External sector: a time of unforeseen volatility and unprecedented pressure

Bangladesh's external sector has never been under so much pressure experiencing such volatility as in the recent past. Trade deficit is anticipated to cross US$ 30.0 billion mark, current account deficit the US$ 18.0 billion mark and the negative overall balance crossing the US$ 5.0 billion mark by the end of FY22. The resultant drawdown on reserves, volume-driven export not catching up with price-driven imports, and the negative growth in remittances had led to significant uncertainties and speculative behaviour in the exchange rate market.

This has lead to the significantly important policy shift after about a decade, to free float from the managed float. Bringing back stability in the exchange rate market and addressing the adverse consequences of imported inflation will call for prudent monetary management, and strategic fiscal management and the coordination between the two.

The negative trade balance is anticipated to exceed (-) US$ 30.0 billion in FY22 is driven by rising imports and relatively lower rise in exports. In the backdrop of the negative growth of remittances, the negative current account deficit rose sharply in the FY22 (July-April): from US$ 1.6 billion to US$ 15.3 billion, unprecedented in recent history. The increase of US$2.5 billion in the Financial Account could not dent on the overall balance position which went from the positive US$7.49 billion to the negative terrain of (-)US$ 3.7 billion.

While export growth has been robust at 34.1 per cent over the first 11 months of FY22, from foreign exchange retention perspective, estimation of net export as against gross export is important. The two figures for FY22 (July-May) are estimated to be US$25.90 billion and US$ 47.17 billion respectively (net export being about 55.0 per cent of gross export).

The slowdown in export growth in May, 2022 in the face of lower growth and even signs of recession in some of the key markets, do not augur well for export sector performance in the coming months.

Also to note, Bangladesh export growth has been mostly volume-driven. Buyers and brands have been able to pass on the rise in the price of the key inputs going into apparels export (cotton, yarn and fabrics), with price of cotton rising by more than 50.0 per cent in April 2022 compared to corresponding period of 2021. This is true both for the US and the EU markets (more for woven-RMG).

While remittance growth was a negative (-15.9 per cent) in the first eleven months of FY22 (July-May), compared to the corresponding period of pre-pandemic FY20 this was 17.2 per cent higher. The floating of currency should reduce the significant difference between the official exchange rate and the curb market and in the informal hundi/howla transactions. However, the incentive for remittance (at 2.5 per cent of remitted amount) should continue for now till the market stabilises when decision can be taken as regards reduction or elimination of the incentives.

The high number of people joining overseas job markets should be reflected in the remittance flow in FY23. In the July-April of FY21- 22 about 7.99 lac people have gone to various countries in middle east. Comparable figures for FY20 and FY21 were 5.31 lac and 2.17 lac. Special attention should be given to new employment opportunities in post-pandemic Malaysia and Singapore job markets.

In view of the steps taken by the Bangladesh Bank (floating exchange rate) and the incentive, and the rising number of migrant workers joining overseas job market, remittance flows should approximate the spike of FY21 in FY23

EXCHANGE RATE: The gap between Real Effective Exchange Rate (REER) and Nominal Effective Exchange Rate (NEER) of Bangladesh was widening over the years which called for adjustment through depreciation of Bangladesh Taka (BDT).

Bangladesh's managed float pursuit till now could not be made to work for several reasons.

While the BB had depreciated the taka eight times this year, it proved to be too little, too late. The declining reserves situation did not allow the BB to go for unlimited dollar injection (it had already done so to the extent of US$ 6.2 billion in FY22). The Centre for Policy Dialogue (CPD) had also argued in successive IRBD's that Bangladesh's exports were becoming less competitive vis-à-vis competitors and remittance flows were also being disincentivised because of this. CPD has been pointing out the need for depreciation of BDT in view of the growing gap between REER and NEER

While the gap between REER and NEER had been rising, the USD-BDT 'Managed Float' exchange rate did not go for necessary correction. Taka became appreciated as a consequence. A market correction, induced by the current Balance of Payments (BoP) position and free float thus did not come as a surprise

To recall, CPD's Policy Suggestions three years back included the followings: (a) A gradual depreciation of the BDT should be pursued with the help of the central bank's sterilisation interventions; (b) A sharp depreciation may have adverse implications for import payments, consumer prices and foreign debt servicing; (c) Depreciation of BDT will also help incentivising export and remittances - hence, cash incentives will not be required!; (d) In the short term, the expected deficit in the current account may be brought down by containing imports; (e) The government may also consider raising import duties on selected luxury items and consumer goods; and (f) Bangladesh Bank can selectively impose higher LC margin to discourage imports.

However, while Bangladesh did start to actively pursue a policy of depreciation, after exhausting its tool of dollar injection, it proved to be too late requiring the surgical operation of moving from managed float to free float. This, under the circumstances, is a step in the right direction. There will be market correction in the USD-BDT exchange rate. However, as in 2012, there is a possibility of (reverse) correction once the foreign exchange market settles down.

In the short run, free float was likely to lead to deepening of imported inflation. However, it is to be noted that Bangladesh was not being able to enforce its 'managed float' anyway in case of L/C openings and settlements and inter-bank dollar market (as also for export settlements and remittance flows). So, the apprehension about 'imported inflation' could not be addressed in any way through the 'managed float'.

In view of the adverse implications of imported inflation on consumer prices and purchasing power of fixed income earners, and to contain import demand, the GoB and BB have taken a number of steps: discouraging import of luxury items through higher L/C margin and imposition of duties on selected items on the one hand, and tariff rate adjustments (reduction of VAT and duties on essential commodities) on the other.

There is a need to coordinate Monetary Policy and Fiscal Policy, particularly in view of the upcoming FY23 budget. To address the adverse impacts of imported inflation, in view of Budget FY23 the government should go for: (a) import duty adjustment, (b) improvement of market management (from import stage to retail, consumer and producer level, (c) use of strategic food stocks and OMS, and (d) strengthening of SSNPs, particularly programmes for food distribution and cash transfer.

Dr Fahmida Khatun is Executive Director, Centre for Policy Dialogue (CPD); Professor Mustafizur Rahman is Distinguished Fellow, CPD; Dr Khondaker Golam Moazzem is Research Director, CPD; and Towfiqul Islam Khan is Senior Research Fellow, CPD. [email protected]; [email protected]

[The article is edited version of power-point presentation made by the authors at the CPD Media Briefing on State of the Bangladesh Economy in FY21-22 (Third Reading) on Sunday]