Until May 26, Bangladesh Bank had a functioning foreign exchange market.
It featured a price that served to bring the market into equilibrium reflecting the supply and demand for foreign currency.
There were certainly some imperfections, but these were limited in impact. Bangladesh Bank managed this market appropriately, buying and selling dollars as deemed necessary.
(Actually, contrary to what has been reported Bangladesh Bank intervened while selling dollars largely through the process of paying large, important L/Cs injecting dollars indirectly in that manner, not by selling dollars at a favorable price to selected banks.)
The main market for foreign exchange had a supply of dollars from exports, from inward remittances, and dollars arising from loans and investments flowing into Bangladesh.
The price was the three-day forward rate for buying dollars, used for paying L/Cs or contracts.
For exports proceeds there was a slightly different price.
There was another rate for remittances but the buying and selling rates are close together.
The export proceeds were divided to pay off any dollar costs linked to the transaction (back to back L/Cs, loans from the Export Development Fund) so part of the export proceeds did not pass through the Taka market.
The remainder could be partially left in the retention fund of dollars allowed to the exporter or sold for Taka.
Banks that had excess dollars sold these to other banks if they needed them.
The interbank rate stayed close to the 3-day forward rate otherwise someone would arbitrage away the difference.
As exporters could sell their dollars to any bank, there was competitive pressure on banks to give their export customers a reasonable rate.
Bangladesh Bank communicated regularly the rate for clearing import payments (called the CB rate.)
But no one paid any attention to this rate and most transactions were based on the three-day forward rate buying or selling dollars.
It was an unusual system but an effective one.
Bangladesh Bank knew exactly what was happening and it worked very well.
Difficulties
The two main difficulties with this system were:
(1) The transactions associated with the forward sales had some cost so there was some economic loss in running the market off the three-day forward rate.
(2) There was considerable confusion in the mind of the public as to what was happening. Everyone thought that the Taka needed to be depreciated.
All the calculations of the real effective exchange rate were wrong as these were based on the so-called official rate rather than the actual transaction rate.
The 3-day forward rate depreciated about 10% over the past year while the official rate hardly changed.
As the pressures in the foreign exchange markets increased the 3-day forward rate deprecated quite sharply; Bangladesh Bank failed to get enough dollars into the market to stabilize the exchange rate.
The official, but irrelevant rate was depreciated bringing public attention to the market condition but this was irrelevant to balance of supply and demand.
Bangladesh Bank now decided that action was necessary to reduce the volatility in the foreign exchange market.
Volatility as used to describe a financial market usually means a lot of up and down in the market prices over a short time period —hours typically or sometimes days.
The exchange rate [the real one—the three day forward] was depreciating, but was not really volatile.
Bangladesh Bank has apparently changed the operation of the market.
Official announcements are not available as this is being written.
But the new system seems to be as follows:
A new exchange rate will be set.
This rate will cover the different types of transactions [import L/Cs, export L/Cs, money transfer rate [TT], remittances and an interbank market.]
All of these rates will be more or less the same with a difference between any two of them one Taka or less.
The banks will establish this rate every morning and get it cleared by BBs, and used for that day. There are three interesting questions:
At what rate will this new foreign exchange market begin?
Will Bangladesh Bank allow this rate to change daily according to the pressure of supply and demand?
Will Bangladesh Bank intervene in the market, and with what object?
Let us make two alternative scenarios that I will call W and K:
W: The new rate for importing L/Cs will be Tk89/dollar.
Bangladesh Bank will not agree to frequent changes in this rate and will depreciation at the rate of 1-1.5% per year.
Finally the central bank will not be specific about intervention but will be prepared to insert dollars but how remains undefined.
The amount of dollars they buy or sell depends on their policy.
If the balance of payments is running a surplus in the past they have held the dollars to keep the Taka from appreciating.
If the balance of payments tends to deficit then BB will have to provide dollars equal to that deficit to maintain the exchange rate.
K: The new rate for import L/Cs will be Tk92/$.
Banks will approve frequent changes in the exchange rate and allow depreciation or appreciation by 12% per annum. [BB will accept changes as the bankers recommend.]
Central Bank intervention would be similar as for alternative W.
However, the greater exchange rate flexibility would reduce the amount of intervention to protect the exchange rate.
W: Would represent a disaster. It is in effect an appreciation of the currency by about 5-6%. [The present rate is about 94-95/$ using the three-day forward rate].
I cannot believe any economist in Bangladesh would think that appreciating the currency when running a —$4-5 billion deficit is acceptable economic policy.
W represents the pretend policy that Bangladesh Bank has presented to the public in the past.
K: this represents a continuation of the present policy in a cleaner more efficient form.
The critical issue is how the balance of payments will behave.
There is plenty of room for dispute on this.
If one believes as is the government’s public position that there will be a surplus; in this instance there is no pressure on the exchange rate.
In FY22 running a deficit of —$4-5 billion there was tremendous pressure on the exchange rate.
Once that pressure goes away in the more favorable conditions the Government expects during FY23, then there is no need for all of this drama.
If there is a substantial deficit in FY23 then the market will prove stronger than Bangladesh Bank, and some form of depreciation of the Taka will emerge.
If the government tries to control imports directly by import licenses, differential exchange rates and such regulatory actions it will result in corruption, confusion and slowing down economic growth as it has in every country that has tried to do this.
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
