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Volatile foreign exchange market and taka devaluation
Md. Abdul Jabbar
3/18/2006
The Bangladesh economy is heavily dependent on commodities imported from abroad. As such, it affects the normal life of the common people if particularly consumer goods are not available in the market. At present, the economy is facing turmoil in controlling the prices of goods in the market. As US dollar is soaring high, the import costs are becoming high resulting in spiral of prices in the commodity market. Such continuous devaluation of Bangladesh Taka (BDT) would create complicated effects on the economy, particularly in regard to prices of consumer items in the market. Over the last one month, the local currency has lost nearly 3.0 per cent value against US dollar raising the import cost higher further.
As the importers are paying higher prices for importing the essential items, the overall price-base is increasing keeping its long-lasting effect in the economy. The recent opening of increased number of letters of credit (LCs) for import of food items, petroleum products, communication equipments and industrial capital equipment and raw-materials are thought to be responsible for higher demand for greenback. It is reported that some commercial banks are facing acute problems in meeting the import payments against their opened L/Cs due to scarcity of greenback in the inter-bank foreign exchange market (IBFEM).
It is also a matter of management that a commercial bank while opening its LC to import the goods, must ensure its square position so that it need not depend on IBFEM totally. Since May 31, 2003, the exchange rate in Bangladesh has been determined in the inter-bank foreign exchange market. The market makers maintain trading in the market by placing continuous quotes in US dollar. Foreign exchange markets have the role of facilitating and channeling the flow of currency between prospective buyers and sellers of it.
There would be no need for such a market if there were no international trade or capital movements. Growing liberalisation of foreign trade and deregulation of current account at the first half of 2003 increased the need for a market where financial companies could trade foreign currency. The market makers' need for currency depends on both their own needs and those of their customers. These customers are businesses needing foreign currency to pay for imported goods. Irrespective of whether customers buy or sell currency from or to market makers, all transactions have an effect on their foreign exchange balances and conceivably also on their expectations of future developments. In addition there are speculators who primarily seek to make profit from trading in foreign currency.
Although speculation can spur movements in the foreign exchange market and even cause unjustified weakening or strengthening of a currency, speculators and other players create a considerable flow in the market. Before the IBFEM was established there was little reason for currency speculation except when a devaluation was expected. The forex market presented more opportunities for profit. The potential gains are high, but the risk is correspondingly great. Before inter-bank forex market was launched, the Central Bank fixed the daily exchange rate of foreign currencies against the US dollar on the basis of day-to-day changes in their relative values.
The average exchange rate could change from one day to the next in accordance with a government decision (the currency was allowed to slide). On May 31, 2003, inter-bank market trading in foreign currency began in Bangladesh. The aim behind setting up the market was to allow the exchange rate to be determined by supply and demand for currency, instead of a unilateral Central Bank decision. The 2003, the first year of the inter-bank forex market, the exchange rate was determined by market participants. The exchange rate was fixed on the basis of the latest exchange rate index position, trading conducted and relative movements of foreign currencies from the day before.
The Bangladesh Bank (BB) blamed poor liability and asset management by some new generation banks and rise in oil and commodity prices in international market for the exchange rate hike. But banking sources said only the first generation banks are not responsible for the crisis. Other private commercial banks, foreign commercial banks and nationalised commercial banks also faced dollar crisis and raised greenback prices in case of LC opening. A huge supply-demand gap of foreign currency has emerged mainly due to opening of a good number of LCs by banks. The BB informed it was not controlling exchange rate directly under the floating exchange rate regime but monitoring the situation cautiously. The BB had directed the commercial banks to improve their liability and asset management.
The BB is also monitoring the situation so that the import of essential commodities and fuel are not hampered. A foreign exchange dealer said depreciation of Taka would shrink import while encouraging export and remittances. At present, the export earnings and particularly remittances are contributing towards maintaining a comfortable foreign exchange reserve. Lack of efficiency in foreign exchange dealings by some commercial banks are creating pressure on forex market, alleged the BB.
The BB has instructed commercial banks to be cautious and efficient enough regarding foreign exchange management and to consider opening letters of credit (L/c) for importing essential products rather than unnecessary and luxurious items. The central bank does not find any reason for continued appreciation of US dollar against Bangladesh Taka (BDT) in the forex market. According to the latest figures, exports and wage earners' remittances constituted inflow of US$7.5 billion as of July-January period of current fiscal year while the country made import payment of US$6.7 billion.
So, BB suspects whether export proceeds were repatriated properly or quantity of imports fell short of the invoices for shady deals. Making the central bank puzzled over the soaring dollar prices refers to its handling efficiency. On the other hand, the experienced fund manager observed that the volatility of forex market was mainly due to some unhealthy competition among some banks that had aggravated the short supply of the US dollar. These banks are collecting remittances by offering higher rates to the exchange houses abroad. This is an absolutely unhealthy practice of the commercial banks", a foreign exchange dealer told.
Due to liberalised forex market (floating exchange rate), some banks are offering higher rates from the previous rates to raise the inflow of remittances from abroad though it is blamed for appreciation of US dollar against BTD. As we do accept the functional force of supply and demand of foreign exchange as a policy and the floating exchange rate, we cannot blame the banks raising such rates. Under a fully flexible exchange rate system, deficits or surpluses tend to be corrected relatively quickly. Although the adjustment process calls for some shift in the IS curve and therefore some shift in the AD curve, the effects on the domestic price level of the shift of the AD curve will not be so large as to make the price level change play a major part in the adjustment process. Consequently, the LM curve may be assumed to remain in its initial position-an assumption that would not be permissible with a significant change in the price level, because that would change the real money supply and the position of the LM curve.
Under the flexible exchange rate system, the Balance of Payment shows surplus while the quantity of foreign currencies received from foreign purchases of goods, services, and real and financial assets exceeds the amount of foreign currencies needed to make payment for goods, services, and assets purchased from foreign countries during the period. Under this system, the foreign exchange value of the BDT is not stabilised within a narrow band by the central bank, but is essentially allowed to find its own level in response to the forces of supply and demand in the free market.
In the case of surplus, the excess supply of foreign currencies means that it will take more units of such currencies than before to exchange for a unit of BDT. The foreign exchange value of the domestic economy's currency will rise.
This discourages exports and encourages imports. Raising demand for industrial goods and for its raw-materials may be termed a good sign for long-term development. So, sustainable development may be ensured if a non-inflationary situation is maintained. We cannot accept the reduced role of the Bangladesh Bank.
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The writer is Senior Vice President of Islami Bank Bangladesh Ltd.
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