Restoring the Balance of Payment Stability in Bangladesh: A Step-By-Step Guide –

After enjoying a decade of stability in exchange rates and external accounts, the policymakers are suddenly embroiled in a crisis scenario. Their challenge is to reset monetary and exchange rate policies so that they do not evolve into a full-blown currency crisis

Bangladesh has been one of the fastest growing economies in the world until 2022. The economy in current US dollars grew from $31 billion in 1991 to $91.6 billion in 2008 and then further accelerated to $460 billion in 2022. 

The five-year average economic growth rate accelerated from 4.15% in 1991-95 to 7.13% in 2016–2020. 

As the population growth rate persistently declined, the per capita GDP growth rate accelerated even faster than the economic growth rate. The per capita GDP increased from US$ 283 in 1991 to US$ 630 in 2009 and then further to US$ 2,688 in 2022. 

Experts identify two key drivers for Bangladesh’s remarkable growth and development. One is the rising export production of manufactured goods. The other is the surging flow of inward remittances. 

Bangladesh has, in fact, received an aggregate capital flow of $233 billion in the form of inward remittances over the period of 2009-2023, an era of remarkable growth and development under Prime Minister Sheikh Hasina. 

In this period, gross domestic savings and investments (in % of GDP) increased. While gross domestic savings (in % of GDP) increased from less than 20% in 2008 to 26% in 2022, gross domestic investment (in % of GDP) surged from 26% to 32% over the same period. 

A saving-investment gap of 6% persisted at this time; Bangladesh faced no unsustainable current account deficits until FY2021.

The surging flow of inward remittances from non-resident Bangladeshi (NRB) citizens financed a persistent excess of investment over saving and trade deficits. 

Bangladesh had overall balance of payment (BOP) stability, accumulating an unprecedented volume of foreign exchange reserves of $48 billion US dollars at the end of August 2021. In fact, the current account deficits averaged only $0.32 billion per year over the 12 years from 2009 to 2021. 

It is noteworthy that Prime Minister Sheikh Hasina began her second term with a meagre $5.7 billion in reserves in 2009. 

The period of prolonged balance of payment stability and the record accumulation of FX reserves has, however, been discontinued after the economy reopened in January 2022 following the global coronavirus pandemic.

Bangladesh observed a prohibitive current account deficit of $18.7 billion in FY2022. The current account imbalance has significantly improved since then and was reported to be $3.3 billion in the latest fiscal year, that is, FY2023. 

However, the overall balance of payment deficit worsened to $8.2 billion last year, mostly because of a significant deficit in the flow of financial accounts. 

The ballooning balance of payments deficit of recent times is causing a fast depletion of foreign exchange reserves, a liquidity crisis in the financial sector, and a crisis in the foreign exchange market in Bangladesh. 

For over twelve months, from July 2021 to June 2022, Bangladesh Bank, the country’s central bank, resorted to selling foreign exchange reserves to support an overvalued taka, the home currency, against the US dollar. 

The policy was untenable, and it caused the rapid depletion of foreign exchange reserves. The central bank has, therefore, resolved to quit its decade-long policy to peg the taka to the US dollar in the range of 80–85. 

The new peg is now at 110.0/$ and possibly further downward at the end of December 2023. The US dollar is reportedly trading at more than Taka 110 per unit in the kerb market. 

The widening gap between the official exchange rate and the market rate is gripping both policymakers and businesses with mounting uncertainty and exchange risk.

After enjoying a decade of stability in exchange rates and external accounts, the policymakers are suddenly embroiled in a crisis scenario. 

Their challenge is to reset monetary and exchange rate policies so that the widening current account and other balance of payment deficits do not evolve into a full-blown currency crisis. 

In order to do so, we need to look into the underlying drivers, both domestic and international, of ballooning current account and overall balance of payment (BOP) deficits. The role of an overvalued nominal exchange rate will be explained as a causal reference to this unwanted outcome. This essay will also shed light on the issue of debt sustainability for Bangladesh.

Firstly, world prices of coal, oil, gas, and other primary commodities, particularly food grains, more than doubled in 2022, resulting in an unprecedented rise in the c.i.f. (cost, insurance, and freight) value of those imports. 

The reopening of the global economy after the coronavirus pandemic, the breakdown of global supply chains, rising trade costs, and the Russian invasion of Ukraine (and so the resultant war in Ukraine) were to blame for surging commodity and energy prices across the globe. 

A big part of prohibitive current account deficits of $18.7 billion in FY2022 resulted from this unfavourable international development. 

Secondly, after 18 months of lockdowns with significantly reduced activity, the Bangladeshi economy reopened in the middle of 2021. It implies that households, governments, and firms have returned to their usual ways of consumption and investment. 

That is, aggregate demand, decimated by the coronavirus pandemic since January 2020, rapidly expanded, and the demand curve shifted to the right. 

The massive fiscal and monetary stimulus, which the government of Prime Minister Sheikh Hasina has rolled out since March 2020, undoubtedly contributed to the further acceleration of aggregate demand. 

Private sector credit growth accelerated from 10% in 2020–21 to 14% in 2021–22. For countries like Bangladesh, this implies further escalation in the demand for imports of raw materials, intermediate inputs, and final goods.

Thirdly, the role of government spending for large infrastructure projects and an overvalued exchange rate of taka until the end of 2021 are critical factors in growing current account deficits. It deserves a careful explanation. 

The Government of Bangladesh surely embarked upon many mega projects in energy, road connectivity, ports, and telecommunication infrastructure. Therefore, the government’s spending accelerated, and a large part of it led to growth in imports of capital goods over time. 

But it is also believed that these mega projects will stimulate national economic growth and employment in the long term. The issue of time and cost overruns is a perennial issue in the developing world. Bangladesh is no exception; instead, it has observed persistent improvement in project management. 

The successful completion of the Padma Multipurpose Bridge, the Dhaka-Chittagong highways, and the like, bear testimony to this claim. Long-term capacity building by the government is also evident in this area. 

However, it is undeniable that rising government spending on building large infrastructure has driven government and public sector dissipation in recent times.

The prohibitive current account deficit of $18.7 billion in 2021–22 and the growing balance of payments deficit of $8.2 billion in 2022–23 are the outcomes of all these factors. At the heart of this imbalance lies widening dissaving by both the government and the private sector. 

While public dissipation is the excess of government spending over its revenue, private sector dissipation is the excess of private sector investments over gross domestic savings. The policymaker’s job is to bring about sustained improvements on both fronts. I will offer a mix of public policies to achieve this end.

Firstly, government spending must decrease in the short-to-medium term. As a national election is imminent, any political government will find it difficult to limit public spending in the very short term. 

Ultimately, every element of government spending will require a critical review. Government spending for unproductive activities is better eliminated or substantially curtailed. 

Government spending for new or early-stage large infrastructure is better deferred indefinitely until the economy navigates into sustainability. Government spending for social safety nets will also need to be revisited and made more efficient. 

Prime Minister Sheikh Hasina and her government are in fact in the process of eliminating or minimising government spending of lesser importance. A substantial improvement in the current account deficit for FY2023 was, in fact, more via administrative guidance.

Secondly, Bangladesh lived with an overvalued exchange rate for years, mostly because the taka had been pegged to the US dollar within the narrow band of 82–84 for an extended period until the end of 2021. 

In an environment where a developing country experiences persistent inflation differentials with respect to the rest of the world and more so against the cohort of low-inflationary advanced economies, a de facto fixed exchange rate will result in a persistent genuine appreciation. 

The extent of real appreciation for Bangladesh was large but varied across countries. 

The central bank must orchestrate a gradual devaluation of the home currency. A 30% nominal devaluation has happened for the taka against the US dollar since 1 January 2022. However, the exchange premium in the kerb market indicates a continued disequilibrium in the foreign exchange market. 

The central bank will likely consider further taka devaluation to eliminate the disequilibrium. Currency depreciation will cause private sector savings to improve over time. 

However, it may be coupled with some fiscal policy reforms. For example, a reduced corporate tax rate will stimulate foreign capital inflow and encourage more capital expenditures by local corporations. 

Bangladesh Bank may also consider offering new incentives in the form of exchange premiums or an increased interest rate to attract an increasing flow of remittances from non-resident Bangladeshis.

Thirdly, tax authorities may revise tariffs and non-tariff regulations discouraging imports of cars and luxury consumer goods. A currency devaluation itself will prove discouraging for this kind of import. 

A new tariff, in addition to some non-tariff barriers, will further diminish their demand. 

On the other hand, reducing tariffs for food and energy imports will somewhat mitigate cost-pushed inflationary pressures. 

But the litmus test for the central bank will be to guide exporters to repatriate their foreign exchange in real time. In times of significant currency devaluation, exporters and domestic residents will form an expectation of further devaluation of home currency and choose dollarisation of their financial assets. 

This downward expectation revision is not the right move and it can bind policymakers in a spiral of currency devaluation without significant improvement in the external account imbalance. Bangladesh Bank must focus on managing this speculative behaviour of economic agents.

Fourthly, a monetary tightening, and so raising the interest rate further, is now imperative to depress aggregate demand components and bring down inflation. 

Household demand for consumption, corporate demand for investments and government spending shall diminish as interest rates keep rising. In an environment of soaring inflation, a slowdown in aggregate demand should be the right policy objective. 

Bangladesh Bank may move faster in this direction. A relative economic contraction is desirable for reducing inflation and improving external account imbalances.

A very unfavourable monetary development has happened across advanced economies since January 2022. It is that advanced economies have invariably pursued monetary tightening, raising interest rates after a decade of low inflation and (nearly) zero interest rate policies. 

It is causing a reversal of global capital flow, putting many developing and emerging market (EM) economies on the cliff. This reversal is causing fast depletion of their foreign exchange (FX) reserves, liquidity crises in the financial system, rising interest rates, and currency crises across the developing world. 

A global capital reversal will cause financial market shocks. Bangladesh, too, is now embroiled in this unfavourable global development. 

Many developing countries, which were hitherto resilient, are now hugely constrained by dwindling foreign exchange reserves and rapidly depreciating home currency. 

Finally, critics of the government are drawing an improper equivalence between Bangladesh and other South Asian neighbours, such as Sri Lanka and Pakistan, with respect to the issue of debt sustainability. 

The country’s external debt stock was reported to be $95.7 billion US dollars, 23.5% of GDP, as of March 2023. Of this, the external indebtedness of the public sector was $73.5 billion. It is about 17% of GDP and 81.4% of it is long-term in nature.

Note that the external indebtedness of the government declined from 42 % of GDP in 1991 to less than 18.5 % in 2023. The total debt servicing is about 6 % of current account receipts (including exports of goods and services and primary income) and 0.82 % of GNI.

An unfavourable development has, however, happened in the area of external indebtedness by the private sector. This volume rapidly increased from $9.2 billion in June 2016 to $25 billion in June 2022. It was reported to be $22.2 billion at the end of March 2023. 

This area will require critical supervision and control by the central bank, as 68 % of this private sector indebtedness is short-term credit. 

A disproportionate share of this private sector external debt is mostly suppliers’ credit, unhedged, subject to variable interest rates, and considered to be opaque. 

Bangladesh Bank may put in place more stringent capital controls so that private sector companies cannot access any sort of foreign-currency-denominated debt without hedging against exchange risks.

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Dr Mizanur Rahman is a Commissioner of the Bangladesh Securities and Exchange Commission and a member of  Financial Reporting Council Bangladesh. Views are his own and not of the Commission or the Council. Any error is solely the author’s personal responsibility. E-mail: [email protected].

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Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard