Bangladesh: Then, Now, and the Impact on International Trade

To gain insight into Bangladesh's current political and economic landscape regarding international trade, it is necessary to assess the country's inherited political and economic challenges emanating from its previous government.

The immediate past government had been in power since 2009 (nearly 15 consecutive years). Although the national elections in 2014 and 2018 were reported as free and fair by some local and international media reports, there were concerns about the limited representation of the people, leading to allegations of vote rigging. During these two administrations, particularly the period from 2015 until August 2024, the government operated in an autocratic manner and the administration turned into a complete "electoral autocracy". As a result, the key elements of democracy, such as the legislative, executive, judiciary, and media, were compromised and skewed in favor of the government. Economic decisions were also not free from government intervention. Hence, Bangladesh Bank, the country’s central bank, was not exempt from this influence. This political setting raises the question of how an authoritarian government was able to remain in power for such a long period, especially in a country where the people strongly believed in a robust democracy. The ruling government chose economic development as a tool and largely sidelined democracy.

The initially peaceful protest was in response to a 5 June 2024 high court ruling to reinstate 56% of government positions based on quota instead of meritocracy. This quota system made it difficult for many young people to secure civil service positions. It was also alleged that supporters of the ruling party chiefly benefitted from this system. When the ruling party used force to suppress the protest, chaos spread across the country. The movement eventually focused on demanding the resignation of prime minister Sheikh Hasina. On 5 August 2024, she resigned and left the country. A new interim government was formed led by noble laureate Dr. Muhammad Yunus.

During the previous government's last five years, the economic situation was domestically very challenging, exacerbated by well-known global geo-political tensions. Events such as the COVID-19 pandemic, the Russia-Ukraine war, the Israel-Palestine conflict, and unstable commodity, oil, and fuel prices had a significant impact on the country due to its heavy reliance on imports. Consequently, Bangladesh's overall inflation increased substantially. Banks have felt liquidity pressure and faced difficulties in making import payments, leading to a persistent decline in the foreign currency reserve position since early 2023. Additionally, the country has had significant non-performing assets in the banking sector. Overall, there are six fundamental challenges in the economy:

• Currency volatility

• Overdue payment status

• Declining foreign currency reserves

• Escalating inflationary pressure

• Chronic Non-Performing Assets

• Correspondent Banks outlook

These challenges are addressed below and discuss action taken by the previous government (Then) and action taken by the interim government thus far (Now).

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Currency Volatility

Then: Bangladesh Bank, through moral persuasion, forcibly fixed the exchange rate for some time to settle import bills with customers and the interbank foreign currency market. However, the cost of foreign currency earnings for the banks was higher than the fixed exchange rate informally set by the Bangladesh Bank. This intervention in the managed float foreign exchange market aimed at controlling the imported inflation rate, but backfired. The foreign exchange market was essentially non-functional for 18 months or so, leading to a disproportionate holding of foreign currency among banks and worsening the situation overall. Under International Monetary Fund (IMF) pressure, the exchange rate eventually nudged closer to the market rate, but the impact of the central bank’s interventions failed to stabilize the exchange rate.

Bangladesh Bank took steps to reduce the import of luxury items by imposing a higher margin of up to 100%. Additionally, the banking sector was cautious about opening new letters of credit during this time. These measures positively impacted the economy by reducing the monthly import volume to around USD 5-5.5 billion, compared to the average monthly volume of USD 7-7.5 billion. However, the policy allowing longer periods for import of raw materials (up to 360 days from 180 days) and capital machinery (up to 3 years from 1 year) increased overall import settlement pressure. As a result, there was persistent strain on foreign exchange. During that period, domestic currency lending rates were capped at a fixed 9% p.a. Hence, domestic currency became cheaper to the business community as the lending rate was at par or below the prevailing inflation rate. Furthermore, a few Islamic banks faced massive deposit withdrawals due to adverse media and decay over customer confidence in those banks. Bangladesh Bank initiated special liquidity support (SLS) to avoid bank runs, mostly through quantitative easing. These actions also contributed to the rising inflationary trend. Despite the Bangladesh Bank removing the cap at a later stage and periodically letting the market determine the lending rate, this protracted decision did little to curb inflation.

Now: The interim government took immediate steps to address economic concerns, including allowing the exchange rate to be market driven, improving the efficiency of the interbank market in both local and foreign currency, and refraining from injecting US dollars into the banking sector from the foreign exchange reserves.

These swift actions have led to stability in the interbank foreign exchange market and exchange rates. However, some local banks are currently experiencing a liquidity crisis due to massive withdrawal of deposits. Bangladesh Bank is in the process of establishing guidelines to encourage stable banks to provide liquidity support to those banks facing a liquidity crunch, backed by the central bank’s guarantee. These measures have resulted in stability in both the domestic and foreign currency markets. 

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Overdue Payment Status

Then: During the last year of the previous government, the disproportionate holding of foreign currency due to an inactive interbank market forced on certain banks’ liquidity position was very challenging. Such banks were unable to honor their obligations on time, particularly those banks having liquidity stresses both in foreign and local currency during that period. Bangladesh Bank also tapped into the reserve and injected foreign currency into commercial banks, assisting banks in making payments. Over a period of time, the overall situation improved and most of the banks made their payments except for a few large amount LC payments for oil imports around USD 2 billion that mainly remained with public sector banks.

Now: The interim government has taken concrete steps to settle overdue bills. The governor stated that USD1 billion has already been paid and the remaining payment will be made in the coming months. Most banks are now honoring their obligations on time.

Declining Foreign Currency Reserves

Then: In August 2021, the gross foreign exchange reserves held by Bangladesh Bank exceeded USD 48 billion, equivalent to over six months' worth of the country's average imports, during that period. However, the payment of various project costs, allocation of funds for refinancing schemes, and loans given to Sri Lanka from the foreign exchange reserves put added pressure on the reserves at the time. The IMF later raised concerns about reserve calculation methods and proposed to disclose it on a net basis. Bangladesh Bank had taken a contradictory stance to halt the declining trend of FX reserved. On one hand, they issued several policy circulars such as increasing margin requirements for opening LCs for luxury items, setting monitoring on per LC value above USD 3 million and persuading banks to restrict opening LCs within their means. At the same time, they released foreign currency from the reserve to make payments for essential commodities and oil imports. The absence of an interbank foreign exchange market also impacted the reserve. Furthermore, the sudden increase of the benchmark rate (SOFR) made the country’s overall loan repayments more expensive. As a result, the country’s net FX reserve position deteriorated for a year and a half, standing at USD 20.39 billion as of July 2024.

Now: Immediately after assuming office, the new Governor of the Bangladesh Bank took a number of initiatives, including:

-- No US dollars have been sold from the reserve since he started his position.

-- Bringing stability in the exchange rates, and thus the interbank markets are operating efficiently

-- The foreign exchange market is liquid.

-- The difference between the official and unofficial exchange rates (kerb market) is negligible (less than 1%), leading to a reduction in remittance flows through informal channels.

-- Remittance flows from August to mid-September 2024 is significantly higher than the same period last year. He anticipates remittance inflows to be between USD 2.5-3 billion in the coming months.

-- The pre-condition set by the IMF to maintain an FX reserve level for September 2024 under the IMF loan agreement of USD 4.7 billion, has been met. The December 2024 target is also expected to be met.

-- Considering the pipeline of soft loans committed by the Asian Development Bank (ADB), International Finance Corporation (IFC), and World Bank (WB), experts anticipate further increase in the reserve position within 2024.

Bangladesh’s current foreign exchange reserve position is USD 20.54 billion, which is equivalent to an average of three months' worth of import payments. According to a statement by the Bangladesh Bank Governor, the continuous decline in the country’s foreign currency reserve position appears to be over and is now projected to increase.

Escalating Inflationary Pressure

Then: Amid the ongoing global crisis, most countries raised interest rates and allowed their exchange rates to fluctuate freely in the face of economic challenges and inflationary pressures. However, Bangladesh Bank took a different approach. It capped the interest rate at 9% and artificially maintained the exchange rate at BDT 89 per USD for an extended period. Consequently, the inflation rate surged to over 10%. Although Bangladesh Bank later increased the interest rate and allowed the exchange rate to fluctuate, this delayed decision-making did not effectively curb rising inflation. In July 2024, inflation in Bangladesh reached a 12-year high of 11.66%, with food inflation at around 14%.

Now: The governor has made reducing the inflation rate to a reasonable level within six months a priority and took several actions upon assuming office, including:

-- Declared no quantitative easing

-- Increased the policy rate by 100 bps, rate will go further to 10% in intervals

-- Global oil and commodity prices are declining, meaning no additional import inflation burden will infuse the economy

-- Upcoming monetary and fiscal policies will be contractionary

-- Endeavoring to cut fiscal expenditures by 1 trillion Taka (around 2% of GDP)

-- Stabilize market-driven exchange rates

-- Stabilize market-driven interest rates

While the inflation rate has already decreased by 1%, time will tell whether a decreasing trend will emerge. However, the governor anticipates that the inflation rate will be at 5-6% by 2025.

Chronic Non-Performing Assets

Then: Recent data published by the Bangladesh Bank shows that the Bangladeshi banking sector is facing significant issues with non-performing assets (NPAs) which have reached a record high. According to central bank data for 1Q24, the amount of NPAs exceeded BDT 182,000 crore (USD 15.1 billion), marking the highest level ever recorded in the country. The previous government had taken a lenient approach toward persistent NPAs and shifted from the international standards for loan classification to more favorable terms. This approach not only increased the NPAs in the banking sector, but also worsened the loan repayment behaviors of many problematic borrowers. As a result, a sizable amount of money was laundered and siphoned abroad. One of the reasons for this nagging problem within the economy is the lack of reform in the banking sector since the early 1990s.

Now: The interim government has vowed to reform the banking sector, including addressing the chronic NPAs issue. A taskforce will work jointly with partners such as the World Bank, Asian Development Bank (ADB), and International Finance Corporation (IFC) to tackle challenges in the banking sector. Previously announced unplanned mergers and acquisitions, as assumed by the then-Governor of the Bangladesh Bank, will not proceed and any mergers and acquisitions (M&A) will occur solely on a commercial basis. The new governor reaffirms that the country needs to first assess the exact position of its banks. Initially, ten banks will be reviewed and then others. This will enable Bangladesh Bank to understand their status and determine the necessary support. It is not appropriate to discuss M&As without first conducting such assessments. However, it is unlikely that there will be 62 banks in the next two to three years. Furthermore, Bangladesh is in discussions with World Bank, US, and UK authorities to assist in the return of siphoned money and has also appointed a legal firm to oversee the possibility of recovering laundered funds.

Correspondent Banks Outlook

Then: Throughout the past regime, correspondent banks were generally supportive, with some exceptions. During the COVID-19 pandemic, most correspondent banks were not as active in Bangladesh. This inactivity did not have a significant impact due to decreased business. The main challenge was meeting trade loan repayments and honoring LC obligations made before the pandemic. Since the domestic foreign exchange market was liquid, there was no immediate pressure to meet these obligations. However, in the last year of the previous government's term, the local foreign exchange market was under stress. Some banks delayed honoring their obligations during this period, leading to a reduction in support from several correspondent banks. As the situation improved, correspondent banks gradually returned to normal relationships with banks that had not delayed payments. Over time, almost all correspondent banks resumed their support.

Now: The sudden transition from the previous government to the interim government has led correspondent banks to closely monitor the situation. As a result, most correspondent banks have temporarily reduced or halted their credit limits, while still accommodating grandfathered transactions. However, a few correspondent banks are operating as usual, demonstrating a firm understanding of the situation. As the political and economic environment becomes clearer, additional correspondent banks have followed suit, particularly with banks adhering to international standard banking practices as in the past.

The Association of Bankers Bangladesh (ABB) conducted a "Meet the Governor" webinar in mid-September 2024 for correspondent banking partners. The webinar primarily addressed questions from various foreign correspondent banks about Bangladesh's economy, banking sectors, the current political landscape, and the way forward. The feedback from most correspondent banks has been positive. 

Future: Undetermined

The previous government's economic activities were largely ad-hoc and politically driven, compromising the autonomy of independent institutions. The interim government, chosen by the people, is working to bring independence to the governing system. In the meantime, several task forces have been formed in various segments as part of prospective reform actions. The task forces will submit their findings by 30 October 2024. Political parties are also aligned with and supportive of reformation efforts prior to conducting a free and fair election. Many people expect that the reform actions may take at least two years. However, whether all reform activities will be completed within two years is not yet clear.