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The balance of payments (BOP) is the record of a country's monetary transactions with the rest of the world. Balance of payments difficulties usually develop slowly over time. They may result from developments such as a high and rising import dependency, slow but gradual loss of key export markets, declining capital inflows, rising foreign debt, unsustainable current account deficits, currency overvaluation and banking sector weaknesses.
BoP difficulties can become even very acute when international reserve fall to such low a level that they become acutely insufficient to cope with fluctuations in imports and exports or reductions in net capital inflow. At the same time foreign loans become difficult to obtain or inaccessible which makes the situation even worse.
For the purposes of balance of payments accounting, international transactions are commonly broken down into three important sub-components: the current account balance (CA), the capital account balance (KA) and the financial account balance (FA). BOP=CA+KA+FA.
It is the current account balance (CAB) of a country's BOP that provides a good idea about its economic activity. There are four major components of a current account. They include goods, services, income and current transfers. A current account surplus is indicative of an economy that is a net creditor to the rest of the world while a deficit reflects an economy that is a net debtor to the rest of the world.
While a current account deficit does not mean the economy is weak nor a surplus means the economy is strong but growing current account deficits are usually a precursor to BoP difficulties. Funding of current account deficits require capital inflows or other net currency inflows (i.e. remittances) or a drawdown in foreign currency reserves.
Also, as balance of payments difficulties intensify, and the scope for monetary policy actions increasingly become very constrained by the need to protect foreign currency reserve in countries with managed float or fixed exchange rate regimes. Therefore, these countries are most likely to ration or control imports or impose or strengthen capital outflows and exchange rate control.
Between 1980 and 2021, Bangladesh achieved a current account surplus for 14 years and a deficit for 28 years. Usually, a country recording a current account surplus indicates its dependence on exports revenue, with high savings and weak domestic demand. On the other hand, a country recording a current account deficit is indicative of its dependence on imports, low savings and high personal consumption rates as a percentage of disposable income.
Between July 2021 and January 2022, Bangladesh's trade deficit increased to a record high of over 82 per cent to US$18.7 billion as the import bill (which included US$5.79 billion on rice) surged by 46 per cent during the same period, despite high export growth. Rapidly increasing international prices of commodities such as food grain and oil also indicate that exchange rate pass-through is much faster for developing countries like Bangladesh (approximately six months) creating faster increased demand for foreign exchange or more precisely the US dollar, as food grain and oil import costs continue to rise, thus creating pressures on foreign exchange reserves and exchange rates as well.
Bangladesh is a net importer of food items, especially food grains. Under the current global economic and political crises, Bangladesh will have to brace for rising food prices over the coming months or even may be years. The current global food price hikes have resulted in a sharp rise in prices of food items in Bangladesh. In fact, Bangladesh saw a record rise in prices of food items in March this year as reflected in food price inflation rising to 6.34 per cent. Bangladesh imported 6.6 million tonnes of food grain in 2020-21. According to the US Department of Agriculture, Bangladesh is expected to import 7.5 million tonnes of wheat and 2.3 million tonnes of corn in 2022-23. Bangladesh's trade exposure to several commodities such as wheat and vegetable oil which are now facing export restrictions can further add to food price inflation in the country.
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As a consequence, Bangladesh now faces balance of payments difficulties as reflected in the declining foreign exchange reserves which stood at US$41 billion this month sufficient enough to cover imports for about six months.
Rising trade deficits are also causing the taka to depreciate against the US dollar. According to the Financial Express (May 26) the taka is traded at Tk 98 in the open market also known as the kerb market against Tk88 in the inter-bank market. Such multiple exchange rates that exist now may result in problems for Bangladesh Bank because different exchange rates are likely to cause losses in foreign currency transactions for the central bank. Therefore, to offset such losses Bangladesh bank may print money which will further add to the inflationary surges now prevailing in Bangladesh.
The exchange rate regime that is in place now in Bangladesh can be described as a pegged exchange rate regime where the Bangladesh taka (BDT) is pegged to the US dollar (USD). The capital account is not fully convertible either in Bangladesh. Also, BDT convertibility into foreign currencies is very strictly regulated.
Therefore, Bangladesh Bank has to intervene as and when necessary in the foreign exchange market to keep the BDT/USD exchange rate at the pegged rate. According to Bangladesh Bank it does so by largely relying on inter-bank exchange rates. This currency peg will work only so long as Bangladesh Bank has sufficient international reserves to keep defending it, if not, the peg will collapse.
It is generally considered that the taka remains overvalued when viewed in terms of the real effective exchange rate (REER) despite the taka has been depreciating in recent times. As volumes of imports and exports are sensitive to REER, the overvalued taka makes Bangladeshi exports relatively more expensive and imports relatively cheaper. Therefore, an artificially high currency peg contributes to overconsumption of imports which can not be sustained in the long run, and often causes inflation. In fact, Bangladesh is now facing rising inflationary pressures.
While the strength of the currency in a freely floating exchange rate system depends on a number of factors such as inflation rate and interest rates to name a few, the pegged exchange rate system as is used in Bangladesh can further create instability in the foreign exchange market as reflected in multiple exchange rates for the taka against the US dollar prevailing now. This can open up the possibility of investor speculation creating a run on the currency. But the taka is not generally a heavily traded currency internationally, as such a currency attack on the taka is unlikely.
As BoP difficulties have intensified, Bangladesh Bank, the country's central bank's ability to use monetary policy options have become very limited as it is primarily focused now on saving foreign exchange reserves. As such, Bangladesh government has introduced a series of foreign exchange and import controls. Such an administrative policy option under the pegged exchange rate system may help the government for the moment not to take any monetary policy adjustment initiatives to address the currently prevailing issues relating to the exchange rate and foreign exchange reserves. If such a policy prolongs, that may result in falling foreign investment with the consequences for exports (Bangladesh heavily relies on imported inputs for its exports) and reduced business confidence. Long lasting import controls will also cause distortions in import patterns impacting on economic efficiency and economic activity.
BoP difficulties faced by Bangladesh is directly linked to the country's international trade competitiveness and the terms of trade (the ratio of prices of exportable goods to the price of importable goods) index is a useful indicator of that trade competitiveness.
Bangladesh has experienced sharply deteriorating terms of trade (ToT). Between 1980 and 2020, the average value of ToT with the base year 2000 stands at 99.91 per cent with a minimum of 57.47 per cent in 2011 and a maximum of 162.26 per cent in 1985. The latest value in 2020 was 64.3.
Such deteriorating ToT are a mystery in the context of the Prebisch-Singer hypothesis which predicts that countries exporting manufacturing (96.3 per cent of total exports in 2020) goods will experience ToT improvement. It is suggested that low quality manufactured export goods has largely contributed to this falling ToT indicating Bangladesh focuses more on quantity exported rather than quality.
The current account is influenced by the international trade competitiveness as well by the fluctuation in the exchange rate. The current account balance of Bangladesh as a percentage of GDP also provides another indication on the level of international competitiveness. Between 1997-98 and 2019-20, the average value of current account balance as percentage of GDP for Bangladesh stood at 0.6 per cent. This figure reached an all time high of 3.3 per cent in 2009-10 and a record low of -3.7 per cent in 2017-18. The data clearly indicate Bangladesh's lack of international competitiveness.
In 2020, manufactured goods accounted for 96.3 per cent of total exports of which ready made garments' (RMG) share was 86 per cent. Such a high dependency on one single product for exports (SITC 841-846) and a very limited number of markets leave Bangladesh vulnerable to external shocks. Also, exports account for a very low share of Gross Domestic Product (GDP) which fell to 15.32 per cent in 2019 from a peak of 20.16 per cent in 2012. It further fell to 12.18 per cent in 2020.
With such a low exports-to-GDP ratio, Bangladesh can be considered relatively a closed economy. Bangladesh indeed remains a relatively closed economy with tariff barriers that are above the already high South Asian average and twice the average of lower middle income countries. Such an inward looking trade policy only encourages rent seeking activities. In 2020, Bangladesh accounted for 0.19 per cent of total global exports and 0.30 of total global imports but the country now stands as the 41st largest economy in the world in terms of GDP. This is also another indication of a fairly closed economy.
BOP constrains now faced by Bangladesh may turn into a looming crisis impacting on economic growth through foreign trade and foreign exchange markets. In addition to affecting economic growth, foreign exchange reserves and exchange rate, these will also have an impact on inflation. Notwithstanding the present day global supply constraints, especially food supply and rising inflationary pressures where now markets are entirely driven by rising inflation expectation and the fear of an impending global recession, the BOP problems will be further compounded by having in place a pegged exchange rate regime. Therefore, Bangladesh must actively consider to switch to the flexible exchange rate regime. Such an exchange rate regime will help make exchange rate adjustments which could help to stimulate exports and conserve foreign exchange reserves.