Depreciating dollar, inflation control and foreign currency reserve
Wednesday, 2 January 2008
Enayet Rasul
THE Bangladesh Bank (BB) applies the country's monetary policy and BB's policy makers have been exercising different options to try and tame the runaway inflation which is noted in the Bangladesh economy. One such move recently involved the sale of some 185 million US dollars from its reserve during October-November to put pressure on the US dollar to depreciate against the Bangladesh Taka (BDT). Thus, the value of the Taka has appreciated against the dollar by some 0.7 per cent. This is being discussed hotly as an achievement of sorts because over the years the BDT has only gone on depreciating against the dollar. For the first time the local currency has gained against the most important international currency, the US Dollar. Thus, the appreciating BDT has soothed the ego of the policy planners and is expected to help in reducing inflation specially the inflation caused by higher priced imported goods as the prices of imported goods are now expected to fall with the value of the Dollar falling against the BDT.
But let us see the extent of the BDT's appreciation against the dollar. The notable thing is that it has been an appreciation in minuscule form, only 0.7 per cent whereas BDT's depreciation against the dollar was seen as particularly rapid in recent years. Thus, the depreciation of the BDT against the dollar was 2.76 per cent in 2004, 9.0 per cent in 2005 and 4.0 per cent in 2006. Only in 2007 it achieved a very modest turnaround of 0. 7 per cent through appreciation and this is being touted as an impressive sign of BDT's growing strength. But it is doubted how far the latest trend towards appreciation is sustainable given the country's relatively small foreign currency reserve and the rising demand for draw downs from it.
Coming back to the calculated sale of some 185 million dollar from its reserve by BB in a bid to decrease the prices of imported goods, it is considered to be a step of rather dubious value. It was calculated by experts that the dollar needs to depreciate by some 2.0 per cent, at least, for the same to have any lowering impact whatsoever on the prices of imported goods. But the appreciation has been only 0.7 per cent and, thus, too small to have any impact on the price levels. For the dollar to depreciate by some 2.0 per cent for creating a downward trend in the price levels, a substantial amount of dollar from the reserve will have to be sold. But can this be a sustainable policy ? The pressure on the reserve is relentlessly growing and could start accelerating in the new year from the need to import foodgrains on a large scale on emergency basis. The costs of importing fuel oils are also soaring. The costs of other imports of both food and non food items, are rising fast. Therefore, the sale of the greenback from the reserve may not be an affordable policy in the medium and long terms. Its utility in the short run that has caused only a small depreciation of the dollar, is found to be also rather useless.
While the dollar depreciation is not having any notable impact on imported inflation, it may, however, have significant negative effects on the country's main export earning sector, readymade garments (RMG). From different estimates, it was calculated that from each dollar of earning, the RMG entrepreneurs had been making a profit of 4.81 BDT. But this profit margin has already decreased to 4.71 BDT from dollar's depreciation by about 10 poisha recently. With dollar's depreciation against BDT by even 20 poisha occurring , the profit margin could reduce to 4.61 BDT. Already, the RMG sector is reeling under pressure for higher wages and the requirements to absorb other growing costs. In this backdrop, cuts in its earnings to the extent shown above, would worryingly squeeze this sector's viability further.
From increasing the supply of dollars in the market as BB has done, the condition for its depreciation can be created. But the real challenge is to maintain this depreciation because the same also depletes the reserve and may create problems for such supply in the future. Dollar devaluation, if adopted as a consistent policy, understandably encourages greater imports from declining import costs. But devaluation's effect can be also loss for the export sectors from declining earnings. Therefore, a devaluation trend can ultimately add to the trade deficit or impact unfavourably on the balance of payments position. Thus, after the primary devaluation, opposite forces may come into play and the dollar could tend to return to its previous value. In other words, the devaluation trend will become harder to sustain and opportunities may not be there for long to influence prices of imported goods through devaluation.
Bangladesh's present foreign currency reserve is valued at 5.16 billion. It is considered to be an all time high reserve of the country which is creating the opportunities to devalue the Dollar from the selling of dollars by the central bank. But this all time high reserve of the country is but peanuts compared to some of its neighbours. India, for example, astonishingly had a reserve of a little over one billion dollar only in the nineties. From that situation it has built a reserve of over 200 billion dollar. A country having such strengths of foreign currency holdings can attempt to spend from its reserve to influence the exchange rate of its currency in relation to other currencies. The same does not apply to Bangladesh for the obvious reasons.
The biggest ever foreign currency reserve of Bangladesh is of little value in the backdrop of the worldwide inflation. With about 5.0 billion dollars in reserve, Bangladesh could expect to meet its import requirements for nearly six months or more in the eighties and even during part of the nineties. Now this amount of reserve is considered barely enough to meet import requirements for even three months due to the high prices of commodities in international markets.
Thus, time has not arrived for Bangladesh to feel so confident from a sense that it possesses a comfortable reserve position. Its reserve position is still too modest and fragile in real terms to be used for getting results in sophisticated operations such as dollar depreciation.
THE Bangladesh Bank (BB) applies the country's monetary policy and BB's policy makers have been exercising different options to try and tame the runaway inflation which is noted in the Bangladesh economy. One such move recently involved the sale of some 185 million US dollars from its reserve during October-November to put pressure on the US dollar to depreciate against the Bangladesh Taka (BDT). Thus, the value of the Taka has appreciated against the dollar by some 0.7 per cent. This is being discussed hotly as an achievement of sorts because over the years the BDT has only gone on depreciating against the dollar. For the first time the local currency has gained against the most important international currency, the US Dollar. Thus, the appreciating BDT has soothed the ego of the policy planners and is expected to help in reducing inflation specially the inflation caused by higher priced imported goods as the prices of imported goods are now expected to fall with the value of the Dollar falling against the BDT.
But let us see the extent of the BDT's appreciation against the dollar. The notable thing is that it has been an appreciation in minuscule form, only 0.7 per cent whereas BDT's depreciation against the dollar was seen as particularly rapid in recent years. Thus, the depreciation of the BDT against the dollar was 2.76 per cent in 2004, 9.0 per cent in 2005 and 4.0 per cent in 2006. Only in 2007 it achieved a very modest turnaround of 0. 7 per cent through appreciation and this is being touted as an impressive sign of BDT's growing strength. But it is doubted how far the latest trend towards appreciation is sustainable given the country's relatively small foreign currency reserve and the rising demand for draw downs from it.
Coming back to the calculated sale of some 185 million dollar from its reserve by BB in a bid to decrease the prices of imported goods, it is considered to be a step of rather dubious value. It was calculated by experts that the dollar needs to depreciate by some 2.0 per cent, at least, for the same to have any lowering impact whatsoever on the prices of imported goods. But the appreciation has been only 0.7 per cent and, thus, too small to have any impact on the price levels. For the dollar to depreciate by some 2.0 per cent for creating a downward trend in the price levels, a substantial amount of dollar from the reserve will have to be sold. But can this be a sustainable policy ? The pressure on the reserve is relentlessly growing and could start accelerating in the new year from the need to import foodgrains on a large scale on emergency basis. The costs of importing fuel oils are also soaring. The costs of other imports of both food and non food items, are rising fast. Therefore, the sale of the greenback from the reserve may not be an affordable policy in the medium and long terms. Its utility in the short run that has caused only a small depreciation of the dollar, is found to be also rather useless.
While the dollar depreciation is not having any notable impact on imported inflation, it may, however, have significant negative effects on the country's main export earning sector, readymade garments (RMG). From different estimates, it was calculated that from each dollar of earning, the RMG entrepreneurs had been making a profit of 4.81 BDT. But this profit margin has already decreased to 4.71 BDT from dollar's depreciation by about 10 poisha recently. With dollar's depreciation against BDT by even 20 poisha occurring , the profit margin could reduce to 4.61 BDT. Already, the RMG sector is reeling under pressure for higher wages and the requirements to absorb other growing costs. In this backdrop, cuts in its earnings to the extent shown above, would worryingly squeeze this sector's viability further.
From increasing the supply of dollars in the market as BB has done, the condition for its depreciation can be created. But the real challenge is to maintain this depreciation because the same also depletes the reserve and may create problems for such supply in the future. Dollar devaluation, if adopted as a consistent policy, understandably encourages greater imports from declining import costs. But devaluation's effect can be also loss for the export sectors from declining earnings. Therefore, a devaluation trend can ultimately add to the trade deficit or impact unfavourably on the balance of payments position. Thus, after the primary devaluation, opposite forces may come into play and the dollar could tend to return to its previous value. In other words, the devaluation trend will become harder to sustain and opportunities may not be there for long to influence prices of imported goods through devaluation.
Bangladesh's present foreign currency reserve is valued at 5.16 billion. It is considered to be an all time high reserve of the country which is creating the opportunities to devalue the Dollar from the selling of dollars by the central bank. But this all time high reserve of the country is but peanuts compared to some of its neighbours. India, for example, astonishingly had a reserve of a little over one billion dollar only in the nineties. From that situation it has built a reserve of over 200 billion dollar. A country having such strengths of foreign currency holdings can attempt to spend from its reserve to influence the exchange rate of its currency in relation to other currencies. The same does not apply to Bangladesh for the obvious reasons.
The biggest ever foreign currency reserve of Bangladesh is of little value in the backdrop of the worldwide inflation. With about 5.0 billion dollars in reserve, Bangladesh could expect to meet its import requirements for nearly six months or more in the eighties and even during part of the nineties. Now this amount of reserve is considered barely enough to meet import requirements for even three months due to the high prices of commodities in international markets.
Thus, time has not arrived for Bangladesh to feel so confident from a sense that it possesses a comfortable reserve position. Its reserve position is still too modest and fragile in real terms to be used for getting results in sophisticated operations such as dollar depreciation.