Exporters have been demanding depreciation of the taka against the US dollar to stay competitive in the export market for a very long time.
Now, the Bangladesh Bank, which has been managing the depreciation pressure through artificial interference, is finally feeling the need for depreciation as well.
The rising Real Effective Exchange Rate (REER) index, along with depreciation by competing countries such as India and China, suggests further depreciation of the local currency in an orderly fashion, the Bangladesh Bank said in its financial stability report for 2019.
REER is a measure of the value of a currency against a weighted average of several foreign currencies – divided by a price deflator or index of costs.
An increase in REER implies that exports become more expensive and imports become cheaper; therefore, an increase indicates a loss in trade competitiveness.
The REER index registered a rise of 2.6 percent last year.
"During the period [last year], the REER index experienced further appreciation, reflecting diminishing export competitiveness of the country," reads the stability report.
The central bank's realisation comes at a time when other competitive countries are ahead of Bangladesh in the exports race – having taken advantage of currency depreciation.
When competing countries – like India and China – experienced substantial depreciation of their currencies against the dollar last year, the Bangladeshi taka saw a 1.18 percent appreciation.
The Indian rupee depreciated by 2.56 percent against the US dollar last year, while China saw a 1.61 percent depreciation of its currency. Vietnam, a close competitor to Bangladesh which is already beating the country in apparel exports, saw a 0.01 percent appreciation of its currency last year.
Vietnam beat Bangladesh in apparel exports in the last five months of 2019. During this period, the Southeast Asian country fetched around $2 billion more than Bangladesh's $12.7 billion.
However, in the last calendar year, Bangladesh was marginally ahead of Vietnam in overall apparel exports. From January to December of 2019, Bangladesh's apparel industry earned $422 million more than that of Vietnam, enabling Bangladesh to retain its second position on the global market.
However, if the latest trend of decline in Bangladesh's apparel exports continues, the country may soon lose its position to Vietnam.
Bangladesh and Vietnam have been holding second and third places, respectively, in apparel exports, over the past decade with a close margin.
The REER index for Bangladesh steadily declined during the first half of 2019, and reached 105.70 – the lowest point of the year. Thereafter, it started to rise and peaked at 111.66 in September before reaching 109.89 in December, according to Bangladesh Bank data.
"Appreciation of REER in the last two consecutive years might have led to lowering of the export competitiveness of the country," said the Bangladesh Bank.
The nominal exchange rate was mostly stable in 2019, even with a depreciation of 1.2 percent, according to the central bank report. The depreciations recorded in 2018 and 2017 were 1.6 percent and 4.8 percent, respectively.
Stability in the nominal exchange rate – the amount of domestic currency needed to purchase foreign currency – last year might be partly attributable to the central bank's support to the foreign exchange market, the stability report adds.
The maximum exchange rate was recorded at Tk84.90 per dollar in December 2019, while the minimum was Tk83.94 in January of that year.
The difference between maximum and minimum taka per dollar was 0.96 last year, which was narrower compared to 1.08 in 2018 and 3.70 in 2017, according to Bangladesh Bank data.
Although Bangladesh's exchange rate is market-determined, it occasionally becomes necessary for the central bank to intervene in the foreign exchange market to maintain the stability in the nominal exchange rate, the report states.
In 2019, the central bank sold $1.62 billion compared to $2.37 billion in 2018, to support the foreign exchange market.
During the last year, the central bank did not purchase any dollars from the market. The extent of required intervention during the year was less than the preceding year, largely due to strong inflow of wage earners' remittances.
However, the size of the support by the Bangladesh Bank during 2019 reflects some pressure on the foreign exchange market from the demand side.
If the central bank stops giving directions and selling dollars, there will be two benefits, said Zahid Hussain, former lead economist of the World Bank's Dhaka office.
"Firstly, there will be a better alignment of the exchange rate, and it will benefit all the local businessmen who are competing on the export market. The government will not have to continue providing the cash subsidy then," he explained.
Secondly, he said, the dollars sold by the Bangladesh Bank leads to a deduction of the corresponding amount of taka from the banks' account with the central bank. As a result, their taka liquidity is reduced – inhibiting their ability to provide loans.
If the Bangladesh Bank stops selling dollars, this liquidity drainage will end, Zahid said.
Market adjustment of the exchange rate will help all exporters, protect domestic import substitutes, and strengthen incentives for remittances, he added.