The crawling peg’s latest move has sent shockwaves through the economic landscape, plunging the taka into a significant devaluation. In one swift stroke, the exchange rate plummeted from Tk 110 to Tk 117, marking a substantial adjustment that reverberates across sectors. This sudden devaluation is not merely a numerical shift; it’s a seismic event with far-reaching consequences for Bangladesh’s economy.
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The recent crawling peg adjustment brings a mixed bag of fortunes. Exporters rejoice as each dollar now fetches Tk 7 more, boosting their competitiveness on the global stage. This aligns with the government’s aim of bolstering trade. However, for import-dependent Bangladesh, the story takes a darker turn. The soaring cost of imports, fueled by the crawling peg, spells trouble for businesses, potentially leading to price hikes on essential goods like edible oil, lentils, and sugar.
Expert Hails Central Bank’s Progressive Measures
A leading economist remarked on 8th May 2024 that the recent decisions by the Bangladesh Bank, including the hike in the policy rate, the transition to a market-driven interest rate, and the adoption of a more flexible exchange rate, mark a significant stride towards revitalizing the nation’s economy. Ahsan H Mansur, Executive Director of the Policy Research Institute of Bangladesh (PRI), lauded these measures as crucial steps towards addressing the prevailing economic challenges.
“It is a commendable progression. While the interest rates for private lending may see an increase, such a move is imperative. We must navigate through this adjustment to effectively confront the existing hurdles,” Mansur stated, highlighting the necessity of aligning interest rates with market dynamics.
Key Decisions by Bangladesh Bank:
- Hike in the policy rate.
- Transition to a market-driven interest rate.
- Adoption of a more flexible exchange rate.
Mansur observed that the current exchange rate regime favored exporters at Tk 110 per dollar and advocated for depreciation to enhance export competitiveness. He also proposed discontinuing subsidies for remittances to promote a balanced foreign exchange market.
Embracing Market-Driven Lending Rates
Simultaneously, Bangladesh Bank ushered in a new era of market-driven lending rates, discarding the erstwhile treasury bill-linked formula that had bound banks for years. This transformative decision heralds a departure from the once-dominant command-and-control paradigm imposed on financial institutions four years ago.
Further underscoring its resolve, the monetary authority raised the overnight repurchase agreement rate by 50 basis points to 8.5 percent, marking the second consecutive hike this year in a bid to shore up short-term borrowing costs for banks.
These decisive actions unfolded in conjunction with the International Monetary Fund’s commitment of $1.15 billion in loans to Bangladesh, symbolizing a synchronized effort to rejuvenate the nation’s economic trajectory.
According to the monetary policy committee of the Bangladesh Bank, the economy confronts twin specters—stubbornly elevated inflation and a precipitous decline in foreign exchange reserves. Despite a medley of measures undertaken by both the central bank and the government to temper inflation, stabilize exchange rates, and safeguard reserves, the challenge persists.
Economic Challenges:
- Confronts twin specters:
- Elevated inflation
- Precipitous decline in foreign exchange reserves.
- Inflation above 9% since March of the previous year.
- Local currency has eroded 35% against the US dollar in the past two years.
- Reserves dwindling by more than half.
Inflation has entrenched itself above 9 percent since March of the previous year, while the local currency has weathered a 35 percent erosion against the US dollar over the past two tumultuous years. With the nation’s reserves dwindling by more than half, Bangladesh finds itself ensnared in one of its most severe economic crises to date—a plight exacerbated by the struggle to amass sufficient tax revenue to meet burgeoning expenses.
The specter of price hikes looms large over the domestic market, as businesses leverage the currency fluctuations as justification. Seizing upon the opportunity, they may exploit the situation to pass on increased costs to consumers. This potential uptick in prices exacerbates the strain on consumers already grappling with rising living expenses.
Battle with Dollar Appreciation
Notably, this isn’t an isolated event. Over the past few years, the dollar’s ascent in both formal and informal markets has been a recurring narrative. Exporters, in particular, have felt the pinch, selling out Tk 120-122 for each dollar to facilitate imports of raw materials and goods.
In the end, the implications are stark. As the dust settles, the likelihood of seeing imported consumer goods soar in domestic markets looms ominously. The crawling peg’s ripple effects underscore the delicate balance between economic policies and real-world repercussions, shaping the fate of nations and livelihoods alike.
The central bank’s decisions coincided with the conclusion of an IMF team’s 15-day visit to Bangladesh, led by Chris Papageorgiou, to discuss economic and financial policies within the framework of the loan program’s second review. Papageorgiou commended the bold actions of the Bangladesh Bank, emphasizing their aim to reposition the exchange rate while embracing a crawling peg regime.
Chris Papageorgiou, speaking at a finance ministry briefing, highlighted declining reserves amid external shocks like the Ukraine war and global interest rate hikes, which have fueled inflation. He praised bold reforms by authorities, advocating for a flexible exchange rate and scrapping the SMART system for greater flexibility. The IMF’s scrutiny uncovered Bangladesh’s stagnant tax-to-GDP ratio, urging reform to boost sustainable revenue generation for crucial social welfare and developmental projects.
IMF Study Findings:
- 1% increase in policy rate leads to 0.5% rise in inflation.
- Exchange rate appreciation curbs inflation by 0.3% within a year.
Citing empirical data from central Asian economies, an IMF study reveals the intricate link between policy rate adjustments and inflation. A 1 percentage point increase in the policy rate spurs a 0.5 percentage point rise in inflation, while a corresponding exchange rate appreciation curbs inflation by 0.3 percentage points within a year. As the repo rate hike tightens monetary conditions, the IMF warns of dearer money and a credit crunch as banks restrict lending. Amidst these concerns, the government’s increased borrowing from banks to cover budget deficits raises worries of worsening liquidity strains and a cycle of high-interest deposit acquisition from customers.
Implications for Individuals, Businesses, and Government
The disparity between rising deposit rates and stagnant lending rates highlights a systemic mismatch, worsened by infrequent adjustments in lending rates. Experts advocate for a market-driven treasury rate to address this issue, emphasizing the urgency of aligning rates with economic realities. The recent repo rate hike, delayed by two years, underscores this urgency.
Heightened borrowing costs ripple through the economy, burdening individuals, businesses, and the government. Banks are expected to pass on the higher policy rate to borrowers, leading to increased interest rates on mortgages, car loans, and business loans. This could dampen consumer spending, trigger reduced investment, and hinder economic growth.
Burden Across Sectors:
- Individuals: Higher borrowing costs impact mortgages and car loans, reducing spending power.
- Businesses: Increased interest rates on loans hinder investment.
- Government: Rising interest payments worsen fiscal deficits, affecting budgets.
- Banks: Expected to raise interest rates on mortgages, car loans, and business loans.
- Consumer Spending: Likely to decrease due to reduced purchasing power.
- Investment: Hindered by higher borrowing costs, leading to slower economic growth.
- Stock Prices: Expected to decrease as rising interest rates dampen economic outlook.
- Housing Market: Affected by unaffordable borrowing costs, impacting economic prospects.
In financial markets, rising interest rates dampen stock prices, while governments face heightened interest payments, worsening fiscal strains and budget deficits. The housing market suffers from unaffordable borrowing costs, further dimming economic prospects.
Amid these challenges, the IMF’s call for fiscal discipline and structural reforms rings loud—a call for Bangladesh to navigate towards fiscal sustainability and economic resilience amidst looming uncertainties.
