Potential uses of international reserves

There comes a question why we need letters of credit (LCs) to import goods when our central bank is holding huge liquidity as international reserves. The LCs need to be guaranteed by international banks, and import is permitted under buyer's/supplier's credit; import payment is settled by importers through external loans from banks abroad in case of buyer's credit. Lenders do not take exposure on importers in Bangladesh in spite of buyer's credit, but on LCs confirmed by first rated international banks. The central bank sets yearly cost ceiling for buyer's credit at 6-month LIBOR + 3.5 per cent. Inside information shows that foreign banks extend loans during the pandemic period at this rate, excluding high cost of confirmation charges. Country ratings by three global rating agencies are reported to be sound. So, we can say that Bangladesh possesses sound reserves for settlement of import payments exceeding acceptable threshold range and acceptable country ratings. Despite this, her external transactions are not being well trusted by counterparts for which extra cost is required. It seems to be not a question of trust, rather global banks including multilaterals are doing business on our import transactions. Hence, sound international reserves and stable country rating seem to be mere indicators, of little help to macroeconomic management.

Alternative view is peculiar with regards to export trade of the country. Our exporters ship goods on sales contracts which become papers in the worst case scenario with payment default by importers abroad. No safeguards are available for exporters.

Let us assume that a bank buys dollar from exporters and pays them in equivalent taka. Where does bank get taka from? Definitely it comes from depositors' money. As such, the bank will try to sell dollar to importers with a reasonable margin to squire up its position. If the bank cannot sell dollar, it will look for other banks who need it. Holding the dollar is a cost and so the bank will sell the same, in case of non-availability of customers in private sectors, to the central bank at insignificant margin.  The central bank will buy the dollar and make taka available in the deposit accounts maintained by the seller bank. Where central bank gets taka? Central bank just makes bookkeeping journal entries under golden rule of accounting system to create taka against purchase of dollars. Their assets, under the system, in balance sheet increase due to debit entry and the same situation takes place on liabilities side due to credit entry to deposit account of the particular bank. What a nice mechanism is devised by John Law to create money by central bank out of nothing!

By purchasing dollar from the banking system, central bank accumulates international reserves which also automatically increase due to interest/profit earned against them.  The government is another source of accumulating reserves by central bank. Soft loans granted by multilateral agencies are channeled through the central bank who buy dollars in the same way as done in case of purchase from banks and makes taka fund available to banks with whom the concerned project offices maintain deposit accounts. A part of the foreign fund as soft or concessional loans is used for import of goods and services. Recently reserves are reported to have increased to a new height and is expected to reach USD 50 billion soon. This is due to incremental dollar fund channeled to the central bank from  both private and the government sources.

Balance of payment (BOP) is a part of macroeconomic accounts, components of which are balances of current accounts plus financial/capital accounts equaling increases/decreases in international reserves. Deficit in current accounts is supported by financial accounts in the form of foreign investment or foreign loans or by support from international reserves. Positive balance in overall BOP leads international reserves to increase. Increased extent increases money supply, while foreign exchange fund is used to finance external economy when they are placed abroad in the form of deposits, loans, purchase of foreign financial instruments. But central bank or its regulatory framework does not permit the reserves to be used for lending to import by the government. Really it is a peculiar arrangement, maybe prescribed by non-state agencies. It ultimately facilitates other economies and support multilateral and international financiers to recycle the same fund for lending our government and private sectors, in the same way of recycling petrodollars in the 70s and 80s of last century. However, Bangladesh Infrastructure Development Fund (BIDF) is learnt to have been established out of international reserves.

Exchange rate between local currency and foreign currencies was declared floating by our central bank in 2003. Under the academic framework of floating exchange rate regime, interaction between demand and supply of currencies set prices. No intervention is required from central bank. In that case, foreign exchange reserves in central bank may be worked for purposes of treasury and open market operations to achieve monetary programmes. The system brings automatic stabilisation in currency value based on flows of goods and services, and finances. On the other hand, fixed exchange rate regime needs frequent intervention by central bank to maintain the value of local currency so as to keep monetary policy at work. But in practice, dejure floating exchange rate works as defacto fixed exchange rate. Central bank intervenes market through sale and buy, and informal instructions to market players for keeping currency undervalued or overvalued.

War on currency is observed due to faults in macroeconomic policy framework. A country should allow to have external loans only by export oriented and import substitution industries for import of capital goods. Access to external finance for working capital to be used for domestic expenses shall never be encouraged. In such situation, the opposite cannot work as supportive tool in case of mismatch between inflows and outflows. Experiences of Asian crisis, Mexican crisis, Russian crisis tell us that reserves can do nothing in urgent situations. Bank of Thailand could not support its currency to fall by the foreign exchange reserves it held. The same situation was faced earlier by Bank of England in 1992, on its pound sterling, due to short selling activities by merchant banks. Prudent macroeconomic framework is helpful to manage external shocks. What is really played in crisis by foreign exchange reserves or high sounding credit rating is a question. Global crises at different phases teach that central banks adopt non-conventional monetary policies through so called quantitative easing which balloons their balance sheets. But the programmes cannot bring effective results like employment, even it cannot create inflation. So, debit-credit mechanism for money creation is workable in normal situation. Monetary policy can rarely bring money supply to the targeted sectors in odd situations. On the other hand, financial inclusion programmes are basically confined to maintaining accounts with banks and with digital wallets which facilitate remittances from one to another without leading people to capitalise their future income. Ridiculously it is said that people working in banking system are actually enjoying the benefits of real financial inclusion through capitalisation of future income at present days by way of easy finance at non-market economic process, thereby living beyond means.

The government needs financing for annual development programmes. External financing is one of the sources in the form of either concessional or non-concessional loans. Concessional loans are longer in tenure granted by multilateral agencies. These loans as noted earlier are one of the components of foreign exchange reserves accumulated by central bank. But concessional loans may, on being graduated to developing stage, not be so cheap. On the other hand, non-concessional ones bear commercial costs, granted by the lenders particularly against sovereign guarantees. The loan proceeds are used for settlement of external obligations. Loan repayments including interests are made through purchase of dollars from domestic market. There is no record of payment default by the government. So, Bangladesh is a good destination for external lenders including multilaterals of such loans.

Investment portfolio of international reserves may be confined to fixed income securities like treasury bills/bonds, 'a' rated instruments etc., as per academic discussion. Central bank deals, in practice, with home government bills/bonds as a part of treasury functions. But international reserves are used to support other governments through purchase of their securities. Where lies the problem of the central bank to extend loans to government for import payments is a question.  Are they scared of non-state agencies like Bretton woods babies?

Last but not least, BIFD has been established. This may be of help to meet external payment obligations needed by the government as a substitute of foreign loans. In that case BIFD should have operational modalities for extending loans by way of designated banks against guarantees from competent ministry with obligation to be repayable through the same banks in the same currency. Alternatively, central bank can establish swap line between foreign exchange reserves and treasury bonds with the government to finance the external payment obligations required for concerned development projects; a bank can work as intermediary in this case. There should be a win-win situation between central bank and the government without tug of war. The use of fund from reserves, in whatever ways, can surely plug in leakage of foreign exchange in the form of interest payments.

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