How BB’s floating rate regime calms forex market

Highlights:

• Taka stable after switch to floating exchange rate in May
• Strong remittance inflows boosted reserves, no dollar intervention needed
• Banks' dollar holdings doubled; interbank market volume rose sharply
• Foreign reserves climbed $6 billion; IMF loans boosted international confidence
• Annual remittance hit $30 billion; money laundering curbed post-government change
• Increased liquidity lowering interest rates; supports imports, lending, economic growth

Bangladesh's foreign exchange market has shown remarkable stability over the past one and a half months, following the Bangladesh Bank's (BB) adoption of a floating exchange rate regime on 14 May. This resilience is largely attributed to a strong inflow of remittances through official banking channels, confounding earlier concerns of a sharp depreciation.

Despite initial worries that greater exchange rate flexibility would trigger a temporary slump in the local currency, the market responded positively. The Taka has seen a slight appreciation, driven by improved dollar availability. Central bank data reveals the interbank exchange rate dropped to Tk122.75 per dollar on 26 June, down from Tk122.96 on 29 May. Similarly, the remittance rate fell to Tk122.50 in June from Tk123 in May.

No intervention needed as dollars flow in

A senior Bangladesh Bank executive confirmed that the central bank was prepared to intervene with dollar support to counter any exchange rate manipulation attempts. However, no intervention proved necessary over the past one and a half months as robust remittance inflows coupled with subdued private sector demand maintained rate stability.

In fact, the Bangladesh Bank actively purchased dollars from commercial banks amid the high influx of remittances, a move that significantly contributed to rebuilding the nation's foreign exchange reserves. Central bank data indicates that banks' dollar holdings surged to over $1 billion after Eid, a substantial increase from approximately $500 million previously.

The transition to a free exchange rate has also revitalised the spot market, with daily interbank transactions now exceeding $50 million, a considerable leap from just $5 million a few months ago.

Reserves climb, international confidence boosted

The Bangladesh Bank's adoption of a floating exchange rate regime aligns with a key recommendation from the International Monetary Fund (IMF), aimed at bolstering the country's foreign exchange reserves. This strategic shift has already yielded positive results, with reserves increasing by nearly $6 billion over the past month.

According to central bank figures, Bangladesh's foreign exchange reserves reached $26.32 billion as of 29 June (as per the IMF's BPM6 calculation), a significant rise from $20.56 billion on 29 May. This level is now sufficient to cover nearly five months of imports.

The release of pledged funds from various multilateral agencies – including the IMF, Asian Infrastructure Investment Bank (AIIB), Asian Development Bank (ADB), Japan International Cooperation Agency (Jica), and the World Bank – has further underpinned this reserve rebuilding effort. The IMF's approval of its fourth and fifth loan tranches, following the Bangladesh Bank's commitment to a floating exchange rate, instilled confidence among other international agencies, encouraging them to disburse their promised funds.

Remittance surge and strategic timing

Furthermore, Bangladesh received a remarkable $30.04 billion in remittances in the just-concluded FY25, an increase of over $6 billion compared to the previous financial year. The central bank attributes this surge to a reduction in money laundering activities following the change in government on 5 August last year.

Bangladesh's experience contrasts sharply with Sri Lanka's, which faced considerable volatility after implementing a free-floating exchange rate under its own IMF programme. In 2023, the Sri Lankan rupee initially depreciated sharply – from 200 to 363 per dollar – before stabilising below 300 in 2024 as reserves recovered.

Bangladesh Bank Governor Ahsan H Mansur recently remarked that choosing the right timing to introduce greater exchange rate flexibility was crucial in avoiding abnormal fluctuations. The central bank strategically implemented the floating regime just ahead of Eid in May, a period traditionally associated with high remittance inflows, which helped cushion the initial impact.

Positive ripple effects across the economy

The substantial $6 billion increase in foreign exchange reserves is set to significantly enhance local currency liquidity for the government, as explained by the senior Bangladesh Bank executive. He indicated that the central bank plans to inject nearly Tk73,000 crore – equivalent to the additional $6 billion – into the economy. This injection is expected to help the government bridge its revenue shortfall and ease interest rates within the banking sector.

Even with a potential rise in private sector credit demand, the official believes the impact on interest rates will be limited due to the increased availability of local currency. Moreover, improved dollar liquidity will empower banks to expand their import financing.

Central bank data shows that monthly imports, which had remained below $5 billion for the past two years, have now climbed to over $5.5 billion in recent months, thanks to the greater dollar availability.

The official also anticipates a decline in interest rates on government treasury bills and bonds – which had been on an upward trend – as the government's need to borrow from banks diminishes with improved liquidity. Interest rates on treasury bills and bonds peaked at 12.24% on 16 June, an all-time high, but had already dropped to 12.03% by 22 June, a downward trend expected to continue. As government borrowing costs fall, banks are likely to reallocate more funds towards private sector lending, thereby fostering business expansion.