Govt.

borrowing and money market developments: The real situation

In the recently ended fiscal year government has borrowed TK 204 billion from the banking sector which was negative TK 38 billion, implying a repayment by the government to the banking system in the preceding fiscal year (FY). Based on these numbers there have been arguments from different quarters that government's fiscal policy is crowding out private sector credit and investment and contributing to the ongoing money market tensions. The analysis presented bellow attempts to identify the real situation, based on data published by Bangladesh Bank (BB) and recent press reports. To finance fiscal deficits, Government of Bangladesh domestically borrows from two sources-the banking system and non-bank sources. The latter takes place primarily in the form of sales of Shonchoy Petra or national savings scheme (NSS) instruments of different maturities/types. We need to understand that the money borrowed through NSS or from commercial banks essentially comes from the same source--deposits of the households with the bank and non-bank institutions. Depending on their respective rates of return, measured by interest rates offered under different instruments, households decide where to invest their financial savings in banking or non-bank instruments. In years when returns on NSS instruments were higher relative to deposit rates of bank, as it was in FY10, households deposited more money in NSS instruments. Consequently, government's non-bank borrowing exceeded it planned borrowing target by a big a margin. The Government ended up borrowing TK 124.2 billion in FY10 compared to only TK 38 billion in its budgetary plan for the fiscal year. In contrast, in FY 11 when the deposit rates of commercial banks had increased relative to that of NSS instruments, people switched their deposits from NSS to banks. As a result, compared to the non-bank borrowing target of TK 80 billion in FY 11, net borrowing was only TK 24.4 billion during the first 11 month of the fiscal. In essence the money which could have been deposited with NSS ended up in banks due to higher interest rates offered by them (banks).

What we see from the above analysis is that the borrowing from bank and non-bank sources is dependent on relative interest rate policy and the amount not received from non-bank has essentially fueled deposit growth of commercial banks. As a result growth of deposit of DMBs has increased at a higher rate than previous fiscal. The developments described above indicate that since NSS and banking system are part of same financial system, what is important is to looking at domestic borrowing of the government, which includes banks and non-banks and not to focus exclusively on only the component of government borrowing from the banking system. On this basis, we now look at whether the government sector really borrowed what it had planned from the domestic sectors.

According to the government plan in FY 10, domestic borrowing was supposed to be TK 205.6 billion but actual borrowing was only TK 86 billion. In FY 11 budget, government announced to borrow TK 236.6 billion from domestic sources and in the event actual borrowing was about TK 236 billion. Thus despite the surge in domestic borrowing over the preceding year, actual borrowing was very much in line with what was planned for at the time the budget was announced. In FY 11 what really changed is the distribution of borrowing between bank and non-bank sources of financing. The amount that the government could not borrow from the non-bank source as per its original plan was largely compensated by borrowing from the banking system. At the same time, due to lesser government borrowing in the form of NSS instruments, bank deposits also increased markedly. Bank deposits increased by TK 645 billion in last twelve month up to April in FY11, compared with an increase of TK 582 billion in FY10. Thus one can argue that the increase in banking sector deposits essentially covered the additional borrowing requirement of the government without exerting any additional pressure on the banking system. The point I wanted to make above is that, fiscal management in FY11 despite its deficiencies in some areas, cannot be blamed for current money market situation and for crowding out private sector investment. The prevailing tightness in liquidity in the money market is primarily attributable to excesslending to the private sector and to a limited extent due to increased borrowing by the public sector enterprises. While I do not see any major problem emerging from the overall level of government borrowing in FY11 from the banking sector, I find a major problem in the reported composition of government borrowing. Based on press reports, out of TK 204 billion borrowed from the banking sector TK 96.4 billion came

from Bangladesh Bank (BB), which in my view is a major concern. As we all know, borrowing from BB is not same as borrowing from deposit money banks (DMBs). BB's lending to the government sector essentially means printing of money which is called high powered money and with money multiplier being around 4, one unit increase in high powered money will result in a four-fold increase in broad money or liquidity expansion over the course of the year. It would have been highly desirable on the part of BB to refrain from injection of such a large quantity of high powered money into the economy in the final months of the fiscal year. BB should have forced the government to borrow from the DMBs. It would have forced commercial banks to contain their levellending to the private sector and would have also entailed higher interest rates on treasury bills.
Instead of allowing money market operate properly, BB injected the liquidity which essentially monetized large part of the government borrowing instantaneously. The effect of such a large scale monetization of the fiscal deficit, if not sterilized, will be seen in the form of higher inflation and a further depreciation of the exchange rate in coming months. The second bubble currently forming in the capital market may also be partly attributable to the liquidity injection by BB. This injection of high powered money has largely happened in May and June, the last two months of the fiscal year. BB should mop up the recent injection of liquidity without any delay and we look forward to seeing definite steps to this end in its forthcoming Monetary Policy Statement.

EXECUTIVE SUMMARY
1. This assessment of public sector accounting and auditing is meant generally to help implement more effective Public Financial Management (PFM) through better quality accounting and public audit processes in Bangladesh and to provide greater stimulus for more cost effective outcomes of government spending. More specific objectives are (a) to provide the countrys accounting and audit authorities and other interested stakeholders with a common well-founded knowledge as to where local practices stand against the internationally developed norms of financial reporting and auditing; (b) to assess prevailing variances; (c) to chart paths for improving the accordance with international standards; and (d) to provide a continuing basis for measuring improvements. 2. Adoption of international standards for accounting and auditing provides the basis for competent financial reporting and transparency. The International Public Sector Accounting Standards Board (IPSASB) of the International Federation of Accountants (IFAC) has developed a core set of accrual-based International Public Sector Accounting Standards (IPSAS) and also a comprehensive IPSAS on the cash basis of accounting. These IPSAS establish an authoritative set of independent international financial reporting standards for governments and others in public sector organizations. The study has taken the international standards as axiomatic with any acceptable options incorporated in the standards. The study has not assessed whether Bangladesh should adopt a limited version of the standards, as the processes of developing those standards have already considered any acceptable options, but they do not override authoritative national standards issued by governments, regulatory or professional accounting bodies. Application of IPSAS by national authorities will support developments in public sector financial reporting directed at improving decision-making, financial management, and accountability and it will , be an integral element of reforms directed at promoting social and economic development. The IPSASB has also developed guidance on the transition from cash- to accrual-based reporting. The traditional emphasis on cash accounting has been found inadequate through failure to recognize true costs, and all assets and liabilities. Cash accounting can too easily neglect asset management, accumulating arrears, future liabilities (e.g. pensions), and contingent liabilities (e.g., guarantees).

3. Annex A explains the methodology used for the assessment. The actions that need to be taken as recommended by this assessment are summarized below. 4. Bangladesh Should Adopt International Public Sector Accounting Standards. Along with the adoption of IPSAS, the Cash Basis IPSAS accounting standard should be applied first, with subsequent gradual implementation of the accrual IPSAS. The International Federation of Accountants issues the IPSAS. Annex B gives a general description of IFAC and a listing of the IPSAS. At the present time, Bangladesh does not comply with the Cash Basis IPSAS, Part 1, in its annual accounts. The Government of Bangladesh (GoB) needs to restructure the present cash basis reporting to conform fully to the Cash Basis IPSAS. Appropriate authorization from the Comptroller and Auditor General (CAG) would be sufficient since no legislation is necessary. A transition path should be developed to moving towards gradual presentation of the full accrual information that would best serve the general financial statement required by Section 7 of the CAG (Additional Functions) Act. Annex C includes the text of the CAG Act. Benefits from adopting accrual reporting are set out in Annex D.

5. A Supplementary Table of Standards and Gaps of this report provides a matrix detailing the current standards, the present position, and options for improvement. A summary of the accounting issues is shown in Table ES1.
TABLE ES1. SUMMARY OF ACCOUNTING STANDARDS ISSUES IN BANGLADESH Standard 1. Does the Public Sector Accounting Law adopt IPSAS? Current status No. There is an accounts code. Action to move towards the international standard Ministry of Finance (MOF) has issued an order requesting the Controller General of Accounts (CGA) to do the needful to prepare GOB financial statements in accordance with IPSAS Cash Basis. The first set of IPSAS-based statements for the core ministries (excluding specialized organizations) will be produced for (fiscal year) FY07-08. The first set of IPSAS-based statements for the specialized organizations will be produced for FY09-10. Action will be taken by early 2007 to form a committee including the CAG, CGA, MOF, and Professional Accounting Institutes, to work on an action plan to adopt accrual accounting in an appropriate timeframe as well as the legal formalities to be complied with. 2. Is the education and training of accountants in accord with IES? No Training in Accounts is provided by FIMA. MOF in consultation with CGA and CAG is to set up an Education Standards Working Committee (including relevant service cadres, academicians and professional accounting institutions) to chalk out the education and training requirement for public sector accountants and auditors. Action is to be taken by MOF by March 2007 together with a Terms of Reference (TOR) for the Committee.

3. Does the ICAB Partially . CAG Code The IFAC Code should be a basis for a code Code of Ethics match is consistent with the specifically suited to public sector accountants. international standards? International Organization of The CGA is to form a committee by March 2007 Supreme Audit Institutions to examine this. (INTOSAI) Code.

Current status Action to move towards the international 4. Is there a body to prescribe public sector accounting standards? the same standards in public compliance. The Financial Reporting Council should monitor 5. Are the financial statements in accord with the IPSAS standard? Financial care of not followed. adoption of the IPSAS Cash Basis standards, the cash flow statement will be consistent with the standards. 6. Is the statement financial cash receipts and of payments in IPSAS government form? to come Are accounting 7. policies and explanatory implementation by notes required? No. This currently presented in formats inconsistent with the IPSAS. No. Statements of accounting policy are not provided in the budget or accounts documents. The concept of CFO managing the management function in each entity will be examined by MOF. MOF up with a policy paper on June 2007. The FMRP might be able to provide assistance 8. Are other disclosures framework tasks of IPSAS? in accord with application departmental the civil Partly. Financial statements are not available within 6 months of the reporting period; some items are not disclosed, and presentation does not meet some transparency requirements. after completion of the logical the project. A study is needed for the of International standards for the accounts and their integration into accounts in accordance with IPSAS. As the Government moves towards this matter. As the Govt. moves towards No. The Cash Basis IPSAS for financial statements is state-owned enterprises. There is no dedicated body. CGA does this but CAG as not is a Standards Board. responsible for prescribing the form and manner of maintaining the public accounts. standard CAG, CGA and ICAB are to use committee established for accounting for this purpose. Audit Committees sector entities should assure

The

CGA

component

of

the

Management Reform Project can take

information is

adoption of the IPSAS Cash Basis standards, the cash flow statement will be consistent with the IPSAS forms. There is a need to state the accounting policy and the basis on which the accounts are prepare d. The current notes will be reviewed and made consistent with IPSAS as im plementation proceeds. It would be necessary to reduce the reporting lag; and to disclose some further information. Need to comply with the disclosure aspects of the treatment of foreign currency. This will be reviewed and made consistent with IPSAS as implementation proceeds. A study of how to incorporate DOSA, CONTASA, SAFE and IMPREST system project accounts is needed for their integration into the civil accounts in accordance with IPSAS and to enable effective auditing.