Over the past fourteen years the balance of payments has been in surplus for 11 years; deficits were experienced in FY11, FY18 and then in FY22.
In FY11 and FY12 the deficits were under one billion dollars.
The FY22 deficit of negative $5.4 billion was the largest deficit and came as a surprise to Bangladesh Bank.
The Monetary Policy Statement for FY22 forecast a +$5.1 billion balance of payments surplus.
Bangladesh Bank had no idea of how FY22 was going to develop.
The forecast current account deficit was negative $2.570 billion versus an actual of negative $18.697 billion.
Exports were forecast to increase at 13% versus an actual of 33%; imports forecast to increase at 13.5% versus an actual of 36%.
Remittances are forecast to increase 20% while the actual declined 8.5%.
Clearly, Bangladesh Bank, like most financial authorities, had no idea what was going to happen.
As the year progressed the overall balance in the first quarter was a deficit of negative $810 million; for second quarter negative $980 million; for third quarter negative $1.31 billion; and for fourth quarter negative $2.3 billion.
The deterioration of the balance of payments started at the beginning of the financial year and continued steadily throughout.
Bangladesh Bank sold dollars to the banks to cover the gap and these sales were approximately the deficit of the balance of payments; there was a small increase in the foreign exchange holdings of the deposit money banks that also was paid for the dollar sales.
Reality kicks in
However, what happened in the foreign exchange market was much more complex.
The way the system was supposed to work is that there was a set of exchange rates set by Bafeda, the organization of the foreign exchange dealers that included an interbank rate, a rate for covering export earnings, a rate for import L/Cs and a rate for remittances.
Each commercial bank did foreign exchange transactions with its customers.
A bank with a shortage or surplus of dollars would buy or sell through the interbank market.
There were always plenty of dollars available and purchasing other currencies was straightforward.
As the balance of payments was strong, no difficulties were encountered.
Although in theory the exchange rate was floating, in fact the central bank wanted to maintain a stable exchange rate.
The Bafeda understood this was the wish of the central bank and so reportedly maintained rates acceptable to that authority.
Prior to FY22, with the balance of payments in surplus, the central bank was buying dollars in amounts roughly comprising the balance of payments surplus.
If these purchases had not taken place then the Taka would have revalued; Bangladesh Bank wanted to accumulate foreign exchange reserves and also maintain a stable exchange rate, but in doing so it allowed a small depreciation of the Taka.
Over the past decade through FY21 the Taka depreciated at an average rate of 1.77% per annum.
The banks never really felt any pressure on the exchange rate.
Last fiscal year
In FY22 everything changed.
The commercial banks immediately felt the shortage of dollars as import growth accelerated.
In addition, remittance growth was declining so the supply of dollars was weakening.
Remarkably most experts and the central bank believed that they had control of the remittance market and never questioned that growth would continue.
The commercial banks depreciated the exchange rate for imports, in response to the shortage of dollars, through a depreciation of the three-day forward rate.
The “official rate” for L/Cs remained but there were limited transactions at this rate.
Dollars were in short supply so naturally the price would increase.
As the commercial banks systematically depreciated the currency, the central bank acquiesced without admitting the real situation.
Remarkably the commentary by all economists continued to describe a fixed rate when in reality the Taka in use for L/C import transactions was depreciating throughout FY22.
The central bank made no change in the interbank market rate and as a result trading in that market stopped.
With the dollar more valuable than the interbank rate, no bank wanted to sell dollars at the low fixed rate and lose money.
Initially export dollar proceeds available to the exporter could be sold for Taka with any bank once back to back L/Cs and Export Development Fund loans were settled.
Bangladesh Bank accepted a recommendation from the commercial banks that the exporter had to settle the incoming dollar proceeds with the bank that originated the export transaction.
This recommendation came from the large banks with significant export customers.
These banks were now able to try to settle with the exporters, payments in Taka with an unfavorable exchange rate.
Export settlements occurred at exchange rates that were literally negotiated with each transaction.
Having set up a system that enabled some commercial banks to make high fees from handling exports, the central bank then punished those who earned these profits following the central bank rules.
Later this punishment was reversed.
The point remains that the commercial banks are meant to be profit-maximizing institutions within the central bank's rules.
It seems unreasonable to step into the middle of this and hand out arbitrary decisions punishing banks for following the rules.
To obtain dollars the commercial banks negotiated the exchange rates for buying remittances.
Once the interbank market ceased to function this was the only way for a bank to obtain dollars it needed for its importing customers.
These changes broke up the single foreign exchange market and created 62 foreign exchange markets, one for each commercial bank.
Banks earned dollars from export proceeds and remittances; these dollars would be sold to importers to finance the dollar costs of L/Cs.
With a non-functioning interbank market there were two consequences: exchange rates did not converge towards a single value and the Taka depreciated more rapidly than was necessary.
This accelerated depreciation occurred as every bank could only obtain more dollars through bidding high rates to the buying houses.
To manage the deficit of the balance of payments there are five paths:
● Pay for the imports with reserves.
● Reduce imports by slowing down economic growth-best done with reduced government budget deficits and higher bank lending rates.
● Depreciating the currency so exports increase as they are cheaper in dollar terms to foreign importers; and imports decline as they are more expensive to Bangladesh importers in Taka.
● Borrow foreign currency from abroad.
● Finally, through regulation make imports more expensive; this usually does not work very well but it gives the Government officials a sense of control.
During FY22 Bangladesh Bank used reserves to pay for imports; the banks depreciated the currency with uncertain realization by Bangladesh Bank that this was happening. [This depreciation was well over 20%.]
The government increased the deficit in fy22, but most of the increase was financed by foreign borrowing.
Net borrowing abroad by the government in FY22 did increase.
Efforts to directly decrease imports seem to have been of modest success.
Importers were now uncertain what exchange rate would apply when their goods arrived. [The L/C value is fixed in the foreign currency, not in Taka.]
Trusting that the central bank would arrest and possibly reverse the depreciating exchange rate, many importers deferred the import payment until late in calendar 2022.
The goods arrived and cleared customs but the L/C was not settled and so did not enter the balance of payments as an import.
Of course, the importer was paying interest on a short-term loan corresponding to the dollar value of the import.
Later the L/C would be settled.
As FY23 began the exchange rate remained volatile.
The preliminary balance of payments was now available for 2022 revealing the full extent of the crisis.
The outlook for FY23 is not favourable and the central bank is still attempting to stabilize the exchange rate.
Forrest Cookson is an economist who has served as the first president of AmCham and has been a consultant for the Bangladesh Bureau of Statistics.