rate may make debt unsustainable. In such cases, the country will be exposed to financial crisis. Recent example is Greece. 35

Question: What is the most prominent document that elaborates the Fiscal Policy of Bangladesh? As head of the government how would you design your next fiscal policy? 36

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