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Abstract
This article provides some preliminary observations on the problem of the overvaluation of the real exchange rate in Bangladesh and its implications for economic policy. It explains the concept of the real exchange rate (RER) and how a sustained overvaluation can harm a country's international competitiveness. The study analyzes the factors that may have contributed to an overvalued RER in Bangladesh, including high inflation relative to its trading partners and large inflows of foreign aid and remittances, which can lead to "Dutch disease" effects. The research explores the negative policy implications of this overvaluation, particularly its impact on the export sector, which is made less competitive, and on the import-competing domestic industries, which face increased pressure from cheaper imports. The paper argues that maintaining a competitive real exchange rate is a critical macroeconomic policy challenge for Bangladesh. The analysis concludes by discussing the difficult policy choices involved in correcting an overvaluation, including nominal devaluation and other structural reforms.
Full Text
The management of the real exchange rate (RER) is a critical, though often overlooked, aspect of macroeconomic policy for a trade-dependent developing country. This paper offers some preliminary observations on the issue of RER overvaluation in Bangladesh. The analysis begins with a clear, non-technical explanation of what the RER is and why it matters for a country's export competitiveness and overall economic health. An overvalued RER, the paper explains, effectively acts as a tax on exports and a subsidy on imports. The core of the article is an examination of the potential causes of RER overvaluation in the Bangladeshi context. It discusses how a fixed or managed nominal exchange rate, when combined with higher domestic inflation than in competitor countries, can lead to a gradual appreciation of the real exchange rate. A key focus is the potential role of "Dutch disease," a phenomenon where large inflows of foreign currency (in Bangladesh's case, from foreign aid and remittances) can put upward pressure on the RER, harming the competitiveness of the tradable goods sector, particularly manufacturing. In the final section, the paper delves into the policy implications. It highlights the difficult dilemma faced by policymakers, as a nominal devaluation to correct the overvaluation can have politically unpopular side effects, such as fueling inflation. The findings underscore the need for a more proactive and flexible exchange rate management policy, complemented by structural reforms to boost productivity, as a key strategy for maintaining the long-term competitiveness of the Bangladeshi economy.