A few policy proposals

There appears to be general support from both industry leaders and economists for a "devaluation" of taka to arrest the eroding price competitiveness of Bangladesh vis-à-vis the close competitors in third markets as well as against each other. This is well and good. But the details need more thoughtful considerations.

The term "devaluation" needs more clarity. There is nothing wrong with it except that it applies to a deliberate policy decision to reduce the value of domestic currency vis-à-vis a basket of foreign currencies or a reserve currency such as the US dollar (USD). Such a policy decision is pertinent when the de jure exchange rate regime in the country is a fixed rate or a crawling peg. 

The de jure exchange rate regime in Bangladesh is a free float, meaning a flexible exchange rate determined by market forces of demand and supply of foreign currency. This has never been the case in reality as Bangladesh Bank (BB) has always intervened by buying and selling and through binding directives under the guise of "moral suasion".

If you look at the trend of the interbank exchange rate in Bangladesh, the rate which BB targets for intervention, it looks like a classic crawling peg. The value of taka against the USD has been allowed to fluctuate at a certain amount, not beyond the decimal point on day-to-day basis, even though there is hardly any evidence (judging from the behavior of the informal market exchange rate) that the taka has been exceptionally volatile. 

So, the first thing we need to do to improve the credibility and transparency of our exchange rate regime is to just admit that we have abandoned the free float. Let us not pretend to have on book a policy that we have never practiced. Whether this is because of the "fear of float" without any rational basis or whether there are some solid economic reasons behind is more or less an academic issue.

Here is a summary of the policy proposals:

• Stop intervening in the foreign exchange market in all shape and form and let the free float be truly free. 

• If there is fear of float, define and announce a credible crawling peg regime.

• Correct the existing overvaluation of taka sufficiently to make exports and import substitution activities competitive in each other's as well as third markets.

• Replace subsidies to exports and remittances by compensated devaluation. 

• Strengthen productivity enhancing investment incentives.

• Prepare a contingency plan to cope with the inflation risk.

Moving forward, we need to define the peg and the crawl so that the market participants know what to expect from the regulator. BB will need to do some quick and rigorous homework to define such a system. It could set the exchange rate peg with reference to a basket of currencies of our major trading partners, appropriately weighted. The exchange rate peg can be set as a reference rate for commercial banks' transactions within a certain percent plus minus band. Vietnam for instance has set this at 3 percent plus minus their reference rate. BB can then intervene by selling and buying foreign currency in the foreign exchange market to tame currency volatility beyond the band. 

There are other issues needing to be addressed as well.

The government has expanded cash subsidies for exports, including garments, and introduced a new subsidy for remittances. There are budgetary provisions for these subsidies in the FY20 budget. This needs to be factored in deciding how much to devalue. 

Some industry leaders have suggested that a devaluation of Tk2 per USD, for instance, is not a competitive devaluation. 

Really? Merchandize exports in FY19 amounted to USD 40.5 billion. A devaluation of Tk2 means exporters will earn an additional Tk81 billion (gross) if they maintain the same level of exports in USD this year. Assuming conservatively 50 percent value addition in total USD value of exports, the net additional earnings in taka is 40.5 billion, slightly higher than the Tk40 billion provision for export subsidies in the FY20 budget. It will also mean an additional earning of Tk32.8 billion if remittances are maintained at the same level as last fiscal year, higher than the Tk30.6 billion budgetary provision for subsidizing remittances in FY20. The subsidy burden on the budget will rise if export earnings and remittances exceed last year's levels.

Thus, the Tk2 per USD devaluation in one go may or may not be competitive in and of itself, but combined with the subsidies already in place, it certainly looks lot better than appears on the surface. 

I am not aware of any criteria that helps define what exactly competitive rate of devaluation is. All that one can say is, when it comes to exchange rate adjustment, discretion rules the day. In lobbying for such discretion, you can't expect to have it both ways – a large devaluation and also a large subsidy. 

I therefore propose that we replace the subsidies to exports and remittances in phases, if not in one go, from next year by compensated devaluation. How much to devalue needs to be based on a rigorous assessment of the existing price competitiveness gap vis-à-vis our major competitors. 

Cash subsidies to exports will need to be revisited any way as we prepare to face the post LDC graduation WTO trade policy compliance rules. 

Yes, devaluation may have an adverse impact on the import of capital machinery and hence on productivity. This can be addressed by removing all remaining duties on capital machinery as well as introducing additional productivity enhancing investment incentives. We can learn from what others have done just by surfing websites.

There is also the question of increased taka value of servicing external debt due to devaluation. Note that most customs duties, supplementary duties and VAT on imports as well as the Advance Income Taxes on exports are based on taka values. A devaluation, by increasing the value of imports and exports in taka, will therefore be revenue enhancing and hence self-financing of additional debt service burden. Even if it is not entirely so, let us keep in mind there is never a free lunch. 

Finally, there is the inflation risk. This can be mitigated through appropriate fiscal, monetary and trade policy response should such a risk become material.