Course corrections missing main course

The balance of payments data for July-January released last week shows an improvement in the current account relative to the same period last year with a deterioration in the financial account. January added to the deficit in trade and current account recorded in the first half of FY23. Deficits in all parts of the BOP eroded the Bangladesh Bank's net international position by $7.4 billion, 3.6 times the erosion last year. External imbalance is showing ominous resilience.

What does lower current account deficit signal?

The 50% July-January reduction of current account deficit relative to the same period last year means the financing burden arising from the goods, services and factor trade transactions has so far been lower. The reduction primarily came from a 10% growth in export shipment and 5.7% decline in imports. The rise in exports to a historic $5 billion per month since November 2022 benefited from the diversion of export orders from China, including high value items, and price increases allowed by the buyers to compensate for the increase in the cost of intermediate inputs.

Diversion from China could revert. China is positioning to recapture lost markets. Cost compensations prevented erosion of domestic income generation from exports. It may not last if buyers press for the reversal of price increase with cotton and yarn prices showing downward tendencies and slower growth in advanced economies are underway.

The decline in imports is not so straightforward to interpret. Consumer goods import growth slowed while all other imports except fertiliser, raw cotton, and crude petroleum declined. Imports closely connected with production and investment such as POL, oil seeds, intermediate pharmaceutical products, plastics and rubber articles, iron, steel and other base metals, and capital goods declined.

Foreign exchange quantity constraints explain the import decline. Rationing of foreign exchange is force majeure when the exchange rate is not free to adjust in real time to correct supply demand imbalances. The question therefore is what the impact on production and even replacement, not to speak of new investment, may be if the administrative control mechanisms to manage rationing stay. So far, drawing down previously accumulated inventories may have diluted the impact on production and investments.

Exchange rate cap explains the failure of remittances despite a surge in employment abroad since the pandemic. The generation of remittance from the increased stock of migrant labour and the path travelled to enter Bangladesh in dollars was subject to several mood swings in the exchange rate regime in the last nine months or so. An abysmal 4.25% remittance growth in July-January, the Expected Time of Arrival of the additional dollars, tells the story. Blame hundis as much as you like, but the rate cap on remittances has made it worse. Banks not able to compromise compliance are at a distinct disadvantage in the remittance transfer business, thus suppressing options available to the remitters.

Financing constraints biting increasingly

The deficit in the financial account turned 2.2 times larger in January than the deficit in the first six months with an adverse turnaround of $9.85 billion relative to January-June last year. The deterioration is proximately attributable to a large sign reversal of short term and long-term credit flows and trade credit. The private sector in Bangladesh accumulated external debt in the past half decade taking advantage of an overvalued taka with a stable outlook and low interest rates abroad. The BOP lines consistently showed net debt inflows since FY17/18. The situation has changed remarkably. At a time when tightening international financial conditions are making history, Bangladeshi borrowers have grown a reputation risk by failing to settle foreign currency obligations in time and seeking repeated payment deferrals. Difficulties in rolling over the accumulated external debt is an inevitable market consequence.

The net outflow on trade credit is related to the boom in exports shipment since November. There is always a lag between shipment, payments and repatriation of the amount paid. The repatriation of earnings from those shipments are not yet in the account balances of our deposit money banks with 120 days just past the first boom in November.

Why is repatriation not happening to the extent expected from the export takeoff? There are always the standard answers about short shipments, discounts, and payment delays. In most cases, exporters have no choice, say industry leaders. There is no evidence to suggest a shift in these structural factors, notwithstanding concerns about impending weakening. The only change of direct relevance to repatriation is the one taka a step increase in the exchange rate cap on export dollars since September 2022. Bafeda has been doing it at the behest of BB.

BB has already unloaded over $10 billion forex reserves and the Deposit Money Banks continued to drawdown their foreign currency balances while falling short in rolling over foreign currency liabilities. Given persistent excess of accrued and off-balance sheet foreign currency liabilities over assets (negative Net Open Position at the aggregate) in the DMBs, what would be your best estimate of the direction of this administered exchange rate for exports? Up, a no brainer.

You may even be willing to borrow short term at 9% locally to finance working capital if the option value of waiting for the next increase fetched one taka more per dollar for your millions of unrepatriated export dollars. There is no risk with the existing cap likely to continue biting. Delaying repatriation of as much money and for as long as you can is the optimal strategy. A financial system where interest waivers and loan default is no big deal if you are connected makes farce of the level playing field.

A policy response seeking relevance

The authorities last week disallowed application of rates after 120 days on delayed repatriation as a disciplinary measure. BB officials allege many exporters have been delaying encashment to gain higher exchange rates "which has now become a trend", more than incidentally set by one-taka discretionary adjustment five times since mid-September 2022 when Bafeda began administering a source based differentiated buying rates of the dollar inflows.

If the dollar rate has been on the rise, exporters will get the rate of the 120th day. If the dollar rate falls, chances of which happening in 2023 is tiny at best, exporters will get the lower rate prevailing on the date the proceeds arrive. Banks will convert into Taka applying "prevailing" exchange rate but pay exporters the rate on the 120th day. The reference rate for the "prevailing" exchange rate is not clear.

Banks potentially are on the side of a one-sided bet in which they cannot lose when taka appreciation is all but ruled out. Banks will retain the difference between converted taka proceeds and the amount paid the exporters in a separate subsidiary ledger account and report the balances monthly to BB within 10 days following the end of any month. Use of these balances are subject to "instructions" not yet communicated by the BB.

The policy looks deceptively repatriation compatible. Exporters can only lose by delaying because the decision will be applicable in case of "adverse" (meaning depreciation) exchange rate difference between the 120th day since the shipment date. The date of surrender can breach the 120th day line foregoing the benefit of anymore one taka increase in the export dollar rate by Bafeda since the breach. Why would Bafeda, a self-regulator run by bankers, want to offer exporters higher rates when their members have a near certain opportunity to pile up subsidiary ledger balances of exchange rate gains to which they can lay a claim?

Will this work? The new arrangement has created incentive to make the export rate sticky, shifting market power in favour of bankers. The officials down the line are vested with extra discretion to negotiate on several variables in the web connecting the officials in BB, NBR, bankers and exporters: shipment date, shipment values, repatriated amount, and the repatriation date.

Banks face a tradeoff between uncertain subsidiary ledger benefits and the dollar liquidity they could attract from the exporters by accommodating with the exchange rate advantage to the exporter client in mind. Such dollar liquidity is handy for meeting their LC obligations and attracting greater volume of import business when the size of the import pie is shrinking. This will be the dominant choice if the banks are not allowed proprietary use of exchange rate gains stored in the subsidiary ledger. Again, the compliant banks are at a distinct disadvantage in this competition.

Smelling the coffee

Management of the exchange rate by fiat has taken a life of its own. Symptoms of anchoring and functional fixedness are glaring. The BB-Bafeda-ABB regulatory nexus relies too heavily on the first piece of information they receive when deciding. Subsequent judgments or decisions are based on the initial anchor that came into place in mid-September 2022. It has tended to use heterodox methods to solve problems, resisting tested approaches. Both anchoring and functional fixedness are reinforced by emotions and feelings obscuring judgments (the affect heuristic).

The regulators are anchored to the September approach because it feels safer to them despite being ineffective. The first reaction of rate setting by Bafeda appealed to fear of inflationary spiral, financial insolvency, and destabilising speculation. Irrespective of consequences, these fears have influenced evaluation of information on the subsequent developments.

Data suggesting the ineffectiveness of the policy are either denied or interpreted as confirmation of prior beliefs. Irrelevant evidence such as the decline in imports is attributed to policies intended to augment the supply of dollars! Policy failure to anticipate the dollar shortage triggered by the rate hikes, commodity price increases and domestic pent-up demand since the pandemic is perhaps directly attributable to misplaced group optimism.

A dollar quantity shock we currently subject the economy to is presumed to be more stabilising than a price shock that would inevitably ensue if the taka were managed with due regard to the propensity to arbitrage. However, the float would most likely induce a foreign exchange supply response, thus easing the quantity constraints which in turn will tame inflation by spinning the wheels of domestic production. Destabilising speculation is happening under the present system anyway as evidenced by frequent revisions in the rules of the game. Insolvency shocks have made their way in through reputation risks arising from the failure to settle payments on time due to dollar shortage.

Bottomline: Shun preannounced rates. Protect reserves. BB cannot keep selling over a billion dollars a month and still expect to raise net international reserves by nearly $4 billion from now onwards till end-June 2023 to avoid breaching the IMF floor.

Zahid Hussain is former Lead Economist of the World Bank, Dhaka office