Case Studies to solve at home

CASE STUDY 1: The dilemma faced by the Bangladesh Bank Governor.

Bangladesh Bank’s Exchange rate problem

Governor Dr. Atiur Rahman has an exchange rate problem in his hand. The Bangladesh Bank’s
de facto policy of pegging the taka against the dollar means it is depreciating against the Indian
rupee, which in turn is fuelling inflationary pressures. 

And yet, the solution is not obvious.  Letting the taka freely float might not be a good idea
because it’s not clear that Bangladesh Bank has the credibility to operate without a nominal
anchor.  Pegging against the rupee is a terrible idea.  And letting taka appreciate a little might
hurt exports.

Is anyone at the Bank thinking about this? Let’s work through the logic with a set of charts.

The chart on the left shows taka’s exchange rate against the dollar, euro, and pound sterling. 
From Nov 2006, 1 dollar has bought about 69 taka.  The IMF classifies Bangladesh Bank as
pursuing a ‘conventional fixed peg arrangement’ against the US dollar (see the link above). Over
this period, however, sterling and euro had not remained fixed against the dollar — dollar
depreciated steadily against most floating currencies until September 2008, when a flight-to-
safety effect during the worst of the             global financial crisis saw dollar appreciate, and then
since March 2009, dollar resumed its depreciating trajectory.  The chart on the left also shows
that taka’s exchange rate against the euro and the sterling follow this steady depreciation, sudden
appreciation, further depreciation trajectory.   

Now look at the chart on the right, which shows taka/rupee rate following a similar trajectory. 

The snag is, taka’s depreciation against euro or sterling can be a good thing for Bangladeshi
exports (more below), but depreciation against rupee is by and large a bad outcome for prices. 
I’ve made the argument before, citing formal econometric studies.    Here let me show another
chart.

This one shows price of one kg boiled rice in Dhaka (smoothed by 3-month-moving-average)
against the taka-rupee rate from Dec 1995 to Dec 2008.  There seems to be a pretty good
relationship — taka depreciates against the rupee today, and rice prices in Dhaka rise a year or so
later. 

 
Since March 2009, taka has depreciated by over 7% against the rupee.  And look and behold,
high rice prices are back in the newspaper headline.

So what should the Bangladesh Bank do?

First thing to note is that the current exchange rate policy is not without merit.  Given large
current account and budget deficits, the medium term expectation for the dollar is to depreciate. 
Fixing taka against the dollar then means depreciation against other major western currencies. 
This can help our export — indeed; this may well be a major factor behind our strong export
performance. And our major export competitors like China or Vietnam (but crucially, not India)
maintain some form of peg against the dollar.  Therefore, letting taka appreciate would probably
hurt our exports.

I say probably because our industry depends on imported raw material and machinery, and
appreciation will help them.  Also, it’s not clear how important the exchange rate is vis-a-vis
other factors (such as the much touted Wal-Mart effect) for our exports.  And finally, for exports,
what matters is real (that is, inflation-adjusted), not nominal, exchange rate — if an undervalued
taka leads to inflation in Bangladesh, then taka will have an effective real appreciation, which
will hurt exports just as badly as if taka were allowed to appreciate.

I am not aware of any well specified exports equation that studies the importance of exchange
rate for our exports, and would highly appreciate if anyone can cite one.  Such a study would
help ascertain the cost of letting taka appreciate.

Meanwhile, it’s very important to realize that the Bank should not even contemplate pegging
taka against the rupee.  There are many paranoid people in Bangladesh who fear ‘becoming like
Nepal or Bhutan’ every time a dog barks.  Well, pegging taka against rupee would make
Bangladesh like Nepal or Bhutan.

Emotional nationalistic jingoism aside, there are sound macroeconomic reasons why we should
not become like Nepal or Bhutan in this regards.  Since the 1960s, macroeconomists have been
aware of the impossible trinity which holds that a country can, at once, achieve only two and
never three of the following: fixed exchange rate, capital mobility, and monetary policy
independence. 

If taka was fixed against the rupee, this would mean our authorities would have to choose either
capital mobility between the two countries, or monetary policy independence.  Given the porous
border and weak institutions, it would be practically impossible to restrict capital mobility.  This
means, we will have to cede monetary policy to the Reserve Bank of India.  

This won’t involve any elaborate state protocol involving horses and other state paraphernalia. 
Most paranoid Indophobes in Dhaka wouldn’t probably even notice it.  But it would mean every
time RBI changes monetary policy, we would have to match it, even if it means slowing our
economy or allowing inflation to rise.  If the RBI was tightening monetary policy, and we didn’t
want to because of weak domestic conditions, there would be capital flight and we could be
threatened with a currency crisis.  Alternatively, if the RBI loosened monetary policy, but we had
inflation worries, there would be hot money flowing in, and the inflation problem would worsen.

This would be a much bigger encroachment to our sovereignty than any security or transit
agreement. So a rupee peg is clearly out, but a dollar peg has clear problems.  What should the
Governor do?  What analysis is guiding his thinking?

(Data source: CEIC Asia, IMF).

Question 1: Why can’t Bangladesh Bank governor let the Taka to free float?

Question 2: Why BDT is depreciating against Indian Rupees but not against USD at that time?

Question 3: What are the advantages and disadvantage of a weaker taka against Indian Rupee?

Question 4: Why is it so hard for BB governor Dr. Atiur Rahman to manage the exchange value
of BDT?

Question 5: How does a healthy foreign reserve make the currency management easier for the
BB governor?

FDI hits all time high

Japan Tobacco’s acquisition of Dhaka Tobacco boosted inflow
 AKM Zamir Uddin

Foreign direct investment to Bangladesh surged 51 percent last fiscal year to its highest on
record, riding largely on Japan Tobacco Inc’s acquisition of Akij Group’s tobacco business for
$1.47 billion.
In 2018-19, net FDI stood at $3.88 billion in contrast to $2.58 billion a year earlier, according to
data from the central bank.

“The rise in the FDI last fiscal year will not bring any positive impact for the country. This will
not create any fresh investment or give a boost to exports,” said Ahsan H Mansur, executive
director of the Policy Research Institute of Bangladesh.

Japan Tobacco has made the investment focusing on the domestic market of Bangladesh and
there is no scope to recruit additional workers from the domestic workforce for the existing
industry, he said.

“This is a one-off investment and indicated that FDI flow may decrease this fiscal year,” said
Mansur, also a former economist of International Monetary Fund.

Japan Tobacco, one of the largest tobacco companies in the world, completed the acquisition of
Dhaka Tobacco, a concern of Akij Group, in November last year, in what was the biggest ever
single FDI in Bangladesh.

Mansur also said there is no ray of hope to widen the periphery of FDI in the next few years as
Bangladesh is yet to become an investment destination for foreigners because of poor
governance and low ranking in the World Bank’s Ease of Doing Business index.

Bangladesh advanced eight notches to 168th out of 190 counties in this year’s ranking.

“But, the progress is not good enough to win the confidence of foreign businesses,” Mansur said.

He suggested the government take immediate measures to attract foreign businesses to prop up
export earnings, create fresh jobs and resolve the ongoing crisis stemming from balance of
payments.  A good number of businesses are now shifting their operations from China due to its
ongoing trade tension with the US and the rising cost of production in the world’s second-largest
economy. 

“The government should seize the opportunity by way of attracting the businesses to the
country,” Mansur said.
The economist, however, expressed his hope that the FDI would increase once the special
economic zones start running in full swing.  Bangladesh Bank calculates the FDI in three
categories: equity, reinvestment of earnings, and intra-company loan.

The FDI posted a significant jump in equity capital, or new investment, climbing 94 percent
year-on-year to $1.19 billion.

Intra-company loans rose 87 percent to $1.33 billion and reinvestment of earnings by existing
foreign companies grew 8.77 percent to $1.36 billion.

The high volume of the FDI has given a positive indication to the country’s business sector, said
Khondaker Golam Moazzem, research director of the Centre for Policy Dialogue.

But the unremarkable growth of the reinvested earnings has hinted that the existing foreign
businesses are cautious towards expansion, he said. There are some complexities and fussy
calculation to estimate intra-company loans, Moazzem said.

“The central bank should verify the figure of intra-company loans cautiously with the help of the
Bangladesh Investment Development Authority. This will help figure out the actual number,” he
said.