Beyond the deficit debate in FY27 budget

The finance minister of the newly formed government has announced its first national budget, amounting to Tk 9.38 lakh crore, for fiscal year 2026–27. One of the most encouraging aspects of the proposed budget is the substantial increase in allocation for education and health. This reflects an important shift towards strengthening human capital, which is essential for long-term inclusive growth.

However, one of the major concerns being raised about the proposed budget is the size of the budget deficit, estimated at around 3.6 percent of GDP. Many have argued that such a deficit could further fuel inflation. This concern is understandable, given the inflationary pressure Bangladesh has experienced in recent years. However, the relationship between budget deficits and inflation is not automatic. It depends largely on how the deficit is financed, the state of aggregate demand, the output gap, and the quality of public expenditure.

As per the proposed budget, the government will raise funds through domestic borrowing of Tk 1.27 lakh crore and international borrowing of Tk 1.16 lakh crore. Such an arrangement should be studied carefully since, while international borrowing may not cause any domestic demand-driven inflation, the government will still need to manage external debt sustainability and foreign exchange reserves. Similarly, domestic borrowing can lead to different consequences based on its source, whether it is from banks or non-banks. In case a substantial amount of money is borrowed from banks, then such action can put pressure on liquidity, interest rates, and credit to the private sector. However, if non-bank sources are tapped, then the inflationary impact and crowding-out effect would be minimal.

It is interesting to note that the budget deficit in FY2025-26 was about 3.6 percent of the GDP, while the signs of slowing inflation were noticed. A key factor here is that Bangladesh has been running its economy below its potential level. According to the Medium-Term Macroeconomic Policy Statement, the difference between the actual and potential GDP has been negative in recent years; that is, about -2.5 percent for FY25 and about -1.5 percent for FY26. It means that the cyountry has not been using all of its capacity. If actual GDP stays lower than potential GDP, then it will not lead to any inflation even with a moderate budget deficit if public expenditure helps improve productivity and employment.

That said, the threat cannot be ignored. The domestic borrowing of Tk 1.27 lakh crore should be handled with care so that it does not exert excessive burden on the banking system. Therefore, it is required for the government to make sure that domestic borrowing is in line with monetary stability and does not weaken private-sector credit growth.

The most challenging target in the proposed budget is revenue collection. The government aims to raise revenue to around 10.2 percent of GDP, while the current revenue-to-GDP ratio remains close to 8 percent. This implies that revenue mobilisation needs to increase by more than 2 percentage points of GDP within a fiscal year. At first glance, this may appear overly ambitious. However, recent research suggests that such an improvement is not impossible.

Using the Bangladesh Bureau of Statistics’ Household Income and Expenditure Survey 2022, a study by the Research and Policy Integration for Development (RAPID) estimated that actual income tax and value-added tax collection stood at 7.58 percent of GDP in 2022, while the potential collection from these sources was around 13.47 percent of GDP. This implies a tax collection gap of about 5.89 percent of GDP. Therefore, raising total revenue by around 2 percentage points of GDP is not unrealistic, provided that efficiency in tax collection is improved, leakages are reduced, and corruption is minimised.

Here, the revenue goal is something that should not just be seen as a mere accounting matter. Rather, it must be treated as a question of governance and reform. It will be important to reform the National Board of Revenue, widen the tax base, limit discretionary exemptions, ensure that value added tax (VAT) compliance is effective, utilize technology, and enhance taxpayers' confidence. Failure to implement such reforms could make the revenue goal remain elusive. But if done properly, it could help generate the necessary fiscal space.

Therefore, the proposed budget should not be judged solely based on its deficit size. While there is no issue with the deficit being as large as 3.6 percent of GDP in an under-utilised economy, the Tk 1.27 lakh crore that the government plans to borrow from internal sources needs to be done cautiously to prevent any strain on liquidity, interest rates, and private investment. Meanwhile, the Tk 1.16 lakh crore, which the government will receive through foreign sources, must be utilised wisely without causing any debt-related problems in the future. The efficiency of financing the deficit, effective use of public funds, and realisation of the ambitious yet necessary revenue target are likely to determine the success of the budget. With improved revenue generation and effective expenditure management, the current budget can stabilise macroeconomic conditions and lay the foundation for inclusive development in the upcoming years.

Dr Md Deen Islam is professor of economics at the University of Dhaka and research director at Research and Policy Integration for Development (RAPID).