Why is Bangladesh facing a dollar crisis while others are not?

"Please give us dollars. We cannot open Letters of Credit to import raw materials." The statement was made by a top businessman who is involved in diversified sectors - from steel to cement, textile, financial institution and others.

The situation looks bleak when we see drug makers facing the same crisis and saying they won't be able to produce drugs if the situation doesn't improve soon. Consumer products giants, who are the most sought-after clients by banks in normal times, are struggling to import essential commodities.

Even importers of some crucial medical products such as blood bags are not getting dollars to open LCs. Why? It doesn't require tens of millions of dollars to import those. Bangladesh needs only nine lakh bags per year, with each bag costing less than TK100, for a total of less than TK10 crore, or approximately $1 million. But banks are unable to provide this paltry sum.

Hundred percent import-oriented businesses are in desperation as they are not receiving any dollars, making it difficult for them to survive. Apart from a few exporters who have enough dollars to meet their own needs, businesses have been suffering from the lack of greenbacks for the last six months. Businesses fear that the situation may not improve even in the next few months, as the International Monetary Fund has asked the Bangladesh Bank to increase its foreign exchange reserves. This means that the BB may not be able to supply enough dollars to meet the demand.

In comparison to Bangladesh, India is managing its financial situation better even though they have similar economic indicators such as per capita income, proportionate GDP, and comparable exports and imports. Why is Bangladesh facing these challenges, even though the situation is far better than that of Pakistan and Sri Lanka?

The ongoing crisis has exposed several weaknesses in Bangladesh's financial management. The country has seen a decrease in its foreign exchange reserves and the local currency, the taka, has depreciated against the dollar by over 20% in six months, causing difficulties for businesses and importers who are struggling to acquire the greenback. 

Infographic: TBS

Why Bangladesh is feeling the pinch and others aren't

One major factor contributing to Bangladesh's financial crisis is the country's overreliance on imports and the lack of local production of raw materials and goods, putting a strain on the country's foreign exchange reserves.

Bangladesh has to import almost everything – from food grains to sugar, edible oil, spices, petroleum products, fertiliser, cotton, yarn, chemicals, machines, raw materials for all kinds of manufacturing units, spices and more. When the Russia-Ukraine war began in February last year, prices of commodities skyrocketed along with a disruption of the supply chain.

Consequently, Bangladesh's import bills for FY22 surged to $82.49 billion, a 36% growth from a year ago. In comparison, import has gone down significantly this year – less than $6 billion per month from an average of over $7 billion last year - and the prices of some commodities are on a decline. So what is the problem now? Why is the situation not improving yet? 

According to bankers, the pressure on foreign exchange is still there because of the payment obligations against the LCs they had opened several months ago.

Naser Ezaz Bijoy, CEO of Standard Chartered Bangladesh (SCB) and president of the Foreign Investors Chamber of Commerce and Industry (FICCI), said the good news is that new LC issuance has come down in recent months. But it may take a few more months to clear the payments against LCs issued before September 2022.

According to him, the next few months are crucial to ensure the stability in the foreign exchange market which will require maintaining the momentum of export growth in the face of the looming risk of recession in Europe and America.

Were BB measures enough and effective?

In May last year, the Bangladesh Bank first imposed restrictions on imports of some goods. It enhanced the margin for opening LCs at a minimum 75% for motor cars, home appliances, electronics and electrical products. For all other goods, the margin was set at 50% excluding baby food, essential food items and fuel, life-saving medicines, local and export-oriented industries and agriculture related products. Later, the LC margin was increased to 100% for some goods, such as motor cars.

Treasury bankers said the practice of restricting imports by increasing the LC margin is an old concept. In the past, some countries have used this policy with some success. For example, in the 1980s, India increased LC margins to curb imports and boost domestic production. The policy was successful in reducing imports and increasing domestic production, but it also led to a shortage of certain imported goods and higher prices for consumers.

But Bangladesh's present crisis is with the dollars and not the taka. Importers who are ready to import with even 100% LC margin are not getting the greenback from banks.

The 1997 financial crisis in Southeast Asia, also known as the Asian financial crisis, had a profound impact on the region's economies. To manage their exchange rates during the crisis, different economies in Southeast Asia employed different strategies.

For example, countries, such as Malaysia and the Philippines, had floating exchange rate systems, which allowed their currencies to fluctuate in response to market forces. To stem the outflow of capital and support their currencies, these countries intervened in the foreign exchange market by selling their own currency and buying foreign currency. They also implemented capital controls to limit the movement of funds in and out of the country.

At that time, Singapore adopted a basket peg for its currency rather than a single currency. This provided some flexibility for the country to manage its exchange rate during the crisis as it allowed the central bank to adjust the weight of different currencies in the basket to respond to market conditions.

Should Bangladesh go for a market-based exchange rate? 

Bangladesh introduced floating exchange (market-based) rate in 2003, but it was never market-driven as the BB always controlled it. 

While controlling the exchange rate can have benefits, such as competitiveness, stability and supporting the monetary policy stance, it can also have significant drawbacks, including depleting foreign exchange reserves and inefficiency.

Analysts and bankers have long been saying that the exchange rate should be left to the market, but the BB did not pay heed to their call until August last year when they felt that they could not supply enough dollars from the reserves to meet the market demand. But that was also a puzzling decision as BB allowed banks and foreign exchange dealers to introduce three exchange rates – one each for remitters, exporters and importers.

Should Bangladesh adopt a basket to peg its currency?

Bangladesh pegs its currency, the taka, to the US dollar, meaning that the value of the taka is fixed relative to the US dollar, and the Bangladesh Bank actively manages the exchange rate to maintain the peg. In practice, this involves buying or selling dollars in the foreign exchange market to keep the exchange rate within a narrow band. The single currency peg provided a stable exchange rate, which helped the country to reduce inflation and promote economic growth by providing a predictable environment for businesses and investors.

Advantages of pegging to a basket of currencies include reduced dependence on a single currency, which can help to mitigate exchange rate volatility, and improved diversification of the economy. 

On the other hand, a basket peg can be more difficult to manage and can result in a less stable exchange rate if the currencies in the basket are not well-aligned.

Ultimately, the decision of whether to switch to a basket peg will depend on the specific economic and financial circumstances in Bangladesh, and the trade-offs between stability, diversification, and manageability of the exchange rate. It is important for policymakers to carefully consider the benefits and drawbacks of each approach before making a decision.

Did Bangladesh do enough to bring in remittance?

Bangladesh received nearly $25 billion from expatriates in the pandemic-hit FY21 and it came down to $21 billion in FY22 despite raising cash incentive to 2.5% from 2%. In the first seven months of the ongoing fiscal year (FY23), $12.45 billion came into the country.

Some 11 lakh Bangladeshis left the country for overseas employment only in 2022, but it is yet to be reflected in the inflow of remittances. Everyone – including central bankers, finance ministry officials, commercial bankers and economists – was talking about channelling remittances through banks instead of Hundi (informal channel). It seems we are serious about rhetoric not actions.

Take the cases of some countries that took initiatives to boost the inflow of remittances in a bid to manage their depleting foreign reserves and exchange rate volatility.

Mexico has implemented various measures to encourage the use of formal channels for remittances, including tax incentives for banks that offer remittance services. The Egyptian government has taken steps to promote the use of formal remittance channels and has established a remittance clearing house to improve the speed and efficiency of remittances.

The Central Bank of the Philippines has implemented policies to encourage the use of formal channels for remittances, such as banks and money transfer operators, to improve the monitoring and stability of the inflow of remittances. The Indian government has taken steps to streamline the remittance process, including simplifying regulations and reducing the cost of remitting money.

These measures have helped to increase the inflow of remittances and improve the stability of foreign reserves and exchange rates in these countries. However, it is important to note that each country's situation is unique, and the specific measures that work best will depend on the country's circumstances.

There should be a remittance campaign to bring in money from the overseas Bangladeshis, according to prominent businessman Kutubuddin Ahmed, founder chairman of Envoy Textiles and Sheltech.

He said in the 1990s India took several steps to make it easier for Indians living abroad to send money back to India, including offering incentives and simplifying the process. The aim was to increase the inflow of foreign currency and improve the country's foreign exchange reserves, which were depleted due to high trade deficits and the high demand for foreign currencies. The campaign was successful and India was able to shore up its foreign currency reserves, stabilise its currency, and address the crisis.