Will Taka Remain Stable?

War leads to further rise in inflation, Policy rate cut may cause depreciation.

Last week exchange rate of Taka reached 123.30 against US dollar. Now the rate settled at Tk 122.75 per USD. The ongoing war in the Middle East cast a shadow over remittance inflow and supply of energy through the strait of Hormuz. Moreover, govt changed Bangladesh Bank governor abruptly and the new governor hinted to lower the policy rate while inflation rate increased further and hovering around 9.13% in February. In January ,it was 8.58%. In this backdrop, serious question raised over continuity of regulatory discipline.

Throughout the fasting month of Ramzan ,key kitchen items registered higher prices. A new war in the Middle East risks worsening the inflation by causing supply problems [for] energy and spiking the fuel price. Despite govt assurance of no fuel crisis at home, the long queue of motorbikes and cars in front of petrol pumps is a testament to panic prevailing at the ground. Central banks of major economies already shelve their plans to lower policy rate while ours one walks on a different direction. Furthermore, abrupt dismissal of governor sent a wrong signal abroad about commitment to reforms. It may delay improvement of our credit ratings, causing troubles to get foreign credit for private sector.

Taking a look at major macroeconomic indicators tells that time is indeed not right for a policy rate slash. During July-January period of 2025-26, export declined to $26.09 billion from $26.36 billion in 2024-25. Trade deficit increased to $13.79 billion in 2025-26(July-January) from $11.74 billion in 2024-25(July-January). Current account deficit declined to $381 million in 2025-26(July-January) million from $1.31 billion in in 2024-25(July-January),riding on growth of remittance. Remittance rose to $19.43 billion in 2025-26(July-January) from $15.96 billion in 2025-26(July-January)(See https://www.bb.org.bd/en/index.php/econdata/bop). Despite improvement in current account deficit, situation is not right for discarding the tight momentary policy. [Particularly] when the war may derail the growth of remittance. At one hand trade deficit is growing ,on the other rising import and uncertainty over remittance put overall macroeconomic situation at a precarious position. In this situation, lowering the policy rate will increase the depreciation pressure on Taka against other currencies. Any wild fall of Taka worsens inflationary situation through pass-through effect of the new exchange rate.

Moreover, further worsening of war will spike fuel prices and deteriorate inflation in advanced economies, where most of our exportable items go. This will cut the purchasing power of their nationals and lower overall consumption. Declining trend of export will further cause depreciation pressure on Taka. When exchange rate and inflation rate will both rise ,real effective exchange rate will fall further given denominator part of the formula remains same(look at the formula).

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)

So far US dollar appreciated against other currencies following the start of the war. Since we do trade with other partners in USD ,a stronger USD translates into depreciation of real exchange rate of Taka given other things remain same. However, inflation is likely to rise amid escalating war . When average of inflation rates in partner countries is higher than exchange rate of Taka and inflation at home,then Taka will appreciate in real term (see the formula).

Stability of Taka depends on many things. But so far the development indicates Taka is likely to depreciate further if the war turns out to be a protracted one. We coped with 40% depreciation of Taka all these years. Similar or more depreciation will be unbearable for us. So cautious monetary policy ,which implies a tighter one, will be good for us. Does the central bank have courage and commitment to do so?

Is Bangladesh Bank Really Independent?(Republished)

Meddling in decision making Yields result no one seeking.

[Republished below a piece I wrote back in June 22,2023.]

Bangladesh Bank raised the policy rate by 50 basis points, detailing its inflation containing measures in the monetary policy statement for July-December. However, the increase may not be good enough to contain the inflation. Real interest rate is still negative( -4.26% for deposit and -1.35% for lending)¹. This means inflation is still higher than nominal interest rate. And we need to raise the interest rate high. Many argue inflation is hovering around 15%. Rate charged by unofficial money lenders could be a good indication of the market rate.

Central bank's argument of injecting $13 billion into market and mopping up Taka in the last one year sounds hollow as inflation officially is around 9.94%. It is not clear how it oozed the demand pressure.

Another thing I discussed earlier following the MPS in January is that Bangladesh Bank flaunts export receipt growth as an indication of demand increase of Bangladeshi items abroad². However, inflationary pressure is still there and prices of lower end items that Bangladesh export in bulk quantities also rise. Bangladesh Bank's own figure on policy rates of advanced countries show an upward trend since December 2022(see picture). Of course demand for Bangladeshi items is in rise in other countries, but the growth in export receipt does not account fully the growth in demand. Inflation played a role here and ratio between export earnings and volume could have yielded a better picture. Cargo handling through Chattogram port also declined significantly in recent months.

Policy rates of advanced countries (Source:MPS,Jul-Dec,2023,Bangladesh Bank)

Bangladesh Bank labelled the decision to downgrading the credit rating of Bangladesh by Moody's as a geopolitical one. Why did some banks based in Dubai and Singapore lower the credit limit and increase loan conditions for Bangladeshi banks if this is so? Both UAE and Singapore have good relations with Bangladesh and affluent Bangladeshis in general pick up the two countries as second home. Singapore is one of the top five investor countries.

Central bank also claimed that it takes decision independently and there is no political intervention.

Central bank is run by prudent and competent personnel. Their integrity and commitment to run an organization is not questioned here. Unfortunately , it is no distant island in Bangladesh’s command and control political atmosphere. On some occasions, past actions revealed how its independence was compromised:

• Bangladesh has long been following multiple exchange rates. Gaps in the rates discouraged bringing foreign currency home and played a conducive role to send foreign currency abroad. Many economists argued this mismatch plus incentives on remittances went in favor of speculators and money launderers. And future depreciation of Taka will benefit opportunists who willfully delayed bringing their earnings at home. It is naïve to say Central bank is ignorant about this fact. I think political pressure held it back from taking the right stand.
• In November last year, while an IMF team was in an official visit to Bangladesh, a little known Nabil Group swindled around Tk 90 billion from several Islamic banks.Till date,whereabouts of the money is not known.This plundering shook depositors' confidence so much that many were prompted to withdraw their money,leading to a liquidity crisis in the Islamic Banks. To address the crisis, central bank provided Tk 147.90 billion credit to the troubled Islamic banks through promissory demand note³.Govt literally printed the money and injected it into the ailing banks⁴. Troubled banks were not able to manage loans from other banks. I think this supply of fund through promissory demand notes was a political decision to restore depositors’ confidence. Similarly it is not clear how Nabil Group managed to get such a huge loan evading Bangladesh Bank radar. Clearly, independent decision making power of Bangladesh Bank is compromised here too.
• Bangladesh Bank recently approved application of Nagad Finance PLC to operate as another non-bank financial institution⁴. It will finance Nagad,set up in 2019 and country’s leading mobile financial services operator. Regulations prior to 2022 clearly stated that MFS operators work as subsidiary of a bank. Nagad is an exception. It is not subsidiary of any bank.Later MFS regulations 2022 allows non-bank financial institution to operate mobile financial services(see pictures). Approval of Nagad Finance hints strong political lobbying.Bangladesh Bank intervened when age limit of a managing director of a specialized bank crossed a threshold limit.But here we see a multibillion Taka company operates year after year not meeting vital criteria and regulations have been changed for its smooth operations.Political objectives here influenced the actions.
  

  MFS Regulations 2018

  

  MFS Regulations 2022

Apart from that Equity And Entrepreneurship Fund (EEF) and EEF for ICT have been misused on several occasions. Often it was found that external influence played a role in some cases.

Bangladesh Bank cannot act freely in the present context. Its exercise of sovereign decision making power has been limited in recent years as political intervention is more frequent. Despite cautious optimism and adherence to contractionary monetary policy , inflationary situation may spiral out of control if central bank kowtows before political pressure.

Notes And References

1. Monetary Policy Statement, July-December,2023,Bangladesh Bank
2. "Will MPS Attain The Goals?",Rezaul Hoque,January 20,2023.For more read at https://hoquestake.blogspot.com/2023/01/will-mps-attain-goals.html?m=1
3. "Receding Trust In Banks",Rezaul Hoque, https://hoquestake.blogspot.com,January 13,2023.For more read at https://hoquestake.blogspot.com/2023/01/receding-trust-in-banks.html?m=1
4. " Inflation Woes Remain",Rezaul Hoque,April 15,2023.https://hoquestake.blogspot.com,For more read at https://hoquestake.blogspot.com/2023/04/inflation-woes-remain.html?m=1
5. "Nagad Finance PlC Gets Bangladesh Bank Approval",bdnews24.com,May 17,2023.For more read at https://bdnews24.com/amp/story/business%2F42fo8053ep

[Update:This piece has been updated by me on June 23,2023 at 10:07 AM, at 12:50 PM and at 13:12 PM Bangladesh Standard Time. Updates include:
10:07: references
12:50: screenshots of the Mobile Financial Services Regulations 2018 and 2022 and inclusion of phrase "...and regulations have been changed for its smooth operations.Political objectives here influenced the actions." at the end of the para highlighting Nagad Finance PLC issue
13:12: screenshot of policy rates of advanced countries and correction of "since April 2023" to "snce December 2022" in para discussing export growth and demand for Bangladeshi items
]

Could MPS2 Contain Inflation?

First monetary policy missed the target, Next one should not be a reason for regret.

The central bank is planning to introduce another Monetary Policy Statement(MPS).As anticipated, it is going to raise again the policy rate. Earlier it had raised both the repo and reverse repo rate by 25 basis points in line with gradualism. This time too it is likely to do so ,but interest rate increase may be more than 25 basis points. In the previous MPS, inflation target was set at 7.50%. However, inflation is around 9.94% according to govt statistics. Since primary concern is checking inflation, more drastic steps are needed.

In the previous piece, I highlighted how govt is accelerating inflation.Sharing parts of it again¹:” Central bank is printing the money and lending it to the government against treasury bonds. Central bank is both the legitimate authority to print money and issue treasury bonds and it is not selling the bonds to the banks. But govt is paying the bills of development expenditures and other spending through checkable deposits, which is increasing in volume. This ultimately leads to lower currency-deposit ratio that ends up in higher money-multiplier. So government's intention to have a low money-multiplier is not working. Central bank could do so by increasing the reserve ratio of banks,which is now only 4%². Higher reserve ratio will do the trick.

However, central bank is not doing so as it could curtail the credit to private sector, which is getting less and less amid govt's increasing borrowings from the banks.For the first two quarters of the next fiscal year,it could forget about private sector credit growth. As election is near, investors will await till the next govt assumes power. Meanwhile, higher reserve ratio could lower the money-multiplier."

Bangladesh Bank quarterly tells a lot about this.Money multiplier was 4.92 at the end of FY 22. It then rose to 5.07 at the first quarter of FY23. It then slided down to 4.63. Though reserve money registered a 17% growth at the second quarter of FY23. But it was not good enough to lower the money multiplier.

Meanwhile, public sector credit growth was recorded to be around 25% at Q2 of FY23. But private sector registered only 12.89% during the same period. It is not known how far the situation will improve ahead of election. Negative growth in volume of cargo handled by Chattogram port (-4.56%), a record in the last three years after COVID,gives an aura of sluggish business environment.

This is the right time to raise the interest rate by more than 100 basis points. If everything goes well ,two quarters later inflationary situation may improve. Government is injecting money into the system, it is quite natural that the long-run interest rate will rise in response to such move. Empirical evidence is there. A free and fair election will bring back investor’s confidence and credit flow to private sector will translate into success stories. Until that happens, central bank is in a comfortable position to take some tough stance.

Notes And References

1. " High Inflation And Unjust Tax: Evils Faced By The Middle Class",Rezaul Hoque,June 08,2023,https://hoquestake.blogspot.com For more read at https://hoquestake.blogspot.com/2023/06/high-inflation-and-unjust-tax-evils.html?m=1
2. Bangladesh Bank Quarterly, vol-XX,No-2,October-December 2022

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.