5 years ago

Exchange rate adjustment of taka: A crying need

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Bangladesh professes to maintain a floating exchange rate of its currency but practices what is called managed floating or pegged floating regime. In foreign exchange parlance this system of exchange rate management is also known as dirty floating. What we are actually doing is pegging our currency to its intervention currency -- the US dollar-- almost always at an overvalued level. The authorities rarely adjust the exchange rate of taka commensurate with its falling purchasing power. Neither do they conduct their monetary and fiscal policies to support the level at which they want to maintain the rate. As a result, despite the cosmetic depreciation of taka during the last one year or so, its real exchange rate has deviated from what should have been an ideal or equilibrium level to achieve the export targets, balance of payment equilibrium, a conducive atmosphere for promoting domestic productive activities and jobs creation.

An overvalued exchanged rate means that the goods and services exported by Bangladesh are getting relatively expensive for the overseas buyers while costs of goods and services imported from abroad are getting cheaper. It explains why the momentum of growth of our exports has slackened over the last few years while imports are rising literally by leaps and bounds. It goes without saying that an overvalued exchange rate depresses demands for domestic goods and services while encourages spending on imports. The main sufferers are the industrial units, especially smaller ones, which find it quite hard to compete with cheap merchandise that gets into the country officially and unofficially, from across the country's porous border. The farmers, who grow food grains with sweat and tears, literally cry over the depressed price of food grains due to import of these items from abroad at a cheaper price thanks to our overvalued currency. On many years, including the current year, many of them cannot recover even the cost of production. Cheaper foreign currency also induces larger than usual number of people for going abroad on pleasure trips or treatment of minor ailments. As a result, our balance of trade as well as balance of payments on current account are worsening as demonstrated by Table I.

The Table I shows that over a period of 5 years exports have increased from $ 29,777 million to $36,205 million denoting a point to point growth rate of 21.58 per cent while import growth escalated from $36,571 million to $54,463 signifying a phenomenal growth by nearly 50 per cent. As a result, the current account balance has shown a deficit of $9,780 million in FY 2018. What is more disquieting is that export of our major traditional items is showing either stagnancy or declining trend as borne out in Table II.

The signals emanating from these data are ominous: our foreign exchange earnings from age-old traditional exports are gradually drying up. Although apparel exports are increasing but the growth rate is inadequate to achieve the target of 60 billion dollar by 2021; that would require a growth by more than 25 per cent per annum. Besides, too much reliance on apparel exports is unwise for two reasons. Firstly, net foreign exchange earnings are only a fraction of what we receive from export of apparels. At least 80 per cent of foreign exchange proceeds from export of ready-made garments are sent out from the country against back-to-back letters of credit (LC). There are other incidental costs like bank charges, LC confirmation, acceptance of documents commission and interest for deferred payment which eat away a good chunk of money from that 20 per cent margin. Rejected consignments by the buyers also involve loss of the country's foreign exchange. Net foreign exchange earnings for use of local fabrics and other accessories through backward linkage is a little higher but the raw cotton, yarn, chemicals etc. used for fabrication of these 'local supplies' including the machinery for this fabrication are imported from abroad. So the claim made by the apparel sector that it earns 80 to 80 per cent of foreign exchange earnings from exports sounds quite sweet but adds only a modest amount to our foreign exchange coffer.

Secondly, Bangladesh is poised to become a middle-income country in not too distant future. That will dilute the edge Bangladesh now enjoys in the labour intensive apparel sector due to escalation of wages and higher standard of living. Apparel industries have shifted or in the process of shifting from many countries like Hong Kong, Philippines, Malaysia and Thailand on account of their rise of per capita income. Empirical evidences suggest that the health of apparel industry and poverty level in a country go hand in hand. It points to the need for diversifying our exports without further delay.

In short, apparel industry is no doubt an important pathway to our economic growth and employment of nearly 4 (four) million workers but, if you take out the enormous social and economic costs, it is not as important as they are made out to be. Frankly speaking, our economic life lines are embellished primarily by millions of farmers who have kept the wheels of the agro-sector production on the move, and nearly ten million migrants abroad who directly and indirectly send close to $25 billion a year to support the balance of payments and our ostentatious living standard.

Coming back to the question of what should be an ideal exchange rate of taka; there are several models to choose from: balance of payment model, asset market model and purchasing power model.

Bangladesh, however, does not follow any of these models but tends to arbitrarily keep the nominal rate of taka somewhat steady while its real effective exchange rate keep on drifting from its moorings i.e. inflation-adjusted real effective exchange rate. Table III captures the changes in the nominal exchange rate of taka vis-à-vis the currencies of our important trading partners.

Table III speaks eloquently about the need for depreciation of Taka. It, however, speaks only a part of the story i.e. changes in the nominal exchange rates. It is interesting to note that the nominal exchange rate of taka has appreciated by 9.0 per cent against Indian Rupee, 33.47  per cent against Pakistan Rupee and 26.95  per cent in respect of Sri Lank Rupee. The level of appreciation of REER (real effective exchange rate) of taka would be significantly if we take into account the lower than Bangladesh's inflation rates of those countries (see Table IV).

However, as indicated above, comparison of nominal exchange rates is not sufficient to understand the strength of currencies. Concepts such as nominal effective exchange rate (NEER) and real effective exchange rate (REER) are better indices for explaining export competitiveness and formulating trade policy responses. NEER measures the value of a currency against a weighted average of a basket of currencies. REER is the inflation adjusted rate. If we factor in the inflation rates of 15 important trading partners the Real Effective Exchange Rates (REER) of taka would certainly turn out to be overly overvalued. It is interesting to note that the currencies of our main export competitors in the subcontinent-India, Pakistan and Sri Lanka - whose inflation rates are lower than ours, have had their currencies depreciated over time but we have made only cosmetic adjustments of the nominal rate.

The conclusion, we cannot afford the luxury of an overvalued currency without diluting our overall objective of balanced economic development through export-led growth. The sooner the rate is adjusted to offset the effects of inflation and depreciation of non-dollar currencies, the better would be for the economy. I would refrain from indicating a bench mark but a depreciation of taka by 6.0 to 7.0 per cent would perhaps be an ideal one.

There would of course be many questions asked by naysayers like the rise of import costs and increase of government's debt service payments and disincentive for FDI (foreign direct investment). These issues are of only secondary importance compared to the overall interest of the country. We have no doubt a comfortable level of foreign exchange reserve of over 30 billion dollar but it is now equivalent to only 5 (five) months' cost of imports. And we have, rather unwisely, allowed private sector to borrow abroad more than $11 billion on short-term basis and repayment of these loans will affect our reserve. It is worth mentioning that India had a huge amount of foreign exchange reserve of $406 billion and China a mammoth $3,053 billion as of 2018 but they consciously maintained their currencies at the undervalued level to sustain their high level of growth.

Syed Ashraf Ali is a former central banker who also served a stint as CEO of a commercial bank.

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