Bangladesh's Forex Market: Between Reform and Regulation

The recent shifts in Bangladesh's foreign exchange market have left both financial analysts and banking professionals at odds. With the central bank taking steps toward liberalizing the currency exchange framework, tensions have emerged regarding the fine line between regulation and market freedom. While the introduction of a more flexible exchange rate system appeared promising, the reality of the implementation has caused confusion and frustration across the sector. Financial experts from Tandexo explore how this delicate balance between liberalization and intervention continues to shape Bangladesh's foreign exchange market.

A Step Towards Flexibility

In response to pressure from the International Monetary Fund (IMF), Bangladesh Bank moved to replace the crawling peg exchange rate system with a more flexible approach. This shift aims to let market forces determine the value of the Taka (BDT) against the US Dollar. However, the central bank has introduced an unofficial "mid-rate" that serves as a benchmark for forex transactions, undermining the potential benefits of this liberalization.

This mid-rate rose from Tk 117 to Tk 119 per dollar in late 2024, fueling discontent among bankers who feel that it limits their ability to negotiate freely. While BB officials argue that the mid-rate is necessary for market stability, critics believe it is a form of control rather than a genuine effort to allow market-driven pricing.

The Impact of the Mid-Rate

Though the concept of a freely negotiated exchange rate was introduced, the central bank's influence remains strong. Banks have been forced to follow the mid-rate when quoting prices, which has led to a growing sense of frustration in the industry. Many financial professionals argue that this system prevents banks from competing on rates, limiting their ability to respond to market dynamics effectively.

An economist and former chief economist at Bangladesh Bank believes the solution lies in removing market interventions altogether. He argues that allowing the exchange rate to be determined solely by supply and demand would stabilize the market and reduce the risk of black markets emerging.

Discrepancies in the Market

Despite the official rates set by the central bank, the actual exchange rates are often far from what is quoted. For example, while banks officially list rates around Tk 121 to Tk 122 per dollar for remittances and export earnings, the actual rates in the market are higher. Importers often pay between Tk 125 and Tk 128 per dollar, creating significant discrepancies between the official and actual rates.

This divergence highlights the growing gap between formal and informal markets. Banks, struggling with profitability due to these rigid rates, are turning to workarounds. Some are sourcing dollars from exchange houses and aggregators to meet demand, further complicating the market's transparency.

Shadow Markets and Workarounds

The emergence of shadow markets has been a direct consequence of the central bank's tight control over exchange rates. These informal channels allow businesses to access foreign exchange at more favorable rates, often bypassing the official banking system entirely. This situation is reminiscent of the illegal "hundi" system, which operates outside the regulated banking sector.

These practices have sparked concerns about the long-term health of the formal forex market. The managing director of Premier Cement Mills, criticized the central bank's approach, saying that it misrepresents the actual conditions in the market. For many businesses, the gap between the official rate and the market rate has become untenable.

Impact on Remittances

Bangladesh's remittance inflows, a critical pillar of the nation's foreign exchange reserves, are also feeling the effects of the new forex policies. In December 2024, the country saw a record $2.64 billion in remittances, driven by the more flexible exchange rate. However, the first few weeks of January 2025 have witnessed a sharp decline in remittance flows, signaling that tighter regulations are beginning to take their toll.

State-owned banks have been particularly hard-hit under the new regime, with many struggling to attract remittance inflows. To address this, the central bank has urged exchange houses to prioritize state banks for remittance sales. However, this move has been criticized by private bankers, who fear it will destabilize the market further.

A Call for True Market Liberalization

Economists and industry experts agree that for the forex market to function effectively, the exchange rate should be allowed to float freely. While the central bank's intentions may be to maintain stability, the current system has created a wide gap between official and unofficial rates, harming remittance flows and discouraging businesses from engaging with the formal banking sector.

The push for a truly liberalized market is gaining traction among economists who argue that removing artificial constraints will help reduce discrepancies and make remittance channels more attractive. "The availability of higher rates in the hundi market diminishes the appeal of formal channels," the former chief economist warns, highlighting the potential for further disruption if the current system persists.

Conclusion: The Path Forward

Bangladesh's forex market stands at a critical juncture. The push for liberalization is commendable, but the continued intervention by the central bank complicates the situation. For true market-driven pricing to emerge, the government must allow the exchange rate to float freely and trust that market forces will drive stability. Until then, the market will likely remain in a state of uncertainty, with shadow markets continuing to thrive and remittance inflows declining.