Ten months ago, I wrote a post on LinkedIn about the taka/dollar exchange rate. The main thesis was that the sharp currency depreciation we were experiencing in 2022 was simply because the Bangladeshi taka was overvalued.
Back then the $1 was equal to around Tk95. Now the official exchange rate is around 108. Cash dollars are available at around Tk111-12 while the “hundi/hawala” rate may be around Tk114-116.
Expected depreciation per year
Between 2003-2013, the US dollar appreciated around 3.2% per year vs the taka. As mentioned in the previous post, this is a reasonable level of dollar appreciation (and taka depreciation) considering the inflation differentials.
I chose 2013 because I believed 2013 had a fair taka value considering we started running current account surpluses in that period consistently.
Based on the first chart below, the actual official exchange rate has now caught up with the 3.2% dollar appreciation per year.
The cash and hundi markets have actually exceeded the 3.2% per year and have actually touched the 4.2% per year number. A simple conclusion here is that the taka has reached close to its fair value for 2023.
Signals from the market on the currency fair value
There is a simple test for seeing if a currency is undervalued or overvalued. That is following the current account balance.
An overvalued currency will lead to current account deficits. As the currency moves closer to fair value the deficits should fall (and sometimes move into surplus depending on the structure of the economy).
If we look at the monthly current account numbers, after 2017 (excluding the Covid period) we are now seeing consistent monthly surpluses.
One challenge in looking at current account numbers is the LC openings have been severely restricted. So, one could argue that with a normalized import number, the current account situation would not have been as good.
This is a logical conclusion but fails to consider a few alternate points.
1. Commodity prices have come down significantly from a year ago (IMF commodity index down 25% YoY). So, the peak import figures of monthly $7bn are no longer relevant.
2. The 25% dollar appreciation vs the taka that has happened automatically reduces import demand to some extent.
3. Apart from official imports, some imports happen via the hundi market. Once official imports rise, so will official remittances. It's important to note that a significant number of Bangladeshis have gone abroad to work in the last two years but official remittances have not increased.
Other than the current account indicator, another indicator is the curb market dollar rate. This rate had reached a high of around Tk114 but has now come down to Tk110-112.
The directional trend has been of taka strength. Plus, the spread vs official rate has narrowed to historical averages. If people felt currency is overvalued, they would purchase dollars heavily and the spreads would have been wider.
Markets are not fully efficient
Even if we all agree that the currency is fairly valued, the taka can definitely depreciate further.
Only in a fully efficient market are things priced exactly at their fair values. Psychological factors, speculation, short term demand/supply imbalances all can play a role in this.
It's also worth mentioning that the financial account is in deficit and so despite the current account surpluses, FX reserves continue to decline.
We apprehend that the financial account will remain in deficit as Bangladesh pays back the short-term loans it took in the last five years.
A sharp drawdown in reserves can lead to speculative moves against the taka.
Monetary policy also plays an important role. Fortunately, money supply growth stands at around 9% which is on the lower side. Any expansionary stance (which seems very unlikely given we are in an IMF program) can also lead to further depreciation of the taka.
Asif Khan, CFA is Chairman of EDGE AMC Limited. All opinions belong to the author personally.