Exchange rate volatility: Wish list versus ground realities

Let us start by putting the facts straight. Bangladesh Taka has been under pressure. As I said, this is not surprising considering the fuel price volatility. We are having excess demand for dollar against taka with insufficient increase in supply. While our exports and remittances grew at 14 percent and 23 percent respectively from a much lower base, our imports have increased by 12 percent from a higher base. Although our current account balance for July-December, 2005 period is showing surplus, it is not taking into account huge outflow for the service sector that would amount to almost $1.2 billion for the entire fiscal year.

The service sector payments include remittances made by airlines, independent power producers, oil and gas companies, dividend and technical fees for multinational companies. Adding to this we have encouraged opening of deferred payment L/Cs to the tune of almost $1 billion in the previous year, which we have to settle throughout this year. So, we would have to take measures to reduce demand and increase supply of foreign currency (FCY).

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We are in a situation where we have to curtail our unnecessary import significantly. Our policy makers have taken measures to reduce import growth by creating obstacles on credit growth and this is evident in the reduction of import year after year. However the interesting thing is that, while we have been willing to curb credit growth, we have not been able accept the necessity of depreciating BDT as a tool for readjusting the demand-supply gap. At one hand we were mentioning the very necessity of reducing import and other outflows, on the other hand we were proposing to keep foreign exchange rate at an artificial level.

We have seen Bangladesh Foreign Exchange Dealers' Association (BAFEDA) deciding to keep foreign exchange rate at a fixed level (at taka 65 first time and then at taka 67). This gave a very wrong signal to all concerned parties in the market and taka was not allowed to find its own level in the market. Everybody had the feeling that the market was not suffering from any supply-demand mismatch. Adding to that, banks started to shift current payment obligation to future, by opening deferred payment L/Cs.

This created twofold problems. First of all it created a huge problem of liquidity. As the deferred L/Cs started to mature, it created additional pressure on the outflows. As a result, the situation has become such that there is no price available for USD against BDT. Even if someone is willing to pay taka 80, there is no guarantee that he would be able to have his desired amount. Secondly, it destroyed the transparency of the price level. As the USD/BDT inter-bank rate was not allowed to rise, a separate -- and totally against the spirit of a healthy inter-bank or money market -- and non-transparent market evolved where USD is being traded indirectly through other currencies like EUR, GBP etc. At present USD/BDT inter-bank rate is about 67.80/90 levels and the volume is really very thin, whereas USD is being effectively traded at 74/75 level through other currency route. This has confused everybody and has added to the liquidity crisis. More over is not reflective of the true market scenario.

Often, we tend to forget the bigger purpose of adopting the principles of market based floating exchange rate. We have accepted market based floating exchange rate system, as it would ensure optimum allocation of resources. If the fuel price rise has created supply-demand imbalance in our economy, we have to depreciate our currency to correct that imbalance. Otherwise, the outflows from the economy would continue to be encouraged while the precious inflows would be under priced and discouraged. As a result, the gap between supply and demand would continue to grow and will create a lingering crisis. By trying to artificially keep the USD/BDT rate low, we have encouraged more imports and other outflows and deprived our exporters and remitters from much-desired incentives.

All of these contributed to the chaos prevalent in the current market, where scrupulous speculators are taking undue advantage and resources have been shifted to undesirable sectors. We have adopted floating exchange rate so that we can bring transparency in the market. But, by deviating from the true spirit of the market economy and trying to artificially control the foreign exchange rate, we have just created more distortion in the market. An often-used excuse for controlling the exchange rate has been to check the inflation. This has little validity as inflation would go up anyway, and it did. The factor price for all inputs would be higher even if we let it be priced at lower exchange rate. The overall downside has been that, we have not been able to control the inflation rate with controlled foreign exchange regime or rate. At the same time, we have let lot of undue consumption to happen at much lower cost, even though the constituencies of those consumption could well afford that incremental cost. This deviation from market principle creates quite a bit of resource drag from sectors where they were much required.

The more important question that we now face is what actually will happen. The situation would continue to be bad, if we let the current market distortion to go on. Our policy makers have taken some good measures to control outflow. However, if we do not use exchange rate to control the outflow, this would not be very effective. So, if the market demands that BDT has to be depreciated, we have to allow that.

The more we would try to control, the longer the period of illiquid situation would prevail, the more we would see price distortion in the market. If we would let USD/BDT to operate freely, it would come into a stable equilibrium level. At some point the rate may even correct itself in a way of BDT appreciation (what we get to see in Sri Lanka, Pakistan or even India).

The important thing for us is to ensure that market has sufficient liquidity and there is no distortion in prices in the form of various level of exchange rate. For the greater interest of the market, we must be able to say good bye to this 'alternate market' which incidentally is becoming the mainstream market, reflecting the true but underlying market situation.

In the longer term export and remittance has to grow to meet ever-increasing demand for growth financing in Bangladesh. In other countries, in the interim commercial borrowing is supporting this. Since our development partners are reluctant to let Bangladesh borrow from the international market, they should seriously think of funding Bangladesh's import of fuel, especially for the increased price and allow private sector other than Bangladesh Petroleum Corporation (BPC) to enjoy the benefit of higher exports and higher remittance, though not high enough to support $1 billion additional fuel import cost.

The writer is a banker.