What IMF's $14.76b reserve ceiling means for Bangladesh economy

The International Monetary Fund (IMF) in its latest review under the $4.7 billion loan package has cut the ceiling for June net foreign exchange reserves to $14.76 billion from the earlier target of $20.1 billion, giving the central bank a great relief.

It can be surmised from the drastic cut in the reserve ceiling that economic activities will continue to shrink in near future.

The reason for such an inference is that the new ceiling is lower than the coverage of three months' import bills if the current import trend is continued.

The IMF uses the rule of thumb that countries should hold foreign exchange reserves covering the import bills of three months to consider adequacy of reserves.

The monthly import is now slightly above $5 billion, which means the country needs to hold reserves of at least above $15 billion. However, reserve requirements will decline if import falls further.

When the IMF set the new floor in its third review conducted in the first week of May for the fourth instalment, the country's net reserve was $13.22 billion.

Taka devaluation to make import costlier

Zahid Hussain, former lead economist, World Bank's Dhaka office, said the relaxed reserve target seems compromised as the Bangladesh Bank introduced new crawling peg, raising dollar price following IMF's suggestion.

The big devaluation of taka will make imports costlier, helping to reduce foreign currency expenditure. On the other hand, the dollar price adjustment is expected to increase remittance inflow, he said.

So, the shrinking economic activities may be taken into consideration in resetting the new reserve ceiling.

Reserve targets usually forecast future trends. If the new reserve floor is considered, the import expenditure is expected to fall below $5 billion in the coming months, which will shrink business activities impacting employment generation negatively.

Meanwhile, the Bangladesh Bank raised the dollar price by Tk7 to settle at Tk 117 on 8 May, a historic highest devaluation of taka in a single day making imports costlier.

This significant devaluation comes at a time when inflation is on the rise and importers are struggling to get dollars to open LCs (Letters of Credit).

The adjustment in dollar price was to get the third instalment of a $4.7 billion loan package released even after failing to meet the previous reserve target of $19.2 billion set for May 2024.

The big devaluation and new net reserve ceiling signals that import will be cut down further to save reserve.

When the country's gross reserve holding was $15 billion in 2013, monthly import was nearly $3 billion and export was slightly above $2 billion.

So, the IMF's new reserve ceiling signals that the central bank has to cut down monthly imports to $3 billion level to meet the reserve holding requirement.

Falling imports mean falling exports

If imports continue to fall, it will ultimately hurt export earnings also, which is already reflected in the current trend as it dipped below $4 billion in April hitting a six-month low.

Earlier, the country's reserve holding was lower than the IMF standard in November 2011 when it was $9.64 billion and monthly import was above $3 billion.

When contacted, a senior executive of the Bangladesh Bank on condition of anonymity said the current gross reserve holding is higher than the IMF's net reserve ceiling.

The country's gross reserve was $19.8 billion on 8 May, enough to cover imports for more than three months.

The difference between gross and net reserve is that short-term liabilities are excluded from net reserve calculation. Net reserve is readily available to meet up liabilities when gross reserve is not. So, the IMF considers net reserve in determining reserve adequacy.

The Bangladesh Bank does not publish net reserve figures as it always claims that gross reserve shows the real picture of reserve holdings.

When asked why the IMF sets a ceiling for net reserve instead of gross reserve, the central bank executive could not give a clear answer, saying there must be a ground that they don't know.

The Bangladesh Bank adopted net reserve calculation from July 2023 as per IMF's Balance of Payments and International Investment Position Manual (BPM6) to meet up the condition to get loan approval.

The country's gross reserves dropped by $6.44 billion to $23.56 billion after adoption of the new reserve calculation method at that time when the net reserve was $19.26 billion.

IMF cut net reserve holding target by $12 billion in six months

The IMF released its first review report in February 2023 when it set a net reserve target at $24.46 billion and since then it revised down the floor in all its three reviews. The cutting down in reserve target was also reflected in the shrinking economy as imports declined by $21 billion in 2023.

Monthly imports fell by $2 billion to $5 billion in the last one year, Bangladesh Bank data shows.

The IMF also adjusted its reserve ceiling with falling imports, resetting it at $17.7 billion for December last year in its second review from the previous $26.8 billion.

After the resetting of the latest ceiling, the central bank tightened its monetary policy further by raising repo rate and dollar price which clearly indicates a further slowdown in the economy in coming days.

Bangladesh Bank quarterly data show the decline in imports was driven by a drastic fall in capital machinery and capital goods, resulting in negative growth in the manufacturing sector. Manufacturers are feeling the pinch of high input costs fuelled by rising interest, pricey dollars and weakening consumption due to high inflation.

The result is reflected in the BBS quarterly data showing that Bangladesh's economic growth slowed to 3.78% in the second quarter of FY24, the slowest in the previous three quarters.

The IMF has lowered the economic growth forecast for Bangladesh to 5.7% for the current FY24, down from its earlier projections of 6% in October and 6.5% in April last year.

In its recently released edition of the World Economic Outlook, the multilateral agency also projected a steady decline in global inflation. However, in Bangladesh, inflation is likely to remain elevated, reaching 9.3% in FY24, up from 9% a year ago.

The World Bank in its latest Macro Poverty Outlook for Bangladesh also pointed out that Bangladesh's economy is expected to decelerate to 5.6% in FY24 from 5.8% in FY23 before returning gradually to its long-term trend above 6%, as elevated inflation will weigh on consumption.