Cenbank races for IMF's $3b reserve goal by June

The Bangladesh Bank needs to rebuild more than $3 billion foreign exchange reserve in four months by June as per performance criteria set by the International Monetary Fund (IMF) to get the second tranche of the $4.7 billion loan package – a task made difficult by the fact that the country's financial accounts have gone negative first time in recent history.

The IMF set the floor on net reserves at $24.46 billion for June – when the lender will conduct the first review of the performance criteria of the central bank.

The net reserve will have to be calculated according to the new formula prescribed by the IMF. According to the central bank data, Bangladesh now has a $20 billion-plus net reserve if the new formula is applied.

This net reserve amount is readily available for intervention in the foreign exchange market and can cover imports for three months if monthly import bills remain within $6 billion. A country is considered in a comfort zone if it has enough forex reserves to cover imports for the next three months.

However, the Bangladesh Bank committed to the Washington-based lender that it will improve its net reserve to four months' of prospective imports by FY26 through prudent aggregate demand management policies, increased exchange rate flexibility, and structural reforms to bolster competitiveness, according to the IMF country report on loan approval for Bangladesh.

The central bank also committed not to engage in foreign currency lending and has already reduced the export development fund from the forex reserve as part of the promise. The Bangladesh Bank also committed to phase out foreign currency lending under this fund gradually.

The Bangladesh Bank has already cut down its monthly import expenditure to $5 billion in January this year, which was above $7 billion until September last year, central bank data shows.

Opening of new LCs (Letter of Credit) dropped to $4.9 billion in January, signalling that foreign payment will continue to decline in the coming months when the LC settlement period comes.

Even with the fall in imports, building a $3 billion reserve in the next four months is difficult for the Bangladesh Bank as the financial account, which helps to build up the reserve, is in negative territory.

A country makes its foreign payments from the current account balance. If the current account balance becomes negative, it makes payment from the financial account and if this account also becomes negative, then the forex reserve becomes the last option for payment.

The four major components of a current account are goods, services, income, and current transfers.

On the other hand, a financial account is a component of a country's balance of payments that covers claims on or liabilities to nonresidents concerning financial assets. Financial account components include direct investment, portfolio investment, and reserve assets.

Bangladesh's financial account posted a $1 billion deficit in July-December of the current fiscal year, a rare incident for any nation, from a nearly $7 billion surplus in the same period of the last year, according to Bangladesh Bank data. 

The Bangladesh Bank in its annual report for FY22 commented that "a higher trade deficit than the inflow of remittances and lower inflows in the capital and financial accounts led to falling in the foreign exchange reserves."

Huge outflow from the capital market amid high currency depreciation and low capital inflow put the financial account in negative territory. Net foreign portfolio investment remained negative since the last year, which means investors sold shares more than injected funds.

The net foreign portfolio investment was negative $30 million in the July-December period of the current fiscal year which was negative $80 million in the same period of the last fiscal year, central bank data shows.

Foreign loan inflow in the private sector also slowed down due to rising payment costs amid currency depreciation and uncertainty in dollar rates. Long and medium-term foreign loans declined by 13% in the July-December period of the current fiscal year compared to the same period last year.

Against this backdrop, bankers believe net reserves will not build up until the financial account turns to positive territory. On condition of anonymity, several Bangladesh Bank officials said that it is very unlikely to meet the IMF performance criteria on maintaining the net reserve floor because of the negative financial account.

They said the forex reserve drastically eroded after the financial account turned negative as all payments had to be made from the reserve. Though the forex erosion stopped in February this year due mostly to import restrictions, it is still difficult to build up a $3 billion solid reserve in four months.

To build a solid reserve as per the IMF formula, they said the Bangladesh Bank needs to surplus the export and remittance earnings more than the import.  
 
Net reserve $20.63b, but how does the new formula calculate it?

The Bangladesh Bank has a gross reserve of $32.63 billion as of 8 February. But this figure is not acceptable to the IMF as the Fund says some of the components will have to be excluded from the gross reserve.

As per the IMF formula based on the Balance of Payments and International Investment Position Manual (BPM6), the Bangladesh Bank will have to exclude a total of $8 billion from the gross reserve.

The exclusion includes $6 billion of foreign currency loans to local banks known as the Export Development Fund (EDF), $2 billion deposits with state-owned local banks, deposits with IDB Group, fixed-income securities below investment grade, a loan to Sri Lanka and other foreign currency assets in non-convertible currencies.

If $8 billion is excluded as per the new calculation, the gross reserve stands at $24.63 billion.

The IMF says the central bank needs to further exclude the reserve-related liabilities to estimate the net reserve. Bangladesh's current reserve-related liabilities amount to $4 billion. If this amount is excluded, the net reserve will be $20.63 billion.

According to the IMF, reserve-related liabilities of the central bank are defined as the sum of the liabilities from Special Drawing Right (SDR) allocation; and all other outstanding liabilities of Bangladesh to the IMF with a maturity of less than one year; and foreign currency liabilities, with a maturity of less than one year, in convertible currencies to nonresidents, including liabilities to the Asian Clearing Union; the Japan Debt Relief Grant, the Foreign Currency Clearing Account, foreign currency swaps, and other futures market contracts.

Cenbank disregarded IMF reserve calculation 

The IMF introduced the BPM6 manual in reporting the reserve and balance of payment in 2012 under its Safeguards Assessments agreement – which applies to all members of the Fund.

Introduced in 2000, the Safeguards Assessments are diagnostic reviews covering five key areas of control and governance within central banks including the external audit mechanism, legal structure and autonomy, the financial reporting framework, internal audit mechanism and the internal controls system.

The IMF conducts its Safeguards Assessments mission every 12 years, as the policy's main objective is to mitigate the risks of misuse of resources and misreporting of data.

Following the launching of BPM6 in 2012, the Bangladesh Bank adopted it for balance of payment reporting but ignored the latest manual for reserve calculation. At that time, Atiur Rahman was the governor of the central bank.       

Therefore, the banking regulator continued forex reporting as per the BPM5 manual, which helped the central bank management show higher forex reserves, prompting the government to use it for different infrastructural projects.

Moreover, the inflated reserve calculation allowed the private sector to borrow from foreign sources which eventually increased the country's external liabilities.

The private sector external debt surged from $10 billion in FY17 to $25.95 billion in FY22, scaling up repayment pressure on the reserve. Though private sector foreign loans increased substantially over the years, the central bank did not make any payment schedule to assess the future payment pressure.

Now as the forex crunch intensifies, relevant departments of the central bank are collecting data from banks to make payment schedules and to assess the prospective repayment pressure in the upcoming months, according to Bangladesh Bank sources.

The huge outflow of foreign currency through private sector debt servicing also accounted for the negative financial account, said central bank officials on condition of anonymity.

After Atiur, the next central bank governor Fazle Kabir also avoided the BPM6 for reserve calculation, making the Bangladesh Bank a contributor to the current forex crisis.

During the Safeguard Assessment mission to Bangladesh in 2021, the IMF raised its objection to the reserve calculation, claiming that the central bank was overstating its foreign exchange reserves by $7.2 billion.

The multilateral lender then said the overestimation might misguide the government in taking decisions about using the reserve.

The foreign exchange reserve of $46 billion as reported at the end of June 2021 – when the IMF report was prepared – was overstated by 15%, said the IMF, adding that actually, the forex reserves would be $39 billion.
 
Export, remittance surpass import

The inflow of export earnings and remittances surpassed the import spending in January due to the drastic move by the Bangladesh Bank to slash the import bills.

In January, total export and remittance earnings were $7 billion as the import payment stood at $5.4 billion, according to the Bangladesh Bank data.

The LC opening value in January was $4.9 billion, far below the previous $1-$2 billion higher monthly import costs than the sum of export and remittance earnings.

As a result, the gap between inflow and outflow narrowed to $1.9 billion in the July-January period of the current fiscal year from $5 billion in the same period of the previous year.

Though declining imports reduced pressure on the balance of payment by improving the forex market liquidity, the situation may not last long as businesses are already facing precarious consequences as they could not import raw materials to continue operations.

On the other hand, though the Bangladesh Bank cut down the import by increasing LC margins for non-essential items, it committed to the IMF to reverse the measures by December this year, according to the IMF country report on loan approval for Bangladesh.