Letting the market dictate dollar rate: The questions it raises

On Thursday, as LC settlements climbed to a record Tk110 per dollar, Bangladesh Bank Governor Abdur Rouf Talukder told journalists that the dollar prices would become stable in two to three months. According to him, the trade gap in July has reduced significantly and a rise in inward remittances is giving the economy breathing space.

He also said that since there is a demand for letting the interbank exchange rate be determined by the market, the Central Bank will go in that direction when the market becomes stable.

Even though Bangladesh Bank committed to a floating exchange rate in 2003, it still intervenes in fixing the exchange rate.

So what has kept the financial watchdog from implementing a floating exchange rate? To learn more about the implications of such a move, The Business Standard has spoken to two eminent economists.

'The situation is quite unstable now. It's difficult to say what is going to happen tomorrow'

Zahid Hussain, former lead economist of the World Bank, Dhaka office

Bangladesh Bank is hoping that within two months the trade deficit will decrease. This hope is based on things like: a trend of prices going down can be seen globally, there are signs that the measures the government has taken to cut imports are working and remittance inflow is going to rise, and although there are signs of an economic depression in Europe and America, it won't affect our exports based on the fact that exports rose in July. They are hoping that after the trade deficit decreases, the demand for dollars will go down and the market will become stable.

But the question remains whether we can make a complete turnaround in two months, if only the trade deficit shrinks. The gap is quite big as well; how much it will decrease that also remains to be seen.

It is clear that as long as the pressure created on the dollar market lasts, we will try to stabilise the dollar rate by interfering. But economists have said that in order to stabilise the dollar rate we have to let it float, because we don't have enough reserves at hand. By just giving out orders over the telephone and selling a limited amount of dollars to government banks for making LC payments for essential goods we can't stabilise the forex market.

The Bangladesh Bank has fixed the LC rate at Tk97, but it is not always possible for banks to follow that rate.Reports say that the actual LC rate is Tk110 per dollar. But the information available regarding the announced rate for banks on the BB website says the rate is much lower. Banks report a rate that ballparks the figure provided by BB, however, newspapers report a different story, so the situation is a little muddy in this regard. So assuming the market can be stabilised this way is not logical to me.

Money exchangers are not a very big market when it comes to dollar trade. There have been raids on them and the licences of 5-6 money exchangers have been cancelled. Some are not even opening their shops because they don't have any dollar or because they are afraid. The rate decreased a little but is there any transaction going on in the markets at all? 

Suppose there is one transaction where the dollar is sold at Tk107 then newspapers will report that dollar price has gone down because the BB is being strict and has increased market monitoring. But I believe transactions in this market have massively gone down due to these measures. This can be compared to cutting down the head because of a headache.

Our main problem is the demand for dollars is much higher than the supply. Either we have to increase the supply or decrease the demand. If we increased the rate the demand would have gone down. 

Bangladesh Bank is also not removing the interest rate cap. If we did that, it would have helped us control both the inflation and stabilise the exchange rate. 

The dollar rate was floating for many years, and we did not see crises like this. Back in 2009-10 when the price of food and oil went up then the price of dollars increased but we still did not have to resort to the draconian measures we are resorting to now. Last year Bangladesh bank sold more than $660 crore; instead of doing that, if they let the rate adjust little by little, now there would be no need to make such a big adjustment in so little time. Instead, we tried to keep the dollar rate fixed because we thought we had plenty of reserves and now we are paying the price. This is pent-up depreciation. 

If the European and American economy goes into recession, if China's growth slows down, the demand for commodities in the global market will fall automatically. This will benefit us as import costs will go down but it will have an impact on our exports as well. So what will happen to our balance of payments is difficult to say.

The situation is quite unstable now. It's difficult to say what is going to happen tomorrow. So whether what they are hoping comes to fruition remains to be seen.

'You cannot leave the exchange rate to the market while holding on to a fixed interest rate regime'

Ahsan H Mansur is the Executive Director at Policy Research Institute of Bangladesh

The Bangladesh Bank governor has stated that the market will take 2-3 months to stabilise and then he hopes to take the decision to leave the exchange rate to the market. It is obviously a positive statement and is grounded in the current economic reality of the country. 

But two months is a long time when it comes to economics and a lot of things might happen within this period. The central bank needs to be prudent in its short-term management of the economy. But if the central bank fails to stabilise the economy within this period, there's always the risk that things will get worse, given the inflexibility of exchange rates.

Another thing that needs to be left to the market is the interest rate. You cannot leave the exchange rate to the market while holding on to a fixed interest rate regime. You need to influence the exchange rate with monetary policy instruments like the interest rate. 

But Bangladesh Bank wants to keep the lending cap. This policy is inconsistent with global practices. Usually, most countries around the world use monetary policy instruments to control the value of the currency, i.e., the exchange rates. The interest rate is a crucial monetary policy instrument that remains under-utilised under the current policy and makes it difficult to manage the exchange rate.