Economic effect of the real effective exchange rate

| Updated:
October 16, 2022 08:30:44

Bangladesh is reaping some gains from a recent decline in the country’s real effective exchange rate (REER) due to record inflation in its major trading partners which is also eroding the value of their currencies.

Economists draw such an inference from central bank data on fluctuations in the value of the taka in local currency and from reported inflation rates reaching double-digit levels in trading partner countries.

However, the rates remained above the 100 mark, reaching 111.48 in July 2022 from 111.34 in June 2022, according to Bangladesh Bank statistics.

The Real Effective Exchange Rate or REER is calculated against a basket of currencies of Bangladesh’s global trading partners including the United States of America, China, India, and the European Union.

An increase in a country’s REER indicates that its exports are becoming more expensive and its imports are becoming cheaper. And its fall indicates the opposite – its exports becoming competitive and its imports expensive.

Policymakers and economists see it as an indicator of a country’s international competitiveness relative to its foreign trade partners.

Economists believe that the decline in the REER indicates that Bangladesh is gaining competitiveness over its competitors in trade in the global market. But he was still well above the 100 point mark.

Dr. Ahsan H. Mansur, executive director of the Bangladesh Policy Research Institute (PRI), told the EF that inflation rates in Bangladesh’s trading partners were on the rise and Bangladesh’s REER was on the rise. down accordingly.

Dr. Mansur notes that the local currency has also depreciated significantly over the past year, which has contributed a lot to the status of the index.

“Such a downward trend will boost the country’s trade competitiveness,” he said.

In addition to monetary value, factors considered in calculating RRSP value include the reading of inflation in the country and its trading partners and the value of two trading partners’ assets in a third country.

The country’s exports grew by more than 13% to $12.5 billion in the first quarter (July-September) of the 2022-23 financial year. On the other side of the foreign trade front, imports soared nearly 17% to $13.7 billion in the first quarter of the current fiscal year.

Dr. Masrur Reaz, chairman of Policy Exchange of Bangladesh, another local think tank, told the FE that the decline in the REER is a reflection of a nominal decline in the exchange rate.

The nominal exchange rate (NER) has depreciated by more than 10% since June 2022. The (interbank exchange rate Tk-USD) in June 2022 was 93.45 Tk and on 04 October 2022 it was 103 .62 Tk. And the “empty market” rate remained much higher.

Dr. Masrur thinks there is a difficult period in terms of the REER ahead, as inflation in Bangladesh has been rising rapidly, especially since last August.

He said advanced economies were now pursuing “quantitative tightening” to tighten money flows into their economies.

The inflation rate of developed economies will fall due to these austerity measures from their central banks.

He predicted that the country’s REER may start rising again in the coming months.

Dr. Mustafa K. Mujeri, former chief economist of the central bank – Bangladesh Bank – told the EF that the country’s nominal exchange rate shock has been more dire so far.

“Gains in trade competitiveness from the improvement in the REER have been swallowed up by the depreciation of the local currency (BDT) against the US dollar.”

Dr. Mujeri, also Executive Director of Inclusive Finance and Development (InM), says the rate of inflation among major trading partners of Bangladesh, including the United States, has accelerated more than the rate of inflation of Bangladesh, which has led to such a change in the REER of the country.

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