Dollar dynamics: Stabilising Bangladesh's currency in turbulent times

The ongoing dollar crisis in Bangladesh is significantly impacting our economy across several sectors. The import-dependent nation is experiencing economic hardship as global prices for fuel oil and other commodities surge, leading to nearly double-digit inflation and depleting foreign reserves. 

With the reserves dwindling, the government has curtailed non-essential imports and limited dollar supply to banks, leading to a decline in new letters of credit (LCs) by 14%, leading to defaults in payments by 9%. 

This scenario has placed medium-sized importers in a precarious position, with the inability to secure new supplies, threatening their financial stability.

The crisis is also affecting large businesses, with instances of goods being stranded at ports due to banks' inability to settle dollar payments, leading to substantial demurrage costs. Private power producers are facing a shortfall of $1 billion needed for fuel oil imports, risking an energy crisis. 

Moreover, the delays in dollar settlements are causing reputational damage, with the potential of a credit rating downgrade by agencies like Moody's (A US-based international credit rating agency), which has already placed the country's ratings under review for downgrade. 

A reduced credit rating would increase import costs for banks as they would have to pay higher commissions for letters of credit confirmations. This situation reveals a cascade of economic challenges triggered by the dollar shortage, affecting trade, inflation, creditworthiness, and ultimately the livelihoods of citizens and businesses alike. 

The ongoing dollar crisis in Bangladesh has multi-faceted causes. Primarily, the taka's value has been decreasing against the dollar for months, with the exchange rate collapse inducing panic in the foreign currency market. 

This depreciation makes imports more expensive, contributing to inflation and signalling macroeconomic instability. Additionally, while a weaker taka theoretically promotes exports and remittances, these have not risen sufficiently to counterbalance the growing import bills, exacerbating the current account deficit. 

Foreign reserves have dwindled by $7 billion since August 2021, heightening the risk of a financial crisis. 

The government's intervention in the exchange rate has led to a scenario where the taka's value has been artificially high, harming the competitiveness of exports and the flow of remittances. 

If the central bank had adhered to an econometric model reflecting these economic realities, the market would not have faced such fluctuations. 

Instead, policy measures have been reactive rather than proactive, failing to maintain a steady real exchange rate index that would support the country's balance of payments and foreign reserves​.

In the face of the ongoing dollar crisis exacerbated by the aftermath of the Covid-19 pandemic and the Russia-Ukraine War, the government under the farsighted leadership of Prime Minister Sheikh Hasina has been exploring robust strategies to mitigate the impact on its economy. 

The other day, I attended a daylong brainstorming session organised by Bangladesh Institute of International and Strategic Studies (BIISS) addressing the country's ongoing economic crisis. 

In regard to strategic solutions, all agreed that the government must implement a multipronged approach, combining short-term stabilisation measures with long-term structural changes to diversify away from the US dollar, ensure the stability of the foreign exchange market, and maintain economic growth. 

These economic challenges underscore the need for Bangladesh to rapidly implement strategies to stabilise its currency, diversify its economy, and seek alternatives to the dollar for its international transactions. 

The impacts are widespread, from individual businesses to the national level, and the solutions will require coordinated efforts across the government and private sectors. 

For immediate relief, the government could implement several measures. These include the establishment of a separate fund for government imports like fuel, which would be allocated to banks solely for settling these import transactions, thereby reducing the private sector's demand for dollars. 

Reducing the Export Retention Quota (ERQ) to 5-10% of repatriated proceeds for exporters and adjusting the Net Open Position (NOP) of banks could also improve the liquidity of foreign currency in the market. 

Additionally, the Bangladesh Bank could inject $1-2 billion from reserves to stabilise the market and control panic-buying of dollars. 

Other measures include devaluing the taka to reflect the market rate realistically, judiciously using forex reserves, and improving remittance flow through formal banking channels. 

Moreover, luxury imports should be curtailed to conserve foreign reserves, and measures to boost remittance flows through official channels must be taken. 

Finally, Bangladesh should consider establishing links with the commodities market for long-term supply contracts and enhance its capacity in international trade​​. 

In the longer term, Bangladesh Bank is looking into alternative payment mechanisms, including with countries like Russia, to circumvent the challenges posed by sanctions and the Swift ban. 

This involves proposals for trade in national currencies and the consideration of barter systems or even cryptocurrency transactions, which Russia has been employing with countries like Brazil and Indonesia. The use of the Chinese Yuan is also being considered as an alternative to the dollar and euro​.

Beyond bilateral mechanisms, there's an ongoing effort to leverage currency swaps as a quasi-barter system for trade settlement. Bangladesh's central bank has reportedly engaged in currency swap arrangements with Russia, allowing for credit facilities in local currencies between central banks to facilitate payments for exporters and importers. 

This system can enable trade even when traditional banking relations are inactive or strained due to external factors such as international sanctions​. 

The promotion of exports through the exploration of new markets and diversification of products is also on the agenda. Bangladesh has historically relied on credits for procuring inputs and cash payments for exports. 

However, the financial crises have necessitated exporting goods on credit under sales contracts without LCs. The development of financial instruments like UPAS (usance payment at sight) LCs, which work as buyer's credit, has been a part of adapting to these changing financial conditions. 

This helps in settling import bills for inputs needed for major export items like ready-made garments, which are heavily reliant on imported raw materials​. 

Each of these measures, while complex and multifaceted, contributes to a broader strategy to reduce Bangladesh's dependence on the US dollar and build resilience against global economic shocks.

These strategies are aimed at providing immediate relief to the foreign exchange market and re-establishing stability, which is vital for business confidence and macroeconomic stability. 

It's important for the government to be proactive, especially since inflationary pressures disproportionately affect the poor and low-income groups. The success of these initiatives will depend on careful implementation, international cooperation, and the continuous monitoring of global economic trends.

Defective policymaking has also played a critical role in the growing crisis. Despite a nominal commitment to a floating exchange rate since 2003, the Bangladesh Bank has continued to heavily manage the exchange rate without being driven by economic rationales. 

This misalignment with economic fundamentals has resulted in sudden shocks and volatility in the financial market. The real effective exchange rate index's rise from 100 in 2016 to 115 by October 2020 reflects the central bank's failure to devalue the taka in line with higher domestic inflation relative to the US, damaging exports and remittances. 

The finance ministry's introduction of incentives to boost remittances has been somewhat of a patchy solution that has failed to address the underlying issues of supply and demand forces in the currency market​​.

However, this crisis is not just a reflection of internal economic policies but also of the broader global economic environment, including the impact of the Covid-19 pandemic and the Russia-Ukraine conflict, which have disrupted trade and financial flows globally. The combination of these external pressures and internal policy missteps has led to the current dollar shortage in Bangladesh. 

Addressing the dollar crisis in Bangladesh requires a nuanced understanding of the financial ecosystem and a multi-dimensional approach that balances immediate relief with strategic long-term reforms. 

Here are some additional measures and considerations that could be integrated into a comprehensive solution. To boost foreign currency reserves, Bangladesh could streamline processes and offer incentives for Foreign Direct Investment (FDI), attracting international businesses and investors. 

Export base should be diversified.  Expanding beyond traditional export goods to include sectors like information technology, pharmaceuticals, and services can provide a hedge against global commodity price fluctuations. 

Financial regulations should be strengthened and financial literacy should be enhanced. Ensuring that financial institutions are well-regulated can prevent market manipulation and speculative trading that may exacerbate currency volatility. 

Educating businesses and the populace on foreign exchange risk management can lead to more informed decisions that support currency stability. Developing tourism as a foreign exchange earner can diversify income sources and reduce reliance on remittances and exports. 

Exploring favourable trade agreements with key partners could help improve the balance of payments. Calibrated interest rate policies might attract foreign capital, stabilising the currency. And international aid and loans must be properly utilised, because strategically leveraging international financial support can provide a buffer while structural adjustments take effect.

All these measures should be tailored to the unique economic landscape of Bangladesh, considering both the short-term need for stability and the long-term goal of sustainable growth. Professional and considered economic policymaking, transparent governance, and international cooperation are key to navigating the current crisis and securing economic resilience.

Dr Rashid Askari is a bilingual writer, academic, translator and former vice chancellor of Islamic University Bangladesh. Sketch: TBS

Dr Rashid Askari is a bilingual writer, academic, translator and former vice chancellor of Islamic University Bangladesh.