Foreigh Currency Reserve of Bangladesh

Topics: Monetary policy, Central bank, Balance of payments Pages: 31 (9699 words) Published: October 3, 2012
ISAS Working Paper
No. 85 – Date: 7 September 2009
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An Economic Analysis of Bangladesh’s Foreign Exchange Reserves M. Shahidul Islam 1 Executive Summary Following the rapid accumulation of foreign exchange reserves in recent months, there has been a growing interest in Bangladesh on the alternative uses of its reserves. However, different reserves adequacy measures based on global best practices confirm that its reserves holding is not markedly higher than what is required. The country’s reserves stand higher than the adequate level only when one considers the current account aspects of reserves benchmark which is perhaps appropriate for the country as its financial system is still autarkic. The dynamics in its balance of payments account also supports the fact. The paper highlights the fact that Bangladesh’s reserves build-up is the result of an ‘investment drought’ in the country. This is partly due to its underdeveloped financial systems, and partly due to other structural problems in the economy – entailing difficulties in properly channelling national savings to investments. As the Bangladesh central bank’s sterilised intervention increases, so will its cost of reserves accumulation. The reason is the interest rate arbitrage between Bangladesh and the United States. The United States government securities market, that absorbs the lion’s share of developing economies reserves, has been offering lower yields following the collapse in interest rate in the country in recent times. Nevertheless, the apparent spread between the United States Treasury and Bangladesh Treasury rates might be not that high in real terms if one weighs in Bangladesh’s certain benefits of reserves holding, particularly on the perspectives of stability in its domestic market. As the interest rate in the United States appears to remain low in the near term and the interest rate regime in Bangladesh is not very flexible to downward, the latter has two choices to make with its growing reserves. First, if one assumes that Bangladesh’s financial sector will not undergo significant reform in years to come, it could channel part of its reserves to alternative investments. Second, the country can expedite its financial sector reform using reserves as insurance. These two options emphasise the fundamental macroeconomic disequilibrium (gross national savings > gross national investment) in the country. The widening gap between savings and investment signals that Bangladesh either needs to adopt institutional reforms so that its economy finds a way to use the surplus savings or it must discover an alternative avenue to utilise them. 1

Mr M. Shahidul Islam is a Research Associate at the Institute of South Asian Studies, an autonomous research institute at the National University of Singapore. He can be contacted at isasmsi@nus.edu.sg.

The paper has a skewed preference for first option as it is the path that most developing countries historically adopted. Moreover, successful sterilisation requires a deep domestic financial market. As far as the second option is concerned, the country can encourage some local investment to “go global” that could ease the pressure on its domestic currency and price level. In the absence of an efficient bureaucracy and required managerial and other technical know-how, the setting up of a sovereign fund to acquire overseas assets may not be viable for the country. In the case of the development of infrastructure fund (or similar investment avenues), the paper recommends that such move should be supported by further research as it is a trade-off between low yield-high liquid assets and high yield-low liquid assets.

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Introduction In its latest monetary policy statement, the Bangladesh Bank, the central monetary authority of Bangladesh, stated that...

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