High inflation reduces foreign exchange reserves, as more reserves are necessary to stabilise the foreign exchange market and cool down inflation, according to a research paper by officials of the Bangladesh Bank.
The Bangladesh Bank Training Academy on Sunday published the biannual journal (January 鈥� June, 2022) 鈥楾houghts on Banking and Finance鈥�, featuring six research-based articles.
A research paper titled 鈥楧oes Remittance Inflow Affect Foreign Exchange Reserve? A Case Study of Bangladesh鈥� found that trade and inflation have a significant but negative long-term impact on reserves.
The study found that 1 per cent decrease in inflation would raise the reserve by 0.11 per cent.
Bangladesh鈥檚 overall inflation rate reached 9.74 per cent in April, remaining over 9 per cent since March 2023.
The net foreign exchange reserves in Bangladesh, as per International Monetary Fund guidelines, fell to $13.15 billion, with the gross reserves dropping to $18.26 billion on May 14, marking a 10-year low, according to Bangladesh Bank data. The reserve was $48 billion in 2021.
To maintain low inflation, stabilising the foreign exchange rate requires more reserves, which are impacted by high inflation, the BBTA study said.
Conversely, stable inflation positively affects reserves, as it enables domestic products to compete better in foreign markets.
According to Bangladesh Bank Order 1972, the first and foremost function of the central bank is to formulate and implement monetary policy to manage the money supply, dollar rate and interest rates to influence the economy鈥檚 overall level of spending and inflation.
The accumulation of foreign exchange reserves is reflected in the balance of payments.
A BoP surplus indicates reserve build-up, while a deficit shows reserve depletion or government borrowing from abroad.
A country with significant reserves can intervene in the foreign exchange market by buying or selling its currency, influencing supply and demand dynamics.
Higher reserves help stabilise or strengthen the domestic currency against others.
Against the backdrop of a severe dollar crisis, the central bank has been selling dollars to commercial banks, with more than $32 billion sold over the past 34 months.
This included $11.6 billion allocated to banks in July-April of the financial year 2023-24, $13.5 billion in FY23 and $7.62 billion in FY22.
However, currency depreciation makes imports more expensive, contributing to domestic inflation, while appreciation makes imports cheaper, reducing inflationary pressures.
Import dependence and other factors also influence inflation.
The interbank dollar rate soared to Tk聽117.5 each after the central bank raised the greenback rate by Tk聽7 each on May 9.
The exchange rate per dollar in the country was Tk聽84.81 in June 2021, Tk聽93.45 on June 2022 and Tk聽106 in June 2023.
Foreign exchange reserves can be increased by remittances, which help in exchange rate stability.
The cost of imported items can affect inflation, thereby influencing the exchange rate.
The study suggested that both the government and the central bank should collaborate to control exchange rate fluctuations.
By implementing appropriate measures, such as intervening in the foreign exchange market, when necessary, they can help in maintaining a stable exchange rate.
This stability, in turn, assists in meeting targeted inflation rates and safeguard the foreign exchange reserves of the country, the study said.
