Using US Dollar in International Trade Facilitation in Bangladesh: Alternatives and Risks
(Published in the Financial Express in December 2019)
Professor Shah Ahsan Habib
Not different from other developing economies, international trade transactions of Bangladesh heavily depend on USD as mode of receiving and making payment. The country’s cross border transactions composed of mainly exportation and importation of goods and services; and cross-border investment and other financial flows are minimal. There is no doubt that making payment through USD to all trading partners might involve transaction costs in the process of currency conversion, and there are inherent exchange rate risks. However, using home currencies and holding extensive volume of multiple currencies (other than USD) involve other risks and complexities.
Evolution of the foreign exchange market in Bangladesh is closely linked with the exchange rate regime of the country. After independence, the exchange rate of the newly created currency of Taka was fixed with the British pound sterling in January 1972, and the dual exchange rate system was replaced by unitary exchange rate mechanism. The pound sterling was floated with dollar, after the breakdown of the Bretton Woods system, which made the taka to float with dollar via the pound sterling. The government pegged the taka to a basket of currencies of its major trading partners with the pound sterling as the intervention currency in 1979. The same exchange rate arrangement continued till the early 1990s. During this period, a notable change was the replacement of pound sterling with that USD as the intervention currency in 1983.
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. BB allowed ADs to maintain accounts in freely convertible currencies with their correspondents/branches abroad subject to compliance with AML-CFT regulations of Bangladesh Bank and other competent authorities. All convertible currencies (USD, GBP, Euro, JPY, CHY, CND) can be used to make and receive international trade payments in the country. According to GFET, LC may provide for payment or reimbursement in any freely convertible foreign currency or by way of credit to the non-resident Taka account of the concerned bank abroad. Payments for imports under barter agreements or under foreign Loans/Grants can be made only in the manner specified for the concerned barter/loan/grant. In addition, in export, payment for goods exported from Bangladesh can be received through an AD in freely convertible foreign currency or in Taka from a non-resident Taka Account. Receipts against exports under various barter and bilateral arrangements should be settled as per instructions issued by Bangladesh Bank from time to time.
In 2018, Bangladesh Bank allowed banks to open clearing accounts in the Chinese currency which has been the largest source of import for Bangladesh since fiscal 2006-07. Thus, banks should be able to settle imports from China easily through the clearing accounts. Before that, banks were already allowed to open such accounts in US dollar, British pound, Euro, Japanese yen and Canadian dollar with the Bangladesh Bank. It is to be mentioned that the Yuan became the fifth currency of the IMF’s special drawing rights (SDR) basket, which determines currencies that countries can receive as part of IMF loans. In addition, Bangladesh Bank has conducted a feasibility study on the impact of USA-China trade tension in 2018 which helps the regulators and market players comprehend the impact as our major import partner is China.
In Bangladesh, the trade transactions are clearly dominated by USD, and use of number of foreign currencies declined over time. However, use of USD remained consistently very high over the years. Other than USD, only the use of Euro was visible with 4 percent, and the uses of other currencies were insignificantly low during 2013-2019. Though the country’s major import partner has been China, import payments have been dominated by USD. Though, BB allowed CHY (Chinese currency) for import payment, till date the mechanism yet to get the expected level of impetus.
In exportation, around 27 currencies were used in 2013 for export receipt, which has increased to 34 in 2015, came down to 16 foreign currencies in 2019. Though the country’s major export trading partner is Germany for last few years, USD remained the sole dominated currency for receiving export payment in Bangladesh. Around 98 percent export transactions were conducted using USD in 2019 and the trend was around 97 percent during last decade. Besides, Euro and GBP were used in export but the amount remained insignificant.
Bangladesh has bilateral agreements with a number of countries to promote the regional cooperation and international trade transactions. The Government of Bangladesh has prepared a policy guideline to explore bilateral FTAs with prospective countries with a view to make deeper trade integration for export diversification and enhancement of Bangladesh’s exports and competitiveness.
The central Banks of Bangladesh, India, Iran, Nepal, Pakistan, Sri Lanka, Myanmar, Bhutan and Maldives have an Agreement to settle current transactions between these countries through the Asian Clearing Union (ACU) mechanism. All such payments to the ACU member countries excepting those covered by loan and credit agreements are accordingly settled through the ACU mechanism in ‘Asian Monetary Units’. However, payments not related to import and export of goods and services are treated as ineligible payments for being settled under ACU mechanism. In case of settlement, one country claims net amount on other country.
In addition, there are options for border trades and border hats with Myanmar and India respectively, to facilitate border business. In 2010, Bangladesh and India opened ‘border haats,’ or ‘common marketplaces’ in different border areas of the two countries with a limit of USD 100 (equivalent to local currencies) for any particular day in the border haats. Moreover, Bangladesh has border trade agreements with Myanmar with a limit of USD 10000 per transactions. Banks from both sides settle their net amount in the transactions through correspondent banks.
To save time and cost in settlements, Bangladesh Bank also operates a foreign currency clearing system enabling the AD banks to settle their mutual claims in USD, GBP, Euro, Japanese Yen, Canadian Dollar and CNY arising from interbank transactions. Under this arrangement, AD banks maintain clearing accounts with the Bangladesh Bank in USD, GBP, Euro, Japanese Yen, Canadian Dollar and CNY. Apart from the purpose of settlement with other ADs, these accounts may also be used for transfers to and from correspondents abroad. However, for trade settlement facilities, around ten Bangladeshi banks have twenty overseas business operation center in the form of representative offices, bank branches and financial agent.
In Bangladesh USD is used as major currency for international trade settlement due to convenience. In import, despite a significant demand for Chinese currency ‘Yuan’ for the last few years, banks cannot capitalize the opportunity in initiating transactions in CNY, China’s own currency. In the absence of this currency facilitation, banks of Bangladesh are to incur extra transaction costs in making import payments in CNY. The key reason behind the non-capitalization of trade settlement is inadequate supply of CNY in the accounts of Chinese banks as opined by industry experts. Moreover, banks in Bangladesh are also concerned with the adverse impact of trade war between China and USA.
In addition, according to statistics of Bangladesh Bank, Bangladesh receives a huge amount of loans and grants in Japanese currency, JPY. The volume of trade transactions in JPY is also considerable. In most of the cases, after receiving JPY, these are converted in other currencies, mostly in USD. Conversion of JPY into other currency is mainly for negative interest rate in JPY, higher charges current account charges in JPY and relatively higher fluctuation than other currencies.
In Bangladesh, a number of UPAS LCs is issued in Euro. Import settlement of those LCs is usually executed by taking loans in Euro or by converting nostro balance of USD into Euro through their correspondent banks. The current mechanism of import payment in Euro is expensive. In some cases, banks open LCs in Euro but makes payment in USD due to the availability and easy arrangement of USD. Though, a large portion of the country’s export is conducted with European countries, the export payments are received in USD mainly.
In case of Bangladesh, the uses of different foreign exchange derivatives are very limited in both local and foreign periphery. Bangladesh foreign exchange market is in many respects very old-fashioned with almost all transactions done in the spot market at spot exchange rates. While there is an active FX swap market, these are very short dated. Most volumes are transacted within one week, which is used as a funding technique by the banks. The outright forward is very popular among corporate entities, which have a genuine underlying transaction. These are usually for 3-6 month tenors but longer tenors of up to 2-3 years can also be undertaken for small ticket sizes. There is no regulatory restriction for the forward tenors. But to hedge the future exchange rate risk, forward products are used in a limited volume.
Dependence on USD for trade and other cross border transactions in the context of Bangladesh is not different from most of the other global economies. Historical evidences and trends clearly support the rationale for huge inclination on the USD throughout the World. Global efforts to search for an alternative to USD have not been successful till date. There are several global instances of having cross-border trade transactions using the currencies of home countries as part of bi-lateral or regional arrangements. The trends rather increased in recent years having more intense multi-dimensional political and economic power game. Special payment and clearing arrangement for trade transactions have been beneficial for Bangladesh. In the context of Bangladesh, extensive reliance on other convertible currencies may not be a wise option; however, home currency use in certain trade transactions with selected countries may help reducing transaction costs. Policy strategies for effective use of some hedging instruments might be helpful to handle foreign exchange and commodity price risks.