Market-based liberalisation of foreign exchange rates and reality

The International Monetary Fund (IMF) suggested the implementation of a flexible currency exchange rate for Bangladesh during a virtual press conference on April 30, coinciding with the release of the Regional Economic Outlook for Asia Pacific countries. This recommendation aligns with the IMF's stance advocating for market-based exchange rates over the past eighteen months. The IMF contends that adopting a market-based currency exchange rate in Bangladesh would yield improvements across various sectors, notably bolstering foreign exchange reserves.

Krishna Srivasan, Director of the IMF's Asia-Pacific Division, highlighted that Bangladesh's current account surplus stood at 4.7 crore US dollars during the July-March period of the current fiscal year. Concurrently, the fiscal deficit amounted to 8.3 crore US dollars.

The fiscal deficit has surged nearly fourfold compared to the previous year, a concerning trend highlighted by Krishna Srivasan, Director of the IMF's Asia-Pacific Division. Srivasan emphasised that implementing a flexible or market-based currency exchange rate in Bangladesh could yield positive outcomes for its financial accounts and alleviate the crisis surrounding foreign exchange reserve preservation. The clear stance of the IMF's Asia-Pacific Division Director has reignited discussions on transitioning to a market-based exchange rate for foreign currency, a proposition long advocated by some economists in the country. The reinforcement of this advice following Srivasan's remarks underscores the urgency of addressing the issue.

The IMF's recent suggestion to transition to a flexible or market-based exchange rate warrants careful consideration and discussion, particularly in light of the current circumstances. Understanding why such advice has been given at this juncture is crucial. It's important to note that Bangladesh had sought and received approval for a loan of US$ 4.7 crore from the IMF last year. Both the first and second installments of this loan have already been disbursed to Bangladesh, with the third installment expected to be released imminently.

Given this context, the IMF's recommendation carries significant weight for several reasons. Firstly, the loan agreement with the IMF likely includes conditions and commitments from Bangladesh, such as implementing reforms to address economic imbalances and promote stability. Failure to heed the IMF's advice on adopting a flexible exchange rate system could potentially jeopardise Bangladesh's ability to receive the next installment of the loan.

Moreover, the IMF loan was intended to assist Bangladesh in bridging its budget deficit and bolstering its foreign exchange reserves. By aligning its exchange rate policies with the IMF's recommendations, Bangladesh could enhance its capacity to achieve these objectives effectively.

It's essential to recognize that IMF loans are typically accompanied by conditions aimed at promoting economic reforms and sustainability. Therefore, Bangladesh's adherence to the IMF's advice on exchange rate flexibility is not only advisable from an economic perspective but also critical for maintaining a positive relationship with the IMF and ensuring continued financial support.

The conditions for loans can vary depending on the country, but they are never granted unconditionally. Despite the assertion by the former finance minister AHM Mustafa Kamal that Bangladesh received the loan exactly as requested, this statement is inaccurate. Bangladesh did not seek a conditional loan, but rather received one in accordance with IMF requirements. The loan approval was contingent upon adhering to IMF conditions, such as implementing reforms in the banking sector and maintaining foreign exchange reserves. Thus, the former finance minister's claim lacks factual accuracy.

If Bangladesh were to adopt a flexible or market-based foreign currency exchange rate at this juncture, it could elicit both positive and negative responses. In a free market economy, governmental control ideally doesn't dictate anything, including exchange rates, but rather serves in a supportive capacity. Government intervention is warranted only if the free market mechanism fails or complications arise. Despite Bangladesh's adherence to a free market economy since 1991, the market has often been hindered from operating freely, leading to adverse outcomes in certain instances. According to the tenets of a free market economy, exchange rates and prices of goods or services should be determined by market forces—specifically, by the interplay between product supply and consumer demand.

The same principles of market determination apply to foreign currency exchange rates; however, Bangladesh Bank has consistently refrained from allowing exchange rates to be determined freely. In instances where there's a threat of local currency devaluation due to shortage of US dollars in the market, Bangladesh Bank has intervened by releasing dollars from foreign exchange reserves to mitigate the crisis. Conversely, when there's an influx of US dollars, the bank endeavors to stabilise the situation by purchasing dollars from the market. However, the rapid depletion of foreign exchange reserves in recent months has rendered Bangladesh Bank unable to control exchange rates through buying and selling US dollars, even if it so desires. While adopting a flexible or market-based foreign currency exchange rate could yield certain benefits, there are associated risks of complications. Therefore, it's advisable to proceed with deliberate caution in this matter.

Economists advocate for market-based foreign exchange rates due to several advantages they offer. With market-based rates, imbalances in currency demand and supply are minimised. Conversely, fixed exchange rates can benefit certain sectors, such as importers. For instance, under a fixed exchange rate regime, importers can procure foreign currency at a stable rate, enabling them to import goods and services at relatively lower costs in local currency terms. This could potentially lead to lower prices for consumers, as imported goods become more affordable. Additionally, industries and manufacturing sectors can benefit from lower costs by importing raw materials, capital machinery, and intermediate goods at reduced expenses.

However, in the context of Bangladesh, despite fixed exchange rates, the prices of imported goods have not decreased as expected. Consumers find themselves purchasing imported goods at higher prices despite the supposedly favorable exchange rates. It's worth noting that Bangladesh relies on imports for approximately 25 percent of its demand and consumption goods.

Out of the total consumption, the remaining 75 percent consists of locally produced goods. While the increase in the foreign exchange rate affects the prices of the 25 percent of products that are imported, the remaining 75 percent should ideally remain affordable. However, the reality diverges from this expectation. Despite the fixed exchange rate of the US dollar by Bangladesh Bank, the bank struggles to meet the demand for US dollars from importers. Consequently, importers resort to acquiring US dollars from the informal market at inflated exchange rates to import various goods. Consequently, they are unable to maintain reasonable prices for imported products, even if they intend to do so.

It's untenable for Bangladesh Bank to fix the exchange rate of the US dollar while failing to supply sufficient currency to meet the demands of foreign exchange users. This initiative could have succeeded only if an ample supply of foreign currency could be guaranteed. As the saying goes, "necessity knows no law," importers and foreign exchange users fulfill their requirements by procuring foreign exchange at elevated rates from the informal market or kerb market.

Factors other than the foreign currency exchange rate play a significant role in driving product price inflation in Bangladesh's domestic market. The presence of politically influenced syndicates and unchecked extortion activities by corrupt individuals at all levels act as major obstacles in maintaining reasonable commodity prices. At the grassroots level, farmers and producers often face unfair pricing practices. For instance, a potato farmer might be compelled to sell his produce at a meager rate of 15 taka per kg, while consumers in the capital are forced to purchase the same potatoes at inflated prices ranging from 60 to 70 taka per kg.

Farmers lack organisation, and due to limited resources and facilities, they are unable to store perishable goods for extended periods. Consequently, they are compelled to sell their products immediately to middlemen at lower prices.

When middlemen transport goods to the city, they often have to pay off extortionists along the way, significantly inflating the product's cost by the time it reaches consumers. While farmers and grassroots producers toil to create these goods, their profits are often usurped by middlemen and extortionists. Local criminals and corrupt elements within law enforcement agencies have formed powerful syndicates, making it nearly impossible to bypass their influence in bringing products to consumers.

If the government were to directly purchase goods from local producers and bring them to urban centers for sale, the activities of middlemen and extortionists could be greatly curtailed. This would ensure fair prices for producers and enable consumers to purchase goods at lower prices. Arguments claiming that market-based foreign exchange rates would unreasonably raise import costs and inflation rates are questionable. The primary driver of price increases is poor market management, rather than the cost of imported goods.

The fixed exchange rate of foreign currency, rather than being market-based, is inflicting various economic repercussions. Exporters are disincentivised to repatriate the foreign exchange earned from their goods due to this fixed rate. Many opt to keep their hard-earned money abroad, speculating that they can benefit if the local currency depreciates. Consequently, there's been a noticeable decline in the inflow of foreign exchange despite an increase in the export of goods and services from Bangladesh.

According to Bangladesh Bank statistics, in the first quarter of the current fiscal year (July-September), the country received $990 crore US dollars for exported goods. However, in the second quarter (October-December), this figure dropped significantly to $907 crore US dollars, despite a $18 crore increase in the export of goods compared to the first quarter.

In the first six months of the current fiscal year, from July to December, the total export value of goods amounted to $2754 crore US dollars. However, during the same period, the actual export earnings that entered the country were only $1897 crore US dollars. Comparatively, in the fiscal year 2020-2021, goods worth a total of $3876 crore US dollars were exported, with $3397 crore US dollars being received by the country. The subsequent year saw an increase in export earnings, totaling $5208 crore US dollars, but only $4360 crore US dollars were repatriated to the country. Similarly, in the last fiscal year, goods worth $5556 crore US dollars were exported, but only $4387 crore US dollars entered the country.

Exporters are withholding a portion of their export earnings for various reasons. If the foreign exchange rate were market-based, they would likely be more inclined to repatriate their export earnings in anticipation of earning higher returns in the local currency.

This scenario also extends to remittances sent by Bangladeshi expatriates to the country. According to World Bank data, last year (2023), expatriates sent a total of $23 billion USD in remittances to Bangladesh, ranking the country seventh globally in terms of remittance inflow. However, this figure doesn't encompass the entirety of remittances sent. Last year witnessed a record number of 13 lakh new workers from Bangladesh seeking employment abroad, particularly in the Middle East, where post-COVID rehabilitation efforts have generated a substantial demand for labor. It's reasonable to assume that the amount remitted by both existing and newly employed expatriates is significantly higher.

Many believe that the amount of remittances entering the country through legal channels is equal to or even less than the amount arriving through informal channels such as "hundi." There are several complications associated with sending remittances through formal banking channels. Workers employed in organisations find it challenging to visit banks monthly to send remittances back home. Similarly, beneficiaries in Bangladesh may face difficulties in withdrawing remittances from banks. In contrast, "hundi" presents fewer obstacles. "Hundi" traders collect foreign currency from expatriates' residences and deliver money to their families through agents in Bangladesh.

Although Bangladesh Bank offers a 5 percent cash incentive on remittances to encourage their transmission through legitimate channels, the exchange rate offered through informal channels like the kerb market is often at least 15 taka higher per US dollar compared to official banking channels. Consequently, expatriates may opt for informal channels to send money home, given the apparent financial advantage.

The two main sources of Bangladesh's foreign exchange earnings are product export earnings and remittances. Due to fixed foreign currency exchange rate and high exchange rate of US dollar in the kerb market, they are interested in remittance through hundi. How currency exchange rates are affected by fixing foreign exchange rates in the banking channel can be explained through an example. Say for example, an exporter or expatriate Bangladeshi will remit his earned money to the country. If he sends this money through legal channel i.e. bank then he will get maybe 110 taka in Bangladeshi currency for every US dollar. But if the same US dollar is sent to the country through hundi, then he will be paid 125 to 130 TAKA against every US dollar. Who wants to miss this tempting opportunity? If the government could stop the hundi business, expatriate Bangladeshis and commodity exporters would repatriate their hard-earned foreign currency through banking channels. But who will tie the bell around the cat's neck? If the exchange rate of foreign currency is based on the market, it will bring benefits to the country's economy in the long term, even if it causes some difficulties in some cases. Therefore, the exchange rate of foreign currency should be left to the market, albeit slowly. This will have benefits in many areas including increase in inflation of reserves.

M A khaleque: Retired general manager and writer on economic affairs