Dollar volatility and blame game

In the past six weeks the price of the US dollar (greenback) fluctuated from as low as Tk 61 to as high as Tk 67, and the Association of Bankers Bangladesh (ABB) and Bangladesh Foreign Exchange Dealers Association (BAFEDA) have tried to implement a so-called single rate for inter-bank dollar transactions to ease the volatile greenback market. However, the single rate could not be executed unanimously because most banks deemed it as interference to the flexible exchange rate. The Bangladesh Bank (BB) has committed to the International Monetary Fund (IMF) that it won't either interfere in the forex market or take any step to bring an end to the continuing dollar crisis. However, a majority of forex market players considers the initiative of ABB or BAFEDA as an indirect intervention of BB.

It has been argued that the demand for the greenback has increased mainly because of rising import growth (24 percent) and weakening export growth (15 percent). The rising oil prices in global markets also accounts for an additional $500 million import bill. The rising value of dollar also contributes to drastic increases in import prices. Increase in private sector credit, especially during the last six months of fiscal year 2005, has also been blamed for recent dollar crisis. However, no one has questioned the direct or indirect effect of government's borrowing. It is reported that Tk 400 million was borrowed during the last five days of fiscal year 2005.

IMF is arguing that it warned BB at the beginning of second quarter of 2005 to increase interest rates to maintain price stability and discourage private sector credit expansion. This policy suggestion was a U-turn by IMF from its previous position of advocating low interest rates. Accordingly, BB reduced its money supply since last April and asked commercial banks to raise interest rates. Inflation rate increased from 6.24 (April) to 6.35 percent (May) after the introduction of IMF-induced interest rate policy. It subsequently increases to 6.9 percent in late July. Surprisingly, after the backdrop of recent dollar crisis, IMF began to criticise BB on the ground that the tighter monetary policy was adopted too late.

IMF also slammed BB for its disappointing role in handling the greenback scarcity. However, IMF wants that neither the government nor BB should interfere in forex market. IMF recently reported that "in view of external sector developments and the unfolding impact of the MFA phase out, an orderly market-based depreciation of the taka is likely and is consistent with the need to maintain macroeconomic stability and improve external competitiveness." At present, IMF suggests that BB should actively use open-market operations and develop liquid inter-bank and treasury markets to ensure that the market maintains adequate liquidity. Now, IMF suggests that BB should allow interest rates to increase in a market-based manner.

The governor of BB also admits that the current volatility in the greenback is not unexpected under a floating exchange rate regimen. However, he reveals that there should be rational coordination among monetary, fiscal, and trade policies to hold back inflation and currency devaluation. Interestingly, the ex-deputy governor of BB (now the managing director of a commercial bank) recently blamed BB for its invisible intervention to control the open market operations of exchange rate mechanism that led to recent volatility in dollar prices. It has been reported that the central bank officials called the commercial banks to lower the quoted rate of dollar. However, the governor of BB denied this allegation on the ground that this kind of intervention is not sustainable. He further argues that if the market fundamentals are correct and fair, there will be a gradual adjustment in currency volatility. This evidence raises the question of transparency and accountability of BB either in contributing to or combating the volatility of the greenback. Conceivably, there might be something peculiar with BB that (among other things) causes recent currency volatility. The policy dilemma of BB is also acute.

Although the dollar market is in turmoil in Bangladesh, the price of dollar has declined in major Asian countries during the same period. The value of dollar declined on August 2 in most of the Asian markets because of renewed concerns about the US trade, budget, and current account deficits and better economic indicators in Japan. Even an increase in federal funds rate (from 3.25 to 3.50 percent) by the Fed on August 9 did not contribute to any fall in major Asian currencies.

The decline in taka against US dollar suggests that the demand for dollar has increased. The first month of fiscal year 2006 experienced a 22 percent increase in foreign currency ($340 million) through remittances. The net positive inflow of remittances is expected to diminish the current pressures on the greenback. However, BB refuses to inject dollars into the economy, fearing a long-term and sustained pressure on foreign direct investment, because higher forex reserves assure foreign investors of repatriating their profit. BB also argues that higher reserves are necessary to meet the demand for priority imports.

BB has asked the commercial banks to be cautious and more conservative in opening import related letter of credits (LCs). However, the Metropolitan Chamber of Commerce and Industry has expressed its concern that the limited LCs from the banking sector have led unscrupulous traders to hoard imported goods that already raised the prices of essential goods.

The finance minister also joined this blame game by rejecting the claim of any dollar crisis in the country. He said that over-commitment for LCs by some small banks to make quick profit has put those banks under self-created dollar crisis. Further, he warned that BB would scrutinise whether these small banks were capable to earn enough foreign exchange to meet the large numbers of LCs that they recently launched. Interestingly, the remarks of the finance minister raise some ridiculous but serious questions: are small banks so powerful to dictate the forex and financial markets in Bangladesh?

How dare a small bank opens a large number of LCs that it can't operate and sustain? Is there any central bank in Bangladesh to monitor the rules and regulations associated with LCs? Or is BB simply obeying IMF's suggestion of "no interference" policy in LCs opening. The other comments made by the finance minister in this regard are also inconsistent with the idea of market economy.

It seems that the blame game started from the top of the government. Neither the government nor BB wants to take any responsibility for the dollar crisis. Does BB actually enjoy any autonomy as claimed? The governor says that market fundamentals will bring stability in forex market although we observed that the taka had gradually depreciated by more than 6 percent within six weeks. The finance minister says that forex reserve is low (around $3 billion or equivalent to 3-months of import bills) and can only meet the demand for most essentials. Unfortunately, we were told exactly the opposite by the finance minister in his last budget speech. Ironically, they all failed to admit that the market fundamentals were not fair. The small banks became the scapegoat in this blame game.

After the Asian crisis in 1997-1998, most of the crisis-affected countries switched from exchange rate based monetary policy framework to the inflation-targeting monetary policy (where interest rates are used as key monetary policy instruments to stabilise the economy). Accordingly, interest rates were increased (again according to IMF suggestion) to curb currency depreciation in those crisis-prone countries. However, many academicians, including Nobel laureate Joseph Stiglitz, argued that rising interest rates destabilised the exchange rates of these countries by raising corporate bankruptcies and accelerating capital outflows. The introduction of new monetary policy device, in fact, increases the contagious effect, i.e. their currency now becomes more sensitive to the competitors' exchange rate.

When the nominal interest rate of a country is changed because of a rise in expected real interest rate, the local currency of that country appreciates. However, when the change is instigated by a rise in the expected rate of inflation, the domestic currency depreciates, as it is the case in Bangladesh now.

The author is a senior Lecturer of Finance at Auckland University of Technology, New Zealand.