How to solve the current account crisis?
Bangladesh observed a prohibitive current account deficit of $17.1 billion in the last fiscal year 2021-22. However, it averaged $0.32 billion per year over the 12-year period from 2009 to 2021.
The growing current account deficit causes a rapid depletion of foreign exchange reserves and a crisis in the foreign exchange market. For more than 12 months, the Bangladesh Bank resorted to selling foreign exchange reserves to support an overvalued taka against the US dollar. The policy was unsustainable and caused a rapid depletion of foreign exchange reserves.
The central bank therefore decided to abandon its decade-long policy of pegging the taka to the US dollar within a range of 80 to 85 Tk. The new peg is now 94.7 Tk and it could continue to decline.
However, the US Dollar is said to be trading at over Tk 100 per unit in the curbside market. The widening gap between the official exchange rate and the market rate plunges policy makers and businesses into uncertainty and growing currency risk.
Government critics draw inappropriate equivalence between Bangladesh and other South Asian neighbors such as Sri Lanka and Pakistan on debt sustainability issue
Policy makers, after enjoying a decade of stable exchange rate and external accounts, are suddenly drawn into a crisis scenario. Their challenge is to reset monetary and exchange rate policies so that the growing current account imbalance does not turn into a full-fledged monetary crisis. To do this, we need to examine the underlying drivers, both domestic and international, of the surge in the current account deficit.
First, world prices for coal, oil, gas and other raw materials, including food grains, have more than doubled over the past 12 months, resulting in an unprecedented increase in the cost, insurance and freight value of these imports. The reopening of the global economy after the coronavirus pandemic, the collapse of global supply chains and the Russian invasion of Ukraine are behind the spike in commodity and energy prices in the world.
Secondly, Bangladesh’s economy, after the long 18 months of shutdown with drastically reduced activity, reopened in mid-2021. This implies that households, government and businesses have returned to the normal mode of consumption and investments. . In other words, aggregate demand, which has been decimated by the pandemic, has rapidly increased and the demand curve has shifted to the right.
The massive fiscal and monetary stimulus, which the government of Prime Minister Sheikh Hasina rolled out in March 2020, certainly contributed to a further acceleration in aggregate demand. In fact, credit growth to the private sector accelerated from 10% in 2020-21 to 15% in 2021-22. For countries like Bangladesh, this means a further escalation in the volume and value of imports of raw materials, intermediate inputs and finished goods.
Third, the role of government spending in large infrastructure projects and an overvalued taka exchange rate through the end of 2021 is a critical issue for the dynamics of current account deficits. This deserves a nuanced explanation.
The government has launched many mega-projects in the fields of energy, connectivity, ports and telecommunications infrastructure.
Government spending therefore accelerated and much of it led to growth in imports of capital goods over time. But it is also believed to boost national economic growth and long-term employment.
The issue of time and cost overruns is a recurring problem in the developing world. Bangladesh is no exception. Instead, she observed a persistent improvement in project management. The successful completion of Padma Multi-Purpose Bridge, Dhaka-Chattogram Expressways and others testify to this assertion. Long-term government capacity building is evident in this area.
The prohibitive current account deficits in 2021-22 are the result of all these factors. At the heart of this imbalance is the widening dissaving of both the government and the private sector. While public dissaving is the excess of government expenditure over its revenue, private sector dissaving is the excess of private sector investment over gross domestic savings. The policymaker’s job is to make lasting improvements on both fronts.
I will propose a mix of public policies to achieve this goal.
First, public spending must decrease. Every element of public expenditure must be subject to critical examination.
Government spending on unproductive activities is better eliminated or significantly reduced and spending on major new or start-up infrastructure is better deferred indefinitely until the economy navigates towards sustainability.
Spending on social safety nets will also need to be reviewed and made more efficient. The government is in effect eliminating or minimizing lesser expenditures.
Second, Bangladesh has lived with an overvalued exchange rate for years until 2021. In an environment where a developing country experiences persistent inflation differentials against the rest of the world and even more so against the cohort of advanced economies with low inflation, a de facto fixed exchange rate will result in persistent real appreciation.
The magnitude of the real appreciation for Bangladesh is significant but varies from country to country. The central bank will have to orchestrate a gradual devaluation of the local currency.
A nominal devaluation of 15% has already occurred in the last six months. The free market exchange premium indicates that the central bank will likely allow further devaluation.
A depreciation of the currency itself will cause private sector dissaving to improve over time. However, it can be associated with certain fiscal policy reforms. For example, a reduced corporate tax rate will stimulate foreign capital inflows and further encourage capital expenditure by local companies. Bangladesh also offers an unexplained income or asset declaration window for non-resident Bangladeshis on the condition that they pay a one-time tax at a reduced rate. But the objective should be the repatriation of capital to the country.
Third, tax authorities can revise tariffs and non-tariff regulations that discourage imports of cars and luxury goods. A depreciation of the currency itself will prove discouraging for such imports. A new additional tariff and certain non-tariff barriers will further reduce their demand. On the other hand, a reduction in tariffs on food and energy imports will to some extent alleviate cost-induced inflationary pressures.
But the litmus test for the central bank will be to help exporters repatriate their currencies in real time. In times of strong currency devaluation, exporters and domestic residents will expect further devaluation of the local currency and will choose dollarization of their financial assets. This downward revision of expectations is an absolute sin and can lock policymakers into a spiral of monetary depreciation without a significant improvement in the imbalance of external accounts. The Bangladesh Bank must focus on managing this speculative behavior of economic agents.
Fourth, monetary tightening, and therefore an increase in interest rates, is now imperative in order to depress the components of aggregate demand and lower inflation. Household demand for consumption, business demand for investment, and government spending will decline as interest rates continue to rise.
In an environment of runaway inflation, a slowdown in aggregate demand is rightly the policy objective. Bangladesh Bank could move faster in this direction. A relative economic contraction is now desirable to reduce inflation and improve the current account imbalance.
Very unfavorable monetary developments are occurring in advanced economies. Advanced economies, too, are invariably pursuing monetary tightening and rising interest rates after a decade of low inflation and (near) zero interest rate policies. It is causing a reversal of global capital flows, putting many developing and emerging market economies on the edge of a precipice.
This reversal causes a rapid depletion of their foreign exchange reserves, liquidity crises in the financial system, rising interest rates and currency crises in the developing world. A global reversal of capital will cause financial and stock market shocks.
Bangladesh, too, is now implicated in this unfavorable global development. Many previously resilient developing countries are now severely constrained by dwindling foreign exchange reserves and rapid currency depreciation.
Finally, critics of the government are drawing an inappropriate equivalence between Bangladesh and other South Asian neighbors such as Sri Lanka and Pakistan when it comes to the issue of debt sustainability.
The country’s outstanding external debt stood at $93.2 billion as of May 2022. Of this amount, the public sector’s external indebtedness was $68.3 billion. It represents 19.25% of GDP and 81.4% of it was long-term.
The State’s external indebtedness has fallen from 42% of GDP in 1991 to less than 20% in 2022. Total debt service represents about 6% of current account receipts (including exports of goods and services and primary income) and 0.82%. % of gross national income.
An unfavorable development occurred in the area of private sector external indebtedness. This volume has rapidly increased from $18.6 billion in June 2021 to $25 billion in May 2022. This is an area of central bank oversight and control, as 68% of this growing indebtedness of the private sector are short-term loans. A disproportionate share of this private sector external debt consists mainly of supplier credit and is considered opaque.
The author is commissioner of the Bangladesh Securities and Exchange Commission. Views are personal.
