Crawling Peg: Aiming For A Stable Dollar Market Ahead

In response to either market pressure or advice from the International Monetary Fund, the central bank of Bangladesh introduced the crawling peg exchange rate mechanism on May 8. This system is new for Bangladesh and involves setting a middle rate to determine the exchange rate, with upper and lower limits forming a band within which the rate can fluctuate. Adjustments to this middle rate and band regulate the market as needed.

Since its implementation, the crawling peg has shown positive results for the country’s dollar market. Banks are enjoying greater freedom in trading, and there are signs of easing dollar liquidity.

Initial Impact and Mechanics

Upon introducing the mechanism, the central bank set the Crawling Peg Mid Rate (CPMR) at Tk117, resulting in a Tk7 spike in the official dollar rate—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.

Effects on Remittance and Transparency

The central bank’s signals play a crucial role in global currency markets. Following the announcement of the crawling peg, the remittance dollar rate increased by Tk1-1.5, and remittance inflows also rose. Under the previous fixed exchange rate system, banks collected remittances at higher rates and sold those dollars to importers at even higher rates, often concealing these rates. The new system has significantly reduced this concealment, with banks now providing accurate information on dollar transactions to the central bank.

Despite the increase in remittance rates from Tk115-116 to Tk118-119, the banking sector has benefited. Central bank data shows $1.38 billion in remittances arrived in the first 17 days of May, and bankers expect this could reach $2.5 billion by the end of the month. This would represent a significant increase compared to the average of less than $2 billion in the first 10 months of the fiscal year.

Revival of Interbank Dollar Transactions

The crawling peg system has also revived interbank dollar transactions after a two-year hiatus. State-owned and private banks had halted such trading since September 2022 due to fixed dollar rates. With interbank trading resuming, banks can now sell dollars at rates up to Tk118, narrowing the gap with the market rate and facilitating transactions.

Benefits to Exporters

Exporters have also benefited, receiving up to Tk118 per dollar under the new system, compared to a maximum of Tk109.50 previously. This 8% increase has made Bangladeshi exporters more competitive internationally. Banks report that exporters are bringing in larger amounts of export proceeds, improving dollar inflow and liquidity.

Future Considerations and Recommendations

Bankers caution that while the crawling peg is a step towards a market-based dollar rate, it will not resolve all issues in the dollar market. Proper implementation, with adjustments based on market reactions, is crucial. They suggest the central bank officially set a clear band, possibly Tk2-Tk3 or 2%-3%, to provide clearer market direction.

Additionally, the mid-rate should be flexible and updated regularly based on the daily Weighted Average Rate (WAR) of the dollar. Using the WAR as the mid-rate for the next day’s trading band would offer better market guidance.

Controlling the dollar rate also depends on money supply. Reducing the money supply can help control the dollar rate and inflation. The central bank has successfully used this method in the past and should intensify efforts to reduce the money supply now.

Overall, the central bank should use the crawling peg and other tools to stabilize the dollar rate and market, while allowing the dollar market to operate naturally. This balanced approach could help maintain stability in Bangladesh’s forex market in the coming months.

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