Forrest Cookson PhD
Over the past year the foreign exchange management has changed with a substantial depreciation of the currency. There is still no stability in the exchange rate and the expected structure has been lost. The impact of this is to cause serious unnecessary losses to the Readymade Garment (RMG) sector. We explain in this article what has happened and suggest some changes.
During FY22 the world inflation raised the prices of imports much faster than exports. Prior to the pandemic the economy was able to earn foreign exchange from exports and remittances sufficient to finance the imports needed for 7% growth. There is a fairly tight link between imports and growth. Imports are needed to finance the raw materials and intermediate goods needed for the manufacturing sector. For the RMG and textile sectors together the imported components amount to about 50% of the value of exports. Similar ratios hold for many other manufacturing sectors. The construction sector requires major imports of steel and cement. Rapid growth requires large investments made of construction and machinery most of which is imported.
When the terms of trade [ratio of export prices to import prices] declined in FY22 the result was a much larger value of imports that could not be financed from the available earnings. This resulted in a sharp decline of $5 billion in the foreign exchange reserves. This was reflected in the sales of dollars by the central bank. The Bangladesh Bank acted promptly to reduce the imports by a number of policy measures making it more difficult to finance imports. A number of administrative actions were taken in an attempt to reduce imports. There is some evidence that this will reduce the imports but this is a slow process.
While the Monetary Policy Statement FY23 paints an unrealistically positive forecast of the balance of payments, a more realistic assessment of prospects for exports and remittances suggest an overall deficit of $5 billion. This means that the reserves would decline by about that amount.
Actually one should note that in FY21 reserves increased by $7 billion so the reserve position is really not so serious, showing an increase of $2 billion over two years.
To contain the loss of reserves requires two actions: Slow the economy to reduce imports and implement a strong export development strategy. While neither of these seem to be current government policy, the actions to reduce imports are likely to result in slower growth of the economy. The uncertainties in managing imports and expectations of continued depreciation of the Taka are already causing disturbances in planning for production in FY23, hence reducing output and investment. The somewhat disorderly slowdown of growth will be associated with the decline in imports. My forecasts suggest that by FY24 the balance of payments will be back in equilibrium. However, the economy will slow down more than what could be achieved with a more orderly approach to managing aggregate demand.
When an order arrives from a buyer, the Bangladesh factory will open import orders for the required imports. These may be back to back L/Cs that are paid when receipts for the export are received; or financed from a loan [denominated in dollars] from the Export Development Fund also repaid when the export receipts are received; and finally, the manufacturer may just order the goods using an L/C that will be paid according to the terms of the L/C. Inputs of goods manufactured or available inside Bangladesh would normally be financed in this way.
When the export proceeds due on the contract appear in Bangladesh the back to back L/Cs and loans from the Export Development Fund are paid off from the dollars. What remains the export may convert partially into Taka and hold dollars according to the rules. Bangladesh Bank now requires that all proceeds be converted into Taka. Desperate for dollars the central bank does not currently allow the Bangladesh manufacturer to hold dollars. This is a temporary provision that will be revoked when the balance of payment corrects.
The simplest way to think about the exchange rate is that there is a rate for buying dollars and a rate for selling dollars. The first rate is used for financing imports or capital payments in dollars; the second rate is used to provide Taka to importers or for sales of dollars for travel or conversion of earnings of foreign companies that is for all purchases of dollars. These two rates should be very close, less than 1%. This has been the way the exchange rate has been managed over the past several years.
The rules of the exchange rate system allowed the exporter to encase his dollars at any bank of his choice. The originator of the back to back L/Cs or loans from the EDF handles settlement; but the remaining dollars were converted by a bank selected by the exporter. This resulted in all banks offering more or less the same rate for conversion of the dollar receipts.
From roughly the beginning of FY2022 imports increased rapidly and the exchange rate for imports began to depreciate. The banks sold dollars on three day forward transaction and avoided the spot rate established by Bangladesh. Bangladesh sold dollars but in such a way as to prevent the market from stabilizing. [Rather than sell to which ever bank needed dollars the central bank sold to the State Banks with large L/Cs.] The tight connection between the buying and selling rate stopped; the interbank market for foreign exchange dried up.
Many RMG companies did not realize what was happening. In effect there was no exchange rate for converting export proceeds. In some banks there was no rate; it differed from one customer to another as banks tried to stick to the Bangladesh Bank rate although that was in order to provide as few Taka to the RMG customer as possible.
The Bangladesh Bank gave the final death to the foreign exchange market for export proceeds by requiring the RMG exporter to use the originating bank for changing the proceeds to Taka. Now there was no way for the exporter to find a rate. This has resulted in the spread between buying and selling rates, less than 1% to increasing in many cases to 10%. The banks with plenty of RMG accounts were exploiting their customers, offering a low rate. This is the situation as this is written. Bangladesh Bank maybe complaining about this, but it is their fault for destroying he market for selling dollars.
The market for foreign exchange now does not have a rate for buying Taka. As the exporter cannot shop for the best rate he is negotiating with his bank. The result is a different rate for every exporter with the average buying rate for dollars much less than the rate for selling dollars to importers. As this is written the buying rate for dollars is 95 to 100 and the selling rate ranges from 105 to 110. The foreign exchange market has now broken up into 60 separate markets that are not inner connected one for each bank.
The impact of this is as follows:
Exporters are not getting the fair market value for their dollars. This is what economists call price discrimination. It is like the charges of a doctor: He charges a high price for a wealthy person and a lower price for a poor person. But the discrimination in the export proceeds market is based on ignorance of the exporters. If exporters read this article they will understand that they have to negotiate harder to get a proper rate for their dollars and there is no official rate.
The single most important thing for the health of the Bangladesh economy is to increase exports. To achieve the nation’s target of rapid growth there is no alternative to vigorous increase of RMG exports and to diversity the range of exported goods. The current arrangements of the foreign exchange market discourage exports. Of course the depreciation of the Taka even with the poor rate for buying dollars, helps the exporters. But there is much more available being denied to the exporter by the price discrimination introduced by Bangladesh Bank.
The foreign buyers are fully aware of the large depreciation of the Taka and many are demanding lower dollar purchase prices. That is the foreign buyer is trying to capture some of the benefits of the depreciation. Thus if a $100,000 order is made with the exchange rate 90, the exporter gets 90 lac Taka. The Taka depreciates to 100. Now the exporter gets 1 crore (10 million) Taka. But the buyer will try to reduce the price to say $95,000. Now the exporter gets 95 lac – 9.5 million [better than the 90 before depreciation] and the foreign buyer has saved $5% on the order.
For the good of the exporters the dollar buying rate should be kept close to the dollar selling rate; this will happen with a competitive market. But with the present rules the exporter is disadvantaged.
The source of this peculiar situation is the large private commercial banks. By the market rules they make a lot of money by the wide spread in the buying and selling rate. It is not clear to me why Bangladesh Bank has allowed this situation to continue.
The consequences of the present market arrangements are as follow:
- The large banks make very high profits; the small banks are cut out of the foreign exchange market. For example the small bank can go to the exporter, who is selling his dollars for 95 to the large bank handling his business, and offer to buy the dollars for 100; either the large bank will agree to the 100 now demanded by the exporter, or the exporter will sell his dollars to the small bank. This makes the market competitive and does not discriminate against the small banks. Is Bangladesh Bank trying to harm the small banks? I cannot imagine a more destructive action by the central bank.
- The exporters do not receive the full benefits of selling their dollars reducing their profits and their investment in expanding their export capacity.
Conclusions:
The rules dealing with the selling of dollars by exporters are reducing the profitability of exports, harming the growth of the economy.
Bangladesh Bank can fix this by allowing the exporter to sell his dollars to any bank.
The present rules discriminate against the smaller banks, surely increasing the number of problem banks as the smaller banks will have little opportunity to earn from the foreign exchange market.
