Bangladesh Exchange Rate Assignment

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A brief history of Exchange rate of Bangladesh Since Bangladesh was the part of Pakistan called East Pakistan, shared the same currency and trade-policy history as the rest of Pakistan until the liberation of Bangladesh. Bangladesh take was created on January 1 1972. Pakistan rupees in circulation remained legal tender until replaced by the take beginning March 4 1972. The take was set at par with the Indian rupee, and fixed to sterling at TX 18. 9677, or TX 7. 2797 to the United States dollar. The path followed by the take was determined partly by the initial value chosen for the new currency in 1972.

Given the devastation experienced by the Bangladesh economy from natural disaster, civil war and war in 1969-1971, the initial value chosen for the take on par with the Indian rupee was in all likelihood unrealistic, even more so to the extent the Indian rupee was itself nominally overvalued at the time. In that time, the principal fact about official exchange-rate policy in Bangladesh has had to do with overseas workers’ remittances far exceeding any single sector of merchandise exports as a support for the balance of payments.

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A multiple exchange-rate system prevailed with a secondary market as an incentive for overseas workers to remit through official channels instead of at parallel or “Hindi” market-rates, the spread between the parallel and official channels being exceptionally high for Bangladesh compared to India and Pakistan. MIFF technical studies laid the groundwork for abolishment of the multiple exchange- rate practice and the unification of exchange-rates, which was accomplished on March 31 1992. The path of the official take is informative as a measure of nominal overvaluation.

Since August 1979, the official take has been pegged within margins to a currency-weighted basket. The take was adjusted as many s 20 times between October 1980 and January 1982, the official rate being reduced to TX. 38. 4 to sterling or TX. 20. 4 per United States dollar. In January 1983, the weights were changed and in March 1985 changed again. On this basis, the nominal effective exchange rate depreciated by 29 percent and the real effective exchange rate by 21 percent between August 1979 and December 1982.

From February 1985, exchange-rate policy has with MIFF support tried to keep in mind an upper limit on the real effective exchange, the nominal rate declining in one year by 20 percent and the real rate by 22 percent. From the end of 985 through November 1988, there was further depreciation of 4 percent. In absence of further nominal depreciation, combined with further deterioration of the domestic price-level, the real exchange rate appreciated by 7 percent between November 1988 and April 1989, followed by further appreciation of over 9 percent during May-June 1989.

A revised index confirmed the loss of competitiveness, indicating at least 12 percent real appreciation by end June 1989 relative to 1988. From November 1988 to February 1990, the take remained at TX 32. 27 per United States dollar with the official secondary market 2 percent higher. In 1990 the rates were depreciated six times by a total of 11 percent, corresponding to 8 percent real depreciation. The official take was at TX. 36. 49 per United States dollar as of July 7 1991.

For most nontraditional exports, a rate based on 100% of the Secondary/ Take Rate was to be used, while other export receipts were governed by a mix of either 1) 40% at the Secondary and 60% at the Effective Rate or 2) 70% at the Secondary and 30% at the Effective Rate. Earnings from raw jute, loose tea and wet blue leather were exchangeable at the Effective Rate. (WAC 1986/87, p. 404) The Secondary Exchange Market, comprised of the Wage Earners’ Scheme and the Export Performance Benefit Scheme, became a free interbrain market and was made applicable also to tourist receipts and most other services receipts.

WAC 1988/89, p. 409) 31 December 1985 The Official Exchange Rate for the Take was adjusted on 14 different occasions during the year, from Tack. 00=US$1 at the end of 1984 to Tack. 00=US$1 at the end of 1985, involving a depreciation of 16. 13%. (MIFF 1986, p. 114) 31 December 1986 The Middle Rate for the Take in terms of U. S. Dollar was adjusted on 4 occasions during the year, from Tack. O=Los$1 at the end of 1985 to Tack. 80=Los$1 at the end of 1986. (MIFF 1987, p. 100) 31 December 1987 The Middle Rate for the Take in terms of U. S.

Dollar was adjusted on 3 occasions during the year, from Tack. 0=US$1 at the end of 1986 to Tack. 20=US$1 at the end of 1987. (MIFF 1988, p. 94) 17 March 1988 The SEEM Rate, instead of the Official Rate, was applied to all encashment of export receipts of the industrial unit in the Export Processing Zone (Peps). The SEEM Rate was also applied to encashment of funds brought in from abroad by the units in Peps for meeting their local expenses. (MIFF 1989, p. 38) 12 November 1988 The Secondary Market Rate did not change during the year and remained at Tack. 925=US$1.

Pegged Exchange Rate Fixed Exchange Rate: In a fixed exchange rate system, exchange rates are either held constant or allowed to fluctuate only within very narrow boundaries. If an exchange rate begins to move too much, governments intervene to maintain it within the boundaries. In some situations, a government will devalue its currency while in other situations it will revalue its currency against other currencies. Advantages: Macs are able to engage in international trade without worrying about the future exchange rates. It reduces the risk of doing business in that country too.

Disadvantages: The government may manipulate the value of the currency. Also, a fixed exchange rate system may make each country more vulnerable to economic conditions in other countries. Floating Exchange Rate: Floating rate systems can be further classified into 2 subcategories: a. Freely floating exchange rate system: Also known as a clean float. In a freely floating exchange rate system, exchange rate values are determined by market forces without intervention by the governments. Advantages: A major advantage of this system is the insulation of a country from the inflation or unemployment problems in other countries.

An additional advantage of this system is that a central bank is not required to constantly maintain ERE within specified boundaries. Disadvantages: A country’s economic problems can sometimes be compounded by freely floating ERE. Under such a system, Macs would need to devote abstaining resources to measuring and managing exposure to ERE fluctuations. B. Managed float exchange rate system: Also known as a dirty float. It is similar to a freely floating system in that exchange rates are allowed to fluctuate on a daily basis and there are no, official boundaries.

It is similar to a fixed rate system in that governments can and sometimes do intervene to prevent their currencies from a sharp fall. Advantage: It prevents a crash in the value of the currency, should it happen. Disadvantage: Some criticize such a policy as it seeks to protect the home currency at the expense of others. Pegged Exchange Rate: Under such a system, the value of the home currency is pegged to a foreign currency. The pegged currency moves in line with that currency to which it is fixed against other currencies.

Some currencies such as the Argentine peso or the Chinese Yuan are pegged against a single currency (US dollar) while some others are pegged against a composite of currencies such as the composite of European currencies. Advantage: If a country conducts most of its trade with another country then pegged system yields benefit to both these countries as it virtually eliminated the exchange rate risk. Current Exchange Rate System of Bangladesh The Bangladesh Bank (B) set foreign currency exchange rate band free from any regulation on May 29, 2003.

It came into effect, officially from June 1, Saturday, when banks started to fix buying and selling rates of dollar and other currencies according to supply and demand situation under the free-float system. The B however said that it would keep an eye on the market and intervene in money market and US dollar selling and purchase transactions whenever needed. The B also said that it would deal with banks on dollar on a case-to-case basis. Though the official change came on May 29, B was effectively pursuing the freely floating rates and did allow the banks to determine the rates for the past one year.

The observed volatility was not significant during this period, which encouraged the B to take this long awaited step. The attraction of a floating exchange rate system is, that at least in theory it provides a kind of automatic mechanism for keeping the balance of payments in equilibrium. Besides, progressive devaluation of the Bangladesh currency, arising out of the fixed exchange rate, has been a regular feature during the last three decades. The devaluations and their effects on the economy subjected the governments to regular criticism by those affected by the same.

Under the floating rate system, the need for such official devaluation of the currency will cease. However, the finance minister indicated that the new exchange rate system will not be totally devoid of official influence. The Bangladesh Bank is likely to resort to buying and selling of foreign currency from time to time to indirectly play a stabilizing role in exchange rate operations. For example, when the floating exchange rate system as made operational in Pakistan, the same led to a jump in the exchange rate of the Rupee by ten or fifteen per cent on the first day.

Thus, Bangladesh had provision for similar safeguards. Reasons for Changing the Fixed Rate System to Floating Some of the reasons the ERE system was changed are discussed below: Balance of Payments disequilibrium can automatically be restored to equilibrium. When the economy experiences a balance of payments deficit, there is excess demand for the foreign currency and the exchange rate of the local currency depreciates. This may have the effect of automatically restoring equilibrium.

In such case, the value of local commodities falls from foreigners’ perspective making them more attractive abroad hence increasing export and value of foreign goods increases from domestic perspective making them less attractive locally. Both could lead to an improvement in the balance of payments situation.  May decrease inflationary pressures and improve international competitiveness. A floating exchange rate can reduce the level of inflation in Olds like Bangladesh. Allowing the exchange rate to float freely should ensure that exports do not become uncompetitive. The basic idea comes from the Purchasing Power Parity theory.

A high rate of inflation tends to make the exports uncompetitive. To keep pace with the other markets in South Asia where India (in 1998), Pakistan (in 2000) and Sir Lankan (in 2001) have already introduced the floating rate system. (Islam, 2003) 4. Donors had also been putting pressure on Bangladesh to go for the floating exchange rate system and reportedly, obtaining foreign assistance from them also depended somewhat on introducing the new floating exchange rate system. Hence, it can be argued that pressure from the MIFF and the World Bank was an important factor behind the regime change.

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