How keeping taka's value artificially high fuelled inflation

The dollar index was at year's highs for most days of October and November. The exchange rates of other major currencies in the world also rose around the time the greenback got stronger. Currencies such as yen, pound, and euro lost their value at that time.

An analysis of available data shows that on 27 September, the US dollar was in its strongest position this year. The pound and euro had their weakest day of the year on almost the same day.

Countries including China, Japan and India also saw their local currency's weakest day in October. Even Pakistan, a weak economy, has consistently devalued its currency in an attempt to adjust with the dollar. The country also saw the lowest value of its currency in September.

The dollar started to weaken in the last week of November and since then the dollar has continued on the trend. On the contrary, currencies such as the pound, euro, and yen have started to regain their lost value.

But, Bangladesh is an exception in this regard.

While currencies other than the US dollar are regaining their values, taka has continued on its weakening streak. Taka had its weakest day in 2022 on 23 December.

Taka lost 21.88% value in 2022. On the other hand, the pound lost 11.85%, euro 6.04%, yen 15.49%, yuan 9.23%, Indian rupee 11.37%, Pakistani rupee 28.15%, and the Vietnamese dong lost 3.53% value in the year.

The US dollar gained value by 7.5% at the end of December compared to the beginning of the year. In other words, the dollar has gained by almost three times as much as taka has lost value.

Economists say one of the reasons for this situation is artificially keeping taka's value higher for a long time.

Though the dollar started to strengthen at the beginning of 2022, the central bank opted for not devaluing taka until April and then tried to maintain taka's value by making small depreciations until August, allowing banks to trade dollars at a much higher rate.  That led to total mismatch in foreign exchange market with the dollar rising to Tk113-114 in the formal market and even Tk120 in the kerb market. Slower growth in export and remittance against surging imports led to a demand-supply imbalance in the exchange market. That is what is causing Bangladesh to suffer now, observe economists.

Besides, due to the sudden reduction in the value of taka, the businessmen who had previously taken loans in dollars from local and foreign banks, now have to buy dollars at a much higher price to repay their loans. As a result, many of them become defaulters by losing their ability to repay loans.

Again, many importers had deferred dollar payments for imports made during the Covid pandemic. They also sold the imported goods adding profit to the purchase price. Now they have to spend at least Tk20-22 more per dollar to settle import payments. At the end of the day, it is the end users who have to pay for the increased import costs and inflation is increasing.

The Bangladesh Bank, however, is citing price hikes of goods in the international market rather than the rise in dollar exchange rate for high inflation in the country.

An official of the Bangladesh Bank on condition of anonymity told TBS, "Inflation is happening all over the world because of an increase in the prices of goods in the international market and Bangladesh is not out of it. As our imports are much higher than our exports, keeping the currency strong benefits the import sector. Above all, this keeps inflation in check. Again, due to the devaluation of taka now imports are being discouraged and exporters are benefiting."

The official also claimed that the sudden devaluation of the local currency did not have much effect on increasing inflation.

According to this official of the central bank, the values of almost all major currencies of the world have decreased against the dollar and the same has happened with taka.

Claiming that the different rates of the dollar are not harming the country's foreign currency inflows, he added that now a good rate is being given for the dollar in various sectors including remittances. Besides, a separate 2.5% incentive is being given on remittances, he continued.

But, Zahid Hussain, former lead economist of World Bank's Dhaka office, has said the crisis is intensifying due to separate exchange rates of the dollar in the local market.

"Why will there be different rates of dollars? There are currently four different rates for the US dollar. Due to this, the country's economy is adversely affected. Many businesses are suffering because of the dollar crisis," he said.

The economist said that the country is receiving at least $500 million less in remittances each month because the dollar rate in case of remittances is kept lower than the market rate.

"Remittance inflows were much higher before the dollar rate for remittances was fixed in September. It is natural that a fall in the dollar rate with other factors remaining the same as before will lead to reduction in remittance inflow. The case of Bangladesh's declining remittance receipts is a classic example for economists. This is also a lesson for us."

According to data provided by the central bank, over $2 billion in remittances came to Bangladesh in each of the first two months of the current financial year, but the figure dropped to $1.5 billion in the following three months.

Zahid Hussain said that the value of taka should be left to market demand and supply, adding, "If the dollar rate is based on the market, there will be an adjustment in demand and supply. If there is a problem, the central bank can intervene. But market-based dollar rates seem to be the solution for now."

He also disagreed with the central bank's idea of adjusting the prevailing rates of the dollar gradually with the equilibrium rate of the market.

"Were the four different rates of the dollar set gradually? It is said that the ABB and Bafeda made these rates after getting instructions from the Bangladesh Bank. If the central bank calls them now, it will be effective from tomorrow.

"The problem actually lies with decision making. Once a decision is made, it can be implemented quickly. By not doing that, a lot of dollars are being sold from reserves, which is reducing our reserves."

The experienced economist believes that the dollar exchange rate should be left to the banks like loan repayment.

He, however, does not think that leaving the exchange rate up to the market will be the solution for sure.  

He said, "We have to focus on the areas from where our regular foreign exchange supply comes from so that the supply can be increased."

Former Bangladesh Bank Governor Salehuddin Ahmed agreed that the foreign currency market is suffering due to different rates of the dollar.

"Thus far, the central bank controlled the value of taka by buying dollars when there was an increased supply of dollars in the market and selling dollars from reserves when there was a crisis. For not letting the dollar rate to float, the value of our taka has gone down a lot in a very short period of time. The situation we are in today could be avoided if the value of taka had been adjusted gradually."

"The value of taka was artificially kept high to support imports, control inflation and project a false image that 'Bangladesh's currency is strong' to the world. Sri Lanka also tried, unsuccessfully, to maintain the value of the dollar by printing rupees. Currency value cannot be maintained by force, it can be managed to some extent. This mistake has been made by the Bangladesh Bank."

When asked what policy the central bank can take on foreign exchange, the former governor said, "The exchange for remittance has been kept low. This is not right. Different dollar rates cannot be maintained. The dollar rate should be allowed to free float. If problems arise later, the central bank can intervene if necessary. But it is not right to hold the rate like this."

In a blog post, IMF's First Deputy Managing Director Gita Gopinath and Research Department Director Pierre-Olivier Gourinchas suggest that the appropriate response is to allow the exchange rate to adjust, while using monetary policy to keep inflation close to its target.

"Temporary foreign exchange intervention may be appropriate. This can also help prevent adverse financial amplification if a large depreciation increases financial stability risks, such as corporate defaults, due to mismatches," they write. Though in rare circumstances a large exchange rate depreciation could de-anchor inflation expectations, monetary policy alone cannot restore price stability, the two IMF executives feel.

Tonmoy Modak is a Junior Staff Correspondent of The Business Standard.