Why was VAT raised suddenly, what is the state of economy

In the first quarter of the 2024-25 fiscal year, growth rate has dropped to 1.81 per cent. There are no signs that this rate will improve significantly in the second quarter. This is reflected in various government statistics.

According to Bangladesh Bank, the growth rate of private sector credit at the end of the first four months of the fiscal year stands at 7.66 per cent, the lowest in the past three and a half years. Furthermore, imports of intermediate goods and capital machinery needed by industries have also decreased.

During the first five months of the 2024-25 fiscal year (July-November), letters of credit (LCs) opened for capital machinery imports were 26 per cent lower compared to the same period in the 2023-24 fiscal year. Similarly, the settlement of LCs for capital machinery imports has decreased by almost 22 per cent. This indicates that new investments in the country have decreased. Furthermore, LC settlements for consumer goods imports between July-November 2024 were 13 per cent lower than the same period in 2023.

Government data shows that between July-November of the 2024-25 fiscal year, revenue collection by the National Board of Revenue (NBR) was 2.62 per cent lower compared to the same period last year, whereas the previous year showed a growth of 14.27 per cent.

Additionally, in the first six months of the current fiscal year, commercial banks provided loans amounting to Tk 690.56 billion. During the same period, Tk 544.13 billion in loans were repaid to Bangladesh Bank, resulting in a net bank loan of Tk 146.43 billion. In contrast, during the corresponding period last year, the government did not take any loans from banks. In the first three months of the current fiscal year, the government borrowed Tk 83.32 billion from savings certificates, compared to a negative borrowing of Tk 12.65 billion during the corresponding period last year.

Another development is that the profit rates on various savings schemes under the National Savings Directorate are being increased. Depending on the type of savings certificates, the interest rate will range from 12.25 per cent to 12.55 per cent, indicating that the government plans to collect more funds through savings bonds.

The main point of presenting these statistics is to explore the reasons behind the government's recent VAT hikes on various goods midway through the fiscal year. It is suggested that the VAT hike was made to meet the International Monetary Fund (IMF) targets. However, the fundamental issue is that government revenue is not increasing. In the first four months of the current fiscal year (July-October), the shortfall in customs and tax revenue was Tk 307.68 billion, even lower than the previous year's figures.

The reality is that Bangladesh has one of the lowest tax-GDP ratios in the world. Despite significant GDP growth over the past 15 years, the ratio of revenue to GDP has not increased, and has actually decreased, with the proportion of direct taxes, such as income tax, being low. To compensate, the government has been increasing VAT, but the problem is that VAT is the same for both the rich and the poor. The decision to increase VAT to boost revenue is unjust. This issue has worsened since the start of the COVID pandemic and has become more severe in the current economic crisis. The rise in the value of the dollar has worsened the situation. As part of the IMF’s $4.5 billion loan programme, the government is cutting subsidies, putting further pressure on low-income people.

Tax evasion is widespread in Bangladesh. Most of the evaded tax does not stay within the country and is siphoned off out of the country. There has been no significant action from the government to curb tax evasion, and in fact, repeated opportunities have been provided for whitening black money, encouraging tax evasion. Additionally, various tax exemptions have further reduced government revenue. Research has also shown that the majority of money laundering from Bangladesh occurs through imports and exports. Overall, while Bangladesh is struggling to collect revenue, it is also failing to stop revenue leakages.

This situation is now compounded by low growth. While tax evasion was noticeable during periods of high growth, it will become even more apparent in a low-growth scenario. With low revenue collection, the government’s capacity to spend has also decreased. According to the finance ministry data, government expenditure in Bangladesh is 13 per cent of GDP. In comparison, this rate is 28.8 per cent in India, 20.4 per cent in Vietnam, 22.3 per cent in Malaysia, 36.8 per cent in the United States, 49.4 per cent in Sweden, and 57 per cent in France.

After the fall of Sheikh Hasina’s government on 5 August 2024, an interim government took charge and began various reform initiatives. The banking sector, which has been severely damaged over the past 15 years, is a major focus of these reforms. Some progress has been made, particularly in aligning the exchange rate with market levels and increasing reserves, although imports have decreased. However, overall business development is not progressing. Firstly, measures against industrial groups with ties to the former government have had an impact, with several production-oriented factories closing down. Secondly, the most critical factor for business development is trust, which has been undermined by ongoing political instability, making it difficult for business activity to increase.

Inflation has been high in Bangladesh for a long time. Bangladesh Bank has been continuously raising interest rates to control inflation, which has increased borrowing costs, but inflation has not been controlled. Analysts argue that in a country like Bangladesh, simply raising interest rates is not enough to control inflation; a coordinated approach with fiscal policies and market management is necessary. The simultaneous increase in interest rates and VAT on various products will likely slow down growth without effectively reducing inflation. This has led to the emergence of stagflation (high inflation + low growth + high unemployment) in the economy. Typically, some level of inflation is needed for growth, but now inflation is rising while growth is declining.

Unemployment is another issue. Even during the past decade of high growth, employment has not increased at the desired rate, a problem long pointed out by economists. This is considered jobless growth. Now the growth rate has dropped below 2 per cent, it is evident that employment has worsened.

When imports of consumer goods decrease, the supply in the market diminishes, and prices rise, which is a basic economic principle. Similarly, when imports of capital and intermediate goods decrease, future investment and economic capacity decline. These trends negatively impact growth, with the World Bank predicting a growth rate of just 4 per cent for the current fiscal year. The government's target is 5.25 per cent, but given the current low investment and high inflation, there are doubts about the feasibility of this target.

In conclusion, the interim government has yet to take steps to bring about long-term economic changes. The decision to increase VAT on over a hundred products is similar to the previous government's policy of favouring the wealthy. As a result, overall economic reforms seem to be lagging.