Finding the right exchange rate balance

It is a very tough exercise for our central bank to arrive at an optimal exchange rate and interest rate and, more importantly, ensure adequate liquidity in the market for credit creation without denting market discipline. Exporters and non-resident remitters want a higher exchange rate to channel their earnings into the country. An entrepreneur setting up a manufacturing plant or expanding a production base wants the import cost of machinery and raw materials to remain competitive.

Bangladesh policy makers, until recently, could not demonstrate strong skills in managing any one of these optimally. Not all blemishes can be laid at their door, yet they remained under pressure from politicians in power or specific business lobbies to keep the dollar price and even interest rates lower while peer countries moved in the opposite direction. While the real effective exchange rate warranted depreciation of the taka, it was held at Tk 84 to Tk 85 for a prolonged period. As prices crept upward, largely due to external factors, authorities chose to keep bank interest rates within 6 to 9 percent, offering extraordinary benefit to large borrowers at the expense of small savers.

The previous political government towards its final phase, as well as the interim administration, continued to keep interest rates high following prescriptions from certain development partners, without sufficient ground-level validation of the claim that high interest rates effectively tame inflation. As a consequence, small and medium enterprises and new entrepreneurs were deprived of liquidity support.

I recently asked several treasury dealers what the appropriate USD-taka rate and interest rate should be if we are to improve liquidity in the market.

Most argued that to make imports of capital machinery, industrial raw materials and essential commodities competitive, while also mobilising remittances and improving liquidity, a balance between demand and supply is essential. In their view, the exchange rate should settle around Tk 115 in the coming weeks. They pointed to the real effective exchange rate falling below Tk 110 in recent months. When asked about a desirable lending rate, their response was that it should hover around 12 to 14 percent, but not exceed that level. Their recommendation was also informed by recent treasury bill and bond auction rates.

The Bangladesh Bank has purchased roughly $6 billion in recent months, injecting slightly less than Tk 750 billion into the market. Remittances are averaging around $30 billion on a run-rate basis. National reserves have risen to $35 billion, with net reserves just below $30 billion. Even so, market liquidity remains below optimal levels, largely due to rising bad loans and a significant volume of currency remaining outside formal accounting and circulation.

I agree with treasury heads that with a visible reduction in the real effective exchange rate, increased inward remittances and potential export growth, the taka may be allowed to appreciate slightly against the US dollar. At the same time, space should be created for small and medium enterprises by easing interest rates. Strong banks have already reduced deposit rates by nearly 2 percent over the past six to nine months. Lending rates should follow.

Our new prime minister, like his late mother, has consistently focused on the investment, employment creation and poverty reduction mantra during pre-election campaigns. If we are to turn that promise into reality, it is time to revisit both interest rate and exchange rate policies and, crucially, ensure that classified loans and unremitted export proceeds return to the national coffers.

Bangladesh can no longer afford to sustain rising bad loans and illicit capital transfers at such a high cost to its poverty reduction journey. More funds must return to the banking system so that they can be channelled into the productive streams of the economy.

Mamun Rashid is an economic analyst and chairman at Financial Excellence Ltd