Reductive though it may be, the most commonly-used indicator of a country’s ‘reserve adequacy’ is reserves in months of imports, aka the reserve import cover (RIC). It measures the number of months of imports that can be paid for with the foreign exchange reserves available with the central bank at any given point.
According to the IMF, this measure “is likely to remain relevant as a simple way of scaling the level of reserves by the size and openness of the economy.”
It is not however the only measure of reserve adequacy – something we’ll return to later.
Recently, a downward slide in Bangladesh’s reserves has been met with great concern among policymakers and other economic actors. From a peak of $48 billion reached in August 2021 – said to be enough to cover 9 months of import at the time – the reserve slid below $40 billion for the first time in two years, earlier this month.
Leave aside for the moment the issue of ‘encumbered’ and ‘unencumbered’ reserves – that may leave the figure a further $7-8 billion lower. For now we will proceed with the figure of $39.67 billion, that was reported on July 20.
It is now being said, on behalf of the government, that the reserve is adequate to cover 5 months of imports, i.e. the RIC is 5 months. Some independent economists however contend the RIC at the moment is 4 months. And one or two are even quoting three months.
More than the reduction in the actual amount – by just one-sixth, or $8 billion – it is the proportionately larger reduction in the reserve import cover from 9 months to 3, 4, or 5 months, that acts as a signal of hard times ahead for most Bangladeshis.
How could an $8 billion reduction in the reserve from August 2021, just one-sixth, lead to almost a halving of the RIC? The key lies in how the reserve import cover is calculated.
Don’t be put off by the math. It is actually very simple.
The formula for the reserve import cover = reserve/annual import x 12 (in words: the reserve figure divided by annual imports, times 12)
Clearly, the import figure we use is extremely important to our calculation. And it is the dramatic change in the import figure we’re using now, as opposed to the one used in August 2021, that is causing our forex reserves to lose even more shine than what might be visible on the surface.
It is a direct result of the record breaking surge in imports that the economy witnessed in the just-concluded fiscal (2021-22). The final official figure is still not in, but Bangladesh Bank’s own estimate puts it at $85 billion.
That represents a whopping 40 percent increase year-on-year. Bangladesh’s 2020-21 import figure, which we do have fully counted from official sources, was $60.7 billion. In August 2021, the RIC would be calculated using this number.
So on the day we hit $48 billion, the RIC was:
48/60.7 x 12 = 9.4
Whatever comes after the decimal is ignored, and so the RIC was 9 months.
Today, using the updated figures for the reserve, as well as imports, the RIC:
39.67/85 = 5.6, or 5 months.
That is the government’s calculation.
More like four?
How might the government’s calculation of the RIC differ from that of some independent economists, who are quoting 4 months? The RIC of 4 months that some economists are quoting, is where we return to the concept of ‘unencumbered’ reserves.
Most macroeconomists, and certainly the IMF institutionally, hold the view that a country should have only its unencumbered foreign liquidity in its reserve calculation, to avoid creating an illusion. ‘What cannot be spent, should not be counted’, goes the dictum.
Bangladesh’s official reserve figure at present includes mainly three ‘encumbered’ items:
The Export Development Fund (foreign currency loans to incentivise exporters, worth $7 billion), a loan to the Payra Port project (this is in Euros, 524.5 million, roughly the same in dollars) and the $200 million currency swap with Sri Lanka.
Since these amounts have been paid out as loans, Bangladesh Bank prefers to record them as ‘foreign currency assets’, and counts the entire amount as part of the reserve, feeding the expectation that it will be fully recovered. Exporters however have been defaulting on the loans already, according to data from the 4 public sector banks through which the EDF was distributed.
Not counting those three items brings the reserve down to around $32 billion. This takes a month off the RIC from the government’s calculation (32/85 x 12 = 4.5).
Going by the ‘What cannot be spent, should not be counted’ principle, it would seem sensible to go with the IMF on this one. What the 4 banks managing the EDF are reporting, and in general the corporate sector’s record on loan repayments, reinforces this view.
Read:Forex reserve: Why $10 billion in 2010 was not a worry, but $40 billion today is
At the very least, you prepare for the worst, while hoping for the best – which in the present context seems to be the soundest financial advice. Which is why all things considered, 4 months is probably the most realistic estimate at the moment, of our RIC.
One or two economists are even quoting 3 months of reserve import cover. The likelihood here is that instead of calculating on the basis of the numbers we have to hand, such as the 2021-22 import figure, they are speculating that imports will keep rising in the next, i.e. current fiscal.
For the $32 billion reserve figure to cover just 3 months, annualised imports would have to comfortably hurdle $100 billion – in fact it would be over $120 billion. But if we only maintain the 40% growth rate in imports, it takes us there. So till the measures announced by the government to rein in imports start taking effect, and showing up in the numbers, by no means can the possibility be dismissed.
With all the uncertainty prevailing in the world economy, a war in Europe with no end in sight, and the persistent upward pressure on energy prices – that Bangladesh must pay – nothing can be taken off the table completely.
All about imports?
Before wrapping up this explainer, it would seem only prudent to flag that the exclusive use of the RIC to assess reserve adequacy, that is already notable in our discourse, is inherently reductive. From constantly focusing on the RIC, we risk internalising that the only use for the reserve is to provide the foreign currency for import payments.
That is far from the case though. A country’s foreign exchange reserve performs a number of functions, many of them in the background of economic activity. A review of the literature reveals at least four broadly identifiable functions:
i) To support and maintain confidence in the government’s policies for monetary and exchange rate management, including the capacity to intervene in support of the national currency (e.g. BB’s frequent recent interventions in the dollar market)
ii) To limit external vulnerability by maintaining foreign currency liquidity when access to borrowing may be limited
iii) To assist the government in meeting its foreign exchange needs and external debt obligations
iv) Maintain a reserve for national disasters or emergencies.
To that end, we must look to explore other indicators of reserve adequacy. The IMF regards the RIC to be an ‘import-based measure’ of reserve adequacy. There are also ‘money-based’ and ‘debt-based’ measures of the same.
An example of the latter is the ratio of Reserves to Short-term External Debt. The IMF quotes empirical studies both within the Fund and outside it that suggest this is in fact “the single-most important indicator of reserve adequacy in countries with significant but uncertain access to capital markets.”
The Reserve Bank of India, in publishing its weekly update on India’s reserve position, always includes two indicators: the RIC, and the short-term external debt ratio.
It might be something to look at for the future.
Source: United News of Bangladesh