The international foreign exchange reserve of a country is not a fixed asset, rather a liquidity to support the economy in crisis
A swap auction between the USD and local currency has been reportedly announced by a neighbouring central bank to keep its foreign exchange market in the liquid position amid the coronavirus outbreak.
The external sectors of the economy are extremely dependent on export of goods and services, and earnings from remittance.
Market liquidity in foreign exchange depends on inflows from different sources including from export of goods and services and earnings from remittance. It also includes inward investment, foreign loans, grants, etc. Outflow on the account is a result of import of goods and services, factor payments, loan repayment, disinvestment proceeds.
There is always a mismatch between inflows and outflows. A positive balance between the two indicates higher inflows compared to outflows and vice versa in case of negative balance.
Global economic activities are being disrupted amid the coronavirus outbreak. Bangladesh is a country that is dependent on import for essential commodities and industrial raw materials. Thus it may face problems in making import payments.
Inflow at present is at a nadir. In a normal situation, an export-led economic model like Bangladesh needs depreciation of local currency to compete in the international market. But in the current period, no economists will be in favour of depreciation of local currency. Rather, they will talk in favour of appreciation or at least stable local currency.
According to the balance of payment (BOP) statement in the last fiscal year, the import figure was more than $55 billion. Irrespective of whether inflows are coming in, we need to meet import payments. But without support from inflows how the import payments will be met remains a question.
The central bank has declared policy supports to international trades, namely extension of back to back letters of credit (LC) usance and import settlement time by six months, loan from Export Development Fund (EDF) extendable to one year, and interest on EDF has been reduced for all in cost of 2% per annum from six-month Libor + 1.50 percent.
Recently, the central bank has pledged to refinance settlement of payment against back to back LCs opened earlier. It has also introduced Green Transformation Fund (GTF). The fund will be available for input imports by all industries. These are good initiatives taken by the central bank that deserve appreciation.
Industrial imports are executed on credit. As per central bank directive, the cost for usance period needs to be within six-month Libor + 3.50 percent.
The Libor has been on a downward trend, hence the overall rate is favourable for importers compared to taking loans from the banking system.
But in the present situation external lenders are not extending finances against import bills accepted by Bangladeshi banks, rather they are observing the market to see what is going to happen. In many cases when agreeing to finance, they are seeking rates higher than the prescribed one.
In addition, the offshore banking services of Bangladeshi banks are not getting funds from their correspondents abroad for financing the so-called UPAS (usance payment at sight) LCs.
As a result of insignificant inflows, the value of taka will depreciate unless otherwise supported by adequate liquidity. The policy support from the central bank for refinancing from EDF to settle payment of back to back LCs will help exporters in this regard.
Extension of usance period for industrial imports will ease the needs of foreign exchange, provided suppliers extend the tenure. In case of non-extension by suppliers, importers will have to seek refinancing from external sources. In that case, the cost is expected to be higher compared to earlier ones.
Bangladesh is always in need of imports for essential commodities. These imports are basically executed through LCs at sight, meaning that the issuing banks need to settle import payments within the periods prescribed by international rules on receipt of import documents.
To settle import payment, banks need liquidity in foreign exchange. In case of a shortfall at their end, they will seek funds from interbank markets. During such stage of shortage, there is a tendency to manipulate the market by those holding sufficient funds. As a result, the manipulation will result in depreciation of the value of taka. As a result, importers need to make higher import payments.
Consequently, the price level at the commodity market will be higher and an inflationary pressure may be created in the economy. The authorities should not allow such situations to happen in the foreign exchange market of the country.
Bangladesh is not in a position of handling huge export orders or expecting huge remittance inflows. Hence the value of taka needs to be maintained at a stable level. International foreign exchange reserve of a country is not a fixed asset, rather a liquidity to support the economy in crisis.
Due to Covid-19 pandemic, the economy is in trouble. It needs support to sustain in the long run.
International reserve can be a support in this regard, particularly the liquidity support for settlement of external liabilities. As such, as a part of liquidity support, the central bank should come forward with packages such as foreign currency/taka swap arrangement for banks, overdraft facilities at reasonable cost, refinancing scheme in foreign exchange for essential imports, deposit facilities to offshore banking services and the like.
It is a common practice that the central bank seeks BOP support from multilateral financing institutions, in particular IMF. Private sector operators, in the current situation, will not be able to avail short term financing in foreign currency for import settlements.
But import is mandatory to keep the country out of supply shocks. As such, support from monetary authority with a BOP credit line from multilateral financiers will ease the liquidity crisis.
Otherwise, access to external finance by private sectors for settlement of import payments will be difficult in the short run.
Considering the current situation and the coming ones, the central bank should prepare itself with policy instruments to keep foreign exchange market of Bangladesh at liquid level.
The author works in a development organization, focusing on economic issues, as a Joint Executive Director