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To devalue or not to devalue?

  • Published at 07:27 pm September 18th, 2015
To devalue or not to devalue?

At this moment, the Bangladesh taka is one of the stronger currencies of the region. Although the taka is not pegged with the dollar, it has been coping well with the recently found strength of the dollar. Against the Indian rupee, the taka has been appreciating strongly in the recent months. What caused this strength? Certainly, the demand for taka in the Forex market has been increasing at a steady rate. This demand has generated from at least two sources: Remittance and exports.

As a result, in recent weeks, some commentators have been engaged in a passionate debate surrounding the taka: To devalue or not devalue. It appears that the arguments have been put forward with the lessons learned from intermediate macro text books, keeping in mind the likely impact of currency devaluation on imports and exports (trade), in particular.

In other words, devaluation means imports become expensive and exports earn more money, given that the terms of trade (ToT) and price ratio of imports and exports (price paid for imports vs price received from exports) remain unchanged in the short-to-medium term. Without going through this economic phenomenon ToT, carefully, uttering the “d word” is likely to be a futile exercise.

Having said that, the ToT is an important element of international trade theory and is a major area of concern for trade policy-makers or trade analysts in both good and bad times. There is another dimension to trade which, sometimes, policy-makers in developing nations are not genuinely interested in to include in this debate: Trade strategies. These are import substitution (IS) and export promotion (EP) strategies.

Politicians in this region passionately talk about the Look East policy, but perhaps ignore the fundamental trade issues of the miracle economies in East Asia which contributed in achieving double-digit growth in the early days.

First, the major rationales for the IS strategy in the early days, on the one hand, are: To stimulate industrial growth and imports need to be cheaper for the import of capital goods, and needs a strong currency. It is relatively easy to launch an IS strategy, initially simple and administratively straight-forward.

Second, the major rationales for the EP strategy, on the other hand, are: Industrial growth rate and output of agricultural commodities grow more rapidly, EP strategy provides less vulnerability on exchange rate movements because foreign exchange earnings grow rapidly with a relatively undervalued currency, and EP strategy, once stabilised, is more likely to be self-sustained and gather momentum.

Third, the mixture of both IS and EP strategies. The mixture of these strategies mainly utilise the major features of both the strategies in order to bring balance and to make the economy stable, particularly at the time of economic shocks. In some circumstances, the mixture works better than either IS or EP policies by themselves, because it is possible to have inefficient EP policies as it is to have inefficient IS policies.

For example, excessive protection is said to lead to high profits, excessive profit remittances, excessively high urban wages, and excessive rural-to-urban migration. At the same time, inefficient use of resources, underutilisation of capacity, and waste also, generally, contribute to excessive protection.

Inefficient policies with respect to exports can take the form of excessive subsidies to inputs into export industries, so that negative “value-added” can occur. “The ultimate test of the respective merits of the EP strategy and IS strategy is not their ability to allocate resources between sectors, but their power to mobilise domestic resources and skills and to create and activate incentives, attitudes, and institutions for development.”

Bangladesh certainly applies a mixture of IS and EP for the expansion of trade, in the era of globalisation. For example, it keeps subsidising the energy sector and tries to promote exports in textile and related industries by keeping the currency value as low as possible in the past.

The recent strength of the taka can be viewed as a reflection of the country-wide infrastructure projects currently in place, for example, the Padma Bridge, elevated road projects in the capital, and the construction and restoration of highways. With such big initiatives in recent years, more imports of capital goods and services has been all but a requirement.

Under such circumstances, it is indeed not harmful in having a strong taka.  However, it needs a close watch to see that this strength does not transform into losing the relative comparative advantage enjoying by the RMG industry. Creating a balance between IS and EP strategies is the beauty in advancing trade in the era of economic globalisation in a developing country like Bangladesh.

What is important, at this stage, is to make exchange rate policies transparent, while the regulator/Bangladesh Bank needs to be watchful, and also let stake-holders know early if there are any short-term uncertainties looming due to unexpected shocks like increase in salary and wages, and utility price increase. For example, the premature increase in energy prices could create some uncertainty in consumer confidence and could be politically damaging as well.

While one can see the legitimacy in increasing the prices of natural gas, it is not certain if the increase in the price of power is going to be friendly to the manufacturing industry or to the consumers at-large, at a time when the global price of oil is on a downward trend and has dropped to almost half from that of last year.

At this stage, if the economic departments of the government are in a mood to double dip (enjoying lower import bill for oil and higher tariff per unit of electricity) to minimise subsidy, it may turn out to be giving the wrong signal to the present growth momentum.

This move would restrict aggregate demand to rise (except public servants and college teachers, due to doubling of their salary from July 2016) and, in turn, increase unemployment, potentially working as a threat to our new-found growth momentum.

It is time that Bangladesh Bank provided its overall position known to businesses, large and small, in terms of any uncertainties in the Forex market, or how long it is going to tolerate the taka’s relative appreciation, keeping in mind the inflation and unemployment figures in the short-to-medium term.

Transparency about the exchange rate policy is very important right now. “To devalue or not,” should not be guided by the mushrooming round-table conferences on this subject, but by the trade strategies warranted in our current finest hour of economic performance, about which Bangladesh Bank knows better, whilst letting our businesses and farmers be made aware of any uncertainties. 

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