Economy is complex and it’s hard to come to a single conclusion often. A lot of things went wrong with Bangladesh’s economy since COVID which resulted in an untamed inflation and the depletion of reserves followed by a dollar crisis. What caused the crisis?
Experts hold different opinions on what actually went wrong and created a dollar crisis. In this article, we are merely trying to provide an account of what have possibly gone wrong and what might require fixing in the coming days.
Bangladesh’s economy had a lot of fault lines like every other economy. A burgeoning Dutch Disease, increasing non-performing loans, a less elastic private sector credit growth, increasing inequality – just to name a few. But these were there pre-COVID and that didn’t result in a rapid inflation. However, COVID, Russia’s invasion of Ukraine and subsequent events exposed these fault lines to the extent that they started affecting price levels.
A Liberal Trade Regime, A Net Importer and A Dollar Crisis
Following its independence in 1971, Bangladesh’s earliest trade policy was import substitution and increasing self-sufficiency. High tariff and non-tariff trade barriers, as well as an overpriced exchange rate system bolstered by the government’s import-substitution industrialization plan, were the defining features of this. The goal of this policy was to create a protected domestic market for manufacturing industries while also strengthening the nation’s balance of payments position (Bhuyan & Rashid, 1993). A policy of moderate liberalization was implemented in the middle of the 1980s with more extensive trade liberalization being initiated at the beginning of the 1990s. Subsequent administrations have since reiterated their commitment to the creation of a trade policy that is more liberal.
Bangladesh Overall Foreign Trade (Thousand $)
Source: World Integrated Trade Solution (WITS)
No Data Found
Bangladesh has always been a net importer, as shown in the graph above, which depicts Bangladesh’s overall import and export between 1989 and 2015. Its imports and exports grew in the same direction, but not essentially to the same extent. A more appropriate account would be imports and exports as percentage of GDP since with the expansion of the economy, imports and exports are supposed to increase. Imports and exports expressed as percentages of GDP provides an intertemporal comparability.
Moderate Decrease in Export/GDP Ratio
First half of 1970s
Stagnant Export/GDP Ratio
Till mid 1980s
Upward Trend in Export/GDP Ratio
Till 2010s
Since trade liberalization, any increase or decrease in imports has been followed by a similar increase or decrease in exports and vice versa. Essentially in the same direction. There was a moderate decrease in the export/GDP ratio in the first half of the 1970s, followed by a stagnant ratio till the mid 1980s. This trend was reversed as garment exports started picking up and the upward trend in the export/GDP ratio continued till 2010. After that, although exports continued to increase in absolute terms, it started declining as a proportion of GDP. Since the mid-1980s, the import/GDP ratio has followed the same trends as that of the export/GDP ratio.
But what really changed is the type of products we import. Import of capital goods have more or less fluctuated between 15-25% of total imports. However, import of intermediate goods have increased to a significant extent, other than the slump in 2002-2008. Imports of raw materials have decreased whereas imports of consumer goods have increased as percentages of total imports.
Capital Goods
Fluctuated between 15-25% of total imports
Consumer Goods
Imports have increased
Raw Materials
Imports have decreased
Capital Goods
Imported the most
The decrease in imports of raw materials, and increase in imports of intermediate goods for production shows a lack of backward linkage industries in Bangladesh. For example – yarn is an input for fabric manufacturing and fabric is an input for cloth manufacturing. In the global value chain, some countries add more substantial value compared to the others. And addition of value depends on the development of technology, knowledge, skill, labor and expertise. The fundamental question is what sort of value do we add to the global value chain?
Sectorwise Share of Total Imports in FY 22-23 (%)
Source : Bangladesh Bank
No Data Found
As evident from the data provided by Bangladesh Bank, more than 20% of Bangladesh’s total imports in FY 22-23 were textile articles, mostly for use in garments production. That means we are importing fabrics to manufacture clothes where our value addition is the labor, the tailoring of the cloth according to the design provided.
$2.76 Billion Imports
Knitted Fabrics
$1.32 Billion Imports
Woven Fabrics
$0.10 Billion Production
Local yarn
However, it has to be acknowledged that yarn manufacturing has gained pace in Bangladesh. In 2020, Bangladesh imported $1.32 billion worth of knitted fabrics, $2.76 billion worth of woven fabrics, and $0.10 billion worth of yarn for the local garment industry. The share of local yarn as input for the garments industry is very low compared to the share of imported yarn, even though the backwards linkage industries are developing, perhaps focusing on them would allow us to create more value and reduce our dependence on imports for production which is now largely limited to tailoring of the cloth from imported fabrics. On the other hand, this import dependence for manufacturing complicates any benefits we may get from higher exchange rates.
Dollar Crisis and Exchange Rate: A Double-edged Sword
Secondly and more importantly, Bangladesh Bank has artificially and coercively kept BDT’s exchange rates low for a long time. One motivation behind that could be keeping price levels low so that exchange rates do not pass through to the market. Another possible motivation can be keeping the cost of imports of intermediate goods low for the exporters since Bangladesh has a high pass-through of exchange rate to the market (Hoque & Razzaque, 2004). But a discrepancy in the shipment value of exports and balance of payments shows that roughly USD 12 billions of export proceeds did not enter Bangladesh last year, which was around six times the unrecovered export proceeds in FY20. That is an unrealistically high number. This unusually high amount of unrecovered export proceeds last year is raising concerns. The widespread belief is that capital flight is happening through under invoicing and over invoicing.
Some people have also argued that many exporters are delaying to bring in their export earning because they are expecting further depreciation of the currency. It is important that the government, the regulatory agencies and the exporters collaboratively ensure the sustainability, stability and growth.
According to the economist, and the World Bank’s former lead private sector specialist, Dr. Syed Akhtar Mahmood, “Interest rates and exchange rates are two major policy tools. If we keep them fixed, we cannot use these major policy tools to tackle any imbalance in the economy. These tools essentially become impotent. However, the government has finally realized, even though belatedly, that these rates have to be flexible. We can thus see a gradual increase in the exchange rates and interest rates. However, the effect of keeping it rigid for a long time is still there. We can identify this rigidity as a policy failure.”
Hundi and an ‘Engineered’ Dollar Exchange Rate
Hundi, the informal and illegal channel for sending remittances, has some unwelcome effects on the economy. If the official exchange rate is lower than what these informal channels offer, remitters will prefer the better exchange rate in the informal market. Artificially pressing down exchange rates might have motivated remitters to use informal channels such as hundi to send their remittances which did not show up in the official foreign currency reserves of the country. According to Bangladesh Bank’s remittance inflow data for the last six quarters, remittance inflows were largely stagnant, other than a few seasonal peaks. According to official data provided by the then Expatriate Welfare Minister of Bangladesh, over 1 million workers migrated abroad in the first half of FY2022. However, remittance figures do not reflect any uptick in remittance earnings being sustained as of yet. One possible explanation for this can be the lower exchange rate being provided officially. The explanation gains more legitimacy when we see banks with higher remittance earnings buying dollar at a higher rate than the others and the BB specified rate.
INR | 66% Depreciation
2011 - 45 INR/USD | 2021 - 75 INR/USD
MYR | 40% Depreciation
2011 - 3 MYR/USD | 2021 - 4.2 MYR/USD
BDT | 14% Depreciation
2011 - 75 BDT/USD | 2021 - 85 BDT/USD
Between 2011 and 2021, BDT’s value decreased from 75 BDT per USD to 85 BDT per USD, which is about a 14% decrease in its value. Over the same period, the Indian Rupee depreciated by 66%, from 45 INR per USD in 2011 to 75 INR per USD in 2021. Even in the case of Malaysian Ringgit, the exchange rate jumped from 3.00 MYR per USD in 2011 to around 4.2 MYR per USD in 2021 which is around 40% decrease in its value. One may question how aligned the BDT/USD exchange rates were with the market-determined rate under a rigid and controlled exchange rate regime. If exchange rates are lower than they would be in a market-determined manner, the possibility of reserve depletion increases since the currency is cheaper than it should be. It encourages importers to import more. Sooner or later, depletion of reserves becomes likely. According to many economists, the artificial low exchange rate has contributed to the depletion of foreign currency reserves after the COVID-19 pandemic.
Of course, one can argue that fuel prices shot up due to Russia invading Ukraine and post-COVID supply chain disruptions. One might as well argue that the quantitative tightening by the US Federal Reserves lead to the dollar crisis. But these are global issues affecting every country and even though most of the countries were initially affected by these, most of them have recovered within a few months. It’s Bangladesh and a few others who have a sustained dollar crisis as of yet. Hence, it can’t be denied that a few policies could have been better crafted.
Private External Debt: Piling up Short-term Liabilities
External debts affect reserves since those have to be repaid in foreign currencies. Most people are discussing about debt-repaymemt obligations that might have contributed to the dollar crisis associated with the foreign assistance accepted by the government for various projects. However, public debts are mostly long-term, concessional loans with low interest rates and long repayment periods. What is more concerning is private external debt which has piled up in the last few years.
More than Doubled
between 2019 and 2022Q2
Short-term Loans Dominate
Disproportionate growth in short-term loans after 2020Q4
Ever since COVID, the private sector has taken a significant amount of short-term external loans. The graph above shows how the composition of private external debts have changed over the years with short-term loans dominating. The change was drastic in every quarter since the first quarter of 2021.
A significant portion of our foreign reserve earnings are being spent after loan servicing, especially the short-term ones. Short term private sector external debt servicing has increased almost two-folds between 2020 and 2022, which aggravated the dollar crisis.
When private sector external debt is used to fund export activities, the repayment problem is less serious since the companies are earning revenues in foreign exchange. But many private companies that have borrowed externally sell their products in the domestic market, and earns little foreign currencies, fuelling the dollar crisis.
More on Debts
There are a few additional factors to consider in understanding inflation, although they may not be as pertinent to the depletion of reserves. In terms of debts, it’s noteworthy that our private sector has experienced certain privileges, and the regulator has been rather generous.
Adjustment of Interest Rates
The Bangladesh Bank has mandated commercial banks to adhere to a single-digit interest rate for lending. While this aims to regulate borrowing costs, it limits the central bank’s ability to adjust interest rates dynamically. This fixed-rate approach creates challenges, contributing to moral hazards for borrowers and diminishing returns for depositors due to lower interest rates on deposits. Consequently, it may encourage depositors to explore alternative avenues for their funds.
Non-performing Loans
The surge in non-performing loans has significantly eroded trust in the banking system, triggering panic and widespread withdrawals. This has resulted in a liquidity crunch, amplifying the challenges associated with non-performing loans.
Central Bank's Role in Government Debt
When the government faces revenue shortfalls, it often turns to the central bank for public debt, which is supplied by printing money. While this may be a last resort, it has become a regular practice in Bangladesh. Enhancing the efficiency of the National Board of Revenue (NBR) and implementing targeted tax policies could bolster government revenue without resorting to central bank loans, which can inadvertently contribute to inflation.
In conclusion, the inflation crisis and dollar crisis could have been managed more effectively by targeting specific products rather than impacting the entire economy. The second part of this series will delve into how the spill-over effect could have been contained.
Bibliography
Bhuyan, A. R., & Rashid, M. (1993). Trade Regimes and Industrial Growth: A Case Study of Bangladesh. Bureau of Economic Research.
Hoque, M. M., & Razzaque, A. (2004). Exchange Rate Pass-Through in Bangladesh’s Export Prices: An Empirical Investigation. The Bangladesh Development Studies, pp. 35-64.
About the Author
Najib Hayder is the Blog Manager at The Confluence. Formerly he has served as the Head of Policy Debate at Youth Policy Forum. A former debater, business graduate by chance and policy-enthusiast by choice, currently pursuing MBA at the Institute of Business Administration (IBA) – University of Dhaka.