Currency swap: Lifeline or looming challenge?

Illustration: TBS

Bangladesh has been a member of the International Monetary Fund (IMF) since 1972, taking 12 loans since its inception in 1974. As of 30 January last year, the International Monetary Fund (IMF) approved a $4.7 billion loan for Bangladesh to aid the country's economic policies and calm the edginess the Bangladesh economy has been experiencing for a while. The decision came at the meeting of the IMF's executive board. 

Although Rahul Anand, the Mission Chief of the International Monetary Fund (IMF), said that Bangladesh was not in crisis, the country, like other countries around the world, is dealing with the impact of global shocks, first from the pandemic and then from the ongoing war in Ukraine. Bangladesh's robust economic recovery from the Covid-19 pandemic was interrupted by Russia's war in Ukraine.

The IMF provided some bindings for receiving $4.7b loans. Increasing the tax-GDP ratio, implementing the VAT law, establishing an asset management company to dispose of soured loans, decreasing the banking sector's default loans to within 10%, and raising the capital adequacy ratio to the BASEL III requirement of 12.5% are among the reforms agreed upon.

According to Bangladesh Bank's data on 3 October 2023, the reserves stood at $26.93 billion. In contrast, according to the IMF's recommended formula specified in the Balance of Payments and International Investment Position Manual (BPM6), they were calculated at $21.03 billion.

The balance of the Nostro Accounts (a bank account that a bank holds in a foreign currency at another bank) was included in these reserves of $26.93 billion, which was the gross reserve. However, according to BPM6, the IMF Nostro Account balance will be blackballed. Such exclusion of Nostro Account Balance has slightly outpaced the country's net international reserves (NIR). 

From September last year until now, the country's reserves have been wandering around $17 billion to 20 billion, which has caused tension for the settlement of the balance of payment (BoP) as our country is import-based. 

On 17 January 2024, the Central Bank of Bangladesh (BB) issued the monetary policy for the second half of the FY January to June 2024 period. BB will adopt a crawling peg to curb exchange rate volatility, raise the policy interest rate, and restrain private sector credit growth to combat inflation.

Bangladesh Bank (BB) has confirmed its commitment to a contractionary policy stance during the second half of FY24 (January–June) to counter the persistent inflationary pressure, intending to reduce inflation to 7.5%.

This year, the main theme of monetary policy is strengthening the local currency, which means controlling inflation and relaxing the country's people. 

Inflation has been hovering around 9%, with food inflation in Bangladesh soaring to 12.54% in August 2023—the highest level in the past 13 years, according to the Bangladesh Bureau of Statistics (BBS). 

The new monetary policy statement also said that to tackle inflation, and the Bangladesh Bank will implement a crawling peg system to regulate atypical fluctuations in the foreign exchange (forex) rate value.

The crawling peg is a system of exchange rate adjustments in which a currency with a fixed exchange rate is allowed to fluctuate within a band of rates. It helps control currency moves, atypically during threats of devaluation. The purpose of crawling pegs is to administer stability. 

While the BDT experienced a marginal depreciation from July to December 2023 compared to the same period the previous year, it stood at 110.00 per dollar as of December 31, 2023. 

This positioning remains broadly competitive among peer countries, reflected by the relative gravity of the recent depreciation of BDT vis-à-vis peer countries' currencies.

However, one of the main objectives of the present monetary policy is to tighten the money supply. Central banks usually apply these techniques to tighten the money supply to increase the repo or policy rates. Presently, BB has increased the repo rate to 8.00%. The repo rate increase means BDT will be more expensive, which leads to decreased inflation. 

In the meantime, to control inflation, Bangladesh Bank introduced a currency SWAP policy on February 15, 2024, with a minimum of seven days and a maximum of 90 days. 

Currency swaps were initially done to circumvent exchange control and governmental limitations on the purchase and/or sale of currencies. Although nations with weak or developing economies generally use foreign exchange controls to limit speculation against their currencies, most developed economies have eliminated controls nowadays.

The country's scheduled banks have suffered liquidity crises since the Covid-19 pandemic. This is mainly (but not only one) because the scheduled banks have been purchasing dollars from the central bank to meet the import payment. 

Bangladesh Bank sold more than nine billion dollars to scheduled banks in the first seven months of this FY. BDT went to the central bank's vault because USD was brought to the scheduled bank vault and accounts. 

The scheduled banks with foreign currencies in their Nostro accounts can exchange them with BDT to support their daily operations. The exchange rate with BDT vis-à-vis is 110 per dollar, plus the difference between the repo rate and SOFR (six-month average) per annum. At present, SOFR is 5.25% per year. 

The Secured Overnight Financing Rate (SOFR) is a benchmark interest rate for dollar-denominated derivatives and loans, superseding the London Interbank Offered Rate (LIBOR).

Here, the scheduled banks that have dollars in their Nostro Accounts' balance can easily take advantage of this benefit: 110 per dollar vis-à-vis the highest 90 days, plus a 2.75% interest rate annually (repo rate minus SOFR, 8.00–5.25, = 2.75%).

On the other hand, commercial banks can deposit their dollars into the Central Bank, exchanging Tk110 per dollar within a specified time. But if these commercial banks want to buy this dollar from the open market, they may need to buy at a high rate, spending more BDT on the day of the dollar drought. 

Only the scheduled banks with dollars in their vaults and Nostro Accounts can use these facilities to return dollars with Tk110 plus 2.75% interest annually. The rest of the banks that don't have dollars have been using liquidity facilities at an 8% repo rate. 

The present currency swap system can slightly mitigate the reserve pressure, but it contradicts the present monetary policy. 

Commercial banks desperately want BDT in exchange for USD. It has been shown that after launching the currency swap system, the commercial banks availed themselves of the Tk65 billion facility within three days. The impact of this Tk65 billion is huge in the banking sector and macroeconomics, known as the money multiplier. 

The Money Multiplier—defined as the M2 money-supply balance divided by the base money supply or reserve money. As of 08 January 2024, this multiplier stood at a record-high level of 5.45, compared to 5.07 at the end of June.

This means every one taka or BDT of the central bank's money in Bangladesh generated around Tk5.45 worth of money supply in the economy. It can be logically inferred from this number that the banking system generates a higher money supply out of the money provided by the Bangladesh Bank.

If the country's money multiplier rate is Tk5.45, then Tk65 billion will generate Tk(65x5.45) = Tk354.25 billion.

Money multipliers are vital in macroeconomics because they regulate the amount of money in circulation, affecting interest rates. They are also important in the banking sector because they shock monetary policy and the cohesion of the banking sector. 

People don't want to know about the increase or decrease of the country's reserves; they desire peace of mind with commodities at affordable prices. 

Besides, not all commercial banks have Nostro accounts. Even if the balance of Nostro Accounts is low for some commercial banks, this will result in unequal competition in the banking sector. 

The weak banks will be weaker. Finally, they must merge with a strong or good one. The problem doesn't end here. Although mergers and acquisitions are difficult, they are possible. Strong banks will try to merge with weak banks for as little as possible in share value. 

Sketch: TBS

Md Badrul Millat Ibne Hannan, CPA (UK), CFC (IFC, Canada), currently working at Islami Bank Bangladesh PLC. 

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.