As the Covid-19 pandemic fanned out of China, emerging and developing countries around the world were hit by a pandemic of capital flight. Since January, about $100 billion left these countries -- an unprecedented sum, three times in magnitude than was the case in the equivalent period in late 2008.
Stock prices stumbled, while the yield on emerging market bonds rose sharply. Investors fled the emerging markets seeking the safe haven of US dollar denominated assets, without discriminating between the countries they were fleeing.
In more recent weeks, a sense of calm seems to have returned to the markets. Capital outflows have subsided, and bond yields have stabilized. Bangladesh was spared the worst in March-April.
As markets start differentiating risks again, the question arises: How vulnerable is Bangladesh to a currency crisis?
A debilitating currency crisis is to an economy what a cardiac arrest is to the human body. Just as there is a sudden stop of the flow of blood in the latter, in the former there is a sudden stop in capital flow into an economy (or sudden withdrawal of capital).
In both cases, the sudden stop could lead to disastrous consequences. Neither is precisely predictable -- if enough of the symptoms are visible, then a sudden stop is likely being experienced. But in both cases, we can look at the underlying fundamentals and judge how much at risk the patient is.
The good news is that with luck, Bangladesh may well avoid the worst should there be another outbreak of capital flight. For example, a recent analysis by The Economist judged that Bangladesh is not at risk of an imminent currency crisis.
The bad news is that we failed to tackle a range of issues during the good times, leaving us more vulnerable than might be recognized. There isn’t any cause for panic, but there is much to worry about.
A ‘sudden stop’ currency crisis
Let’s take this step by step. What exactly happens in a “sudden stop” currency crisis?
A sudden capital outflow indicates that investors (foreigners, but could also be the local elite) now view investment returns in the country to be less favourable than in other locations. If the country has a freely floating exchange rate, its currency depreciates as investors sell the local currency to buy foreign currency (primarily against the US dollar, but could be against other currencies too).
Whereas many of our neighbours have seen their currencies depreciate since the end of 2019, taka has hardly moved against the US dollar (Chart 1).
That said, taka isn’t exactly a freely floating currency, as Bangladesh Bank is widely acknowledged to intervene in the foreign exchange market. If the local currency is fixed or managed, as is the case for taka, the central bank draws down its foreign reserves to defend the exchange rate during a sudden stop.
Bangladesh Bank’s foreign reserves stood at nearly $33 billion in February 2020, the latest period for which there is data. That is, it is entirely possible that part of this reserve was depleted in more recent months.
Nonetheless, it’s important to note that going into the pandemic, foreign reserves were sufficient to cover over seven months of imports (Chart 2). For context, the IMF rule-of-thumb is that foreign reserves should cover three months of imports.
Further, there weren’t any signs of reserves being depleted in the recent past, suggesting that taka hasn’t been particularly overvalued. That taka wasn’t particularly overvalued in 2019 is also supported by an analysis of the country’s current account deficit in the IMF’s latest in-depth report on Bangladesh (published in September 2019).
If the currency was overvalued, exports would be subdued and imports buoyed, resulting in a current account deficit that is wider than might be expected.
However, the IMF found that Bangladesh’s current account deficit could be explained by its economic fundamentals. The salient point here is that if taka weren’t particularly overvalued, then it might not be in the cross-hairs of a speculative attack.
The fallout of the pandemic is, of course, still cascading through the world economy, with the implications for the exchange rate quite ambiguous at this stage. On the one hand, remittances and ready-made garment exports are both likely to suffer large falls in the coming months and quarters -- the question is really how prolonged the slump will be.
But the resultant fall in the supply of foreign currencies is, at least in part, going to be offset by a fall in the demand for them given import bills are plummeting as global oil prices slump and import volumes fall (reflecting the general economic slowdown).
It is far too early to predict which of these effects will dominate. In October 2019, the IMF projected a current account deficit of about 2% of GDP for Bangladesh in 2020 and 2021.
In the first major assessment of the pandemic in South Asia, the World Bank projected current account deficits of around 3–3¼% of GDP during 2020-22. The detailed IMF World Economic Outlook, expected later this month, will shed further light.
As it happens, in its September 2019 report, the IMF did consider a scenario whereby the current account deficit widened to over 5½ of GDP, on the back of dwindling remittances and higher imports reflecting an infrastructure boom. In the scenario, the burgeoning deficit is financed either by a fall in reserves or a rise in the stock of foreign currency denominated debt.
At an extreme, external public debt reaches around 18% of GDP by 2025. To put that in context, according to official data, Bangladesh’s external debt (that is, what all Bangladeshis -- both the government and the private sector -- owed to foreigners) was low compared with neighbours as of 2018 (Chart 3).
In 2017-18, external public debt (that is, what the government owed to foreigners) stood at about $40 billion, over a third of which was owed to the World Bank, another fifth to the Asian Development Bank, and a tenth to Japan.
Most of what the government borrowed from foreigners has been to finance infrastructure projects. As of 2018, the country did not have much to fear by way of foreign currency debt.
Not just foreign currency debt, it would appear that according to official data, Bangladesh is not as indebted as one might fear. In 2019, the general government gross debt (that is, what the government owed to Bangladeshi private sector as well as foreigners) stood at about 35% of GDP, relatively lower than our neighbours (Chart 4).
To put that into context, debt-to-GDP ratio of over 50-60% is usually considered alarming for developing countries.
The analysis thus far suggests that there is no need to panic, a currency crisis isn’t imminent in Bangladesh. Why then should we worry?
A contagion crisis
For all their similarities, currency crises are different from cardiac arrests in one important way -- the latter is not contagious, but the former could be. When a country experiences a currency crisis because of some particular affliction, speculators can attack the currencies of other countries with similar vulnerabilities.
As a result, a country that isn’t particularly indebted or have manageable external accounts, could still find itself in crisis. There are reasons to worry about Bangladesh because it could be hit by a contagion crisis.
Suppose Sri Lanka or Pakistan were to be hit by renewed bouts of currency woes because of their large external deficits and debts. But in the ensuing turmoil, one or more of their major banks failed.
In such a situation, speculators may well look around for neighbouring countries with banking troubles. And we know that Bangladesh has troubled banks.
Back in September 2019, IMF noted that: Failure to effectively address the problems in the banking system, including high non-performing loans pose a medium likelihood risk to the economy, with a medium-to-high impact in the near term if it hit; and High and increasing non-performing loans and low capital adequacy would hamper the banking sector’s ability to finance business investment, add fiscal burden, and hamper growth.
The pandemic is already hitting the economy hard. The World Bank is projecting GDP growth to slow to 3% or less. Surely this will aggravate the banks’ non-performing loan problem, which could shave another percentage point off growth.
It’s not at all a stretch to worry about a contagion crisis emanating from our banks. And there may be more.
The World Bank also projects that public debt is going to top 50% of GDP in 2021-22 -- close to dangerous territory. And all of this analysis is based on official data, about whose veracity considerable scepticism abounds.
As it happens, it is difficult to concoct and manipulate data to fool the experts for years on end. So the official figures may well be sound. But to the extent there is any whiff of impropriety or irregularity, Bangladesh may get affected by a contagion from other countries where the official data is less sound.
Ultimately the credibility of the official data is questioned not because of macro-fiscal technicalities, but because over the past decade the health of the country’s institutions have deteriorated. When it comes to a sudden stop crisis, institutions and politics can matter as much as specific policies or data.
Argentina is an instructive case -- the country has experienced currency crises repeatedly over many decades under democratic and authoritarian regimes of various political ideologies pursuing various policies, reflecting the fact that the country’s polity and institutions lack credibility.
Bangladesh has a sickly polity. Just as an overweight, stressed out person is at heightened risk of a cardiac arrest even if the vitals at a point in time aren’t alarming, so it is that there is a lot to worry about Bangladesh.
Jyoti Rahman is a political blogger. This article was first published on jrahman.wordpress.com
