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Your savings can hurt you,
especially, if you are Belal...

Excessive government borrowing in an overheating economy leads to higher inflation, posits Nofel Wahid.

I recently went back home (Dhaka) for a short visit. While I was there, I had a very interesting conversation with our chauffer, Belal. This is how the conversation went.

The morning after my arrival, I saw Belal with a bank deposit book. I asked him if he was depositing money for my parents. Not that it was any of my business, but I was curious nonetheless.

Belal replied that it was not actually my parent's money, but his own savings that he was going to deposit at the bank. He proceeded to tell me about how he had setup a time-deposit savings scheme after the birth of his daughter, and that he deposits Tk. 500 a month into that savings account.

I commended Belal on his prudent financial management skills, and didn't think much of our conversation thereafter.

Strange as this may sound, the Government's recent decision to allow the whitening of black money through investments in the stock exchange reminded me of Belal's story.

If you are scratching your head wondering what the connection is, let me expound further.

Low-income individuals like Belal can deposit their savings in a bank, but they can't borrow against those savings. This is reflected in data collected by the International Monetary Fund (IMF) which shows that over 4 crore households in Bangladesh deposited money at commercial banks in 2010, but only 80 lakh households borrowed money from commercial banks.

Although those figures include people in the middle or high-income category who chose not to borrow (even if a bank was willing to lend to them), a large majority of the roughly 3.2 crore households which didn't borrow money last year, despite having savings, are low-income households.

The simple reality is -- no bank in Dhaka will lend to Belal, and millions like him, who are employed in the informal economy.

Why? Well, your guess is as good as mine.

Surely no one can argue that Belal is not creditworthy? He has a job, saves Tk. 500 a month.

One might argue that he has no assets to offer as collateral to get a loan. Eh, did we not invent microcredit?

If there can be a Grameen branch in Manhattan, New York, why can there not be a Grameen branch in Dhaka to lend to people like Belal? If the Government doesn't like Dr. Yunus and has an axe to grind against Grameen Bank, that's fine. But what is stopping the Government from allowing the likes of Sonali or Pubali banks (just to name a couple) to open microcredit branches in Dhaka?

If you think that this is a gross injustice being perpetrated by intransigent bureaucrats and their political minders, here's the real kicker.

Guess who gets to borrow thousands and thousands of crores every year without any savings of its own? The Government.

The Government has been running a budget deficit of between 2-5% of GDP (depending on initial or revised budget numbers) for more than a decade. On average, more than half of those deficits have been financed through domestic borrowing from the banking sector.

As a matter of fact, banking data shows that Government borrowing in recent years has almost entirely been sourced from household deposits. Household deposits at commercial banks have averaged at around 25% of GDP over the last five years, while commercial bank lending to households has remained constant at around 11% of GDP over that same period.

The 14-percentage point difference between what households save and what they borrow almost entirely accounts for the Government's average stock of debt owed to the domestic banking sector over the past five years (see chart below).

So in other words, while the likes of Belal save with no hope of borrowing against their savings, the Government borrows that money with no savings of its own.

Perhaps an even more important question that needs to be asked is -- what is the Government doing with the money it borrows from the banking sector?

It is providing 'sweet-heart' deals to black money-earners. By allowing black money-earners to legalise their illegal income by paying a 10% tax and investing it in the stock market, instead of the 25% tax they are expected to pay, the Government is exacerbating its budget deficit.

I acknowledge that tax concessions to black money-earners are not the only budget item being financed through domestic bank borrowing. But a wrong is a wrong!

And let's not even get into the Government's moral bankruptcy of vowing, on the one hand, to prosecute alleged wrong-doers identified by the Mr. Ibrahim Khalid's enquiry, and giving tax concessions to black money-earners on the other hand.

One may even argue that black money flows into the ailing stock market will likely boost share prices and greatly benefit retail investors, who undoubtedly suffered large losses at the start of the year. And we may already be seeing that effect come into play, given the recent stock
market rally.

Source: IMF Financial Access Survey and International Financial Statistics databases.

Be that as it may, surely the Government has higher priorities than trying to artificially reflate share prices and bailout stock market investors?

The Government's culpability on that front is not just limited to providing tax concessions to black money-earners. It recently set up a Tk. 5,000 crore investment fund with the primary aim of preventing excessive stock market volatility.

Whether an investment fund with Tk. 5,000 crore in assets will be effective in stabilising the stock market during periods of heightened stress remains to be seen. After all, the Dhaka Stock Exchange has a total market capitalisation of more than Tk. 2,50,000 crore market.

Analogies such as a drop in a bucket or a speck of dust in the wind come to mind!

Furthermore, the Bangladesh Fund will draw-in capital from other government-owned financial institutions, most notable among them being the four national commercial banks (NCBs) -- Sonali, Janata, Agrani and Rupali bank. It is not entirely clear how the involvement of the NCBs does not contravene Bangladesh Bank regulations, which require commercial banks to set up independent subsidiaries to invest and gain exposure to the stock market.

Setting aside the regulatory questions, there are significant balance sheet risks facing the Government as a result of this move to set up the Bangladesh Fund. Any losses made by the Bangladesh Fund are a contingent liability on the Government's bottom line.

Put simply, the Bangladesh Fund's losses will increase the Government's budget deficit.

That's not to say that efforts to ensure a robust capital market are not important. A deep and stable capital market is undoubtedly an important driver of growth. But throwing good money after bad to support an inflated and unsound market, which might ultimately result in more losses and higher budget deficits for the Government, is bad policy.

It is vitally important for a 'financially-closed' economy such as ours that the Government leaves no stone unturned to ensure that its budget deficits are as small as possible. Failure to do so means that the Government has to borrow more of Belal's money to finance its budget deficit. Many economic studies have shown that excessive government borrowing in an overheating economy, such as ours, leads to higher inflation.

And who would be most affected by higher inflation? Belal.

Nofel Wahid is an applied economist, and can be contacted at wnofel@gmail.com.