CREATIVE ONLINE: Economic Determinants of Foreign Exchange Reserve of Bangladesh: A Study On Causes and Effects by Golam Rabby Masud

Economic Determinants of Foreign Exchange Reserve of Bangladesh: A Study On Causes and Effects

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. 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

Table of Contents
Chapter	Title	Page
	Title Page	i
	Acknowledgement	ii
	Abstract	iii
	Table of Contents	iv
	List of Figures	v
	List of tables	vi
	Abbreviations	vii
1	Introduction	1
	Background	1
	Statement of Problems	1
	Objectives of Study	3
2	Literature Review	4
3	3.1 Data Sources	6
	3.2 Methodology	7
4	4. Results and Discussion	7
	4.1 Correlation	8
	4.2 Regression	8
	Regression Results	9,10
	4.3 Remittance	11
	4.4 Export	13
	4.5 Import	14
	4.6 FDI	15

5	Conclusions and Policy Implication	16
6	Bibliography/References	17
7	Appendices	19

List of Figures
Figure	Title	Page
Figure-1.1	Time series trend of Foreign exchange reserve In million USD for years 2004-2013	3
Figure-4.1	Time series trend of Foreign exchange reserve, Export, Import, Remittance and FDI for years 2004-2013	10
Figure-4.2	Remittance, export, import and FDI trend from 2004-2013 in million USD	11
Figure-4.3	Remittance trend from 2004-2013 in million USD	11
Figure-4.4	Export trend from 2004-2013 in million USD	13
Figure-4.5	Import trend from 2004-2013 in million USD	14
Figure-4.6	FDI trend from 2004-2013 in million USD	15

List of Tables
Table	Title	Page
Table-4.1	Correlation result of foreign exchange reserve with remittance, export, import and FDI in years 2004-2013	8
Table-4.2	Regression results of the impact of remittance, export, import and FDI on foreign exchange reserves in year 2004-2013	8

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:

Y_t= β₀ + β₁(remittance) + β₁ (export) + β₂ (import) + β₃ (FDI) + U_t

Where, Y_tis 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.

Bibliography/References

Aizenman, J. and Lee, J. 2005. International Reserves: Precautionary verses Mercantalist Views: Theory and Evidence .NBER Working Paper No. 11366.

Aizenman, J. and Lee,Y. and Rhee, Y. 2004. International Reserves Management and capital mobility: Policy Consideration and a Case Study of Korea. NBER Working Paper No. 10534.

Aizenman, J., and Marion N.2002. The High Demand for International Reserves in the Far East: What's Going On? Working Paper, UC Santa Cruz and the NBER. College of Dartmouth.

Ali, M.M. and Medhekar, A. 2012 Management of Macro Economic Performance of Bangladesh: An Empirical Analysis, International Review of Business Research Papers, Vol. 8. No.1. Pp. 64 – 83.

Arize, A.C.2012. Foreign Exchange Reserves in Asia and Its Impact on Import Demand. International Journal of Economics and Finance, Vol.4, No.3.

Bangladesh Economic Update, 2012.Unnayan Onneshan, Vol- 3, No.7 (July)

Batter, D. 1982 “Central Bank’s Demand for Foreign Reserves Under Fixed and Floating Exchange Rates”. Federal Reserve Bank of St. Louis, 1982.

Calvo, Guillermo and Reinhart, Carmen.2000. “Fear of Floating” NBER Working Paper No-7993.

Chowdhury, K.R. , Hamid, F and Chatterjee D.D. 2010.Remittance as at tool of Economic Development: BD Perspective. BD Research Publications Journal, Volume: Y’s Issue: 3. Page 286-296.

Chowdhury, M.N.M., Uddin, M.J. and Islam, M.S.(2014). An Econometric Analysis of the Determinants of Foreign Exchange Reserves in Bangladesh. Journal of World Economic Research. Vol. 3(6), 72-82.doi: 10.11648/j.jwer.20140306.12

Damodar N. G. (1995) Basic Econometrics, Third Edition, McGraw-Hill Inc., 1995-1998, Singapore.

Delatte, A.L and Fouquau, Julien (2009), The Determinants of International Reserves in the Emerging Countries: a Non Linear Approach MRPA Paper No.16311.

Disyatat, P.2001.Currency Crisis and Foreign Reserves: “A Simple Model” Working Paper, IMF.

Dooley,M.P.D.Folkerts-Landau,and P.Garber.2004. “The Revived Bretton-Woods System.” International Journal of Finance and Economics 9(4):307-18.

Eichengroen, B. and Mathieson D.J.(2000). The Currency Composition of Foreign Exchange Reserves: Retrospect and Prospect. IMF Working Paper.

Flood, R and Marion, N. (2002). Holding International Reserves in an Era of High capital Mobility, IMF working Paper, 62.

Frenkel, J.1978. “The Demand for International Reserves by Developed and Less-Developed Countries.” Economica New Series, 41, 1974:14-24.

Fukuda, S. and Yoshifumikon-2007.Macroeconomic Impact of Foreign Exchange Reserves Accumulation: A theory and Some International Evidence University of Tokyo.

Gantt, R.P.(2010). Central Bank Holding of Foreign Exchange Reserves: Why Have Theory Grown So Fast? Montuna StateUniversity. Bozeman. (April).

Gosselin, M.A, and Parent, N. (2005), An Empirical Analysis of Foreign Exchange Reserves in Emerging Asia: Bank of Canada Working Paper 2005-38, December 2005.

Green Span, A.1999. “Currency Reserves and Debt” .Remarks at the World Bank Conference on Trends in Reserves. (April).

International Financial Statistics, (2005) website

International Monetary Fund (IMF), (2003). “Are Foreign Exchange Reserves in Asia too High?” World Economic Outlook (September):63-77.

International Monetary Fund (IMF), International Financial Statistic Database. Available Through Ames Library Website. Accessed January28, 2005.

Landell-Mills, J.M. 1989. “The Demand for International Reserves and Their Opportunity cost”. International Monetary Fund Staff Papers 36(3):107-32.

Lane, P.R and Burke D.2001. “The Emprises of Foreign Reserves”. Open Economy Review 12(4):423-34.

Lizondo,J and mathiieson D. 1987. “The Stability of the Demand for International Reserves”. Journal of International Money and Finance.6 (3): 251-82.

Mankiw, N.G. (2001) Macroeconomics, Fifth Edition.

Mendoza, R.U.2004. “ International Reserves Holding in the Developing World: Self Insurance in a Crisis Prone era?” Emerging Market Review 5(1):61-82.

Obstfeld , M Shembaugh, J.C, and Taylor A.M(2008). Financial Stability, The Trilemma, and international Reserves. NBER Working Papers (14826).1-23.

Obstfeld, M.Shembaugh, J.C, and Taylor A.M (2009).Financial Instability Swap lines in the Panic of 2008. NBER Working Paper (14826). 1-23.

Prabheesh, K P; Malathy, D and Madhumathi, R (2007) Demand for Foreign Exchange Reserves in India: A Cointegration Approach, South Asian Journal of Management,Vol.14, No.2, 2007, 36-46.

Reserve Accumulation’, L. K. Jha Memorial Lecture. Reserve Bank of India, Mumbai.

Rezaulk (2011) Maintaining International Reserves Under Three Major Political Reimes in Bangladesh. http://www.bukisa.com/articles/617887_maintaininginternational- reserves-under-three-major-political-regimesin- bangladesh.

Romero, A.M.(2005) 05, A. M, "Comparative Study: Factors that Affect Foreign Currency Reserves in China and India" Illinois Wesleyan University, Honors Projects. Paper 33. http://digitalcommons.iwu.edu/econ_honproj/33

Sehgal, S. and Sharma, C. (2008) A Study of Adequacy, Cost and Determinants of International Reserves in India, International Research Journal of Finance and Economics ISSN 1450-2887 Issue 20 (2008) © Euro Journals Publishing, Inc. 2008.

Snowdon B. and Vene H.R., Modern Macroeconomics, Edward Elgar Publishing, Inc. 136 West Street Suite 202 Northampton Massachusetts 01060 USA.

Summers, L H, 2006, ‘Reflections on Global Account Imbalances and Emerging Markets

Uddin, H.2010. An Empirical Examination of Exchange Rate between Bangladesh Taka and US Dollar after Switching to floating Syatem.Universuty of Share Job, United Arab Emirates.

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/Removed^a
Model	Variables Entered		Variables Removed		Method
1	FDI, remittance, import, export^b		.		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	.950^a	.903		.891		1358.43637
a. Predictors: (Constant), FDI, remittance, import, export

Appendix -7.6 (ANOVA)

ANOVA^a
Model		Sum of Squares	df	Mean Square	F	Sig.
1	Regression	598206571.984	4	149551642.996	81.042	.000^b
	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)

Coefficients^a
Model		Unstandardized Coefficients		Standardized Coefficients	t	Sig.
Model		B	Std. Error	Beta	t	Sig.
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 Correlations^a
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

CREATIVE ONLINE

Pages

Sunday, August 30, 2015

Economic Determinants of Foreign Exchange Reserve of Bangladesh: A Study On Causes and Effects by Golam Rabby Masud

1 comment: