Gone with the cap

Remittances from workers overseas through formal channels have been variable around an often rising level in the past decade following 2001-10 when total remittances multiplied over five times. The recent depreciation across several currencies is reportedly having a positive impact on the volume of money transfers to many countries. Bangladesh appears to be slipping from this group despite improved remittance fundamentals. Remittances through the formal channels are down by around $500 million per month since mid-September when a system of multiple exchange rate ceilings came into place.

Near yet far

Bangladesh has grown a labour stock and diaspora abroad equivalent to over half the size of the Sri Lankan population. The numbers held steady in 2020, despite initial concerns that they would decrease in response to the pandemic, increasing sharply in 2021 and the first nine months of 2022. Easing of mobility restrictions globally kindled the pent-up demand for migrant labour.

The pandemic disrupted international migration temporarily. Millions of workers lost jobs in 2020 to early 2021 in the Gulf Cooperation Council countries and Malaysia. Millions others managed to stay where they were. They cut their consumption, entertainment, and movements. Some countries increased workers' wages. Many migrant workers even expanded their financial support to struggling families back home. The availability of vaccines and the opening of GCC economies enabled a return of reverse migrants and more to host countries in mid-2021 and onwards.

There is an association between the growth of the stock of workers abroad and growth of remittances. Bangladeshi remitters are in 168 different countries around the world – GCC, Malaysia, Singapore, India, Japan, China, US, Europe and so on. When a greater number of people go there, more money eventually comes home with a few months of lags. Annual remittance growth peaked at 35.4% in 2019 following high double digit annual growth in the stock of workers in the preceding two years (Table-1). Remittance growth slowed subsequently as did the growth in migrants abroad.

Table-1: Sources of remittance growth

Variations in growth of remittance per worker have dominated variations in growth of total remittances. This implies a significant role for factors other than the growth in the stock of workers abroad. The 20.4% peak in remittance growth per worker coincided with the peak in total remittance growth in 2019, a year in which growth in the stock of workers bottomed out at 2.3%. The journey since has been downhill with formal remittance per worker declining in 2021 and 2022 following high double-digit growth in the preceding two years.

The lagged effects of the 1.5 million added to the workers abroad in the last 18 months have been due. They found employment in countries (Saudi Arabia 59%, Oman 15%, the Emirates 10%) where several rounds of commodity price increases turned budget deficits into surpluses while bumping up GDP growth. Inflation increased by lower magnitudes from very low levels. The wages in almost all labour destinations have reportedly increased.

The rise of the USD boosted global remittances from countries with exchange rates pegged to the USD. South Asian migrant workers in GCC countries are getting much better deals in their home currencies for remitting money than workers in countries such as Malaysia, Singapore, and Japan where exchange rates have depreciated against the dollar. Over three fourth of the stock of Bangladeshi migrant workers being in GCC countries means Bangladesh had the conditions to see a rise in remittance due to dollar appreciation as well. Additional boosts were supposed to come from the compassionate effects of rising inflation and slower income growth at home.

An odd turn

Poised to move last year's 1.5% remittance growth to the pre-pandemic double digit territory, Bangladesh appeared to be getting there. Monthly remittance crawled up from $1.7 billion in January-March to $1.9 billion in April-June and over $2 billion in July-August 2022. Then came a concerning twist amidst continued strength in labour outflow (Table-2). Remittances halved $500 million in the second half of September, sliding to $1.5 billion per month through October.

Table-2: Recent remittance trends

A break appears to have set in. Exchange rate caps on inflows through the banks and exchange houses effective since mid-September was the highlight of the month. Data indicate a possible association between the rate caps and the drop in remittance inflows through formal channels. This is turning out to be a natural experiment when the exchange rate regime changed while other things indeed remained the same; thus enabling the attribution of the fall in the monthly level of remittances to the new regime.

The informal channels gained what the formal channels lost in the last year and a half. Bangladeshi workers abroad have not all of a sudden stopped remitting or switched to a protracted wait and see mode. Diversion to informal channels underpinned the decline in formal remittance per worker in 2021 (Table 1) as currency trading through the informal channels returned from coma. Trade, migration, and travel surged from the second half of 2021 and, albeit at a slowing pace, in 2022.

These led to the recovery of the share of the informal market lost in 2020-21. Formal remittance fell $3.7 billion in FY22, of which remittance inflow from GCC countries and Malaysia accounted for $3.5 billion. All these countries have thriving hundi markets. The rise in the share of the informal market was predominantly a correction in the post pandemic new normal.

Formal market loses more territory

The caps ceded more territory to the informal market by redrawing the market boundaries. The informal market has a larger space to intermediate between buyers not able to access dollars and the sellers not willing to sell dollars in the formal market at the capped rates.

Sharp discontinuities have emerged between the informal market rates and the formal rates. Prior to the cap, the remitter could choose between rates offered by the banks and exchange houses from a tight range of rates emerging out of competition between the dealers with each other. The caps ruled out banks' offering over Tk99 to direct remitters (exporters, migrant workers, investors, tourists) and Tk108 to exchange houses.

This hit individual remittance through the banks' nostro accounts. Those remitting at exchange rates in the greater than Tk99 to less than Tk108 range prior to the cap had to consider switching to the exchange houses or informal channels because the only other option is to transfer through the banks at the lower Tk99 rate. They could no longer trade their dollars for taka at any other rate in the banking system without routing through the exchange houses. If the switching costs are the same, the remitter is likely to have chosen the informal channels because of their higher rates, anecdotally between Tk112-120.

The caps pushed a chunk of remittance supply away from the exchange houses as well. The average cost of buying foreign exchange in the banking industry has been closer to the cap on banks than the cap on the exchange houses. The average cost declined from Tk103.3 per USD on September 13 to Tk102.6 per USD on November 3, reflecting a decrease in the share of dollars remitted through the exchange houses at a time of declining total remittances through the formal channels. The decrease could not have been due to a lower willingness of banks to take remittances from the exchange houses. The banks are dollar starved. The Tk108 cap pushed out those remitting through exchange houses at above this rate prior to the cap.

Anchoring inflated informal premium

The caps consolidated a pre-existing high informal market premium. The premium peaked at 12.1% in August from 1.4% in June (Table-2). Since the lowest cap of Tk99 per USD was higher than the previous BB regimented rates in the Tk94-96 range, the measured premium declined to 10.3% in September but was still 7.4 times higher than in June. The officially reported "unofficial" exchange rate looks strangely stuck at Tk108 per dollar since mid-September suggesting that premium measured using this rate can be highly understated. The caps have sealed the shrinkage of the premium from below asymmetrically for the banks and the exchange houses.

Is the informal market rate undervalued because of perhaps excessive capital flight? Judging from BB's real effective exchange rate ranging between Tk112 to Tk123 per dollar in October, the undervaluation assertion is not compelling. However, the cap may be propagating capital flight by making informal market dollars cheaper as leaks in supply from the formal channel remain elevated. 

The new regime is a drag on foreign exchange crossing borders. The recent decrease in the exchange house rate from Tk108 to Tk107 may exacerbate the drain from the formal channels. The caps are likely to bite for a while with the dollar remaining going. Yet another differentiation allowing bankers to offer Tk107 for remittances by those paid "salaries" in service industries has convoluted the rate structure further.

Zahid Hussain is former lead economist of World Bank Dhaka office