The US only accounted for approximately 19% of Bangladesh’s total exports in 2013. The rest went to other countries, mostly European Union economies that use the ‘Euro.’ And when it comes to imports, Bangladesh’s major import sources are China and India, as shown in the table.
Given those facts, it is hard to justify why Bangladesh’s international trade is mostly financed in US dollars. The use of the US dollar for international transactions rose with US preeminence after the Second World War, and changed little for decades.
In that respect it is not too unlike English, which has remained the most widely-used international language, despite British global influence having long since waned. When it comes to international benchmarks, inertia matters.
However, the times are changing. With China’s economic re-emergence the Chinese Renminbi (RMB) is fast becoming an alternative trade currency. Last year, the RMB surpassed the Euro to become the second most widely-used currency for international trade.
Although the Chinese Government is currently promoting RMB invoicing with its key trading partners such as the US, the EU, Australia and a few others, we are not too far away from a future when the Chinese Government’s attention will turn to South Asia, primarily India, but also Pakistan and Bangladesh.
Don’t be surprised if five years down the road the Chinese Government gives the Bangladeshi Government a quiet nudge to encourage local banks and businessmen to start invoicing trade with China in RMB, and not US dollars. If that happens, it will be to our benefit for two reasons.
First of all, it will lower the cost of trade. Currently, a Bangladeshi importer pays a transaction fee to a local bank to buy US dollars, which is then used to pay the Chinese exporter. The Chinese exporter then pays another transaction fee to a Chinese bank to convert the US dollars into RMB for everyday use. These transaction fees at both ends are a cost barrier to more trade between Bangladesh and China.
Now imagine if the Bangladeshi importer could buy RMB from a local bank to pay the Chinese exporter. The Chinese exporter would no longer have to pay an extra transaction cost, which creates an incentive to trade more with Bangladesh compared to some other country where RMB invoicing does not happen.
The same advantage would work for our exporters too. If Bangladeshi RMG exporters were paid in Taka by the Chinese importer, it would save costs, boost profits and would create an incentive to export more to China.
Direct financing of international trade in other currencies would reduce the need for using the US dollar as an intermediary currency. It would reduce the emphasis that is currently placed on the US dollar-Taka exchange rate by BB, and make macroeconomic management less prone to policy coordination and timing errors.
The Bangladesh Bank (BB) has an explicit policy of “managing” the US dollar exchange rate. Whether the focus is on landing the exchange rate at a certain level (say Tk70 per US dollar) or managing the volatility of the Taka against the US dollar is a moot point.
BB’s key priority is essentially to ensure that the US dollar exchange rate doesn’t cause headaches, either by appreciating too much and annoying exporters or by becoming too volatile and annoying everybody, exporters and importers alike.
That has been the primary motivation behind BB’s policy of buying US dollars over the past year or so, which has boosted our foreign exchange reserves to more than $18bn. It is not the only reason why foreign exchange reserves have spiked, but it is the primary policy driver behind that development.
However, BB’s US dollar-centric foreign exchange policy regime is not without its tradeoffs. Generally speaking, buying foreign exchange from the market (i.e. banks) boosts the monetary base and can lead to higher inflation.
In our case, this may not have happened because demand fell due to the political turmoil we witnessed last year. However, the political turmoil also led to supply-side disruptions, which can also lead to higher inflation.
How does that make sense! How can political turmoil lead to higher inflation on the one hand and dampen inflation on the other?
Well, that’s the economy for you. It’s complex to say the least. One shock or event can lead to a chain reaction, and untangling each cause-and-effect is not easy.
It is not easy for any policymaking institution, and much less so for under-skilled developing economy institutions such as the BB. Timing and coordination errors in policymaking are common. BB’s mismanagement of its bank loan provisioning policy is a case in point.
Over the past couple of years, BB had moved towards raising bad loan provisioning standards within local banks to international best practice. BB was slowly chipping away at it until a sudden reversal of policy late last year. In fact, BB had tightened loan provisioning standards as late as September last year, before reversing the course a couple of months later.
The justification provided was that political turmoil had taken a toll on the economy and businessmen were finding it difficult to service their loans. Therefore, loan provisioning standards applied by banks had to be weakened. BB only realised that in December last year? Seriously!
It demonstrates the kind of policy timing and coordination errors government institutions make. BB would probably respond to such criticism by saying that hindsight is 20-20 and they had to act, so better late than never. Fair enough.
But what is even better is if you are able to create conditions that don’t require policy interventions to begin with, and therefore, minimise the risk of policy mistakes.
The simple fact is that the BB would not need to closely manage or target the US dollar exchange rate if most of Bangladesh’s international trade was not financed in US dollars. It would enable them to avoid a complex political economy balancing act that now requires them to ensure both exporters and importers are happy with the US dollar exchange rate level.
The other significant benefit from having international trade financed in other currencies is that it makes capital account liberalisation easier. BB has slowly come around to undertaking reforms that will liberalise the financial sector and open up the capital account.
However, one of the biggest impediments to timely reforms is the strongly-held fear within BB that opening up the capital account will lead to large flights of foreign capital (i.e. US dollars) from Bangladesh. This in turn would lead to higher US dollar exchange rate volatility and cause macroeconomic headaches.
Net capital outflows from liberalisation may or may not be large, but US dollars outflows will not matter as much if import payments from China and India are financed in RMB and Rupees. Those two economies alone account for nearly 40% of total imports, and direct financing of trade in those currencies reduces the need to hold vast amounts of US dollars to cushion against balance of payment shocks.
The currency mix of foreign exchange reserves may need to be diversified if more trade is financed in other currencies, but that has little to do with the US dollar volatility argument for adopting a painfully slow approach to liberalising the capital account.
Furthermore, initially allowing capital outflows in RMB to Hong Kong or Shanghai is another solution to liberalising the capital account without having any impact on the US dollar exchange rate. This would increase financial flows between Bangladesh and China and increase the liquidity of each currency in the respective economies. Ensuring greater market liquidity is an important hedge against volatility and reduces the need for holding large foreign currency reserves.
It is somewhat bemusing to often hear the Bangladesh Bank cite the risk of making policy error when talking about capital account liberalisation. And yet, that does not appear to be a constraint when it comes to its foreign exchange rate policies, where defending a nearly-fixed US dollar exchange rate has led BB to pile up massive foreign exchange reserves and stoke inflationary risks.
Overly restrictive capital controls have hampered the development of the Bangladeshi financial system, and is one of the main reasons behind double-digit interest rates. The private sector does not invest as much as it should; and why should they when the money needed to invest attracts a penalty rate of 15%. Not surprisingly, Bangladesh’s GDP growth has stagnated at 6% per annum.
Changing that story will require a whole raft of reforms. Not all of it falls on the shoulders of the Bangladesh Bank. But taking measures such as promoting the use of other currencies to finance international trade, allowing the US dollar to float more freely and liberalising the capital account lies squarely in the Bangladesh Bank’s court.
