What does a new IMF loan mean for Bangladesh

The International Monetary Fund (IMF) has approved a $4.7 billion loan for Bangladesh: $3.3 billion under the Extended Credit Facility (ECF) and Extended Fund Facility (EFF) arrangements and $1.4 billion under the new Resilience and Sustainability Facility (RSF). The IMF announcement noted that “Bangladesh is the first Asian country to access the RSF.”

When Bangladesh applied for the IMF loan, citizens were concerned about the state of the country’s economy, as the application came at a time when Pakistan’s economy was in turmoil and Sri Lanka’s economy had crumbled. What does the IMF loan really mean for Bangladesh’s economy?

First, it’s important to realize that Bangladesh has not asked for a “bailout” package like Sri Lanka and Pakistan but rather for a stabilization package. Giving financial support to a country or firm that faces insolvency is referred to as a “bailout,” whereas an EFF package is granted to fund structural reform, an RSF toe ensure balance of payment (BOP) stability, and an ECF for a stable and sustainable economic position. As the IMF put it, the loan “will help preserve macroeconomic stability and prevent disruptive adjustments to protect the vulnerable.”

In other words, rather than waiting for a crisis, Bangladesh’s government has decided to take a precautionary measure and look for ways to overcome economic troubles before the whole economy begins to falter.

Generally, the IMF offers help through the ECF/EFF and RSF when a country suffers from balance of payment volatility and needs to set a policy direction. In essence, the IMF offers a country short- to medium-term funding, while allowing the borrower to return the funds over a longer duration. For instance, an ECF has a zero-interest rate, a 5-and-a-half-year grace period, and final maturity at 10 years. Therefore, a country can obtain these funds without incurring any costs, use the money to implement structural changes that would boost its economy, and then repay the loan with zero interest after 10 years, when the country will be able to benefit from the reforms. With this deferred repayment schedule, such funds not only lessen strain on the BOP, but also allow the government to return with a better financial foundation for a thriving economy.

Bangladesh is receiving this stabilization package, but that doesn’t imply it lacks the foreign currency needed to cover its import expenses. Generally, three months of import cover is internationally accepted as a healthy reserves position, and with $33.75 billion (gross) in reserves as of December 2022, Bangladesh has enough dollars to cover its import expenses for four months. Thus Bangladesh’s economy may be volatile for now but it can’t be labeled as unhealthy. The nation is borrowing from the IMF not because it is experiencing a financial catastrophe like Sri Lanka or Pakistan, but rather as a preventative step.

However, in order to receive the loan, every borrowing country must implement the IMF’s recommendations.

The creation of an asset management business to recover and dispose of defaulted loans is one of the reforms the IMF has suggested for Bangladesh. This reform is desperately needed given how quickly non-performing loans have been growing in the banking sector of the country. Another crucial step that the nation should have taken, even without the IMF’s advice, is the modification of outdated laws such as the Bank Company Act 1991 to reflect current society. Enhancing financial sector regulation and setting a ceiling on the government’s budget deficit are also some of the conditions set by the IMF. The rationale is that increasing waste reduction efforts will eventually relieve economic pressure.

Bangladesh still needs to worry about a few areas, though.

First, Bangladesh is no longer able to independently determine economic policy. Whenever the government designs a policy, it must guarantee that it does not contravene any of the IMF’s conditions. For example, until recently, Bangladesh Bank (BB) set monetary policy based on its own assessment of what is best for the national economy. However, BB recently declared a shift from a Keynesian to a monetarist economy and chose to let the economy operate as a free market. BB had no alternative; market-driven fuel prices were one of the IMF’s requirements.

Without a doubt, Bangladesh would have to adjust to a monetarist economy sooner or later, as a part of the financial inclusion push that has been prioritized globally since 2009. The question is whether the economy can actually survive without any government support.

The IMF also wants Bangladesh to increase its government revenue. If, to increase revenue, the country chooses to increase the tax rate or VAT, it may marginalize and further impoverish the poor. Thus, implementing all of the IMF’s recommendations without upsetting the current system will be difficult.

That said, Bangladesh’s tax to GDP ratio is only 7.5 percent, whereas World Bank suggests the ideal ratio would be 15 percent. Thus, Bangladesh has a wide scope to raise VAT and tax revenue. But to ensure the tax increases don’t negatively impact the poor, the additional funds collected should be used to increase the social safety net and public spending in a way that is in line with the goal of poverty reduction.

The funds will be provided in installments by the IMF. That means the money could be withdrawn unless Bangladesh rigorously adheres to the terms. In the past, when rumors grew about alleged corruption in the Padma bridge financing, the World Bank withdrew its money from the project, followed by the Asian Development Bank, Japan International Cooperation Agency, and Islamic Development Bank. If similar suspicions resurface in Bangladesh, the IMF may also suspend its funds. In such a circumstance, the economy will struggle to function on its own because funding from other sources will be unavailable then.

Today, when the global economy is encountering challenges, the IMF is the best source of funding and advice for Bangladesh. But the country must keep in mind that the debt must be returned. The country must focus on two aspects in order to overcome the issue. To begin, the country must ensure that the flow of funds from the IMF is not interrupted. It must constantly monitor the fund’s flow and utilization, and the money must be converted into real gains. Without raising production, the nation won’t be able to benefit from the loan for as long.

Second, Bangladesh needs a backup plan. What if the IMF stops its funding after a few installments? The backup plan may be a bilateral agreement with developed countries like the United States or China, or regional assistance from SAARC or ASEAN.

Regardless of where the money comes from, the ultimate solution to today’s economic volatility is production. There is simply no alternative to increasing domestic production to ensure economic health. So Bangladesh must ensure that it is disbursing funds to boost up production, which will bring foreign exchanges in and improve the BOP. The decision to take out a loan from the IMF can only be judged successful if the economy is stronger in 10 years than it is today.

Source: The Diplomat