Bangladesh: Staff Report for the 2021 Article IV Consultation— Debt Sustainability Analysis

BANGLADESH

Abstract

BANGLADESH

Title Page

BANGLADESH

STAFF REPORT FOR THE 2021 ARTICLE IV CONSULTATION— DEBT SUSTAINABILITY ANALYSIS

February 15, 2022

Approved By

Anne-Marie Gulde-Wolf and Kevin Fletcher (IMF) and Marcello Estevão and Zoubida Allaoua (IDA)

Prepared by the staffs of the International Monetary Fund and the International Development Association

Bangladesh: Joint Bank Fund Debt Sustainability Analysis

article image

Bangladesh remains at a low risk of external and overall debt distress. External and domestic debt indicators are below their respective thresholds under the baseline and stress test scenarios, despite a lower debt-carrying capacity threshold, due to a debt carrying capacity downgrade from strong to medium, driven mostly by a lower CPIA score in 2020. Growth is projected to be slower than estimated in the previous DSA over the medium-term, reflecting the prolonged nature of the pandemic, nation-wide lockdowns, and slower-than-expected roll out of vaccines, and converges to the previous DSA growth rates over long run. Favorable debt dynamics in the medium term keep the PPG external debt-to-GDP ratio on a declining path, and the overall public debt-to-GDP ratio stabilizes, although at a higher level than in the previous DSA. Risks are on the downside and include pandemic-related uncertainties, rising commodity prices, higher domestic interest rates, elevated NPLs, prospective losses from natural disasters. Under these circumstances, financing the much-needed climate adaptive expenditure, as laid out in the 8th five year plan (FYP) and Delta Plan, will be challenging unless financed concessionally or through non-debt creating flows (foreign direct investment). Improving the investment climate to attract FDI and raising the revenue-to-GDP ratio to boost social spending while limiting fiscal risks remain top priorities.

A. Background and Developments on Debt

1. Total public debt in Bangladesh stood at about US$147.8 billion in FY21, around 41.4 percent of GDP.1 The majority of public debt over the last decade is domestic and denominated in local currency. In FY21, domestic debt was 58 percent of the total public and publicly guaranteed (PPG) debt stock.

2. About half of the outstanding domestic debt is composed of National Saving Certificates (NSCs). NSCs stifle the development of a domestic bond market as they provide a yield of around 9–11 percent, whereas government bonds of similar maturities provide a yield between 5 and 6 percent.2 The authorities lowered the interest rates of new issuances of NSCs in September 2021, linking rates to investment brackets to disincentivize investments from high income individuals. However, NSC rates still remain well above market rates. Continued reforms to align NSC interest rates to market-determined rates, together with phasing out the cap on lending rates and floor on deposit rates, would help debt dynamics by lowering the cost of domestic borrowing, improving monetary policy transmission and deepening domestic debt markets.3

Selected NSC Interest Rates

article image
Source: Ministry of Finance
uA003fig01

Government T-bill and T-bond rates

(in percent)

Citation: IMF Staff Country Reports 2022, 071; 10.5089/9798400201943.002.A003

Source: Bangladesh Bank.

3. A shariah-compliant investment instrument, ‘Ijarah Sukuk’, was launched for the first time in December 2020. A second tranche of this instrument, totaling Tk. 40 billion, was issued in June 2021. The oversubscription of the second issuance (Tk 327 billion) points to a huge demand for the instrument. The authorities are planning to continue issuing these Sukuk bonds.

uA003fig02

Public and Publicly Guartanteed Debt

(In percent of GDP)

Citation: IMF Staff Country Reports 2022, 071; 10.5089/9798400201943.002.A003

Sources: Data from authorities and IMF staff estimates.
uA003fig03

Domestic Debt by Type, FY 2021

(In percent of total domestic debt)

Citation: IMF Staff Country Reports 2022, 071; 10.5089/9798400201943.002.A003

Source: Data from the authorities.
uA003fig04

External Debt

(In percent of GDP)

Citation: IMF Staff Country Reports 2022, 071; 10.5089/9798400201943.002.A003

Sources: Data from authorities and IMF staff estimates.
uA003fig05

External PPS Debt by Creditor, FY 2021

(Percent of external PPG)

Citation: IMF Staff Country Reports 2022, 071; 10.5089/9798400201943.002.A003

Sources: Data from Country Authorities

4. External PPG debt stood at US$62 billion in FY21, around 17.5 percent of GDP.4 External PPG debt is predominantly owed to multilateral and bilateral creditors, 53.2 and 30.3 percent of outstanding external PPG debt respectively, with some guaranteed SOE debt. External medium- and long-term (MLT) PPG debt has helped finance infrastructure projects and is expected to decrease gradually from about 16.9 percent of GDP in FY21, to about 11.6 percent of GDP by 2042. With some rationalization of capital goods imports, private sector debt fell to about 2.0 percent of GDP in FY20 (4.7 percent in FY19) and picked up slightly to around 2.3 percent of GDP in FY21, primarily driven by an increase in short term trade credit.5 Despite several new infrastructure megaprojects and slower GDP growth, the larger share of concessional external borrowing has helped external PPG debt-to-GDP ratio remain on a downward path. However, infrastructure needs in Bangladesh remain high. In the absence of reforms to attract FDI, external financing for large projects will be constrained. Overall public debt-to-GDP (41.4 percent in FY21) is expected to stabilize at around 41.8 percent by FY31 and thereafter. However, domestic debt remains sensitive to interest rates and overall debt ratings are sensitive to changes in potential CI ratings, which impact the debt carrying capacity threshold.

Text Table. Bangladesh: Outstanding External PPG Debt by Creditor

(end-FY21)

article image
Source: Data from the authorities

B. Macroeconomic and Financing Assumptions

5. The macroeconomic assumptions underlying this debt sustainability analysis (DSA) are as follows:

  • Growth and inflation. Near term growth projections are less optimistic than in the June 2020 RCF/RFI report, reflecting the prolonged nature of the pandemic, another round of nationwide lockdowns (mid-April to mid-August 2021) and restrictions, subdued credit growth and a low vaccination rate.6 The authorities also revised down the FY20 growth to 3.5 percent.7 Real GDP growth is projected to pick up to 6.6 percent in FY22 as the impact of COVID-19 abates and policies remain accommodative. As the external environment improves and the domestic vaccination program progresses, growth is projected to reach 7.1 percent in FY23. Inflation is expected to increase in FY 22–23 on the back of higher global commodity prices and economic recovery and then moderates over the medium and long-term, staying anchored around 5.5 percent. External debt dynamics under the baseline are favorable under a projected medium (long)-term growth rate of around 7.1 (6.5) percent and an effective nominal interest rate of new US$ borrowing around 3.0 percent. In the long run, investment and productivity enhancements are assumed to play a critical role in driving growth. Exports as a share of GDP is assumed to moderate due to the impact of LDC graduation keeping growth in the long-term lower than in the medium-term. Important risks to future GDP growth could arise from a prolonged impact of the pandemic, accompanied by slow implementation of macro critical structural reforms to boost productivity and exports, or a large depreciation with rising debt servicing costs without matching increases in domestic revenues, elevated NPLs, diverting resources from growth friendly investment spending.

  • Fiscal policy. The primary fiscal balance is projected to be weaker over the medium term than in the June 2020 RCF/RFI report. The fiscal (primary) deficit is projected to peak at 6.1 (3.6) percent of GDP in FY22 as the authorities increase pandemic-related spending. In the absence of measures to mobilize tax and non-tax collections, the revenue-to-GDP ratio is expected to remain flat at about 11 percent of GDP over the medium-term—0.7 percent of GDP below the authorities’ medium term target8 However, the authorities have established a track record of remaining within their deficit target of 5 percent of GDP and have maintained a low deficit throughout FY21 by curtailing non-priority current spending, suspending low-priority capital projects as revenue under-performed, and under-executing ADP spending due to COVID-19. A timely and orderly exit from the stimulus is expected to bring the deficit back to 5 percent of GDP by FY25, keeping the overall public debt ratio below the debt threshold.

  • Current account (CA) dynamics. The CA deficit moderated in FY20 and FY21 due to a temporary surge in remittances and a gradual recovery in exports. Remittance inflows peaked in FY21 (growing at about 36 percent y/y), reflecting a temporary switch from the informal channels to the formal banking channels, a 2 percent incentive scheme introduced by the authorities in July 2019, as well as savings from returning migrants. Decline in remittance inflows in the first six months of FY22 (July-December) suggest that remittances will settle down closer to the pre-COVID 19 levels.9 Starting FY22, the CA-to-GDP ratio is expected to widen as the share of remittances decline, and the share of exports to GDP grow only modestly absent major reforms. With expected increase in imports of capital goods, industrial raw materials, food and energy, the CA deficit is expected to increase to around 2.5 percent of GDP over the medium term. With FDI inflows remaining below LIDC peers, FDI-linked technology absorption and innovation, is expected to remain weak. Slower-than-expected growth in trading partners due to the pandemic, shocks to commodity prices, including LNG, oil and food, as well as higher frequency of natural disasters could lead to a further deterioration in the CA deficit.

  • Financing assumptions. On average, net external financing, as a share of total financing, is projected to stabilize around 19 percent. Reserves were also bolstered by the recent SDR allocation of US$1.457 billion (0.4 percent of GDP). Reserve coverage is expected to fall steadily before stabilizing at around 5 months of prospective import coverage. The concessionality of debt is expected to decline over the medium-term as Bangladesh graduates from the LDC status and income levels rise. Cost of domestic debt is assumed to vary from 7.0 percent for T-bills, 7.5 percent (1–3 year) to 9 percent (for above 3 years and up to 7 years) and 10.5 percent above 7 years. The debt is assumed to be skewed towards T-bonds, with the share increasing from 75 percent in the medium-term to 90 percent by FY42. The assumptions on the share are slightly more skewed towards long term debt than the June 2020 RCF/RFI report (with T-bond share between 65–80 percent of total debt issued), the interest rates are expected to be lower as a result of the NSC price reforms but overall debt is sensitive to higher interest rates.10

Text Table. Bangladesh: Macroeconomic Assumptions

article image

6. Unexpected changes to debt have been small (Figures 1 and 2). Historically, PPG external debt has been driven by favorable growth and a positive CA balance. The historical residual is high due to infrastructure related increases in external debt occurring at the same time that growth was strong and the CA was in surplus. Looking forward, the residual declines due to a slowdown in short-term flows.

7. Realism tools suggest that the macroeconomic projections are consistent with the experience of LICs and under the pandemic (Figure 4). The 3-year adjustment in the primary balance is near the median of the sample of 3-year fiscal adjustments for LICs since 1990 that were under an IMF supported program. The growth projections are explained only partially by the fiscal multiplier applied to the fiscal deficit, especially in the outer years. This suggests growth is determined also by other factors such as normalization and non-recurrence of lockdowns. Public and private investment plans are in line with previous and historical projections, and so is the contribution of government capital investment to GDP.

8. Guaranteed SOE debt is included in the baseline projection. The stock of guaranteed SOE debt in FY21 is estimated to be about US$8.2 billion or around 13 percent of the PPG external debt stock. The authorities are working to standardize the reporting of SOE debt to cover non-guaranteed debt. This DSA is prepared on a currency basis as data are not available for the residency basis. The difference between the two definitions should not materially affect the assessment. The calibrations of the contingent liability shock is based on the default values for the SOE debt (2 percent of GDP) and financial market component (5 percent of GDP) since they are sufficient to represent potential fiscal risks. The stock of debt linked to private public partnerships (PPPs) is less than 3 percent of GDP. A natural disaster stress test was also applied, calibrated at the default setting of a one-time 10 percent of GDP shock to the external debt-to-GDP ratio.

Text Table. Bangladesh: Debt Coverage

article image

The default shock of 2% of GDP will be triggered for countries whose governirient-guaianteed debt is not fully captured under the country’s public debt definition (1.). If it is already included in the government debt (1.) and risks associated with SoE’s debt not guaranteed by the government is assessed to be negligible, a country team may reduce this to 0%.

C. Country Classification and Determination of Scenario Stress Tests.

9. The debt carrying capacity for Bangladesh has been downgraded from strong to medium, based on the October 2021 WEO and the 2020 World Bank CPIA. The Composite Index (CI) is based on a weighted average of several factors such as the country’s real GDP growth, remittances, international reserves, world growth, and the World Bank CPIA score. The downgrade is driven mostly by a lower CPIA score in 2020 – reflecting institutional weaknesses- as well as expected worsening of world and domestic growth projections. The CI is calculated for the last two WEO vintages, in this case the October 2021 and April 2021 WEO, and uses 10-year averages of the variables, with 5 years of historical data and 5 years of projections. The threshold for a medium classification is a CI score above 2.69 and below 3.05.11 The downgrade of the overall debt carrying capacity lowered the threshold from 70 percent of GDP to 55 percent of GDP.12 The thresholds for external debt indicators were also reduced implying a lower fiscal space and the need to mobilize revenue to support the much-needed social and developmental spending.

Text Table. Bangladesh: Country Classification

article image

D. External and Public Debt Sustainability

10. All external debt indicators are below their respective thresholds under the baseline and stress-test scenarios (Figure 1). External PPG debt-to-GDP ratios are expected to settle at around 11.6 percent by FY42. The most extreme shock to the external PPG debt-to-GDP ratio is a non-debt flows shock, or a shock to official transfers, remittances and FDI. Given the still competitive RMG sector, the PV of debt-to-exports and debt service-to-exports ratios remain well below their thresholds even under the most extreme shock to exports. The debt service-to-revenue ratio is on a declining trend and remains under the threshold under the most extreme shock of a one-time depreciation.13

11. Overall public debt indicators suggest a low overall risk of debt distress (Figure 2). The PV of total public debt-to-GDP (higher compared to the June RCF/RFI report) is below its indicative threshold. The largest shock to this indicator is a natural disaster. The shock is kept at default calibrations and is equivalent to a one-time 10 percent of GDP shock14. Indicators in percent of revenues are on a slightly increasing trend, further highlighting the importance of raising the revenue-to-GDP ratio which is assumed to remain stagnant at a low level over the projection period. Increasing the revenue-to-GDP ratio will be critical in providing non-debt financing to growth-enhancing and climate-resilient infrastructure projects. Reforms to improve investment climate are crucial for attracting FDI.

E. Assessment

12. Bangladesh has a low risk of external debt distress and a low overall risk of debt distress. All external debt indicators are below their corresponding thresholds under the most extreme shock. The overall public debt is only slightly below its indicative threshold. This suggests that vulnerabilities have increased since the RCF/RFI assessment due to adverse impact of COVID-19 pandemic on growth and revenues. This also reflects the downgrade in debt carrying capacity from strong to medium is due to the deterioration of the CPIA performance, and a pandemic-driven reduction in global growth which flags lower debt carrying capacity. Risks are titled to the downside. This has further increased the urgency of mobilizing revenue to support the much-needed spending to support pro-poor growth recovery. Also, implementing the adaptive expenditure, as laid out in the 8th FYP and the Delta Plan, will be challenging unless it is financed through concessional or non-debt creating flows (FDI). The authorities should continue to seek concessional financing to the extent possible, as well as improve the investment climate to attract FDI financing. In line with the recommendations of the recently concluded Medium Term Debt Strategy (MTDS) TA mission, staff advice is to continue NSCs price reforms to facilitate the development of domestic debt and capital markets.

F. Authorities’ Views

13. The authorities agree that the risk of external debt distress and overall risk of debt distress remains low. The authorities remain cautious about contracting external debt. The authorities agreed that domestic interest costs are high and that NSC reforms would help. They expressed concern about the lowering of their debt carrying capacity, which is mostly driven by the CPIA score. They also noted that while the public debt included guaranteed debt held by the SOEs the analysis does not consider the revenues generated by those entities. The authorities acknowledged that access to concessional financing will gradually decline as they proceed toward upper middle-income status. The authorities are enhancing the investment climate to attract financing and investments. They are committed to the automation of revenue administration, and tax expenditure rationalization to boost tax revenues. The authorities plan to publish the updated MTDS within the third quarter of FY22. Authorities are taking mitigating steps including a gradual phase out of inconsistent cash incentives and subsidies and rationalizing of tariffs to be consistent with the WTO framework in time with the graduation process in 2026. The government is also planning to formulate a ‘National Tariff Policy’ with a view to coordinate the tariff rationalization process, to maintain predictability of tariff rate determination, and to encourage export diversification.

Figure 1.
Figure 1.

Bangladesh: Indicators of Public and Publicly Guaranteed External Debt, 2022–20321/

(In percent, unless otherwise mentioned)

Citation: IMF Staff Country Reports 2022, 071; 10.5089/9798400201943.002.A003

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in or before 2032. The stress test with a one-off breach is also presented (if any), while the one-off breach is deemed away for mechanical signals. When a stress test with a one-off breach happens to be the most exterme shock even after disregarding the one-off breach, only that stress test (with a one-off breach) would be presented.
Figure 2.
Figure 2.

Bangladesh: Indicators of Public Debt, 2022–20321/

(In percent)

Citation: IMF Staff Country Reports 2022, 071; 10.5089/9798400201943.002.A003

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in or before 2032. The stress test with a one-off breach is also presented (if any), while the one-off breach is deemed away for mechanical signals. When a stress test with a one-off breach happens to be the most exterme shock even after disregarding the one-off breach, only that stress test (with a one-off breach) would be presented.
Figure 3.
Figure 3.

Bangladesh: Drivers of Debt Dynamics – Baseline Scenario

Citation: IMF Staff Country Reports 2022, 071; 10.5089/9798400201943.002.A003

1/ Difference between anticipated and actual contributions on debt ratios.2/ Distribution across LIGs for which LIC DSAs were produced.3/ Given the relatively low private external debt for average low-income countries, a ppt change in PPG eternal debt should be largely explained by the drivers of the external debt dynamics equation.
Figure 4.
Figure 4.

Bangladesh: Realism Tools

Citation: IMF Staff Country Reports 2022, 071; 10.5089/9798400201943.002.A003

Table 1.

Bangladesh: External Debt Sustainability Framework, Baseline Scenario, 2019–2042 1/

(In percent of GDP, unless otherwise indicated)

article image
Sources: Country authorities: and stall estimates and projections.1/ Includes both public and private sector external debt.2/ Derived as [r – g – ρ(1+g)]/(1+g+ρ+gρ) times previous period debt ratio. with r : nominal interest rate: g : real GDP growth rate. and ρ : growth rate of GDP deflator in US. dollar terms.3/ Includes exceptional financing (re. changes in arrears and debt relief); changes in gross loreign assets: and valuation adjustments For projections also includes contribution from price and exchange rate changes.4/ Current—year interest payments divided by previous period debt stock.5/ Defined as grants, concessional loans, and debt relief.6/ Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).7/ Assumes that PV of private sector debt is equivalent to its face value.8/ Historical averages are generally derived over the past 10 years, subject to data availability. whereas projections averages are over the first year of projection and the next 10 years.
Table 2.

Bangladesh: Public Sector Debt Sustainability Framework, Baseline Scenario, 2019–2042

(In percent of GDP, unless otherwise indicated)

article image
Sources Country authorities: and staff estimates and projections.1/ Coverage of debt: The central government, central bank government-guaranteed debt . Definition of external debt is Currency-based.2/ The underlying PV of external debt-to-GDP ratio under the public DSA (fitters from the external DSA with the size of differences depending on exchange rates projections.3/ Debt service is defined as the sum of interest and amortization of medium and long-term. and short-term debt.4/ Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period and other debt creating/reducing flows.5/ Defined as a primary deficit minus a change in the public debt-to-GDP ratio ((-): a primary surplus), which would stabilizes the debt ratio only in the year in question.6/ Historical averages are generally derived over the past to years. subject to data availability, whereas projections averages are over the first year of projection and the next 10 years.
Table 3.

Bangladesh: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2022–2032

(In percent)

article image
Sources: Country authorities; and staff estimates and projections.

A bold value indicates a breach of the threshold.

Variables include real GDP growth, GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Includes official and private transfers and FDI.

Table 4.

Bangladesh: Sensitivity Analysis for Key Indicators for Public Debt, 2022–2032

(In percent)

article image
Sources: Country authorities: and staff estimates and projections.

A bold value indicates a breach of the benchmark.

Variables include real GDP growth. GDP deflator and primary deficit in percent of GDP.

Includes official and private transfers and FDI.

1

FY21 is the fiscal year from July 2020 to June 2021.

2

NSCs were introduced in the subcontinent in 1944 by the National Savings Institute of the Ministry of Finance of India. The intent was to promote savings among the population and finance the government’s budget deficit. Currently, the Department of National Savings under the Bangladesh Ministry of Finance issues NSCs.

3

Effective FY20, the authorities digitized the issuance of NSCs and linked it to the purchasers’ tax identification number to enforce the existing cap on their issuance and increased the tax on interest income from 5 to 10 percent. This resulted in a decline in NSC issuance in FY20 by around 70 percent compared to FY19. NSC issuance in FY21 rebounded driven by the exceptional remittance inflows and the increase in the spread between the deposit rate and the NSC rate.

4

The total external PPG debt includes US$50.9 billion central government debt, US$1.268 billion IMF debt (including RCF/RFI), and US$8.2 billion guaranteed commercial debt, US$2.0 billion of short term debt.

5

Trade credits include the difference between the customs record and the actual transaction record, which are settled in the short term.

6

As of February 2, 2022, around 36 percent of total population have received their second dose. The authorities aim to vaccinate 70 to 80 percent of total population by early 2022.

7

In November 2021, the Bangladesh Bureau of Statistics (BBS) released a rebased series of national accounts (base year 2015/16). The rebasing has led to an increase in GDP levels and a slight decline in GDP growth rates, partly reflecting wider coverage of economic activities and methodological changes. For instance, FY20 GDP at current prices is 15.7 percent higher, while real GDP growth rate is 0.06 percentage point lower, compared to the existing data (base year 2005/06). BBS is finalizing the underlying balanced supply and use tables (SUTs) and working on producing back-casted historical GDP series. In the absence of full data, the DSA uses the 2005/06 base year GDP

8

In the medium term budgetary framework, the authorities growth assumptions underpinning revenue projections are more optimistic.

9

The slowdown in the remittance inflows was expected, as the number of expatriate workers going abroad declined in 2021 amid the ongoing pandemic.

10

Note, for external debt the only exception is the assumption of sovereign commercial borrowing at 9 percent rate assuming authorities will access the market. The export import bank of NPC debt is assumed at 3.18 percent rate as in RCF/RFI. The T bill rates are very low 1.5–6.0 percent range (91 day- 10 year) in FY21 likely reflecting the excess liquidity in the system. These rates were in the 7–9 percent range in FY20 and assumed to revert.

11

The CPIA score, which determined the debt carrying capacity until April 2019, was revised down slightly, and was one of the key drivers of change in CI and country classification. Starting 2019 the CPIA was lowered to 3.10 from 3.38 in 2015 and projected to stay at 3.10 thereafter.

12

Changes in a country’s classification would require two consecutive signals where country’s CI exceed its classification cut-off. The cut-off are greater than 2.69 and lower than 3.05 for medium CI rating.

13

Per BB’s end year balance of payments data, disbursements of short-term debt of US$1,142 million in FY20 and US$2,064 million in F21 are included in PPG debt. These were assumed zero in the June 2020 RCF/RFI report.

14

A World Bank (2016) study, Bangladesh: Building Resilience to Climate Change, estimated that that with a per capita GDP of about $1,220, the economic losses in Bangladesh over the past 40 years were an about $12 billion, depressing GDP annually by 0.5 to 1 percent.

Bangladesh: 2021 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Bangladesh
Author: International Monetary Fund. Asia and Pacific Dept