Syndicate content

The Dutch Disease has not Infected Bangladesh, not yet any way

Zahid Hussain's picture

The Netherlands’ discovery of large natural gas deposits in the North Sea in the 1960s had serious repercussions on important segments of its economy, as the Dutch guilder became stronger, making Dutch non-oil exports less competitive. This has come to be known as "Dutch disease" or “resource curse.” Although generally associated with a natural resource discovery, it can arise from any large inflow of foreign currency--foreign assistance, foreign direct investment and remittances, among others. A surge in remittances can be expected to result in appreciation of the currency in the receiving country with all its attendant consequences of crowding out exports, crowding in imports, and induce movement of resources into the production of non-traded goods.

Bangladesh has experienced a remittance boom since FY01—with annual flows rising from $1.9 billion to $9.7 billion in FY09—growing at a compounded annual rate of 22.6 percent for eight years and still counting! As a result, remittance has now reached nearly 11 percent of GDP and is now the single largest source of foreign exchange earnings.

Foreign assistance and net foreign exchange earnings from merchandize exports do not even come close. Based on this some prominent Bangladeshi economists have argued that the Dutch disease has in fact infected Bangladesh.

…easy access to foreign exchange from exports to protected markets and from remittances of workers abroad, exacerbated by large foreign aid flows, closely resembles the phenomenon of “resource curse” or “Dutch disease”. These flows kept the rate of exchange well above the critical level at which a broad range of exports would have become competitive and some of the traditional exports that have been wiped out would have remained competitive”, claims Dr. Azizur Rahman Khan in a recent publication.

While this view appears to be gaining popularity, I argue here that it is not evidence based.

First, the main transmission mechanism—exchange rate appreciation—has not really happened no matter how one looks at it. Bangladesh’s nominal exchange rate against the US dollar depreciated by 24.7 percent during FY01-09. The nominal effective exchange rate (NEER) also depreciated by 32 percent during FY01-08. It appreciated by 7.2 percent during September 2008 to April 2009. This was almost entirely reversed in the next six months. The Real Effective Exchange Rate (REER) also depreciated by 15 percent during FY02 to August 2008 followed by about 8 percent appreciation during September, 2008 to March, 2009. This was partially reversed in the next seven months with the depreciation of REER by 3.3 percent.

Second, the brief NEER and REER appreciation is more a correction of misalignment from the equilibrium exchange rate. According to Bangladesh Bank, the REER based nominal exchange rate in May 2008 was Tk 56.7 per dollar compared with the actual exchange rate of Tk 68.5 per dollar in the same month. Taka was way undervalued!

Third, exports, particularly garments, have boomed. Export of woven garments has increased from $3.36 billion in FY01 to $5.9 billion in FY09 and knitwear exports have increased from $1.5 billion to $6.4 billion during the same period. This is anything but Dutch disease. In fact, the under-valuation of the Taka may have contributed to this boom.

This is not to suggest complacence. Hopefully, the new found sources of income in foreign labor markets will last. If the large and increasing inflow of remittances is sustained, pressure on exchange rate to appreciate will continue. Building up reserves to prevent this will test Bangladesh Bank’s ability to sterilize the impact on the supply of money.

As the Bank’s Growth Commission report cautions: “Bad policies are often good policies applied for too long.” Policymakers need to manage the inevitable structural changes in the economy so as to ensure economic stability. They may want to take steps to boost productivity in the export sector and invest in easing the most binding constraints such as power and gas. They may also want to diversify exports to reduce dependency on the garment sector and make them less vulnerable to external shocks, such as a sudden drop in apparel prices.

Comments

Submitted by Prajwol on
Good informative article on Bangladesh. It seems most of the "under-developed" are relying more and more on remittance for foreign exchange, which I feel is a sorry state. Remittance can build personal wealth, but it can never build the better society around it. The migrant worker sends a big check back home and the family builds a big house, but outside that house there won't be good roads, sewer system, clean drinking water, etc :( But it's nice to know that their garment industry is picking up. I, personally being from a landlocked country, always envied the countries with access to their sea port. Bangladesh should maximize their exports not remittance.

Add new comment