Assignment

On
Dollar crisis and its impact on Bangladesh

Prepared for
Prodip Chandra Bishwas
Lecturer
Department of Finance & Banking
Faculty of Business studies
Jahangirnagar University

Prepared by
Anika Tasneem Hridi
ID: 1658, Batch: 10th
Department of Finance & Banking
Faculty of Business studies
Jahangirnagar University

Date of submission: 10th July, 2023

Currency crisis
In modern history, there have been several instances of currency crises. These are a sudden and
drastic devaluation in a nation's currency matched by volatile markets and a lack of faith in the
nation's economy.
A currency crisis is sometimes predictable, yet they are often sudden. It may be precipitated by
governments, investors, central banks, or any combination of actors. But the result is always the
same: The negative outlook causes wide-scale economic damage and a loss of capital.
Reasons for a worldwide dollar crisis
The US dollar is the most potent currency in the world today and is the world's leading reserve
currency. About 90 per cent of the world's total economic transactions are conducted through US
dollars. According to estimates, there is currently around 1.8 trillion US dollars’ worth of paper
and metal currency circulating worldwide. The US dollar is almost essential for international
trade.
The situation in the world has been turbulent since the beginning of the Corona pandemic that
has been going on for more than two years due to the Russia-Ukraine war. The price of fuel is
increasing in the international market, and the price of daily commodities is going out of hand.
Due to the sudden increase in import costs, the foreign exchange reserves of various countries
have been strained. Bangladesh is no exception.
The central bank of any country keeps such reserves to meet import costs, deal with the country's
financial disaster, prevent the depreciation of the local currency, strengthen the monetary policy,
implement the budget, provide money for large projects, and ensure the payment of foreign
debts.
Recent data show that foreign exchange reserves are depleting in various countries. Statistics
show that China currently has the largest foreign exchange reserves in the world. In June 2022,
the country's reserves were US$ 3.24 trillion dollars. However, China's reserves have fallen
significantly compared to last year's.
Since investors always seek the highest profits that are predictable or "safe", especially from
abroad, they increase investment to create a strong capital account and consequently create a
high demand for dollars. On the other hand, import costs which are the result of the import of
goods and services from other countries in which dollars go out of the country, i.e., if imports are
more significant than exports, there will be a current account deficit, thereby increasing the
pressure on the foreign currency or the dollar, creating a crisis.
The US dollar is the foundation of the world economy and a reserve currency for international
trade and finance. Like other fiat currencies, the dollar's relative value depends on economic
activity and the outlook for the United States.
Exporting goods or services in dollar creates demand because consumers pay in dollar. So they
have to sell their currency and convert it into dollar to make payments.
Additionally, when the US government or large American corporations issue bonds to raise
capital that foreign investors purchase, those payments must also be made in dollar. This also
applies to purchases of US corporate stocks from non-US investors, requiring the foreign
investors to sell their currency to buy dollar to buy those stocks.
These examples show how the US creates more demand for dollar and thereby puts pressure on
the supply of dollar, increasing the dollar value relative to the currency sold to buy dollar and
creating a crisis in the sector.
After all, the US dollar is considered a great security during times of global economic
uncertainty, so demand for the dollar can often persist despite fluctuations in the performance of
the US economy. For example, in cases where the US economy weakens and rising
unemployment reduces purchasing power, i.e., faces the possibility of a sell-off, bonds or stocks
can be sold to return to their local currency. The dollar is affected when foreign investors buy
back or buy their local currency.
The business people are primarily responsible for measuring whether the supply of dollar will be
greater or lesser than the demand for dollars. To determine this, we need to pay attention to any
news or events that may affect the dollar's value. These include releasing government statistics,
such as reserves, payroll, GDP, and other economic data that can help us determine whether the
economy has strengths or weaknesses.
There are several reasons for the increase in the US dollar value, but the primary factor is the
demand for dollars. As the demand for the dollar increases, so does its value. Conversely, if the
market falls, so does value. Demand for dollar increases when international parties, such as
foreign nationals, foreign central banks, or foreign financial institutions demand more dollars.
Demand for the dollar is generally high because it is the world's reserve currency. Other factors
that affect whether the dollar appreciates against other currencies include inflation rates, trade
deficits, and political stability.
Factors affecting exchange rates between currencies include currency reserve status, inflation,
political stability, interest rates, trade deficit/surplus, and public debt. A weak currency is one
whose value declines relative to other currencies. A weak currency can indicate economic and
social fragility in many cases. A weak currency can arise from high levels of inequality, political
instability, government debt and trade deficits
Finally, experts are currently talking about various reasons behind the global dollar crisis, such as
the import-export deficit
 the war between Russia and Ukraine
 increase in military spending by the United States and allied countries, including Europe,
decrease in remittance flow
 economic and commercial blockade imposed by the United States on various countries
including Russia
  increase in fuel oil prices and reduced supply, corruption in developing countries and
money laundering abroad
 hoarding of extra dollars by traders hoping to make extraordinary profits, etc.

Why is Bangladesh facing a dollar crisis while others are not?

"Please give us dollars. We cannot open Letters of Credit to import raw materials." The statement
was made by a top businessman who is involved in diversified sectors - from steel to cement,
textile, financial institution and others.
Hundred percent import-oriented businesses are in desperation as they are not receiving any
dollars, making it difficult for them to survive. Apart from a few exporters who have enough
dollars to meet their own needs, businesses have been suffering from the lack of greenbacks for
the last six months. Businesses fear that the situation may not improve even in the next few
months, as the International Monetary Fund has asked the Bangladesh Bank to increase its
foreign exchange reserves. This means that the BB may not be able to supply enough dollars to
meet the demand.
In comparison to Bangladesh, India is managing its financial situation better even though they
have similar economic indicators such as per capita income, proportionate GDP, and comparable
exports and imports. Why is Bangladesh facing these challenges, even though the situation is far
better than that of Pakistan and Sri Lanka?
The ongoing crisis has exposed several weaknesses in Bangladesh's financial management. The
country has seen a decrease in its foreign exchange reserves and the local currency, the taka, has
depreciated against the dollar by over 20% in six months, causing difficulties for businesses and
importers who are struggling to acquire the greenback.
One major factor contributing to Bangladesh's financial crisis is the country's overreliance on
imports and the lack of local production of raw materials and goods, putting a strain on the
country's foreign exchange reserves.
Bangladesh has to import almost everything – from food grains to sugar, edible oil, spices,
petroleum products, fertiliser, cotton, yarn, chemicals, machines, raw materials for all kinds of
manufacturing units, spices and more. When the Russia-Ukraine war began in February last year,
prices of commodities skyrocketed along with a disruption of the supply chain.
Consequently, Bangladesh's import bills for FY22 surged to $82.49 billion, a 36% growth from a
year ago. In comparison, import has gone down significantly this year – less than $6 billion per
month from an average of over $7 billion last year - and the prices of some commodities are on a
decline. So what is the problem now? Why is the situation not improving yet?
According to bankers, the pressure on foreign exchange is still there because of the payment
obligations against the LCs they had opened several months ago.
Were Bangladesh Bank’s measures enough and effective?
In May 2022, the Bangladesh Bank first imposed restrictions on imports of some goods. It
enhanced the margin for opening LCs at a minimum 75% for motor cars, home appliances,
electronics and electrical products. For all other goods, the margin was set at 50% excluding
baby food, essential food items and fuel, life-saving medicines, local and export-oriented
industries and agriculture related products. Later, the LC margin was increased to 100% for some
goods, such as motor cars.
Treasury bankers said the practice of restricting imports by increasing the LC margin is an old
concept. In the past, some countries have used this policy with some success. For example, in the
1980s, India increased LC margins to curb imports and boost domestic production. The policy
was successful in reducing imports and increasing domestic production, but it also led to a
shortage of certain imported goods and higher prices for consumers.
But Bangladesh's present crisis is with the dollars and not the taka. Importers who are ready to
import with even 100% LC margin are not getting the greenback from banks.
The 1997 financial crisis in Southeast Asia, also known as the Asian financial crisis, had a
profound impact on the region's economies. To manage their exchange rates during the crisis,
different economies in Southeast Asia employed different strategies.
For example, countries, such as Malaysia and the Philippines, had floating exchange rate
systems, which allowed their currencies to fluctuate in response to market forces. To stem the
outflow of capital and support their currencies, these countries intervened in the foreign
exchange market by selling their own currency and buying foreign currency. They also
implemented capital controls to limit the movement of funds in and out of the country.
At that time, Singapore adopted a basket peg for its currency rather than a single currency. This
provided some flexibility for the country to manage its exchange rate during the crisis as it
allowed the central bank to adjust the weight of different currencies in the basket to respond to
market conditions.
Impacts of dollar crisis on the economy of Bangladesh
The current crisis began with the Covid-19 pandemic that affected production and import-export
related activities across the world leading to high rates of inflation. As fears of a global recession
rose, every economy in the world used stimulus packages or financial assistance to increase its
money supply and boost production. The scenario began to improve by the end of 2021 but the
Russia-Ukraine war disrupted the supply chains of oil, gas, fertilizers, chemicals, and various
other agricultural commodities. This induced further inflation across the world, particularly in
the USA, reaching 8.5% in March 2022, the highest since 1981. To tackle inflation, the US
Federal Reserve decided to raise interest rates luring investors from across the world. More than
50% of the rise in dollar value can be explained by the Fed’s aggressive monetary policy.
Besides, high energy prices have been hitting fuel importers, like most of Europe and the
developing world (including Bangladesh), harder than the USA since it is less reliant on oil and
gas imports. As a result, most currencies in the world started to lose their value against the dollar.
The rise in dollar value primarily affected Bangladesh’s imports and exports. While imports
became more expensive, exports should have ideally increased due to competitive prices.
However, the rise in fuel prices increased the costs of production while the domestic inflation
rates and contractionary monetary policies in North America and Europe slowed down the
demand for most of Bangladesh’s export items, resulting in decreased exports. Imports, on the
other hand also increased in volume due to the GoB’s post-Covid-19 stimulus package and the
Import Policy Order 2021-24, which eased import regulation and increased access to duty-free
imports. Remittance flows into the country also decreased by 15% in FY22 compared to FY21.
Consequently, the fall in exports and rise in import payments led to higher demand for the dollar
and a growing balance of payment deficit (with a historically high trade deficit of USD 33.25
billion in FY2021-22) which had to be covered by foreign exchange reserves. Concurrently, a
more expensive dollar and its shortage in the domestic market pushed BB to inject funds from
the foreign exchange reserves into the market to stabilize the exchange rate.