Cablegate: Government Proposes Development Focused Budget For

DE RUEHKA #0957/01 1650000
R 140000Z JUN 07





E.O. 12958: N/A
FY 08

1. Summary: The Bangladesh government released a draft
fiscal year 2008 (starting July 1, 2007) budget on June 7.
In his budget message, Finance Advisor Mirza Islam identified
seven key development and economic growth challenges and the
government's plan for meeting those challenges. Agriculture,
education, health, power and transportation infrastructure,
and information and communications technology were key
beneficiaries. The budget proposes a more focused approach
to the annual development program, with fewer projects
implemented more quickly. Adjustments to tax policy are
intended to reduce dependence on import tariffs while
increasing the share of revenue from income and VAT taxes.
In an important structural change, the budget will finance
the outstanding debt of several state-owned enterprises, in
particular over $1 billion of debt owed by the Bangladesh
Petroleum Corporation to the government owned banks.
Conspicuously absent was discussion of the defense budget,
which received modest increases over FY 07 expenditures.
Business and civil society reaction was generally positive.
The final budget will be issued by ordinance following a
brief public comment period. End Summary.

2. Budget Facts: The government is proposing a $12.44
billion budget for FY08, 30% larger than the revised FY 07
(ending June 30) budget, funded by a near doubling of both
domestic borrowing ($2.75 billion) and foreign assistance
($1.7 billion). Revenues are projected to rise 15.8 %
through broadening of the tax base, enhanced enforcement,
introduction of an improved self-assessment system and
limitations on the discretionary authority of tax
administrators. While more realistic than the previous
budget's 20% projected revenue growth, the FY 08 projections
are still 4.5 percentage points higher than the 11.3% growth
achieved in the first eight months of FY 07. The projected
deficit, including the allowance for the BPC debt, is $4.26
billion, or 5.6% of GDP. The budget assumes 7% real GDP
growth, slightly higher than the 6.8% achieved in FY 06.
(Political turmoil is expected to limit growth for FY 07 to
between 6% and 6.3%.)

3. Budget Reflects Interim Government's Priorities:
Elections are a key priority. The budget provides a 350%
increase in funding for the Election Commission from $17.1
million to $76.6 million, over 50% more than the Commission
requested. Funding for the Annual Development Program is up
slightly over the original FY07 budget but reflects a 23%
increase over the FY 07 revised figure (based on actual
expenditures). Historically, actual ADP expenditures are
significantly lower than the budget targets, which help
offset revenue shortfalls. This year, the government
proposes to concentrate on fewer ADP projects and introduce
administrative changes to ensure earlier and more complete
implementation. Power and infrastructure (34.4%) and social
safety net (34.3%) receive the lion's share of the ADP
budget. The government promises to eliminate power shortages
by 2010 with nearly 2300 MW of new power generation and
increased attention to maintenance and operational efficiency
of the installed base. Likewise, the budget includes
significant allocations to both add new road and rail
infrastructure and address long-neglected maintenance of
existing roads and rail lines.

4. Social Priorities Also Addressed: Education and
religion received the highest share (16.3%) of the total ADP
allocation, with funding for 15,000 additional primary
teachers, expansion of stipends for poor female and (for the
first time) male students, additional classrooms, and pilot
jobs-training programs. The budget introduces performance
evaluation for non-government schools receiving government
teacher salary support and introduces a competitive grant
program to promote international standard research at the
university level. The budget also increases spending on
social welfare, women and youth development, including a
pilot stipend program for poor lactating mothers.

5. Tackling Inflation: Mirza boldly predicted inflation
would moderate to 6.5%. The budget contains modest
provisions to reduce the price of essentials, including
elimination of tariffs on edible oils, wheat and other
essential consumables, subsidies to farmers to offset rising
costs for fertilizer and diesel fuel, increased government
imports for market stabilization and to support the
vulnerable group feeding program, and development of
additional wholesale markets to increase efficiency in the
distribution chain. Mirza stressed, however, that many of
the factors contributing to higher inflation were beyond the

DHAKA 00000957 002 OF 002

scope of the budget.

6. Down Payment on Structural Imbalances: Responding to
longstanding IMF recommendations, the budget proposes to
gradually eliminate below-market energy pricing by the
state-owned energy companies and transfer their liabilities
to the national budget. The budget includes various income
support mechanisms to cushion the impact of rising energy
prices on the poor. The most significant impact is the
recognition of the $1.08 billion debt of the Bangladesh
Petroleum Corporation to the national commercial banks
(NCBs). The financing of this debt is the principal cause of
the projected increase in domestic financing. The immediate
monetary impact should be minimal (this is the recognition of
a pre-existing debt, not new spending) and is a positive
change in the government's fiscal transparency. Addressing
the BPC debt to the NCBs should also facilitate ongoing IMF
supported efforts to privatize the NCBs. The budget also
proposes public trading of the shares of the state-owned
enterprises both to bolster the capitalizations of the
country's two stock exchanges and to introduce greater
accountability into the organizations. The budget addresses
regional development imbalances by directing a larger share
of development funds to the three less developed western

7. Business Gets Few Perks: The budget was largely
neutral for business, with most of the impact coming from tax
changes. The top tariff slab remained 25% but the other two
slabs increased from 5% to 10% and from 12% to 15%. The 4%
infrastructure surcharge was eliminated, in many cases
offsetting the tariff increases. Some business deductions
were liberalized while withholding provisions were
strengthened. Taxes based on gross revenues were halved.
The list of goods and services subject to VAT was expanded
while procedures for calculating and assessing VAT were
streamlined. Funding to support development of the
information and communications technology sector increased
21%. Funding for SMEs, worker training and support in the
ready-made garment sector, agricultural research, and other
business incentive funds saw modest increases. For most
businesses, the real impact lies elsewhere in the budget's
emphasis on infrastructure and human capital development.

8. Military Slice Modest: The FY 08 budget includes $768
million (5.6%) for defense spending, up 11.5% from the
original FY07 budget but a mere $11 million (1.4%) above
projected FY 07 expenditures. The government did not provide
a breakdown of military spending.

9. Public Reaction Positive: Business leaders generally
welcomed the budget proposal, while cautioning that
implementation would be challenging. Although winners and
losers quibbled over specific tax changes, no one challenged
the overall approach. Civil society analysts also reacted
favorably to the budget while expressing similar concerns
over implementation.

10. Comment: The FY 08 budget is a serious attempt to
address longstanding economic and social development needs.
It is reasonable to think the government will achieve its
goal of earlier and more complete implementation of its
planned annual development program expenditures, as these are
largely within the government's control. The risk is that
the corresponding revenue and donor assistance growth needed
to fund those expenditures, over which the government has
significantly less control, will as in the past fall well
short of budget projections. The additional budget shortfall
could significantly expand an already large budget deficit,
undermining macroeconomic stability and the government's
efforts to combat inflation while fostering stable economic
growth. End Comment.

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