Competitiveness, Consumption, and Currency

The debate over Bangladesh’s exchange rate policy is often presented in overly simplified terms. One side argues that the currency has been kept too stable, weakening export competitiveness. The other fears that depreciation would fuel inflation and erode purchasing power.

In reality, both perspectives capture only part of the story. The actual economic outcome depends not just on how much the exchange rate moves, but on how much of that movement is transmitted into the real economy.

Over the past two decades, domestic prices in Bangladesh have risen by roughly 200%, while the exchange rate has depreciated by about 40%.

At first glance, this suggests a significant misalignment. However, exchange rate changes do not fully pass through into export earnings, import costs, or domestic prices.

A large portion is absorbed through business adjustments, margins, and behavioral responses. In Bangladesh’s case, a reasonable assumption is that about 40 percent of exchange rate changes actually affect the real economy.

This seemingly technical concept -- partial pass-through -- completely changes how we interpret exchange rate policy. To make this clearer, consider a simple, intuitive example using broad macroeconomic numbers.

Assume that Bangladesh’s external sector consists of exports of USD 25 billion (net of import content), imports of USD 50 billion (excluding those linked to exports), and remittances of USD 30 billion.

This leaves a small net external surplus of about USD 5 billion. Meanwhile, the domestic economy is much larger, with GDP of USD 450 billion, of which roughly USD 300 billion is consumption.

Now consider the actual path the economy has taken. The exchange rate depreciated by 40 percent over time. However, with only 40% pass-through, the effective impact on the real economy is about 16 percent.

In simple terms, although the currency weakened by 40%, prices, exports, and imports adjusted as if the change were only 16%.

Under this scenario, export earnings rise from 25 to about 29 billion in local currency terms. Remittances increase from 30 to about 34.8 billion.

Imports also become more expensive, increasing from 50 to about 58 billion. As a result, the net external balance improves slightly -- from 5 to around 5.8 billion.

At the same time, domestic consumption rises from 300 to about 348 billion, reflecting higher prices. This increase represents the cost borne by households.

What emerges is a clear picture: The external sector gains modestly, while consumers face a moderate increase in the cost of living. The overall effect is gradual and manageable, which helps explain why the economy has remained relatively stable.

Now consider an alternative scenario. What if the exchange rate had fully adjusted to match domestic inflation of 200%?

In that case, the currency would have depreciated by roughly 200 percent. With the same 40 percent pass-through, the effective real impact would be about 80%.

Under this more aggressive adjustment, exports would rise from 25 to about 45 billion, and remittances from 30 to around 54 billion. Imports would increase significantly, from 50 to about 90 billion. The net external balance would improve more noticeably -- from 5 to around 9 billion.

However, the domestic impact would be far more severe. Consumption would rise from 300 to about 540 billion, reflecting a sharp increase in prices. This represents a substantial erosion of purchasing power for households.

To understand the net effect, it is useful to compare the gains and losses in both scenarios. In the first scenario (actual path), the external sector gains roughly 0.8 billion (from 5 to 5.8 billion), while consumers bear an additional burden of about 48 billion (increase in consumption from 300 to 348 billion). The adjustment is small and spread over time, making it easier for the economy to absorb.

In the second scenario (full adjustment), the external sector gains about 4 billion (from 5 to 9 billion), but consumers face an additional burden of 240 billion (increase in consumption from 300 to 540 billion). The gains are larger, but so are the costs -- and by a much greater margin.

This comparison highlights a crucial insight: Exchange rate adjustment does not create large net gains for the economy as a whole. Instead, it redistributes income.

Exporters and remittance earners benefit, while consumers bear the cost through higher prices. Because consumption dominates the economy, the overall impact tends to be negative in the short run, especially under large adjustments.

This also explains why Bangladesh’s gradual approach has worked to some extent. By allowing only partial and delayed adjustment, the economy avoided large shocks to consumption. At the same time, competitiveness pressures built up slowly rather than abruptly.

However, this strategy has limits. If the exchange rate is kept too stable for too long, misalignment accumulates, making eventual adjustment more difficult. On the other hand, rapid depreciation can destabilize the economy by sharply increasing inflation.

The policy challenge, therefore, is not whether to adjust the exchange rate, but how to do it in a balanced way.

A key lesson is that gradualism matters. A crawling exchange rate regime -- where the currency adjusts steadily in line with inflation differentials -- can help maintain competitiveness without imposing sudden costs on consumers.

Such an approach reduces uncertainty and allows businesses to plan ahead.

Equally important is the development of financial instruments that allow firms to manage exchange rate risk. When businesses can hedge against currency movements, the economy becomes more resilient, and the need for heavy central bank intervention diminishes.

Communication also plays a critical role. Exchange rate changes are often misunderstood, leading to exaggerated expectations.

Policymakers need to clearly explain that depreciation does not fully translate into inflation or export gains. Its effects are partial, gradual, and distributed across the economy.

Finally, protecting consumers should not rely on artificially stabilizing the currency. While this may provide temporary relief, it delays necessary adjustments and can lead to larger problems later.

A better approach is targeted support for vulnerable groups, combined with policies that enhance productivity and reduce structural costs.

In the end, Bangladesh’s experience shows that exchange rate policy is fundamentally about managing trade-offs. The currency is not just a price; it is a mechanism that balances the interests of different sectors of the economy.

The actual path -- moderate depreciation with partial pass-through -- resulted in small external gains and manageable domestic costs. A more aggressive adjustment would have delivered larger external benefits, but at a much higher cost to consumers.

The implication is clear. The goal of exchange rate policy should not be to maximize depreciation or stability, but to ensure a smooth and predictable adjustment process that aligns with the economy’s structure. Only then can the balance between competitiveness and consumption be maintained in a sustainable way.

Tashzid Reza works in a trade finance company operating as a liaison office in Bangladesh.