Economic Determinants of Foreign Exchange Reserve of
Bangladesh: A Study On Causes and Effects
by
Golam
Rabby Masud
A project
submitted in partial fulfillment of the requirements for the
degree of
Professional Masters in
Banking and
Finance
Examination
Committee: Dr. Donyaprueth Krairit (Chairperson)
Dr. Tanatat Puttasuwan (Co-chairperson)
Dr. Sundar Venkatesh
Dr. Tanatat Puttasuwan (Co-chairperson)
Dr. Sundar Venkatesh
Dr. Yuosre Badir
Nationality:
Bangladeshi
Previous
Degree: Master of Social Science in
Economics
University of Dhaka
Bangladesh
Scholarship Donor: Bangladesh
Bank (Central Bank of Bangladesh)
Asian
Institute of Technology
School of
Management
Thailand
May 2015
ACKNOWLEDGEMENT
Guidance
provided by Dr. Tanatat
Puttasuwan, the supervisor
of my project work, is greatly appreciated for his valuable and constructive
suggestions during the planning and development of this project work. He offered me constant guidance and many
insightful and constructive observations throughout the study. His support,
encouragement and availability to discuss ideas and problems have contributed
much in completing this work. He always kept me on task and pointing out me
back to my research paper objectives. His patience and high efficiency in guiding me
in a proper way in conducting this research is really appreciated. His
friendly guidance and cooperation which is very rare inspired us to
successfully complete the whole
work.
The completion
of this work may not be possible without the true and cordial support of my
supervisor and Bangladesh Bank (BB) colleagues who give me advice as well as
required information at every stage of writing this work.
I am personally
being obliged to the authority of Bangladesh Bank (Central Bank of Bangladesh)
for granting full bright scholarship.
I would like to
express my thankfulness to honorable faculties for teaching relevant and
updated courses and also to the staffs who give us all necessary official
support related with this program.
My deepest
appreciation to my
parents and family
members for their continuous inspiration and encouragement.
Sincerely,
Golam
Rabby Masud
Asian
Institute of Technology
Bangkok,
Thailand
e-mail:
masudrabby@yahoo.com
February, 2015
Abstract
Bangladesh has
experienced increases in the level of foreign reserves as well as increases in
remittance, export and import size. Foreign reserve has increased to 22 billion
USD at the end of 2014 which was 2.7 billion USD in 2004. In the same time
period, export, import, remittance and foreign direct investment have increased
by 15.5%, 15.23%, 17.73% and 21.28% respectively. For effective reserve
management, the monetary authority needs to know what factors generate reserves
in the economy and analyze the level of contribution of those factors. There
are some strong components which cause directly to increase or decrease foreign
exchange reserve and they have also some effects. This paper intends to find
out what are the reasons of recent large amount of foreign reserves of
Bangladesh. In this research work correlation and regression analyses are used
to find out the impact of export, import, remittance and FDI on foreign
exchange reserve of Bangladesh. This paper examines the linkage between foreign
reserve and export, import, remittance and foreign direct investment of
Bangladesh for last ten years. The volume of export and remittance are found to
have significant positive effect on changes in the amount of reserve. The paper
suggests that the amount of exchange reserves increase, it may affect the
demand for imports since more funds will be available for imports. And finally
it is found that foreign direct investment has no significant impact on the
amount of reserve in case of Bangladesh. The result of this study suggests that
Bangladesh should promote remittance and export sector of economy for a sound
reserve growth.
Key words:
Foreign exchange reserve, export, import, remittance, FDI.
Table of Contents
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Table of
Contents
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Chapter
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Title
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Page
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Title Page
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i
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Acknowledgement
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ii
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Abstract
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iii
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Table of Contents
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iv
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List
of Figures
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v
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List of tables
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vi
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Abbreviations
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vii
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1
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Introduction
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1
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Background
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1
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Statement of Problems
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1
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Objectives of Study
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3
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2
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Literature Review
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4
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3
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3.1 Data Sources
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6
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3.2 Methodology
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7
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4
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4. Results and
Discussion
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7
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4.1 Correlation
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8
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4.2 Regression
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8
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Regression Results
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9,10
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4.3 Remittance
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11
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4.4 Export
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13
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4.5 Import
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14
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4.6
FDI
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15
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5
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Conclusions and Policy Implication
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16
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6
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Bibliography/References
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17
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7
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Appendices
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19
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List of
Figures
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Figure
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Title
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Page
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Figure-1.1
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Time
series trend of Foreign exchange reserve
In million USD for years 2004-2013
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3
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Figure-4.1
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Time series trend of Foreign exchange
reserve,
Export,
Import, Remittance and FDI for years 2004-2013
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10
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Figure-4.2
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Remittance,
export, import and FDI trend from
2004-2013 in
million USD
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11
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Figure-4.3
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Remittance trend from 2004-2013 in
million USD
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11
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Figure-4.4
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Export trend
from 2004-2013 in million USD
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13
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Figure-4.5
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Import trend from 2004-2013 in million
USD
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14
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Figure-4.6
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FDI trend from 2004-2013 in million
USD
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15
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List of
Tables
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Table
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Title
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Page
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Table-4.1
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Correlation result of foreign exchange
reserve with remittance, export, import and FDI in years 2004-2013
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8
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Table-4.2
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Regression
results of the impact of remittance, export, import and FDI on foreign
exchange reserves in year 2004-2013
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8
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Abbreviations
BB- Bangladesh Bank
BOP- Balance of Payments
FDI- Foreign Direct
Investment
FY- Financial Year
GDP- Gross Domestic
Products
IFS- International
Financial Statistics
IMF- International
Monetary Fund
MOF- Ministry of
Finance
MPI- Marginal
Propensity to Import
OLS- Ordinary Least
Squares
RMG- Ready Made
Garments
SDR- Special Drawing
Rights
WTO- World Trade
Organization
chapter 1
Introduction
Background:
In August 2014,
Bangladesh’s international reserves hit a record high of $22.07 billion. Some
economists diagnose this stockpile as a sign of weakness in the economy.
However, others say that BB is actually heading in the right direction and
Bangladeshi economists should celebrate this as the beginning of a comfort zone.
There are
various factors like export, import, remittance and foreign direct investment that
play a role to grow the amount of foreign reserves. Since we want Bangladesh to sustain its growth
like other emerging economies, the country must try to know what variable is
important to its reserve growth and should maintain the way what is appropriate
for it.
Statement of the
problems:
The motivation
of maintaining adequate level of foreign reserves ensures the protection of the
value of domestic currency, strengthening a country’s credit worthiness,
international payment obligations and providing insurance against external
shocks. After the East Asian
crisis in 1997-98, developing countries concentrated on increase their foreign
exchange reserves holding as a safeguard of external imbalances and to protect
the value of their domestic currencies.
At the end of
March 2012, rising markets and developing countries together held a large
portion of world’s total international reserves and that is 60.24%.It is now
important issues for central bankers to manage and analyze cause and effect of
such large reserves. The components of
foreign reserve of Bangladesh are different foreign currencies, gold, reserve
position in the IMF and special drawing rights (SDR), which are under control
of the central bank and readily available for any Balance of Payments (BOP)
financing.
Bangladesh, like
other promising Asian countries, is also stockpiling foreign reserves. It is on
the second position in South Asia in August 2014 (India is the 1st) with a
reserve level of above USD 22.07 billion.
There are many
components of foreign reserves. It is necessary to know how these components
react with growing foreign reserve for a country and how would the central bank
evaluate and consider these components as important variables of growing reserves.
Some economists
think that holding dollar denominated reserves is costly. Because keeping
reserves in US treasury gives only a modest return and far below the costs of
borrowing of the government. Rather, a higher return can be achieved by making
real investment in the economy such as roads, bridges. So, why should the money
be kept as reserves and why should the government pay higher interests for
outstanding liabilities. Summers (2006) thinks excessive reserves to
be wasteful because of large infrastructure and social needs in up-and-coming
markets. Obviously, Bangladesh has huge investment needs for infrastructure and
other economic sectors.
However,
proponents of huge reserves give emphasize more on macroeconomic imbalances
such as currency or financial crisis in today’s macro-economic environment than
the opportunity costs of holding reserves. International capital market may
shut their doors or IMF bailout is also not guaranteed if there is a case of
balance of payment crisis in the economy. That is why to avoid such crisis this
group believes that it is necessary to build high reserves stock (Aizenman and
Marion, 2002).
Another reason
of holding reserves for a country is to maintain fixed exchange rate. Monetary
authorities frequently use foreign exchange to intervene in market. By this way
they keep the value of the domestic currency at target level.
Requirement for
reserves will be smaller if a country moves to a free floating regime but in
realworld, the
central bank always wants to hold reserve in fear of floating. Foreign exchange
reserves can also save the national banking sector domestically. It helps the
credit sector from outflows of domestic or external resources.
So it can be
deliberately said that reserve accumulation to a certain level is a practical
macroeconomic decision while slowing down the pace of reserve accumulation is
also desirable as it may lead to increasing costs beyond a certain level. In
case of Bangladesh it is necessary to accumulate reserve in effective way. For
effective reserve management, the monetary authority needs to know what factors
generate reserves in the economy and analyze the level of contribution of those
factors.
There are some
key issues which influence the growth of reserve. According to IMF World
Economic Outlook 2003- Economy size, exchange rate volatility, current account
vulnerability, capital account vulnerability and opportunity cost - these are
some input issues when a country decides for increasing reserves. One of the
most important motives for which countries want to increase reserves is to
smooth unpredictable fluctuations in consumption and import payments. This can
be called the ‘precautionary motive’ of holding reserve (IMF 2003). All
governments want to avoid the risks of devaluation of domestic currencies and
maintain their sovereign risk ratings in the face of macroeconomic imbalances.
At the onset of severe currency devaluation, the central bank can easily buy
its currency with its foreign exchange reserve to preserve the value of the
domestic currency at target level. There are some strong components which cause
directly to increase or decrease foreign exchange reserve and they have also
some effects. This paper intends to find out what are the reasons of recent
large amount of foreign reserves of Bangladesh.
The present paper analyzes the determinants
of foreign exchange reserves in the context of Bangladeshi economy. In the
past, foreign reserves of Bangladesh have not been much hopeful. On many times
its foreign reserve balances were unable to pay for its import bill. Bangladesh
is defined as a net importing country and it faces large trade deficit always.
But, Bangladesh had been gathering a high level of foreign exchange reserves in
the last few years. It is necessary to find out the reasons for this high level
of reserves.
The reserves position of Bangladesh is
determined by some fctors. One important part is its transaction with the rest
of the world and the other factor is the flow of fund in or out of the country.
On this view a country’s reserve position is determined by its trade balance
and it is an important factor for determining. For Bangladesh similar to many
other developing countries export, import, foreign direct investment (FDI) and
remittance flow are major factors in creating reserves balance. This paper will
examine these factors closely and will try to find impact of these factors on
recent high foreign exchange reserve amount of Bangladesh.
Figure-1.1 Time series trend of Foreign exchange
reserve
In million USD (2004-2003)
Source:
Bangladesh Bank (Appendix-7.1)
Objectives of the Study
Bangladesh has
recently been acquiring foreign exchange reserves at a good pace in the South
Asian region and as an emerging economy; it also has huge real investment
demand. Thus it is important to investigate the factors actually determining
the foreign reserve of Bangladesh.
· Set up a regression model to show the relationship among these factors and
Foreign Exchange Reserves and show the level of impact of these factors on
Reserves.
· To discover the strength of different factors in influencing foreign exchange
reserves.
· To point out some important determinants to move up the amount of foreign
exchange reserves and to examine how and to what extent these factors are
efficient.
· Suggest some strategy for overall improvement of Foreign Exchange Reserves
based on observed results.
It can be said that
Foreign Reserve is one of important sectors for economy. The outcome of the
research will be very helpful for Bangladesh government, banks and also for the
people of Bangladesh.
chapter 2
Literature Review
The research on foreign currency reserves begins mainly from the time of
Bretton Woods system. Researchers were focused mainly on classifying
the effects that the Bretton Woods system, and its collapse, had on foreign exchange
reserves of the research papers in 60, 70 and 80’s decades. The global reserves except gold were US$ 991
billion (International Financial Statistics, 2005) at the end of 1995. By the end of 2003, the foreign reserves
become US$ 2224 billion (IFS, 2005). This points out that the global foreign
exchange reserve has become more than doubled within very shortest possible
time. This remarkable change in foreign
reserves encourages the researchers to make research what the determinants are
and which factors are keeping superior contribution to increase foreign exchange
reserves. Through empirical research on
international reserves, Lane and Burke (2001) were able to get some explanatory variables as
determinants of foreign reserves. The
determinants of foreign exchange reserves holding reported in this literature
can be classified into five types: exchange rate flexibility, current account
vulnerability, capital account vulnerability, opportunity cost and economic
size. In the literature per capita GDP
is used as pointer of economic size. The
vulnerability of current account can be indicated by such measures as export
and import. Central bank will increase
their reserve in response to a greater exposure to external shock in the long
run. For this motive, the level of foreign
reserves should be positively correlated with an increase in both exports and
imports. Financial openness is the
reason of increase in Capital account vulnerability and probability of resident
based capital flight from the domestic currency. Therefore reserves should be positively
correlated with such variables. Exchange
rate flexibility is usually important; it reduces the demand for reserves. There is an opportunity cost of holding
reserves as the monetary authority swaps high-yield domestic assets for low
yield foreign ones. It corresponds to
the gap between the yield on reserves and marginal productivity of an alternative
investment. This variable is reflecting
measurement problems.
Mendoza (2004) viewed the precautionary analytical framework
as a natural expansion of all previous theories. She showed in her studies that most Asian
countries increase their level of reserves for self guarantee purposes in the
aftermath of the Asian financial crisis. Again, Lizondo and Matheieson (1987) found that the debt crisis of the early 1980’s
in Latin America created a structural break in the demand of reserves.
Frenkel, in his 1978 seminal paper, said that an economy’s
openness to external shocks is measured by the marginal propensity to import
(MPI) . It would be positively related to foreign exchange reserves if the
reserves were held for precautionary purpose. Frenkel calculated MPI of country as the ratio of imports over
GDP. Batter (1982) recognized an empirical study partly based on
Frankel’s model to determine the demand for foreign exchange
reserves under floating and fixed exchange rates. He identified four major
determinants of reserve holding: the variability of international payments and
receipts, the opportunity cost of holding reserves, the propensity to import and
a scale determinant measuring the size of international transaction. Eichengroen and Mathieson (2000) developed a theory of the determinants of
foreign exchange reserves portfolio composition for those countries that
release relevant data. They projected
the demand for the level of foreign reserve using three principal determinants:
trade flows, existence of currency pegs and financial flows. Theory originated
that there was a “striking” stability over time in both the currency composition
of foreign reserves and also in the connection between the demand for reserves
and these principal determinants. Distayat (2001) build on his research and developed a reserve demand model
compatible with the 2nd generation financial crisis.
Aizenman and Marion (2002) found that foreign exchange reserves
holding for the 1980-1996 periods in the Far East countries are the result of
several factors such as: international transactions, international transaction
volatility, the exchange rate arrangement, political uncertainty and
corruption. The IMF (2003) calculated a straightforward empirical model that incorporates
various determinants of reserves holding. The model is estimated using a large
panel that considers 122 emerging market economies with annual data from 1980
to 1996. In the study the population level, real per capita GDP, the ratio of
import to GDP and the volatility of the exchange rate are found to be
statistically significant determinants of real foreign exchange reserves.
Predicted values from this model over the 1992-2002 periods disclose that
foreign reserves in Latin America are not excessive, while those in rising Asia
have increased more than warranted by the determinants since 2001. The IMF makes
an opinion that foreign exchange reserves in rising Asia have reached a point
where some slowdown in the rate of accumulation is needed.
Using data for Korea, Aizenman, Lee and Rhee (2004) found
evidence of a break in the pattern of holding foreign reserves in the post 1997
period. The authors argued that the self-assurance motive became stronger
following the crisis. They specifically said that trade openness is significant
in explaining foreign exchange reserves before the crisis, but that it loses
significance after the crisis. They claimed that this was consistent with the
increased relative importance of financial openness. They considered foreigners’
equity positions and short-term external debts as additional explanatory
variables to examine whether increased external financial exposure is a driving
factor behind reserves build up in the post-crisis period. Their study found
that coefficients on those variables are significant after the crisis,
supporting the view that Korea increased its level of reserves to increase its assurance
against sudden stop of capital flows. Dooley, Folkents-Landay, and Garber
(2004) claimed that foreign reserves buildup reflects the intervention of Asian
central banks who want to prevent their currency from appreciating against the
US dollar in order to promote export growth. However, Aizenman and Lee (2005)
found limited support for the mercantilist motives using lagged export growth
and deviations from predicted purchasing power parity in addition to the
standard determinants. Gosselin and Parent (2005) observed the issue of foreign
reserves accumulation by central banks in emerging-market economics. They found
a structural break in the variables for reserves in the aftermath of Asians financial
crisis.
Romero (2005) projected reserves holding for China and India. This research
inspected which variables affect one country more than the other. She revealed
that, the Chinese government remains in tight control of the economy, including
foreign reserves and the exchange rates. So, market oriented determinants don’t
explain reserve holding for China but those are very much significant in case
of India.
Prabhesh, Malathy and Madhumati (2007) examined the determinants of foreign
exchange reserves for India from 1983 to 2005. They found that long-run foreign
exchange reserve of India is a function of capital account vulnerability, current
account vulnerability, exchange rate flexibility and opportunity cost of
holding reserves. They also concluded that the reserves holding behavior is
mainly affected by the capital account vulnerability indicative of the self insurance
motive against residential base capital flights and less sensitive to its
opportunity cost. Schgal and Sharma (2008) found the evidence both for
precautionary and mercantile motives behind holding reserves in India. They also
found that the exchange rate volatility and the risky capital flows have
positive impact on foreign exchange reserves holding.
Delatte and Fouquau (2009) implemented a non linear approach to observe the
dynamics of the reserves holding and found evidence for the presence of a non
linear behavior in the demand for foreign exchange reserves. This research
identified the misalignment of real exchange rate and the level of the US real
interest rate where two threshold variables that may explain properly the
acceleration of foreign reserves accumulation. Obstfeld et al. (2008) and
Obstfeld et al. (2009) first claimed that financial openness is a strong predictor
of foreign reserves and subsequently that a country’s foreign reserves holding
just before the (2008) crisis, relative to their predicted holdings based on
these financial motives can significantly predict exchange rate fluctuations of
both emerging and advanced countries in 2008.By running a research work within
50 countries of the world Gantt (2010) found that the level of foreign reserves
is determined by a combination of monetary aggregate (Money supply), trade
variables (import, export) and characteristics of exchange rate regime.
Although literature reviewed here suggests some variables as determinants
of foreign reserves for many countries, but little had been said about foreign
exchange reserves adequacy. A traditional assessment developed, after the collapsed
of Bretton Woods system, used to rules of thumbs, such as import cover of three
months. Without a doubt, when India is holding over 20 months of import cover
(IMF, 2005), that assessment does not apply today. Neither do most of other measures
projected in the late 70’s and early 80’s literature. Reserves adequacy procedures
had been changed after the onset of the financial crisis in the 1990s. Calvo
(1996) recommended that, a country’s vulnerability to crisis should be measured,
in part, by the size of its money supply, defined broadly, relative to its foreign
reserves holding, since broad money reflects exposure to the withdrawal of assets
of a country. Greenspan (1999) extended, the Gnidotti rule* a previous
reserves adequacy measure, which recommended that countries should hold enough
reserves to be able to live without new foreign borrowing up to one year.
Greenspan (1999) expanded this rule by adding a test that “the average maturity
of a country’s external liability should exceed a certain threshold, such as
three years”. *The Guidotti
rule states that the reserves
of a country should equal
short-term external debt (one-year or less maturity), implying a ratio of
reserves-to-short term debt of 1. The
underlying principle is that countries should have enough reserves to resist a
massive withdrawal of short term foreign capital.
In the context of economy of Bangladesh, research on the determinants of
foreign reserves has received little attention. Ali and Medhekar (2012) completed
a fine study about multifold effects on real monetary external sectors determinants
by taking data from 1971 to 2010 in the context of Bangladesh. The study found
that, foreign reserve is directly related to GDP in the context of Bangladesh economy.
He also pointed out that commercial transportation, international commitment and
transfer payment of the countries affects the foreign reserves position and it
cannot be completely predetermined. Rezaulk (2011) examined the performance of various
political governments in Bangladesh with respect to maintaining an adequate
level of foreign exchange reserves during their regimes. He established that foreign
reserve formation is closely to the policies adopted and performances attained
in the external sector of the economy by the respective political government.
He also found that foreign aid is the strongest determinant of foreign
reserves. He predicted that if Bangladesh can maintain her increasing trend of
remittance earnings, export earnings and foreign direct investment flows we can
anticipate a further boost in its foreign reserve level in the near future. Md.
Niaz Murshed Chowdhury, Mohammed Jashim Uddin, Dr. Mohammad Saiful Islam (2014)
made an analysis of the factors of foreign
exchange reserves which was a good study with econometric variables . This
paper contributes to the literature by providing estimates of reserves
function, using a set of explanatory variables and important econometric techniques.
chapter 3
3.
Data sources and Methodology
3.1. Data Sources
This
research uses annual time series quarterly data for the period of 2004-2013 for
the five variables, remittance, imports, exports, foreign direct investment (FDI)
and foreign exchange reserve in million USD. Data are given in appendix-7.1
Quarterly data of reserve, remittance, export, import and FDI (2004-2013)Page-20;Appendix-7.2
Yearly data of reserve, remittance, export, import and FDI (2004-2013) Page-21;
Appendix-7.3 Yearly growth of reserve, remittance, export, import and FDI
(2004-2013) Page-21.
Data in this study has been used extensively from the secondary sources.
All the figures that were used in this study were collected from the following
sources. Bangladesh Economic Survey, various issues published by the ministry
of finance, Economic trends (monthly), published by the statistical department
of the central bank of Bangladesh, official website of the central bank,
ministry of finance and export promotion Bureau of Bangladesh, Bangladesh Bank
annual report, published by Bangladesh Bank, The world economic outlook 2010, published
by International Monetary Fund, World Bank databank, official website of World
Bank, The Global Economy website, Bangladesh Bank Bulletin, Asian Development
Bank (ADB) database. We have also consulted published books, working papers,
reports, research monographs, journals and research works found in internet that
are relevant to the study.
3.2
Methodology
A regression analysis is undertaken to determine the factors affecting the
foreign exchange reserves.
Model: measures the effects of remittance,
import, export, foreign direct investment on the foreign exchange reserves.
Model
In linear Model, foreign exchange reserves has been assumed to be a linear
function of remittance, export, import and foreign direct investment (FDI)
The linear model is defined as
follows:
Yt = β0 + β1 (remittance) + β1
(export) + β2 (import) + β3 (FDI) + Ut
Where, Yt is foreign currency reserves in million USD (including
gold) for period t; where t = sample quarter 1 to 40 over the period
from March 2004 to December 2013: March 2004 = 1 and December 2013 =40. All
variables are in million USD.
In order to figure out the determinants of foreign exchange reserves in
Bangladesh, we used the Ordinary Least Square (OLS) as method. The sample
period for investigation in 2004-2013 the empirical analysis of this study
employed annual secondary data, collected from different sources, which are
time series data.
1.
Now we will run a correlation to find how the variables
relate with each other.
2.
A regression analysis will be used to find the impact of
independent variables (remittance, export, import and FDI on dependant variable
(foreign exchange reserve).
chapter 4
4 Results
and Discussion
4.1 Correlation
The correlation
analysis shows that foreign exchange reserve of Bangladesh is positively
related to remittance (0.938), export (0.884), import (0.854) and FDI (0.35).
But remittance, export, import show higher degree of correlation. That means if
remittance, export and import go up reserve will also up. FDI shows lower
degree of positive correlation. That means in case of Bangladesh FDI is not a
very important factor for reserve growth. To maintain a smooth reserve
Bangladesh has to maintain remittance and export sector properly. These are two
important sector of economy.
Table-4.1 Correlation result of foreign
exchange reserve with remittance, export, import and FDI in years 2004-2013 (Appendix-7.4)
|
Name of variables
|
Correlation value with
foreign exchange reserve
|
|
Remittance
|
.938
|
|
Export
|
.884
|
|
Import
|
.854
|
|
FDI
|
.350
|
4.2 Regression
Table-4.2 Regression results of the
impact of remittance, export, import and FDI on foreign exchange reserves in
year 2004-2013 (Appendix-7.5, 7.6, 7.7)
|
Name of variables
|
Coefficients
|
t
values
|
p-values
(Significance)
|
|
Adjusted
R2
|
F-test value
|
|
(Constant)
|
-498.317
|
-.832
|
.411
|
|
.891
|
81.042
p value (sig.) = .000
|
|
Remittance
|
4.001
|
6.214
|
.000
|
|
||
|
Export
|
1.309
|
2.238
|
.032
|
|
||
|
Import
|
-.927
|
-2.088
|
.044
|
|
||
|
FDI
|
-4.243
|
-1.874
|
.069
|
|
Here F = 81.042 is
large and p value (sig.) = .000 which is highly significant. That means sample
fits the model very well. In this model, considered samples are very good fits
to explain Foreign Exchange Reserve of Bangladesh.
Again, t-values for
Remittance= 6.214, Export= 2.238, Import= - 2.088 and FDI = - 1.874
This model predicts
that among the independent variables, the goodness of fit of remittance and
export is very well with Foreign Exchange Reserve of Bangladesh.
Adjusted R2 is .89 > 0.5 means that it
is a very good fit. 89% of total variability in Foreign Exchange Reserve of
Bangladesh can be explained by remittance, export, import and FDI in this
model.
The Level of
significance is also called p value. In case of remittance and export p values
are <.05 clearly. So, in this model remittance and export are closely
related with foreign exchange reserve. These two components have a significant
effect on growth of reserve of Bangladesh.
Decrease in import will
help reserve to grow more. But in case of Bangladesh, import cannot be avoided
largely as trade deficit always happens in balance of trade.
FDI is not a consistent
tool in Bangladesh economy. FDI of this year may be a result of 5 years ago.
FDI is not significant to foreign exchange reserve of Bangladesh.
|
Estimated
Foreign Exchange Reserve,
ŷ = - 498.317 + 4.001(remittance) + 1.309
(export) - 0.927 (import) - 4.243 (FDI)
|
Coefficient of Remittance and export is positive. That means
the more remittance Bangladesh earn, the more reserve will it gain. The model
predicts that 1 million USD increase in remittance will make increase in
reserve by 4.001 million USD holding other things (export, import and FDI)
constant. Remittance is a key issue for foreign reserve of
Bangladesh. Remittance can be used to start and support firms and industries
which will promote export. Thus increase in remittance is not only a direct
cause of raising reserve but also it helps to grow up export and foreign
exchange reserves indirectly.
1 million USD increase in export will make an increase in
reserve by 1.309 million USD holding other things (remittance, import and FDI)
constant.
Coefficient of import is negative. So, the model predicts
that 1 million USD increase in import will make a decrease in reserve by .927
million USD holding other things (remittance, export and FDI) constant.
Coefficient of FDI is also negative. 1 million USD increase
in FDI will make a decrease in reserve by 4.24 million USD holding other things
(remittance, export and import) constant. This is because foreigners
invest in any country to make profit. When foreign direct investment comes it
increases reserve of that country at that time. But after some periods they
start to recover their investment by making profit and taking it to their own
country. As an example we can say that a foreign company comes and invest 1.00
million USD in Bangladesh. At that time foreign reserve of Bangladesh
increases. After 5 years they make huge profit of 10.00 million USD and take
away the part of that profit (suppose 5.00 million) to their home country. Then
it causes reserve of Bangladesh to decrease. That is why in this research
regression result shows negative coefficient in the case of FDI.
Regression Results
To sum up
the analysis it can be concluded that in case of Bangladesh,
· Remittance and export have significant positive impact on amount of foreign
reserve
· Import has significant negative effect on reserve
· Foreign direct investment (FDI) is insignificant to reserve of Bangladesh.
Figure-4.1 (in million USD)
Time series
trend of Foreign exchange reserve, export, import, remittance and FDI
(2004-2013):
In figure-4.1, reserve grows steeply in
2012-2013.Export and remittance were also growing in that period.
But import did not grow in the same pace. It was one
of the causes why reserve grew fast in 2013.
Source:
Bangladesh Bank (appendix – 7.1, 7.2)
Figure-4.2
(in
million USD)
Remittance,
export, import and FDI trend from 2004-2013
Source: Bangladesh Bank (appendix – 7.2)
4.3 Remittance
From regression
and correlation analysis, we found that foreign reserve of Bangladesh is
significantly and mostly dependable on remittance.
Figure-4.3
(Remittance trend from 2004-2013 in million USD)
Source: Bangladesh Bank (appendix – 7.2)
Foreign
remittance is the single most important source of foreign exchange reserve for a
labor exporting country like Bangladesh. Studies show that remittances can alleviate
foreign exchange growth, moderate development finance, improve balance of
payments. It can alleviate pressures on external borrowing and supplement to
household consumption and investment. The inflow of remittances to Bangladesh
is affected by various micro and macro factors.
Remittances from
international migration also play an important role for a positive current account
balance of Bangladesh. World Bank (2012) reported Bangladesh was the seven
largest economy of remittance receiver (US$ 11.65 billion) in Fiscal Year (FY)
2010-11. A substantial part of remittances has been used for export-related
businesses and brought diversification in the national budget over the last
four years (MOF, 2013).
The treasury management
wing of Bangladesh Bank estimates the total remittance figure to cross the 14
billion mark prior to the closer of FY 2012-2013, which is 54.12 per cent
higher than remittances received five years ago. Of the amount, two-thirds came
from Middle Eastern countries alone.
Bangladesh can
take some steps to boost up remittance sector as it is the heart of economy. Expansion of the labor market, increase women employment with female labor
migration from lagging regions of the country, digitalization in migration
management, enhancement of welfare activities for the expatriates and their
families, providing soft loans for migration purpose, full tax exemption for
the remittance income, and stop harassment of workers by the middlemen, improving
training techniques, enhancement of skills of migrant workers and exploration of new labor
markets for skilled as well as less skilled labor- these are some steps that
Bangladesh should take to enhance remittance sector.
4.4. Exports
From regression
and correlation analysis, we found that foreign reserve of Bangladesh is
significantly dependable on export.
Figure-4.4
(Export trend from 2004-2013 in million USD)
Source:
Bangladesh Bank (appendix – 7.2)
Exports are
significant cause to increase reserves and can provide greater access to
international markets. Among exports of manufactures, textiles and clothing
(ready-made garments and knitwear) accounted for nearly 75 per cent of total
merchandise exports in 2003-04 which indicates a high concentration of export in
this sector. Cheap labor is available in the country. That is the cause why RMG
sector is dominating the export of Bangladesh.
The economy
continues to exhibit favorable developments despite a challenging global environment.
Exports are picking up, remittances remain strong and inflation pressures have
eased over the past year, supported by prudent fiscal and monetary policies.
Reserve stood at US$14.5 billion as of end-April 2013 what was almost double
the equivalent import cover compared to late 2011.
Following the
removal of various restrictions in international trade in textiles in the first
decade of this century, Bangladesh has quickly moved to become one of the
leading RMG exporters in the world. The country has earned foreign exchange
equivalent of US$ 19.1 billion during 2011-12 from the sector. More
importantly, the development of the sector has also proved to be an agent of
social change. There are around 3.6 million employees in the sector, of which,
around 2.88 million are women. The success of the RMG export sector is often
seen as the reason for improvement in the overall position of women in the
country. It may be noted that population growth and the fertility rate in
Bangladesh is lower than the South Asian average.
For instance,
policies would have to be oriented towards export promotion. Political
vulnerability will surely destroy the export sector of Bangladesh. So, it is
high time to make the country politically sound and to make policies to promotion
export.
4.5. Imports
From regression
and correlation analysis, we found that foreign reserve of Bangladesh is
negatively related with import. That means a decrease in import will make an
increase in reserve.
Figure-4.5(Import
trend from 2004-2013 in million USD)
Source: Bangladesh Bank (appendix – 7.2)
Bangladesh has
experienced increases in the level of their foreign exchange reserves as well
as increases in their import quantity. Theory suggests that as the level of reserves
increases, it makes demand for import shift high because more funds will be
available for imports. An increase in reserves may have a positive effect on
the demand for imports of goods and services since it relaxes the excess
demand liquidity restriction
Food shortages
have been a major problem in Bangladesh, although over the last two decades
there has been a significant increase in domestic production. Though Bangladesh
has low agricultural productivity, it needs to decrease the food gap and reduce
its import dependence. As a net food importing country, it has continued
interest and concerns regarding the WTO negotiations on agriculture.
Decrease in import will
help reserve to grow more. But in case of Bangladesh, import cannot be avoided
largely as trade deficit always happens in balance of trade.
4.6.
Foreign Direct Investment
From regression
and correlation analysis, we found that impact of Foreign Direct Investment
(FDI) is insignificant on foreign reserve of Bangladesh. It is true that large
amount of FDI would increase reserve if it was consistent but for various
reasons Bangladesh has a long way to go to achieve it in desired level.
Figure-4.6
(FDI trend from 2004-2013 in million USD)
Source:
Bangladesh Bank (appendix – 7.2)
Bangladesh has
many advantages for being a prime destination for FDI. With a 160 million
population, it is found that labor force is very cheap here. So, the most
abundant factor of production is low-cost labor. This characteristic makes the
country ideal for labor-intensive industries.
The densely
populated city centers also provide for an untapped, sizeable market. Only
limit is to such a market that the products offered will either only appeal to
the upper socioeconomic strata or will have to incorporate low-cost items to
appeal to the general population.
There is also an
abundance of natural resources, such as methane gas, water and coal. Furthermore,
infrastructure of Bangladesh remains underdeveloped and this provides a wide
array of markets for incoming foreign investment with little or no domestic
competition. It is also significant to realize that the government has neither
the capital nor the resources to expand many areas of its infrastructure. Ss a
result it has attempted to open its economy towards foreign capital,
particularly in areas such as power plants, construction, transportation, etc.
Hence, the country has adopted a sequence of liberalized industrial policy
reform to attract FDI.
chapter 5
5. Conclusions and Policy Implication
5.1 Conclusion
A sound level of foreign exchange reserves indicates how much well-built the
foreign sector of a country is. Fundamentally, there is no alternative to keep
substantial amount of foreign exchange reserves in a country if the government
want to avoid fluctuation of exchange rate and to keep the currency stable. In
the deficiency of sound level of foreign reserves, speculation attack currency
and make devaluation of it vigorously. Bangladesh which is a developing country
with a low level of income, its foreign exchange reserves are very important
for a sustainable development.
Many research works have been done on the topic of resolving of foreign
reserves by Asian countries. Although there is no convincing evidence in the
literature as to which variables determine foreign exchange reserves, the
result of this study seem to be consistent with the findings of previous works.
The main purpose of this study is to recognize the determinants of foreign
exchange reserves by estimating an appropriate international reserves function.
This study considers a correlation and a regression analyses to find the
impact of export, import, remittance and FDI on foreign exchange reserve. After
testing foreign direct investment, remittance, import, export; we identified
remittance and export variables that may determine the foreign exchange
reserves of Bangladesh. The major findings of the paper states that foreign
currency reserves linearly depend on remittance, import and export. If import
increases, reserve will fall. But high reserve also creates a demand for
import. That is the reason why import grows up with growing of reserves. The
study also finds that foreign direct investment is not a significant determinant
of foreign reserves for the sample data. Because, in recent years, many
developed countries and international organizations have reduced or even
stopped their considerable amount of investment due to various causes such as
the global economic recession, various unfeasible condition by contributor
countries, unwanted existing corruption of the country, political turmoil and
so on.
5.2 Policy Implication
So, policy should be made to promote remittance and export sector to
accumulate safe basement of reserve. Trade deficit should be minimized. Import
of working capital and raw materials should be maintained in a way that will
promote export of final goods. Food gap should be minimized by developing
agricultural sector which will surely reduce import. And finally it is high
time to stop corruption, political unrest in the country which will surely
promote export, remittance and FDI.
There were some issues left uncharted in this paper due to data
constraints. Further research can be done by taking more explanatory variables
in the model. Despite the limitations, it can be helpful to central bank and
government to get an indication to make monetary and economic policy.
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chapter 7
7. Appendixes
Appendix-7.1 Quarterly data of reserve, remittance, export,
import and FDI(2004-2013)
|
Year
|
Quarter
|
remittance
|
ex_rate
|
reserve_million_USD
|
export
|
import
|
FDI
|
|
2004
|
1
|
735.00
|
58.928
|
2757.43
|
1889.00
|
2104.00
|
96.00
|
|
2004
|
2
|
843.00
|
59.651
|
2567.29
|
1694.00
|
2263.00
|
96.00
|
|
2004
|
3
|
925.00
|
59.530
|
3140.42
|
1788.00
|
2705.00
|
96.00
|
|
2004
|
4
|
869.00
|
59.942
|
3266.67
|
2150.00
|
2736.00
|
97.00
|
|
2005
|
1
|
836.00
|
62.774
|
3190.81
|
2335.00
|
2745.00
|
160.00
|
|
2005
|
2
|
943.00
|
63.604
|
3003.12
|
1922.00
|
2867.00
|
160.00
|
|
2005
|
3
|
1044.00
|
65.071
|
2909.90
|
2004.00
|
3180.00
|
240.00
|
|
2005
|
4
|
1025.00
|
65.861
|
2421.46
|
2312.00
|
3078.00
|
240.00
|
|
2006
|
1
|
1071.00
|
67.931
|
2943.00
|
2444.00
|
3040.00
|
150.00
|
|
2006
|
2
|
1108.00
|
69.793
|
3091.42
|
2449.00
|
3149.00
|
150.00
|
|
2006
|
3
|
1296.00
|
69.060
|
3645.79
|
2547.00
|
3344.00
|
170.00
|
|
2006
|
4
|
1327.00
|
68.949
|
3587.60
|
2972.00
|
3768.00
|
205.00
|
|
2007
|
1
|
1071.00
|
69.226
|
4203.36
|
3233.00
|
3594.00
|
206.00
|
|
2007
|
2
|
1108.00
|
68.988
|
4435.54
|
2953.00
|
3852.00
|
205.00
|
|
2007
|
3
|
1296.00
|
68.648
|
5270.63
|
2797.00
|
4088.00
|
175.00
|
|
2007
|
4
|
1327.00
|
68.637
|
5151.86
|
3070.00
|
3977.00
|
174.00
|
|
2008
|
1
|
1629.00
|
68.580
|
6049.87
|
3040.00
|
4222.00
|
198.00
|
|
2008
|
2
|
1812.00
|
68.578
|
5399.42
|
3382.00
|
4426.00
|
170.00
|
|
2008
|
3
|
2208.00
|
68.518
|
6042.65
|
3623.00
|
5318.00
|
106.00
|
|
2008
|
4
|
2266.00
|
68.718
|
5297.49
|
3900.00
|
5520.00
|
286.00
|
|
2009
|
1
|
2337.00
|
68.944
|
5910.78
|
4355.00
|
5711.00
|
395.00
|
|
2009
|
2
|
2168.00
|
69.031
|
6598.08
|
3353.00
|
4971.00
|
311.00
|
|
2009
|
3
|
2529.00
|
69.060
|
9200.84
|
3970.00
|
5036.00
|
176.00
|
|
2009
|
4
|
2655.00
|
69.122
|
10377.01
|
3905.00
|
4573.00
|
59.00
|
|
2010
|
1
|
2708.00
|
69.248
|
10577.80
|
3876.00
|
4614.00
|
170.00
|
|
2010
|
2
|
2825.00
|
69.303
|
10160.41
|
3410.00
|
5434.00
|
27.00
|
|
2010
|
3
|
2737.00
|
69.540
|
10970.31
|
4270.00
|
5437.00
|
91.00
|
|
2010
|
4
|
2717.00
|
70.506
|
10532.35
|
4680.00
|
5903.00
|
348.00
|
|
2011
|
1
|
2659.00
|
71.401
|
10845.90
|
5037.00
|
6333.00
|
171.00
|
|
2011
|
2
|
2892.00
|
73.330
|
9872.23
|
5257.00
|
7409.00
|
171.00
|
|
2011
|
3
|
3060.00
|
74.561
|
10175.09
|
5718.00
|
8096.00
|
229.00
|
|
2011
|
4
|
3039.00
|
77.317
|
8334.39
|
6996.00
|
8498.00
|
197.00
|
|
2012
|
1
|
2944.00
|
82.775
|
8440.25
|
6104.00
|
8011.00
|
350.00
|
|
2012
|
2
|
3072.00
|
81.855
|
9454.70
|
5530.00
|
9203.00
|
348.00
|
|
2012
|
3
|
3431.00
|
81.686
|
11506.82
|
6047.00
|
7220.00
|
249.00
|
|
2012
|
4
|
3288.00
|
81.135
|
11703.96
|
6309.00
|
7716.00
|
444.00
|
|
2013
|
1
|
3524.00
|
79.041
|
13884.87
|
6175.00
|
8050.00
|
399.00
|
|
2013
|
2
|
3812.00
|
77.870
|
14835.57
|
6212.00
|
8012.00
|
398.00
|
|
2013
|
3
|
3621.00
|
77.751
|
16377.55
|
6970.00
|
8158.00
|
466.00
|
|
2013
|
4
|
3381.00
|
77.750
|
17017.82
|
7200.00
|
9350.00
|
37.00
|
Appendix-7.2
Yearly data of reserve, remittance, export, import and FDI
(2004-2013)
|
Year
|
remittance
|
export
|
import
|
FDI
|
|
2004
|
3372
|
7521
|
9808
|
385
|
|
2005
|
3848
|
8573
|
11870
|
800
|
|
2006
|
4802
|
10412
|
13301
|
675
|
|
2007
|
5979
|
12053
|
15511
|
760
|
|
2008
|
7915
|
13945
|
19486
|
760
|
|
2009
|
9689
|
15583
|
20291
|
941
|
|
2010
|
10987
|
16236
|
21388
|
636
|
|
2011
|
11650
|
23008
|
30336
|
768
|
|
2012
|
12735
|
23990
|
32150
|
1391
|
|
2013
|
14338
|
26557
|
33570
|
1300
|
Appendix-7.3 Yearly
growth of reserve, remittance, export, import and FDI (2004-2013)
|
reserve
|
remitt%
|
exp
|
imp
|
FDI
|
|
-25.87%
|
14.12%
|
13.99%
|
21.02%
|
1.077922
|
|
48.16%
|
24.79%
|
21.45%
|
12.06%
|
-0.15625
|
|
43.60%
|
24.51%
|
15.76%
|
16.62%
|
0.125926
|
|
2.83%
|
32.38%
|
15.70%
|
25.63%
|
0
|
|
95.89%
|
22.41%
|
11.75%
|
4.13%
|
0.238158
|
|
1.50%
|
13.40%
|
4.19%
|
5.41%
|
-0.32412
|
|
-20.87%
|
6.03%
|
41.71%
|
41.84%
|
0.207547
|
|
40.43%
|
9.31%
|
4.27%
|
5.98%
|
0.811198
|
|
45.40%
|
12.59%
|
10.70%
|
4.42%
|
-0.06542
|
|
231.06%
|
159.54%
|
139.51%
|
137.09%
|
191.50%
|
|
25.67%
|
17.73%
|
15.50%
|
15.23%
|
21.28%
|
Last line is average yearly growth of the variables.
Appendix
-7.4 (Correlation Analysis)
|
Correlations
|
||||||
|
|
reserve_million_USD
|
remittance
|
export
|
import
|
FDI
|
|
|
Pearson Correlation
|
reserve_million_USD
|
1.000
|
.938
|
.884
|
.854
|
.350
|
|
remittance
|
.938
|
1.000
|
.932
|
.930
|
.461
|
|
|
export
|
.884
|
.932
|
1.000
|
.971
|
.512
|
|
|
import
|
.854
|
.930
|
.971
|
1.000
|
.502
|
|
|
FDI
|
.350
|
.461
|
.512
|
.502
|
1.000
|
|
|
Sig. (1-tailed)
|
reserve_million_USD
|
.
|
.000
|
.000
|
.000
|
.013
|
|
remittance
|
.000
|
.
|
.000
|
.000
|
.001
|
|
|
export
|
.000
|
.000
|
.
|
.000
|
.000
|
|
|
import
|
.000
|
.000
|
.000
|
.
|
.000
|
|
|
FDI
|
.013
|
.001
|
.000
|
.000
|
.
|
|
|
N
|
reserve_million_USD
|
40
|
40
|
40
|
40
|
40
|
|
remittance
|
40
|
40
|
40
|
40
|
40
|
|
|
export
|
40
|
40
|
40
|
40
|
40
|
|
|
import
|
40
|
40
|
40
|
40
|
40
|
|
|
FDI
|
40
|
40
|
40
|
40
|
40
|
|
Appendix
-7.5 (Model Summery)
|
Variables Entered/Removeda
|
|||||||
|
Model
|
Variables Entered
|
Variables Removed
|
Method
|
||||
|
1
|
FDI, remittance, import, exportb
|
.
|
Enter
|
||||
|
a. Dependent Variable: reserve_million_USD
|
|||||||
|
b. All requested variables entered.
|
|||||||
|
Model Summary
|
|||||||
|
Model
|
R
|
R Square
|
Adjusted R Square
|
Std. Error of the Estimate
|
|||
|
1
|
.950a
|
.903
|
.891
|
1358.43637
|
|||
|
a. Predictors: (Constant), FDI, remittance,
import, export
|
|||||||
Appendix -7.6 (ANOVA)
|
ANOVAa
|
||||||
|
Model
|
Sum of Squares
|
df
|
Mean Square
|
F
|
Sig.
|
|
|
1
|
Regression
|
598206571.984
|
4
|
149551642.996
|
81.042
|
.000b
|
|
Residual
|
64587228.249
|
35
|
1845349.379
|
|
|
|
|
Total
|
662793800.233
|
39
|
|
|
|
|
|
a. Dependent Variable: reserve_million_USD
|
||||||
|
b. Predictors: (Constant), FDI, remittance,
import, export
|
||||||
|
At 95% confidence interval or α= .05
Degrees
of freedom, n-5 = 40-5 = 35
Total (actual)
sum of Squares = 662793800.2
Regression
(estimated) Sum of Squares = 598206572
Residual
(errors) Sum of Squares = 64587228.25
Regression
(estimated) Sum of Squares + Residual (errors) Sum of Squares = Total
(actual) sum of Squares
598206572
+ 64587228.25 = 662793800.2
Degrees
of freedom (df)
Number of
regressors (Constant, Remittance, Export, Import, FDI) = n = 5
Degrees of freedom (df) for regression = n-1
= 4
Degrees
of freedom (df) for Residuals (error) depends on sample size. Here sample
size is 40.
Degrees of
freedom (df) for Residuals (error) = 40 – n = 40 – 5 = 35
So
Mean square for regression = Regression Sum of Squares /df =598206572/4
=149551643
Mean square for
residuals = 64587228.25/35 = 1845349.379
So, F = Mean
square for regression/ Mean square for residuals =149551643/1845349.379
=81.042
|
Appendix
-7.7 (Coefficients)
|
Coefficientsa
|
||||||
|
Model
|
Unstandardized Coefficients
|
Standardized Coefficients
|
t
|
Sig.
|
||
|
B
|
Std. Error
|
Beta
|
||||
|
1
|
(Constant)
|
-498.317
|
599.028
|
|
-.832
|
.411
|
|
remittance
|
4.001
|
.644
|
.948
|
6.214
|
.000
|
|
|
export
|
1.309
|
.585
|
.524
|
2.238
|
.032
|
|
|
import
|
-.927
|
.444
|
-.479
|
-2.088
|
.044
|
|
|
FDI
|
-4.243
|
2.264
|
-.115
|
-1.874
|
.069
|
|
|
a. Dependent Variable: reserve_million_USD
|
||||||
|
t- values, for Constant, β/Std.Error= -498.317/ 599.028 = -.832
Remittance=
6.214 Export= 2.238 Import= - 2.088 FDI = - 1.874
|
Appendix
-7.8 (Coefficient Correlation)
|
Coefficient Correlationsa
|
||||||
|
Model
|
FDI
|
Remittance
|
import
|
export
|
||
|
1
|
Correlations
|
FDI
|
1.000
|
.061
|
-.039
|
-.135
|
|
remittance
|
.061
|
1.000
|
-.295
|
-.334
|
||
|
Import
|
-.039
|
-.295
|
1.000
|
-.766
|
||
|
Export
|
-.135
|
-.334
|
-.766
|
1.000
|
||
|
Covariances
|
FDI
|
5.127
|
.089
|
-.039
|
-.179
|
|
|
Remittance
|
.089
|
.415
|
-.084
|
-.126
|
||
|
Import
|
-.039
|
-.084
|
.197
|
-.199
|
||
|
Export
|
-.179
|
-.126
|
-.199
|
.342
|
||
|
a. Dependent Variable: reserve_million_USD
|
||||||
