Will budget FY25 stabilise forex market?

One of the critical macroeconomic challenges Bangladesh is currently facing is the depletion of foreign exchange reserves and increasing depreciation pressure on the exchange rate. To address this, the Bangladesh Bank has adopted a more market-based approach to exchange rate determination, known as a crawling peg system.

The question is whether the proposed budget for the fiscal year 2024-25 will help stabilise the foreign exchange market or hinder Bangladesh Bank's efforts to manage the foreign exchange crisis.

To answer this, an investigation is needed into how various policies in the proposed budget will affect key components of the external sector, such as exports, imports, remittances, foreign direct investments, and interest payments on overseas loans. These components determine the demand and supply of foreign currencies and influence exchange rates.

The budget for 2024-25 proposes the withdrawal of supplementary duties on 19 products and the reduction of supplementary duties on 172 products. Additionally, duties will be withdrawn from 91 products, and duties on 10 products will be adjusted to the bound rate. However, exports from Bangladesh, especially major export items, are likely to face tougher competition in the global market due to reduced export incentives and the erosion of trade preferences in major destinations.

While these withdrawals and reductions in regulatory and supplementary duties are part of tariff rationalisation and necessary to comply with World Trade Organisation (WTO) regulations, they will likely increase the trade deficit. This could create a larger net demand for foreign currencies and put depreciation pressure on the exchange rates unless the government continues to tightly control imports in the next fiscal year.

FDI in Bangladesh has been declining for several years, and the proposed budget aims to attract only $1 billion over the next five years, which is meagre compared to the overall size of the economy. The budget lacks specific policies and initiatives to attract more foreign investment in the future.

Furthermore, there are no additional incentives in the proposed budget to boost remittance inflows. Additionally, a significant amount of foreign exchange is needed for interest payments on overseas loans. With the current level of remittance inflows, an insignificant amount of foreign investment, and increasing interest payments, it will become increasingly difficult to cover the widening trade deficit.

The government's only option to bridge this gap is to continue restricting imports, which could harm industrialisation and export capacity, as most industries in Bangladesh depend on imported raw materials and machinery. This could make the foreign exchange market more unstable, especially in the long run.

The outlook for the foreign exchange market in the next fiscal year remains bleak. The situation could deteriorate further if the government fails to take strong action against corruption. One of the main reasons for not receiving all remittances through formal channels and for invoicing malpractices is the demand for foreign currencies to launder corrupt money in foreign countries.

The proposed budget mentions the adoption of a zero-tolerance policy against corruption, including measures such as digitalising the Anti-Corruption Commission, forming anti-corruption committees in towns, districts, and upazilas with local community members, and holding public hearings. While these measures sound promising, they are unlikely to have a significant impact on curbing rampant corruption.

Public officials hold immense power, and there are no examples of any accused corrupt government officials facing real consequences. If this continues, any attempt to stabilise the foreign exchange market will be futile, whether through monetary policy or fiscal policy. The proposed budget is not very encouraging in this regard.

The author is an associate professor of economics at the University of Dhaka.