Crawling Peg Exchange Rate System: Necessity of Ceiling and Floor

 

Central bank is reported to have introduced crawling peg exchange rate system for spot purchases and sales of US dollars. Under this system, a crawling peg mid rate is set at 117.00 Taka for per US dollar. Banks are allowed to purchase and sell US dollars freely around the mid rate with their customers and in interbank deals.

Different types of exchange arrangements are available in theory and practice. According to IMF classification, exchange rate arrangements are of four categories. They are hard pegs, soft pegs, floating, and other arrangements.

Under hard pegs, the value of a currency of a country is directly related to the value of another country’s currency or a basket of other currencies. Countries that use hard pegs need to give up control over monetary policy. Countries that adopt alternative national currencies are included in this category.

Soft pegs are considered a position in between fixed rates and floating rates. These are of five categories: conventional pegged arrangement, stabilized arrangement, crawling peg, crawl-like arrangement, pegged exchange rate within horizontal bands.

Conventional pegged arrangement means a country’s currency is formally pegged to another currency or a basket of currencies from significant financial or trading partners at a fixed rate. The country’s authorities are prepared to intervene directly or indirectly to maintain the fixed parity. Stabilized arrangement is a spot market rate that remains within a set margin for six months or more and but it is not floating.

Under crawling peg, currency is adjusted at a fixed exchange rate or according to the changes of selected quantitative indicators, such as the past inflation difference with major trading partners or the difference between the inflation target and expected inflation of major trading partners. In crawl-like arrangement, the exchange rate remains within a set range with respect to a statistically defined trend for six months or more and the exchange agreement cannot be considered floating. The minimum rate of variation is higher than that allowed in a fixed agreement.

Pegged exchange rate within horizontal bands refers to the value of the currency is kept within a band of the fixed central exchange rate or the difference between the maximum and minimum value of the exchange rate. Floating exchange rates are largely market determined and there is no defined or predictable exchange rate channel. This kind of arrangements subdivided into different categories such as free floating, and simple floating or intervention floating. Although the government and central banks do not totally set the floating exchange rate, they may nevertheless take some moves to keep the currency at a reasonable price for global trade. Floating exchange rates turns with the changes in supply-demand relationship of money, sometimes they may alter several times during one day.

When the exchange rate arrangement does not fit the criteria for any of the categories, the system is categorized as other arrangement.
The above points are basically discussion based on theories and on practices in some cases. In respect of Bangladesh context, history shows that it had been maintaining various pegged exchange rate regimes. During 1972-1979, exchange rate was pegged to pound sterling. In 1980-1982, it was pegged to a basket of major trading partners' currencies. Pound sterling worked as intervening currency. The intervening currency was changed, during the period from 1983 to 1999, to US dollar. It would keep pegs to a basket of major trading partners' currencies.

During the period from 2000 to 2003, crawling band was in force. Floating exchange rate was adopted in late May of 2003. Due to Russia-Ukraine war, supply chain became disrupted. Global price level rose to an abnormal height resulting in payment pressures. This led Taka to face depreciation to a large extent. To retain the value of Taka, exchange rate was managed by bankers’ associations from September, 2022. De jure floating exchange rate was adopted in 2003. But it was de facto managed floating. 

It is not possible for countries like ours to adopt floating exchange. Exchange rate needs to be managed by any means, with a view to maintain value of local currency. The arrangements may be stabilized arrangement, or crawling peg, or crawl-like peg, or managed floating. There are some challenges in implementing the acceptable arrangement.

Bangladesh Taka is convertible for current account transactions, transactions under capital account is permissible for inward investment. Outward investment including repatriation of fund by non-residents is subject to permission from competent authorities. There are other areas like misinvoicing which create demand for payments in conduit path. Of all sources of inflows, wage remittances are one of the best alternatives. This works as supply side, which are normally traded at higher rates compared to rates available in official channels.

The recent policy note on exchange rate is highlighted in the media at negative tone particularly. The system sets a mid rate without prescribing ceiling and floor. This band is well discussed in relevant areas including banking system. It is a question if prescription from the authority is required for ceiling and floor along with mid rate. The notification of central bank states that banks can purchase and sell US dollars freely around the mid rate of 117 Taka with their customers and in interbank deals. Considering the mid rate, the aggregate of purchases and sales will definitely be 234 Taka. It means that banks can purchase each US dollar at 107 Taka and sell at 127 Taka. The aggregate stands at 234 Taka resulting in mid rate of 117 Taka. Alternatively, 116.50 Taka can be used to purchase each US dollar with 117.50 Taka for sales. This will bring same aggregate of 234 Taka and mid rate at 117 Taka. Banks’ dealings with customers will definitely vary from customer to customer, from transaction to transaction and so on. Whatever the rate is for the settlement of deals, banks need to maintain weighted average mid rate within the set point. The calculation is simple. Only continuous look is required to avoid deviation from mid rate. Authority concerned is expected to monitor the transactions in such way so that mid rate is not breached. In view of this perspective, no question to set ceiling and floor is needed.

It is said Taka depreciation can encourage inflows of foreign currency. But reality is different. A little depreciation leads higher depreciation in shadow market because of strong demand side. As a result, this cannot exchange rate arrangement to work in true sense. The fundamental solution is to suppress the shadow market. But it is not so easy. Alternative solution is to increase income from external sources phasing out dependency on transfer payments. Still now, Bangladesh depends on exports of readymade garments. There is possibility to promote export markets by new products which have local market and foreign markets. This can be possible provided that policy support is extended to exporters having potentiality to work in domestic and international markets. Service sector needs to be promoted with protection of service income. Protection is also needed for income earned on account of professional services provided abroad by physical presence, cross border travel and transport, income from incoming tourism, etc. In case of substantial inflows from economic transactions, exchange rate can automatically be fixed at flexible arrangement.


Mehdi Rahman works in the
development sector.