The Effects of Macroeconomic Shocks and Uncertainty on Bangladesh’s Fiscal Sustainability

In recent years, Bangladesh has implemented a deficit-biased fiscal policy backed by robust GDP growth and relatively low interest rates, taking advantage of its access to concessional financing. However, gradual integration with the global economy has exposed the country to external macroeconomic shocks. This paper employs a Structural Vector Autoregression (SVAR) model with short-run restrictions to identify three external shocks: an increase in foreign interest rates, a rise in commodity prices, and an exchange rate appreciation. It examines the impact of these shocks on Bangladesh's economy through impulse response functions using annual data from 1983 to 2023. The results show that commodity price inflation and exchange rate appreciation worsen the government’s fiscal balance, while higher foreign interest rates primarily raise domestic interest rates, with an insignificant impact on fiscal balance. Additionally, by employing a standard VAR model with macroeconomic variables that directly influence the government’s debt dynamics, this paper projects government debt over the 2024-2028 period in a stochastic framework. The projection shows that the government’s median debt remains at 37.1% of GDP by the end of 2028, with a 30.1% probability that the debt level exceeds 40% of GDP. Two alternative scenarios: i) a 2% rise in the foreign interest rates and ii) a 10% depreciation of the real exchange rate above the baseline, raise this probability to 38.7% and 56.2%, respectively.