Weakening Of Taka: When Desirable

Competitiveness through depreciation, Desirable when there is less inflation.

For the major part of the FY 2026,Taka remained stable against the USD. There is an overall balance in the Balance of Payment. And foreign exchange reserve is continuously increasing. Till June 2026, forex reserve stood at $31.74 billion. According to MPS, reference exchange rate was Tk 123.18/USD in June 2026,registering 0.39 % depreciation in FY 2026.

The depreciation rate is decent. But further weakening of Taka could be good for economy. Inflation is the obstacle in the path of major depreciation. Inflation in June was 9.14%, a slight decrease from 9.42% in May 2026. A larger depreciation may aggravate the inflation.

Export and remittance are the two sectors that enjoy greater benefit of depreciation. But the two jointly account for around 16% of GDP. Meanwhile, dollars earned and received go for paying up the import bills and foreign debt repayments. Our import was $61 billion in 2025 and external debt was around $112 billion (source: Wikipedia). They jointly account for 33.92% of GDP. Crux of the matter is sectors benefitted from large depreciation of Taka account lesser percentage of GDP than sectors affected by such depreciation. Large depreciation may spike the imported inflation and increase our debt service payment in Taka amount.

But depreciation is related to export competitiveness. So when competitiveness is top priority depreciation is the way. Vietnam, where export accounts for 90% of GDP, witnessed around 0.11% depreciation of its Dong in the first six months in 2026. Since a communist regime is in charge of running the country and export accounts for a huge percentage of GDP, Vietnam is in a comfortable position to use its currency to increase its export competitiveness.

Even India witnessed 10% depreciation of Rupee in one year and large part of it happened in the first six months of 2026. In India, export and remittance jointly account for 23.97% of GDP while import and external debt jointly account for 41.95% of GDP.

I think slow and gradual depreciation is ok for our economy. 1% or 2% depreciation will not aggravate the inflation that much. Regular intervention of the central bank,therefore, in the forex market is necessary. According to MPS,in FY 26,central bank spent $6.43 billion in forex market intervention.

Steady flow of remittance and BB's intervention translated into 0.39% depreciation of Taka. This is why central needs to hold lots of Taka. That is why it is not right to use central bank's money in other purposes, particularly in meeting political pledges. Central bank plans to spend Tk 19000 crore of its money as part of stimulus package. Central bank needs money to emergency intervention and that is why its money should be untouched.

Use of local currency to boost export competitiveness is indeed good for the economy. Timing and priority are the two factors that influence the decision regarding the depreciation. Since fuel price is rising amid high inflation at the local market, this is not high time for big depreciation. However, central bank's intervention ,which requires huge amount of money at its disposal, in the forex market at right time can thwart any appreciation pressure on Taka and ensure export competitiveness.

Challenge Posed By Currency Tool

Striking the iron when it is hot, Strong local currency is what you got.

The World Bank lowered growth forecast for Bangladesh to 3.3 % for FY 2026. Moreover, it fears more than 3 million Bangladeshis may go under poverty line next year. Despite sign of reconciliation between the USA and China (President Trump hints lowering the tariffs on China and China exempts few US items from retaliation list) ,prospect of global trade remains uncertain. There is no sign that a consensus will be reached within 90 days though bilateral negotiation is in full swing with many countries. The Federal Reserve plans to lower the policy rate in May. It will weaken the USD. At the same time, it will be high time for the US to employ the currency tool if the ongoing negotiation may not yield expected result. I think the Trump administration will not wait too long to employ the tool. They want to do the unpleasant things at the start of the tenure and reap the benefits at the last leg of the tenure, when the fallout of the reciprocal tariffs will be offset and faded from people's memory.

Given the lack of response from outside world, it is highly likely that Trump administration may resort to currency tool this year. Will the Fed allow the Trump administration to print and $1 trillion and give it to procure rivals' currencies in a bid to appreciate their value against USD?Answer is still unknown ,but further weakening of US dollar will put appreciation pressure on other currencies.

To make clear my point, let us take a look at the formula of Real Effective Exchange Rate(REER):

REER at period t= (Exchange rate index of a country x Inflation rate of the country)x 100÷(Average of trading partners' exchange rate index x weight x Average of inflation rates in partner countries)

Exchange Rate Index at t= (Exchange rate of a county's currency at t)÷(Exchange rate of a county's currency at base period)

The US do trade with most of the countries. Any weakening of US dollar (look at the denominator) means REER of a currency appreciates given its exchange rate remains the same. The USA accounts 20% of our exports whereas the EU accounts more than 45% of our exports. Meanwhile, China and India are our top two importing [sources]. Moreover, except Eurozone, Bangladesh does trade with most of its trading partners in USD. So USD carries [(if not then it should)]more weight in REER calculation and thereby deeply influences REER of Taka. The point is any future depreciation [of USD] will put appreciation pressure on Taka (look at the formula). Since the tariff debate,we have seen Euro, Yuan [,] Dong, Rupee depreciated. This clearly makes possibility of REER appreciation of Taka stronger unless the central bank intervenes in the forex market.

We cannot make great leap towards productivity through technological innovation [in short span of time]. But we can retain the competitiveness through local currency depreciation. For that central bank's active role is what we needed.

Trump administration can also employ International Emergency Economic Powers Act that permits the US president to withhold interest payment on US treasury bonds or to freeze payments to other countries. When this will happen many countries will try to lower their US treasury bond holding, leading to appreciate their currencies. Either approach leads to REER appreciation of local currency.The USA will try its best to make USD less attractive as the reserve currency. So central bank should have a contingency plan on how to convert part of the reserve in gold,Euro or other IMF reserve currencies.

Recipe For Meeting The Revenue Target

Meeting revenue target and boosting foreign currency, Depreciation is the best bet in this urgency.

Bangladesh Bureau of Statistics (BBS) has revealed the March inflation data. General inflation increased slightly to 9.35%. Though food inflation declined from 9.24% to 8.93%, non-food inflation rose to 9.70% from 9.38% in February. On several occasions, Bangladesh Bank Governor stressed policy rate will be lowered when inflation will be lower than 8%. On going trade war casts shadow over global commodity demand, setting a downward pressure on inflation. Positive real interest rate ( since January) and decline in inflation show sign of optimism in containing the inflation. Uncertainties unleashed by tariff cast shadow over GDP growth,forcing ADB to lower its growth forecast to 3.8% for Bangladesh. Govt is planning to downsize the budget by Tk [70 billion*], a record in recent years acknowledging the reality. The IMF has set new revenue target of Tk 570 billion for the rest of the fiscal year as a condition to get the fourth and fifth installments of the credit package.

So meeting the revenue target and staying competitive amid uncertainties and contractionary policy appear to be the challenges faced by this govt. Govt is continuing the monthly fuel price adjustment through Bangladesh Energy Regulatory Commission (BERC). To make BPC profitable, it has not lowered the prices for last couple of months. When oil prices at international market show a downward pressure, lowering fuel prices at home will help tremendously its subsequent policy actions. In May 2024,I penned a piece titled "BB's Twin Actions" where I argued how depreciation of Taka at one hand increases govt revenue through market mechanism and, on the other , boosts export without deteriorating the inflationary situation. Briefly repeating the argument again: depreciating the local currency will help NBR bagging a huge revenue from the import duties,which account for a large part of revenue collection; it will also halt the need for unnecessary incentives for exporters and remitters as higher exchange rate itself works as incentives. Govt has 2.5 months in this fiscal year and a depreciation is a must (say 10%) to meet the big jump in revenue [collection]. Time is perfect for doing so as oil prices declined by 7% than what it was prior to reciprocal tariff announcement.

As I highlighted in my previous piece, this depreciation also makes Bangladeshi goods more competitive without incurring extra spending. Not far too often we have this chance to go for depreciation. It also makes our position at the negotiation table much more comfortable. We know our goods have become competitive again and govt does not have control over private sector when many of the goods may become cheaper in international market in future. Now at the negotiation table , you promise to import some specific goods more, but in future it turns out that at the international market its prices will come down. Then you have to import it at higher prices to respect the deal at the cost of trade account balance and current account balance, crucial for a tiny country like us. So focus should be [on how] to narrow down trade imbalance between the two countries without mentioning any specific item. When international market says an American good is cheaper, we will buy it more from them. Some goods are strategically important for us. Soybean, LNG,cotton,scrap metal are used as intermediate goods in agriculture, RMG,Transport, steel and real-estate sectors. So these goods could be bought in abundance. In addition, used car,beef,pecan,wheat,biofuel,used bus/van could be considered for import if their prices are competitive in international market.

In brief, depreciation will augment govt's revenue to get the IMF credit and boost future export and remittances. It will also put us in a comfortable position to negotiate with the USA.

[*Update: This piece has been updated on April 15,2025 at 20:55 PM Bangladesh Standard Time.Update includes the revised budget downsize figure.]

Depreciation Is The Key

A correction fully translates tariff's rise in import prices, To fight risks,depreciation sounds best among the choices.

As the world is still coping with the uncertainties associated with reciprocal tariffs,Mr Trump made it clear that he has no intention to "pause the tariff". Meanwhile, Bangladesh decided to sent a letter to the USA to postpone the decision for 90 days. Govt is planning to bring down the tariff on several US goods so that import from the USA could rise. Govt is even mulling to import LNG from the USA.

What is worrying is that several US buyers are withholding their purchase orders for indefinite period. Chief disaccord turns out to be who will bear the extra price emanating from the tariff. Big brands remain silent here ,but others press the exporters here to bear fully the brunt of it.

Now latest development hints that researchers from American Enterprise Institute questioned the formula used for reciprocal tariff. Let us look at the formula again:

Change in tariffs= (US exports to partner - US imports from partner) ÷ (Elasticity of import demand with respect to import prices × Elasticity of import prices with respect to tariffs × US imports from partner)

The first two terms in the denominator are set to be -4 and 0.25 respectively. But the researchers pointed out that the Trump administration erroneously used elasticity of retail prices with respect to tariffs instead of elasticity of import prices with respect to tariffs(which is set to be 0.945 or 1). Elasticity of import demand with respect to import prices shows how much import demand changes in response to a 1% increase in import prices. Similarly, elasticity of import prices with respect to tariffs shows how much import prices change in response to a 1% increase in tariffs. Product of the two terms tells how much the import demand changes for 1 % increase in tariffs.

The researchers claim the original author (Alberto Cavallo) made it clear that tariffs are passed fully to import prices and elasticity of import prices with respect to tariffs is used in the calculation of the actual formula, not the retail prices (see"Trump's Formula 'Based On An Error' - Conservative Think Tank", Jason Lemon,Newsweek, April 5,2025). If this argument is true then a 1% increase in tariff leads to a decrease in [import] demand by 4%. Inflation is also much higher than the earlier estimation.

The corrected reciprocal formula [may] significantly lower Bangladesh's tariffs to 9% (0.185 divided by 2), much lower than the earlier 37%.

Stephen Miran in his paper, discussed in the previous piece, argues that if the tariffed country fully depreciates its currency then price of the tariffed good will not rise in the USA. However, if the tariffed country does not cooperate, price of the imported good rises. So the corrected formula shows imported good's price increases fully in response to an increase in tariff, depicting the noncooperation scenario. Under the corrected formula, Bangladesh's tariff becomes even lower (7%) when trade deficits take into account tariffs already paid to the USA on exports.

So, in brief, Bangladesh faces tariffs in the range of 9% to 37%.

The USA shows no sign of relaxing it and Bangladesh is a marginalized country, hinges on exports and remittances heavily. Unilaterally, Bangladesh can depreciate Taka and retain the competitiveness , mitigating the risks posed by reciprocal tariffs. In the previous piece, I argued that Bangladesh can easily depreciate Taka 10% by now and near future without any trouble. We witness crude oil prices already dropped by 7% in the international market. The uncertainty is still there,indicating oil prices may plunge even further. So passthrough effect of 10% depreciation will be offset by fall in oil prices.

In the case of worst case scenario( tariffs stay for indefinite period), we have to depreciate the currency by 37%. So exchange rate of USD against Taka will be varied between Tk 134.20(10%) and Tk 167 (37%).

Compared to China, Vietnam and Cambodia, Bangladesh's tariffs are lower. China cannot sustain 104% depreciation of Yuan. Capital flight will be enormous. So Bangladesh does not need to compete with China to depreciate its currency by that insane amount.

Depreciation will work as incentives for the exporters and consumers will not feel the heat amid falling oil and commodity prices globally. The SMEs may incur loss from rising cost of imported goods. But Bangladesh Bank already installed a mechanism of extended credit facility for the SMEs to mitigate the loss from interest rate rise. Its coverage can be extended for mitigating risks from exchange rate variation. So more SMEs which do not know how to cope with risks from interest rate rise and exchange rate variation could be brought under its coverage. Giving them credit for 3/4 years will allow them to sustain their businesses in the face of potential risks from volatility.

Taka depreciation works to address many of the challenges emanating from this tariff debate. Meanwhile, Chinese central bank lowered the reserve requirements for the banks in a bid to increase liquidity in the market. On the other hand, the Federal Reserve is scheduled to lower the policy rate by May. This means foreign credit will be cheap in the coming months. As China is keen to depreciate the Yuan and gives its firms and institutions more money to invest ,some will end up abroad for sure.

As Taka depreciation sounds more plausible than any other measure, we should go for it. We have a valid reason for doing so. Foreign buyers want it,international commodity prices set the right context and incentives for exporters amid monetary contraction policy call for depreciation of Taka.

In brief things surfaced here from above discussion are: a claim says original formula reflects complete increase in import prices resulting from an increase in tariff. This correction [may] further lower reciprocal tariffs for Bangladesh and it is manageable for the govt [if the correction is taken into consideration]. Depreciation of Taka appears to be the plausible solution for the moment given the prevailing context.

Who Is Running The Narrative Mill?

As tools to change economy's fate, Under scanner are real policy and exchange rate.

Recently, a strong argument was put forward against pursuing high policy rate and depreciation of Taka against USD in the past. The two key policy decisions have been termed as a result of specific narrative. The argument came from a gentleman who is executive director of a local think tank. I am a bit surprised by reading the opinion piece and expected more economic reasoning behind such argument. (See "Shud Har,Mudra Binimoy Har Ebong Mullo Sphitir Boyaner Punorbhabna(Rethinking The Narrative Of Interest Rate, Exchange Rate and Inflation)", Sajjad Zohir,February 16,2025,Daily Bonikbarta )

The gentleman belongs to the same school of thought who believe raising the policy rate is not the solution to tame the inflation and transitory effect of depreciation worsens the inflation.

In the past,we heard argument that higher tariffs on commodities barred bringing down the price levels. For edible oil and sugar, the NBR should not have lifted off the tariffs since the two are major sources of revenue. And the decision cost the govt at least Tk 3156.5 crore (See "Where Is The Change?" published here on January 18,2025).Now govt is facing a revenue shortage(27% of the first half of current fiscal year) amid high inflation and chronic soybean oil shortage. For five long years, we have not raised the interest rate enough to beat the inflation. Rather, sticking to 9% and 6% rates for all these years led to massive money laundering. To meet the liquidity crisis of the banks, the central bank literally printed and injected money into the trouble ridden banks.

High interest rate worked as a screen to discourage potential money launderers from taking further loan. It also helped the govt to check its spending on interests of National Savings Certificate(NSC). High deposit rates and restrictions diverted money from non-bank savings to other sources(see the MPS, page-10).

Govt's heavy borrowing from banks is another reason for not having enough money at the banks. Public sector credit growth (18.1%) is higher than the projection(14.2%). So there is not enough of the pie left for the private sector. This is happening when foreign budget support is drying up.

Governance crisis in the banks is the main reason many clients feel shy to go to the banks. However, the governor claims many clients resumed depositing money into trouble-ridden specialized banks. Bangladesh Bank claims tight liquidity situation is due to continuous support of the subsidized Taka against USD, poor recovery of credit,cash holding, size of NPL and dismal state of deposit growth( see the MPS, page-10).

Real interest rate has only become positive in January 2025 if our inflation reading is correct. It is true that large depreciation causes inflation through transitory effect in the short run. But look at the timing of our depreciation: once it was done when crude oil price was falling. Now prices of rice and other commodities are falling. This somehow offset the pass-through effect of depreciation in the long run. I somehow find the statement depreciation causes domino effect of inflation a bit banal. When nominal interest rate is below inflation rate,the central bank intervenes and raises the policy rate,causing the local currency to appreciate against major currencies. It holds back the currency to depreciate further. Meanwhile, the new exchange rate of Taka attracts export order and remitter. This is indeed the case. Last year, despite the political turbulence, our RMG export registered 7.23% growth and remittances registered 22% growth. Riding on this achievement, our overall Balance of Payment deficit declined to $384 million in FY 2025 from $3.5 billion in FY 2024(see The MPS,page-14). This further stabilizes the local currency and thwarts the depreciation pressure ( more USD coming in then going out).

If the central bank were stuck at the old exchange rate, then it might have to sell more USD from reserve (which is now more than $20 billion),print and inject more Taka into the system (worsening the inflation), to increase the size of NPL,leading to a macroeconomic disaster.

Another good thing about large depreciation is that it works as incentives both for the exporters and the remitters. The extra Taka the remitter/exporter get will help him/ her to mitigate the loss from inflation and higher policy rate. Govt also saves the money given as incentives to these two groups. Previously govt gave 5% incentives to remitters. It has now become 2.5% and this costs the govt Tk 70 billion every year,as claimed by the governor himself. We can still save this Tk 70 billion, by discontinuing this 2.5% incentive and without disrupting the remittances inflow.

Despite high interest rate, undocumented money or money at hand is not coming to the banking system due to governance or political reason. Some of the areas where undocumented money may find the safe sanctuary are real estate, IT and the stock market. Scam ruined the IT sector. Political uncertainty and misaligned interest rate bar developers to undertake new project in the real estate. In addition, govt doubled the registration and reregistration fees in a bid to boost revenue earning amid revenue shortfall,discouraging owners/buyers to sell/buy property. Again undocumented money not coming to the system is mainly due to political uncertainty and governance situation, which caused the macroeconomic instability.

I still do not find any logical explanation why he thinks real policy rate or real exchange rate concepts are mere "narrative". If real interest rate is negative, then investing the pension money into interest- bearing assets of local institution and govt will ruin millions of employees including those from public and private think tanks.This is what the IMF laid bare in their discussion with the Pension Fund Authority , which intended to invest pension fund into NSC when inflation rate surpassed nominal interest rate.

Yes it is true that inflation is sometimes wielded as argument to raise the salary. But it is true for those affluent countries where collective bargaining is strong and government is no short of resources. Neither of the two presents here. So the argument inflation is put forward as a reason to salary hike is not true for Bangladesh.

Misaligned policy rate ,pegged exchange rate and high inflation are some of the reasons international credit rating agencies in unison downgraded our credit ratings. Singapore and UAE based banks charge more conditions and interest rate to lend us credit. Most importantly, I have deep faith in standard text books which never include mere "narrative".

Macroeconomy Amid Trade War VII

Clashes of the titans in trade May prolong the struggling state.

Bangladesh Bank in a surprising move revealed that exports figure was erroneously inflated by $10 billion in July-March period of the current fiscal year. So it corrected the export earnings for the above duration, shrinking the total exports to $30.8 billion. The origin of the error was attributed to National Board of Revenue, which made "multiple entries" into the database of each shipment. This disclosure was made at a moment when the IMF cleared third tranche of $1.15 billion and Bangladeshi Prime Minister is going to visit China for a 7 billion yuan credit package. Before the error correction, both the trade and current account balances were surplus. Now ,trade deficit is $18.69 billion while current account deficit is $5.73 billion(Source: Bangladesh Bank). This will clearly put huge pressure on the exchange rate. Earlier, in my piece titled "BB's Twin Actions" in May this year,I argued how the depreciation of taka augmented the govt revenue when government was scratching head how to meet revenue target. This time I think the central bank is setting the context for such move. In this fiscal year, NBR collected a revenue of Taka 3.24 trillion against an IMF target of Taka 3.94 trillion. There is already a deficit. For 2025, the revenue target is Taka 4.8 trillion. Despite the tremendous growth in revenue generation, NBR may not achieve this target with its current capacity. The easy solution is to go for the depreciation. Moody's projection of 2% depreciation of Taka by the end of December will make the exchange rate Taka 119.34 against 1 USD. But current reality calls for larger depreciation. If the 7 billion yuan credit package plus the rupee swap unfolds before November 5 ,then we may avoid further pressure on foreign reserves. This somehow partly offsets the need for large depreciation.Anyway, depreciation is good for the economy when govt is pursuing contractionary monetary policy. When the trade war will be intensified, yuan will be further weakened to make Chinese goods more competitive in the global market. Because China has no obligation to comply US suggestion to appreciate its currency amid war. This means we are going to see more depreciation for sure. Now let's see what the macroeconomy will look like taking into account the exchange rate of Taka amid the trade war.

Exchange rate of Taka: More than Taka 117 /USD

Fed funds rate: 5.33%
Chinese policy rate: 3.45%

It will improve the forex reserves by improving both the trade and current account balances. However, it has the potential to deteriorate the inflationary situation. But previously we saw that trade tensions shrank global growth,which lowered demand of major goods. So trade war may translate into lowering of prices of major commodities including crude oil. So this reduction in prices of major commodities in the international market may offset the inflationary situation stemming from pass-through effect. At the same time, interest rate hikes are likely to deal with the inflationary pressure. Government's revenue target will be met through the increased revenue generation resulting from depreciation. More remittances will come from abroad. Export orders will be higher due to trade war and depreciation. Less borrowing from abroad as depreciation works as export incentives.

Fed funds rate: More than 5.33%
Chinese policy rate: Less than 3.45%

Remittances and export earnings will come in abundance but less in volume compared to the previous scenario as return on dollar deposits is high. Trade balance and current account balance will improve but not as much as the one depicted in previous scenario. Inflationary pressure will be higher than previous scenario. Government's revenue generation from depreciation will be lower than the previous scenario. Foreign borrowing will be lesser than previous scenario. Export orders will be lesser than previous scenario.

Fed funds rate: Less than 5.33%
Chinese policy rate: Less than 3.45%

Rapid improvement in forex reserves,trade and current account balance. Inflationary pressure will not matter as foreign goods will be cheaper due to low interest rate abroad. Government's revenue generation will be higher than previous scenarios. Export orders will be higher than any other scenarios.

Exchange rate of Taka: Less than Taka 117 /USD

Fed funds rate: 5.33%
Chinese policy rate: 3.45%

When Taka appreciates, trade and current account balance deteriorate. But inflationary pressure will be low and consumers at home will enjoy the benefit of low prices of commodities stemming from trade war. Less remittances and export earnings will come to the country. Government revenue target will not be met. So govt may opt for costly borrowing from abroad and domestic sources. Debt burden may worsen. Domestic borrowing may worsen future inflationary situation. Domestic goods will be less competitive as export orders will be lesser than earlier scenarios. As Chinese/Vietnamese goods will be cheaper ,Bangladesh may loose market share in nontraditional markets.

Fed funds rate: More than 5.33%
Chinese policy rate: Less than 3.45%

There may be current account and trade deficits. More reliance on Chinese credit. Inflationary pressure will be lower but a bit higher than previous scenario. Government and private sectors may go for costly borrowing. Loss of nontraditional market share to Chinese/Vietnamese goods will be higher than previous scenario due to appreciation of Taka and high interest on dollar borrowing. Export orders will be lesser than previous scenario. Government revenue generation may not meet the target. Low remittances inflow and export earnings repatriation due to high return on dollar deposits.

Fed funds rate: Less than 5.33%
Chinese policy rate: Less than 3.45%

Impact on trade and current account balance is not known. But it will be worse than the scenarios depicted when Taka depreciates. Government revenue generation will not be met. But cheaper borrowing options will be available both for the private and public sectors. Cheaper export credit will help exporters to deal with the appreciation challenges. Loss of market share to competitors will be less than previous scenarios.

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.

Let The Market Decide The Exchange Rate

Falling value of Taka against the dollar Brings more remittances from blue collar. Letting market fix the exchange rate Withers away chances to speculate.

Central bank has decided to delay the decision to pursue unitary exchange rate till September.Rate set for remittances is higher than that for export earnings. Two conditions among others set by IMF to get the next instalment of IMF credit are : to raise the forex reserve by $1 billion ( total $23 billion excluding the $7 billion lent to commercial banks) and to follow a unitary exchange rate system from the start of new fiscal year (July).

Bakri eid witnessed overwhelming swell in forex reserves. Migrant Bangladeshi workers sent around $2 billion in the 21 days of June. So actual forex reserve reached $24 billion from $22 billion. However, Bangladesh Bank keeps showing the forex reserve as $31 billion (including the $7 billion loan to commercial banks). News reports say the central bank has started buying US dollars from banks to swell the forex reserve further. But the decision to postpone a unitary exchange rate came amid government’s repeated failures to provide adequate foreign currency to power plants to procure coal from abroad. In addition, govt's debt service obligation and some ongoing big infrastructure projects also put pressure on dollar demand. Govt may print more money to meet the need. Further depreciation of Taka may raise the cost of such project and sending money abroad.

In September, an IMF team will come to a scheduled visit to review the conditions set by it for clearing the second instalment. Raising the policy rate (repo rate) by 50 basis points ,increasing the reserve by $1 billion ,removing the cap on bank lending rate, raising the utility bills, moving towards market determined fuel rate ,redefining social security spending etc show how far the government has progressed. However, increasing the tenure of directors originating from the same family in the amendment of bank company act, delaying the unitary exchange rate, reclassification of default loans through 20% repayment also indicate government is in no mood for any bold reform work.

Meanwhile, many including me argue that such small increase in policy rate may not contain the inflation rate. In addition, setting the exchange rate at multiple levels also encourage money laundering. Remember that there is unprecedented hike in policy rates in occidental countries. In particular, USA surpassed all of them. So dollar deposits earn more than other currency deposits. So investment, clandestine money flow ends up in America. This partly explains 94% reduction in the deposits held by Bangladeshis in Swiss banks. When Canada,UK toughened their immigration policy ,Bangladeshi deposits in Swiss banks swelled. By not allowing Taka to depreciate further and not raising the policy rate enough,we are making it easier for the wealthy to invest in these countries. Many of our exporters and importers have partners abroad. Through them they can put their money into these foreign currency deposits or cut some sort of currency swap agreements to take advantage of the arbitrage opportunity if domestic exchange rate is not favorable enough. If they see interest rate will rise in future and Taka will depreciate more, then they will prefer to bring the export proceeds later to gain more. That is why the best remedy is to trust the market and let it fix the rate. This will wither away all the speculative motive. However, the current decision of the central bank has introduced friction into market, which in the end helps the currency speculator.

Devalue Currency To Augment Demand

Taka loses fast its value against dollar,
Reasons put forward for paying the bills of importer.
Increase in money supply depreciates local currency,
Devalued taka augments demand, output and local vacancy.
Overshooting exchange rate may approach stable value,
Lowering interest rate is a must amid pandemic flu.

A recent news report (May 20)says there has been a dollar crisis. To meet the growing import bill amid sluggish export, demand for dollar surged. Taka against dollar has been depreciated to Tk 88.50 at the banks. This is happening when government doled out Tk 5000 crore credit to RMG owners to clear dues of workers. In addition, government assured cash benefits to rural poor and other incentives to various sectors. By the time I am writing this piece, remittances in the month of Ramzan have reached $1.09 billion.

I embarked upon to see what impact an increase in M2 would leave on exchange rate. M2 comprises of currency outside bank, demand deposits, narrow money supply and time deposits. Data were taken from Bangladesh Economic Review 2018 for the period 1996-2018.

Autocorrelation check for 23 observations and 1 explanatory variable reported positive correlation (d = 0.374). I did not transform the data. It was assumed that during the unit root test inclusion of lagged residuals will take care the autocorrelation.

Then I went for unit root test to see whether exchange rate and M2 were stationary. To bare eyes, it appeared that both the variables wandered around a trend. So I constructed the following regression equations:

🔺 Exch_t = a + bt + c Exch_t-1 + d 🔺 Exch_t-1
🔺 M2_t = a + bt + c M2_t-1 + d 🔺 M2_t-1
Where 🔺 Exch_t= Differences in exchange rate at t,
Exch_t-1 = exchange rate at t-1,
🔺 M2_t= Differences in M2 at t,
M2_t-1= M2 at t-1,
🔺 M2_t-1= Differences in M2 at t-1,
t = a time trend variable, here year.

After the regression run , I obtained the following result: 🔺 Exch_t = -1778.34 + 0.902t -0.501Exch_t-1 + 0.455 🔺 Exch_t-1
(t=-2.52, p=0.022, se=706.22) (t = 2.53, p=0.022, se=0.36) (t=-2.79, p=0.012, se=0.18) (t=1.97, p=0.065, se=0.230)
(F=3.39, p=0.042) 🔺 M2_t = -7176664 + 3590.12t + 0.0028M2_t-1 + 0.373 🔺 M2_t-1
(t= -2.59, p=0.019, se=2774933) (t=2.59, p=0.019, se=1386.81) ( t= 0.088, p= 0.93, se=0.0313) (t=1.27, p=0.22, se=0.29)
(F=67.54, p=0.00)

Huge standard errors put question mark on the intercept and trend coefficient of 🔺 M2 function. Tau statistics of slope coefficients of lagged exchange rate and M2 , -2.79 and 0.88 , in absolute terms were smaller than MacKinnon critical tau statistics at 5% level, -3.4620. So I did not throw away the null hypothesis that c=0 or exchange rate or M2 are nonstationary.

As the first differences of these two variables appeared to be nonstationary, it was assumed , for the sake of simplicity that they were integrated on order d,I(d). Regressing exchange rate on M2 , I obtained the residuals for cointegration test. Then I ran the following regression:

🔺 resid_t = b resid_t-1 + c 🔺 resid_t-1

And the result was: 🔺 resid_t = -0.160 resid_t-1 + 0.51 🔺 resid_t-1

(t=-2.012, p=0.058,se=0.079) (t= 2.84, p=0.010,se=0.18)

(F=5.85,p=0.011)

The computed tau statistic -2.012 was greater than the critical value -3.37% at the 5% level of significance. I did not reject the null hypothesis that least squares residuals are not cointegrated. Cointegrated Regression Durbin Watson (CRDW) test also validated the claim . The computed d = 0.374 turned out to be smaller than the critical value 0.386 at 5% level of significance. So I did not reject the hypothesis that exchange rate and M2 are not cointegrated.

In this particular situation, exchange rate and M2 were I(d) series and not cointegrated. So I went for a VAR model:

🔺 Exch_t = b₁🔺 Exch_t-1 + b₂ 🔺 Exch_t-2+ b₃🔺 M2_t-1 + b₄ 🔺 M2_t-2+ v^🔺Exch_t

🔺 M2_t = c₁ 🔺Exch_t-1 + c₂ 🔺 Exch_t-2+ c₃ 🔺 M2_t-1 + c₄ 🔺 M2_t-2+ v^🔺M2_t

VAR model did not fit well (🔺 Exch chi² =6.88, p= 0.144, and for 🔺 M2 chi²= 142.85, p=0.00). Nevertheless, I wanted to see the Impulse Response Function (IRF) that shows effect of a shock of endogenous variable on itself and other endogenous variables. An increase in orthogonalized shock to M2 resulted in a short decrease ( depreciation of Taka ) in the exchange rate that withers away 1 period later.

Though the VAR model is to be accepted with a dollop of salt, this is pretty much in line with theory found in economic text book. Temporary drop in global demand shifts the DD schedule, which shows mixes of output and exchange rate for keeping output market in equilibrium in the short-spell, to the left. This in turn reduces full employment-level output to a lesser level, provoking depreciation of currency. A currency depreciation augments both aggregate demand and output at home. Meanwhile, increase in money supply in the domestic market depreciates exchange rate and causes AA schedule, which links exchange rates and output levels to keep the money and foreign exchange markets in equilibrium, to shift upward. Domestic goods become more competitive in global market , triggering a rise in domestic output and employment. For a given level of output, an increase in money supply can cause exchange rate to overshoot its long-term exchange rate for a while. One may argue that since our import surpasses our export and in this time of falling export earnings a depreciation may erode our current account balance. Point is that economic theory says for a brief period there may be a dent in the current account balance (ours a negative) but in the long run it will definitely improve.

Point is currency depreciation is good for our economy and wild fall in Taka may approach its long-run value with the course of time. To revive the falling demand, government can do more apart from doling out incentives. One step can be to lower the domestic interest rate in a bid to increase the money supply.