Making the economy breathe easier

The Bangladesh economy has entered 2024 with acute cost-of-living pressures, external payment imbalances, shortage of dollar liquidity, elevated illicit capital outflows, and vulnerable balance sheets in several, not all, bank and non-bank financial institutions.

Economic activity slowed in 2023. Policies have moved in ways tried before in Bangladesh and elsewhere but haven't worked. The market playing field is immutably tilted towards the connected. Market policing, based on superficial intelligence, has veered into cat-and-mouse games.

Unorthodox model did not deliver

Students of Bangladesh's economy might look back at 2023 as the continuation of a natural experiment, that started in 2022, on the effect of crawling peg pricing regimes under different institutional clothes in the foreign exchange and credit markets. The evidence so far confirms the text bookish prediction: The cure is worse than the disease.

The decline in all major categories of imports in 2023 is telling. The tables have turned. Corporates now seek bankers instead of the good old days when it was the other way around.

Foreign exchange shortage repressed import demand. Bankers are unable to open letters of credit (LCs) because they can't sell what they don't have—foreign exchange. The outstanding bills in foreign exchange in power and energy jumped to about $5 billion, according to media reports quoting official sources.

The gaps between export shipments and export receipts widened. The shortfall in receipts relative to the Bangladesh Bank estimates of the shipment value of exports increased to 22 percent in FY23 from 16 percent in FY21.

The first quarter of FY24 showed a further increase to 28 percent. Such steep increases cannot be explained simply by lags between shipment and payment or other routine adjustments (buyers' payment behaviour, discounts, rejections). Underpricing dollars relative to parallel market rates had a much bigger say as did illicit capital outflows incentivised by such underpricing and perhaps political uncertainties.

The operation of the exchange rate regime is as captive to the BB mood swings today as it was a year ago. Markets have probably adjusted to the higher transaction costs of trading at prices different from the de jure prices directly or indirectly administered by the regulator in the foreign exchange and financial markets.

In their December 2023 Article IV report, the International Monetary Fund changed Bangladesh's exchange rate regime from "crawl like" to "other managed", a term used when the exchange rate regime does not meet the criteria of any of the other categories. In other words, the model of the Bangladesh Foreign Exchange Dealer's Association (BAFEDA) and the Association of Bankers, Bangladesh (ABB) is an outlier in the global context.

The path forward

The monetary policy operating model has brought greater integration of policy and money market rates. Rates are better aligned with changes in the demand and supply of liquidity.

The anchor of SMART—the 182-day Treasury Bill rate—has moved almost every week of late. The BB adjusted the spread on SMART by 75 basis points in two steps in the last half of 2023. The bank lending rate ceiling moved up from 9 percent at the end of June to 11.89 percent in January.

The SMART has so far behaved pretty much like a crawling peg pricing system with a clearly defined formula. The pass-through of policy rates to the lending rate cap has increased. Its impact on inflation and external balance are still birds in the bushes because of the late start with a low acceleration. Broader space for rate flexibility is needed to make a dent in inflation and improve the efficiency of credit allocation.

The crawling peg in the case of the spot exchange rate has been ad hoc, showing no learning in 2023. The BAFEDA-ABB set export and remittance rates in irregular meetings. The discontinuous upward adjustment path so far followed encourages speculation.

The mind-baffling revaluation of the buying and selling rates by Tk 1 per US dollar in December in the midst of the dollar shortage in the formal system has predictably made no difference to the parallel market rates.

Foreign exchange rationing will not ease if the BB backed the BAFEDA-ABB model of exchange rate setting continues. A more data-based crawling peg is an unnecessary detour in journeying back to a managed float before such a switch becomes a force majeure.

The will to act on balance sheet reforms in the financial sector lacks urgency. Legislation and data for addressing distressed assets are in place as is a framework for Prompt Corrective Action. Yet the forward guidance on reforms features tardiness hardly befitting the gravity of the risk the zombies in the sector pose to the financial system. The PCA framework is projected to be effective at end March 2025. Why wait so long?

Procrastinate at own peril

Procrastinating major course corrections hoping global headwinds will fade sooner than later is not advisable. Hope-based policies did not serve us well in 2023. The IMF disbursed the second tranche in December signaling the programme is broadly on track.

The limits of the IMF programme beyond providing cash dollar support are increasingly self-evident. There is no alternative to home-grown reforms.

Macroeconomic stability is the oxygen without which the economy cannot breathe at ease. However, oxygen is not all one needs to make all organs healthier. Let 2024 be a year when the policy discourse is able to get back to the health issues from the unavoidable preoccupation with the readings of the oximeter.

Downsides risks are material. Some of them, such as access to external trade and finance, are embedded in deep uncertainties and the known post-LDC graduation challenges. Easing global conditions won't mean much if domestic policy is not attuned to reality.

The author is an economist