Are Domestic Transactions in Foreign Currency A Necessity?

 

Foreign exchange transactions are guided by foreign exchange regulations of the country. In a simple sense, transactions between residents and non-residents should be executed in foreign exchange. A simple example can be cited in this regard. A foreigner visiting Bangladesh will use foreign currency to meet expenses. In this case, the person needs to encash foreign currency into Taka. Alternatively, foreign currency can be used for meeting expenses in shops, hotels having permission under foreign exchange regulations. In the same way, Bangladeshi people going abroad will take foreign currency in cash or through international cards for meeting expenses. These are transactions at individual levels.

In economic perspective, there are two paths through which cross border transactions are executed - current account and capital account. Business transactions like exports and imports of goods and services are executed under current account, in particular. On the other hand, generally investment typed transactions are executed under capital account. Capital account also gives birth to current account transactions for payments in the form of profit, dividend, interest, etc,

In the above cases, proposition of transactions in foreign currency between residents and non-residents is held true. But foreign exchange transactions in some cases allow transactions between residents in foreign currency. History indicates that Bangladesh economy started moving upward with export trade in readymade garments. Export was dependent mainly on input imports of fabrics and different accessories. Imports were facilitated by customs bond licenses for which no duties were required. The inputs were imported under letter of credit (LCs) against export LCs. These import LCs are known as back to back LCs.

Garment trade promotes backward linkage industries from spinning mills to different accessories industries. Under customs bond licenses, garment exporters become eligible to procure inputs from local manufacturer-suppliers through inland back to back LCs which are denominated in foreign currency. As per value added tax regulations, local suppliers are treated as exporters provided that such supplies are executed by inland back to back LCs in foreign currency. All exporters do not work under bond licenses. But there are many accessories operating under bonded licenses. Exporters operating without customs bond licenses are allowed to procure inputs in foreign currency as per policy from packaging industries, manufacturers of hanger and plastic goods operating under bond licenses. In addition, inland LCs can be issued in foreign currency favoring local contractors to implement local work order, procurement of which is initiated under international tender. Payments for such LCs established against work order are allowed to be settled in foreign currency which can be used to settle import payment obligations of relevant contractors.

Trading of exports and imports requires freight charges. Foreign exchange regulations permit payments of freight charges against FOB imports in foreign currency to carrier companies locally. Such payments in foreign currencies can be retained in foreign currency accounts for settlement outward payments with counterparts abroad.

The local territory is divided into two portions - domestic tariff area and specialized zone areas. Export processing zones, economic zones, etc. working as duty free areas are referred to as specialized areas. Transactions between these two areas are executed in foreign currency for treatment of the respective transactions as exports or imports.

In view of the points noted above, it is observed that transactions are executed in foreign currency between residents in some cases. With regards to customs bond facilities, settlement against local deliveries in foreign currency facilities to avail waiver of value added tax and others, if any. The settlement deemed to be made out of export proceeds indicates that local deliveries have been used for relevant export transactions. There is a paradox observed here. Transactions are of two criteria - inland LCs and payments thereof in foreign currency. Involvement of LCs in the transactions means that banks take exposure on customers favoring whom LCs are issued. In terms of conditions contained in LCs, suppliers will submit documents to banks which will be sent to counterpart banks for payments. LC issuing banks need to honor the documents provided that the same is in order. As such, banks need to pay to suppliers’ banks whether export proceeds are available or not. In this perspective, settlement of payments cannot ensure exports of goods. On the other hand, expenses between selling and buying prices of foreign currency are not saved in case export proceeds are not available.

In other cases of non-export transactions in foreign currency, there is every possibility of mismatch between receipts of payments from local sources and settlement of payments abroad. As such, there comes a question of the utility in settlement of local transactions in foreign currency.

In export trade, back to back LCs are opened for input procurements to execute an order. Payments for back to back LCs are kept aside out of export proceeds as per foreign exchange regulations. The amount is retained in foreign currency till settlement of payments against procurement under back to back LCs. This is applicable both for imports from external sources and for internal procurements. There is a challenge for local suppliers. They receive payments in foreign currency against their supplies from exporters. The business model they operate is not as similar to exporters producing outputs through inputs arranged under back to back LCs. They need to procure inputs from local and external sources in bulk. It means that they are required to procure inputs in wholesale-mode but sell in retail-mode. Payments in foreign currency against retail sales cannot support to make their import payments. Exporters can retain foreign currency till settlement of back to back LCs. But foreign exchange regulations do not allow local suppliers to retain foreign currency for indefinite periods. Retention period for them is only one month to settle import payments. Simply it is not possible to facilitate import payments out of fund retained in foreign currency. On expiry of the retention period, the fund is sold to banks which pay buying rates against the purchase. On the other hand, payments for bulk imports are settled in foreign currency from banks’ own sources at their selling rate. As such, local transactions in foreign currency and retention of the same do nothing to support in minimizing exchange loss faced by suppliers.

Central bank is reported to operate export development fund (EDF) for input procurements by exporters from external and internal sources. The source of fund used for the purpose is international reserve of the country. It is said that use of fund in such a way makes international reserve encumbered. As such, used fund cannot be a part of international reserve. In this view, fund size from EDF is said to be at reducing trend. As an alternative way, a new scheme in the name of export facilitation prefinancing fund has been introduced in Taka. The fund will be used for procurement by exporters. Since this is a Taka fund, it is not easy to use it for settlement of local procurements under back to back LCs in foreign currency. This is possible only if foreign exchange market is in a sound liquid position.

Due to Russia-Ukraine war, disruption of global supply chain led foreign exchange market to face high pressure. Taka lost substantial value. As a part to bring the situation under control, different policy measures were adopted. One of the measures is to encash export proceeds within a specified period. Very recently, central bank has brought restrictions to transfer value added portion of export proceeds to different banks; with instruction for immediate encashment of value added portion. Retention of fund in foreign currency for settlement of local payments can apparently do nothing for liquidity of the market. But such fund becomes a liability of banks with corresponding balance held abroad. The net position is zero. However, use of the fund leads banks to be in negative position. The situation may result in problems by banks to meet demand of the customers concerned unless prudent fund management is in place.

As said earlier, transactions in foreign currency are not supportive to beneficiaries against local supplies, local projects, transportation charges, etc. due to timing mismatch. But procedures are operational since long with the introduction of inland back to back LCs in terms of regulations on duties, taxes, levies, etc. It is a question if it ensures anything to protect revenue loss. Since banks take exposure on issuance of inland LCs, they are bound to make payments whether export proceeds are available or not. As such, back to back payments in foreign currency do not indicate that ultimate export has been executed. In other cases like local projects, transport charges, confirmation of export is not mandatory. As such, should local transactions not be stopped to bring foreign exchange market liquidity to a better level by fine tuning relevant regulations?

 
Mehdi Rahman works in the
development sector.