Crawling peg: Promising a stable dollar market ahead
In response to either market pressure or advice from the International Monetary Fund, the central bank introduced the crawling peg exchange rate mechanism on 8 May.
The crawling peg system is new for Bangladesh. Generally, in this process, a middle rate is set to determine the exchange rate, along with upper and lower limits forming a band within which the rate can fluctuate. The market is regulated by adjusting this middle rate and band as needed.
In the two weeks since its enforcement, the crawling peg seems to have yielded positive results for the country’s dollar market. Banks are exercising more freedom in trading and there are indications of an easing of dollar liquidity.
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Now is a good time to analyse how the system has achieved this and its potential for a balanced forex market in the upcoming months.
Upon introducing the mechanism, the central bank set the Crawling Peg Mid Rate (CPMR) at Tk117. This caused a Tk7 spike in the official dollar rate, marking the highest single-day increase in the country’s history. Banks were permitted to trade dollars around the CPMR without an official band, but were verbally advised to keep transactions within Tk116-118.
No need to conceal rate info
In terms of remittance dollars, the signals from the central banks play a crucial role in global currency markets.
Consequently, the remittance dollar rate increased by Tk1-1.5 the day after the Bangladesh Bank announced the crawling peg while remittance inflows also rose.
Previously, with a fixed exchange rate, banks collected remittances at higher rates and sold those dollars to importers at even higher rates. However, banks tended to conceal these high rates in various ways.
Since the introduction of the crawling peg, banks’ concealing information has decreased significantly and are now providing accurate information on dollar transactions to the central bank.
Effect on remittance inflow
Although the dollar rate for remittances has increased from Tk115-116 to Tk118-119 under the new system, there was no alternative considering the circumstances.
The increase in remittance rates, however, has also benefited the banking sector. Central bank data shows $1.38 billion in remittances arrived in the first 17 days of May.
Bankers expect that if this pace continues, Bangladesh could receive close to $2.5 billion in remittances by the end of the month.
In the first 10 months of the current fiscal year, remittances averaged less than $2 billion. Therefore, with the introduction of the crawling peg, remittances are likely to increase by an additional $500 million in May.
Interbank dollar transactions
After two years, the crawling peg system has enabled the resumption of interbank dollar transactions.
State-owned and private banks had halted such trading since September 2022 due to fixed dollar rates by the Association of Bankers, Bangladesh, and Bangladesh Foreign Exchange Dealers Association.
Banks were forced to buy dollars at inflated rates but could not disclose it. With interbank trading, banks had to accept the central bank’s announced rate, leading to losses during dollar crises.
The crawling peg has simplified this process. Previously, interbank sales were capped at Tk110, but now banks can sell up to Tk118, narrowing the gap with the market rate and facilitating interbank transactions.
Stakeholders believe if the system operates smoothly, interbank transactions will gradually resume. Many banks hold surplus dollars and selling them at market prices would increase dollar supply.
They also say banks with high dollar demand can then purchase from the interbank reducing competition for remittance dollars. With less competition, remittance dollar prices are less likely to spike suddenly in the market.
Benefits to exporters
Earlier, exporters used to get a maximum rate of Tk109.50 per dollar. After the introduction of the crawling peg system, they are getting a maximum rate of Tk118.
This means Bangladeshi exporters are getting about 8% more and gained some ground in competing with exporters from other nations.
The banking sector has already started receiving the result of the increase in the dollar rate of export proceeds.
Managing directors of several banks told The Business Standard that exporters are now bringing home larger amounts of export proceeds. They are making efforts to collect payments which is improving dollar inflow and liquidity in banks.
Besides, due to exporters having access to more liquidity, it will increase their ability to determine the wages of the workers taking into account the inflation of the country.
Moving forward
Bankers said crawling peg is not a market-based dollar rate but a step towards it. They caution that it won’t resolve all issues in the dollar market or maintain a low dollar rate. Proper implementation of the crawling peg is crucial, with adjustments informed by market reactions.
Firstly, they suggested the central bank officially set a clear band, possibly Tk2-Tk3 or 2%-3%. The current guidance of “around the CPMR” is not providing any clear direction to the market.
Explaining the matter, they said the demand for dollars in the country now is much higher than supply as the rate is around Tk118 in the market. This creates upward pressure on the rate despite raising the dollar price. Therefore, the market should be allowed to function according to its own rules to avoid further depletion of forex reserves.
The country’s gross reserves currently stand at $18.61 billion, at least $5 billion less than usable reserves. Gross reserves at the beginning of the current fiscal year were $23.75 billion. That is, reserves have fallen by about 22% in a span of about 11 months.
The main reason for this decline was the sale of dollars from reserves to state-owned banks to pay for government imports.
State-owned banks must collect dollars from the market according to their demand to prevent a fall in reserves. This will be possible only when the interbank dollar market is fully operational, bankers said.
Secondly, the crawling peg is effective only if the mid-rate is flexible. The central bank has currently fixed the mid-rate at Tk117, but it should be updated regularly based on the daily Weighted Average Rate (WAR) of the dollar, which was Tk117.77 last Thursday.
Bankers suggested using the WAR as the mid-rate for the next day’s trading band to provide better market guidance and observation.
Thirdly, the dollar rate depends on the money supply. If banks and traders have ample money, the dollar rate will rise. To control the dollar rate and reduce inflation, the money supply must be decreased.
A banking expert noted that the central bank has successfully reduced the money supply in the past to control inflation. This tested method should be used again in the current situation. While the central bank is already trying to reduce the money supply, these efforts need to be intensified.
Besides, banks should reduce lending through tools like repo and the assured liquidity support facility (ALSF), he said. A reduced money supply will create liquidity stress, leaving banks with few options but to raise money by selling surplus dollars or borrowing through currency swaps. This will decrease dollar demand.
Although this approach may not favour investment growth, the central bank might need to make such tough decisions to resolve the crisis, he added. “Overall, the central bank should use the crawling peg and other tools to stabilise the dollar rate and market, while allowing the dollar market to run its course.”
