There is nothing to be panicked about if taka slides further against the dollar. It's not only that the market demands it, but it is also the penalty the nation must pay for the government's wrong policy on the exchange rate in the first place. Since the early 2020s, taka was wrongly overvalued, hurting exports and remittances and boosting imports for long. These widened the current account deficits and depleted the foreign currency reserves. Sliding of taka would help reset these trajectories and leave the central bank in a better shape than before.

Some people misconstrue the value of taka and wrongly tie it with the strength of the government. It's the opposite for a developing nation like Bangladesh. Let me explain the case particularly for those who mix taka's value with politics. The exchange rate is the amount of foreign currency that one unit of domestic currency can buy. It's the amount of US dollar that one unit of taka can buy, which is $0.011494252 (=1/87) or close to 1.15 cents when one dollar is sold for Tk 87.

Next, if one dollar is sold for Tk 91, both the exchange rate and the value of taka go down to $0.01098901 (=1/91) or close to 1.1 cents. Now, taka's purchasing power has fallen from 1.15 cents to 1.1 cents—which we term as devaluation of local currency. Some people take this weakening of taka as a sign of weakness in the economy, and even go as far as to blame the government for making the nation weaker on the global stage. Is that so?

Like the interest rate, the exchange rate is a tool for the central bank to regulate the economy and guide it in the right direction, so that inflation is controlled and employment is maximised. In any journey, reaching the destination is the main objective. Passengers hardly care about how the driver is using the clutch, brake, and accelerator. Of course, we always need to appoint an experienced and efficient driver to avoid accidents. And herein lies the importance of policymaking and having the right people in the driving seat.

Since the early 2000s, the government committed to the regime of floating exchange rates. Essentially, it remained highly administered and artificially managed—a style often termed as a "dirty float". The central bank can iron out the day-to-day volatility of taka's value, but it shouldn't stay too far away from the interbank value, or the market value determined by a fair play of demand and supply. The kerb-side or street-market value which the brokers determine unofficially is often a reflection of the market value.

To illustrate a case, Bangladesh Bank (BB) assigned the rate for importers—called BC rate or bills for collection rate—at Tk 86.75 on May 9, 2022. This rate assignment is impractical and has no connection with what is going on in the market. Importers had to buy dollars at as high a rate as Tk 95 to pay import bills. Banks were compelled to collect high price for the dollar because the demand far outstripped the supply. BB has a research division that is capable of analysing the dynamics to reflect a fair exchange rate. But who cares about research? Knowledge or expertise takes a back seat, while obedience to the finance ministry—which is supposed to be guided by political judgment—matters the most. Hence, BB's mistakes in policymaking seem unavoidable.

Taka has long remained artificially overvalued, and thus deprived millions of remittance-recipients since the dollar was undervalued. When remittance began to decline due to BB's poor valuation of the dollar and expatriates resorted to using hundis or other informal channels, BB introduced a nuisance in the form of 2 percent incentive (now 2.5 percent) to be added on top of the dollar's value in taka. Why can't BB add that 2.5 percent directly on the dollar's value? The dollar deserves more than that amount against taka to reflect the market price. Why is that extra piece of cake needed in a set-up of a market economy? The result: more tangles, more circulars, more layers, more frills, more sweeteners, and invariably, more complexities with more corruption. We are not sure whose brainchild this "remittance incentive" is, but it resembles a piece of advice under the Pakistani regime that had introduced more regulations and bureaucratic tentacles to rule Bengalis.

BB advisers must come out of that mindset and devise ways on how to ensure a fair play of demand and supply to determine interest rates, exchange rates, and a correct value of taka. A fair price never requires a subsidy or an incentive. Vitamin tablets are redundant if someone takes natural healthy foods. Controls are the mantra of the mediocre because controls make them feel important.

Our foreign reserves stood at USD 46 billion in December 2021, and it has slid to USD 41 billion—equivalent to roughly 6 months' imports given the current pace. It's still fine. But if taka isn't allowed to reflect its real value by sliding further against dollar, foreign reserves will reach an alarming low in a year or so. Why? At the end of FY 2022 in June, imports may hit up to USD 80 billion and exports USD 50 billion. A major part of this trade deficit of USD 30 billion will be offset by the expected remittance of USD 20 billion. Since balance of services is in deficit, the total current account deficits are expected to be USD 18 billion or so. If capital accounts can't offset the deficits, the reserves' coverage length of import bills will shrink further.

But if taka depreciates against the dollar, the rise in both exports and remittances will outpace that in imports, dwindling the current account deficits and boosting foreign reserves. The government's recent ban on luxury imports seems to be politically popular, but it is also losing its import duties which are much higher on luxuries. The widening tentacles of import restrictions will add further salt to the injury of our fiscal capacity, which is one of the lowest in the world. The government will then resort to using more of its favourite tool—Sanchayapatra—another example of non-market pricing and the most expensive deficit financing of the government.

Coming closer to the market in fixing both exchange rates and interest rates is the best answer to avoiding all ad hoc circulars, frills, subsidies, incentives, and restrictions—which engender policing, rent-seeking, and corruption. Taka's value may rise or fall based on its market value, and the economy will either gain or lose at times. But keeping its value artificially too high is foolish. It will do more harm than good to the economy by damaging its balance of payments.   

Dr Birupaksha Paul is a professor of economics at the State University of New York at Cortland in the US and former chief economist of Bangladesh Bank.