Exchange Rate Policy and Real Exchange Rate Behaviour in Bangladesh: 1972-2008

This paper reviews the evolution of exchange rate policy and examines the real exchange rate behaviour in Bangladesh over the period 1972-2008. It deploys Pesaran’s bounds testing approach to cointegration to determine whether there exists a long-run equilibrium relationship between the real effective exchange rate of the Bangladesh taka and its fundamental determinants. The paper also investigates whether the monetary authorities in Bangladesh adopted a strategy of ‘real exchange rate targeting’ to achieve a real objective such as export promotion. Empirical results suggest that the real effective exchange rate of the taka forms a cointegration relationship with fundamental determinants, such as the external terms of trade, trade openness, current account balances, external debt, investment, seigniorage and the government’s current expenditures. Empirical results also suggest that, except for the period 1998-2004, there was no significant real exchange rate misalignment in Bangladesh since it started trade reforms in the mid-1980s. The results of bivariate Granger causality testing suggest that the real exchange rate misalignment was causally linked to the cyclical component of budget deficits, excess money supply and the cyclical component of real output. Finally, empirical results suggest that the monetary authorities in Bangladesh adopted a strategy of real exchange rate targeting to maintain trade competitiveness from the mid-1980s until the late 1990s.