1.

0 Exchange Rate System in Bangladesh

The Finance minister of Bangladesh declared sometime ago that
Bangladesh would soon introduce the floating exchange rate in place
of the fixed exchange rate. Donors also have been also putting
pressure on Bangladesh to go for the floating exchange rate and
reportedly, the getting of foreign assistance from them also depends
considerably on introducing the new system of exchange of currency.
Many countries of the world are operating a floating exchange rate
system as a relatively more efficient and gainful system in place of the
fixed exchange rate system. The neighboring countries of Bangladesh
have all gone for the floating rate system in 1998. Pakistan in 2000
and Sri Lanka in 2001. Media reports suggest that Bangladesh is under
intense pressure by the International Monetary Fund (IMF) to change its
prevailing exchange rate regime to one in which the nominal exchange
rate will be determined primarily, if not solely, determined by the
market forces of demand for and supply of foreign exchange. In light of
this development, our report will seek to determine the different
foreign exchange systems and assess the specified pros and cons of
each in Bangladesh perspective.

1.1 Several key exchange systems are:

a)
b)
c)
d)
e)

Fixed exchange rate system

Floating exchange rate system
Managed float/ dirty float
Pegged exchange rate system
Joint float

A) Fixed Exchange Rate: a fixed exchange rate is a stated exchange rate between two
currencies at which anyone can transact. In a fixed exchange rate system the Central
bank commits to buy and sell at a fixed rate. This system was maintained globally
from 1944 until the early 1970s under the supervision of the International Monetary
Fund (IMF). Suprisingly Bangladesh maintained this system until few months ago. A
country such as Bangladesh might import more than it exports for quite sometime
without causing a change in fixed exchange rate. However the crucial point that
needs to be recognized here is that fixed exchange rate is only fixed in the short run
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and definitely is subject to periodic adjustments. For a country like Bangladesh, the
continual excess of imports over exports puts pressure on the value of Bangladeshs
currency as the world supply of Bangladeshs currency continues to grow.
Eventually, the fixed exchange rate between Bangladesh and exporting nations will
be adjusted but the Bangladesh currency will be devalued. The value of other
currencies will increase relative to Bangladeshi taka.
It may seem perplexing that the value of the currencies would not adjust smoothly
over time, as Bangladesh continues its program of excess imports. A fixed exchange
rate system however prevents gradual adjustment. Rates are fixed through the
intervention of the central banks of Bangladesh and other exporting countries. As
excess supplies of Bangladesh currency accumulate, central banks may use there
reserves of other currencies to buy Taka, there by easing the imbalance between
supply and demand that would arise at the fixed level of rates. Sometimes the excess
supply of taka may become excessive where central bank becomes unable or
unwilling to purchase all of the taka that is supplied, when this happens, yet again
Bangladeshi taka will devalue again and set a new rate of exchange as the official
rate.
One obvious and apparently disadvantageous feature of a fixed exchange rate system
is that changes in the exchange rates occur infrequently, but when they do, the
changes are rather large. There are, however, considerable advantages to a fixed
exchange rate system. First, fixed exchange rates make planning exchange
transactions considerably easier. If business can depend on a fixed exchange rate for
the preceding year, they would not face any exchange risk the risk that the value
of a currency will change relative to other currencies. Freedom from exchange risk
facilitates business planning and promotes international trade. Second, for firms
engaged in international commerce, fixed exchange rates mean that accounting
income is not sensitive to exchange rte fluctuations. Third, a fixed rate may provide a
form of discipline for economic policies by the participating countries. Pertaining to
these advantages, one should realize that pursuing these policies would likely effect
in devaluing the ones currency, which could be considered good for exporting
countries and worse for importing countries.
B) Floating Exchange rate: This system is solely determined by the supply and
demand of a countrys currency. The key point noticeable is that the central bank
does not attempt to influence the value of the currency by trading in the foreign
exchange market. When a country like Bangladesh, runs a balance of payments
deficit, the supply of taka offered on world financial markets exceeds the demand,
and its value depreciates in comparison to other currencies. The idea behind this in
Bangladesh perspective; say Bangladesh is initially in a situation where the supply of
and demand of taka is equal and hence the foreign exchange rate is in equilibrium. In
general we Bangladeshis prefer to use foreign products rather than use our own. So
to meet this demand, our traders import huge quantities of items that are in demand.
This trading shifts the entire supply curve of taka to the right since we trade
excessive amounts of taka for dollars or any other currency to transact this business.

At the old exchange rate, Bangladesh now has a deficit in its balance of payments,
which translates into a supply of taka greater than the demand as our foreign
investment is not that lucrative. By using the floating exchange system, the taka will
depreciate toward a new lower equilibrium level. Benefits of this would be in the
long run. How? Firstly, it allows the central bank to follow a counter-cyclical
monetary policy (even with internationally integrated financial markets), automatic
accommodation of terms of trade stocks, giving the government clear lender-of-last
capacity to rescue failing banks and revenues from seignorage, and avoiding the
damaging speculative attacks that currency pegs have been prone to recent years. In
short the floating exchange rate system helps to correct payment imbalances
automatically, it helps to insulate from external events because exchange rate adjusts
to compensate and most importantly the Bangladeshi government can choose any
inflation rate (exchange rate will adjust) which is a key factor to a countrys mass
economy.
C) Managed Float/ Dirty float: Few countries have truly freely floating exchange
rates, because central banks seem unable to resist the temptation to intervene. When
the central bank of a country engages in market transactions to influence the
exchange value of its currency, but the rate is basically a floating rate, then this
system is categorized as a managed float or dirty float. Certain benefits pursue this
system. First it prevents large imbalances in exchange rates and it also helps a
country to develop its own region al currency schemes.
D) Pegged Exchange system: This pertains to a currency being pegged to the value of
another currency, that it self floats. As a scenario, Bangladesh might try to maintain a
fixed exchange rate with the dollar, but the dollar itself might float against most of
the worlds currencies. In such a situation, the taka of Bangladesh would be
considered to be pegged with the dollar. Pegged currencies may be pegged to a single
currency while others could be pegged to a basket, or portfolio, of currencies.
Unfortunately this system is not that feasible in the Bangladesh perspective. Why?
The main ingredient to influence an adequate pegged system is to have enough
foreign currency reserve. The rational point behind this suggests that; should the
exchange rate come under pressure, the authorities must have adequate foreign
exchange to intervene effectively in the market to maintain the pegged rate. The
reason being; authorities cannot remain as idle onlookers when the exchange rates
fluctuate wildly. The experience of developing countries worldwide (in some cases
even developed countries) shows that authorities can not avoid intervening in foreign
exchange markets under floating regimes in order to maintain a reasonable degree of
stability in the exchange rate. In relevance to the above point, the need for
intervention may be even stronger for Bangladesh with its thin foreign exchange
market, which typically implies greater fluctuations. Another factor for the market
being thin and being controlled by a small number of operators, pegged float will
inevitably lead to a large degree of volatility. This in turn inhibits trade as well as
investment (both local and foreign) due to greater exposure of economic agents to
exchange rate risks. Yes we can hedge this risk but in reality a) Bangladesh dont

have any organized markets for currency futures and options b) The foreign
exchange market is extremely thin.
E) Joint Float: The policy of joint float is another exchange rate management technique
dealing specifically with the foreign exchange futures market. In a joint float,
currencies participating in this system have fixed exchange values relative to other
currencies that do not participate in the joint float, but the group of currency floats
relative to other currencies that do not participate in the joint float. The prime
example of the joint float technique comes from the European Economic Community
(EEC), or the common market. The member nations formed the European Monetary
System (EMS) in 1979 and created the European Currency unit (ECU). In theory, a
joint float system means that the values of the currencies of the participating
countries for example (EU) will be fixed relative to another but will float relative to
external countries. This has important implications for speculation and hedging in all
of these currencies, particularly where the futures market is concerned. One of the
key points why; it would be hard for Bangladesh to adapt to such a system.

1.2 Historical perspective of Exchange Rate System

This section provides a brief review of exchange rate policy in Bangladesh since
independence. The discussion is organized by political regime, starting with the Mujib
regime.
The Mujib Regime: 1972 1975
On 3 January 1972 the exchange rate of the newly created currency (taka) was fixed with
the British pound sterling at the rate of 1 = taka 18.9677. The establishment of this
unitary exchange rate mechanism replaced the dual exchange rate system of the Pakistani
era. During the early years of independence the government adopted an expansionary
monetary and fiscal policy. This either generated or accelerated inflation to the level of
about 50 percent per annum during the period 1972-1975. This made the taka grossly
overvalued, especially with Indias rupee and that created large official imbalance with,
and destablishing smuggling out of essential goods to, India. The decade of the 1970s
was crucial insofar as macroeconomic management. The government introduced an
unsustainable monetary and fiscal policy regime within a pegged exchange rate system.
This created a prolonged exchange rate misalignment, causing a major damage to the
economy.(Akhtar Hossain, 2000)
Table 1: Nominal and Real Exchange Rate, +Bangladesh, 1971 1976
Nominal Exchange Rate
Year
1971
1972

taka/$ Rs./$ taka/Rs.

7.761 7.492 1.036
7.594 7.594 1.000

Real Exhange Rate

of the Taka with:
Rs.
$
3.48 38.81
2.52 27.61

1973
1974
1975
1976

7.742 7.742
8.113 8.102
12.019 8.376
15.347 8.960

1.000
1.001
1.435
1.713

1.98
1.65
2.06
2.22

20.09
15.18
20.13
26.55

Note:
+ The real exchange rate is defined as the nominal exchange rate of the taka per
unit of foreign currency (Indias rupee or the US dollar) multiplied by the corresponding
relative price level.
Source: The basic data for the nominal exchange rate are obtained from IMF, IFS
yearbook 1995 plus monthly issues of later dates.
The Zia Regime: 1976 1981
The Zia government continued with a passie exchange rate policy, that is it did not
devaluate the taka ( although it was overvalued) but imposed restrictions on imports as a
means to keep trade deficits under control. There were two reasons why there was no
balance of payments crisis during the Zia regime. First, there were sustained inflows of
workers remittances and foreign aid. Second, the government was able to arrange
commercial loans on some occasions when it faced an economic crisis.(Akhtar Hossain,
2000)
Table 2: Nominal and Real Exchange Rate, Bangladesh, 1976- 1981
Nominal Exchange Rate
Year
1976
1977
1978
1979
1980
1981

taka/$ Rs./$
15.347 8.960
15.375 8.739
15.016 8.193
15.552 8.126
15.454 7.863
17.987 8.659

taka/Rs.
1.713
1.759
1.833
1.914
1.965
2.077

Real Exhange Rate

of the Taka with:
Rs.
$
2.22 26.55
2.35 27.03
2.39 26.95
2.30 22.52
2.32 26.94
2.39 29.80

Notes and Sources: As table 1

The Ershad Regime: 1982 - 1990
The Ershad government, which came to power in early 1982, continued with exchange
rate policy with Zia government, but with a minor adjustment. In 1983, it replaced the
pound sterling wit the US dollar as the intervening currency. Facing serious
macroeconomic problems, the government accepted World Bank-IMF structural
adjustment loans under conditionality. Despite pressure from the World Bank and the
IMF, he did not have much commitment to structural reforms as that might have affected
those vested interest groups who became his political supporters. As a result, there was
not much improvement in macroeconomic policy. The government continued with an

expansionary monetary and fiscal policy. Trade deficit were also large of about 13
percent of output.(World Bank, 1996)

Table 3: Nominal and Real Exchange Rate, Bangladesh, 1982 - 1990

Nominal Exchange Rate
Year
1982
1983
1984
1985
1986
1987
1988
1989
1990

taka/$ Rs./$ taka/Rs.

22.118 9.455 2.339
24.615 10.099 2.437
25.354 11.363 2.231
27.995 12.369 2.263
30.407 12.611 2.411
30.950 12.962 2.388
31.733 13.917 2.280
32.270 16.226 1.989
34.569 17.504 1.975

Real Exhange Rate

of the Taka with:
Rs.
$
2.58 34.55
2.75 36.28
2.47 35.29
2.39 36.45
2.49 36.34
2.45 35.00
2.34 34.14
1.97 33.11
1.98 34.57

Notes and Sources: As table 1

Khaleda Regime: 1991 1996
The Khaleda government, which came to power in February 1991, continued with
economic reforms under IMF-World Bank structural adjustment programs. On January
1992, the government unified the exchange rate regime by abolishing the secondary
exchange market and made an improvement in current account transactions by removing
some exchange controls. Another positive step was the development of interbank foreign
exchange markets. The removal of exchange controls induced inflows of workers
remittances through the official channels. This lowered the level of current account
deficit. Large inflows of foreign remittances, however, boosted foreign exchange
reserves.(World Bank, 1996) ]
Table 4: Nominal and Real Exchange Rate, Bangladesh, 1976- 1981
Nominal Exchange Rate
Year
1991
1992
1993
1994
1995

taka/$ Rs./$ taka/Rs.

36.596 22.742 1.609
38.951 25.918 1.503
39.567 30.493 1.298
40.212 31.374 1.282
40.278 31.427 1.242

Real Exhange Rate

of the Taka with:
Rs.
$
1.71 35.57
1.71 35.57
1.57 39.13
1.65 39.37
1.67 38.34

Notes and Sources: As table 1

Sheikh Hasina Regime: 1997 2001

This regime was the continuation of IMF-World Bank structural adjustment programs.
The growth of export was satisfactory due to devaluation of taka.
Khaleda Regime: 2001 present
Due to the pressure from IMF-World Bank and donor countries, few days ago
Bangladesh has changed its exchange rate policy. It has shifted from fixed to floating
exchange rate. In this system market forces will determine the exchange rate system.
1.3 Reasons for Changing Exchange Rate System
There are three main reasons for the developing countries including Bangladesh switch
from fixed to flexile rate arrangements. First, as inflation rate in many developing
countries at high levels during the 1980s, they allowed their currencies to depreciate to
restore external competitiveness. This was part of the general shift in economic policies
in developing countries from inward-looking to export-oriented industrialization. Second,
the switch from pegging to flexible exchane rate arrangement was intended to minimise
the adverse effects of fluctions in the exchange rate of major currencies. Third, the move
was politically convenient to most governments of developing countries as they took
advantage of fluctuatons in major currencies to camouflage an effective depreciation of
their currencies. (Aghevli, Khan and Montiel, 1991).

The Advantages and Disadvantages of Fixed and Flexible Exchange Rate Systems

Fixed Exchange System

Advantages
Disadvantages
Certainty about
Parities become out
Value of currency
of
date and have to
change
No speculation if
Speculative
Markets are convinced
Pressures build up
Exchange rates can
and large changes
Be maintained
the exchange

Floating Exchange system

Advantages

Disadvantages

Automatic correction
Speculation may drive
of payments imbalances
exchange rate
Governments can choose
Unstable/uncertain
Any domestic inflation
exchange rate
Rate

in

Rate may be
required
Automatic correction
Parity becomes a
of monetary errorspolitical issue
excess money flows
abroad
Force Government to
of Monetary
Keep prices in line
Policy
With World prices
Increase credibility in
Does not work
Fighting inflation
against real shocks
(Inflation expectations

Insulation from External

Freedom to choose
Events
inflation rate may be a

Problem
Loss Monetary Policy
Credibility/ Inflation
Problems can occur
Can help with real shocks
Output effected by
(Aggregate demand)
monetary shocks
for

output stability
should go down)
Works against Nominal
Large capital inflow
(monetary) shocks for
a problem
output stability

Can handle large capital

inflows
are

Which Exchange
Rate should be
Pegged??

Regulation on Foreign Exchange Market

However, that the new exchange rate system will not be totally devoid of official
influence. The Bangladesh Bank is likely to resort to buying and selling of foreign
currency from time to time to indirectly play a stabilizing role in exchange rate
operations. For example, when the floating exchange rate system was made operational in
Pakistan, the same led to a jump in the exchange rate of the Rupee by ten or fifteen per
cent on the first day. Thus, Bangladesh must have provision for similar safeguards.
Bangladesh Bank should be able to buy up foreign currencies when the supply of the
same will increase and to sell the same when the supply will be squeezed to counteract
volatility in the exchange rate operations. The activities of speculators or those who buy
and sell foreign currency in bulk to make capital gain will also need regulation under the
new system and Bangladesh Bank's buying and selling operations will also likely hedge
against such activities.

Foreign Exchange Activities in Bangladesh Commercial Banks

Foreign exchange trade is of vital importance to the economic development of
Bangladesh. The countrys import needs are large and the imperative to increase exports
is immediate. In order to finance those imports and also to reduce the countrys
dependence on foreign aid grants, the government, since liberation, has been trying to
enhance foreign exchange earnings through planned and increased exports. The Banks
being part of the major implementation of this plan. In 2001-2002, foreign exchange
trade contributed to government revenue more than 37 percent. Last decade export

10

earnings increased by 14% per annum on current dollar prices, which accumulated a lot
of taka inflow as the dollar appreciated at an average of 4% each year.
The Financial sectors of Bangladesh (Banks) are being complemented by appropriate
forex regime. An Active exchange rate policy to maintain the competitiveness of the
economy is being followed in the back drop of the Uruguay Round Multilateral Trade
Agreements and particularly, the gradual merger of Multifiber arrangement into the
GATT the exchange rate will be closely monitored. By the pressure form banks the taka
has been made convertible on all international current transactions. Hence giving the
gateway to the world financial markets and making foreign exchange trade more
profitable and volatile in Bangladesh concept.
For this report we looked into the foreign currency activities of Bangladesh Krishi Bank:
Bangladesh Krishi Bank (BKB) has been engaged in Foreign Exchange Business since
1980. It deals in all kinds of export, import, remittance and other sorts of foreign
exchange business. BKB has got 170 major correspondent banks globally and maintain
sufficient number of Nostro accounts in various foreign currencies with different
leading banks in important business centers of the world. Recently BKB has taken a
massive foreign exchange businesses program to increase business four times over the
previous year substantiality. Besides import of capital machinery and raw materials for
agro-processing industries and export of agricultural products, foreign remittance & all
sorts of foreign exchange transaction services provided regularly.

o
o
o
o
o
o
o
o
o
o
o

Letter of Credit (LC)

Bill purchase/Discount
Export Credit (Pre Shipment & Post Shipment)
Remittance (Inward outward)
Collection, Purchase and Sale of Foreign Currency and Travelers
Cheques.
Guarantees in Foreign Currency.
Foreign Currency accounts.
NFCD (Non-Resident Foreign Currency Deposit) A/C.
RFCD (Resident Foreign Currency Deposit) A/C
Forward Contracts
Dealing Room
S.W.I.F.T. (Society for Worldwide Interbank Financial
Telecommunication).

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1) Import Finance
BKB deals in all kinds of Documentary Credit operation under different credit
Lines/Aid/Loan/Grants/cash etc. BKB finances in the following import sectors for
boosting exports, All kinds of Capital Machineries for the development of economy
giving special emphasis on Agro based industries/Ready made Garments industries
and imports substitute industries. Import of all kinds of industrial Raw Materials for
the industries
2) Export Finance
BKB supports exports of any kinds giving special emphasis on the following
Financial assistance to all kind of export oriented industry and other products
specially export of fruits & vegetables
Offers Concessional rate of interest for the Export Finance.
Does all activities in exports, such as:
Export bill negotiation /Purchase/Collection.
Help's export firms getting export incentive.
Financial support for materializing the export order.
(3) Foreign Remittance
BKB plays an important role in the field of foreign remittances. Most of the
BKB branches (919) located at the remote areas of rural Bangladesh.
The Bangladeshi people working abroad and their relatives in the country maintain
bank accounts with the BKB branches. Bank has an arrangement to allow
Bangladeshi people working abroad to send their foreign currencies to their relatives
at home. Necessary step's have been taken to widen this sector so that the Bank can
serve more people and collect more remittances

4)

Foreign exchanges activities

BKB extends its service to the travelers through endorsement of cash FC/TC in
passports.
BKB renders Hajj services to the pilgrims.
BKB deals in spot and forward sale and purchase foreign currency in local interbank market.

12

Reuter advice to the potential Entrepreneur/ Trader/ Businessmen for import and
export.

In light of all the foreign exchange activities we tend to focus on the Letter of credit
which is one of the main sources of foreign exchange trade and deposit. From this
activity alone, Bangladesh krishi bank generates substantial amount of profits
Profit Schemes in terms of commission:

Negotiation of documents - .25%

Realization commission - .15%

Back to Back L/C commission varies on company CIB report

L/C opening commission - .6%

Acceptance charge - .9% if with in 120 days

.6% if with in 90 days

The Bank also generates a substantial portion of its revenues in international markets
from the foreign currency deposits against Letter of credit in Sonali Bank, which subjects
its operations to the exposure of foreign currency fluctuations. The impact of currency
fluctuations can be positive or negative in any given period. The Banks ability to
counteract foreign currency exchange movement is primarily dependent on pricing. To
minimize the adverse impact of foreign currency fluctuations on its foreign currency
Letter of credit, the bank may engage in foreign currency-denominated borrowings. The
Bank determines the aggregate amount of such borrowings based on its forecast of the
Letter of credits net asset position and the relative strength of the U.S. dollar as compared
to foreign currencies. These borrowings create foreign currency-denominated liabilities
that hedge the Banks foreign currency-denominated foreign net assets (Bonds). Upon
receipt of the borrowed foreign currency-denominated funds, the Bank converts those
funds to U.S. dollars at the spot exchange rate. Exchange gains and losses on the foreign
currency-denominated borrowings are recognized in earnings as incurred.
From time to time, the Bank may use over-the-counter foreign exchange swaps to reduce
the interest expense incurred on its overseas borrowings. When a foreign exchange swap
is used, the currency received by the bank in the spot market component of the foreign
exchange swap is used to close out borrowings in a similar currency and, simultaneously,
the original borrowing position is reinstituted through a forward contract (not exceeding
six months). The net interest value of the foreign exchange swap contract is amortized to
earnings over the life of the contract. Exchange gains or losses on the foreign currency
component of the forward contract are recognized in earnings as incurred in each

13

accounting period. The Bank does not enter into foreign exchange swaps because of
unavailability of Currency and swap market in bangladesh and for trading purposes soon
to be initiated when the dealing room is fully active.
In effect to the new policies of the government the krishi Bank may, from time to time,
also purchase U.S. dollar call options when the dollar appreciates since they do not have
the control to increase the taka value. The new regulation prevents these call options not
to exceed one year. The Banks purchase of call options will allow it to protect a portion
of its expected foreign currency-denominated revenues (dollars) from adverse foreign
currency exchange movement. The bank has to defer premiums and any gains for its call
options activity until the option exercise date.

14

Reference
E. Gup Benton and R. Fraser, Donald (1989), Commercial Bank Management, John
Wiley & Sons Inc.
W. Koch, Timothy. and S. Scott, Macdonald (2003),
South-Western.

Bank Management, Thomson

Hossain, Akhtar (2000), Exchange Rates, Capital Flows and International Trade: The
Case of Bangladesh, The University Press Limited, Dhaka.
Miller, Leroy, Roger and D. Van Hoose (1993), Modern Money and Banking, McGraw
Hill, Inc.
W. Kolb, Robert,(1997), Futures, Options, & Swaps, Blackwell Business

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