The causes of forex reserve buildup

The sagging investments caused by the political turmoil late last year drove down the demand for industrial machinery import. Resultantly, the overall import fell and the pressure on the foreign currency also declined leading to buildup of the foreign currency reserve. On December 19, 2013 the foreign currency reserve increased to Tk 18.0 billion (1,800 crore).
There has long been a sagging demand for investment and consequently the import flow has decreased. In each month the total volume of import is declining compared to the previous year. Accordingly, many banks are facing problems with the remittance inflow. Because of any demand in the market, the banks are selling the foreign currency to the Bangladesh Bank (BB). In 2012 the BB purchased about $ 4.54 billion (454 crore) or Tk 360 billion (36,000 crore). Moreover, the BB purchased about $ 1.49 billion equivalent to Tk 120 billion. Still the BB is purchasing dollar funds from the banks.
While the imports are decreasing, the foreign currency reserve is increasing as the BB is purchasing dollars from the banks. Furthermore, potential entrepreneurs are not in the market. Those, who queue up for loans, do not get the funds disbursed in fear of incurring losses. That means good entrepreneurs are scarce in the market. The ultimate result is the overall imports have decreased.
Many banks collect remittances from overseas sources. As there is little demand for dollars in the local market, the banks are compelled to come to the BB. Nevertheless, the BB cannot provide the money in the local currency against the dollar funds. In addition, the BB provides bonds to the banks. That is why the reserve management cost is increasing more than before. Moreover, Islami banks are being provided bonds having six months' maturity period. Thus Islami banks are inviting more problems by selling their dollar funds to the BB.
It is clear that banks are unable to hold all the foreign currency that they actually earn. According to the BB guideline, a bank should not hold dollar fund more than 9 per cent of its total asset. Because of the investment instability, the demand for dollar is too low and that is why, all banks have a surplus volume of dollars. If the dollar is purchased from the BB, money circulation increases in the market. Considering this, in 2010 the BB increased the dollar holding limit to 15 per cent from 9 per cent for banks. In that situation, many banks hold more dollars than that stipulated by the dollar holding rule. If this phenomenon goes on, all banks will face a severe problem.
Lastly, the increase in the foreign exchange reserve can be explained mainly in three ways. First, imports have decreased due to the decreasing demand for investments. Secondly, in recent years the commodity import had decreased as there was sufficient domestic production. Thirdly, banks have failed to utilise the remittances that they actually earned.
The writer is a student, Department of Finance, University of Dhaka. nasima.neha@yahoo.com