Discussions around foreign aid or investment, technically known as official development assistance (ODA), and the consequent debt liabilities have gained renewed traction with developments in 2022 around the world, including in Bangladesh. The impacts of the Russia–Ukraine war, at a time when the Bangladesh economy was on its way to post-covid-19 pandemic recovery, have added new dimensions to this discourse.

The debates around ODA have resurged also because Sri Lanka, a neighbouring country of Bangladesh, has faced severe debt-induced hardships to its economy in 2022. Sri Lanka is known for its robust economy and high standard of living in the South Asian context. The crisis that has hit the country has led to concerns about debt sustainability taking centre stage in other countries in the region as well.

Bangladesh’s record of foreign loan servicing has been quite robust. However, the Sri Lankan crisis has coincided with Bangladesh’s hitherto comfortable foreign exchange (forex) reserves coming under considerable pressure. This pressure owes mainly to high global price-induced import payments and the rising trade and current account deficits. As a consequence, Bangladesh’s currency, the taka (BDT), has depreciated significantly, going down by about 12% in the third quarter of 2022.

Given these economic headwinds, the Bangladesh government has opted for some unprecedented measures. A combination of policies was put into action, including curtailing imports and slowing down foreign-funded development projects. These policies were undertaken to lower demand for the US dollar and to stabilise the foreign exchange market. The pressure on forex has also led Bangladesh to seek support from international financial institutions.[1]

Against this backdrop, two developments are anticipated: increasingly large amounts of foreign aid to the country and higher debt service payments in the foreseeable future. These in their turn have attracted the attention of policy analysts to issues related to Bangladesh’s debt management capacity over the medium-term future.

… higher borrowing by a country should not represent cause for concern if this is well planned and if an optimal return on investment can be ensured.

In general, higher borrowing by a country should not represent cause for concern if this is well planned and if an optimal return on investment can be ensured.[2] In view of this, the objective of this writeup is rather narrow: to perform a critical review of Bangladesh’s debt repayment obligations. This is important because any debt-related concern has economy-wide ramifications. In this connection, the writeup explores three specific issues: 1) the overseas borrowing scenario and debt servicing trends; 2) pursuit of a cautionary policy; and 3) ways to mitigate risk.

The borrowing scenario

As of March 2022, Bangladesh’s outstanding foreign debt was USD 68 billion. To put this in context, it was 16.9% of the country’s gross domestic product (GDP) and 91.3% of its forex earnings. These figures are comfortably below the two thresholds used by the intergovernmental financial institutions, the World Bank and the International Monetary Fund (IMF), to assess the strength of ‘debt carrying capacity’ of a country.[3]

In 2020–2021, Bangladesh’s foreign debt service as a share of domestic revenue was 8.3% – again, well below the World Bank/IMF threshold (of 23%). To track another indicator from the same time, foreign debt service payments as a share of export plus remittance earnings was 4.5%, against the critical threshold was 21%.

Thus, in terms of macro indicators, such as outstanding foreign debt and foreign debt servicing obligations, Bangladesh’s position is quite good. No surprise, then, that many international financial institutions label Bangladesh a ‘strong debt-carrying country.’ It is noteworthy that the overwhelming part, 93.9%, of the foreign debt is of a long-term nature. This gives Bangladesh leeway to carry out debt repayment and debt sustainability planning well ahead of time.

Another positive aspect for Bangladesh relates to the structure of its foreign loans. In the 50 years after its independence in 1971 (i.e. from 1971 to 2021), Bangladesh received a total of USD 101 billion in foreign loans. The overwhelming share (82%, or USD 84 billion) was in project-centric loans, such as for infrastructure and capacity-building. The shares of food and commodity aid were rather low by comparison (7% and 11%, respectively). This pattern has skewed further since the late 2010s. For instance, in 2020–2021, the share of project loans in total loans was 99.8%! As of 2022, loans in the pipeline, amounting to USD 50 billion, are almost all geared towards project aid.[4]

As such, Bangladesh’s foreign borrowing is being channelled mainly towards what economists call the hard area of socioeconomic infrastructure and the soft area of human development. Therefore, foreign aid to the country is geared towards generating positive multiplier effects in the economy and is not towards direct consumption.

Cautionary policy

This holistic diagnosis of the foreign aid and debt management scenario in Bangladesh points to a comfortable situation for the country. But challenges remain. Bangladesh should exercise due caution in going forward from 2022. There are several reasons for this.

Bangladesh’s economy is not analogous to Sri Lanka’s. However, as a regional economy, the Sri Lankan experience serves as a learning opportunity for Bangladesh. What Sri Lanka has shown is that a well-developed economy can still fall into the dreaded debt trap – in Sri Lanka’s case, all because overseas borrowing was ill planned, money was poorly spent, debt servicing liabilities were unanticipated and forex reserves were inadequately replenished.

In short, Sri Lanka’s debt-related policy-making has had many shortcomings. In itself, the country’s debt to GDP ratio was not very high. Even at the crisis point in March 2022, it was 67%, which is not significantly higher than the 55% threshold. Many developing countries deal with higher debt–GDP ratios – but do not face bankruptcy.

Asking some basic questions can lead to lessons from the Sri Lanka case. Were the terms and conditions of borrowing rigorously negotiated with foreign partners?[5] Were the borrowed funds channelled to priority sectors? Were the estimated returns on investment rates justified? Was the repayment plan well sequenced with the obligations? Were the exchange rate risks factored into the estimations?[6]

… Bangladesh’s two major indicators, the foreign debt–GDP ratio and the debt servicing–forex ratio, are robust.

As mentioned, Bangladesh’s two major indicators, the foreign debt–GDP ratio and the debt servicing–forex ratio, are robust. However, in recent years, foreign loan-related spending has risen notably, in terms of both the amount and the debt servicing liabilities. To understand the situation, consider this pattern: the foreign debt–GDP ratio in 2011–2012 was 17.6%; this came down to 12.8% in 2016–2017 but then climbed steadily back to 16% in 2020–2021. This rising trend is set to continue against the backdrop of increased foreign borrowing for development needs.

Let’s consider another indicator. In 2011–2012 and 2014–2015, foreign aid to Bangladesh was USD 2.1 billion and USD 3 billion, respectively. By 2020–2021, the foreign aid figure had more than doubled, to USD 8 billion. By 2022–2023, in just one year, it would increase by 50% to USD 12 billion!

The rise in Bangladesh’s public sector debt is reflected by the country’s outstanding foreign debt. The foreign debt figures for June of 2021 and June of 2022 show a 22% annual increase (USD 62.9 billion to USD 68.25 billion). Standing in 2023, the aid in the pipeline of USD 50 billion will lead to a rise in external debt over the next three to five years.

It is worth mentioning that interest rates on foreign loans have been on the rise. Meanwhile, the grant element in the loan portfolio of Bangladesh has been on a declining path. In 1991–1992, loans and grants in total foreign borrowing took up 49% and 51%, respectively. In 2011–2012, the position was 72% versus 28%. The loan–grant split was skewed further by 2020–2021, to 94% versus 6%.

The terms of borrowing have also changed for Bangladesh over the years. The country’s 2015 graduation from the World Bank’s low-income category to lower-middle-income status meant that it was no longer eligible for what is called a ‘soft loan’ from the World Bank.[7]

As for the World Bank, its soft loan window, the International Development Association (IDA), replenishes its fund and disburses its loans via convening meetings held every three years, known as replenishment rounds. Its latest replenishment round was the 20th (IDA20), which took place in 2021. IDA20’s three-year lending programme (applicable from July 2022) sanctioned a loan of USD 6 billion for Bangladesh. The interest rate of 33% on this loan amount is on market terms, popularly known as ‘non-concessional terms.’ In the case of IDA19, the rate was nearly one-third of this, at about 13.7% of the loan. Lending institutions such as the Manila-based Asian Development Bank are also following suit with more non-concessional loans.

Bangladesh’s bilateral partners are also making their lending terms more stringent. Loans from China and Russia have higher interest rates and shorter grace and maturity periods than a decade ago. Since the 2010s, these have emerged as important features in Bangladesh’s loan portfolio. The terms of these borrowings are less generous: four to five years of grace and fifteen years of maturity for suppliers’ credit and two to three years of grace and twelve to fifteen years of maturity in the case of buyers’ credit.

For Bangladesh, 48% of the USD 4 billion in outstanding loans from China is of either the suppliers’ credit or the buyers’ credit type. These have higher interest rates (2.2–3.25% for buyers’ credit and 3.5–5% for suppliers’ credit) and more stringent terms than before. They also have high service charges.

For Bangladesh, 48% of the USD 4 billion in outstanding loans from China is of either the suppliers’ credit or the buyers’ credit type.

Meanwhile, time and cost overruns are common in the implementation of public infrastructure projects (PIPs) in Bangladesh. Given the proliferation of these PIPs, issues of good governance and value for money in their implementation are gaining in importance. The oft-experienced delays in foreign-funded projects lead to cost escalations and to situations whereby debt repayment for some projects resumes even when implementation of the project is yet to begin! Some projects under Indian lines of credit (LoCs) are cases in point. This type of situation could undermine Bangladesh’s sound debt management.

With rising borrowing, Bangladesh’s foreign debt servicing liabilities will also go up in the near future. To start with, the country’s debt servicing payment for foreign medium- to long-term loans was USD 2 billion in 2021–2022. According to Bangladesh’s Finance Ministry’s foreign loan-dealing body, the Economic Relations Division (ERD), the figure will be USD 4 billion in 2024–2025 and USD 5.2 billion in 2029–2030.

Currency depreciation has emerged as another big worry for Bangladesh’s foreign debt repayment. This relates particularly to projects funded through foreign loans that will generate income in local currency. Any currency depreciation will have adverse impacts in terms of foreign debt repayment liabilities. This worry was heightened in the third quarter of 2022 when Bangladeshi currency, the taka (BDT), suddenly depreciated by 12%.

Strategies going forward

When it comes to foreign borrowing and debt servicing, Bangladesh has no room for complacency. The country has set its eyes on two development milestones in the next two decades: achievement of the United Nations-mandated Sustainable Development Goals in 2030 and then its own advanced economy attainment through its Vision 2041. Foreign sources will be a crucial part of the resource package employed in reaching these goals.

At the same time, Bangladesh will witness debt servicing liabilities increasing at a faster rate than previously. This is because interest rates on borrowing are set to rise and the terms will become more stringent. An across-the-board strategy will be needed.

Make realistic projections as regards debt servicing obligations: Bangladesh’s Economic Relations Division (ERD), an organ of the Finance Ministry, estimates debt servicing liabilities, which are essentially payments for the underwriting of foreign borrowing. The ERD’s projections factor in loan grace periods, maturity periods, rates of interest and other borrowing terms.

For Bangladesh, many loans, particularly those from China and Russia but also those from India, are of a semi- or non-concessional nature.[8] The share of the country’s non-concessional loans in the borrowing portfolio is set to rise as Bangladesh graduates into the world’s middle-income club. It is thus very important that debt repayment estimates factor in changing realities and anticipated risks.

Strengthen governance in PIPs: A good governance framework is needed for public infrastructure projects (PIPs), particularly for those with a high amount of borrowed money. Several mega-PIPs in Bangladesh are listed for special scrutiny, and progress is monitored. But time extensions and cost escalations, and the consequent rise in borrowing, are red flags in this area.

A good PIP governance framework for Bangladesh could emulate the Organisation for Economic Co-operation and Development’s framework for good governance…

A good PIP governance framework for Bangladesh could emulate the Organisation for Economic Co-operation and Development’s framework for good governance, which is a tool for monitoring the implementation of infrastructure projects. There is a need to raise institutional capacities for oversight in the agency responsible for development project tracking, the Implementation Monitoring and Evaluation Department (IMED), which comes under the country’s apex policy formulation body, the Bangladesh Planning Commission. A key lesson from the Sri Lankan experience relates to the need to maintain the highest standards in the selection and implementation of PIPs underwritten by borrowed money.

Factor in exchange rate movement: Bangladesh should note the risks emanating from exchange rate movements. This is important when estimating the returns on foreign borrowing-induced investment. Movements in the forex rate have impacts on projects that are geared to the domestic market and whose earnings are in local currency. This will include a significant number of foreign-financed public infrastructure projects (PIPs) in Bangladesh. Currency hedging can be a smart way to mitigate the impacts of future exchange rate fluctuations.

Be mindful of the dual graduation: Bangladesh’s graduation from United Nations-designated least developed country (LDC) status itself does not have any significant implications in terms of access to aid and concessional funds. However, the country needs to be mindful of two issues. First, Bangladesh will miss out on LDC-related technical support from international partners like the United Nations agencies once it graduates out of the group. Some LDC-focused financial support windows, such as the LDC-specific Climate Fund, will be unavailable on graduation. Second, graduation will influence the decisions of lending countries because their general policy is to prioritise low-income countries and LDCs when sanctioning soft loans.

Seek alternative funding sources: Bangladesh will need significant resources to underwrite its development aspirations. A large share of ODA is currently being channelled towards humanitarian responses.  Meanwhile, aid for other development needs is under pressure. As demand on aid funding rises, policy-makers need to actively explore alternative options, such as blended finance, climate finance and South–South finance.

Diversify the sources of development finance: In managing financial flows, Bangladesh should seek more loans that it can use flexibly. Loans for budgetary needs are a good example here. Loans from non-traditional multilateral sources such as the Shanghai-based New Development Bank (NDB) and the Beijing-based Asian Infrastructure Investment Bank (AIIB) should be explored.[9] Bangladesh should join the call for expansion of windows such as the IMF’s Resilience and Sustainable Trust fund that are geared to mitigate external shocks.

Many countries are exploring currency swap options to reduce pressure on dollar-dominated forex reserves. Bangladesh’s central bank should look into this option for future needs.

Agree on a reliable forex reserve figure: Researchers and policy-makers need a clear understanding of the size of the country’s forex that is unencumbered. Unencumbered forex can be used to underwrite imports and service debt obligations. Unfortunately, this is an unsettled matter in Bangladesh. A debate between Bangladesh’s central bank and the international financing agency IMF about the actual size of forex reserves has highlighted this issue in 2022. Basically, the IMF estimates the actual forex reserve to be USD 7 billion, lower than the central bank’s figure.

Researchers and policy-makers need a clear understanding of the size of Bangladesh’s forex that is unencumbered.

Keep private sector borrowing under vigilance: Bangladesh’s private sector loans from foreign sources are rising fast. There is no sovereign guarantee for the repayment of private loans but the government still needs to be mindful. The country’s combined foreign borrowings, public and private, will surely create pressure on debt repayment and the forex market.[10] Policy-makers should monitor private sector loans to forestall any trend affecting Bangladesh’s international credit rating.

Concluding remarks

While Bangladesh’s foreign borrowing situation and debt servicing track record have been impressive, there are reasons to be cautious going forward. Foreign borrowing is rising fast, the shares of grant and concessional loans are on the decline and the terms of loans are getting more stringent. Debt servicing liabilities will rise as the grace period for some big loans starts ending. In short, the landscape will change in an unprecedented way. Bangladesh will have to adopt a forward-looking debt sustainability strategy to maintain its robust track record as a ‘strong debt-carrying country.’

 

[1] In 2022, Bangladesh sought ‘budgetary’ support from the World Bank (and other financial institutions) and ‘balance of payments’ support from the International Monetary Fund (IMF).

[2] As long as foreign borrowing is done strategically, debt servicing obligations are under control, the borrowing generates the expected socioeconomic returns and the country’s forex reserves are adequate to underwrite the obligations.

[3] World Bank/IMF-prescribed ‘debt carrying capacity’ is 55% of a country’s GDP and 240% of its earnings from exports and remittances.

[4] A small amount of the loans is earmarked for support to general budgetary spending by the government.

[5] Such as the interest rate, the grace period and the maturity period.

[6] The returns are accrued in local currency but repayments have to be made in foreign currency.

[7] For soft loans, the interest/service charge is very low, at 0.7% per annum, with 40 years’ maturity and 10 years’ grace.

[8] Many of these loans have service charges attached.

[9] Bangladesh has already borrowed from these institutions.

[10] Bangladesh’s private and public borrowing amount is USD 93.2 billion as of March 2022.

 

Photo ©️ Mahmud Hossain Opu

Mustafizur Rahman is Distinguished Fellow at the Centre for Policy Dialogue. He is an economist. He specialises in fiscal monetary policies, reforms and regionalisation. He was an expert on the panel for Bangladesh’s 7th Five Year Plan and the Perspective Plan 2041. He has been awarded the Ibrahim Memorial Gold Medal by the University of Dhaka. He pursued his doctoral studies in Development Economics at Moscow State University, Russia.