The Financial Express

Overvalued currency—a discouragement to external sectors

Mehdi Rahman | Published: October 09, 2019 20:28:36

Representational image Representational image

It is true that trade is run by regulatory framework. With regard to international trade, global regulations like WTO rules, ICC norms, etc., work to operate cross border flows of goods and services. However, the economics of cross currency valuation has a role for an economy's competitiveness in international trade. Currency manipulation through undervaluation of home currency is an old concept under 'beggar thy neighbour' formula. For a short time, it may work fine but in the long run, negative result is very possible due to continued depreciation of local currency.

Trade war is going on within major trade partners of the globe. Tariff is being imposed instead of market access.  In this situation, currency is found undervalued (RMR7) to sustain export trade. The trade war makes global trade slow moving. This is affecting export sectors of many emerging countries.

Bangladesh is not out of them. It faces such setbacks. Export sectors especially readymade garment (RMG) sector are facing such pressure which leads to closer of factories, in some cases. Its ultimate effects are grave.

To encourage export, currently export sectors including RMG are within the framework of subsidies -- rates ranging from 2 per cent to 20 per cent. To avail the facilities, exporters need to comply with different formalities like documentary application, audit etc.

Hence, these facilities are available but not readily available at dire working capital need. Global trade in slow motion leads Bangladesh export at slow pace in RMG sector. Continuation of such trend for a longer period may lead many factories to close. This will result in job evaporation. A great number of people is employed in this sector.

People employed therein are continuously facing competition to retain their jobs. In trade, demand and supply with fierce competition reach to a point where reasonable price is set. Their jobs are always in competition. They are not in permanent job categories like armchair jobholders. Slow pace in export orders will make their jobs disappear within a short time resulting in problems of domestic trading activities. So, their jobs need to be retained, anyhow. As such, activities of factories need to continue. To run in a smooth way, factories need reasonable margin but present export orders do not provide such margin.

This situates factory closure and job disappearance. Neighbouring countries are found giving different types of facilities to export sectors. Recent change in their currency value is a good incentive to exporters.

The sector for which we are talking about is one of the biggest providers of jobs. Employment #in this sector boosts local trading. Job disappearance will kill their livelihood, leading to negative impact on domestic trading with stoppage in vast backward linkage activities. As such, cheap imports by overvalued currency will not sustain unless mass people have necessary purchasing power.

Value of currency has two sides, as usual: positive and negative. In case of overvalued currency, import as well as foreign borrowing is cheap. Purchase of foreign currency by local currencies leads hidden money to move abroad illegitimately. On the other hand, export competitiveness is hampered. Wage remitters also face financial loss in sending money through official channels.

At the beginning of this century, exchange rate between local currency and foreign currency was declared floating under foreign exchange regulatory framework. Exchange rate under the regime is determined by the economic forces - demand and supply. As a result, dejure floating exchange rate regime is in place. But it is a defacto managed regime since market is intervened to keep the value of local currency at so called desired level for bringing positive-sum result. In reality, the practice brings negative result to a great extent to major areas where huge employment is generated. It helps cheap imports, external borrowing, and capital flight. Alternatively, it can be said that it discourages wage remittances which are used for illegitimate remittance flight. Without official inflows, money supply channels become inoperative. On the other hand, exports become non-competitive. Entrepreneurs are rarely encouraged to invest in export oriented industries.

A country of huge population may be a better market for foreign suppliers. It is a potential place for industries substitute for imports. But import substitution economic development concept is workable through employment generation provided that substantial local value addition is available for the output. Say an output of 100 units with 20 per cent local contents will not create huge employment. On the other hand, use of 80 per cent local contents for the outputs creates mass employment. Huge employment creates purchasing power for common people resulting in virtuous circle to the economy. But outputs produced with minimal local inputs do not create such situation. Considering this situation of low content use for outputs, import substitution economic development model merely works. As such, export led economic model is vital for absorption of huge population in employment net. Its benefits are visible as we see through establishment of export zones.

As stated, RMG is one of the single export sectors of Bangladesh generating exports around 85 per cent. This sector is being affected adversely due to slow pace of global trade. RMG is a manufacturing industry having direct relations with backward linkage industries. In addition, support services including banking and transportation are to a great extent dependent directly on this sector.

It is reported that direct employment in this sector is around 40 million people. To facilitate the sector, additional stimulus package in the form of cash incentive is going to be available to them. Such option is also open to wage remittances. However, RMG needs additional support for its long term sustainability for which flexibility in exchange rate without intervention is needed.

It is said that depreciation in local currency will give negative impact on import payment. This may result in inflationary pressure, it is true. But imported goods need to be sold in the market. For this, people need purchasing power. Recent trend in global trading environment may affect our major export sectors like RMG which will lead to job disappearance. This will be a major setback for the economy. So price enhancement to some extent will not be a major problem provided the mass people have employment with purchasing power. On the other hand, market in competition will not allow unbearable inflation. So, inflation resulting from flexibility in local currency exchange is not a threat for the economy.

Export sectors produce goods for consumption by people living abroad. Import substitute industries produce for local people. Employment by local industries may not clear market. Autonomous purchasing power needs to be injected to clear the market. Deficit financing by the government is one of the injecting tools in this regard. But the government cannot do as required.

RMG is still in good shape for export trade which needs to be supported for sustained existence. Potentiality is still therein for expansion for which incentives are required to be extended to RMG. Hence, depreciation of local currency will result in a positive situation. It is frequently said that flexibility in exchange rate affects government adversely since it needs foreign exchange to pay its imports like fuel. But it will not suffer from depreciation, rather additional cost will be offset through additional revenue to be generated by way of import duties. Unnecessary import at depreciated local currency will be discouraged. Incremental money supply to the economy basically from export receipts and wage remittances will boost domestic trading. Illegitimate cross border outflows will be discouraged as well.

Mehdi Rahman works for a development organisation.


Share if you like