Off the mark: it’s not your money

The acceleration of growth of national income of the country during the new millennium owes much to the large increase in inward remittances from its expatriate workers. These remittances have not only considerably raised the income of households, but also provided adequate foreign exchange to pay for our perpetual trade deficits and considerable foreign debt servicing obligations. For the first time in the history of the country, the domestic currency has not depreciated much for nearly four years. On the contrary, taka would have appreciated significantly if Bangladesh Bank (BB) had not intervened aggressively to hold down its value.
The large inflow of remittances has increased the stock of international reserves from only $1.3 billion in FY2001 to $10.7 billion dollars at the end of FY2010, i.e. from 1.7 months of import payments to 5.4 months. This is a fairly comfortable situation which has given the economy a cushion against external shocks and some measure of confidence.

The confidence, however, seems to have gone overboard. Many people including senior policymakers have questioned the wisdom of holding such a 'large' stock of foreign reserves. They have suggested that the government should use the reserves to immediately undertake the much-needed large infrastructure projects. Some have questioned the logic of borrowing from overseas when the government could use the nation's stock of international reserves. Furthermore, they have suggested that the government should devise schemes that reduce consumption and unproductive investment (presumably land or real estate purchases) by the expatriates and their families so that more funds could be channelled into productive investment.

There appears to be some confusion regarding what the international reserves of BB are and who owns it. For one thing, the government does not own the reserves, and hence, cannot plan its expenditure on the volume of the reserves. When the central bank purchases foreign exchange (say remittances) that adds to its assets, it also creates an equivalent amount of liabilities in the form of commercial banks' reserves with itself. If the government were to simply lift the foreign exchange from the central bank, the asset liability balance will be disrupted and the integrity of the monetary system will be jeopardised. Hence, if the government wishes to use the foreign reserves it has to either borrow or buy in a prescribed manner.

Suppose the government wants to purchase $1 billion worth of machinery and equipment for power plants from overseas. If the government wishes to utilise the stock of international reserves held by BB to pay for the imports, it will have to either buy or borrow. In the case of the former, the government will pay BB taka equivalent of $1 billion with checks drawn against commercial banks with which it holds deposits. It could also pay with the deposits it holds with BB. When the purchase is completed, BB's stock of international reserves or foreign assets will decline by $1 billion. This reduction in BB's assets will be exactly matched by a reduction of liabilities, in this case the reserves of commercial banks with BB, by the same amount. The reduction in bank reserves will lead to a multiple reduction of the money supply.

If on the other hand, the government borrows, it will tender some debt instruments, such as treasury bills or bonds, worth $1 billion in payment of foreign exchange of the same amount. In this case, the stock of foreign assets of BB is reduced by $1 billion, but its stock of domestic assets increases by $1 billion, such that the net asset position does not change. Hence, no change in its liability will be necessitated by this transaction and hence, there will be no change in the money supply.

If the private sector were to purchase foreign exchange of $1 billion from BB for importing goods, the outcome would be exactly the same as above. However, the private sector in Bangladesh cannot borrow from BB in the manner the government does by tendering securities. It can only borrow taka from the discount window if BB allows it to, and then use the proceeds to purchase foreign exchange. BB's total assets and liabilities situation is not changed by such a transaction.

Outright purchase of foreign exchange from BB, whether by the government or the private sector has a contractionary impact on the money supply. But government borrowing has no monetary implication. The fiscal balance of the government is of course affected by the borrowing. In the current year the government has additional fund to spend, but it will incur interest cost in the future years and eventually the loan will have to be retired when the securities mature.

It should be noted that the government has seldom been able to fully spend either the resources made available by the annual development plans (ADP) or foreign aid. It spent only 48 percent of ADP during the first 9 months of the last fiscal year and 47 percent of the available project aid (Economic Review 2010). The chronic failure to utilise foreign aid has resulted in a very large amount of unspent foreign exchange (more than $8 billion) in the aid pipeline. Thus, the binding constraint to investment is not the availability of funds, whether in local resources or foreign exchange, but rather the lack of adequate capacity of the government to spend or invest.

The remittance money is owned by the expatriate workers or their families. Most workers cannot take their families overseas with them. They send money home to defray the expenses of their families. How this money will be spent and how much of it will be saved are decisions exclusively of the remitters and their families, just as it is the decision of the resident population how they spend their incomes. There is little scope for direct interference in this regard by the policymakers.

If the government wishes to encourage savings it can devise some attractive saving instruments so that the expatriate workers and their families are encouraged to invest in these instruments. Whether such a policy will actually increase the saving rate is a moot point. Higher yields of saving instruments will encourage greater saving through an intertemporal substitution effect, i.e. postponement of current consumption in order to consume more in the future. However, the higher earnings will also discourage saving through an income effect. The final outcome is ambiguous: it could lead to either an increase or a reduction in total savings.

Where the remittances will be invested depend on relative profitability and security of investment. As long as it is more profitable to invest in land or real estate, much of the investment will flow in that direction. If the government wishes to attract remittances to other saving instruments, it will have to ensure that their yields are higher than that of real estate. Frequently, the value of financial investment is eroded by inflation, but the value of land and real estate ride ahead of inflation. These days investment in the stock market seems to offer rather high returns. This is encouraging a large flow of money into the stock market notwithstanding the dire warnings of the regulators and experts.
Those who provide such advice as mentioned above overlook two things. First, savers and investors are not the same group of people, and second, Bangladesh is one of those countries that currently have significant surplus savings. The country has not been able to fully invest the collective savings of its nationals during the last few years as shown in the Table below.

Table: Investment, saving and current account

The investment ratio is considerably less than the saving ratio. In other words, the investors have not been able to invest the entire savings made available by the savers. This has shown up as current account surplus in the balance of payments and a build up of the international reserves; i.e. at the macro level, Bangladesh is lending money to the rest of the world. It is precisely the paucity of investment that has caused the augmentation of the reserves, and not the other way round as is commonly believed. If Bangladesh wants to utilise its savings domestically, it has to increase the capacity to invest. This would require at the least an improvement in institutional and physical infrastructure, especially power. Without business-friendly services and environment, the country will be unable to fully utilise its savings. Such facile measures as floating additional saving instruments will simply redistribute current savings, but do little to encourage investment.
——————————
Professor M A Taslim is the CEO, Bangladesh Foreign Trade Institute