Foreign exchange reserves, a critical economic indicator, have witnessed a persistent decline over the past few years.
As per data provided by the Bangladesh Bank, in August 2021 the foreign exchange reserves held by the Bangladesh Bank exceeded $48 billion. However, as of October 18, 2023, these reserves significantly dwindled to $26.68 billion.
Notably, according to the International Monetary Fund (IMF) accounting system, the reserves are even lower, standing at $20.95 billion.
On top of that if the net reserves are calculated, it becomes evident that they have fallen below the $17 billion-mark.
Over the last two years, the data from the Bangladesh Bank reveals a disconcerting trend: the reserves have been depleting at an average rate of nearly $1 billion each month.
This decline can be attributed to a combination of global economic challenges and certain ill-advised policies, both of which have contributed to this deterioration of a vital economic indicator.
Fixing the dollar price
One of the main sources of foreign exchange in Bangladesh has historically been the hard-earned dollars sent by expatriates.
However, the legal inflow of dollars has declined, and this decline is attributed to the central bank’s fixation of the dollar price.
Zahid Hossain, the former chief economist at the World Bank Dhaka office, has said that the central bank’s decision to fix the dollar price has not effectively controlled inflation, and it has not led to an increased supply of dollars.
Consequently, banks have struggled to secure the necessary dollars for imports, some being forced to purchase dollars at higher prices.
Bangladesh Bank, without fully comprehending the realities faced by banks and businesses, initiated punitive actions against certain banks.
The central bank conducted special inspections in these banks and even removed the heads of treasury from six domestic and foreign banks who were involved in selling dollars at enhanced prices.
These actions had a negative impact on remittances, causing a drop of $500 million dollars in September last year.
In the first three months of the current fiscal year (July-September), the flow of remittances decreased by a substantial 13.34%.
In September of the same year, remittances to the country dwindled to just $1.34 billion, marking the lowest figure in 41 months.
Experts and concerned individuals have attributed this steep decline in remittances to Bangladesh Bank’s stringent control over the dollar exchange rate.
In this context, Saleh Uddin Ahmed, former governor of Bangladesh Bank, said that the fear of rising inflation has led to the unchecked use of hundi for dollar transactions. Consequently, the flow of dollars has diminished, and the foreign exchange reserves are not seeing an increase.
Reluctance to raise policy interest rates
In the wake of the ongoing global crisis, most countries around the world have taken decisive actions to raise interest rates as a means to combat economic challenges and control inflation.
However, Bangladesh has been notably hesitant about increasing policy interest rates from the outset, primarily as part of an effort to curtail import costs. Some experts speculate that a substantial amount of money may have been illicitly transferred out of Bangladesh due to this.
Nonetheless, a pivotal shift occurred on October 4 when the central bank decided to raise the policy interest rate, also known as the repo rate, by 75 percentage points. Consequently, the repo rate has been adjusted to 7.25% from its previous level of 6.5%.
The IMF conducted a study in several Central Asian countries to explore how increases in policy interest rates impact inflation.
Their findings reveal that for every one percentage point increase in the policy rate, inflation decreases by 0.5 percentage points in the first year.
Furthermore, a 1 percentage point increase in the exchange rate results in a 0.3 percentage point reduction in inflation.
However, in consideration of factors such as private investment and import costs, Bangladesh Bank had maintained a cautious approach in raising policy rates until now. This approach had placed mounting pressure on foreign exchange reserves.
Officials at Bangladesh Bank may have argued that the institution had adhered to its strategy of gradual policy rate increases, largely due to concerns about inflating private investment and import expenses.
Nonetheless, the situation has intensified the strain on foreign exchange reserves. To address this crisis, Bangladesh Bank has now granted banks the opportunity to purchase dollars at a higher rate.
Taxation of interest on foreign loans
However, the central bank is not the sole authority driving essential policy changes or imposing potentially unfavorable measures.
Traders are pointing fingers at the National Board of Revenue (NBR) for the decline in dollars from Bangladesh, citing that foreign loans in dollars have become more costly than local loans due to a substantial 20% withholding tax on interest payments for foreign loans.
In response, Bangladesh Bank has formally requested the National Board of Revenue (NBR) to reconsider the imposition of a 20% withholding tax on interest payments for foreign loans in the current budget, echoing the demands of the Association of Bakers, Bangladesh (ABB). The central bank has emphasized that this tax will significantly inflate the cost of borrowing from foreign sources, effectively raising the cost of foreign borrowing by one-fourth.
In this context, Bangladesh Bank Executive Director Mezbaul Haque, said: “The central bank has written to the NBR, outlining the difficulties faced by banks in obtaining foreign loans. On behalf of Bangladesh Bank, we have urged the NBR to reconsider the matter and withdraw the tax.”
Bankers are apprehensive that this tax is curbing dollar lending, which may lead to further reductions in foreign exchange reserves.
Concurrently, the private sector is under pressure to repay foreign loans. In the first seven months of this year, the private sector acquired $3.41 billion more in foreign debt than it needed to repay.
During this period, the outstanding debt to be repaid stood at $10.93 billion, while new loans amounted to $10.59 billion.
According to data from Bangladesh Bank, the foreign debt of the private sector was $22.18 billion in the previous March, but it had surged to $24.31 billion just three months ago in January.
Notably, interest rates in the international market are now determined using the Secured Overnight Financing Rate (SOFR) rather than the previous LIBOR benchmark.
Foreign loans come with an additional interest margin of up to 3.5%. The recent interest rate hike by the US Federal Reserve has pushed the SOFR rate to 5.31%, a significant jump from the 0.25% rate during the pandemic. Consequently, international loan interest rates have escalated.
For instance, if an individual were to take a $2 million loan for one year through Buyers Credit or an offshore banking unit, the interest cost would be approximately $180,000.
However, with the imposition of the new withholding tax, borrowers are now burdened with interest-related taxes of around Tk39 lakh.
Although this tax is ostensibly levied on foreign companies, the ultimate cost falls on the borrower. Consequently, the interest rate on foreign loans has surged to approximately 11%, making foreign debt more expensive than local debt.
The NBR had previously exempted tax on foreign loan interest through a circular issued on November 29, 1976. However, this long-standing exemption was revoked by a circular issued on May 23 this year, coinciding with the dollar crisis.
Zahid Hossain, former World Bank chief economist, has warned that the NBR’s decision will negatively impact the inflow of dollars, deterring many from seeking loans abroad and exacerbating the foreign exchange crisis.
Discouraging bonds for expats
A savings scheme known as the Wage Earner Development Bond (WEDB) was initially launched for expatriates with the aim of boosting remittance flows.
Many expats found the scheme appealing due to its attractive returns, prompting increased interest in sending remittances through formal banking channels based on the premise of investing in these bonds.
However, allegations of black money being funneled into these bonds, coupled with tightened investment limits and various restrictions, have led to a decline in investments.
The government initiated measures to curb investments in this sector starting from 2020, which has had an adverse impact on remittances. With reduced sales of these bonds, funds from other sectors have been used to repay earlier investments.
Despite the government’s unfavorable policies regarding the bonds, expatriates invested Tk1,600 crore in the 2020-21 fiscal year. However, within a year, in the 2021-22 financial year, this investment dropped to Tk866 crore. In this year, the principal stood at Tk1,282 crore. This resulted in a deficit of Tk415 crore.
Analysis of central bank data indicates that the negative policy on WEDB has led to a situation where the amount of dollars sent by expatriates exceeds the amount deposited in reserves, contributing to a decrease in the reserve.
Previously, expatriates could invest any amount in this sector. However, on December 21, 2020, the limit was reduced to Tk1 crore, and reinvestment was discontinued.
Subsequently, when the dollar crisis began in the country, in April 2022, the interest rate was halved. As a result, expatriates began turning away from these bonds.
Had the interest rate not been halved during the country’s dollar crisis in April 2022, the reserve would have increased to some extent, Dr Zahid Hossain said.
Many expats have expressed that they turned away not only from wage earner bonds but also from the banking system due to the drastic reduction in interest rates in 2022.
During that time, bank deposit interest rates were also at their lowest, coinciding with the resurgence of the hundi system.
Consequently, most expatriates opted for the hundi route, which provided better returns compared to banks.
Many individuals withdrew money from banks and entrusted it to informal money transfer channels in various countries. This shift resulted in a liquidity crisis in the banking sector and put foreign exchange reserves under pressure.
When analyzing the data, it becomes apparent that in 2018, $200 million was accumulated in reserves through the sale of wage earner bonds.
By 2020, this figure dropped to $135 million, and in 2021, it further decreased to $107 million.
Central bank data reveals that net sales of WEBD fell by $35 million from January to October 2022.
Additionally, expatriates have also retreated from US dollar investment bonds due to negative policies.
The sale of these bonds had played a role in boosting reserves. In 2019, $25 million were deposited in reserves through the sale of these bonds, which dwindled to $22 million in 2020 and further decreased in 2021. As of October 2022, net sales of US dollar premium bonds stood at $2.16 million.
It is worth noting that Wage-Earner Development Bonds now offer 9% interest, down from the previous 12%. Similarly, the US dollar premium bond provides 3.5% interest, a reduction from the earlier 7.5%, and US dollar investment bonds now yield 3% interest, down from the previous 6.5%.
Surge of hundi
In the first six months of 2023, 618,000 workers have departed from Bangladesh to various countries. Additionally, last year marked a record-breaking figure of 1,136,000 workers leaving the country.
With such an increase in the number of workers going abroad, one would naturally expect a corresponding rise in remittances.
However, the remittance flow is on the decline due to the prevalence of hundi, an informal money transfer system.
Economists suggest that the significant volume of remittances sent through hundi channels has caused a diversion of these dollars into the parallel or open market.
This surge in the supply of dollars in the parallel market has led to a simultaneous increase in demand and prices.
Presently, the exchange rate for a dollar in the kerb market stands at Tk120. In contrast, for every dollar of remittances received through official banking channels, expatriates are getting a maximum of Tk112 to Tk115, including incentives.
According to the World Bank, during the last fiscal year, the variance between the official and unofficial dollar exchange rates in Bangladesh ranged from 12-18%.
No timely and logical initiative
Even during double-digit inflation, Bangladesh Bank could not manage to move away from the single-digit pegged interest rate.
Development assistance from reserves has failed to repay loans. A part of the export income could not be brought back to the country. Almost hundreds of millions of dollars have been stuck abroad for two years.
There was no timely and logical initiative by the regulatory body to keep the dollar rate competitive with hundi, proliferation of hundi through digital banking, online gambling and crypto business to stop dollar laundering.
In this context, Dr Zaid Bakht, a researcher at the Bangladesh Development Research Institute (BIDS) and chairman of Agrani Bank, has pointed out that the primary reason for the decline in reserves is the inadequacy of Bangladesh Bank’s efforts to combat money laundering.
He said that earlier successes in controlling hundi were achieved through monitoring mobile banking transactions in the remittance sector, but these activities have now waned.
The second reason is the failure of Bangladesh Bank to curb commercial banks from engaging in dollar transactions at elevated prices, which has impeded the implementation of Bangladesh Foreign Exchange Dealers Association’s (BAFEDA) fixed exchange rates.
Dollar sales from reserves
Apart from meeting government loan installments, servicing charges, and government-related fees, Bangladesh Bank has also been engaged in the sale of dollars from its reserves.
It provides dollars to banks for various government imports. This practice has persisted for over two years, primarily due to a shortage of dollars in banks.
In the initial three and a half months of the current fiscal year, more than $4 billion have had to be sold from the reserve.
To put it in perspective, in the preceding fiscal year, a record-breaking $13.58 billion was sold from the reserves. During the fiscal year 2021-22, the central bank’s dollar sales amounted to $7.62 billion.
