The dollar is sometimes referred to as 'the cleanest shirt in the laundry basket' or 'the least-ugly mug in a beauty contest'. The value of the US dollar against the most currencies in the world, except for a few South American countries, like Brazil, Uruguay, Peru, and Mexico, has increased at an incredible rate. The Sri Lankan rupee has had the hardest fall--about 80 per cent-- although Sri Lanka's economic mismanagement is largely to blame for this plight. The Indian rupee has also depreciated significantly. The value of the British pound has been dampened against the dollar by about 22 percent, the Japanese Yen by 20 percent, and the Euro by 15 percent compared to the same time last year. Even the Chinese renminbi, which has been pegged to the dollar, fell by 11 percent. At the same time, Bangladesh's currency depreciated more than 20 percent.
The reason for a sudden increase in the price of the US currency is simply the mechanism of supply and demand. The demand for dollars on the global market is now on the rise. Most economic indicators are pointing to a potential global recession ahead. All countries are raising interest rates trying to curb inflation. But interest rates in the United States have increased much more than expected, even more than in many other developed countries. This increased interest tempts investors to withdraw their investment from emerging economies and invest in relatively safe assets like US Treasury bonds. The Institute of International Finance recently revealed in a report that foreign investors have pulled a record amount of funds out of emerging markets over the past five months in a row to invest in developed countries, particularly in dollar-denominated asset.
Since dollar-denominated assets require dollar amount, investors are buying US dollars in exchange for other currencies, leading to an increased demand for the greenback on the global market. In line with the rising demand, the value of the dollar increases. On the other hand, sale of other currencies to buy dollar increases their supply on the market, leading to a decrease in the value of those currencies.
No doubt, a rising dollar negatively impacts emerging countries like Bangladesh. The simultaneous presence of high inflation and a mounting external debt indicates a tough time ahead for the country.
Currently non-economic indicator reveals a positive scenario for Bangladesh. The world is merely on course to recovery from the outbreak of natural calamities caused by the Novel Coronavirus. Like in other countries, the level of pandemic-induced poverty increased. In particular, people living below the extreme poverty line has increased significantly. South Asian Network on Economic Modeling (SANEM) shows that the population living below the poverty line was 21.6 per cent of the total population in 2018, which nearly doubled to 42 per cent in 2020. The picture of 2021 gives some hope, but it is marginal. According to World Bank statistics, the population living below the extreme poverty line was 12.5 per cent in 2020, which declined to 11.9 percent in 2021. Various government incentives to mitigate the negative impact of the pandemic have helped reduce poverty to some extent, albeit marginally.
However, the prevailing high inflation has caused a serious damage to the livelihood of the mass population of the country. The inflation rate in the country is now more than 9.0 per cent. According to the data of Bangladesh Bureau of Statistics (BBS), the rate of inflation in September was 9.10 per cent which increased to 9.52 per cent in October. A crucial reason for this increase is the appreciation of the dollar against the Bangladeshi taka (BDT). The devaluation of taka has increased the price of imported goods. In simple words, the price of imported goods is paid in US dollars. With the upward trend in the dollar value, importers now need more domestic currency (BDT) than before to purchase the same amount of the US dollar. Since the payment for import is higher than the export earnings for Bangladesh, the depreciation of the BDT against the dollar increases the price of goods and services. On top of that, Russia's war in Ukraine has rubbed salt into an injury. Bangladesh imports various food and industrial products, including fuel, from these two countries. The war has created disruptions to the global supply chain and increased the price of imported goods. As a result, the government of Bangladesh hiked the prices of almost all types of fuel in last August.
Needless to say, the dollar appreciation will have a greater impact on foreign-debt repayments. At the end of FY 2020-21, Bangladesh's external debt amounted to US$60.15 billion compared to US$51.13 billion in the previous fiscal year. In other words, the foreign debt increased by about 18 per cent in a single year. It is estimated that by the end of 2023, Bangladesh's foreign debt will increase to US$115.0 billion If this trend continues, and by the end of 2024, Bangladesh will have a huge debt burden of US$130.0 billion on its shoulders. Most of the foreign loans are from the Asian Development Bank and the World Bank (about US$25.0 billion). The rest were borrowed mainly from three friendly countries-- India, China, and Russia. The amount of loans taken from China is US$17.54 billion, Russia US$11.38 billion, and India US$73.6 billion.
Due to the grace period, the debt burden on the domestic economy was low at the beginning as the government was not required to repay debts. The government must start the payment of loan installment consisting of interest and part of the principal by next year. Since the majority of foreign debts are denominated in dollar, the rise in the dollar value will increase the debt burden. Perhaps, the policymakers of the country would have considered the appreciation of dollars in making the borrowing decision.
However, such an incredible devaluation of the Bangladeshi taka was unpredictable and could not have been taken into consideration in making the borrowing decision. This means that the government is likely to face difficulties in repaying the increased debt burden. If this debt-servicing burden forces the government to take recourse to domestic sources of finance, the financial system of the country will face a tremendous pressure. Government borrowing is interest-inelastic which means that government borrowing does not depend on interest rate. However, private sector is interest-sensitive, and the level of private borrowing is mainly determined by the interest rate. Therefore, public borrowing from domestic sources may crowd the private sector out.
The financial sector of Bangladesh, basically a bank-based system, is already in a fragile state. Capital market is dominated by banks, bar some telecom companies. Corporate bond market is practically non-existent. Hence, the banking sector is the main source of funds to meet the required funding needs of individuals and firms. But that banking sector is plagued by various problems. The critical among them is the mounting level of default loan. According to Bangladesh Bank statistics, the amount of default loan was BDT1.13 trillion at the end of March 2022, which rose to BDT 1.25 trillion at the end of June 2022. This means that the amount of defaulted loans has increased by Tk 11817 billion in just three months. State-owned banks have the highest proportion of default loans which is about 22 per cent, or BDT 554.28 billion, of the total loans at the end of June 2022. Default loans of private banks accounted for 6 per cent of the total loans at the same time. These estimates were 20 per cent and 5.84 per cent, respectively, in the previous quarter.
The interest-rate cap on deposit was fixed at 6 per cent in April 2020. However, the prevailing inflation rate of the country surpasses 9.0 per cent. It means, the real interest rate on deposit is negative as it is calculated by subtracting inflation from the nominal interest rate. In other words, the real value of bank deposits will decrease over time. This situation will encourage current consumption and discourage savings. In the long run it will have an adverse effect on the economy. However, the interest rate for all deposits is not the same. Interest rates vary depending on the type of deposit and tenure. According to Bangladesh Bank estimation, the average interest rate on deposits was 4.07 per cent in August. At current inflation rate, there is no economic rationale for depositors to keep money in banks.
The effect of negative real deposit rate, however, is felt on the growth of bank deposits. According to the data provided by the Bangladesh Bank, the deposit growth rate in the third quarter of the fiscal year 2022 was 10.2 per cent which decreased to 9.3 per cent in the last quarter (June 2022). Whereas in June 2021, the growth of deposit in the banking sector was 13.8 per cent. On the other hand, the 9.0-percent cap on lending rate, which is also lower than the inflation rate, encourages borrowers to borrow. The credit-growth rate was 14.4 per cent in June 2022, which was 13.4 per cent in the previous quarter. The trend of increased lending activities amidst the declining deposit growth rate, is likely to put a strain on the banks' own funds, which, in turn will weaken the banks' resilience and sustainability.
All these elements are feared to put a negative pressure on the national economy. The government has already taken various measures to conserve energy of the country. For example, planned blackout for several hours in a day has been initiated sequentially in different regions of the country. In addition, reducing business hours and other related strictness in using energy have been instituted. Strict implementation of these plans will weaken business and depress economic activity, which will drag down the GDP growth trend. The Economist's research unit, Economist Intelligence, projects Bangladesh's GDP growth at 5.7 per cent in FY2022-2023, down from 7.2 per cent in 2021-2022.
Considering the current situation, it will be difficult for the government to face this challenge of the economy. Investment is needed to stimulate the economy, which depends on how cheaply banks can provide funds to borrowers. In this sense, the current cap on lending rate at 9.0 per cent may seem a good policy. On the other hand, there is no alternative to increasing the interest rate on loans to reduce the flow of money and the resulting inflation. The International Monetary Fund has already called for the lifting of the ceiling and floor on lending and deposit rates. It is a dilemma for the government because increasing the loan interest will have a negative impact on private-sector investment, while the loan interest should be increased to attract foreign investment as well as reduce inflation. Perhaps, this has encouraged government not to intervene on the current interest rate. However, the government needs to take several steps to reduce the dollar-driven inflation.
First, efforts should continue to increase the supply of dollars in the domestic economy. To achieve this objective, emphasis is to be placed on increasing the inflow of remittance. The government has already announced an incentive of 2.5 per cent on remittance which is highly commendable. Even if the remittance flow has increased responding this policy, it is not up to the expectation. All obstacles prevailing in the flow of remittance should be removed. Hundi is considered main obstacle in this particular regard. It is reported in the print and electronic media that the exchange rate offered by hundi is higher than the bank exchange rate even after adding 2.5-percent government incentives. Hence, the government must do a lot of work on this channel so that expatriates feel interested to send money through legitimate channels. The central bank may consider harmonizing the dollar price in tandem with the market price of dollar.
Second, the scope of activities that increase demand for dollars in the country must be limited for the time being. The crackdown on the import of luxury goods is certainly commendable. But import of basic goods should be reduced as much as possible and the gap should be met by domestic production. For example, there are ample scopes for production of staples including rice and wheat in the country. This possibility needs to be fully exploited. In case the import of some goods and services is essential, the diversification of sources is highly desirable. If alternative destinations for imported goods were identified before, the ongoing war between Russia and Ukraine would have much lesser impact than it is now.
Third, the demand for the dollar can be reduced by relying on alternative currencies for international trade settlement. The BRICS (Brazil, Russia, India, China, South Africa) have announced the launch of a common currency basket. It remains to be seen how successful this currency basket may turn up in the future. But the urge for alternative currency to US dollar for bilateral transactions is timely. Recently, there has been a lot of talks about the use of Indian rupee for trade settlement between Bangladesh and India. Such a possibility should be thoroughly explored. Bilateral trade between Bangladesh and India is huge. However, the balance of payments is in favour of India. That is, Bangladesh pays more for imports than it receives for exports from India. In this situation, India will have some advantages if trade takes place in Rupee. But no country is likely to lose if it is planned properly.
The exchange rate of the two countries' currencies can be determined in terms of gold standard. Initially, it would be appropriate to fix a ceiling on transactions in Rupees which is equal to or less than the value of Bangladesh's exports to India. This can be adjusted later, if necessary. Such an initiative can be structured for a single country at the beginning on an experimental basis and can be expanded later depending on the feedback. This sort of currency diversification will certainly reduce the dependency on the dollar.
The appreciation of the dollar is not an artificial or manufactured phenomenon; rather, it is a logical and natural consequence of the current world order. As the rest of the world braces for a possible economic downturn, US GDP growth remains largely stable. This stability has helped keep the value of the dollar consistent, making any dollar-denominated financial asset safer to investors. As a result, any signals that indicate adverse economic condition triggers the withdrawal of funds from emerging economies and flow to dollar-denominated assets. This implies that the generic tool to avoid the negative impact of dollar appreciation is to accelerate the GDP growth of the domestic economy.
Prof. M. Kabir Hassan is with University of New Orleans. [email protected]
Dr Mohammad Dulal Miah is with University of [email protected]
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