Key Takeaways:
- IMF praises Bangladesh for enhancing economic resilience with this move
- Non-market exchange rates caused financial deficits, leading to this shift
- Exporters and remitters will benefit from increased currency stability and predictability
The International Monetary Fund (IMF) has praised Bangladesh for its recent adoption of the Crawling Peg Mid-Rate (CPMR) system, highlighting its potential to bolster foreign exchange reserves in the future. According to Chris Papageorgiou, IMF mission chief for Bangladesh, the transition to a crawling peg within a band exchange rate arrangement marks a significant stride towards enhancing exchange rate flexibility. This increased flexibility is expected to facilitate a more orderly adjustment of external imbalances and fortify foreign exchange reserves.
Balancing Monetary and Fiscal Policies to Strengthening Economic Resilience
Chris Papageorgiou of the IMF elaborated that aligning the exchange rate with market-clearing levels in the short term is expected to boost the competitiveness of Bangladesh’s exports, increase remittance inflows, and expedite the repatriation of export earnings. This approach should alleviate pressures in the foreign exchange market, with Bangladesh Bank recently reducing foreign exchange sales and selectively engaging in purchases to support this goal.
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While the new exchange rate regime is conducive to safeguarding and augmenting foreign exchange reserves, Papageorgiou emphasized the need for complementary policies. These should include maintaining a prudent monetary and fiscal stance, rationalizing non-monetary uses of reserves, reducing uncertainties, enhancing the business environment to attract non-speculative foreign capital inflows, and instituting mechanisms to deepen liquidity in the foreign exchange market.
Papageorgiou also commended Bangladesh’s commitment to comprehensive reforms addressing longstanding structural challenges, including those related to climate change. Since the approval of the authorities’ economic reform program supported by the IMF in January 2023, notable progress has been made. This includes adopting a more flexible exchange rate framework, modernizing monetary policy frameworks, rationalizing energy subsidies, and bolstering social protection measures for the most vulnerable. Additionally, regulatory enhancements in the banking sector and initiatives addressing climate change are underway.
Is Full Market-Driven Exchange the Answer?
In the short term, adjusting the exchange rate to market-clearing levels is expected to enhance the competitiveness of Bangladesh’s exports, stimulate remittance inflows, and expedite the repatriation of export proceeds, alleviating pressures in the foreign exchange market. Bangladesh Bank has recently reduced foreign exchange sales and selectively made purchases.
Chris Papageorgiou noted that while the new exchange rate regime is conducive to safeguarding and boosting foreign exchange reserves, additional supportive policies are essential. These should include maintaining a tighter monetary and fiscal stance, rationalizing non-monetary uses of reserves, reducing uncertainties, improving the business environment, and developing mechanisms to deepen market liquidity.
Papageorgiou also praised Bangladesh’s commitment to comprehensive reforms addressing structural challenges and vulnerabilities, including those related to climate change. However, some experts argue that the introduction of the crawling peg system for the taka is a delayed and insufficient response, suggesting a full embrace of market-driven exchange rates to stop the depletion of reserves.
Will Bangladesh Align New Exchange Rate with Informal Market Rates?
In January, Bangladesh’s central bank announced plans to implement the crawling peg, reversing an earlier commitment to a fully floating exchange rate. The system is set to launch by June, marking a notable departure from the tightly controlled exchange rate policies maintained since independence in 1971, which relied on fixed rates to manage currency volatility.
Now faced with a critical decision, Bangladesh confronts the crawling peg—a mechanism that allows limited fluctuations within a predefined range, striking a balance between fixed and fully floating rates. This shift aims to inject flexibility into the exchange rate regime, a key recommendation from the International Monetary Fund (IMF). Yet, a pivotal question looms: will the central bank align the new exchange corridor with informal market rates to combat clandestine currency flows?
Since mid-2022, the depreciation of the taka against the dollar has been pronounced, largely attributed to a persistent balance of payments deficit that has sharply eroded foreign exchange reserves. This depreciation has exacerbated domestic inflation by driving up import costs. In response to these challenges, Bangladesh Bank has initiated a phased transition towards a market-oriented exchange rate system, with the crawling peg representing a pivotal step towards greater exchange rate flexibility and a safeguard against further reserve depletion.
The crawling peg holds promise in rebuilding resilience and enhancing adaptability to external shocks, crucial as Bangladesh prepares to graduate from the Least Developed Country (LDC) status by 2026 and integrates more deeply into the global financial landscape. This evolution signals a shift towards a more modern and forward-looking monetary policy framework, affording the central bank greater autonomy in monetary policy decisions.
“While reforms to enhance exchange rate flexibility have been accelerated appropriately, managing transitional risks remains paramount. Strategic policy measures to restore external resilience must be carefully calibrated and sequenced to ensure a smooth transition towards greater exchange rate flexibility,” noted an IMF report in December 2023.
Crawling Peg to Bring Relief to Exporters and Remitters
Under the crawling peg system, the exchange rate would be linked to a selected basket of currencies and operate within predefined bounds to mitigate excessive volatility in the currency’s value.
“The central bank will establish a stable reference rate while retaining flexibility to intervene as needed to maintain the currency within specified parameters,” stated Bangladesh Bank in January.
Before the discussions surrounding the crawling peg, Bangladesh introduced a purportedly market-based exchange rate in July 2023, although in practice, rates were largely influenced by unofficial directives from the Bangladesh Foreign Exchange Dealers’ Association and the Association of Bankers.
According to an IMF assessment, the lack of a genuinely market-based exchange rate contributed to a widening financial account deficit, ballooning to $8.36 billion from $2.32 billion in the July-February period year-over-year. This divergence led to significant portions of export earnings remaining offshore and remittances flowing through unofficial channels.
Bangladesh currently navigates a complex landscape of heightened inflation and slowing economic growth. Enhanced exchange rate flexibility holds the potential to mitigate forex reserve losses and alleviate taka depreciation pressures, initially triggered by deteriorating terms of trade and exacerbated by shifts in the financial account.
The prospective implementation of the crawling peg system is anticipated to bring relief to exporters and remitters alike, offering hope for improved stability and predictability in currency transactions.
