Exchange rates of taka and the story of its roller coaster journey

The year 1971 saw wars of two different dimensions. One was our own war against Pakistan's military junta. The other was warfare of the abstract kind fought by the world's economic powers to defend the Bretton Woods' par value system.
Bangladesh's war of independence unfolded many tragic events but ended happily with the surrender of Pakistan's 'invincible' army on December 16, 1971. At about the same time the supposedly 'invincible' US dollar to which Bretton Woods system was anchored as a proxy for gold also capitulated to the evolving realities in the world economic order.
The reason was simple -- the US ambivalence with regard to its obligations to convert, on demand, into gold dollar balances held by foreigners. The US merrily raked up huge balance of payments deficits seriously undermining their capacity to meet the potential demand for conversion. Inevitably it prompted a 'gold rush' but the Fort Knox did not have enough of this enigmatic yellow metal.  
In the backdrop of mounting pressure on dollar, the USA first devalued its currency against gold and abandoned the convertibility of dollar into gold on August 15, 1971. Immediately, official parities and intervention points were abandoned and major countries floated their currencies. There followed sporadic efforts by the world leaders to resuscitate the dying par value system but they all proved short lived and finally gave way to 'floating exchange rate' regime.
Bangladesh was born amidst these chaos in the international monetary order. The authorities had no clue as to what kind of exchange rate system could be adopted. There was little historical experience which countries, least of all a new born country, could draw upon to choose a proper exchange rate system. Bangladesh's predicaments were compounded by other equally pressing problems.
Firstly, it did not have any foreign exchange reserve; all foreign exchanges earned including those in the pipelines against exports from Bangladesh had been taken away by Pakistan's central bank (State Bank of Pakistan).
Secondly, the country's productive capabilities -- factories, roads and highways, ports and transports -- were all in shambles. So were the organisational structures.
Thirdly, the pound sterling to which taka and the currencies of other sub-continental countries had deep-rooted links was itself going through a period of crisis.
Fourthly, Bangladesh inherited a complex exchange rate system from Pakistan. This system was tailor -- made for the benefits of the vested groups.  As part of this objective Pakistan authorities consciously maintained an overvalued currency i.e. the value of Pak rupee was set at an artificially high level inconsistent with its true purchasing power.
To neutralise the negative effects of an unrealistic and overvalued rupee on exports, Pakistan introduced various incentive schemes to promote exports. One, introduced in1959, was known as 'Export Bonus Scheme'. The vouchers issued to the exporters under the scheme could be sold in the market at prices several times higher than its face value. The holders of these voucher could convert these into Import Licences for import of goods -- mostly luxury. Thus the burden of sustaining the overvalued rupee was passed on to the general consumers and the producers of primary commodities.
The Export Bonus Scheme had a profound impact on Pakistan's exchange rates structure. The growers of primary commodities -- jute, cotton, tea etc. -- were deprived of legitimate prices on account of an overvalued currency. On the other hand, industrialists enjoyed two kinds of benefit -- Bonus Vouchers on their exports and access to cheap raw materials, namely jute and cotton for running their jute and cotton mills. Besides, they enjoyed the benefits of cheap import of capital machinery at the highly overvalued official exchange rate. Thus, an elaborate stage was set for the emergence of the legendary twenty two families. This powerful group in time played a decisive role in shaping Pakistan's economic and political destinies leading eventually to the disintegration of the country in 1971.
Bangladesh's own exchange regime: With international monetary order in chaos and a highly manipulated exchange rate system inherited from pre-liberation Pakistan, Bangladesh set out on the arduous task to determine the exchange rate and to choose an anchor for her currency. By the time Bangladesh gained independence from Pakistan the official exchange rate had been set at Rs. 13.43 per pound sterling but the operation of the export Bonus Scheme produced effective multiple exchange rates ranging from Rs 13.43 to Rs. 22 per pound sterling -- a 29% devaluation of the appreciated official rate of the Pakistan rupee. Bangladesh wisely threw away this scheme in favour of a unified or single rate of exchange. On January 10, 1972, Bangladesh, for the first time, declared the par value at TK 18.9667 per pound sterling.
This exchange rate also soon proved to be unrealistic. The fledgling economy confronted shocks from two sources -- domestic and external. The war with Pakistan left its inevitable mark on the Bangladesh's fragile economic structure. The external shocks emanating from escalating oil prices following the Arab Israel war in 1973 literally drained whatever resources the country could mobilize for reconstruction of the war ravaged country.
In this desperate situation, the authority tried to severely curtail imports. Similarly, the release of foreign exchange for invisible payments was severely restricted.
The devastating flood of 1974 turned out to be the proverbial last straw on the back of the fragile economy. The efforts to provide succour to the flood affected millions nearly drained away the country's meagre foreign exchange resources. At this stage that Government hit upon a plan to allow import of goods with foreign exchange earnings of overseas Bangladesh nationals. This arrangement later came to be known as Wage Earners Scheme and still later as Secondary Exchange Market (SEM) before being abandoned on January 1, 1992.
Rigid exchange control, as it always does, drove people to the free market, known variously as   black market, kerb market, hundi market, hawla market and secondary market. By 1975, demand heavily outstripped supply, so much so that exchange rate of taka in the unofficial market reached almost Tk 60 to a pound -- nearly 3 times the official price of Tk 19.9667. This underscored the need for another revision but the authorities preferred to play a waiting game; they spent nearly three years before taking any action for adjustment of the taka rates. The long awaited devaluation was made on May 17, 1975 when the new central rate of taka was raised from TK 18.9667 to TK 30 per pound denoting a devaluation of about 58%.  
By this time pound sterling had lost its importance as international settlement currency. In 1983, Bangladesh made the long awaited shift to the US dollar but this was not as strong a peg as it was under the Bretton Woods system. The US dollar became a mere intervention currency and the exchange rate of taka would henceforth be expressed in that currency with options to change it as and when occasions warranted. Bangladesh indeed kept on devaluing her currency, partly to neutralize the effects of high domestic inflation and partly to offset the adverse change in the terms of trade.
Bangladesh's quest for a market oriented exchange rate: The search for a relatively balanced approach eventually led to adoption of a trade weighted basket of currencies consisting of Bangladesh's major trading partners. An index was prepared each day reflecting the changes in the exchange rate of taka and the inflation rates vis-à-vis the currencies in the basket. Taka-dollar rates were refixed normally in accord with the changes in the indices.
Bangladesh's management of exchange rates in the nineties was characterised by relative stability of the rates and a renewed confidence in the value of taka. This helped the exports and the remittances from overseas Bangladeshis to grow at a rapid pace. It also paved the way for dismantling or lowering many of the exchange control barriers leading eventually to declaration of taka as convertible for current transactions on March 24, 1994.
In May 2003 Bangladesh reached an important milestone in the management of exchange rates by allowing the taka to float in the market. It means, instead of Bangladesh Bank dictating the rates the taka was left to find its own level through the interaction of demand for and supply of foreign currencies -- chiefly US dollar -- for day to day transactions. It is, however, not a completely free floating. The central bank stands ready to mop up excess supply of foreign exchange or meet the shortfall from its reserve to stabilize the rate around a predetermined level. In foreign exchange parlance, this system is sometimes referred to as 'managed floating, sometimes as 'dirty floating'.
Contrary to popular apprehension that floating of taka would seriously undermine its value, the exchange rate of taka surprisingly maintained a stable position and did not create any undue turbulence in the exchange market. Taka, in fact maintained a steady level more or less similar to the level obtaining prior to floatation. The stability can be attributed to the improvement of the balance of payments, rigid monetary policy of the central bank to discourage building up foreign exchange reserve and monitoring of speculative transactions of the banks.
Where do we go from here? As of now, our foreign exchange reserve has risen to a record level of $26 billion. It may have infused certain degree of complacence in the psyche of the Bangladesh authorities. As a result, the signals that are getting louder for depreciating the taka have largely been ignored.
Firstly, taka has significantly appreciated in terms of non-dollar currencies especially the currencies of our important trade partners like euro, yen and India rupee. It has weakened our competitive strength vis-à-vis our competitors especially in respect of apparel exports as demonstrated by sluggish export orders from euro zones.
Secondly, the foreign exchange reserve is not as big as it apparently looks. It would largely be neutralized by accelerated borrowing in foreign currencies by Bangladesh entities. By now foreign currency loans have reportedly shot up to over $7 billion. The euphoria regarding foreign exchange reserve needs to be tempered by the potential outflow of foreign exchange against these loans in the not too distant future.
Thirdly, the foreign exchange reserve is quintessentially fuelled by migrants' remittances amounting to about $25 billion a year sent through official and unofficial channel. (The much hyped apparel sector pales into insignificance if we take out the costs of imported inputs.) The falling oil price will affect the prospect of export of manpower to the Gulf Region where most of our expatriate workers are concentrated. In fact, there could be a reversal of the flow if the oil price continues to remain at this level.
Our inflation rate is hovering over 6% per annum for some years now. With grandiose development projects in the pipeline and the recent pay hike of the public sector employees, the prognosis does not look any brighter either. The high inflation rate in Bangladesh has made Bangladesh a less attractive source country for our trade partners. Our complacency with regard to the size of foreign exchange reserve should not make us oblivious to the need for periodical adjustment of exchange rate commensurate with the taka's real strength or what the economists refer to as purchasing power parity.
Finally, the quantum of foreign exchange reserve must not be seen as 'be all end all' objective. We need not forget that China, with a foreign exchange reserve of $ 3.6 trillion, consciously maintain a highly undervalued Yuan to maintain its supremacy in the export trade. India, with a foreign exchange reserve of $352 billion has maintained the exchange rate of rupee at reasonable level to offset the impacts of inflation and the changing panorama in the international trade.
The conclusion I wish to draw is that we cannot afford the luxury of an overvalued currency without diluting our overall objective of balanced economic development through export led growth. The sooner the rate is adjusted to offset the effects of inflation and depreciation of non-dollar currencies the better would be for the economy.
The writer is a former Executive Director of Bangladesh Bank. [email protected].