Emerging stress in the forex market
Economic management often involves working out appropriate responses to exogenous events. The risk and uncertainty associated with such exogeneity create deviations from the ideal scenario that an economy may strive to achieve. Troubleshooting and contingency responses are, therefore, essential elements of macroeconomic management.
The supply-chain disruptions following the Covid-19 pandemic, aggravated further by the Russia-Ukraine war in close succession have exposed economies across the globe to a lot of vulnerability. Although the Covid situation has improved remarkably, economic recovery is faltering due to these exigencies. Faced with such a situation, Bangladesh needs to take a close hard look at the problems encountered and dispassionately adopt policies that will enable it to navigate smoothly out of these difficult times.
Bangladesh's balance of payments (BOP) is now in the red zone. Although export during the first nine months of the current fiscal year (FY22) grew at an impressive rate of nearly 33 per cent, it was not big enough to cover the faster growth in imports which during the July-March period expanded at a rate of nearly 44 per cent resulting in a widened trade deficit. Similarly, remittance inflow registered a decline of nearly 18 per cent during July-March over the same period in the previous fiscal year. However, compared to the same period in FY18 and FY19, yearly growth in remittance inflow in the current fiscal year has been found to be nearly 12 per cent, but this growth also was not big enough to cover the current account deficit which at the end of March 2022 rose to around $14 billion. The overall BOP deficit was recorded at $3.02 billion at the end of March 2022.
Keeping pace with rising international commodity prices, inflation in Bangladesh also showed a steady rising trend reaching 6.6 per cent in March 2022 on a point-to-point basis. To reign in the current account deficit, Bangladesh Bank (BB) depreciated taka by 3.7 per cent between July and May 2022. However, to avoid major inflationary shock to the economy the pace of depreciation was slow. As a result, BB had to sell nearly $5.3 billion to meet the higher demand for imports and the foreign exchange reserves came down from nearly $45 billion in July 2021 to $42 billion in May 2022.
The measures undertaken by the BB are being criticised as inadequate for containing import surge and reserves retention. The critics recommend substantial depreciation of the local currency to drastically reduce the big gap between the official and the open market rate. In their opinion, the depreciation of taka in a big way would help improve significantly the remittance inflow situation and would also help eliminate the risks of various types of crises emanating from macroeconomic instability. In this respect, the central bank is faced with the dilemma that a massive exchange rate depreciation would fuel the current inflation while the slow pace of exchange rate depreciation entails the risk of further depletion of the reserves.
The debate has assumed special significance due to two other reasons. First, the preparation of the upcoming national budget for FY23 is in its final stage and intense discussions are taking place regarding appropriate budgetary measures that will be needed to counter the inflationary impact of rising world commodity prices and the depreciation of the local currency. Second, in the backdrop of the recent Sri Lankan economic crisis, apprehensions are being expressed that Bangladesh may be on its way to facing a similar eventuality.
One of the main sources of the current pressure on the foreign exchange market is the sharp rise in global commodity prices and freight charges following the supply-chain disruptions caused by the Covid-19 pandemic. This has been aggravated by the negative economic impacts of the Russia-Ukraine war. Thus, import has become more costly. To buy the same amounts of the same goods Bangladesh needs more foreign currency. In contrast, the rise in the export price index for our export commodities has been rather limited and also there has not been any commensurate increase in the wages of expatriate Bangladeshi workers. This implies a deterioration in our terms of trade. Global inflation has caused, at the unit level, our demand for foreign currency to go up by a higher extent than the increase in the supply of foreign currency. As this mismatch between the demand and supply of foreign currency is likely to persist in the medium term, the way to bridge the gap is to adjust the exchange rate. Taking into consideration the economic loss which particularly the poor people endured during the pandemic, we may choose our own pace of exchange rate adjustment but there is no escape from the need for price correction of the local currency.
The pressure on the foreign exchange market generated through the rising commodity prices in the global market got further intense due to the sudden release of pent-up import demand. During the pandemic period, businesses put on hold new investment plans and expansion of production activities. With improvements in the Covid situation, economic recovery picked up and there was a rush for increased imports of capital machinery, intermediate goods and raw materials to expand production, which was also facilitated by impressive growth in export demands. The fear of a further rise in the price of imports in the coming days also prompted entrepreneurs to scramble hurriedly to get done with all their immediate import needs. This was accompanied by an escalation in foreign exchange demand due to the rapid rise in foreign travels by Bangladeshis for medical, pilgrimage, education and recreation purposes as entry restrictions in the destination countries got relaxed.
Given that such a sudden surge in import demand is likely to be transitory, the usual policy response for meeting the excess demand for foreign exchange is to draw down the reserves and BB has been doing exactly that during the past nine months. The resulting decline in the foreign exchange reserve generated the fear that a persistent decline in reserves may eventually push Bangladesh to a Sri Lanka-type situation.
A realistic assessment of the situation, however, points to the fact that as the pent-up import demand gets realised, the import spree is likely to slow down. Also, the rising import prices along with the steady depreciation of taka is likely to put a break on import growth while steady export performance and efforts to woe higher remittance are likely to ease the foreign exchange crunch. Moreover, we need to remember that the main purpose of building up foreign exchange reserve is to meet such a contingency situation when there is a sudden spike in imports. So, opting for sharp depreciation of the taka instead of releasing foreign exchange from the reserve to ease the crunch would be an inappropriate panic response.
An exogenous factor putting pressure on the exchange rate management is the depreciation of other major currencies in the international market against dollar. This usually calls for commensurate depreciation of taka to keep our export competitive vis-a-vis that of our peers. However, the urgency with which such adjustment needs to be made depends on the current state of our export. As mentioned earlier, Bangladesh's export experienced a robust 33 per cent growth during the first nine months of the current fiscal year compared to the same period in the previous year. As Fig-1 shows, monthly exports during this period demonstrate a rising trend. Thus, Bangladesh seems to be in a relatively comfortable position with regard to her current exports and the medium-term outlook appears quite optimistic. In that backdrop, it may be prudent to carry out exchange rate adjustment at a gradual pace to avoid the inflationary impact of further depreciation of the local currency.
Proponents of sharp depreciation of taka argue that failure to adjust the exchange rate adequately is having a major toll on remittance inflow as remittances get diverted to the illegal channel to take advantage of the wider spread between the official and the kerb market exchange rate.
The government seems to be aware of this concern and accordingly raised the incentive for remittance from the existing 2.0 per cent to 2.5 per cent. If we look at the remittance inflow during the first ten months of the fiscal years in the recent past (Table-1), we see that in FY21, there was a big jump of 39 per cent in remittance inflow (from $14.86 billion to $20.67). The main reason behind this was the fact that the pandemic seriously restricted the scope of illegal channels of remittance as economic activities and inter-country travels stagnated. Improvements in the Covid situation restored the play of the illegal channel and hence there was a sharp decline in remittance inflow in FY22 compared to that in FY21. However, if we compare the remittance inflow during the first 10 months in pre-Covid normal years, namely FY19 and FY 20 with that in FY22, we see that remittance inflow increased from $13.30 billion in FY19 and from $14.86 billion in FY20 to $17.31 billion in FY22, which implies a respectable yearly growth of 10.1 per cent over FY19-FY22 and 8.2 per cent over FY20-FY22. Fig-2 also illustrates that excluding the sharp pick of FY21, the remittance inflow during the first ten months of the last eight fiscal years depicts a rising trend. This implies that government measure to provide 2.5 per cent incentive for remittance has been helping in maintaining a rising trend in remittance inflow, and therefore in the light of the widening gap between the official and the kerb market rate the government may consider a further upward adjustment in the incentive rate and no major adjustment in the exchange rate is immediately called for to influence remittance inflow.
To sum up, despite significant turbulence in the foreign exchange market in recent months, the policy response of Bangladesh Bank in the form of gradual depreciation of taka and release of foreign exchange reserve to manage price and exchange rate stability seems to have been well-calibrated. A slight increase in the remittance incentive and release of an additional $1-$2 billion from the reserves may further help stabilise the market.
Dr Zaid Bakht is Chairman, Agrani Bank Ltd. [email protected]