An exchange rate is a rate at which one currency will be exchanged for another currency. An exchange rate system is closely related to monetary policy of that country. There are three basic types of exchange systems: floating, fixed and pegged float exchange. Most exchange rates are defined as floating and will rise or fall based on the supply and demand in the market. Some exchange rates are pegged or fixed to the value of a specific countrys currency. A floating exchange rate is determined by the private market through supply and demand. A fixed or pegged rate are controlled by central bank.
There are generally four methods used to exchange dollars or other foreign currencies; hard pegs, soft pegs, crawling peg and basket peg. In the hard peg system, currency is fixed at a specific rate against another currency, like the Saudi Riyal which has been pegged to the US dollar. In the soft peg system, the currency is allowed to float, usually within a band; the central bank or government intervenes less frequently. A currency basket is commonly used by investors to minimize the risk of currency fluctuations and also governments when setting the market value of a countrys currency.
Many countries use floating exchange rates to keep the value of the dollar fully market-oriented and non-interventionist. The price of the dollar fluctuates with the market and the economy. The depletion of foreign exchange reserves, sluggish remittance inflows and stagnant export earnings are contributing to the imbalance in the foreign exchange market.
On March 24, 1994 the Bangladesh Taka was declared convertible for current account transactions in terms of Article VIII of the IMF Articles of Agreement. Bangladesh adopted a floating exchange rate regime on May 30, 2003. The Bangladesh Bank actually introduced a managed floating exchange rate mechanism. In fact, Bangladesh Bank has never fully released money to the market. Until 2022, the central bank maintained a controlled exchange rate mechanism, allowing currency appreciation and depreciation on a limited scale. Bangladesh imports more than its exports. As a result, Bangladesh Bank has always try to maintain value of money.
The interbank exchange rate in Bangladesh has surged to Tk 110 per dollar amid an ongoing dollar crisis, causing a significant depreciation of the taka by about 30 per cent since the Russia-Ukraine war began on 24 February 2022, which has made imports costlier. Another reason could be an energy price hike and a lack of adequate policy measures, both fiscal and monetary. Due to increasing value of dollar, commodity prices go up briskly. The current exchange rate has climbed from Tk 94.7 in July 2022 and Tk 84.8 in July 2021.Bangladeshs taka has been facing volatility for more than one-and-a-half years as external payment pressure continued to grow while export and remittance did not grow as required. And in the face of increased external payment pressure, Bangladesh started to see its foreign reserves fall, with the taka losing strength against the US dollar and other major currencies. The Bangladesh Foreign Exchange Dealers Association (BAFEDA) and the Association of Bankers, Bangladesh (ABB) fixed the single exchange rate to buy US dollar at Tk 109.50 and sell them at Tk 110. This is a market-based exchange rate because they have fixed it after observing the market. Simultaneously, banks were asked to stop imposing multiple rates for remittances, export bills and importers in order to stabilise the foreign exchange market.
The Bangladesh Bank announced a new monetary policy on 15 January 2024 and is set to adopt a crawling peg exchange rate for foreign exchange. A crawling peg allows the currency to fluctuate between an upper and lower band. Under the new policy, there will be a narrow band corridor where the real effective exchange rate (REER) stands in the middle. The corridor will have an upper ceiling and floor rate, and the exchange rate will move within the bounds. The currency is maintained within certain fluctuation margins of at least ±1 percent around a central rate-or the margin between the maximum and minimum value of the exchange rate exceeds 2 percent-and the central rate or margins are adjusted periodically at a fixed rate or in response to changes in selective quantitative indicators. The degree of exchange rate flexibility is a function of the band width. Bands are either symmetric around a crawling central parity or widen gradually with an asymmetric choice of the crawl of upper and lower bands (in the latter case, there may be no preannounced central rate). The commitment to maintain the exchange rate within the band imposes constraints on monetary policy, with the degree of policy independence being a function of the band width. Crawling is two types i.e active & passive. Active crawling peg is a series of adjustments are pre-announced and implemented over time making domestic inflation predictable. Passive crawling peg allows for periodical adjustments in exchange rate, typically done to adjust for higher inflation versus the currency used in the peg.
Nobody disclosed how exactly this system will work. It is known that the Bangladesh Bank is planning to introduce this method by next March. They has resorted to International Monetary Fund (IMF) to introduce this system. A technical team of IMF will come and a road map for implementation of the system will be fixed according to their advice. In order to keep the dollar price stable, the upper and lower band of dollar price may be set by the Central Bank or BAFEDA. Within that band, price of dollar will fluctuate based on supply and demand. This limit may increase or decrease by a small amount each week. As a result, its price will also fluctuate in coordination with the market.
The crawling peg system has many risks such as: creating artificial exchange rates; increasing the risk of speculators, forex traders, and market forces, which may crush the mechanism to prevent destabilisation of currencies; and draining foreign exchange reserves amid central bank interventions and manipulations through active crawling pegs. Only Nicaragua and Vietnam employ the crawling peg system, while China has adopted a variation, often termed a delayed peg. In the past, countries like Botswana, Argentina, Ecuador, Uruguay, and Costa Rica experimented with crawling pegs but later abandoned them.
Actually crawling peg remains vulnerable to speculation as it presents an artificial exchange rate and depends on central bank currency manipulation and management. In comparison, it may provide a temporary solution to a problem. Economists say that no policy will work unless it is possible to control illegal hundi & money laundering. At present foreign currency crisis is now very deep in the country. In this situation, if the exchange rate of the dollar is completely left to the market, the situation can take a dire shape. It is from this concern that the central bank is talking about the crawling peg policy. If only this policy is introduced without improving other existing conditions, it cannot be expected to get much benefit. Now it is necessary to urgently introduce good governance in financial sectors. Exports need to be diversified rather than solely relying on ready-made garments. Also strict action should be taken against money laundering. At the same time, effective measures should be taken to attract foreign investment.
The writer is Officials of Islami Bank PLC
