In June, Bangladesh Bank disclosed for the first time that it had decided to allow the exchange rate for the taka to float against the dollar, in a major shift from the managed rate.
This means the price of the dollar in the market will be determined by demand and supply and banks will be allowed to set their own dollar prices.
"The price of the dollar will be set by the open market," Bangladesh Bank Executive Director Md Serajul Islam said. "Bankers have said that, without this step, remittances will fall."
Despite allowing the currency to float, Bangladesh would still monitor the price, Islam said.
Since 23 February, going by the official exchange rate, the taka had depreciated by around 11 percent in this period. However, the maximum depreciation, using the media reported 120 taka per dollar reached in the kerb market in mid-July, had been nearly 40 percent.
In August, the new Bangladesh Bank Governor Abdur Rouf Talukder told journalists that the dollar prices would become stable in two to three months. According to him, the trade gap in July had reduced significantly and a rise in inward remittances was giving the economy breathing space.
He also said that since there is a demand for letting the interbank exchange rate be determined by the market, the central bank will go in that direction when the market becomes stable.
This week, Bangladesh Bank loosened its grip on its currency and allowed the taka to weaken to a record low to preserve dwindling dollars.
Not for the first time, Finance Minister AHM Mustafa Kamal said the government is considering introducing market-based foreign currency exchange rate soon - in other words, to let taka float. What it means effectively is to adopt a market-determined exchange rate, and then refraining from intervening to artificially set a different rate.
"Bangladesh will gradually go for the floating exchange rate," Finance Minister AHM Mustafa Kamal said at a media briefing in Dhaka on Wednesday (Sept. 14). "Demand and supply will determine the price of the currency. We'll follow what other developing economies are doing."
"Today or tomorrow, we will have to go for market-based trading of foreign currency," he told reporters after the meetings of the Cabinet Committee on Economic Affairs and the Cabinet Committee on Government Purchase.
What makes this time different is that for the first time, the central bank has appeared to accept a suggested rate from the market, along with a mechanism for determining it on a regular basis going forward.
Facing up to reality
The finance minister's remarks came against the backdrop of the recent instability in the foreign currency market where the US dollar's exchange rate recently went up to Tk119 from Tk85.
Banks in a meeting earlier in the week fixed the buying and selling rates of the US dollar in order to contain the volatility in the foreign exchange market - the so-called market-determined exchange rate. They also put forward a mechanism for determining the market-based rate going forward.
In the meeting, it was decided that banks will offer a maximum of Tk 108 for a US dollar for the remittances coming through exchange houses, including the funds that are channelled by banks' own exchange houses, with the objective of attracting increased forex currencies from Bangladeshis living abroad.
Exporters and remitters who will send money directly to banks will get Tk 99 for each dollar, according to the decision of the Bangladesh Foreign Exchange Dealers' Association (Bafeda) and the Association of Bankers' Bangladesh (ABB).
Both platforms of the bankers agreed about the new uniform exchange rates considering the overall market situation and in order to bring stability to the foreign exchange market and better serve their customers.
As per the decision, importers will have to buy the greenback to clear payments based on the weighted average of the maximum rates plus Tk 1. It means that importers will have to pay Tk 104-Tk 105 for a dollar.
The weighted average cost will be calculated based on the actual costs on a rolling basis over a five-day period.
Following the meeting, the taka fell to as low as 106.9 per dollar on Tuesday, according to data from the central bank. It was the largest single day decline for taka against dollar in its history.
Bankers hailed the decision, saying the rates are very close to the market realities and are a step toward determining the rates on the basis of demand and supply.
"We think these rates are fair under the current circumstances and these are the just market rates for the US dollar. This is a big milestone for the banking sector. This is a journey toward a more market-determined exchange rate," Selim RF Hussain, chairman of the ABB, was quoted as saying by Bloomberg.
The new dollar rates come as the foreign currency reserves slipped to $37.6 billion last week following the settlement of import payments worth $1.73 billion through the Asian Clearing Union, an arrangement for clearing trade bills among the participating central banks of Bangladesh, Bhutan, India, Iran, the Maldives, Myanmar, Nepal, Pakistan, and Sri Lanka.
According to a BAFEDA report, 25 banks cut their weighted average rate following the meeting from what they paid on the previous day. Another 11 banks slightly raised their rate. Two banks, however, kept the rate unchanged during the two days. However, everyone is expected to fall in line with the new policy soon.
"The weighted average rate will fall further in the days ahead," said Selim RF Hussain
For now, this is probably the extent of the BB's shift in policy to letting the currency float -adopting the rate suggested by BAFEDA and resolving not to artificially changing it.
According to the BB website, the interbank exchange rate was Tk 106.15 on Tuesday (Sept. 13), the day after the BAFEDA - ABB meeting. The rate was Tk 96 a dollar on Monday and Tk 95 a day before.
Previously, the central bank published the interbank dollar price at which rate it sold the greenback to the banks on its website. The change implies now, the interbank dollar rate will be the rate suggested by the dealer banks, based on demand and supply.
The BB on its website said, "Exchange rates of the taka for inter-bank and customer transactions are set by the dealer banks, based on demand and supply interaction and indicative rates suggested by Bangladesh Foreign Exchange Dealers' Association."
It also adds: "The Bangladesh Bank is not in the market on a day-to-day basis, and undertakes dollar purchase or sale transactions with dealer banks only as and when needed to maintain orderly market conditions."
Note the phrase "as and when needed" - it tells you that should the need arise, the central bank still reserves the right to intervene and effectively override what it has committed to.
In truth, most central banks find it difficult to totally let go of the currency, except those of the highly industrialised countries, that too those that have the privilege of being responsible for one of the major reserve currencies - the dollar of course, being the King, as THE world's reserve currency.
In the modern world, most of the world's currencies are floating, and include the most widely traded currencies: the United States dollar, the euro, the Swiss franc, the Indian rupee, the pound sterling, the Japanese yen, and the Australian dollar. However, even with floating currencies, central banks often participate in markets to attempt to influence the value of the exchange rate.
Going by the 'least intervention' principle, the Canadian dollar most closely resembles a pure floating currency because the Canadian national bank has not interfered with its price since it officially stopped doing so during 1998. The US dollar is a close second, with very little change of its foreign reserves. By contrast, Japan and the UK intervene to a greater extent, and India has medium-range intervention by its national bank, the Reserve Bank of India.
Since 1993, the Indian rupee (INR) has officially been following a market-determined exchange rate - price is determined by demand for and supply of foreign exchange - with intervention by the Reserve Bank of India from time-to-time.
Most economists support the move towards floating exchange rates - to the extent that the central bank interferes less in the currency markets. As is well known by now, despite committing to a floating exchange rate since 2003, Bangladesh Bank (BB) kept on heavily fixing the exchange rate, in what is known as a managed, or 'dirty' float.
Biru Paksha Paul, who served a spell as chief economist at the central bank before returning to teach in the US (he is currently at SUNY Cortland), has repeatedly asserted since leaving his post that the interventions were often, even predominantly, not due to any research findings, but because of political preferences - and that is what economists find most disturbing.
In an email exchange with Dhaka Courier this week, Dr Paul wrote: "Any central bank must be a knowledge institution and its leadership must be selected from economists or monetary economists in particular. In Bangladesh, we don't see that. We see someone retired from bureaucracy comes to lead a central bank and he becomes a play tool of the finance ministry. How can you expect this type of leadership will understand the value of research? This is my frustration."
"Our institutional leadership must be driven by merit, talent, and not by sheer obedience," he adds, for good effect.
According to Dr Paul's research, regression analysis over 2003-2013 would suggest a Tk 2 increase in the dollar's value every year, making the dollar's current price Tk 98 or so - closer to the current market price than Shapla Chattor had it.
"Had BB followed an econometric model to make the change monthly, we wouldn't have faced this sudden shock and the ensuing volatility in the whole financial market," he writes, of the volatility the market has endured in the last few months.
Bangladesh has effectively resorted to artificially depressing the dollar's value for years now. But the 'hideous' strength of the dollar in recent times has made it impossible to do so without significantly depleting the country's reserve of dollars - that almost showed up as a crisis just recently.
Which is why it is more prudent to view the move to let aka float as more of a recognition of reality, belated and reactionary, rather than a policy manoeuvre in itself. Those expecting much relief by way of the dollar becoming cheaper as a result of this will be well-advised to think again.
Ahsan H Mansur, executive director of the Policy Research Institute of Bangladesh, while speaking about the BB's new interbank rate, said the changes in the interbank rate for the greenback would have no new effect on inflation.
"This is because importers are already importing by buying dollars at more than Tk 107 each. But public imports such as petroleum will be costly and additional cost has to be borne by the government from its coffers," he said.
"If the government does not hike prices, the net impact on consumer prices will be zero, while the subsidy through the appreciated exchange rate (borne by the Bangladesh Bank) will be replaced by explicit fiscal subsidy."
Interest rates held on to
Responding to a question on refixing the bank lending rates during the same exchange with journalists, the finance minister dismissed the possibility of any upward or downward change in lending rates against the existing rates of 6% and 9% on deposits and bank loans respectively. This has been raising the ire among economists, but the finance minister has remained adamant about holding on to this, come what may.
"The current interest rates between 6% and 9% are working well," he said, dismissing itn as a tool for controlling inflation in Bangladesh.
"Many countries pursue the path of increasing interest rates to contain inflation. But it is very tough in countries like Bangladesh to contain inflation by increasing or decreasing the interest rate," he said, adding, the central bank here does the job in two ways - by taking fiscal measures and monitoring the market.
He may find he has to come off that decision though in future because floating exchange rates work best with an independent monetary policy - for which the interest rate is the principal tool available to central banks.
About the current state of the foreign exchange reserves, the finance minister insisted the country is in a good state.
"Our remittance is increasing while export is rising and import is decreasing," he said, claiming that there is no crisis in the foreign currency market. The foreign exchange reserve will again go up to $48 billion soon, he said.
Responding to another question on import of Russian fuel in roubles, the finance minister said work is in progress in this regard.
"But in such a case, Bangladesh will have to do it through currency swap. Russia has to accept our currency first," he said.
As alluded to earlier, Bangladesh has been struggling to protect its foreign-exchange reserves as surging import costs erode its stockpile of dollars. Prime Minister Sheikh Hasina's government is seeking a loan from the International Monetary Fund to create buffers for the economy. Talks are ongoing with the World Bank and Asian Development Bank as well.
In recent weeks the government has been cracking down on money hoarders and profiteers amid the dollar shortage. The country's foreign currency reserves declined to $38.9 billion as of Sept. 7 from $48.1 billion a year earlier, enough to cover roughly four months of imports.
"It's the road to market-driven rates," said Syed Mahbubur Rahman, managing director and CEO of Mutual Trust Bank Ltd., referring to the taka's depreciation. "Banks are now free to determine the rates based on certain parameters."
From 1946 to the early 1970s, the Bretton Woods system made fixed currencies the norm; however, during 1971, the US government decided to discontinue maintaining the dollar exchange at 1/35 of an ounce of gold and so its currency was no longer fixed. After the end of the Smithsonian Agreement in 1973, most of the world's currencies followed suit. However, some countries, such as most of the Arab states of the Persian Gulf region, fixed their currency to the value of another currency, which has been associated more recently with slower rates of growth. When a currency floats, quantities other than the exchange rate itself are used to administer monetary policy.
The United Kingdom's pound sterling was the primary reserve currency of much of the world in the 19th century and first half of the 20th century. That status ended when the UK almost bankrupted itself fighting World War I and World War II and its place was taken by the United States dollar. In the 1950s, 55% of global reserves were still held in sterling; but the share was 10% lower within 20 years.
Some economists believe that in most circumstances, floating exchange rates are preferable to fixed exchange rates. As floating exchange rates adjust automatically, they enable a country to dampen the effect of shocks and foreign business cycles and to preempt the possibility of having a balance of payments crisis - which was, or has been the fear rattling policymakers in the last few months. However, they also engender unpredictability and uncertainty. In certain situations, fixed exchange rates may be preferable for their greater stability and certainty. You can see why the managed float has its advantages. But not when there are questions to be raised over the competence and commitment of those assigned to do the managing.
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