Representational image. This file photo shows Bangladeshi migrant workers stand in a queue at Dhaka airport.

The interest rate cap on loans, the frequent changes to the exchange rate regime and a relaxed attitude to enforcing austerity measures are the major challenges facing Bangladesh in restoring stability in the economy. 

On several occasions in the last couple of months both the government and the Bangladesh Bank have claimed that the foreign exchange market will become stable within two to three months. But in reality, the situation is getting complicated with each passing day.

The latest blow came last month when remittance and export receipts fell significantly whereas higher import bills, which have been at the heart of the pain facing the economy, have deepened the stress.

The poor show of the three major indicators of the economy brought the foreign exchange reserves further down: It stood at $36.44 billion on September 28, down 6.7 per cent from August 31 and 21.25 per cent from a year ago.

In order to curb inflation, which has been running high for several months for higher commodity prices and energy costs and US dollar shortages, the central bank asked banks to receive the full amount in advance from importers while opening letters of credit for consumer goods. But import payments have not declined as expected.

The BB has also increased its key interest rate thrice since May, raising it to 5.75 per cent, in keeping with the stance the central banks around the world are following.

The key interest rate, which is termed repurchase agreement (repo) in Bangladesh, determines the interest rate on both deposits and loans in the banking system. Banks also take short-term loans from the central bank quoting the rate.

A higher repo rate is supposed to make funds costlier, which, in turn, will discourage borrowers from taking loans.

INTEREST RATE CAP DISTORTING MARKETS

The BB has maintained a 9 per cent interest rate cap since April 2020 at the instruction of the government, paving the way for the availability of cheaper funds for borrowers.

Economists have been mostly unanimous in calling for the withdrawal of the ceiling in order to reduce the money supply since inflation has gone up and imports escalated. 

But the central bank has not paid heed to the suggestions. Subsequently, the country's private sector credit growth swelled to 14.07 per cent in August, reaching the touching distance of the BB's target of 14.10 per cent set for the whole fiscal year.

Central banks usually raise the repo rate to reduce the money supply in order to contain inflation, but BB's repo rate hike is not working at all thanks to the interest rate cap.

Zahid Hussain, a former lead economist of the World Bank's Dhaka office, says that inflation could have been tackled had the BB withdrawn the interest rate cap.

In July, inflation fell to 7.48 per cent from a nine-year high of 7.56 per cent in June. The government has not published the figure for August and September.

A withdrawal of the interest rate cap can also help rein in import payments as it would discourage borrowers from importing more.

But in reality, overall import payments swelled 26.5 per cent year-on-year to $20.69 billion in the first three months of the fiscal year.

REPEATED CHANGES TO EXCHANGE RATE REGIME

The central bank has seemed to be in a quagmire while setting the exchange rate of the taka against the dollar since volatility hit the foreign exchange market.

The BB had followed a fixed exchange rate for a long time to ensure a stronger local currency, albeit artificially. But such a stance has come under pressure once reserves started depleting to keep the wheels of the economy moving.

In June, the BB decided to move towards a floating exchange rate when remittances started to decline sharply. It later backpedalled when the taka lost its value sharply against the dollar.

The US dollar traded at Tk 105.20 on October 2, up 23 per cent year-on-year.

On September 12, banks were allowed to set the exchange rate under the guidance of the central bank.

"The repeated changes to the exchange rate regime have adversely affected the remittance flow," Hussain said.

Despite a surge in the outflow of migrant workers, remittances declined 11 per cent year-on-year to $1.54 billion in September, the lowest in seven months. Migrant workers sent home more than $2 billion each month between July and August.

"There is no reason for the remittance to fall in September as a record 7.84 lakh migrant workers left the country for jobs abroad in the first eight months of this year," said Hussain.

Experts blame the hundi, an illegal cross-boundary financial transaction system, for the falling remittance.

Expatriate Bangladeshis used to get as high as Tk 115 for each dollar if they sent the money through the official channel. But as per a decision taken by banks last month, no lender now offers more than Tk 108 for a dollar from foreign exchange houses, which facilitate remittance transfers.

"The central bank should follow a uniform exchange rate instead of multiple fixed exchange rates," said Ahsan H Mansur, executive director of the Policy Research Institute of Bangladesh.

"If the fluctuation in the exchange rate regime persists, the remittance flow will continue facing difficulties."

In addition, exchange houses might not have remitted the money immediately so that the foreign exchange market faces further volatility and they can gain from the situation.

He hopes remittance flow would accelerate within a few months if a proper policy action is taken.

"Law enforcement agencies should take strict actions against the people involved in hundi," said Mustafizur Rahman, a distinguished fellow at the Centre for Policy Dialogue. 

AUSTERITY MEASURES NOT FOLLOWED PROPERLY

Although the government earlier took various initiatives to implement austerity measures, no significant progress to this end is visible.

The country has been enforcing power outage since July to save diesel amid its spike in price globally, in a bid to cut consumption and save US dollars. It has also stopped importing liquefied natural gas, sending the supply of natural gas low amid inadequate domestic generation.  

But since factories are facing more than 10 hours of load-shedding nowadays, many manufacturers have turned to diesel owing to a lower pressure of gas and power supply, said Faruque Hassan, president of the Bangladesh Garment Manufacturers and Exporters Association, on Sunday. 

As a result, the consumption of diesel has increased, he said.

Zahid Hussain urged the government to stop the implementation of development projects funded by the domestic resources.

This is because a large amount of US dollars is required to implement such projects and it is mobilised from the local source. Although the government had earlier taken a decision not to implement such projects, adequate action is not visible.

"Austerity measures are also important for the private sector," said Mansur.