8 things the government can do to stabilize the dollar rate

Exchange rate management is an important task for the central bank. In Bangladesh, although the central bank maintains a floating exchange rate, it manages the foreign exchange market through interventions. Even then, volatility in the forex market reached an all-time high. The supply of dollars to the economy is less than the demand. There has also been panic buying.

The global economy is experiencing weak growth, high inflation and supply disruptions following the Covid pandemic as well as the Russian-Ukrainian war. Inflationary pressure is also felt in Bangladesh, mainly due to high import costs. In the first nine months (July-March) of FY 2021-22, import payment increased by 44%, while export revenue increased by 33%. This implies that the trade deficit has increased to $24.9 billion. In contrast, remittances fell by 18% over the same period. As a result, the current account deficit increased to around $14 billion during the above-mentioned period.

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The demand for foreign currency has also increased due to travel with the reopening of borders. More and more students began to go abroad for higher education, which had dwindled due to the pandemic. Even though their tuition fees are paid through formal channels, personal expenses are managed through purchases in the external market beyond official travel quotas. For medical treatment, people buy US dollars through informal channels because expenses cannot be covered by credit cards due to transaction limits. Due to procedural delays, many do not want to go through the formal Bangladesh Bank application channel. Also, the demand for foreign currency is high during Hajj. There is also pressure on foreign currencies as much of the ill-gotten money is transacted in foreign currencies these days.

Foreign exchange pressure not only led to the devaluation of the taka against the dollar, but also at least three exchange rates, making the situation complex. In the informal market, 1 USD trades at around 100 Tk. On the other hand, the interbank rate has been 94-96 Tk per dollar, while banks are selling 1 USD at 96-98 Tk. But Bangladesh Bank sells 1 USD at 87.50 Tk. In order to avoid the pressure of transacting at the dictated spot rate, banks were seen transacting at the short-term forward rate. As a result, business is conducted at a higher cost.

During the 2021-22 financial year, the Bangladesh Bank injected about USD 5 billion into the foreign exchange market to maintain exchange rate stability. This may have helped the government import fuel and other essentials at lower prices, but it could not stabilize the exchange rate. Indeed, the taka was only devalued against the dollar by 3.38% in the first nine months of FY22. Several countries, including China, India, Pakistan, Sri Lanka, the Philippines, Turkey and the United Kingdom, devalued their local currencies by 5 to 50%.

As a trading nation, Bangladesh tries to maintain an exchange rate that helps both exporters and importers. The current crisis requires immediate government intervention to improve the supply of foreign currencies in the market. Here are eight actionable recommendations for overcoming today’s forex challenges.

1) A separate fund should be created for government imports such as fuel. This should only be granted to banks for the payment of government imports; banks will not retain any markup for these payments. This will reduce the pressure on the private sector’s demand for dollars for the import of other essential products.

2) The Export Retention Quota (ERQ) should be reduced to 5-10% of repatriated revenue for exporters over the next six months. They must collect all other than consecutive import payments for the next six months.

3) The current net open position (NOP) of banks should be reduced by 50% immediately to inject currency flows into the market. Seventy-five percent of the existing NOP should be immediately sold on the interbank market to facilitate the supply of the various banks.

4) The Bangladesh Bank should inject an additional $1-2 billion from reserves to stabilize the market and reduce panic buying to depress the exchange rate. It can be mentioned that to support the rupee against the dollar, the Reserve Bank of India sold $20.1 billion in the spot foreign exchange market in March 2022.

5) The taka should be devalued to approximate the interbank rate and be realistic against the market rate to align with the current situation. This should cool the market and restore stability.

6) Foreign exchange reserves should be used wisely. The import of luxury items should be restricted until the situation improves.

7) Effective measures involving all stakeholders are needed to improve the flow of remittances. Remittances do not pass through the banking channel even after the incentives given to senders. Hundi is more lucrative for senders as it offers higher rates compared to the formal banking channel.

8) Bangladesh should gradually establish links with the future commodity market to secure a long-term supply contract with a few global suppliers. Of course, Bangladesh needs to increase its trade capacity to operate in the international commodity market.

The current exchange rate volatility is not helpful to businesses or individuals. The foreign exchange market is the main determinant of inflation. Therefore, a stable exchange rate is important for price stability. This, in turn, will help maintain a stable macroeconomics. The government should also be proactive, as inflationary pressure has hit the poor and low-income groups hard in the current circumstances.

Dr Fahmida Khatun is executive director of the Center for Policy Dialogue (CPD). The opinions expressed in this article are those of the author.

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