What impact will a forward forex rate have?

The process of currently fixing the dollar price to be paid or received in the future is called forward dollar selling and buying. 

Prior to the new guidelines, there were no rules on how banks would determine the value of the dollar in such cases. Until now, each bank used to determine the forward dollar selling and buying rate in a separate process.

On Sunday, the buying rate of the dollar was Tk110 and the selling rate was Tk109.50 at the consumer level. Banks can now charge a maximum rate of Tk123.35 for a one-year forward dollar purchase and Tk122.73 for a one-year forward dollar sale. However, if the deadline is reduced, the price of the dollar will also decrease.

The Business Standard reached out to experts for their take on the matter. 

'The central bank's latest decision seems inconsistent with its own policy'

Zahid Hussain

Former lead economist of the World Bank's Dhaka office

Bangladesh Bank's Monetary Policy Statement (July-December 2023) clearly states that a competitive and market-based floating, flexible and unified exchange rate regime is expected to be established for all international transactions within the third quarter of 2023. 

The central bank's latest decision on the ceiling of the foreign exchange forward premium seems inconsistent with its own policy. And this fresh move will certainly impact Bangladesh Bank's credibility. We all know that policy credibility is crucial for policy implementation. In another sentence, it can be said that if BB wants to make a policy effective, then it should effectively follow the policies it sets. 

According to BB's new circular, the forward premium will not exceed SMART plus 5% per annum, with declared spot rates for forward dealings with customers. Currently, the SMART of a 180-day treasury bill is 7.14% and the inter-bank US dollar rate is Tk 110 each. So the maximum allowable forward premium will be 12.14% per annum and therefore, the maximum forward exchange rate for each US dollar would be Tk123-Tk124 in 2024. 

Now the question is how and from where Bangladesh can ensure the supply of US dollars. 

Yesterday [25 September], I checked the forward rate in the market would be Tk127 in 2024. That means a party will have to pay Tk127 in exchange for one USD after one year. But the BB's new rule has set a cap on the forward premium. If the fixed exchange rate seems lower compared to the market, formal channels of the remittance flow will fail. 

The central bank has sought an explanation from 12 banks who had allegedly exploited the US dollar crisis for excessive profit while violating the rate set by the Bangladesh Foreign Exchange Dealer's Association (BAFEDA). This move has resulted in the lowest remittance in recent months. 

Bangladesh received the US dollar equivalent of Tk105.49 crore as an inward remittance in the first 22 days of September. This should have been more than Tk200 crore because thousands of Bangladeshi workers have become migrant workers in the post-Covid years. 

Why the remittance flow is decreasing? Might be the expatriate workers have found alternatives because they certainly don't want to deprive their families [receiver] of the best rate of their hard-earned remittance.  

The recently published Fitch Ratings has revised the Outlook on Bangladesh's Long-Term Foreign-Currency Issuer Default Rating (IDR) to Negative from Stable. Explaining the reasons, the report says that the negative outlook reflects a deterioration in external buffers, which has increased vulnerability to shocks. According to the report, Bangladesh's incremental policy response, including exchange-rate system changes, and continued support from external official creditors, has been 'insufficient' to stem the fall in foreign reserves and resolve domestic US-dollar liquidity strains. 

Here, the 'right' exchange rate is important to ensure the flow of the forex. 

'Businesses will be able to reduce their exposure to price fluctuations'

Ahsan H Mansur

Executive Director, Policy Research Institute of Bangladesh

The central bank's decision to establish a forward contract market to determine the rate of foreign exchange to be delivered in future is a significant and positive initiative for Bangladesh. 

Prior to the introduction of these new guidelines, there was a lack of standardized rules governing how banks determined the value of the dollar in such cases. Up until now, each bank employed a separate process to determine their forward dollar selling and buying rates. 

While previous attempts to introduce forward contracts were limited to three and six-month durations, this marks the first time Bangladesh Bank is implementing a one-year initiative, a notable step in the right direction.

Presently, the customer is uncertain regarding the future price of the dollar because the customer calculates the selling price of their imported product based on the dollar's value at the moment of payment.

The forward dollar buying rate establishes in advance the rate at which the customer will purchase dollars one year from now. In a similar vein, the forward dollar buying rate predefines the amount an exporter will receive when their export proceeds are paid out in dollars after a one-year period.

It is worth noting that the rates for forward contracts will not be set by Bangladesh Bank itself; rather, they will eventually be determined by the market. However, it's important to acknowledge that we are not yet at a stage where this market-driven approach is fully functional. Bangladesh may require at least a year to fully leave it up to the market.

The primary beneficiaries of this move are expected to be businesses. For instance, companies, including our petroleum corporation, will have the ability to purchase edible oil in advance at fixed rates, even if the actual delivery occurs in the future. This proactive approach allows them to secure prices and reduce their exposure to price fluctuations, ultimately enhancing financial stability.

Some banks may have concerns about this decision. Some are yet to follow the rates due to a shortage of the currency.  Also, some banks might not be convinced that the rates being fixed now will be advantageous for them in the future. However, ultimately, the market will determine these rates, and this should alleviate banks' concerns.

Overall, Bangladesh Bank's initiative to establish a forward contract market for foreign exchange is a positive step toward promoting stability, fostering healthy competition, and facilitating effective risk management in the business environment. 

'I would suggest a similar initiative in setting the exchange rate for remittance'

Md Sameer Sattar

President, Dhaka Chamber of Commerce and Industries 

Foreign exchange has been in a volatile situation for some period of time. In this situation, Bangladesh Bank's latest move to fix a forward foreign exchange rate is indeed a timely initiative. 

This is true that the forward contracts do not address the US dollar crisis immediately. But I believe this will assure the business communities about certainty in the next year while keeping a certain discipline in the market. At least the business people will not need to worry about the volatility that they are facing at present. 

One thing I want to mention is that this fixed rate should be a ceiling or the maximum. I would suggest timely adjustments of the rate for export and import, if the foreign exchange rate falls in the market by 2024. For example, a businessman books a forward bill at Tk124 per US dollar now. The businessman will incur a loss if the price of the US dollar falls in 2024. So there should be a mechanism for the price adjustment. 

However, overcoming the existing challenges in foreign exchange requires an increase in the remittance flow.  We presume that migrant workers mostly avoid the official channels while sending the remittance at better prices in the informal market such as via hundi. 

The newly fixed forward foreign exchange rate will benefit the export-import business in the future. I would suggest a similar initiative in setting the exchange rate for remittance, which will be close to the prevailing rate in the grey market. If there is a better price, the overseas workers will prefer sending their money through the proper channels.