Why BB retains high exchange rate by buying dollars despite high inflation
Fed rate cut is expected to create more space for BB to buy dollars for reserve building without impacting inflation
Despite strong appreciation pressure on the taka from rising dollar inflows, the Bangladesh Bank (BB) has kept the exchange rate elevated by purchasing dollars from commercial banks since July, even as inflation remains stubbornly above 8%.
The central bank has bought $1.88 billion since 13 July, injecting nearly Tk23,000 crore into the market to hold the dollar above Tk121. This has lifted foreign exchange reserves to over $26 billion — enough to cover nearly six months of imports — while offering support to exporters and remitters.
But the policy has done little to ease inflation, which has stayed high largely due to the taka's steep depreciation over the past two years.
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Why the central bank is buying dollars
The move is seen as less about suppressing inflation than about stabilising the exchange rate and rebuilding reserves.
"The main purpose of buying dollars is to build reserves and stabilise rates. The dollar supply in the market is now ample, but demand is weak," said Zahid Hussain, former lead economist at the World Bank's Dhaka office.
Industry insiders note that without intervention, the exchange rate could fall to Tk115, as banks are flush with dollars amid low investment demand. "The appreciation pressure on the taka is not driven by higher production or growth, but by stagnant investment," a senior BB official told TBS.
"Political unrest has kept investment low, reducing demand for dollars," the official added. He said allowing the exchange rate to fall would hurt exporters and remitters. Importers would gain little, as low investment demand is already reflected in negative growth in capital machinery and industrial raw materials.
Asked if BB's approach would fuel inflation, Zahid Hussain said, "Buying dollars injects additional taka into the system, creating excess liquidity. For example, purchasing $2 billion introduces roughly around Tk22,000 crore into the banking system."
"However, the credit growth has not increased significantly, which means this extra money remains largely within the banking system. Many banks are investing these funds in treasury bills and bonds," said the economist.
Meanwhile, the US Federal Reserve's 25-basis-point rate cut in September, lowering the federal funds rate to 4.00%-4.25%, is expected to give BB more room to purchase dollars.
The central bank executive explained that the rate cut will weaken the dollar globally, allowing BB to buy more dollars from the market without putting additional pressure on inflation.
He said BB is buying dollars to keep the exchange rate within a band prescribed by the IMF. The band is calculated based on the currencies of five major trading partners. When the exchange rate hits the lower band, BB intervenes by buying dollars; when it reaches the upper band, it sells dollars. The band is not disclosed to prevent market manipulation.
Enough dollars to meet import demand
He also noted that the exchange rate has not risen despite the dollar purchases, indicating sufficient dollars to meet import demand. Moreover, the rate has been gradually declining since July, when the dollar was nearly Tk123. In its latest auction on 22 September, BB bought dollars at Tk121.75.
The BB has used the situation as an opportunity to rebuild reserves, which will help maintain a stable exchange rate when pent-up demand emerges, the BB official said.
Imports of capital machinery have fallen sharply, reducing dollar demand. BB data shows that letters of credit (LCs) for capital machinery imports declined nearly 25.5% in FY25.
A private bank's treasury chief told TBS that with lower capital machinery imports, dollar demand has decreased compared to earlier periods.
Asked if BB's dollar purchases constitute artificial intervention, Zahid Hussain said the forex market now operates independently, unlike in the past when the bank fixed dollar rates.
Cenbank managed to stabilise exchange rate
The central bank's approach has managed to stabilise the exchange rate. Fahmida Khatun, executive director at the Centre for Policy Dialogue (CPD), said, "Purchasing dollars from banks via auctions is an effective tool to keep the exchange rate stable, benefiting remittance inflows and exports."
Fahmida emphasised that stability in the dollar rate is essential for imports, exports, and investment.
Zahid Hussain said, "If investment rises and the economy recovers in the coming days, dollar demand will increase rapidly, and the current reserves will help meet that demand."
He said if BB allowed the taka to appreciate by lowering the dollar rate during this period, import costs – especially for food – would decrease somewhat.
"One of the main drivers of rising inflation since 2022 has been taka depreciation. According to my estimates, roughly 50% of inflation in 2022–23 was due to the rising dollar price," he said, adding that if the dollar price falls too sharply, exports and remittances could be adversely affected.
Zahid Hussain concluded that BB faces a policy dilemma: it must build reserves and protect exports and remittances, while also controlling excess liquidity and curbing inflation. In practice, however, the central bank is prioritising the first objective.
Why inflation remains high despite a stable dollar
Inflation eased to 8.29% year-on-year in August, the lowest level in 37 months, aided by tight monetary and fiscal policies. However, it remains well above BB's target of keeping inflation within 6.5% for FY26.
A central bank official, speaking anonymously, said this is because lower international prices were not passed on to consumers. For example, energy and fertiliser prices declined globally, but the government did not adjust domestic prices, which helped reduce subsidy pressure.
Meanwhile, businesses had opened letters of credit (LCs) at above Tk124 last year, but with the exchange rate falling to Tk122–Tk121, they did not lower their prices, effectively earning more profit from the stable exchange rate.
The official expressed hope that the continuation of a stable exchange rate will help bring inflation closer to the expected level soon.
Real Effective Exchange Rate
Although the central bank has been buying dollars to counter appreciation pressure, the taka still appears overvalued by more than Tk4 in the REER (Real Effective Exchange Rate) Index.
The REER index – a weighted average of a country's currency against a basket of major currencies – rose to 103 in August, suggesting the exchange rate should be above Tk126. According to the central bank's monthly publication "Major Economic Indicators", the increase reflects a marginal loss of competitiveness for the taka in international trade, driven by unfavourable price differentials with trading partners.
The central bank executive, however, explained that price differentials are a minor factor, while the main driver of the index is the weakening of the dollar globally.
How businesses are being supported with an unchanged policy rate
The central bank executive said that raising the policy rate is one tool to curb inflation. However, BB has chosen to keep the policy rate unchanged as an alternative strategy to maintaining a high exchange rate.
Stable lending rates have helped businesses reduce costs, he added. BB plans to lower the policy rate once inflation falls to the expected level, ensuring that supporting exporters and remitters does not hurt importers.
The yield on 10-year Treasury bonds has dropped by 246 basis points over the past three months, falling below 10% for the first time in two years. In a recent auction, the interest rate on 10-year bonds stood at 9.89%, down sharply from 12.35% three months ago, signalling a likely fall in lending rates in the money market.
The central bank has kept its key policy rate at 10% to contain inflation while supporting economic stability.
How the Fed rate cut will help BB rebuild reserves
The Fed's rate cut is expected to influence central bank strategies worldwide. Interest rate reductions typically weaken the US dollar, as lower yields make it less attractive to foreign investors.
Following the announcement, the Dollar Index has shown signs of softening, with major currencies like the euro, yen, and pound gaining ground. This dollar depreciation is expected to continue, with two more cuts signalled for the rest of the year.
The central bank executive said Bangladesh stands to benefit, as a stronger performance of other currencies in the REER basket will enhance the taka's export competitiveness. He added that BB will be able to buy more dollars while maintaining a high exchange rate without fueling inflation. The move will also help rebuild foreign exchange reserves, as a weaker dollar is likely to increase short-term private sector inflows.
He noted that lower global interest rates will reduce debt-servicing costs for the government, easing pressure on the forex market.
What experts say
CPD's Fahmida Khatun said, "The central bank always tries to keep the dollar market stable. Sudden fluctuations in the dollar rate can create problems for the economy. At the same time, the rate should be maintained at a level that ensures importers do not face difficulties, keeping a balanced approach."
She said, "The dollar rate has been left to the market, and efforts are being made to make it market-based. By purchasing dollars through auctions, the central bank is also increasing reserves. This method is used in other countries like India. When a dollar shortage arises in the market, the central bank will release dollars. This way, the market is kept relatively stable."
"Gradual increases or decreases in the rate are fine, but sudden spikes or drops are harmful to the economy, as such changes make the market more volatile," Fahmida added.
