1.

Introduction

1.1: Rationale:

Exchange rate indicates the global position of economy of the country. The country's
economic development is closely related with its foreign exchange system. Foreign exchange
rate is a vital component for the country's economic activities too. I have tried to evaluate the
impact of the floating exchange rate regime on our economy. To measure this, I have
analyzed some factors which are very important in this area. Such as: The foreign exchange
reserve, the workers remittance and the export. The analysis was based on the data of 2000 to
2012. Besides this, I have tried to study the experience of some peer countries to justify the
situation of ours. Moreover, impact of liberalization in foreign exchange framework has also
been focused

1.2: Objectives

Broad Objective:
 To understand the relationship of exchange rate with the variables of
macroeconomics.
Specific Objective:
 To evaluate the exchange rate regimes in Bangladesh economy: Fixed and
Floating.
 To evaluate the floating arrangement's performance in three macro
economic variables: Export, Workers Remittance, and Foreign Currency
Reserve.

1.3: Scope

The key factor of this paper is the evaluation of the impact of exchange rate on the
fundamental macroeconomic indicators of the economy. I have identified the three main
fundamental factors to measure their impact with exchange rate. Those are export, workers
remittance and foreign exchange reserve. I used the empirical data of recent years to justify
the whole thing.
1
1.4: Limitations

 Data Confidentiality: Banking information is confidential & critical. The main barrier in
preparing this report was data confidentiality. Though I saw the bank's internal procedure
that is being used in processing and evaluating any documentary operation, I was not
allowed to disclose that in my internship report.
 Lack of Information: I've got to know that some of the relevant papers which contain
updated data are still not is published. Many procedural matters are conducted directly in
the operations by the top management level, which may also have some sort of
restrictions.

2
 2. Overview of the Organization

2.1: Introducing the Organization

I am currently working in the Foreign Exchange Investment Department of Bangladesh Bank.

Therefore, I am doing my internship here. Bangladesh Bank is the central bank of Bangladesh
that acts as the regulatory body for the banking system and non banking financial institutions.
The functions of Bangladesh Bank include currency issuance, perusing of monetary policy
and management of reserves. Bangladesh Bank acts as the banks of the Government. It also
acts as the banker of the all commercial banks. All banks in Bangladesh keep and maintain
their accounts with Bangladesh Bank and they borrow money from Bangladesh Bank when
necessary.

2.2: Historical Background of Bangladesh Bank

After the separation of Pakistan from India in 1947, the State Bank of Pakistan was
established in 1 st July 1948. The Office of the Deputy Governor of the State Bank of
Pakistan in Dhaka operated as its Head Office. But when on December 16, 1971 Bangladesh
has introduced as a newly independent country in the world, Bangladesh Bank was
established as the central Bank of Bangladesh. It was recognized by the" Bangladesh Bank
Order - 1972" made by the president's order no - 127 of 1972. Through this order, the entire
operation of the former state Bank of Pakistan was transferred to Bangladesh Bank. It is the
statutory authority to regulate, control, and facilitate economic activities through proper
formulation of monetary policy.

2.3: Vision and Mission of the Organization

Vision
To develop continually as a forward-looking central bank with competent and committed
professionals of high ethical standards, conducting monetary management and financial
sector supervision to maintain price stability and financial system robustness, supporting
rapid broad based inclusive economic growth, employment generation and poverty
eradication in Bangladesh.
3
Mission
 Regulating and supervising banks and financial institutions
 Advising the government on interactions and impacts of fiscal, monetary and other
economic policies.
 Managing currency issue and regulating payment system
 Managing foreign exchange reserves and regulating the foreign exchange market.
Formulating monetary and credit policies

2.4: Main Functions of the Organization

Bangladesh Bank performs all the core functions of a typical monetary and financial sector
regulator, and a number of other non core functions. The major functional areas include:

 To act as a reservoir of foreign currency

 To formulate and implement monetary and credit policies.
 To regulate and supervise the banks and financial institutions and to work
for the development of domestic financial markets.
 To prevent Money Laundering.
 To Collect and furnish of credit information.
 To implement the Foreign exchange regulation Act
 To manage a Deposit Insurance Scheme etc.

2.5: Branches of the Organization

At present, Bangladesh Bank has 10 branches in Bangladesh. These branches are-

Motijheel Office Sadarghat Offlee
Chittagong Offlee Khulna Offlce

Barishal Offlce Rajshahi Offiee

Rangpur Offlce Bogra Offlee

Sylhet Omce Mymensingh Omce
,

4
2.6: Departments of the Organization
There are 43 departments in Bangladesh Bank which are actively performing their
activities. These departments are created for doing the works easily as per the requirements of
Bangladesh Bank. This department's are-
Common Services Department
Bangladesh Financial Intelligence
Unite
Banking Regulation and Policy
Department
Accounts & Budgeting Department
Debt Management Department
Department of Financial
Institutions and Markets
Department of Banking Inspection 2
Department of Printing and
Publications
Forex Reserve & Treasury
Management Department
Foreign Exchange Investment
Department
Foreign Exchange Policy
Department
Governor's Secretariat
Security Management Department
Investment Promotion & Financing
Facility Project Cell
Law Department
Policy Analysis Unit
Statistics Department
Information Systems Development
Department
Foreign Exchange Operation
Department
Expenditure Management Department
Bangladesh Bank Training Academy
Central Bank Strengthening Project Cell
Credit Information Bureau
Department of Banking Inspection 1
Department of Currency Management
and Payment System
Department of Off-Site Supervision
Equity and Entrepreneurship Fund Unit
Foreign Exchange Inspection & Vigilance
Department
Foreign Exchange Operation Department
Agriculture Credit Department
Human Resources Department
Internal Audit Department
IT Operation & Communication
Department
Monetary Policy Department
Researcb Department
SME & Special Programmes Department
Special Studies Cell
5
2.7: General Activities of Foreign Exchange Investment
Department (FEID)

 Monitoring the activities of subsidiaries of Bangladeshi companies in abroad

established.

 To accord permission under Section 18A of the Foreign Exchange Regulation 1947 to
the individuals/firms/companies to work as agents in Bangladesh of non-resident
companies/firms and monitoring repatriation or receiving commission as agent.
Agents:

o Indenting Agent
o Buying Agent
o Courier Service Agent
o Freight Forwarder Agent
o Shipping Agent
o General Sales Agent of foreign Airlines
o Pre-shipment Inspection Agent
o Local Agents
o Satellite Channel Distributors
o Internet Service Provider etc.

 Releasing funds in favor of Bangladeshi individuals or firms earned as consulting fees

or other fees without obtaining prior permission from Bangladesh Bank.

 To accord permission under Section 18A of Foreign Exchange Regulation Act, 1947
for foreign nationals employed in Bangladesh (those who are employed in
branch/liaison offices of foreign companies/firms).

 To accord permission for opening branch/liaison Office in Bangladesh by foreign

entities including airlines, companies, firms under Section 18B of Foreign Exchange
Regulation Act, 1947 and monitoring the remittance as sales proceeds thereof.

 Post-facto checking of profit remittance of branch offices of foreign banks.

 Post-facto checking of profit remittance of branch offices of foreign companies/firms.

 Post-facto checking of dividend remittance of foreign share holders of Bangladeshi

companies.

6
 Post-facto checking of remittance of Royalty/technical know-how/management fees,
audit fees, travelers' fees, software fees (training, installation, purchase), travel agents'
fees, global health care fees, expatriate's salary, etc.
 Post-facto checking of remittance of Management fees/salaries/insurance premium,
etc. of foreign expatriate of the international hotels, e.g. Pan Pacific Sonargoan Hotel,
Hotel Sheraton, Hotel Radisson and Westin.

 To accord permission for remittance of Management fees/salaries/insurance premium,

etc. of foreign expatriate of the international hotel Westin.

 Formulation of policy/guidelines for service sector as a whole related to permission

under Section 18A of Foreign Exchange Regulations Act, 1947.

 Examination of draft bilateral investment promotion agreements with different

countries and international agencies relating to investment and providing opinion as
asked by different government authorities on the issue.

 Providing opinion to various government authorities on service sector industry and its
policy matters.

 Miscellaneous.

7
 3. Literature Review

3.1: Microeconomics and Exchange Rates

Macroeconomics is considered with the overall performance of the economy. Some
macroeconomic variables are interest rate, inflation rate, current account balance, gross
domestic product, exchange rate and so on.

Exchange Rate is how much of one currency is worth in terms of another. A growing body of
literature has recently focused on Exchange rate. It is now widely recognized that Exchange
rate are important to economic development. The foreign exchange market is one of the
largest markets in the world

Exchange rate management is one of the central issues of macroeconomic policies. On May
2003, Bangladesh bank adopted the floating rate regime. Historically, Bangladesh had been
maintaining various pegged exchange rate regimes. As example, from 1972 to 1979, it was
using the pegged to British pound sterling, from 1980 to 1982, it was using the pegged to a
basket of major trading partners' currencies with pound sterling, from 1983 to 1999, it was
using pegged to a basket of major trading partners' currencies with US dollar and from 2000
to 2003, it was using the adjustable pegged system. Bangladesh changed its exchange rate
regime from the adjustable pegged to floating on May 31, 2003. And this shift was fine and
the first ten months was proved as its best period.

3.2: Types of Exchange Rates

Exchange rate systems can be classified according to the degree by which exchange rates are
Control by the Government. Exchange rate systems normally fall into one of the following
Categories:
 Fixed Exchange Rate
 Floating Exchange Rate
 Pegged Exchange Rate

8
3.2.1: Fixed Exchange Rate
In a fixed exchange rate system, exchange rates are either held constant or allowed to
fluctuate only within very narrow boundaries. If an exchange rate begins on move too much,
governments intervene to maintain it within the boundaries. In some situations, a government
will devalue its currency while in other situations it will revalue its currency against other
currencies.
Advantages: MNCs are able to engage in international trade without worrying about the
future exchange rates. It reduces the risk of doing business in that country too.
Disadvantages: The government may manipulate the value of the currency. Also, a fixed
exchange rate system may make each country more vulnerable to economic conditions in
other countries.

3.2.2: Floating Exchange Rate

Floating rate systems can be further classified into 2 subcategories:

Freely Floating Exchange Rate System: Also known as a clean float. In a freely
floating exchange rate system, exchange rate values are determined by market
forces without intervention by the governments.

Advantages: It helps solve unemployment problems in other countries. An additional

advantage of this system is that a central bank is not required to constantly maintain ER
within specified boundaries.

Disadvantages: A country's economic problems can sometimes be compounded

by freely floating ER. Under such a system, MNCs would need to devote
substantial resources to measuring and managing exposure to ER fluctuations.

Managed Float Exchange Rate System: Also known as a dirty float. It is

similar to a freely floating system in that exchange rates are allowed to fluctuate
on a daily basis and there are no official boundaries. It is similar to a fixed rate
system in that governments can and sometimes do intervene to prevent their
currencies from a sharp fall.

9
Advantage: It prevents a crash in the value of the currency, should it happen.

Disadvantage: Some criticize such a policy as it seeks to protect the home

currency at the expense of others.

3.2.3: Pegged Exchange Rate: Under such a system, the value of the home currency is
pegged to a foreign currency. The pegged currency moves in line with that currency to which
it is fixed against other currencies. Some currencies such as the Argentine peso or the
Chinese Yuan are pegged against a single currency (US dollar) while some others are pegged
against a composite of currencies such as the composite of European currencies.

Advantage: If a country conducts most of its trade with another country then
pegged system Yields benefit to both these countries as it virtually eliminated
the exchange rate risk.

Disadvantage: The risk associated with depreciation of that currency to which it is pegged.

3.3: Determinants of Exchange Rate

Numerous factors determine exchange rates, and all are related to the trading relationship
between two countries. Remember, exchange rates are relative, and are expressed as a
comparison of the currencies of two countries. The following are some of the principal
determinants of the exchange rate between two countries. Note that these factors are in no
particular order; like many aspects of economics, the relative importance of these factors is
subject to much talk topic.

3.3.1: Differentials in Inflation Rate

As per general rule, a country with a consistently lower inflation rate exhibit a rising currency
value, as its purchasing power increases relative to other currencies. During the last half of
the twentieth century, the countries with low inflation included Japan, Germany and
Switzerland, while the U.S. and Canada achieved low inflation only later. Those countries
with higher inflation typically see depreciation in their currency in relation to the currencies
of their trading partners. This is also usually accompanied by higher interest rates.

10
3.3.2: Differentials in Interest Rate
Interest rates, inflation and exchange rates are all highly correlated. By manipulating interest
rates, central banks exert influence over both inflation and exchange rates, and changing
interest rates impact inflation and currency values. Higher interest rates offer lenders in an
economy a higher return relative to other countries. Therefore, higher interest rates attract
foreign capital and cause the exchange rate to rise. The impact of higher interest rates is
mitigated, however, if inflation in the country is much higher than in others, or if additional
factors serve to drive the currency down. The opposite relationship exists for decreasing
interest rates - that is, lower interest rates tend to decrease exchange rates.

3.3.3: Current Account Deficit

The current account is the balance of trade between a country and its trading partners, re
flecking all payments between countries for goods, services, interest and dividends. A deficit
in the current account shows the country is spending more on foreign trade than it is earning,
and that it is borrowing capital from foreign sources to make up the deficit. In other words,
the country requires more foreign currency than it receives through sales of exports, and it
supplies more of its own currency than foreigners demand for its products. The excess
demand for foreign currency lowers the country's exchange rate until domestic goods and
services are cheap enough for foreigners.

3.3.4: Public Debt

Countries will engage in large-scale deficit financing to pay for public sector projects and
governmental funding. While such activity stimulates the domestic economy, nations with
large public deficits and debts are less attractive to foreign investors. A large debt
encourages inflation, and if inflation is high, the debt will be serviced and ultimately paid off
with cheaper real dollars in the future.

11
3.4: Evolution of Exchange Rate Regime

Bangladesh was using the fixed exchange rate system since January 3, 1972. The central
bank changed its exchange rate system in June 2003, aftermore than 31 years. Bangladesh is
using the floating exchange rate system since the former advisor; ministry of finance of
caretaker government, Dr. Mirza Azizul Islam presented a paper about the disadvantages of
fixed exchange rate system and the probable implications of using the floating exchange rate
system along with a comparison of some neighboring countries. He also explained that the
floating exchange rate can produce greater volatility in exchange rates and this can heavily
harm our economy.

Bangladesh pursued a 'fixed exchange rate' regime up to 1979. From 1979 to 2003, it
followed the managed floating exchange rate system. From May, 2003, Bangladesh took
clean floating exchange rate policy by using convertible current account.

3.5: Some evidences about the regime

Hossain (2005) refereeing Rahman and Bayes stated that Bangladesh took floating exchange
rate system due to: (i) global competitiveness; (ii) improve export dimensions (Hi) reduce
import pressure; (iv) increase the substitutes products for export. Aziz (2003) showed that
according to the statements of the finance ministers for last decades, the main reasons for the
currency depreciation are: (1) rise in export, (2) reduce import,(3)promote the inward
remittances trough pursue wage earners, and (4) increase foreign exchange reserve.

As per the "Financial Sector Review(2006)' of the central bank of the country, the prime
reasons of exchange rate policy determination are: (i) export promotion; (ii) encourage
inward remittances;(iii) keeping the price level stable, and (iv) preserve a variable account
situation externally.

Prior to adopting floating exchange rate regime, Islam (2003) argued that the economic and
institutional prerequisites of a floating exchange rate regime are not met in Bangladesh.

12
By doing a correlation analysis, Rahman and Barua (2006) explore the possible explanation
of the exchange rate movement. And they found the correlation between depreciation and
export- import gap, LIC openings for imports and the volatility of exchange rate has a
positive correlation and it was .45.

The experiences of some countries in the region which implemented major changes in their
exchange rate regimes in recent years can provide useful lessons for Bangladesh.

According to ECONOMY, "India's economic reforms," The reformation process was started
in July 1991. The reforms of the last decade and a half have gone a long way in freeing the
domestic economy from the control regime. This approach was adopted since the reforms
were introduced in 1991 in the wake a balance of payments crisis that was certainly severe.
However, it was not a prolonged crisis with a long period of non-performance. This
reformation affected the working of the economy.

While studying the deregulation of china, we have got to know many ideas. The deregulation
was done to shield the Chinese industry. At the time of economic recession in China, the
demand for its domestic products was decreasing. As a result, it had to depend on its export
to earn revenue. And due to the lower consumption of domestic product, it decreased the
income of the country as well as the GDP. Now since the deregulation of Chinese yuan, its
exchange rate is expected to go up

According to Foreign Exchange Policy and Intervention in Thailand, Since 2 July 1997,
Thailand has adopted the managed-float exchange rate regime, replacing the basket-peg
regime which had been in operation since 1984. The determination of the value of their
BAHT was done by the market force. The Bank of Thailand 'manages' the exchange rate by
intervening in the foreign exchange market from time to time in order to prevent excessive
volatilities in the markets. In other words, movements in the exchange rates which are in line
with the changes in economic fundamental and financial development would only be
smoothened and not resisted.
The managed-float exchange rate regime was introduced in May 2000.

The experiences of South East and South Asian countries showed that they had to intervene
in the market for smooth moving. The experience supports the beliefs of Mr. Kindleberger
that the regulators should be careful about the behavior of markets. Regulators should be
watchful about the market's behavior and intervene when needed without hesitations 13
According to Gale Raj,Yanice Colon.Silvana Kostembaum &Robert Cordova," Malaysia's
economy rebounded considerably well from the 1997 Asian crisis without incurring in IMF
loans and hence future debt. We find that the country is able to revitalize its economy to
become strong. This can be attributed to its well-sounded financial and monetary policies as
well as the confidence the Malaysian people and surrounding country governments have in
the Malaysian administration."

Bangladesh has initiated a new exchange rate policy according to IMF (article: 8) with the
current account fully convertible. But the capital account of our economy is not convertible
because there is little scope of capital flight.

This paper will assess whether the exchange rate regime change indeed has created any
significant impact on the economy of the nation as well as the comparative analysis with the
neighboring countries situation.

In the worst case scenario, a government may print money to pay part of a large
debt, but increasing the money supply inevitably causes inflation. Moreover, if a
government is not able to service its deficit through domestic means (selling
domestic bonds, increasing the money supply), then it must increase the supply of
securities for sale to foreigners, thereby lowering their prices. Finally, a large debt
may prove worrisome to foreigners if they believe the country risks defaulting on
its obligations. Foreigners will be less willing to own securities denominated
in that currency if the risk of default is great.

14
 4. Methodology

4.1: Introduction
To obtain the objectives of the study, I have collected different types of data. The study
contains a huge amount of data and information. I have followed some methods to collect the
information. This report is prepared according to:
 Primary Data
 Secondary data

Primary Data: For collecting primary data I have followed interview method like face to
face conversation with the head of the department, respective officials of different sections of
FEID. Observation of the officials' activities and their attitudes and discussion with my
supervisor also helped me to collect primary data.

Secondary data: I have collected secondary data through different types of publications
like Annual Report of Bangladesh Bank, Bangladesh Bank order -1972, journals and relevant
books and files and documents. I have also used the data from the website of Bangladesh
bank, websites of IMF, ADB and other related sources.

My research process is conducted through a gradual step by step process. Firstly, I've located
the research idea, research questions and research objectives. Next, I've tried to determine the
research philosophy, research strategy. After setting up all the research related issues, I've
tried to collect data in a primary basis. On the basis of those data, I've tried to analyze the
impacts of the decisions which I've got to know while collecting the data. Following all the
aforementioned steps while conducting the research I have tried to make it a well conducted
schematic journey.

4.2: Defining and Selecting Research Philosophy

Among different types of research philosophy, I've used the phenomenology. In case of
phenomenology the researcher understands the complex decision making behavior of the
respondents and he or she also understands the systematic and unsystematic biases in the
decision making procedure of the respondents. This research of mine had been based on the
interviews of the respondents and other cognitive factors that have affected my psychology.
For this reason, I've chosen the phenomenology.
15
4.3: Defining and Selecting Research Approach
The two major streams of any research are: Deduction & Induction. According to deduction
procedure, null hypothesis is formed up and these hypotheses are tested based on the
collected data. On the other hand, in case of induction, we generalize the patterns and the
theory formation is done at the end of the research. While conducting the research, I've
followed the inductive approach since I've drawn a conclusion at the end of the research after
collecting the required information by interviewing.

4.4: Defining and Selecting Research Design

There are two basic forms of research designs: Qualitative and Quantitative. Among
these two, I've used the qualitative form to conduct my research. In case of the quantitative
research design it is relatively easy to test the research validity and reliability, moreover data
collection through surveying instrument is relatively easy. But the authenticity of the
collected data is always a big problem. On the other hand, in case of the qualitative research
it is easier to collect the information if needed through a forced discussion. But it is relatively
difficult test the research validity and reliability. While conducting this research I'm going to
follow the qualitative research trajectory.

4.5: Research Instruments

In this portion of the research methodology, I am going to address the data collection
mechanism I have used to conduct my research.

4.5.1: Interviewing the Officers

For resource shortage and unavailability of information, I had to depend on interviewing the
officers of the organization. Some employees working at the department were interviewed
for my research work.

4.5.2: Data Collection Mechanism

There are a few mechanisms used in collecting primary data like the questionnaire, focus
group discussion and interviewing. In case of the questionnaire based survey it is relatively
easy to spread out the questionnaires over a widely spread geographical locations. But
authenticity of the responses will always pose a big question for the researcher. Interviewing
either by self- filled up form or through a face-to-face interviewing will do the job in a
precise and effective manner. Focus group discussion is a qualitative data collection
mechanism where the discussions are guided by the researcher.

For collecting the primary data, I have opted for interviewing. Along with that, to conduct
this research, I had to depend on secondary data too. The corporate website of Bangladesh
Bank was a powerful s pport. Moreover, the journals, periodicals were also used while
necessary. 16
4.6: Ethical considerations
The officials who were interviewed, was informed clearly about the objectives of the
study and their participation was voluntary. The full introduction of the interviewed officials
has been kept secret. It has been ensured by me to the organization that I will not publish the
data collected from them to the outsiders as they are too confidential and related to their
internal work procedures.

17
 5. Findings

The world economy experienced some sort of fixed and flexible exchange rate. During
interwar period (1914-1944) the classical Gold Standard broke down and in July 1944
representatives of 44 countries succeeded to establish the 'Bretton Woods' system.

Agnieszka Markiewicz has said that the countries those experience higher inflation and have
higher budget deficits prefer flexible regime and the countries those have more developed
financial sector, prefer floating regime and the countries those have stronger government and
higher political stability, favor pegged exchange rate regime. Bangladesh was using the fixed
rate system since 1972. After more than 31 years, the Central Bank of Bangladesh
(Bangladesh Bank) changed it into a floating exchange rate system in June 2003. Since then
the country has been using the floating exchange rate system. Dr. Mirza Azizul Islam, the
former advisor, Ministry of Finance of the Caretaker Government of Bangladesh, presented a
paper in January 2003, to explain the performance of fixed rate system and the possible
effects if it changes into the floating exchange rate. He advised that the countries those use
floating regime, produces greater volatility in exchange rates. The uncertainty is formed and
affects adversely the overall trade and investment of a country, which is already afflicted by
many unfavorable elements in Bangladesh.

One might think that if a fixed exchange rate system is in place then it's trivial that changing
the system into floating will have a significant impact on the value of the country's currency.
The question we are dealing with in this paper is interesting because of the fact that even in
the fixed regime; Bangladesh Bank followed an active exchange rate policy. Between 1983
and 2003, there have been as many as 89 adjustments in the value of Taka, 83 of which were
devaluations and 6 of which were revaluations. So, in one way, testing the statistical
significance of the regime change sort of indicates how efficient the Bangladesh Bank was in
terms of pricing its currency during the fixed regime and about its transition to floating
regime.

18
5.1 Historical overview of Exchange Rate System of Bangladesh

Exchange rate regime of Bangladesh can be characterized mostly as a fixed rate system

imposed and influenced by the government. If the real effective exchange rate (REER) as

estimated on the basis of current par value significantly diverged from the desired REER,

corrective response was initiated by changing the nominal exchange rate. The exchange rate

policies are made on behalf of the Ministry of Finance. Bangladesh Bank, the central bank of

Bangladesh, has not the full authority in determining the exchange rates.

5.2 Reasons for Changing the Fixed Rate System to Floating

Some of the reasons why the exchange rate system was changed are discussed below:

• Balance of Payments disequilibrium can automatically be restored to equilibrium. In

case of balance of payments deficit, the demand for foreign currency is increased. As a
result, the exchange rate of the local currency is depreciated. This may have the effect of
automatically restoring equilibrium. In such case, the value of local commodities falls from
foreigners' perspective making them more attractive abroad hence increasing export and
value of foreign goods increases from domestic perspective making them less attractive.
• Floating exchange rate may decrease inflationary pressures and improve
international competitiveness. Allowing the exchange rate to float freely should ensure that
exports do not become
uncompetitive. The basic idea comes from the Purchasing Power Parity theory. A high rate
of inflation tends to make the exports uncompetitive.
• To keep pace with the other markets in South Asia where India (in1991), Pakistan
(in 2000) and Sri Lanka have already introduced the floating rate system. (Islam, 2003)
Bangladesh also had to do this.
• The grantor of foreign countries also put pressure on the policies of exchange rate.
Hence, it has been seen that the IMF and World Bank influences a lot in our exchange rate
determination.

19
5.3 Current Exchange Rate System of Bangladesh

The Bangladesh Bank set foreign currency exchange rate band free from any regulation on
May 29, 2003. The BB however said that it would keep an eye on the market and intervene
in market and US dollar selling and purchase transactions whenever needed. The central
bank also said that it will deal with the dollars on a case to case basis. But it was officially
enabled on May 29. The observed volatility was not significant during this period, which
encouraged the Bangladesh Bank to take this long awaited step. The attraction of a floating
exchange rate system is that at least in theory it provides a kind of automatic mechanism for
keeping the balance of payments in equilibrium. The devaluations and their effects on the
economy subjected the governments to regular criticism by those affected by the same.
Under the floating rate system, the need for such official devaluation of the currency will
cease. The Bangladesh Bank is likely to resort to buying and selling of foreign currency from
time to time to indirectly playa stabilizing role in exchange rate operations. For example,
when the floating exchange rate system was made operational in Pakistan, the same led to a
jump in the exchange rate of the Rupee by ten or fifteen per cent on the first day. Thus,
Bangladesh had provision for similar safeguards.

5.4 Performance during Fixed Rate Regime

Let's take a look at the performance of Bangladesh in terms of certain key objectives that an
Exchange rate regime is expected to promote and how it fared during the fixed rate regime.
According to Dr. Mirza Azizul Islam, the relevant objectives are: (a) the prevention of any
major misalignment of exchange rate and (b) the promotion of exports and containment of
current account deficit; (c) moderation of inflation; and (d) enhancement of remittances.

(a) Misalignment of exchange rate: The prevention of misalignment implies that the actual
exchange rate should correspond to the estimate of equilibrium exchange rate. A recent
study undertaken by ADB concluded that the misalignment between the actual and
equilibrium exchange rate for the period 1997 to 2001 was small and progressively narrowed
since 1998. During 2001, the misalignment was only 2.2 per cent. Also, the exchange rate
policy succeeded in preventing appreciation of the real effective exchange rate throughout
the 1990s. It can thus be concluded that the fixed exchange rate regime has avoided any
major misalignment in the exchange rate.
20
(b) Exports and current account balance: Bangladesh's achievement in terms of
containing current account deficit was not unsatisfactory.

(c) Inflation: Bangladesh did reasonably well in terms of inflation factor. Its inflation has
never been in double digit level during the past decade. Except 1999, in every year its
inflation rate has been too lower or similar to the other countries of South Asian region.

(d) Remittances: Remittances by Bangladeshi workers employed abroad play an important

role in moderating the country's trade deficit. There was only a minor blip in 2001. The
performance of Bangladesh in terms of certain key objectives that an exchange rate regime
is expected to promote has been quite satisfactory. So it is arguable that the fixed exchange
rate regime of Bangladesh had served the country reasonably wll.

5.5: Initial Performance after the Regime Change

It was feared by some that the introduction of the freely floating system may immediately
adversely affect the value of the taka as it did when this change took place in the neighboring
country. There had been a dip in the value of the weaker currency right after floatation. But
this did not happen for the taka, which initially remained strong after the flotation.

Contrary to a lot of speculation about a possible drastic fall in the value of taka it actually
fared wll initially. We can see it by looking at the following exchange rates between taka and
the USD. Exchange rate of BDT against USD on May 22, 2003 (a week before the regime
change): Tk 57.80/ USD (The Daily Star, May 23, 2003) Exchange rate of BOT against
USD on August 18, 2003 (about one and a half month after the regime change): Tk 57.82/
USD. lt's obvious here that taka had not depreciated much against the USD in the early days
after the regime change. It actually gained initially and then remained steady as dollar
showed signs of weakening against the Euro. Other economic indicators also did not hint any
significant deviations after the introduction of the freely floating system. For example, the
flow of remittances maintained its upward trend as it did during the fixed rate regime. Also,
offering of dollar denominated bonds increased the reserve of dollars. The rate of inflation
was 5.98% in March 2003, which is higher than 4.58% in the fiscal year of 2000-2001. The
current account deficit was 15,809 Crore BDT ($ 2.72 billion). GDP growth was
21
 approximately 5.5% in 2003 - 2004 (Data source: Bangladesh Bureau of Statistics) Thus, we
can conclude that immediately after the exchange rate system regime change, performance
had been reasonable compared to the performance during the fixed rate regime. In
comparison, the BDT had fared more or less the same in the competitive environment.
However, since then, value of taka has fallen drastically against dollar. In February 2007,
BDT against USD was Tk 69.00/USD. Many have attributed this fall in taka value to the
floating exchange rate regime. Some of the other note-worthy factors that may influence
the change in exchange rate of Taka are changes in net exports or trade deficits, changes in
foreign currency reserves, changes in real interest rate and change in the rate of inflation.

5.6: Comparison between Previous Foreign Exchange

Policy and Present Foreign Exchange Policy

To evaluate the performance of Bangladesh considering the two different exchange

rate regimes, some data comparison has been made among three neighboring
countries in South Asia. My selected countries are: India, Pakistan and Srilanka.

5.6.1: Growth Rate of GDP

After comparing the experiences of the neighbor countries, we have got to know that
Bangladesh also faced more or less similar situation like the other countries before using the
floating rate regime. From the adoption of floating exchange rate by Bangladesh, it has been
seen that there is a positive trend of GDP growth .

Table 5.1: Growth Rate of GDB (% per year)

Country 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Bangladesh 4.4 5.3 5.7 6.0 6.6 6.4 6.2 5.7 6.1 6.7 6.2 6.0 5.6

India 4.0 8.2 7.4 7.6 9.7 9.2 6.7 8.6 9.3 6.7 4.5 4.9 5.5

Pakistan 3.1 5.1 5.5 5.8 5.8 6.8 2.7 0.4 2.6 3.7 4.4 3.6 3.4

Srilanka 4.0 5.9 5.0 5.5 7.7 6,8 6.0 3.5 8.0 8.3 6.3 7.3 7.5

Source: Asian Development Outlook 2014, ADB

22
 5.6.2: Current Account Balance
Inflation is highly
In comparison with the selected countries, it has been seen that the situation of current account
balance is better since the starting dayof the
balance is better since the starting day of the adoption of new exchange rate system. And
sometimes it has been observed that the position of our country is better than Srilanka,
Pakistan
In and India
comparison withinthe
some casescountries,
selected except theit year 2005.seen that the situation of current
has been

Table 5.2: Current Account Balance as Percentage of GDP

Country 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Bangladesh 0.4 0.5 0.0 -1.5 1.3 1.4 0.9 2.7 3.7 -1.5 -0.4 1.9 -0.5

India 0.8 0.7 0.3 0.3 -1.2 -1.4 -2.4 -2.8 -2.7 -4.2 -4.7 -2.2 -2.5

Pakistan 4.6 5.9 3.0 2.1 -3.9 -4.8 -8.5 -5.5 -2.2 0.1 -2.1 -1.1 -1.4

Srilanka -1.8 -2.2 -3.0 -3.5 -5.3 -4.3 -9.5 -0.5 -2.2 -7.8 -6.6 -2.0 -2.6

Source: Asian Development Outlook 2012, ADB

5.6.3: Inflation Situation

Inflation is highly related to the exchange rate regime because the exchange rate can affect
the domestic price of the products. This increases capital flight, increases income distribution
and produces poverty. The relevant data are presented in the following table no.-3.

Table 5.3: Inflation in Bangladesh and Selected Other Three Countries

Country 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Bangladesh 2.8 4.4 4.7 5.2 7.2 7.2 9.9 7.6 6.8 10.9 8.7 6.8 7.5

India 3.4 5.3 5.0 5.0 5.2 5.0 8.7 2.1 9.2 8.9 7.4 5.9 6.0

Pakistan 3.5 3.1 4.0 6.2 7.9 7.8 12.0 20.8 11.7 13.7 11.0 7.4 9.0

Srilanka 10.2 2.6 4.4 7.3 10.0 15.8 22.6 3.4 5.9 6.7 7.9 6.9 5.0

Source: Asian Development Outlook 2012, ADB

23
It is showing that there is an increasing trend of inflation since the adaptation of floating
exchange rate regime. The major reasons of the adoption of new exchange rate system is
mainly the government's commitment to the liberalization of the country's economy and to
take the appropriate steps to create suitable environment of the economy for entering into
capital account convertibility regime. Rather than this, there was IMF's 'conditionality' to
enter into new floating exchange rate regime.

5.7: Effects of Floating Exchange Rate on Macro Economy of

Bangladesh
Introduction of floating exchange rate was debatable issue and also there were some
criticisms about the competence of Bangladesh Bank from some view point. But our central
bank has performed in a better way in this case. It had no volatility in exchange rate, no
speculation in prices. To analyze this, I have identified the following factors: Export, The
workers' remittance and the foreign reserve.

5.7.1: The Export Situation

The export situation from 2001 to 2014 shows an increased movement. The graph is showing
that it has been increasing gradually.

Table 5.4: The Export Volume in USD

Year The Export Volume in USD (in million)

2001-02 5986.09
2002-03 6548.44
2003-04 7602.99
2004-05 8654.52
2005-06 10526.16
2006-07 12177.86
2007-08 14110.80
2008-09 15565.19
2009-10 16204.65
2010-11 22924.38
2011-12 24230.00 24
 2012-13 26185.27
2013-14 31456.34
Source: The Export Promotion Bureau, Bangladesh, half yearly report, 2014

5.7.2: Enhancement of Workers’ Remittance

The Inward remittances from Bangladeshi nationals working abroad remained strong in
FY10 even in the face of global economic slowdown and continued to play an important role
in strengthening the current account. In FY12, the growth rate of workers' remittances is
calculated as 10.2%. The underlying reason was that Bangladesh Bank has simplified the
approval policy of drawing arrangements between foreign exchange houses and domestic
banks.

After analyzing the growth rate of workers' remittances, it I have seen that the rate is
increasing significantly after adopting the floating rate regime. And from 2003 to 2012, it is
20.52% than that of fixed exchange rate regime of Bangladesh which is calculated as 11.89%
(1993-2002). The increasing amount of workers remittance helps to balance the trade deficit
in a prudent manner.

5.7.3: Reserve Position

The amount of foreign exchange reserve has been increased significantly over the last couple
of years. The rate was quite flat in 2003 to 2005 but it started to increase in 2007.

Table 5.5: The Foreign Reserve Position

Period Reserve ($)

2002-03 2469.6
2003-04 2705
2004-05 2930
2005-06 3483.8
2006-07 5077.2
2007-08 6148.8
2008-09 7470.9
2009-10 10749.7
2010-11 10911.6
25
 2011-12 10601.15
2012-13 15315.2
2013-14 21558.0
Source: Bangladesh bank Annual Report, 2001-2013

After adopting the floating exchange rate regime, the reserve started to increase due to
higher workers' remittances and higher rate of export.

5.7.4: The Growth Rate of GDP

In 2011, the rate of GDP increased to 6.7% whereas the average rate was 5.47% from 1994 to
2010. For this increasing development, now-a-days, Bangladesh has been called as a
developing country as the growth rate of GDP is 7.0% in FYl1-12

Table 5.6: GDP Growth Rate of Bangladesh

Year Growth Rate (in percentage)

2001-02 5.3
2002-03 4.8
2003-04 5.3
2004-05 5.5
2005-06 5.4
2006-07 6.7
2007-08 6.5
2008-09 6.2
2009-10 5.9
2010-11 5.8
2011-12 6.7
2012-13 6.3
2013-14 6.01
Source: Bangladesh bank Annual Report, 2001-2013

26
 6. Analysis of Findings

In March 2003, the parliament passed three bills in its attempt to bring massive reforms in
the banking as well as the financial sector. The most important bill was Bangladesh Bank
Amendment Bill 2003 by which the bank was given autonomy in its operations. Introduction
of the Central Bank Strengthening Project (CBSP) in 2003 jointly funded by the World Bank
and Government of Bangladesh is another important phase in the reform process. The
objective is to achieve a strong and effective regulatory and supervisory system for
Bangladesh's banking sector. This will help the central bank in three areas:

 Strengthening the legal framework,

 Reorganizing and modernization of Bangladesh Bank by focusing on

 Functional Reorganization
 Automation
 Human Resource Development
 Strengthening the research department, accounting and auditing

6.1: Exchange Rate Movement

When the foreign exchange policy is reformed, it certainly affects the exchange rate of that
country. In the recent Taka depreciates against US$ drastically.

Table 6.1: Exchange Rate Movement

Date Exchange Rate USD/BD

April 08, 2001- April 08, 2002 54.9671
April 08, 2002- April 08, 2003 56.3306
April 08, 2003- April 08, 2004 57.2961
April 08, 2004- April 08, 2005 63.4143
April 08, 2005- April 08, 2006 67.7894
April 08, 2006- April 08, 2007 66.4382
April 08, 2007- April 08, 2008 67.5205
April 08, 2008- April 08, 2009 67.5012
April 08, 2009- April 08, 2010 68.0070
27
 April 08, 2010- April 08, 2011 71.4096
April 08, 2011- April 08, 2012 80.4926
April 08, 2012- April 08, 2013 76.5826
April 08, 2013- April 08, 2014 76.4054
Source: Historical Exchange Rates from the Website of OANDA

Although US dollar is decreasing against Euro, CHF, Yen and GBP, it is being stronger
against Bangladeshi taka. This increasing trend is showing the shortage of supply of the
foreign currency.

6.2: Currency Depreciation

It is normally believed that the floating exchange rate system enhances the possibility of
currency depreciation. In fact, adopting a floating exchange rate system doesn't necessarily
mean that the currency will be depreciated. Currency might appreciate or depreciate,
depending on the nature of the country's trade balance. Demand of the currency is usually
higher than the supply in an export driven economy which leads to the appreciation of the
currency. Consequently, floating exchange rate would lead to currency depreciation in an
import based country like Bangladesh.

It has been noticed that the currency depreciation has taken place in Bangladesh over the
years, as a result of adopting flexible exchange rate gradually.

Table 6.2: Percentage Change of Depreciation of BDT

against USD During FY 2005-06 to FY 2011-12
Period Percentage Depreciation of BDT against $USD
2005-06 9.25
2006-07 2.92
2007-08 -0.62
2008-09 0.29
2009-10 0.56
2010-11 2.66
2011-12 2.8
2012-13 2.87
2013-14 2.95
Source: Bangladesh Economic Review, Bangladesh Bank

28
From the table we can see that the depreciation continued year by year and in 2013 1 Taka is
depreciated by 0.0128 USD.
Being an import oriented country; Bangladesh might face difficulties as its import cost
would be stimulated further as a result of currency depreciation. This higher cost of import
may eventually soar up the price level in the domestic market.

Bangladesh earns a sizable amount of foreign exchange by exporting some specific

products such as - readymade garments, leather, shrimp, jute, medicine and recently from
ship industry. If the currency depreciates further the earnings from exporting goods and
services would augment which prompts domestic exporters to export more. This tendency
might create supply shock in the domestic market causing in price level rise.

6.3: IMF’s Loan and its Implications on Bangladesh Economy

The IMF standby loans are provided to its members basically to maintain the balance of
payments difficulties usually on the basis of strict adherence to stipulated corrective
measures. The conditions of giving loans by IMF are about similar to those of World Bank.
Bangladesh Economic Update has analyzed this issue of the loan of one billion dollar by IMF
to Bangladesh and its effects on the economy of our country.

Conditions of IMF's USD one billion loan to Bangladesh:

1. Pursuing a contraction monetary policy in order to check inflationary pressure.
2. Further liberalization of tariff level
3. More liberal exchange regime by moving into floating exchange rate regime.
4. Privatization of the loss making SOE's in order to create more efficiency and
more competencies.
5. Placing new VAT and income tax in order to achieve revenue targets.
6. Phasing out bank lending rate ceilings (for bringing in greater flexibility in the
lending regime).
7. Raising CNG and furnace oil prices.
8. Introducing a debt management strategy to reduce budget deficit.
9. Plan to streamline the ADP project approval and implementation process.
10. Develop a new auction mechanism for government paper.
11.Complete audits of SCBs accounts for the year 2010 using internationally
affiliated reputed auditor.

29
The International Monetary Fund (IMF) forced Bangladesh to change its current
managed floating exchange rate system and move to dean floating exchange rate
system where the exchange rate of taka is determined by the interaction of demand
and supply of taka in the foreign exchange market.

Now- a-days, in 2013, it's again thinking to bring change in the Exchange Rate
Policy in Bangladesh. It's trying to force our co ntry to keep the capital account
convertible. But, at present, our economy is not enough sufficient to follow this
strategy.

6.4: Keeping the Capital Account Convertible According to

IMF'S New Decision

The term capital account convertibility refers to an uninterrupted movement of

capital assets from one country to another at a market determined exchange rate.
Capital account convertibility is a feature of a nation's financial regime that centers
on the ability to conduct transactions of local financial assets freely at a market
determined exchange rate (Wikipedia). In the words of Legmen, it is basically a
policy that allows the easy exchange of local currency for foreign currency at a low
rate.

6.4.1: Pure Floating Exchange Rate and Capital Convertibility in

Bangladesh
Capital account convertibility is one of the major tools of developed countries to
attract the foreign investment into local market. From the context of Bangladesh, the
full capital convertibility with clean floating exchange rate might be an erroneous
policy right now. Under the clean floating exchange rate system and under perfect
capital mobility there might arise the subsequent penalties.

 A vast amount of domestic currency may shift to foreign countries .

 Very highly capitalized foreign banks and profit maximizing multinational
companies will enter and can create an unequal playing field.
 The economy is likely to face an extreme volatility under the perfect capital
convertibility by inviting 'hot money' into the country.

30
6.4.2: Capital Convertibility under Floating Exchange Rate Regime
Likely to Create Capital Outflow
The exchange rate system, capital mobility and interest rate are three very sensitive elements
for any country's macroeconomic policy perspective. If there are any mismatches in the
policy formulation, the whole economy can be broken. Professor Mundell and Fleming have
shown the effects of monetary and fiscal policy in an open economy under the perfect and
imperfect capital mobility. According to Mundell-Fleming model, the monetary policy would
be effective in floating exchange rate system and fiscal policy would be useful under the
fixed exchange rate regime.

Bangladesh is required to adopt a contractionary monetary policy by reducing money supply

and raising interest rate and to pursue a contractionary fiscal policy by raising the income tax
and VAT as well as reducing the government expenditure for receiving the 1 billion dollar
loan from IMF.

Under the floating exchange rate regime, if Bangladesh Bank pursues a contraction monetary
policy the LM curve would shift to the left causing increase in interest rate which would
allow a huge capital inflow in the country. At the same time, BOT will be appreciated that
might create a more export competitive atmosphere, as a result interest rate would be high
which would reduce the aggregate demand through reducing investment. This would cause a
reduction in interest rate. There may be capital outflow, if the interest rate is decreased like
this. According to Mundell Fleming model, if Bangladesh initiates both contractionary
monetary and fiscal policy by adopting pure floating exchange rate system, there might be a
huge capital outflow from Bangladesh that will dampen savings and there would be an
adverse impact over the local manufacturing industries due to declining investment.
Consequently, IMF's conditionality for USD one billion loans might inflict serious pressure
over the balance of payment and GDP growth in Bangladesh.

31
 7. Recommendations and Conclusion

7.1: Recommendations
After considering the whole analysis, some recommendations can be made to stabilize the
FX- market for the government and Bangladesh Bank. The points are written down below:

Control Inflation
Effective measures are needed to be taken by the central bank to control inflation by reducing
money supply in the economy. To control inflation, this tight monetary policy can be
effective.

Reduce Trade Deficit

One of the important components to reduce the trade deficit is to enhance export volume of
goods and services.

Enhancing Foreign Direct Investment

Sufficient inflow of foreign direct investment could enhance the capital inflow in the country
for long term.

Short Term Foreign Borrowings

Borrowings from abroad is another option for supplying liquidity in the market.

Effective Capital Market

To stabilize the foreign exchange market, it is necessary to develop the capital market.

Derivatives Market

Various derivatives can be introduced.

Autonomy of the Capital Bank

The autonomy of the central bank is desirable issue for the economy. The central bank should
operate and perform independently with full automation.

32
7.2: Conclusion
This study shows that floating exchange rate regime has constructive effect on economic
growth. The shifting period was stable of the exchange rate regime. A increasing growth in
various economic variables has been seen after adopting the floating exchange rate
regime. The increasing trend of export, workers' remittances and foreign reserves has
developed the economy of our country. The reforms that have taken place over the past two
decades helped the central bank to evolve to a stronger position compared to the past. These
reforms enabled the central bank to govern the financial sector in a more focused and
objective manner. It has gradually developed the rules and procedures along with the fit and
proper test criteria to maintain financial sector discipline. These changes can increase
financial intermediation and enhance financial deepening. However, it seems that many of
the changes are donor dictated rather than to be domestically formulated. The chronology of
the reforms and the evaluation of the various reforms associated with central bank and
financial sector suggest and indicate donor participation.

The international organizations are still trying to deregulate our foreign exchange policies for
their convenience. The IMF's loan that is to be provided might have a negative impact in
Bangladesh economy. Bangladesh Bank has already phased out the interest rate ceiling
following the IMF's conditionality in an effort to stabilize the inflationary situation and to
eradicate the pressure on balance of payment. The country might face trouble in some areas
like high inflation, slow remittance and pressure on balance of payment if IMF's prescriptions
are implemented. If Bangladesh Bank allows a greater flexible exchange rate policy as a
major requirement of IMF, the country would face a huge trade deficit. The export sector is
also likely to face a difficult competitive edge with its current competitors. Moreover, the
consumer welfare security might be constrained as a result of raising CNG and furnace oil
prices and placing a new VAT regime. This would worsen the rising inequality level which is
a major concern of the government.

The tariff structure of a country should be formulated according to its own economic nature
and strength. Further deregulation of tariff regime may enhance the susceptibility of local
industry as well as the trade balance. The conditionality of IMF may be a threat to maintain
our economic growth.

33
 Bibliography

1. Annual Reports of Bangladesh Bank

2. Financial Sector Review, Bangladesh Bank
3. Asian Development Outlook
4. The Economic Review, Ministry of Finance, Bangladesh
5. Islam, Mirza (2003): "Exchange Rate Policy of Bangladesh- Not Floating Does Not
Mean Sinking", January 02.2003.
6. Younus, S. and Chowdhury, M.I., An Analysis of Bangladesh's Transition of Flexible
Exchange Rate Regime; 2006
7. Haydory Akbar Ahmed, Background Paper for the State of Governance in
Bangladesh
2006-:"Bangladesh Bank Reforms- Changes and Challenges.
8. Economic Policy Paper on Relaxation of Controls on Foreign Exchange.

34