US Dollar in international trade transactions: Alternatives and risks


Shah Ahsan Habib | Published: January 14, 2020 20:32:42


US Dollar in international trade transactions: Alternatives and risks

Not different from other developing economies, international trade transactions of Bangladesh heavily depend on US Dollar as the key mode of receiving and making payments. The country's cross border transactions comprise mainly export and import of goods and services with cross-border investment and other financial flows being minimal. There is no doubt that making payment through USD to all trading partners involves transaction costs in the process of currency conversion, and there are inherent exchange rate risks. However, using home currencies and holding extensive volume of multiple currencies (other than USD) involves other risks and complexities.

Evolution of the foreign exchange market in Bangladesh is closely linked with the exchange rate regime of the country. After independence, the exchange rate of the newly created currency of Taka was fixed with the British pound sterling in January 1972, and the dual exchange rate system was replaced by unitary exchange rate mechanism. Pound sterling was floated with dollar, after the breakdown of the Bretton Woods system, which made the Taka to float with Dollar via Pound sterling. The government pegged the Taka to a basket of currencies of its major trading partners with the Pound sterling as the intervention currency in 1979. The same exchange rate arrangement continued till the early 1990s. During this period, a notable change was the replacement of Pound sterling with that of USD as the intervention currency in 1983.

The Bangladesh Bank is empowered by the Foreign Exchange Regulation Act of 1947 to regulate the foreign exchange regime. It, however, does not operate directly and instead regularly oversees activities in the market and intervenes, if necessary, through commercial banks. BB allowed authorised dealers (Ads) to maintain accounts in freely convertible currencies with their correspondents/branches abroad subject to compliance with AML-CFT regulations of Bangladesh Bank and other competent authorities. All convertible currencies (USD, GBP, Euro, JPY, CHY, CND etc) can be used to make and receive international trade payments in the country. According to foreign exchange transaction guideline of BB, LC may provide for payment or reimbursement in any freely convertible foreign currency or by way of credit to the non-resident Taka account of the concerned bank abroad. Payments for imports under barter agreements or under foreign loans/grants can be made only in the manner specified for the concerned barter/loan/grant. In addition, in export, payment for goods exported from Bangladesh can be received through an AD in freely convertible foreign currency or in Taka from a non-resident Taka Account. Receipts against exports under various barter and bilateral arrangements should be settled as per instructions issued by Bangladesh Bank from time to time.

In 2018, Bangladesh Bank allowed banks to open clearing accounts in the Chinese currency; China being the largest source of import for Bangladesh since fiscal 2006-07. Before that, banks were allowed to open such accounts in USD, Pound sterling, Euro, Japanese Yen and Canadian Dollar with the Bangladesh Bank. It is to be mentioned that the Yuan became the fifth currency of the IMF's special drawing rights (SDR) basket which determines currencies that countries can receive as part of IMF loans.

In Bangladesh, the trade transactions are clearly dominated by USD, and use of a number of foreign currencies declined over time.  However, use of USD remained consistently very high over the years. Other than USD, the use of Euro was visible in only 4 per cent of transactions, and the uses of other currencies were insignificantly low during 2013-2019. Although the country's major import partner has been China, import payments have been dominated by USD. Though, BB allowed Chinese Yuan for import payment, till date the mechanism is yet to get the expected level of impetus.

Around 27 currencies were used in 2013 for export receipt, which rose to 34 in 2015 but came down to 16 in 2019. Though the country's major export trading partner is Germany for last few years, USD remained the dominating currency for receiving export payment in Bangladesh. Around 98 per cent export transactions were conducted using USD in 2019 and the trend was around 97 per cent during the last decade. Besides, Euro and GBP were used in export but the amount remained insignificant.

Bangladesh has bilateral agreements with a number of countries to promote regional cooperation and international trade transactions. The government has prepared a policy guideline to explore bilateral FTAs with prospective countries with a view to making deeper trade integration for export growth and export diversification.

The central Banks of Bangladesh, India, Iran, Nepal, Pakistan, Sri Lanka, Myanmar, Bhutan and Maldives have an Agreement to settle current transactions among these countries through the Asian Clearing Union (ACU) mechanism. All payments to the ACU member countries excepting those covered by loan and credit agreements are settled through the ACU mechanism in 'Asian Monetary Units'. However, payments not related to import and export of goods and services are treated as ineligible payments for being settled under ACU mechanism.

In addition, there are options for border trades and border hats with Myanmar and India respectively to facilitate border business.  In 2010, Bangladesh and India opened 'border haats,' or 'common marketplaces' in different border areas of the two countries with a limit of USD 100 (equivalent to local currencies) for any particular day in the border haats. Moreover, Bangladesh has border trade agreement with Myanmar with a limit of USD 10000 per transaction. Banks from both sides settle their net amount in the transactions through correspondent banks.

To save time and cost in settlements,  Bangladesh Bank also  operates a foreign currency clearing system enabling the ADs to settle their claims in USD, GBP, Euro, Japanese Yen, Canadian Dollar and CNY arising from inter-bank transactions.  Under this arrangement, AD banks maintain clearing accounts with the Bangladesh Bank in USD, GBP, Euro, Japanese Yen, Canadian Dollar and CNY. Apart from the purpose of settlement with other ADs, these accounts may also be used for transfers to and from correspondents abroad. However, for trade settlement facilities, around ten Bangladeshi banks have twenty overseas business operation centres in the form of representative offices, bank branches and financial agents.

In Bangladesh, USD is used as the major currency for international trade settlements, because of convenience. In import, despite a significant demand for Chinese Yuan for the last few years, banks could not make use of the opportunity of initiating transactions in CNY. In the absence of this currency facilitation, banks of Bangladesh are to incur extra transaction costs in making import payments in CNY. The key reason behind this is inadequate supply of CNY in the accounts of Chinese banks, as opined by industry experts. Moreover, banks in Bangladesh are also concerned with the adverse impact of trade war between China and USA.

In addition, according to statistics of Bangladesh Bank, Bangladesh receives a huge amount of loans and grants in Japanese Yen.  The volume of trade transactions in JPY is also considerable.    In most of the cases, after receiving JPY, these are converted in other currencies, mostly in USD.  Conversion of JPY into another currency is mainly for negative interest rate in JPY, higher current account charges in JPY and relatively higher fluctuation than other currencies. 

In Bangladesh, a number of usance payable at sight (UPAS) LCs were issued in Euro. Import settlement of those LCs is usually executed by taking loans in Euro or by converting nostro balance of USD into Euro through their correspondent banks.  The current mechanism of import payment in Euro is expensive. In some cases, banks open LCs in Euro but make payment in USD due to the easy availability of USD.

Bangladesh foreign exchange market is in many respects very old-fashioned with almost all transactions done in the spot market at spot exchange rates. While there is an active FX swap market, these are very short-dated. Most volumes are transacted within one week, which is used as a funding technique by the banks. The outright forward mechanism is very popular among corporate entities. These are usually for 3-6 month tenors but longer tenors of up to 2-3 years can also be undertaken. There is no regulatory restriction for the forward tenors. But to hedge the future exchange rate risk, forward products are used in a limited volume.

Dependence on USD for trade and other cross border transactions in the context of Bangladesh is not different from most other global economies. Global efforts to search for an alternative to USD have not been successful till date.  There are several global instances of having cross-border trade transactions using the currencies of home countries as part of bilateral or regional arrangements. The trends increased in recent years with multi-dimensional political and economic influences. Special payment and clearing arrangement for trade transactions have been beneficial for Bangladesh. In the context of Bangladesh, extensive reliance on other convertible currencies may not be a wise option; however, home currency use in certain trade transactions with selected countries may help in reducing transaction costs.  Policy strategies for effective use of some hedging instruments might be helpful to handle foreign exchange and commodity price risks.

Dr. Shah Md. Ahsan Habib is Professor and Director (Training) at Bangladesh Institute of Bank Management (BIBM). 

ahsan@bibm.org.bd

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