Depreciation of the taka and import restrictions
Chakhawat Hossain |
April 30, 2022 9:27:45 PM
During Covid-19, the central bank has been busy implementing various stimulus packages. No tense situation was encountered with regard to the external sector as imports were at a manageable level along with export earnings and remittances. Salary remittances increased with a record jump of around 36% in fiscal year 2020-21 (FY21). There were many reasons behind this. One of the reasons was the use of the official channel to send money to the country by remittance service providers since the informal market was in an inoperative phase.
With the new normal at the end of Covid-19, shocks were felt on the supply side due to the disruption in global production. The current situation shows the world price level at a new high. Bangladeshi exports are growing upwards, but unit price changes are not as large as those seen in world commodity prices. Bangladesh would not have faced the Asian financial crisis in the 1990s of the last century. No negative impact is found in 2008 and after the global financial crisis. The underlying reason is that the external sector of Bangladesh is still regulated. In many cases, central bank authorization is required for external transactions, even for current payments above thresholds. Remittances for overseas investment are subject to approval by a high-level committee in accordance with the rule recently issued by the government.
During the current period, the external sector is under pressure due to huge outward remittances from import payments compared to inward receipts from exports and wage remittances. According to economic data available on the central bank’s website, the difference between export receipts and import payments is recorded at a negative amount of more than US$22 billion through February 2022 of the fiscal year In progress. Since Bangladesh imports more than it exports, the difference is supported by income from wages and other services. The net trade position in the same period last year was negative, recorded at over US$12 billion. Considering other items, including wage remittances, the current account balance stands at nearly $13 billion (negative) through February of the current fiscal year, which was nearly $1.0 billion (positive) in the same period last year. Regardless of the position, the foreign exchange reserve is above $44 billion, indicating solid strength in the economy.
The situation warrants prudent currency management. Very recently, the central bank ordered banks to levy a 25% cash margin on the issuance of import letters of credit. However, the requirement does not apply to the import of baby food, essential food items including fuel, life-saving medicines, domestic and export-oriented industries, and business sectors. .
There are many alternatives to manage the external sectors for which experiences are necessary. As stated earlier, Bangladesh is in a regulated state when it comes to foreign exchange trading. This avoids risks. But global supply shocks require careful attention. The recent instructions will certainly support the forex market with ease in import payments. This does not mean that importers cannot import luxury goods. These can be imported with cash by importers; banks will not assist importers to import without cash collateral. It will also streamline credit management by banks, including discouraging unnecessary imports.
What other alternatives to the central bank might be is a question. In this context, exchange rate management can be cited. Since 2003, banks have been able to set the rates for selling and buying foreign currencies. The rate must be determined with the interaction between demand and supply. But it is quite difficult to make the exchange rate float freely for countries like ours since we need to import essential products. As such, the foreign exchange market has been intervened by the central bank, including dictating exchange rates.
There is a tussle over the exchange rate. Foreign currency holders benefit from the depreciation of the exchange rate. But outgoing payments for different purposes, including import payments, are being hit hard. As mentioned earlier, Bangladesh needs imports of basic necessities. The depreciation of the taka will lead to an increase in the prices of basic necessities. On the other hand, the appreciation of the taka encourages excess imports which also hit import-substituting industries. But currency depreciation supports export trade, including the huge flow of wage transfers.
Economic development models are basically of two types: import-substituting industries and export-oriented industries. The latter is still vulnerable, requiring continuous support for its sustainability. As a result, import substitution industries are gaining favor from all corners. But there is also a paradox, high tariff walls are needed to protect substitute imports of the same products. In both models, imports are essential. Settlement of payments made by exporters on their imports is made from export earnings. But these payments by importers for local industries or essential imports for local consumption bear an additional cost if the local currency depreciates.
Tariff walls and the maintenance of a stable and persistent local currency are phenomena of anti-export bias. There are different stories depending on the adequacy to savings. The history of economic development of East Asian countries shows that the export-oriented model works well. For an economy moderately dependent on imports, import substitution is hardly feasible. Despite this, there is an emphasis on industrialization for import substitution due to different popular conceptual angles. The recent decision by the central bank on the margin requirement for establishing import letters of credit indicates that Bangladesh is on the path to import substitution. This can facilitate the import of certain items, with the stability of the value of the local currency. But the change in the level of world prices will cause local prices to rise, upward pressure on inflation. The pressure will be eased if foreign currency inflows and outflows match well. As an alternative to suppressing imports, movement of the exchange rate based on the market trend can ease the situation. But this has a cost. It will affect a group of people on fixed incomes.
The initiative of the central bank to impose a margin for the opening of letters of credit can soften the foreign exchange market. But the approach is inward looking, suppressing real demand to keep the price of imports affordable. Certainly, the stable price of the local currency in terms of foreign currency can protect the price level of imported goods. Another paradox is that Taka cannot buy foreign goods, international currency is needed. Revenue from external sources can generate import purchasing capacity. Government support for external sources of income through exchange rate advantages can increase income from abroad. Considering the global outlook, the only measure to restrict imports is one-way traffic which cannot bring the desired results. In addition to import measures, attention should be paid to other aspects. Under the program, Taka can be reasonably depreciated from its overvalued position. In addition to increasing revenue from external sources, this can work as an automatic stabilization of imports, reducing unnecessary imports. One-sided political support facilitates only one side. This deprives the other side – the acquirers of foreign currencies. They cannot be ignored considering their immense contribution to monetary support by earning foreign currency. In this specific context, that Taka is not led to its optimal price?