Replacing LC system with cash import better option

Foreign trade and foreign exchange play very important roles in the economy of a country. Bangladesh, with an open economy and small domestic resource base, depends largely on the external sector for her economic development. Due to domestic resource constraints the government has incorporated the mantra of export-led growth into its policy stances.
This paper revisits three important tools of economic management -- exchange control, exchange rate and back-to-back letters of credit -- and suggests how they can be made more responsive to achieving our cherished vision of turning Bangladesh into a middle-income country.    
Exchange control: Exchange control in Bangladesh is a legacy from the British government. During the Second World War (1939-45) Britain, as part of her war efforts, imposed exchange control metropolitan Britain as well as her colonies to conserve foreign exchange, gold and critical resources. A series of notifications were issued during the war (1939-45) underlining the restrictive measures covering all aspects of foreign exchange, including gold.
The war ended in 1945, but before it did, the Great War had shaken the world economic order from its moorings. So, instead of shelving the controls, the Government of British India consolidated the rules and regulations and passed an Act in parliament in June 1947-known as Foreign Exchange Regulation Act 1947. Later that year, India and Pakistan won freedom and both adopted this Act. Bangladesh also inherited this Act when it parted its company with Pakistan in 1971.
The nine-month war against Pakistan in 1971-our liberation war-left our economy and the infrastructure in a shambles. External shocks like oil price hike of 1973 and domestic shocks like floods in 1974 further added to the woes of Bangladesh.  Bangladesh's export earnings had come down to trickles and foreign-exchange reserves had all but dried up. That left the authority with no option than to continue the rigid exchange control.
Bangladesh has come a long way from the painful days of scarcity. Foreign-exchange regulations have been significantly relaxed, Bangladesh taka was made convertible for current-account transactions in 1994, the exchange rate of the taka is by and large dictated by the market forces of demand and supply under the (managed) floating-rate system introduced in 2003. Annual volume of exports escalated from a proverbial peanut to about $31 billion during the last fiscal (2014-15). Expatriates' remittances which were only a trickle prior to the Liberation of Bangladesh has soared to $15 billion in addition to another $10 billion or so coming through the unofficial channel. The volume of foreign-exchange transactions has now reached a new height  while the interbank foreign-exchange market has lent depth to the market. In short, Bangladesh is now strongly is poised to take off to a higher level of growth.
In the meantime, globalization has set the tone for movement of capital, trade and services. It has exposed us to higher level of dynamism via integration of markets. What we need at this stage is greater policy transparency, information dissemination and data monitoring.
Clearly, we need to shift our focus from micro to macro management of foreign-exchange flows and market. Policymakers and regulators have to change their attitude towards more market-friendly approach facilitating trade and payments as well as developing orderly foreign-exchange markets.
What we see, however, is that regulators are still relying on the rules and regulations that were set in the backdrop of scarcity of foreign and other negative economic parameters. It explains why we are still carrying an excess baggage of absurd rules and regulations that lost their relevance long ago. The instances are numerous but I would refrain from reciting them for lack of space.  
Convergence of free market and the official exchange rate coupled with liberalization of foreign-exchange quota for current-account transactions has taken away much of the steam from the rationale for maintaining rigidity for monitoring receipt of foreign-exchange by the residents in Bangladesh. For instance, in the seventies and eighties when the gap between the free market and official market was high, most of the migrants' remittances were routed through free market in spite of the incentives given to them under the home remittance bonus scheme. Now that the two exchange rates-free market rates and official exchange rates-have converged quite close to the intrinsic value of, it is no longer necessary to wield big sticks to induce the eight million expatriates to send money through official channel. Money still goes to the kerb market but that is an inevitable consequence of exchange- and import control.       
Too much emphasis on micro-level management of foreign exchange not only unnecessarily ties down large number of manpower but breeds corruption and militates against creation of market-friendly environment.
The conclusion we can draw is that foreign-exchange-control regulations have largely become irrelevant to Bangladesh's changed situation. The authorities may work towards further relaxing exchange control and modalities for enforcement of control as a prelude to making our currency convertible for current-account transactions.
Exchange rate system: Bangladesh switched to floating exchange-rate system in 2003. Under this system exchange rate of the taka is supposed to be determined by the market forces of demand and supply. In reality, however, Bangladesh Bank indirectly intervenes in the market by mopping up excess supply of foreign exchange. When the demand is high, the central bank meets the excess demand by releasing foreign exchange from its reserves. Thus the exchange rate that is seen or claimed as the product of interaction of demand and supply is in fact decided a priori by the central bank. In the foreign-exchange parlance it is termed 'managed floating' or 'dirty floating'.
One can understand the need for intervention to iron out temporary fluctuations but the taka rate has been held too long around the current rate of Tk 78 per US dollar. Our healthy foreign-exchange reserves undoubtedly infused certain degree of complacence in the psyche of the Bangladesh authorities to maintain an overvalued currency. What is ignored is the signal that is getting louder for depreciation of the taka.
Firstly, although exchange rate of the taka has apparently remained stable, it in fact significantly appreciated in terms of non-dollar currencies, especially the currencies of our important trade partners like euro, yen and the Indian rupee. It has weakened our competitive strength vis-à-vis our competitors.
Secondly, the foreign-exchange reserves are not as big as those apparently look. 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 reserves needs to be tempered by the potential outflow of foreign exchange against these loans in not too distant a 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 falling oil prices will affect the prospect of export of manpower to the Gulf region where most of our expatriate workers are concentrated. In fact, home remittances by our workers have already started to decline.
The inflation rate is hovering over 6% per annum for some years now. A sluggish trend has reportedly set in the apparel sector, especially for exports to the euro zone. Other industries are also starting to feel the pinch and are now clamouring for subsidies. In the meantime, avalanche of goods entering the country through illegal channels is throttling our indigenous industries, particularly small-and medium-sized industrial units. Due to cheaper Indian rupee and other-east Asian currencies planeloads of people are visiting these countries for fun and frolic while the flow of foreign tourists to Bangladesh has come down to trickles.      
The conclusion we 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.  
Back to back letter of credit: Letters of credit opened by apparel exporters for import of fabrics and accessories on deferred payment terms to execute the export orders are called back-to-back letter of credit. Technically these are not back-to-back letter of credit as defined by the International Chamber of Commerce. The problem is not with its wrong name but its effects on our foreign-exchange earnings.
This system of this hybrid form of back-to-back letter of credit was introduced in the middle of seventies when our foreign-exchange reserves had nearly dried up. Deferred payment-imports under these LCs involve costs like interest for the credit period, LC-confirmation-and bill-acceptance fees and other ancillary costs. A safe assumption is that import on credit terms, directly or indirectly, imposes an additional cost of anything from 4.0 to 5.0 per cent on the garment units. At this rate the country loses something like $600 million every year.
Bulk of this money can be saved if we allow the apparel makers to import their inputs on cash-payment basis like other ordinary imports. This will involve outlay of some amount from our foreign-exchange reserves. There is little logic behind paying interest to foreign buyers or banks at 4 to 5% per annum when our yield on investment of reserves is next to nothing (less than1% pa).   
Additionally, cash import will provide an opportunity for the banks in Bangladesh to finance the imports by deploying their own funds in this relatively safe business.
The writer is a former Executive Director of Bangladesh Bank. [email protected]