2 months ago

In need of a free-floated exchange rate regime

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In a previous write-up in May last year, this scribe argued that the artificially-inflated value of Bangladesh’s currency, the Taka, was hurting exporters and remitters alike.

The piece also tried to portray that the currency management meant indirectly taxing exporters and remitters while subsidising importers. It is based on the real effective exchange rate (REER), which would indicate a gap of Tk 20-25 per USD. Since then, a debate around whether Bangladesh should adopt a free-floated currency or continue with its managed currency regime has been ongoing. While some argue that a managed currency can provide greater stability and control, others maintain that a free-floated currency would better serve the needs of the economy.

The current piece will try to explore the reasons behind the need of a free-floated currency in the country.

For starters, a freely floating currency allows for greater flexibility in responding to economic shocks. The government can intervene in the foreign exchange market to stabilise a managed currency. But this often comes at the expense of other economic goals, such as inflation control.

A free-floating currency, on the other hand, can adjust to market forces, allowing the exchange rate to fluctuate based on changes in supply and demand. This flexibility allows the economy to respond to changes in the global market more quickly, which is especially important for a country like Bangladesh that relies heavily on exports and remittances to balance its ever-increasing import bills.

Secondly, free-floated currencies can boost economic competitiveness. With a managed currency, the government may be tempted to artificially raise the exchange rate to facilitate imports to some extent. While this may benefit traders and markets in the short term, it may lead to inflation and, in the long run, reduce the country’s competitiveness in the global market.

The exchange rate of a free-floated currency is determined by market forces, providing a more accurate reflection of the country’s economic competitiveness. This can encourage investments in industries, reducing reliance on otherwise “currency-induced” cheaper imports and promoting long-term economic growth.

Thirdly, a freely floating currency can boost transparency and accountability. The government has a significant control over the exchange rate in a managed currency, limiting the private sector’s ability to borrow from international markets.

A free-floated currency, on the other hand, promotes transparency and accountability because the exchange rate is determined by market forces, as such will create opportunity for entrepreneurs in the country to access international financing with greater success, in building industries to replace imports. This can help to alleviate stress on domestic financial markets and promote more efficient resource allocation in the economy.

Finally, a freely floating currency can help to maintain financial stability. There is a perceived risk of capital flight with a managed currency whenever investors may be concerned about government intervention in the foreign exchange market.

A free-floated currency, on the other hand, promotes financial stability by allowing the market to adjust to changes in supply and demand, which can help to prevent abrupt changes in the exchange rate, as changes in the exchange rates become predictable based on economic parameters.

Thus, a managed currency can provide stability and control, a free-floated currency is better suited to the needs of Bangladesh’s economy, as it offers greater flexibility in responding to economic shocks, promotes economic competitiveness, transparency, accountability, and financial stability. So, the policymakers need to seriously consider transitioning to a free-floated currency regime to ensure the long-term stability of the economy. 

It may also provide a stable environment for investments and innovation to excel and prosper. It is time to make the seesaw of forex trade be corrected by an open market; it is the time for future proofing our economy.

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