Taka slightly undervalued for first time, but economic benefits in question

The overall inflation in Bangladesh fell slightly to 9.24% in April from 9.33% in March, according to the latest data from the Bangladesh Bureau of Statistics (BBS)

The REER index, set to 100 in the base year 2016, signifies the competitiveness of the currency. An index above 100 indicates overvaluation, 100 means fair value, and below 100 indicates undervaluation.

The taka REER index came down to 99.67 on 26 July when the REER based exchange rate was Tk108.64 per dollar, lower from the nominal exchange rate of Tk109.

The REER index came down to below 100 as the taka depreciated by 13.12% in the last one year from July 2022, second highest devaluation after Turkish Lira among other trading partners.

The top two trading partner countries India and China saw 3.44% and 5.76% currency depreciation respectively during the same period, according to Bangladesh Bank data.

The currency of a nation is said to be undervalued when its value in foreign exchange is low as compared to other trading partners when devaluation is the deliberate downward adjustment to the value of a country’s currency relative to another currency.

The REER index came down to 100 from the beginning of July and remained at per most of the time which indicates that taka is now at its fair value.

Even though undervalued currency helps a nation improve trade balance by boosting export and remittance inflow, Bangladesh economy is not enjoying the benefit, raising questions about data input in REER calculation.

REER guides a central bank to take policy about exchange rate movement to support economic growth.

Although REER indicates undervalued currency, there is pressure of further devaluation as the dollar rate for import is above Tk114 when Bangladesh Bank’s set exchange rate is Tk109.50.

Despite the undervaluation, there are questions about whether the economy is truly benefiting, as the indicators of improved trade balance and financial account haven’t matched the currency movement.

Zahid Hussain, former lead economist at the World Bank’s Dhaka office, points out that the gap between the officially declared exchange rate and the market rate remains above Tk5, questioning whether the taka is truly undervalued.

He said undervalued currency is supposed to have results in boosting exports and improving balance of payment and financial account but these indicators are not matching with currency movement.

Moreover, inflation is the major factor for REER calculation and inflation remained upward in Bangladesh when it cooled down in other trading partner countries, he noted. “In this context, REER is supposed to go up and the Taka is still supposed to be overvalued. So, the undervalued currency is even supposed to go up with rising inflation.”

He added that an undervalued dollar was expected to build reserves, but there’s still pressure to sell dollars from the reserve due to the higher market exchange rate compared to the official rate.

Additionally, Bangladesh Bank is not devaluing the dollar in line with market demand, which contradicts the idea of an undervalued Taka.

The validity of REER calculations in this context is being questioned to determine if the taka is truly undervalued or possibly overvalued.

A senior executive at the Bangladesh Bank, involved in preparing the REER index, acknowledged the discrepancy between the undervalued taka and economic indicators.

The official admitted that the benefits of an undervalued taka have not been realised and attributed the undervaluation to a rapid devaluation relative to other countries.

The Bangladesh Bank devalued the local currency by 25% from Tk85 in January last year.

Furthermore, the real nominal exchange rate isn’t factored into REER calculations, contributing to the undervalued taka.

Exporters, though initially benefiting from the undervalued taka, are facing increased business costs and stagnant export orders.

Syed Nazrul Islam, first vice president of Bangladesh Garment Manufacturers and Exporters Association (BGMEA), said they are not getting benefit from undervalued taka as cost of business has increased by 30% to 35% over the last one year due to energy price hike.

Moreover, export order is not rising amid the global crisis, he added.

Shovon Islam, managing director of Sparrow Group, said exporters are making some good money from undervalued taka even after energy price hike as wages in the garment sector have not been adjusted with inflation yet.

“Exporters sold their goods or took orders calculating dollar price at Tk86 to Tk87 but now they are receiving Tk109 per dollar,” he explained.

However, this benefit will not last long as exporters will have to go for wage adjustment by December, he observed.

Some other Asian currencies, including those of India and Pakistan, have recently experienced undervaluation due to devaluation pressures.

Bangladesh’s currency, too, has been undervalued, leading to a depletion in its foreign exchange reserves, primarily caused by a dollar crisis.

Despite reinstating a unified exchange rate regime in line with IMF’s demand in July, a gap between the official and market rates persists, intensifying devaluation pressure to safeguard reserves. This gap has now exceeded Tk5 per US dollar.

While the central bank sets the rate at Tk109.50, banks are often using higher rates such as Tk114-116 for import letters of credit, market insiders reveal.

Since implementing the unified exchange rate on 13 July, Bangladesh’s foreign exchange reserves have continued to decline, reaching $23.3 billion on 2 August from $23.56 billion on 13 July. This covers imports for nearly four months, exceeding the international standard of three months’ coverage.

The currency devaluation on 3 July was the steepest in Bangladesh’s history, with the taka devalued by Tk2.85 to set the rate at Tk108.85 for one dollar from the foreign exchange reserves.

The central bank’s move was aimed at implementing a unified and market-driven exchange rate regime, ending multiple exchange rate mechanisms, and fulfilling one of the IMF’s conditions to qualify for a $4.7 billion loan package approved in January 2023.