Government Influence on Exchange Rate in Bangladesh:

Problems and Deficiencies of Managed Floating Regime

Abstract: Exchange rate is the price of one nations currency in

terms of another currency. Like the determination of price of a
commodity or service in a free commodity market, the equilibrium
exchange rate is also determined in the free foreign exchange
market by the demand for and supply of foreign exchange. The
equilibrium rate of foreign exchange in the free foreign exchange
market is determined at the point of intersection of the supply and
demand curves for foreign exchange. The government of
Bangladesh intervenes into the valuation process right here.
Presently Bangladesh is following the Managed Floating Regime
for its valuation of currency which is also known as Dirty Floating.
Basing on these backgrounds the paper deals with how the
exchange rate of Bangladesh is set through the active participation
of the monetary control body. What odds are causing because of
these interventions and how we can get rid of it; these are topics
discussed in this paper.

Keywords: Exchange rate of Bangladesh, Managed Floating,

Government Intervention

1.0 INTRODUCTION
The exchange rate expresses the national currency's quotation in respect to foreign ones. Being
one of the central issues of the macroeconomic policy exchange rate has received tremendous
attention from policy makers after Bangladesh has taken on the floating exchange rate in 2003.
The changing of exchange rate brought many arguments regarding which one is better for
Bangladesh. Many prefer the fixed exchange rate while many prefer floating exchange rate
system. The policies of money supply can affect the exchange rate. Every country has a central
bank that can intervene in the foreign exchange market if it feels necessary to control currency
value or inflation. The central bank can try to control the money supply in the market for the
better economic condition of the country. Normally the central bank intervenes for smoothing the
exchange rate movements and to establish implicit exchange rate boundaries. Sometimes they
attempt direct intervention by exchanging currencies that it holds as reserve for other foreign
currencies. Sometimes they attempt for downward pressure on their home currencies and
sometimes they put upward pressure depending on what the country needs. The feds can also try
to intervene indirectly by influencing the other factors that eventually affects the exchange rate.
The feds can use stimulative policy (loose money) or restrictive policy (tight money) in order to
correct weak home currency or high inflation. Bangladesh Bank also intervenes to control
exchange rate with the floating exchange rate system. So, it can be called managed floating or
dirty floating system. Both the systems that Bangladesh has experienced carry pros and cons.
Enough analysis should be done on which one is more suitable for the economic condition of
Bangladesh so that Bangladesh can have a better result in the long run.

2.0 PROBLEM STATEMENT

The paper will focus on the governments influence, intervention, their impacts and analysis of
such kind on the exchange rate of a country. The country of concern in this paper is Bangladesh.
Bangladesh adopted fully market-based floating exchange rate system on the 31st of May 2003.
But Bangladesh Bank also pledged that it would scrutinize the market and intervene in the
money market and US dollar transactions, if needed to ensure orderly conditions in the market.
But this managed floating is not also the best solution for a country like Bangladesh.

Fitting an economy is the main purpose for any policy. The change in the regime has brought
some cons along with the pros. A well fitting exchange rate policy is therefore necessary to have
stability, growth and development in the economy.

3.0 RESEARCH OBJECTIVE

The main objective of the paper is to know the prevalent situation in Bangladesh. The paper aims
so unveil the government practices in regulating the exchange rate as it is a very important factor
in reaching the macroeconomic objectives especially because the exchange rate plays a huge role
in achieving the economic growth of a country.
The paper thus attempts to:
I.
II.

Characterize the exchange rate policies Bangladesh is currently pursuing.

Evaluate the appropriateness of such policies in the light of both international and
domestic economic conditions.

III.

Show what the problems are within.

IV.

Suggest what might be the probable way out of it.

IV.1

LITERATURE REVIEW

Exchange rate is price of one nations currency in terms of another currency. (Investopedia)
There are very few research papers done on the effects of government policy on exchange rate in
Bangladesh and abroad. Some papers contradict some others papers as well. The theory of
Uncovered Interest Parity (UIP) suggests that difference in interest rates between two countries is
equal to the expected change in exchange rates between the countries' currencies. But, Alain P.
Chaboud and Jonathan H. Wrigh (2003) in its Uncovered Interest Parity: It Works, But Not For
Long rejected the theory of Uncovered Interest Parity. Also there are literature about
inflationary connection of exchange rate and governments actions and policies.
Like the determination of price of a commodity or service in a free commodity market. The
equilibrium exchange rate is also determined in the free foreign exchange market by the demand
for and supply of foreign exchange. To make the demand and supply functions of foreign
exchange look like the familiar conventional market demand and supply functions we define the
3

rate of exchange as the price of one unit of foreign currency expressed in terms of the units of the
home currency. The equilibrium rate of foreign exchange in the free foreign exchange market is
determined at the point of intersection of the supply and demand curves for foreign exchange.
Exchange rate systems can be classified according to the degree by which exchange rates
controlled by the government. Exchange rate systems normally fall into one of the following
categories:

Gold Standard

Fixed

Freely floating (Clean Floating)

Managed floating (Dirty Floating)

Pegged.

In the research, we hope to discuss about the categories above. More importantly, the paper will
cover the current scenario of how the exchange rate is influenced. The factors
The factors that cause currency supply and demand schedules to change areI.

Relative inflation rates:

Changes in relative inflation rates can affect international trade activities which influence the
demand for and supply of currencies and therefore influence exchange rate movement.
II.

Relative interest rates:

Changes in relative interest rates affect investment in foreign securities, which influences the
demand and supply of currencies and therefore influences exchange rates.
III.

Relative income level:

A third factor affecting exchange rates is relative income levels. Due to high income
unnecessary and luxurious foreign goods will be imported. That case foreign currency will
spend more which negatively affect our foreign currency reserve.
IV.

Government controls:
Another factor affecting exchange rates is govt. controls such as4

V.

Imposing foreign exchange barriers

Imposing foreign trade barriers

Intervening (buying and selling currencies) in the foreign exchange market.

Other factors

The main purpose of the paper would be to elaborate as to how the government controls are
affecting the way the exchange rate is set.
Exchange rate is one of the key macroeconomic variables. Like monetary policy, exchange rate
policy is under the purview of the monetary authority. Bangladeshs exchange rate policy can be
classified into three regimes since independence. During the period 1972- 1979, BD followed fix
pegged exchange rate regime. Since May 2003 floating exchange rate policy has been in place
(Akhtaruzzaman, Begum A. 2015).
In Aghion, Bacchetta and Banerjees (2000, 2001) it suggests a possibility of an increase in
interest rate leading to exchange rate depreciation for a certain parameters due to higher domestic
interest rates diminishing investment and future outputs and reducing foreign demand for home
currency. This creates currency depreciation.
Dornbusch (1976) developed a theory of exchange rate movements under perfect capital
mobility, a slow adjustment of goods market, relative to asset markets and consistent expectation.
The paper also suggests that in the short run a monetary expansion is shown to induce an
immediate depreciation in the exchange rate and accounts therefore for the fluctuation of
exchange rate. (Dornbusch, 1976). In terms of theory a number of models have weakened or
even reversed the link between interest rate hikes and currency appreciations.
Hossain (2002) investigates the exchange rate responses to inflation in Bangladesh for the period
1973-1999. He finds that the effect of devaluation on inflation during the fixed exchange rate
regime was not significant, and he claims the results to be robust for the whole sample period.
By analyzing the movement of the real exchange rate and trade balance in Bangladesh for the
period 1973-1996, Hossain (1997) finds that the continued inflows of foreign capitalforeign
aid and overseas worker's remittances have caused an appreciation of the real exchange rate by
increasing the relative demand for non-tradables.
5

Rahman and Basher (2001) have estimated the equilibrium real exchange rate as well as
exchange rate misalignment for the period 1977-1998. They find that trade liberalization and
increase in debt service burden results in a real depreciation of the currency; while increase in
capital inflow, improvement in terms of trade, and increase in government consumption of nontradables results in a real appreciation of the currency. From the estimated long run equilibrium
real exchange rate, they find that Bangladesh currency was considerably overvalued until late
1980s. However, the real exchange rate broadly was in equilibrium during the 1990s. An ADB
study concludes that the misalignment between the actual and equilibrium exchange rate for the
period 1997-2001 has been small and has progressively narrowed since 1998. During 2001, the
misalignment was only 2.2 percent.
Prior to adopting floating exchange rate regime, Islam (2003) concludes that the economic and
institutional prerequisites of a floating exchange rate regime are not met in Bangladesh. Some
recent studies have tried to explain the behaviour of nominal exchange rates of Bangladesh after
its transition to the floating rate regime.
By doing a correlation analysis, Rahman and Barua (2006) explore the possible explanation of
the exchange rate movement. They found that there is a strong correlation (-0.40) between
depreciation and export-import gap as a share of reserves, L/C openings for imports also have a
positive correlation (0.45) with volatility of the exchange rate which implies that the higher the
L/C openings the more volatile is the exchange rate. They conclude that high seasonal demand
for foreign currency because of increased import bills, systematic withdrawal of excess liquidity
by Bangladesh Bank, relatively faster expansion of credit and higher interest rates on various
national savings instruments are the reasons behind the interest rate hike in the money market
and depreciation of the nominal exchange rate.
Lyons and Rose (1995) also looked in the matter of interest differentials and exchange rate
movements and found that currencies which were attacked actually appreciated rather than
depreciating. Many recent studies of disaster risk models have also replicated the failure of UIP
showing a negative relationship between interest rates and currency values.
Younus and Chowdhury (2006) made an attempt to analyze Bangladeshs transition to floating
regime and its impact on macroeconomic variables. They find that output growth in Bangladesh
6

performed well in the intermediate and floating exchange rate regimes. Inflation is lower in the
intermediate regime despite higher money supply and exchange rate depreciation. They also find
that currency depreciation boosted export growth in the floating regime. The literature has kept a
vast area open for searching a properly fitting exchange rate which will adjust well with the
Bangladesh economy without hampering the surroundings.
5.0 BENEFITS OF THE STUDY
The data presented here will support the analysis here for further explanation. The country and
the economy will be benefited through the study. The paper aims so unveil the government
practices in regulating the exchange rate as it is a very important factor in reaching the
macroeconomic objectives especially because the exchange rate plays a huge role in achieving
the economic growth of a country. Through this, the future researchers who are on the track will
be benefited a lot. Also Bangladesh will find a proper way to deal with the exchange rate. In this
age of globalization the points suggested here are the probable solution to the problem
Bangladesh is facing right now.

6.0 METHODOLOGY AND DATA

The whole study is qualitative one with descriptive analysis of the topic. The data were collected
from secondary sources. The list of the sources includes: World Bank Data, Bangladesh Bank
(Economic data, Economic statistics and Exchange rate of Taka), Bangladesh Bureau of
Statistics (BBS) and such forth. Also the researches in the similar field of other researchers were
taken into account.
The data is totally secondary based due to the lack of time and knowledge required to conduct
the research.

7.0 LIMITATIONS OF THE STUDY

Though the studys context is very small and mainly based on qualitative data, even there were
some limitations we faced while continuing. They are

Limitation of required expertise to conduct extensive quantitative analysis.

Limitation of time series data.

7

Unavailability of access to resources.

Authorization and copyright issues while doing the background study.

Limitation of time frame.

8.0 HISTORY OF EXCHANGE RATE REGIMES

Here the world exchange rate history is described chronologicallyGold Standard

From 1876 to 1913, the exchange rate followed gold standard, in which the exchange rate
system was dependent on the respective currencys comparative convertibility to an
ounce of gold.

During the World War I, this method of determination of the exchange rate had to be
reassessed and ultimately was suspended. According to economists, the main reason for
the failure of gold standard after World War I was The Bank of Englands unstable
liquidity position.

To minimize the effect, Britain had to impose exchange controls that drastically
weakened the standard. For this reason gold prices no longer played the role that it did
before.

In financing the wars and abandoning gold, many belligerents suffered strong inflations.
Many European countries faced drastic inflation, having their price level becoming
double, triple and even quadrupled.

Some economic historians blame the gold standard for the prolonged economic
depression during World War II, which started from 1929 and lasted for about a decade.

After the suspension of the gold standard in 1914 there was a collapse of the exchange rate
market. In 1920s, some countries wanted to follow the gold standard again to get the old
exchange rate in practice but this could not be done since after the devastating effects faced by
most of the developed countries could be recovered after World War I.

Bretton Woods Agreement and Adjustable Peg System

Close to the end of World War II, the Bretton Woods Agreement was signed. It is the
landmark system for monetary and exchange rate management established in 1944.

730 Delegates from 44 different countries, met to create a new international monetary
system in which they wanted to ensure a foreign exchange rate system, prevent
competitive devaluations and promote economic growth.

Bretton Woods Agreement brought a new system adjustable peg to avoid making
deleterious macroeconomic adjustments to maintain the exchange rate.

Because of the new system by Bretton Woods Agreement two most important systems in
the world were created : i) International Monetary fund and ii) World Bank Group.

International Monetary Fund - The IMF was created to monitor exchange rates and lend
reserve currencies to nations. It was formally introduced in December 1945 when 29
members signed the Articles of Agreement

World Bank Group - which was set up to provide financial assistance for countries during
the reconstruction post World War I phase

The new system required that each country value its currency in terms of gold or the
United States dollar, which was fixed the exchange rate among all currencies. The
countries were required to maintain the exchange rate to within 1% of the peg, but, if
special circumstances required, they could allow the exchange rate to fluctuate by up to
10%. This is why pegged system is said to be a hybrid of fixed and floating exchange rate
regimes.

When any country needed to change the exchange rate more than 10% then the country
needed to take approval from IMF board. This prevented their currencies from
devaluation.

The Bretton Woods system began to weaken in the 1960s, when foreigners accumulated
large amounts of U.S. dollars from post World War II aid and sales of their exports in the
United States. Then the decision was made dollars would no longer be convertible to gold
and Bretton Woods system could no longer exists.
9

The Smithsonian Agreement and Fixed and Floating Exchange Rate

After the Bretton Woods Agreement, the Smithsonian Agreement was signed in 1971.It
was the first time in exchange rate history, the market forces of supply and demand began
to determine the exchange rate. It implemented a par value fixed exchange rate that was
not backed by silver or gold.

The Smithsonian Agreement did not last very long. By 1973, the extensively traded
currencies were permitted to fluctuate. In a floating currency system, a currencys value
is allowed to vary in keeping with the conditions of the foreign exchange market. It lead
to devaluation of 8% of U.S dollar and raised the price of gold from $35 to $38.

The advantage of a floating exchange rate system is that it is self in sync. A floating
currency system allows greater liquidity and central bank control.

The problem of Smithsonian Agreement is that it can be subject to attacks by speculators,

or sudden panic-driven moves by investors that lead to currency crises and recessions.

8.1 Advantages and Disadvantages Faced throughout this Timeline

Gold Standard
Advantages:

Inflation was hardly experienced during this system.

Low inflation allows long-term planning. There are many large projects that must be paid
for over time. It would be almost impossible to project future costs without knowing what
future prices were going to be.

Since gold is not divided equally it can lead to imbalances as countries having it as
natural resource can exploit countries that have less gold reserves.

Disadvantages:

The Bank of Englands unstable liquidity position.

In financing the wars and abandoning gold , many belligerents suffered strong inflation

10

Since gold is not divided equally it can lead to imbalances as countries having it as
natural resource can exploit countries that have less gold reserves.

The main problem with the gold standard was that if a country was not competitive in the
world marketplace, it would lose more and more gold as more goods were imported and
less exported. With less gold in stock, the country would have to contract the money
supply, which would hurt the country's economy.

Bretton Woods Agreement and Peg System

Advantages:

Bretton Woods Agreement created two most important systems in the world:
I.
II.

International Monetary fund and

World Bank Group.

It has an immensely positive effect on a countrys export and import, especially between
a nation with low production costs and another with a stronger currency. A richer nation
can produce in a country where the production costs are smaller. When these nations
convert their earnings into their domestic currencies, both the country can be seen to be
benefited.

It raises standard of living and economic growth and prevents volatile swings in
exchange rate.

Disadvantages:

During this time the supply of U.S dollar exceeded its demand which cause overvaluation
of the currency.

Large amount of reserve has to be maintained in central bank which can cause inflation.

The Smithsonian Agreement

Advantages:

It was the first time in exchange rate history, the market forces of supply and demand
began to determine the exchange rate.
11

It allowed greater liquidity and central bank control.

Disadvantages:

The problem of Smithsonian Agreement is that it can be subject to attacks by speculators

or sudden panic-driven moves by investors that lead to currency crises and recessions.

9.0 EXCHANGE RATE REGIME IN BANGLADESH: A CRITICAL

EVALUATION
The Bangladeshi taka (sign: or Tk, code: BDT) is the official currency of the Bangladesh.
Upon Bangladesh's independence, the value of the Bangladeshi taka was set between 7.5 and
8.0 to US$1. Except for fiscal year 1978, the taka's value relative to the U.S. dollar declined
every year from 1971 through the end of 1987. To help offset this phenomenon Bangladesh first
used the compensatory financing facility of the International Monetary Fund in fiscal year 1974.
Despite the increasing need for assistance, the Mujib government was initially unwilling to meet
the IMF's conditions on monetary and fiscal policy. By fiscal year 1975, however, the
government revised its stance, declaring a devaluation of the taka by 56 percent and agreeing to
establish the Bangladesh Aid Group by the World Bank (Bangladesh taka, 2016).
Bangladesh faced two major exchange rate regimes since its inception.
Fixed Rate: Bangladesh has been operating under fixed exchange rate until May 2003.
Bangladesh had been maintaining various pegged exchange rate regimes, such as pegged to the
British pound sterling (1972-1979), pegged to a basket of major trading partners' currencies with
pound sterling as the intervening currency (1980-1982), pegged to a basket of major trading
partners' currencies with US dollar as the intervening currency (1983-1999), and an adjustable
pegged system (2000-2003).
Floating Exchange Rate: On the 31st of May 2003, Bangladesh adopted fully market-based
floating exchange rate system. From then on, Bangladesh bank notified that it would no longer
maintain a pre announce exchange rate bands for transactions with banks and the banks will fix
buying and selling rates of dollar and other currencies according to supply and demand situation
in the market. But Bangladesh Bank also pledged that it would scrutinize the market and
12

intervene in the money market and US dollar transactions, if needed to ensure orderly conditions
in the market. So, the exchange rate was actually Managed Floating Exchange Rate.
The transition was smooth and the first ten months can be called the honeymoon period as the
exchange rate stayed stable and experienced less than 1.0 percent depreciation from June 2003 to
April 2004. It kept on rising gradually from mid-2004 and it reached its peak at Tk. 70/USD in
2006 from Tk. 58/USD, accounting for 20 per cent depreciation. Since then, it remains fairly
stable and has been fluctuating between Taka 68 and 69 (2007-2009). The floating regime in
Bangladesh is, therefore can be characterized by both volatility and stability (Table 1).
Although, officially Bangladesh maintains floating exchange rate system, empirical evidence and
theory suggests that floating exchange rates are characterized by little intervention in the
exchange rate markets together with unlimited volatility of the nominal exchange rate.
Since little or no intervention is required in a floating regime, reserves exhibit relatively low
volatility. However, it is seen that exchange rate, reserves and interest rates volatility rates are
very low for the period 2007- 2009, indicating an active intervention in the foreign exchange
market. Bangladesh practices a managed floating rate system from the very beginning of its
transition to floating regime. (Tabassum, 2010)
However Bangladesh Government adopting market based floating exchange rate system was not
beyond controversy.

9.1 Reasons behind Fixed Exchange Rate Regime in Bangladesh

Although there were pressure from exporters to depreciate the currency, Bangladesh maintained
fixed exchange rate for quite a long time. There are macroeconomic consequences of
devaluations. They are;

To avoid inflation. Inflation would be fuelled by pass through effect of imported items
through depreciated currency. It might also be fuelled by intervention activities for
further depreciation. And because Bangladesh is an imported dependent country, any
change in price in the international market will eventually transmit to domestic prices.

Depreciation also affects output growth through different channels including the balance
sheet channel.
13

Interest rate is affected as well. Usually a larger depreciation entails a smaller increase in
interest rates and this has effect on the credit channel

By keeping the fixed exchange rate Bangladesh can also keep stable wages and prices in
the economy.

Fixed exchange rate stimulates economic growth in the long run. Even in exporting sector
less volatility in the real effective exchange rate results in positive impact on the overall
exports.

The Policy makers should also continue to embark on productive activities that will
increase Bangladeshs exports more than her imports which can be achieved through
fixed exchange rate. (Islam, 2016)

Therefore, the overall impact of depreciation depends on the trade-off between these effects.
Because of all these the govt. of Bangladesh has kept the exchange rate fixed for so long.
(Limited, 2015)
However, the govt. has to pay a price for keeping a fixed exchange rate. The fixed exchange rate
was hurting the earning from the exports. Greater earnings can be achieved by Bangladesh if she
depreciates its currency value. Also in fixed exchange rate regimes international cooperation and
intellectual consensus are often required to adjust to the macroeconomic imbalances. Such
cooperation and consensus usually require a strong economy to act as leader, which Bangladesh
is not.

9.2 Reasons behind Moving to Floating Exchange Rate Regime

Many supported the decision of adopting the floating exchange rate. The reasons being;

The floating exchange rate would increase exports in Bangladesh since price support is
very crucial for the export sector. Ahmed and Uddin (2009) found that export growth is
often considered to be a principal determinant of production and employment growth in
an economy and they argued that foreign currency made available through export
earnings facilitates import of capital goods, which in turn increases production potential
of an economy. And in Bangladesh currency depreciation boosted export growth in the
floating regime.
14

Floating system results in high exchange rate which stimulates economic growth in the
short run

The exchange rate would be as stable as macroeconomic indicators since the exchange
rate is linked to monetary policy

The real advantage of a floating exchange rate can be seen in the trade relationship. If the
exchange rate is weak and international traders from the weak currency countries
translate their earning back to their respective countries theres a greater amount of profit
than having a stronger exchange rate. So, for Bangladesh keeping the exchange rate low
ensures a domestic product's competitiveness abroad and profitability at home.

9.3 Risks of Floating Exchange rate system

Many studies suggested that economic and financial strength of Bangladesh was not good
enough to successfully operate under the chosen regime and predicted that it might create excess
volatility in the exchange market and as a result would adversely affect international trade and
investment.
The rapid rate of inflation has become a major economic and social problem for Bangladesh.
This can be an effect of the free floating system according to many policy makers and
researchers. They believe that the depreciation of the exchange rate is the primary culprit
underlying rapid inflation in Bangladesh. Exchange rate raises the taka price of imported inputs
that pushes up the cost of production and that in turn fuels inflation (Ahmed, 2012). And since
Bangladesh Bank intervenes in the foreign exchange market to maintain a long term value of the
currency, Bangladesh Bank must have to acquire a good stock of international reserves.

10.0 THINKING THE OTHER WAY ROUND: MANAGED PEG REGIME

Bangladesh has had a floating exchange rate, fixed and as well as managed floating exchange
rate. The main reason of proposing managed peg exchange rate is due to the economic benefits
of an undervalued currency. A weaker currency means that imports are relatively expensive and
exports are relatively cheaper. A managed peg system therefore will allow Bangladesh to achieve
a higher export-led growth rate since Bangladeshi goods will become more appealing to foreign
firms and consumers; which in turn will provide more jobs for Bangladeshi workers. This
15

therefore will support Bangladeshs market oriented development strategy and reflects why the
taka should follow managed peg exchange rate. Because in managed peg exchange rate, the
government can manage the exchange rate by pegging with selected countries. Also the vice
versa of the whole system is possible.
Till now China is the only country who manually manages pegging its currency against other
currencies. The basket to which China fixes the RNB contains 11 currencies: the US dollar,
euro, British pound, Japanese yen, Russian ruble, Australian dollar, Canadian dollar, South
Korean won, Malaysia ringgit, Singapore dollar and Thailand baht. Considering the international
trade (both import and export) of Bangladesh, the most crucial countries contributing in trade
volume are (alphabetically): Australia, Belgium, Brazil, Canada, China, Denmark, France,
Germany, Hong Kong, India, Indonesia, Italy, Japan, Kuwait, Malaysia, Netherlands, Poland,
Russia, Saudi Arabia, Singapore, South Korea, Spain, Sweden, Taiwan, Thailand, Turkey, UAE,
USA and UK. Here we have 29 countries, among them there might be common currencies,
dependent currencies, weak currencies etc. which gives Bangladesh the opportunity to
manipulate and peg with only a few currency to cover businesses over the whole world.
A managed peg exchange rate system is beneficial for Bangladesh as a developing economy
because it will give a lower inflation and facilitate more investment. FDI is also crucial because
it provides access to foreign technology and know-how. The exchange rate and Bangladeshs
four macroeconomic performance indicators (growth, unemployment, inflation, balance of
payment) are interlinked. Bangladesh therefore must continue a gradual move away from the
managed floating system in order to maintain economic stability and achieve a relatively
balanced balance of payments account.

10.1 Objectives and Reasons to Move towards Managed Peg Regime

1.
2.
3.
4.

To increase flexibility
To trade with different currency easily
To enjoy cheaper import cost or higher export growth.
If government has maintains a policy of intervening in currency markets to limit or halt
the appreciation of its currency, taka against other major currencies, especially the U.S.
dollar; the policy will appear to be largely intended to keep the export industries

16

competitive internationally and to attract foreign direct investment (FDI), which can be
major factors behind rapid economic growth.

10.2 Probable Shortcomings

There are some probable shortcomings or problems present in the proposed system

The valuation of the multiple currencies, continuous monitoring, necessary

adjustments etc. will require extra budget, effort and concentration which require
extra resources to be allocated in the sector.

The measurements are very sensitive, weightage of the currencies is to be measured

very carefully and any minor mistake can hamper the economy badly.

Any official or unofficial currency manipulation will raise international controversy

which will affect the international trade.

The lag time of the adjustments and policy implementation will become risky for the
economy.

Volume of international trade (both import and export) might not get affected or
might get affected in a negative nature with the changed policy also that will initiate a
currency risk for Bangladesh.

11.0 RECOMMENDATIONS
Currently exchange rates are managed on an ad-hoc basis without having clear targets or
objectives. However, this management can be rated as good as the exchange rate remains very
close to its equilibrium as warranted by economic fundamentals. But in case of any abnormal
shocks or casualties it would be impossible to regain the control over exchange rate without
hampering other aspects of the economy. So, certainly there is scope to improve exchange rate
management under a managed peg regime.
There is no simple formula or policy for exchange rate management to achieve two important
goals of exchange rate management, such as competitiveness and price stability, simultaneously
(Ohno, 1999).
17

In the absence of a solid consensus on the proper target of exchange rate management, we
propose to adopt the following pragmatic policies:
Crisis management: Bangladesh has not yet been faced any currency crisis, and therefore the
capacity of exchange rate management has not been tested yet. With gradual economic
development, shocks such as sudden shifts in FDI, export demand or the terms of trade, large
business swings, significant resource discovery (or loss), major natural disasters etc. may occur.
In that case a trigger mechanism needs to be adopted for additional adjustments.
Accumulation of Reserves: To maintain managed floats, Bangladesh needs to accumulate a
sufficiently large stock of reserves.
Proper Security of the Reserves: Very recently Bangladesh has experienced an attack on the
reserve which is yet to recover. The central and monetary regulators should increase their priority
level for security of the national reserve.
Institutional Development: The foreign exchange market of Bangladesh is in an embryonic
stage and thin in terms of daily transactions. If the economy goes on board on a middle-income
growth path in near future, the market will need to expand and forward transactions will need to
be encouraged. Therefore, to reap the maximum benefits of the exchange rate regime, there is no
alternative other than building institutions and bringing efficiency and depth to the foreign
exchange market. Also, it is necessary to develop well equipped capital markets with further
financial liberalization.

12.0 Conclusion
Given the small and weak foreign exchange market, high exchange rate move across and
exchange rate shocks (exchange market pressure); it appears to be difficult for Bangladesh to
maintain a managed floating regime. Given the vulnerable financial system, this study suggests
that it is better for Bangladesh to operate as managed peg regime with small interventions.
Simultaneously, Bangladesh Bank needs to work on developing mechanisms for inflation
targeting policies, ensuring efficiency in the financial system, and building necessary institutions
in order to manage exchange rates efficiently. Maintaining short-term stability and also mediumto-long term flexibility should be the general objective of exchange rate management policy of
Bangladesh.

18

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20

Appendix
Table 1: Volatility and Stability of Bangladesh Exchange Rate
90
85
80
75
70

USD vs TK

65
60

Table 2: Inflation over Time

Annual Inflation %
15
Annual Inflation %

10
5
0
2010

2012

2014

2016

Table 3: Annual Growth Rate (Percentage)

21

Annual Growth %
7
Annual Growth%

6.5
6
5.5
2010

2012

2014

2016

Table 4: Balance of Payment

Balance of Payment (Billion US $)

50
40
Balance of Payment

30
20
10
0
2010

2012

2014

2016

22