What impact market-based USD exchange rate will have

The International Monetary Fund (IMF) and Bangladesh Bank have finally decided to adopt a market-based exchange rate for the US dollar. From May 15, scheduled banks are now setting the US dollar exchange rate themselves. Previously, despite multiple suggestions or conditions from the IMF to adopt a market-based exchange rate for the US dollar, Bangladesh Bank had not agreed to comply. Instead, the central bank had been setting the exchange rate based on a crawling peg system.

The crawling peg system is a middle ground between a fixed exchange rate and a market-based one. Under this system, Bangladesh Bank would set the "mid-rate" of the US dollar, and scheduled banks and institutions involved in dollar transactions could buy and sell US dollars at a rate up to 2.5% above or below that mid-rate. In other words, Bangladesh Bank would determine the upper and lower bounds of the exchange rate for the US dollar. Scheduled banks were allowed to sell the dollar at Tk 1 higher than the upper limit as well.

Most recently, Bangladesh Bank had set the upper limit for the US dollar at Tk 119. Generally, banks were selling each US dollar at Tk 123. With the move to make the exchange rate market-based, Bangladesh Bank will no longer impose any control over the market rate of the US dollar. However, if any abnormal situation arises in the currency market, Bangladesh Bank will be able to intervene immediately. That is, even from a distance, Bangladesh Bank will retain indirect control over the currency market.

There had been discussions for quite some time about making the US dollar's exchange rate market-based. However, Bangladesh Bank had not taken any positive steps in this regard. The reason is that if the exchange rate of the US dollar is determined by the market, there is a strong possibility that the value of the local currency, the taka, will depreciate significantly. If the exchange rate of the taka falls, the cost of imported goods will rise, leading to public suffering. This is particularly concerning because the country has been experiencing high domestic inflation for almost the past three years. The inflation rate remains above 9 percent. In one of its reports, the IMF noted that Bangladesh’s overall inflation rate could hover close to 10 percent this year (2025). The World Bank stated that the current food inflation rate in Bangladesh is the highest among South Asian countries. In such a situation, it is natural that Bangladesh Bank would not want to take the additional risk of higher inflation by leaving the exchange rate of the US dollar entirely to the market. But the question remains—is the exchange rate of the US dollar solely responsible for the high inflation in our country? Or are there other factors at play?

In recent years, the persistent trend of high inflation in the domestic market has largely been the result of flawed policies by Bangladesh Bank. Just as the post-COVID global economy was beginning to recover, the Russia-Ukraine war broke out. Due to the war in Ukraine, global fuel prices surged abnormally, causing severe disruptions to supply chains. As a result, high inflationary pressures began to surface in countries across the world. Even top economies like the United States saw inflation rates rise to 9.1 percent, the highest in 40 years.

During that time, the Federal Reserve Bank of the United States raised its policy rate multiple times. As a consequence, interest rates on bank loans increased proportionately, reducing borrowers' interest in taking loans at higher rates. This led to a contraction in money supply in the market. Following the example of the Federal Reserve Bank of the United States, central banks in 77 countries, including Bangladesh, started raising their policy rates. Although Bangladesh Bank also increased the policy rate, it continued to keep the maximum interest rate on bank loans fixed at 9 percent for a long time.

Even when the inflation rate rose above 9.5 percent, the interest rate on bank loans was still fixed at 9 percent. There is no reason to believe that Bangladesh Bank made such a decision out of ignorance. Rather, it is widely believed that this destructive move was taken to appease a particular pro-government business group. Due to the relatively low interest rates on bank loans amidst high inflation, this group took out large loans from banks and diverted the funds to sectors other than those intended for investment. There are even allegations that some of this money was laundered abroad.

To appease this group, the exchange rate for the US dollar was kept fixed with a 10 percent margin. When a severe dollar crisis emerged in the market, the US dollar began selling at TK 122 to Tk 123 in the curb market. Businesspeople and entrepreneurs could not purchase US dollars from banks. As a result, they were compelled to buy dollars at higher prices from the curb market. Meanwhile, the pro-government business group continued to meet their needs by buying dollars from banks and engaged in capital flight by over-invoicing during imports. As the exchange rate in the banking channel was lower, expatriate Bangladeshis began sending remittances through hundi, expecting better rates in the curb market. Consequently, remittance inflows were not increasing as expected. Exporters also began retaining their foreign earnings abroad instead of bringing them back to the country. Later, they too brought in export earnings through hundi. This created additional pressure on Bangladesh Bank’s foreign currency reserves.

When the government changed following the student-people uprising in July-August last year, a new governor was appointed to Bangladesh Bank. After changes at the top level of the central bank, the new management withdrew the maximum interest rate cap of 9 percent on bank loans. Now, scheduled banks are allowed to set interest rates based on market demand.

As a result, the flow of private sector bank credit has dropped dramatically. A recent statistic mentioned that private sector credit growth was recorded at 7.28 percent. However, during high inflation, the target for private sector credit growth was set at 14.1 percent in one monetary policy. In fact, the growth had reached 14.7 percent. At the same time, imports of capital machinery for industrial use had dropped by 76 percent, while imports of raw materials and intermediate goods declined by 14 percent each. So, the question remains: where did the private sector credit actually go?

It is feared that if the exchange rate of the US dollar is made market-based, the value of the local currency taka will drop significantly. As a result, import costs will rise sharply, pushing inflation to even higher levels. But the question is: is the rise in the US dollar exchange rate the only reason behind high inflation in Bangladesh’s domestic market? Or are there other underlying causes? Bangladesh meets about 25 percent of its total consumable goods through imports. The remaining 75 percent is produced locally. So then, why are the prices of all goods increasing?

The main reason behind the persistent trend of high inflation in Bangladesh's domestic market is weak market management. In every government term, strong business syndicates aligned with political allies emerge and dominate the market. No government takes any real action against these syndicates. In fact, they often refuse to even acknowledge their existence. During the transportation of goods, extortion takes place at various points along the roads, ultimately raising the transportation costs. When product prices rise due to such extortion or syndicate control, it is ultimately the consumers who bear the brunt.

In its report, the White Paper Committee formed under the initiative of the interim government stated that from 2009 to 2023, approximately $23,400 crore—equivalent to Tk 28 lakh crore—was laundered abroad from Bangladesh. These days, money is not smuggled physically in sacks. Rather, it is done through hundi or under the guise of international trade.

A few years ago, Global Financial Integrity (GFI) reported that every year, around Tk 64,000 crore is laundered out of Bangladesh under the cover of international trade. Preventing this kind of trade-based money laundering is not impossible. If the declared value of imported goods by individuals or businesses were properly verified, instances of over-invoicing could be detected. Thanks to modern technology, the international market price of any product can be verified. Even assistance can be sought from Bangladeshi embassies abroad. But the real issue lies at the root: Are those tasked with verifying the value of imported goods fulfilling their responsibilities with integrity? That remains a critical question.

There is another problem. Importers who engage in over-invoicing often cannot sell the imported goods at fair prices due to strategic reasons—doing so could expose their manipulation. For example, if someone declares the value of a product that actually costs Tk 100 as Tk 125 during import, they cannot then sell it locally at Tk 105. That would immediately raise suspicion. So, they are compelled to sell that product at Tk 135-140 in the local market to cover their tracks.

In a report, the World Bank mentioned that by next year (2026), the prices of fuel and other commodities in the international market are expected to fall by 10 to 12 percent. But the question is: Can we realistically hope that the prices of related imported goods in Bangladesh's domestic market will also decrease accordingly?

A former World Bank official and renowned economist has stated that considering the way Bangladesh’s economy is beginning to recover, this is the right time to make the exchange rate of the US dollar market-based. Since the change in government, there has been a positive trend in export trade. Earnings from the manpower export sector have increased more than at any point in the past. In the first ten months of the current fiscal year, $25 billion in remittances have been received. This amount, collected over just 10 months, surpasses any full fiscal year's remittance earnings in the past. If the remittance inflows for May and June are added, total remittances for the fiscal year could reach the landmark of $30 billion.

Due to the crawling peg system that previously determined the exchange rate, the difference between the currency exchange rates in the banking channel and the curb market had narrowed to a minimum. As a result, expatriate Bangladeshis are now sending remittances through legal channels. With the exchange rate of the US dollar now becoming market-based, the practice of sending remittances through hundi is expected to decline further in the future.

Most of the people who migrate from Bangladesh are unskilled or untrained. However, there is a much higher demand for skilled and trained professionals in any foreign labour market. Therefore, going forward, Bangladesh must take strategic initiatives to send more skilled workers and professionals abroad. At the same time, it is essential to explore new destinations for manpower export.

Expatriate Bangladeshis often face difficulties in accessing banking services. It is not always feasible for them to take leave from work and visit a bank just to send remittances home. Therefore, Bangladeshi banks with branches abroad should deploy additional staff to collect remittances directly from expatriates at their residences, if needed. Moreover, there is a need to open more overseas branches of Bangladeshi banks to make remittance services more accessible. Among exporters, those who do not repatriate their entire foreign earnings and instead keep them abroad will likely be more inclined to bring their export earnings back into the country if the exchange rate of the US dollar increases.

It is not appropriate to keep the foreign exchange rate fixed under the pretext of preventing price increases in goods. Given the current progress of Bangladesh’s economy, making the US dollar exchange rate market-based is unlikely to cause significant difficulties. Blaming the rise in prices in the market solely on the exchange rate of the US dollar will not be beneficial. To control the market, effective initiatives must be taken by the government authorities. No benefits will be gained by controlling the exchange rate of the US dollar.

M A Khaleque: Retired banker and economic writer