Published:  12:06 AM, 06 January 2025

Managing Exchange Rate Through Auto Piloting

Managing Exchange Rate Through Auto Piloting
 
Demand is equal to supply in theory. In practice, supply stays as stock at day-end. Demand may face deprivation because of shortage in supply. Mismatch is always there. Short supply results in price hike. On the other hand, excess supply reduces price. This proposition holds true if other things remain same. A home can live alone depending on its production. This is a process of subsistent living. Hunter-gatherer society moves to farming society for the betterment of life. But the system is treated as a better version of subsistent living. Transactions facilitate better living compared to subsistence. This happens through barter arrangements between homes.

Farming led to navigate production process in structured framework. Uncertainty of hunter-gathering ended. Farming brought division of work in work places. The system was facilitated by money. Barter system was phased out with the introduction of money as medium of payments. Person becomes involved with a part of total work flows. In exchange of work, money is paid. Money makes its holders as jacks of all trades. It can buy which is necessary. But mismatch is there. Money earned cannot buy as much as needed. In practice, money is demanded but income level restricts to have money as necessary. Is it a supply shock of money? Definitely it is. This is a common problem for employed people who face shortage of money at month end. Solution is there in the society. Consumer credit is extended by neighboring shops. This works as means to support month-end's needs. In corporate jargon, it is known as trade credit. In modern times, money is also available in the form of credit. Banking system extends such support through credit card.

In every aspect of life, there is a mismatch between demand and supply, income and expenses, inflows and outflows. Mismatch is everywhere. My mismatch brings a window of business to others. This has been seen in cases presented earlier. But there is a question whether all mismatches are supported by facilitating tools like credit facilities. The answer is both 'yes' and 'no'. Behavior is a factor here. Credit facilities are available based on payments behaviors. Month-end needs are supported by shops which expect to receive payments at the beginning of following month. In case of default in making payments, different scenarios become visible. Customers can again avail goods on credit but the charges are higher compared to prevailing prices. The simple equation is that shoppers add default risk premium in prices. As such, default increases cost of living. Persistent default will stop credit facilities. In this situation, both demand and supply are available but they do not meet each other. This is a situation known as 'instability'. It is negative side of stability. Is instability a cyclical effect? Maybe it is a part of cycle. But persistent instability may result in worse situation which is not expected.

Instability is a outcome in life. What leads to instability? As noted earlier, credit facilities depend on payments behaviors. In technical tone, it is said as 'creditworthiness'. It is a factor under which availability of credit including its price depends. Frequent defaults or irregularities in making repayments lead to cut credit facilities. As such, there needs a balancing position so that demand can meet supply. Economics is said to be a study of scarcity. Abundance is very rare in practical situations. Credit is a way out in the monetary society to cater the needs. This is a point which balances between demand and supply. Use of credit is said to receive facilities out of future income. It may burst once. Despite, it cannot be avoided in the credit society. Credit money can promote production which is necessary for development.

An economy is a part of the globe. It is like a segment which cannot run alone. Rather it needs to depend on others for mutual benefits. Each economy is a nation state. Transactions of a nation state with other states are reflected through the balance of payments (BoP) statement. Economic activities of a country with other countries are presented in current account part of the BoP statement. It is a balance between inflows and outflows generated from export and import of goods and services, inter alia. Economic outputs exceeding purchases from external sources indicate surplus going abroad as investments. The opposite is a deficit for which financial support from external sources are necessary.

In respect of trade transactions with external sector, sales contracts and letters of credit work as underlying instruments. Payments are required to be made as per arrangements. Normally it takes time to make payments. Banks in most cases are exposed with commitment to make payments on agreed upon dates. In case of Bangladesh context, our current position is found in deficit territory. Banks may not be in a position to arrange fund available for settlement. Where is to search the fund? Definitely, they will look for inflows. The flows routed through them may not be as same as they need. There are different options available. These are fund from interbank market, purchase of foreign currency from customers of other banks, arrangements from exchange houses on account of wage remittances, etc. The situation is challenging unless own sources are not available. Many say, banks should take exposure as much as they have capacity. Beyond the limit, exposure becomes a bottleneck. But 'pay as you earn' cannot be possible to apply here. As a result, payments commitments become defaulted. Continuation of defaults in settlement of payments leads to cease credit lines by lenders abroad.

Banks face problems to make time-bound payments. They try to keep their commitments. To overcome the situation, they are found playing insane leading market volatile. It can be noted that foreign money transfer companies are a major part in foreign exchange market of the country. They work as supply sides. The deals arranged with them are that they receive quotes and arrange remittances within two days for delivery to ultimate beneficiaries. These money transfer operators become exchange rate makers because of high demand of greenback. Bangladeshi banks are exchange rate takers! Tough competition in arranging foreign exchange leads banks to quote high rates of exchange. As a result, price of local currency faces depreciation. Wage remittances are supposed to enter the country today or tomorrow. But high rates destroy exchange rate stability leading market to face volatility in internal market. We depend on external sector for imports of strategic goods like fuel, fertilizer, etc. Price hike of foreign currency imports inflation which spreads all over the economy. Mass people face its impact. Beneficiaries of wage earnings cannot avoid the pains.

What is the alternative to manage foreign exchange market needs to be sought. As current account is in deficit, external borrowing is inevitable. Therefore, credit lines need to be maintained with counterparts abroad. There are two types of credit lines. By confirmation and import bill discounting lines, foreign banks extend these services based on our credibility. Under the arrangement, payments need to be settled on specified dates, there is no alternative. Local banks' ratings become downgraded in case of payments default. Banks are reported to have defaulted in making timely payments, resulting in disruption of credit lines by counterpart banks abroad. The situation needs to be turned around so as to confidence can be restored. Hence, overdue needs to be settled immediately.

Banks in Bangladesh are restricted to have finance from external sources except trade finance in the form of confirmation services, usance bills payments under acceptances, etc. But offshore banking services of Bangladeshi banks can borrow from external sources. Offshore can place fund to their mainline operations, domestic banking units. Banks should utilize the opportunity. They should establish mid-term revolving credit lines with banks abroad. Trade payments can be settled by this credit line without buying greenback at higher rates.

Until our current position becomes surplus, dependency on external borrowing will continue. But the situation should not be made jeopardized through buying foreign currency at higher rates. It is high time to restore the situation by paying off old dues and establishing mid-term revolving credit lines with counterparts abroad. This can auto pilot exchange rate.
 

Mehdi Rahman works in the
development sector. He also
writes on business phenomena
and monetary issues.



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