The Bizarre Case Of Exchange Rate Fixing

Bizarre fixing of exchange rate Only changes few people’s fate. Reconciliation is a must To bring confidence and trust.

IMF has cleared second tranche of $4.7 billion credit package for Bangladesh. In addition to this $689 million, Bangladesh Bank also confirmed that this month the country would receive $90 million as budget assistance from South Korea.

No sooner the decision has taken Bangladesh Foreign Exchange Dealer’s Association (BAFEDA) and Association of Bankers Bangladesh (ABB) raised value of Taka against the US dollar by 25 paisa. It is still unknown what is the rate outside Bangladesh. So far no information indicates that exchange rate of taka against major currencies appreciated in the unofficial market. International money transfer companies like Western Union and other similar companies have not yet updated their exchange rate. Bangladesh Bank has not been raised the policy rate again. Most important thing is that demand for dollar is still high. This decision is not market based and undoubtedly will give benefits to ABB and BAFEDA, which for a long time enjoy the privilege to fix the exchange rate. Taka's interaction with major currencies could be the determinant for the exchange rate. However, this latest development will pave the way for BAFEDA and ABB to make some gain: they may buy the USD at official rate from Bangladesh Bank and sell it at a higher rate (most likely the unofficial rate) to the clients. Not only the few foreign remittance houses ,Bangladeshi platforms of foreign exchange dealers join the club of exploiting the currency market.

I think Bangladesh Bank should monitor taka's value against the major currencies of major trading partners plus the rate offered by major international banks and money transfer houses and project an uniform rate on its website everyday (if possible)/every week.

It has widely been reported that reduction in tax rebate is on the table as part of the IMF conditionalities. For far too long corporate tax has been kept low,around 22%. In many countries, it is around 40% or 35%. Meanwhile, country is facing a budget deficit. What is the point of keeping it low while you are borrowing from abroad to finance the deficit here. Think of an individual household on a tight income. Any spending increases in one month forces it to borrow from somewhere else. To keep the debt low and to keep the spending-earning gap low, it has to cut spending and/or increase the earning. Same holds true for a government. In the face of growing budget deficit, it has to raise taxes and cut spending to narrow the budget deficit. If the government kept the tax low for some period, then it has to raise the taxes later to maintain at least an affordable level budget deficit. As our budget deficit is growing year after year, our taxes (including corporate tax) are also kept low. It only contributes to worsening the problem. It appears govt shelves the unpopular part of raising the taxes for future generation/government. In future,we have to pay more taxes just to keep the budget deficit low or zero. The longer this issue remains unaddressed, the higher the magnitude of the taxes we have to pay later. This is as simple as that. And standard economics text book corroborates this.

The budget deficit is growing because there is no reconciliation between the two major political parties. Amid this if one sided election is held there may be a silent capital flight. Because capital associated with the main opposition party may find it difficult to operate here in this country. Domestic investment may become sluggish. So government’s revenue collection target may hit a dead end because of lack of economic activity. In this backdrop, it is worthless to go ahead with an election that has a price-tag of taka 14/20 billion. Government needs to curtail its spending amid austerity instead of amplifying it.

A quick economic recovery demands government settle electoral issues with the main opposition party. Bypassing it may widen our deficit and delay the recovery.

Wrong Move And Slow Policy Alignment

50 paisa raise without hike in policy rate A wrong move that may not improve the current state.

Recently, Bangladesh Foreign Exchange Dealers Association and Association of Bangladesh Bankers decided to raise the exchange rate of taka against USD by 50 paisa. Exchange rate of taka has become 110 against the USD from taka 110.50/USD. But this appreciation is not result of interest rate hike rather it is set by some platforms. Meanwhile, local banks unofficially and foreign remittance houses are offering USD at taka 120 or below , slight appreciation from the previous week. It is unclear how the move may help improving the inflationary situation. On the contrary, banks and local exchange houses are likely to gain from such appreciation. This is the right time for another significant raise in policy rate amid dull economic activity. Yet it did not happen. Back in October I penned a piece titled "Slow Alignment Costs Investment", highlighting the costs of slow alignment. Sharing it again:

Recently, the World Bank has downsized Bangladesh growth forecast. It also predicts that inflation in the next fiscal year will be hovering around 8.5%. Earlier IMF in its economic outlook said that it would take at least 2/3 years for Bangladesh to stabilize its economy.

Bangladesh Bank has already said that it has no intention to change its monetary policy before the next general election. This means easing of inflationary pressure may take some time.[However,on October 04,2023,Bangladesh Bank has raised the policy rate/repo rate by 75 basis points.]

Meanwhile, soaring inflation dents in the pockets of lower income group and casts shadow over the investment projects outside the economic zones. If there were several raises in policy rates in one/two quarters( that I argued in a previous piece,see "Could Bangladesh Get The Second Credit Pack?" ), things might have improved one/two quarter later. Now, real interest rate is negative, meaning nominal interest rate is still below the inflation rate. Notion such as this misalignment will be addressed future—interest rate will rise further ---will hold back investors to go ahead with investment projects. Why?

Answer lies on how big investors make their decision. If you look at the discounting criteria then it is not a wise idea to implement a project when interest rate is likely to rise further. Because net present value of cash inflow decreases as interest rate increases. Moreover,cost of capital goes up further,raising the cost of doing business in the country. For FDI project or investors investing in economic zones,this may not be a big issue as they have access to cheap foreign credit/financing. But interest rate could become a factor when their local vendors try to purchase things from local market. Not only the interest rate, the rigid exchange rate may also increase their cost of doing business.

While inflation may continue to dominate interest rate, interest rate may vary in future. In such case, internal rate of return (IRR) based decision becomes untenable as interest rate varies in short period.

Tribal nature of our politics plays a conducive role in mingling business with politics. In such case, investment projects associated with ruling regime with payback period longer than 5 years will go abroad. Investment with higher cash inflows and payback period less than 5 years may see the light. Now guess what businesses will offer you high cash inflows in the face of overwhelming odds! Meanwhile, investment projects associated with opposition creed may go abroad as they may find it difficult to operate here.

Failure of MPS to contain inflation casts shadow over the economy. Interest rate policy chases the inflation at slow pace, sending wrong signal to investors. Political impasse and US Visa restrictions complicated the matter. Amid high inflation we need investment projects to create jobs and generate optimism in the economy. Yet the current policy shelves those projects at a later date or pushes them abroad.