Foreign bill payment in taka: A potential game-changer?

Bangladesh has very recently made its first payment in the local currency, taka, for a predominantly foreign loan-funded project — indicating a possibility of being quite a game-changer. 

The project in question involves the construction of a 24-kilometre elevated expressway connecting Dhaka to Ashulia, with an estimated cost of Tk17,653 crore (approximately $1.2 billion). 

China is providing 85% of the funding as a loan at a 2% interest rate, repayable over 20 years, including a five-year grace period. The Bangladesh government is financing the remaining 15%.

The Export-Import Bank of China is paying the loan part in US dollars to the Chinese contractor, China National Machinery Import & Export Corporation, which is implementing the project. The Bangladesh government will reimburse the bank.

Media reports suggest the Bangladesh government has convinced the contractor to accept the 15% in taka as they will have some spending to do in Bangladesh.

This method is aimed at preserving the foreign exchange reserves of Bangladesh, which have been declining sharply due to the impact of the Covid-19 pandemic on exports, remittances, and imports. 

According to Bangladesh Bank data, the foreign exchange reserve dropped to $29.92 billion on 31 May from $42.20 billion on the same day last year. According to the International Monetary Fund formula, Bangladesh's foreign reserves stand at $26.3 billion.

There has been considerable buzz associated with this development as many believe this can help preserve Bangladesh's foreign reserves without slowing down vital development work. But things are rarely this simple.  

Before Bangladesh, several other countries also adopted similar approaches, if not exactly the same method, in recent years, providing valuable insights for us.

In 2009, Brazil's state-owned oil company, Petrobras, issued bonds denominated in Brazilian reals to finance its investments. This move helped the company reduce its exposure to foreign currency risk and contributed to developing the local bond market. 

However, the subsequent depreciation of the real against the US dollar increased the cost of servicing the debt for Petrobras, highlighting the potential risks associated with local currency financing.

In 2016, India's National Highways Authority (NHAI) issued masala bonds, which are rupee-denominated bonds issued in international markets. This allowed NHAI to raise funds for infrastructure projects without increasing its foreign currency debt.

These examples highlight the importance of maintaining a stable local currency to minimise the risks associated with local currency financing. Bangladesh must ensure that its macroeconomic policies support the stability of the taka to maximise the benefits of this approach.

Another important conclusion is that the development of local bond markets, which offer an alternative funding source for infrastructure projects, has contributed to the success of local currency financing in these nations. Bangladesh could consider developing its bond market to facilitate local currency financing for future projects, which at the moment is almost nonexistent.

There are quite a few pros if this can be pulled off successfully. Firstly, the preservation of foreign currency reserves. Bangladesh aims to better preserve its foreign currency reserves by making payments in the local currency.

"Since taka is our own currency, we don't have to buy it from anyone or use up our export earnings. Since we are going through a crisis because there is a shortage of dollars, if this strategy can be replicated in other projects, that would be even better," explained Abul Kasem Khan, director of the Federation of Bangladesh Chambers of Commerce and Industry (FBCCI).

But this approach is not without its limitations.

One of the biggest issues is this approach can be adopted in a handful of scenarios, limiting its effect on the economy. Experts don't think this will have a big enough impact on the dollar crisis.  

"We should not get too excited. This strategy has limited possibilities. Foreign contractors will only accept this approach in specific cases. We will not be able to use this method in loan repayment either, which is putting a lot of pressure on our foreign reserves," said Dr Zahid Hussain, former lead economist of the World Bank Dhaka office.

One major caveat to the success of this approach is it depends on the willingness of foreign contractors to accept payments in the local currency, which may not always be the case. 

"Foreign contractors may not always be interested in receiving payments in taka. They will only be doing so whenever they have to source something from Bangladesh, be it raw materials or labour. Otherwise, what is the use for taka they have?  There are only a handful of projects like that," warned Dr Hussain.

This type of payment will be effective in construction projects where things like bricks, rods, cement, and other building materials are procured locally. In import-based projects "taka will be of no use to the project. For example, in projects like the Roopur Nuclear Plant, taka will be of little use since the contractors will be paying in dollars," elaborated Dr Hussain.

Increased use of the local currency for large-scale projects could put upward pressure on inflation if not managed carefully. "We should be careful about whether this creates inflationary pressure," said Abul Kasem Khan.

Successful implementation of this method in other projects can ensure reduced dependency on foreign currency. This strategy reduces the country's reliance on foreign currency for infrastructure projects, potentially making it less vulnerable to fluctuations in exchange rates. 

Dr Zahid Hussain believes despite its limitations this move indeed has benefits for Bangladesh and it can "ease pressure on our foreign reserve."

This strategy might also go on to encourage local spending. Paying in taka may encourage foreign contractors to spend more within Bangladesh, boosting the local economy and creating jobs.

According to Abul Kasem Khan, "The foreign contractors also need taka to make payments here. If there is demand for taka created among them, the value of taka will also rise, as the value of any currency depends on supply and demand. So, this will help make taka stronger."

This may also increase the ease of doing business in some cases. A contractor who is paid in dollars is brought in using taka. "If they have to pay local workers in taka, they would have to go through the process of converting the dollar back into taka. This step will now be eliminated," said Dr Hussain.

The experts agree that if this method can indeed be used in other projects, it can have a long-term positive effect on the economy as a whole.

Demonstrating the viability of this method could strengthen Bangladesh's bargaining power in negotiations with foreign contractors and lenders, potentially leading to more favourable terms for future projects.

As things stand, the long-term success of this approach will depend on the stability of the local currency and whether the foreign contractors are willing to accept payment in taka. 

If widely adopted, this method could usher in a new era of infrastructure financing, allowing us to continue pursuing vital projects while keeping our reserves healthy.