We are in the middle of the first full working week since Bangladesh's declared adoption of a floating exchange rate for taka against the US dollar, paving the way for the forces of demand and supply - in a word, the market - to determine the rate going forward.

Bangladeshi officials however, have a history of such utterances, without the necessary follow up actions. Most famously perhaps, there is even a formal commitment from 2003(Bangladesh Bank. Exchange Rate Circular No. 01, 2003 - still available on the BB website), that the central bank subsequently abandoned.

As a result, for almost its entire existence as a sovereign currency, taka's value has been artificially set by the country's monetary authority, i.e. Bangladesh Bank, and then allowed to float within a certain band - the so-called managed or 'dirty' floating exchange rate.

In order to maintain the rate at or near its preferred level, the central bank would intervene in the currency markets to buy or sell dollars as the intervention currency. Maintaining an artificially overvalued rate in comparison to the market value, as Bangladesh Bank has almost always done, necessitates selling dollars from its foreign exchange reserves.

Why now?

But the "strongest dollar in a generation", witnessed over the last year or so and likely to persist well into the foreseeable future, was starting to make the dirty floating system very expensive to maintain for Shapla Chattor, rapidly depleting its reserve of dollars.

In the 2021-22 fiscal, that ended on June 30, Bangladesh Bank spent $7.62 billion from the country's foreign exchange reserves as it scrambled to slow down taka's slide against what some are calling "the hideous strength of the dollar." In the first two months of the current fiscal, July-August, that coincided with a period in which even the government was forced to recognise the impacts of a range of worrying signs for the economy, it escalated dangerously.

During this period, the central bank spent a further $2.85 billion on shoring up its preferred, overvalued rate, or rates, as it kept stretching to hold on, for taka against the dollar. If you annualise that, you're looking at spending over $15 billion over the course of the fiscal. Probably more, with all the signs being that US Federal Reserve policies are likely to strengthen the greenback further over the foreseeable future.

At a time when the quite rapid depletion of the forex reserves from its peak of $48.1 billion in August 2021 to some $37 billion at the moment has become a matter of concern (and the IMF credibly contending that effectively it is a further $7 billion less), the central bank has been forced to realise it is unsustainably costly to hold on. It has to let taka float.

Does it mean BB will not sell dollars again?

What that basically means is to adopt a hands-off approach. To refrain from using its intervention tools. Importantly though, it doesn't give up its authority to do so. It may become interventionist again, at any point - unless it gets to a point where you are charged as a 'currency manipulator', as the US did with China in 2019, there is nothing really to give you pause even, once you decide to do it. There is nothing to bind you to 'letting it float'.

And central banks can be clingy. There are no purely floating currencies, it's all a bit relative. Canada has had a floating exchange rate for longer than any other country. The Canadian national bank has not interfered with its dollar's price since 1998. The US dollar is a close second. 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.

What kind of exchange rate regime a country maintains over a given period is actually a call that can only truly be made after the event, when you have the data to tell you to what extent there may or may not have been intervention. It's a bit like assessing whether you've been faithful in a relationship or not - you cannot have it up front. You have to look back.

But a commitment can be important, and the closest thing resembling such a commitment for Bangladesh Bank that suggests it is preparing to go further this time than it has gone before to letting the currency float came last week: for the first time, Shapla Chattor appeared to accept a suggested rate from the market, along with a mechanism for determining it on a regular basis going forward.

What is the market rate?

The task for coming up with the market-determined exchange rate had been left to the Bangladesh Foreign Exchange Dealers' Association (Bafeda), in consultation with the Association of Bankers Bangladesh (ABB). After months of meetings between the three parties, last week (September 11), the rate put forward by them, along with a mechanism - a weighted average based on actual transactions over the previous 5 working days - was accepted by Bangladesh Bank in a meeting, and subsequently announced.

Since September 13, this rate has been published on the BB website as the nominal rate for the dollar, along with the following note: "Exchange rates of Taka for inter-bank and customer transactions are set by the dealer banks, based on demand-supply interaction and indicative rates suggested by Bangladesh Foreign Exchange Dealers' Association. Bangladesh Bank is not in the market on a day-to-day basis, and undertakes USD 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 (most likely if the government perceives taka has depreciated too much), the central bank still reserves the right to intervene and effectively override what it has committed to.

There will be teething issues - reports suggest Bangladesh Bank is still selling dollars, but if it stays the road, this will taper down. There are criticisms of the agreement entered into with BAFEDA, in particular how it creates three different dollar rates - one for exporters, one for remitters and one for importers. And leaving the exchange rate to the market while holding on to a fixed interest rate regime (interest rate on lending is currently capped at 9%) goes against conventional wisdom in economics. These are issues we will get to explore in future.

Explainers related to the economy are vetted by economists.

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