Managing exchange rate for business competition

FE Team | Published: December 22, 2023 18:57:51

Bangladesh's economy witnessed an impressive growth at a rate that was close to China's over a decade until the pandemic struck the country, thanks to the competitiveness of its external trade, especially apparel export. But, of late, the trade has reportedly been losing competitiveness due to a host of factors ranging from higher import taxes, non-tariff barriers, over-dependence on a single export item and to the overvalued local currency, the Bangladesh Taka (BDT). The competitiveness is going to erode further once the country's graduation from Least Developed Countries (LDCs) is completed for it to face challenges from external trade. Among the different factors affecting trade competitiveness negatively, the overvalued BDT's role in it has recently come into sharper focus. This is especially after Bangladesh's overseas trading partners have been enjoying benefits of falling recessionary pressure in their economies. Notably, the recessionary trends in the US and other advanced economies were attributable to appreciating US dollar (USD) including other currencies of the advanced economies. Now that BDT remains overpriced, Bangladesh's overseas trading partners are being put at a disadvantage.
Against this backdrop, the Bangladesh Bank (BB), which regularly does the job of assessing BDT's worth vis-à-vis the currencies of its major trading partners, in its recent statement reported that BDT has been depreciated 17 times since July last year. Even so, it is still overpriced by 5.6 per cent. In this context, in its regulatory review, the BB has further noted that BDT's Real Effective Exchange Rate (REER), which compares the value of a country's currency against the weighted average of its major trading partners' currencies, is at Tk116.42. But the nominal exchange rate of BDT at the bilateral level remained at Tk110.25.
REER actually represents the value of one country's products when expressed in terms of their value in another country. That means, REER can compare the value of currencies in relation to each other over time taking into consideration the effect of inflation. This is in contrast to the nominal exchange rate which looks at a currency's worth in terms of other currencies simply from their exchange rates at a particular point of time. Though nominal rate is good at telling comparative worth of different currencies at a certain time, it cannot say what can actually be bought with each currency. This comparative buying power of currencies, actually, is an indicator of the economies that those currencies represent. The BB, which calculates REER index by comparing values of currencies and inflation rates of its 15 trading partners, found BDT highly overvalued during the time when the prevailing interest rates in the country's financial market were between 6.0 and 9.0 per cents.To cite an example, in April, 2022, the difference between nominal and REER-based exchange rates was more than14.12. This indicates a wide dispersal from the equilibrium level of REER assumed to be constant at 100. The lower the dispersal from equilibrium is, the higher the business competitiveness of a currency.
With restrictions imposed on imports, the rate of dispersal, thankfully, came close to zero, according to the BB. But given that nominal exchange rate of BDT against USD is lower than the REER-based one, BDT is remaining overvalued. Experts believe, it is due to higher inflation rate in Bangladesh than that in the economies of its trading partners. Obviously, it is negatively impacting Bangladesh's business competiveness internationally. In this context, the IMF recently stressed maintaining greater exchange-rate flexibility so that BDT can effectively stand external shocks. To remain competitive, the central bank will be required to manage BDT's exchange rate efficiently, despite the enormous challenges it implies.