Foreign Exchange Market in Bangladesh

Foreign Exchange Market

Foreign exchange Market is a place in which foreign exchange transactions take place. In other word, foreign exchange transaction is a market where foreign money were brought and sold. It is a part of money market in financial centre.

Function of foreign exchange market: The basic and primary function of a foreign exchange market is to transfer purchasing power between countries. The transfer function is performed through T.T, M.T, Draft, Bill of exchange, Letters of credit, etc. the bill of exchange is the most important and effective method of transferring purchasing power between two parties.

Another important function of foreign exchange market is to provide credit to the importer debtor. The exporters draw the bill of exchange on importers on their bankers. On acceptance of the bills by the importer or their bankers, the exporter will get the money realized on the maturity of the bills. In case the exporters are anxious to receive the payment earlier, the bills can be discounted from their bankers, or foreign exchange banks or discount houses.

The Foreign Exchange market performs the hedging function covering the risks on foreign exchange transactions. There are frequent fluctuations in exchange rates. If the rate is favorable, the exporter will gain and vice verse. In order to avoid the risk involved, the foreign exchange market provides hedges or actual claims through forward contracts in exchange against such fluctuations. The agencies of foreign currencies guarantee payment of foreign exchange at a fixed rate. The exchange agencies bear the risks of fluctuation of exchange rates.

Different Foreign Exchange Regimes

Immediately after liberation, the Bangladesh currency taka was pegged with pound sterling but was brought at par with the Indian rupee. Within a short time, the value of taka experienced a rapid decline against foreign currencies and in May 1975, it was substantially devalued. In 1976, Bangladesh adopted a regime of managed float, which continued up to August 1979, when a currency-weighted basket method of exchange rate was introduced. The exchange rate management policy was again replaced in 1983 by the trade-weighted basket method and US the dollar was chosen as intervention currency. By this time a secondary exchange market (SEM) was allowed to grow parallel to the official exchange rate.

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Up to 1990, multiple exchange rates were allowed under different names of export benefit schemes such as, Export Bonus Scheme, XPL, XPB, EFAS, IECS, and Home Remittances Scheme. This led to a wide divergence between the official rate and the SEM rate. The situation also gradually gave rise to a number of conflicting regulations, poor risk management, and various types of implicit or explicit government guarantees to the users of foreign exchange. This resulted in a number of macro-economic imbalances prompting the government to adjust the official rate in phases and to liquidate its difference with the rate at SEM. The two rates were finally unified in January 1992. The first step towards currency convertibility was taken on 17 July 1993 and this marked the beginning of a relatively open foreign exchange market in the country. Until then the Bangladesh Bank used to declare mid-rate along with the buying and selling rates for dollar applicable to authorized dealers. Initially the spread was Tk 0.10, which was gradually widened to Tk 0.30.

Until late in 2003, Bangladesh followed an exchange rate policy of occasionally adjusting the rate with an eye on maintaining export competitiveness, mainly with reference to the trend of Real Effective Exchange Rate Index based on a trade weighted basket of currencies acted as a sort of benchmark for the banks to set their own rates.

From May 31, 2003, the exchange rates for the Bangladesh Bank’s spot purchase and sale transactions of US dollars with authorized dealers were to be decided without reference to any pre-announced band and the Taka essentially became a floating currency of major trade partners. The Bangladesh Bank had a preannounce one Taka wide band within which it would, at its discretion, undertake US Dollar purchase and sale transactions with banks. The banks were free to set their own rates for their interbank and customer transactions. Those rates generally tended to be outside the announced rate band for transactions between the Bangladesh Bank and authorized dealers.

Limits of Foreign Exchange Trading

The foreign exchange market of the country is confined to the city of Dhaka. The 32 scheduled banks operating as authorized dealers in the inter-bank foreign exchange market are not permitted to run a position beyond certain limits. In the event of speculation on an appreciation of the value, an authorized dealer may buy more foreign currencies than it needs, but at the

end of the day it must maintain its limit by selling excess currencies either in the inter-bank market or to customers. Authorized dealers maintain clearing accounts with the Bangladesh Bank in dollar, pound sterling, mark and yen to settle their mutual claims. If there any excess foreign exchange holdings exist after these transactions, it is obligatory for them to sell it to the Bangladesh Bank. In case of shortfall of the limit, authorized dealers have to cover it either through purchase from the market or from the Bangladesh Bank.

Role of Bangladesh Bank

At present, the system of exchange rate management in Bangladesh is to monitor the movement of the exchange rate of taka against a basket of currencies through a mechanism of real effective exchange rate (RFER) intended to be kept close to the equilibrium rate. The players in the foreign exchange market of Bangladesh are the Bangladesh Bank, authorized dealers, and customers. The Bangladesh Bank is empowered by the Foreign Exchange Regulation Act of 1947 to regulate the foreign exchange regime. It, however, does not operate directly and instead, regularly watches activities in the market and intervenes, if necessary, through commercial banks. From time to time it issues guidelines for market participants in the light of the country's monetary policy stance, foreign exchange reserve position, balance of payments, and overall macro-economic situation. Guidelines are issued through a regularly updated Exchange Control Manual published by the Bangladesh Bank.

According to Bangladesh Bank “banks and authorized dealers are free to set their own rates of foreign exchange against Bangladesh Taka for their inter-bank and customer transactions. The exchange rate is being determined in the market on the basis of market demand and supply forces of the respective currencies. However, to avoid any unusual volatility in the exchange rate, BB occasionally engages itself to intervene in the market through purchase and sale US Dollar as and when it deems necessary to maintain stability in the foreign exchange market. Bangladesh Taka is fully convertible for current international transactions.” However, only authorized dealers are allowed to participate in trading with license from Bangladesh Bank, and license may be revoked due to irregularities or if the Bangladesh Bank regulations are not followed.

The exchange rates of Bangladesh Taka were left on the market forces after the floatation where any intervention in the foreign exchange market by the Bangladesh Bank is not enviable. The exchange rates of Bangladesh Taka against major international currencies witnessed somewhat stability since then, which did not warrant any intervention in the foreign exchange market by the Bangladesh Bank. In view of keeping foreign exchange reserve at a comfortable level, however, the Bangladesh Bank had to participate in the market. Data as shown at the table below indicate that the Bangladesh Bank did not sell any foreign currency during the last two fiscal years.

Purchases and Sales of Foreign Exchange by the Bangladesh Bank

(Million US$)

Particulars 2002 2003 2004 2005 2006 2007

Purchase 507.1 503.9 314.0 459.5 413.0 649.5

Sale 63.9 0.0 0.0 70.1 77.0 0.0

Source: Bangladesh Bank Annual Reports 2002- 2007

The Bangladesh Bank only purchased US $ 503.9 million and US $ 314.0 million during 2003 and 2004 respectively. Overall trends in both the sales and purchases of foreign currency by the Bangladesh Bank show declining trends during 2002-2004 indicating gradually less necessity for intervention by the Bangladesh Bank.

Because of relatively faster growth in import payments than export receipts, the demand for foreign exchange than that of supply was much stronger during the last half of 2005 generating some depreciating pressure on the Taka-Dollar exchange rate. With a view to mitigating the mismatch between the supply and demand for foreign exchange, the Bangladesh Bank intervened by selling a sizeable of amount of foreign currency in the foreign exchange market. The Bangladesh Bank sold USD 459.5 million as against the purchase of USD 70.1 million in 2005. Bangladesh Bank's intervention helped stabilize the exchange rate to Taka 63.70 during fourth quarter of 2005, although pressure on forex market continued, reflecting widening current account deficit.

Bangladesh Bank also allowed limited overdraft facility on foreign currency clearing account with the Bangladesh Bank to NCBs and some private sector banks facing temporary mismatch in liquidity and relaxed restrictions on swap and forward operations in order to give banks some flexibility to manage their liquidity.

Pressure in the foreign exchange market continued due to price hike of oil and petroleum products and major import commodities coupled with higher growth in lending to the private sector, which led to rapid growth in imports demand in the face of slowdown in export earnings in the first half of 2006. But due to adoption of contractionary monetary policy together with substantial inflow of foreign exchange from export earnings and remittances, the situations eased later on. To increase the supply of foreign currencies in the market, BB sold USD 413.0 million as against the purchase of USD 77.0 million in 2006. Overall trend in purchases of foreign currency by the BB, were showing declining trends during 2004 to 2006 indicating gradually less necessity for intervention by the Bangladesh Bank.

According Bangladesh bank annual report, in 2007, to absorb excess liquidity from the foreign exchange market, Bangladesh Bank purchased USD 649.50 million from banks and had no sales. However, an HSBC report (Bangladesh Review & Outlook) quoting newspapers mentioned that Bangladesh Bank sold USD 220.0 million near the end of 2007 to support the market for commodity import payments.

Authorized Dealers of Foreign Exchange

The authorized dealers are the only resident entities in the foreign exchange market to transact and hold foreign exchange both at home and abroad. Bangladesh Bank issues licenses of authorized dealership in foreign currencies only to scheduled banks. The amount of foreign exchange holdings by the authorized dealers are subject to open position limits prescribed by Bangladesh Bank, which itself purchases and sells dollars from and to the dealers on spot basis. The size of each such transaction with Bangladesh Bank is required to be in multiples of $10,000, subject to a minimum of $50,000. In addition to authorized dealers, there are registered moneychangers to buy foreign currencies from tourists and sell them to outgoing Bangladeshi travelers as per entitlement. Their excess holdings beyond the permitted balance are required to be retained with authorized dealers. Some service institutions like hotels and

shops have also obtained limited money changing licenses to accept foreign currencies the foreign tourists, but those are to be sold to authorized dealers. Transactions by customers take place mainly to satisfy customer demand for individual needs and to facilitate export, import, and remittances.

The phenomenal growth of inter-bank transactions was due mainly to relaxation of exchange control regulations and expansion of the activities of the Bangladesh Foreign Exchange Dealers Association (BAFEDA) formed on 12 August 1993. The association was incorporated as a non-profit organization under the Companies Act (Act.XVIII) of 1994 on March 30, 1998. At present, 44 banks operating in Bangladesh are member of the association.

Objectives of BAFEDA

According to the Constitution of Bangladesh Foreign Exchange Dealers' Association, the objectives of the Association are:

i. To create and promote inter-bank foreign exchange dealings and develop good fellowship that is indispensable in foreign exchange dealings and relations;

ii. To function in the best interest of the members and also to do all such other things as may be necessary or desirable in furtherance of the objectives of the Association;

iii. To arrange that the foreign exchange dealers of member banks keep one another informed and they render assistance to one another without prejudice to the interests of their respective institutions;

iv. To do all that is necessary in the power of the Association and the members, collectively and individually, and also to uphold high standards of ethics by rendering quality service in foreign exchange dealings.

For smooth functioning of the inter-bank foreign exchange market, a “Code of Conduct” for Bangladesh Inter-Bank Foreign Exchange and Treasury Operations and also “BAFEDA Rules” were formulated earlier, with the approval of Bangladesh Bank.

Members of BAFEDA

The association may have two classes of members Committees-

Primary Members: This remains open to all scheduled banks in Bangladesh, who are authorized dealers and actively engaged in dealing in foreign exchange. The members are represented by the Chief Executives. However, after giving a due notice, a member may withdraw from the Association.

Associate Member: This includes those who are authorized in sale and purchase of foreign currencies and also active in financing import and export activities in Bangladesh. Associate membership is subject to approval of the Executive Committee. Associate members have no voting rights.

Transaction in the Interbank Market

Transactions volume in the inter-bank foreign exchange market was USD 56.0 billion in 2001, and USD 98.4 billion in 2002. Forward transactions had a 4.7 fold increase from USD 7.19 billion of 2001 to USD 33.7 billion in 2002. This ballooning of forward transactions volume was not a balanced growth however; forward sales of dealers were covered mostly by spot purchases rather than by matching forward purchases from exporters and other non-bank foreign exchange earners. Soon after, Bangladesh Bank put up a series of restrictions, at the same time paving the way for floating the currency as was done on May 31, 2003.

The interbank foreign exchange transaction volume in 2003 was USD 91.08 billion less than the previous years, mainly because of the restriction imposed on building up forward sales covered by spot rather than forward purchases. Due to further restrictions imposed on building up forward sales covered by spot rather than forward purchases, the interbank foreign exchange transaction volume in 2004 stood at USD 56.39 billion, and spot transactions at USD 40.8 billion.

In 2005, all authorized dealer banks were instructed not to undertake any non-real cross currency forward and swap transactions, and consequently the interbank foreign exchange transactions volume in 2005 stood at USD 19.9 billion and volume of forward transactions came down to USD 0.3 billion in 2005

As authorized dealer banks were instructed not to undertake any non-real cross currency forward and swap transactions, volume of inter-bank forward transactions was almost nil in 2006, and the volume of inter-bank foreign exchange transactions in 2006 stood at USD 20.3 billion. This trend continued in 2007, and the volume inter-bank foreign exchange transactions stood at USD 19.2 billion

Size of the Market

The size of the market may be difficult to measure but estimates can be made based on figures of export, import, remittance, and interbank foreign exchange transactions.

Before deregulation of foreign exchange market the volume of inter-bank transaction was low. The assured access to funds from Bangladesh Bank at known cost as well as the assured buy-sell margins and transaction fees contained in the pre-determined exchange rate provided little inducement for authorized dealers to engage in inter-bank transactions. However, the situation has been changing and the reliance of authorized dealers on the Bangladesh Bank is gradually declining.

The average monthly transactions of foreign exchange in the inter-bank market accounted for $23.46 million in 1991-92 and crossed the $1 billion mark in 1998-99. The average monthly turnover for the six months between July and December 2000 was $1.5 billion.

From the table bellow have some ideas regarding the volume of trade might be gathered:

Foreign Exchange Components and Estimation of Market Volume

(Billion USD)

Components 2000 2001 2002 2003 2004 2005 2006 2007

Foreign Aid 1.58 1.37 1.44 1.59 1.03 1.49 1.57 1.63

Export 5.75 6.47 5.99 6.55 7.60 8.65 10.53 12.18

Remittances 1.95 1.88 2.50 3.06 3.37 3.85 4.80 5.98

Total Inflow 9.28 9.72 9.93 11.20 12.01 13.99 16.90 19.78

Import 7.57 8.43 7.70 8.71 9.84 11.87 13.30 15.51

Foreign Debt Servicing

0.55 0.57 0.59 0.61 0.59 0.66 0.67 0.70

Total Out Flow

8.11 9.00 8.28 9.32 10.43 12.53 13.97 16.22

Total (major) Transactions

17.39 18.72 18.21 20.51 22.44 26.52 30.86 36.00

Total Interbank Transactions

N/A 56.00 98.40 91.08 56.39 19.90 20.30 19.20

Forward Transactions

N/A 7.19 33.70 24.65* 15.60 0.30 Nil Nil

* Estimated Source: Bangladesh Bank

However, the following table gives the current trading volume (according to HSBC)

Daily Average FCY/BDT Turnover in Spot USD 15-20 million

Daily Average FCY/FCY turnover in Spot USD 70-80 million

Daily Average Forward turnover in Interbank Insignificant

Daily Average SWAP turnover in Interbank USD 2-3 million

Nature of Trading

The-inter bank foreign exchange market of Bangladesh is still at its rudimentary stage. The market is an oligopolistic one and is dominated by a few relatively large banks, which have remained only as dealers instead of developing themselves into buyers or sellers. The most widely used practice is spot transaction; this covers 95% of the total transactions. Only forward transactions offer protection against foreign exchange risks. Deals in foreign exchange market are usually confirmed over telephone, followed by a written advice. Confirmed deals may be cancelled on payment of necessary costs.

There also exists a ‘kerb’ market, where currency racketeers transact foreign currencies through a chain of middlemen. This market emerged in the restricted regime of foreign exchange transaction but continues to be active. This market operates in the alleys or lanes and by-lanes of Dhaka city around the foreign exchange branches of authorized banks. Dealers of hundi also form part of this market. A sizeable amount of foreign currencies is channeled through this market every year.

Major Factors that Affect the Foreign Exchange Market

Some of the major factors that affect the foreign exchange market in Bangladesh are:

i) Exchange rates

ii) Remittances

iii) Foreign Exchange Reserve

iv) Foreign Exchange Regulations

Exchange Rate

Bangladesh Bank limits its market interventions to countering disorderly movements and to building a more comfortable reserves position consistent with the macroeconomic program agreed with the International Monetary Fund. A managed floating exchange rate system in force since May 2003 has served the economy well, enabling it to adjust relatively smoothly to the changing external environment, especially in absorbing the oil price shock, supporting export growth, and protecting reserves.

The exchange rates of Taka for inter-bank and customer transactions are set by the dealer banks themselves, based on demand-supply interaction. The Bangladesh Bank is not present in the market on a day-to-day basis and undertakes purchase or sale transactions with the dealer banks only as needed to maintain orderly market conditions. The exchange rates are used as reference rates to purchase or sale transactions for Bangladesh Bank with Government or different International Organization. But USD/BDT buying and selling rates represent previous day inter-bank market's highest and lowest exchange rates.

Forecast of USD-BDT Movement for the Year 2008:

Forecast of USD-BDT for Year 2008

Month Taka per USD

Jan-08 68.60

Feb-08 69.00

Mar-08 67.00

Apr-08 69.50

May-08 69.00

Jun-08 68.50

Jul-08 68.00

Aug-08 67.00

Sep-08 66.50

Oct-08 68.00

Nov-08 68.50

Dec-08 67.75

Source: HSBC

The exchange rate came under increasing pressure during much of 2006, because of slowing financial account inflows and higher import prices for oil and some other products. The currency stabilized in the last quarter of the fiscal year, as the tighter monetary policy started to have an effect, and the current account strengthened notably. The exchange rate stood at Tk69.7/$1 in June 2006, representing an 8.5% depreciation against the US dollar in 2006 (see figure below). The marked depreciation in the nominal rate offset Bangladesh's higher inflation relative to its trading partners, and the real effective exchange rate of the taka depreciated by 5.3% in 2006, boosting the country's external competitiveness.

Buying and selling rates of other currencies in terms of taka

Currency Buying Selling

USD 68.58 68.58

JPY 0.69 0.69

GBP 136.71 136.74

EUR 108.32 108.35

CAD 67.10 67.14

AUD 62.92 62.94

Nominal exchange rate (Source: Bangladesh Bank)

Remittances and Non-Official Channel Foreign Exchange (Hundi)

Experiencing a huge surplus of labor and economic stagnation immediately after its independence in 1971, Bangladesh has pursued an active policy to locate overseas labor markets for its nationals and has been amazingly successful in penetrating the labor markets of the oil-rich Middle Eastern countries as early as the mid-1970s. Soon after penetrating the Middle East market in the 1970s, Bangladesh began targeting the comparatively developed economies of East and Southeast Asia. Some countries of East and Southeast Asia had experienced labour shortages in the late 1980s and started hiring a large number of foreign workers. Bangladesh established contacts with these countries and began sending thousands of its nationals to these new destinations since the early 1990s. To Bangladeshi migrants, these new destinations were economically more rewarding as they could draw higher wages compared to their counterparts in the Middle East.

This possibility of higher earnings induced the migration of better educated and enterprising Bangladeshis who were mostly unemployed or underemployed in Bangladesh.

As the labour markets in East and Southeast Asia are limited and controlled by strict regulatory measures, the flow of documented migrants to this region is mainly demand-driven. However, with the growth of migrant networks over time, a growing number of prospective migrants are able to circumvent the official regulation—a phenomenon that has given rise to undocumented migration in the region. According to some available data, the total cumulative figure for Bangladeshi documented migrants overseas until 2004 was approximately 4 million and for East and Southeast Asia alone, it was around half a million. However, it is understood that the size of undocumented migrants will be much higher in both regions. In the last decade, around 200,000 Bangladeshis annually migrated overseas for work through the official channel.

Bangladesh’s attempt to earn foreign currencies through the export of surplus labor has shown remarkable success. According to official data of Bangladesh Bank and BMET, Bangladesh received more than US$ 32 billion remittances from its migrant population between 1976 and February 2005. The formal remittance to Bangladesh has increased in congruence with the flow of migrant workers overseas. While in 1976 only US$ 24 million entered the country through formal channels, this number rose to around 1.09 billion in 1993, around 2.07 billion in 2001 and, finally, US$ 3.18 billion in 2003. The data on informal remittances is sketchy. An ILO study on remittances in Bangladesh revealed that ten out of 100 remittance receiving families faced problems with the hundi, whereas 19 people encountered problems with official transfer methods. The ILO study also found that the minimum time required to transfer the remittances was one hour and the maximum time was 25 days (bank draft). It is thus obvious that a large amount of cash enters the country informally.

To increase the inflow of remittances through formal channels, Bangladesh Bank, as the central bank of the country, plays a crucial role. Bangladesh Bank permits banks to establish drawing arrangements with foreign banks and Exchange houses for facilitating remittance by Bangladeshi nationals living abroad. Persons willing to remit their earnings

Through official channels can buy either Taka draft (Bangladeshi currency) or US dollar draft from these foreign banks and Exchange houses with drawing arrangements with different banks in Bangladesh. Bangladeshi nationals living abroad can send Foreign Exchange directly to their own bank accounts maintained in Bangladesh or to their nominated person's/relative's bank accounts in Bangladesh. Banks that are allowed to deal with foreign exchange either have their

own exchange branches or link up with international banks or money exchange companies in the host countries. Private Banks are not allowed to have branches in cities overseas. However, they have correspondent banks.

Some NCBs and PCBs had opened their operations in East and Southeast Asia in the 1990s. Some Bangladeshi banks that have arrangements with foreign banks and exchange houses in East and Southeast Asia are Sonali Bank, Janata Bank, National Bank, Agrani Bank, Islami Bank and United Commercial Bank. Transfers of money from these banks usually take a week in the case of receiving banks situated in the capital city Dhaka. However, if the receiving banks are situated in the district cities, the delivery time to banks extends to a few weeks. Migrant workers often blame the malpractices and unfriendliness of bank officials in Bangladesh. Likewise in some host countries, especially Singapore and Malaysia, it has been observed that there is a lack of customer-friendly attitude among the agents of exchange houses established by Bangladeshi banks.

Besides the facilitation measures for the remittance, strengthening of anti-hundi surveillance also aided the growth in remittances. Vigilance was tightened against bank accounts in Bangladesh being used for local transfers of funds to cover hundi transactions diverting away inward remittances of workers abroad. This surveillance was supported strongly with the enactment in April 2002 of a new law for prevention of money laundering activities in Bangladesh “The Money Laundering Prevention Act, 2002”.

Also, Bangladesh Bank has been making vigorous efforts for preventing flow of remittances through unofficial channels. These include expansion of activities of drawing arrangements, review of statements received from foreign banks/exchange houses, close monitoring and supervision of banks etc. Besides, the concerned scheduled banks had ensured quick delivery of remittances by reducing lead-time to the beneficiaries in Bangladesh, which brought substantial development in the delivery system. It is to be mentioned that, drawing arrangements have been made between 35 Bangladeshi banks and 380 foreign banks/exchange houses situated throughout the globe. Furthermore, an annual remittance threshold has been fixed up amounting to USD 3.00 million for each USA based exchange houses, GBP 2.00 million for UK-based exchange houses and 2.5 million for Canadian exchange houses. For these measures, remittances recorded a substantial increase by 24.8 percent to USD 4801.9 million during 2006, Remittances as percentage of GDP increased by 1.37 percentage point to 7.74 in 2006 from 6.37 in 2005. Remittances reached an astounding USD 5,979 million in 2007.

Foreign Exchange Reserve

Foreign Exchange Reserve is the stock of foreign currencies a country holds to buffer out imbalances between foreign receipts and payments. Bangladesh Bank, the central bank of the country, holds the stock of convertible foreign exchange reserve of the country in the form of liquid assets. In the first 2-3 years after liberation, the foreign exchange reserve of the country was composed mainly of aid/grants and export earnings. Subsequently, Bangladesh diversified export products and expanded its export base. It could also geographically diversify the direction of the export trade by exploring new areas. The export earnings gradually emerged as the main source of the country's foreign exchange reserves. In 1974, Bangladesh introduced the wage earners' scheme, which, by now, has become a significant source of foreign exchange. Bangladesh receives financial assistance from IMF under various arrangements, which also constitutes an important source of the foreign exchange reserve of the country. Moreover, as its member, Bangladesh receives additional SDR allocations from IMF. Historically, the foreign exchange reserves of Bangladesh has been largely inadequate compared to its needs for financing imports, meeting debt service liabilities, and paying for factor earnings of the foreign nationals. A growing demand for foreign exchange emanated from people traveling abroad for education, training and medical service outside the country.

Since liberation, Bangladesh had been following a very restrictive import policy and rationing scarce foreign exchange. In the process of economic reform and liberalization, restrictive policies were gradually replaced by liberal policies. Generally, the reserve position of a country is determined by factors such as vulnerability in balance of payments, the speed of reserve depletion, opportunity cost of holding reserves, and the international liquidity position. The supply of primary exportables from Bangladesh is inelastic in the short run and the country is dependent on imports for supply of industrial consumer goods, machinery and industrial raw materials. The prices of imported goods often fluctuate. As a result, the balance of payments situation remains under pressure. The balance is influenced by internal shocks generating from damages caused by floods or droughts as well external shocks originating from declines in prices of exportables or rise in prices of imported goods.

Bangladesh does not have easy access to international liquidity, particularly to commercial credit, and the availability of funds from official sources is subject to various conditionalities. This is why Bangladesh has to maintain a reasonable level of foreign exchange reserve equivalent to an amount that covers payment for at least about 3 months' imports. The trend of the reserve shows no uniform growth although there had been a rise in export earnings as well as workers' remittances. The reserves of $122 million recorded during 1981-82 were equivalent to less than a month's import payment. This occurred due to mainly a substantial decline in the prices of the country's exportables, suspension of IMF's Extended Fund Facility Programme, and lower aid disbursement. Amidst fluctuations, the reserves reached a peak level of $3.37 billion in April 1995 and then declined to $1.3 billion or equivalent to about 2 months' of import payment in December 2001.

Foreign exchange controls

Foreign exchange controls are various forms of controls imposed by a government on the purchase/sale of foreign currencies by residents or on the purchase/sale of local currency by nonresidents.

Common foreign exchange controls include:

Banning the use of foreign currency within the country Banning locals from possessing foreign currency

Restricting currency exchange to government-approved exchangers

Fixed exchange rates

Restrictions on the amount of currency that may be imported or exported

Countries with foreign exchange controls are also known as "Article 14 countries," after the provision in the International Monetary Fund agreement allowing exchange controls for transitional economies. Such controls used to be common in most countries, particularly poorer ones, until the 1990s when free trade and globalization started a trend towards economic liberalization. Today, countries which still impose exchange controls are the exception rather than the rule.

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Foreign Exchange Regulations

Of major note is, of course, that of May 31, 2003 to have a managed float of BDT, whereby Bangladesh Bank will have a minimum interaction with the market except as in stabilizing role. Also of not are those of 2005 and 2006 restricting swaps and forwards.

Some major changes in regulations are given below.

Year 2002

Bangladesh continued in 2002 with the policy of leaving the banks authorized to deal in foreign exchange, free to set their spot and forward exchange rates for customer transactions and interbank transactions, with the Bangladesh Bank announcing a one-Taka wide band within which it will buy and sell US dollars from and to the Authorized Dealer banks on a spot basis. This band was revised once in 2002, on 6 January 2002, to Taka 57.40--58.40 per US dollar from the previous Taka 56.50 to 57.50, involving depreciation by 1.6 percent.

Year 2003

Effective from 31st May 2003, Bangladesh stepped into fully market based exchange rate for the Taka, with BB notifying that it no longer had a pre-announced rate band for transactions with banks and that it would intervene in the market only as and when needed to ensure orderly market conditions. The BB took elaborate preparation prior to this changeover to equip itself with the necessary instruments to maintain the stability of the market exchange rate and interest rates. Monitoring of key market variables and forecasting of liquidity were strengthened; monitoring of open exchange positions of the banks and of the capital controls were paid special attention. Repo and reverse repo with banks by the BB were introduced to enable a firm grip on market liquidity.

The major changes in foreign exchange regulations in 2003 were:

a) With a view to ensuring balanced buildup of forward purchase and sale commitments, authorized dealers were instructed to cover their forward sales of foreign exchange with forward rather than spot purchases.

b) The foreign exchange retention quota for exporters was enhanced from 40 percent to 50 percent for merchandise exports and software/IT exports. The retention quota for exports with high import content was increased from 7.5 to 10 percent.

c) Exemption from declaration to the customs authorities of foreign exchange brought into Bangladesh by an incoming passenger was lowered to USD 3,000 from USD 5,000.

Year 2004

The major changes in foreign exchange regulations in 2004 were as under:

a) In order to avoid risk/gain associated with transactions other than real transactions, the authorized dealers instructed to establish contract of new cross currency forward and swap transactions only against customer requirements without renewal of earlier non-real

Contracts of forward and swap transactions at their maturity.

b) To boost up the garments industries, cash incentives payment systems on fob export value of local garments in lieu of bonded warehouse or duty draw back facilities have been revised.

c) Validity period for export of Crust Leather has been extended up to 30 June 2004.

d) To increase the export of agricultural goods and to encourage the exporter of such goods, cash incentive has been increased from 15 percent to 25 percent in case of export of fresh vegetables and agro-based products. It has also been extended from 20 percent to 25 percent in case of fruits export.

e) A facility of 5 percent cash incentive has been declared in 2004 against the export of jute goods produced by government and non- government jute mills.

f) With a view to diversifying and expanding export of agricultural products 10% cash incentive introduced for export of tobacco and 15% for export of potato.

g) The ceiling of foreign currency to be brought into Bangladesh without declaration to the customs authority was refixed at USD 5,000 from USD 3,000.

h) For convenience of the incoming and outgoing tourists/travelers and to eliminate the illegal activities in foreign exchange, Bangladesh Bank issued 636 money changers (MCs) licenses till September 26, 1999. Subsequently, 376 licenses were cancelled upon detection of irregularities committed by the MCs leaving 260 in operation. On-site and Offsite supervision on the activities of money changers has been further strengthened to ensure disciplined operations in this area.

Year 2005


a) The compulsion of covering forward sales by forward purchases with the same amount

were relaxed. Under the new arrangement Authorized Dealers (AD) were required to cover at least 50 percent of their forward sales by forward purchases. The remaining portion may be covered by inter-bank forward purchase and spot purchase of export bills. Besides, forward sales associated with swap transactions were not required to be covered by forward purchases. However, outstanding swap transactions would have to be limited up to the open position limit designated for the transacting AD. Banks were advised to undertake swap transactions in line with counter party limit in accordance with core risk management guidelines issued by Banking Regulation and Policy Department of Bangladesh Bank on October 7, 2003.

b) ADs were instructed to prepare and submit currency-wise daily foreign exchange position as per revised format of exchange position statement.

c) Cash incentives for export of agriculture and agricultural products (fresh vegetables/fruits/ agro-processing produces) would be 30 percent instead of 25 percent effective from July 1, 2004.

d) Non-packer exporters would get cash incentives at 10 percent in case of export of frozen shrimp and other fish for retail packing.

e) Cash incentives or subsidy for export of jute and jute goods by Government and Private sector jute mills at 7.5 percent effective from July 1, 2004 to June 30, 2005.

f) To prevent the irregularities regarding non-entering of imported goods and non-tracing of the importers against imports and import payments, all banks were advised to make themselves confirmed about the authenticity of importers, importers present and permanent addresses, their business, their good will, their previous transactions, eligibility etc. before opening of letter of credit. However banks have also been advised to make sure about entering of imported goods against import payments.

g) Restriction of advance payment against imports without the permission of Bangladesh Bank were withdrawn subject to availability of bank guarantee issued by internationally recognized and renowned foreign banks on behalf of the foreign beneficiaries/suppliers.

h) To encourage more foreign investment in Bangladesh and to create scope for local commercial banks to profitably invest their funds, local banks were given authorization to provide working capital loan facilities to B and C type industries in EPZs.

i) To ensure about entering of imported goods against import payments, commercial banks were advised not to open new LCs on behalf of the importers against outstanding/nonsubmitted bill of entries.

Year 2006

The major changes in foreign exchange regulations in FY06 were as under:

a) In order to attract more investment "The US Dollar Premium Bond Rules 2002” and “The US Dollar Investment Bond Rules 2002” have been revised with effect from 3 July 2005. According to the revised US Dollar Premium Bond Rules and Investment Bond Rules, non-resident account holder means an individual of Bangladesh or foreign national residing abroad and holding a non-resident foreign currency account in a bank branch in Bangladesh with Authorized Dealership in foreign exchange.

b) It has been decided that prior Bangladesh Bank approval will, however, not be required for Taka advances by way of purchase of cheques in freely convertible currencies drawn by foreign embassies/international organizations/foreign nationals employed therein on their bank accounts abroad, provided that

(i) The Authorized Dealer is fully satisfied about collectibility of cheque proceeds in foreign currency within four weeks of purchase,

(ii) The expected collection period is fully factored in while deciding the purchase price in Taka, and

(iii) The purchases are with recourse to drawers of the cheques for any difficulty in collection.

c) It has been clarified that balance in the Nonresident Investors Taka Account (NITA) held for investment in Bangladeshi shares and securities may be transferred to the Foreign Currency Account (FCA) of the same person with the respective AD without prior approval of Bangladesh Bank. Similarly, balance in the FCA may also be transferred to NITA without prior approval of Bangladesh Bank. However, in both the cases a written request of the account holder will be required.

d) To attract investment in agro-based industry in Ishwardi EPZ it has been decided that subsidy facility would be given for the export of liquid glucose produced in this EPZ and the rate of

subsidy will be 20 percent of net repatriated fob value. This facility will be applicable for liquid glucose shipped during July 1, 2005 to June 30, 2006.

e) A decision has been taken by the government of Bangladesh that subsidy facility will be given against export of light engineering products (Carbon Rod for battery, UM-1/R-20/D size battery, UM-3/R-06/AA size battery and locally manufactured glassware, manufacturing machinery, moulds and parts) produced within the country. This facility will be applicable for the export products where shipment will be made during 1 July 2005 to 30 June 2006. If these products have value addition of more than 50 percent, then subsidy will be given at the rate of 10 percent of repatriated of net export value under prescribed conditions. In this connection, some guidelines have been issued to the ADs for compliance.

f) Authorized Dealers are instructed that besides bills of lading and Air Way Bills issued by the concerned carriers, negotiation of export bills may also take place against Forwarders' Cargo Receipts (FCRs) and House Air Way Bills (HAWBs) issued by freight forwarders provided that

i) The export letter of credit and the export sale contract specifically provide for negotiation of export bill against FCR/HAWB (as the case may be ) issued by a freight forwarder, and

ii) The freight forwarder issuing the FCR/HAWB is operating in Bangladesh with authorization from the Bangladesh Bank under Section 18A of the FER Act 1947.

g) Under Export Development Fund (EDF) preshipment credit facility in US Dollar was initially introduced for import of raw materials, accessories, spare parts and packing materials against export letter of credits on sight basis. Now it has also been extended for import of the same items on sight basis against export contract, provided that if any export proceeds becomes overdue for not being repatriated within four months after the shipment, the concerned exporter and/or business entity is not allowed to avail further facility under Export Development Fund. A single borrower exposure limit is fixed up to a maximum of USD 1.00 million.

Year 2007


a) Export subsidy for export of Halal meat will be given at 20 percent during 2007.

b) Cash incentives for export of selected items during 2007 is as follows; 5 percent for export oriented local textile sector, 10 percent for frozen shrimp and fishes, 15 percent for leather products, 15 percent and 20 percent (depend on using local material) for products made by hoogla, straw, coir of sugar cane, 10 percent for tobacco, 10 percent for potato, 15 percent for bicycle and crust bone, 7.5 percent for jute products, 15 percent for hatching eggs and dayold chicken of poultry industries, 10 percent for light engineering products and 20 percent for agro and agro processing products.

c) To attract investment in agro-based industry in Ishwardi EPZ it has been decided that

subsidy facility would be given for the export of liquid glucose produced in this EPZ and the rate of subsidy will be 20 percent of net repatriated fob value. This facility will be

applicable for liquid glucose shipped during 1 July 2005 to 30 June 2008.

d) On August 2006, it was decided that term loans in Taka for capacity expansion/BMRE of foreign owned/controlled industrial firms may henceforth be extended/renewed by banks without prior approval of Bangladesh Bank provided that: 1) the term loan in Taka does not exceed, as percentage of total term borrowing, the percentage of equity of the firm/company held by Bangladeshi nationals and firms/ companies not owned or controlled by foreigners, and 2) total debt of the firm/company does not exceed the 50:50 debt equity ratio. Besides, if requested, Bangladesh Bank may give consent to term borrowing proposals not confirming with the stipulations stated above.

e) For implementation of Uniform Customs and Practices for Documentary Credits (UCPDC-600), 2007 Revision, the Authorized Dealers (ADs) are advised to explicitly mention that UCPDC-600 shall apply for all Letters of Credit (LCs) to be opened from 1 July 2007. Similarly, in case of exports from Bangladesh against LCs are in conformity with the rule of UCPDC- 600. If otherwise, ADs shall get the LCs amended accordingly.

References

1. Multinational Business Finance by David K. Eiteman, Arthur I. Stinehill, Michael H. Moffet

2. Bangladesh Review & Outlook - 2007, HSBC

3. Bangladesh Bank, Annual Reports 2002, 2003, 2004, 2005, 2006, 2007

4. Weekly Currency roundup, Standard Chartered Bank

5. Bangladesh Bank Quarterly Report Oct-Dec, 2007

6. The Social Organization of Remittances: Channelling Remittances from East and Southeast Asia to Bangladesh by Md Mizanur Rahman and Brenda S.A. Yeoh

7. http://www.bangladesh-bank.org

8. http://www.bafeda.com/

9. http://www.cpd-bangladesh.org

Foreign Exchange Market in Bangladesh

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