Home ›› 04 Dec 2022 ›› Editorial
It has been about two decades since Bangladesh entered into the floating exchange rate from the fixed exchange rate. Initially, the Bangladeshi currency Taka was pegged to British Pound Sterling and subsequently to USD. A currency pegged to any hard currency helped build confidence in economic policies, specifically in pursuance of sound monetary policy. The dollarization of currencies represents either a complete replacement of USD for domestic money or a more strict one-to-one correspondence to the domestic currency that binds the monetary authority to be more disciplined. Countries with fixed exchange rates are more vulnerable to currency crises and twin currency and banking crises. As the economy grows and is more open to international financial markets, the benefits of a floating exchange rate provide leverage in exchange rate management. Floating exchange rates possess a built-in stabilizer to ensure equilibrium in the balance of payments equilibrium. The currency depreciates in the event of a continuous balance of payments deficit, helping export earnings through the competitive edge and discouraging imports until the balance of payments is restored at a sustained level. A floating exchange rate favors monetary autonomy, and countries are free to choose an inflation target. A tighter monetary policy results in currency appreciation and an expansionary policy evokes inflationary pressure in the first trial and ultimately results in depreciation. However, to be fair, floating does not empower the market to exercise its uninterrupted power. Intervention may be there in the managed or dirty floating. Managed floating The crucial indicators are the balance of payments position, the level of international reserve, and the de facto development of the parallel markets in foreign exchange.
There is a general propensity for currency depreciation at the initial onslaught of floating. The Thai Baht experienced an initial depreciation of 24 percent against the vehicle currency of USD. Pakistan and Si Lanka experienced depreciation of their money to 10-20 percent immediately after the floating. The Philippine peso experienced the same fate when the market put pressure to float in July 1997. The central bank sought the favor of the IMF for further down sliding the value of the peso. India entered into the floating exchange rate in March 1993. It was convenient as India’s foreign exchange reserves had grown significantly since 1991. The reserves, which stood at USD 6 billion in end-March 1991, increased gradually to USD 25 billion by end-March 1995. The Indian economy was poised to meet any challenges and was not considering any help from multilateral donors. Foreign reserve augmentation bestowed confidence to repay the overseas debt of USD 13 billion well ahead of time. The rupee appreciated by 5.5 percent against the USD. India retired USD 2.8 billion of debt to the World Bank and Asian Development Bank on February 2002, which saved about USD 200 million in interest payments. IMF document cataloged India’s foreign exchange management as excellent and comparable to global best practices. The country intervened to even lumpy demand and supply in thin markets and exercised caution in destabilizing speculation while facilitating foreign exchange transactions at market rates for all permissible purposes. Liquidity is, therefore, an essential consideration in reserve management policy.
Bangladesh was careful in switching to a new market-based rule, and the transition was smooth as the currency did not face any turbulent period in the next few months. The Taka remained firm against the USD. The variation in parity was instead in a narrow range. Empirical conjectures assert that Taka depreciated less than 2 percent from June 2003 to April 2004. Then about 20 percent by 2006 to reach Taka 70 per USD before stabilizing around that level. There were sporadic occurrences when the exchange rate “ got a little erratic but never to the extent of the crisis.” The monetary authority at the initial stage through repo withdrew over Tk. 1120 immediately after the flotation, the liquidity withdrawal triggered an overshoot in the call money rate to 35 percent. Subsequently, the pace eased due to lower government borrowing from the banking system against treasury bills. The reserve position was satisfactory even after paying USD 250 million to the Asian Clearing Union [ ACU] in the aftermath of flotation.
The encouraging situation was due to the rapid increase in remittance and augmentation of export earnings. Moreover, the lower price of USD helped the Bangladesh Bank in reserve augmentation by purchasing from the market. In addition, an excellent macroeconomic condition, such as a low level of inflation, prudent fiscal management, and accommodating current account deficit, provided leverage in averting any disaster at the initial state. Another conduit was the funding by the IMF, World Bank, and the Japanese debt relief fund that boosted reserves close to USD 2.5 billion during the first week of July 2003 and helped build confidence. Furthermore, the three-year finding by the IMF under the Poverty Reduction and Growth Facility [PRGF] to an SDR 400 million [65 percent of quota] boosted reserves and salvaged the currency from depreciation. In addition, the World Bank provided another support through the 5 - year target of strategic development embedded in the interim poverty reduction towards the Millennium Development goals of the United Nations.
The exchange rate was on a steady path till the end of 2018 with 1 USD = Tk 83, but the foreign exchange market experienced a jitter on the onslaught of Covid-19 and the aftermath of the Russia -Ukraine war. The soaring price of oil and other essential imports put pressure on the current account of the balance of payments, and the exchange rate spiked on June 13, 2022, to Tk 94 per USD with a series of depreciations and finally during November 2022, hovering between the Tk 102 to 106. Bangladesh Bank injected more than USD 7 billion to help settle bank import bills and from further sliding of the Taka.
Economists generally consider several fundamental parameters in sustaining sound macroeconomic management that help maintain a steady exchange rate conducive to trade. First, fiscal prudence; secondly, a floating exchange rate endorses open adoption of market-based interest rates, money supply consistent with growth fundamentals, and regulation of bank loans. Third, a cautious look at the current account deficit, a widening gap between export earnings and import payments, may accentuate currency depreciation. Fourth, it is essential to stop trade-based money laundering through over-invoicing. Finally, the development of a parallel foreign exchange market threatens reserve management.
The writer teaches at BRAC University and BIDS as an adjunct Faculty in the Master’s Programme in Economics. He can be contacted at mirobaidurr7@gmail.com.
