When the Taka Slides and the Reserves Blink

Diagnosis. Reserve loss is the visible symptom of a balance-of-payments gap. Decompose it:

• Current account: the import bill is dominated by fuel, edible oil, and wheat - goods with low short-run price elasticity of demand. A 14 percent depreciation raises their taka cost almost one-for-one in the short run, so the trade balance can worsen before it improves (a J-curve). Meanwhile export supply is capacity-constrained, so the export response is slow.
• Financial account: exporters delaying repatriation and importers front-loading are expectational capital flows. They are not driven by interest differentials but by the expected path of the exchange rate. This is the crucial point: the financial account is bleeding because the market expects more depreciation.

Why smoothing is self-defeating. Defending the currency by selling reserves does three harmful things simultaneously:

1. It validates the expectation that the authorities will hold the rate, so exporters wait for a better rate and importers rush - the very behaviour that drains reserves.
2. It signals that reserves are finite; once the market can estimate cover (3.8 months and falling), the defence loses credibility and the eventual adjustment is larger.
3. It forces the central bank to sell dollars while the interest rate stays low, so the domestic liquidity injection from intervention is unsterilised or only partly sterilised, feeding inflation.

The classic policy trilemma applies: with a managed float and an open capital account, defending a level and setting an independent interest rate are in tension. Smoothing the path (reducing volatility) is legitimate; defending a level against a persistent fundamental gap is not.

Evaluating the debt-service argument. The argument has a kernel of truth but inverts the arithmetic. If domestic public debt is largely short-term or floating-rate, a rate rise does raise the immediate interest bill. But:

• If inflation is 9.4 percent and the policy rate is well below it, the real rate is deeply negative. Negative real rates penalise savers, encourage dollarisation and asset speculation, and - critically - make holding the taka unattractive, which worsens the very capital flight draining reserves. Low rates are therefore contributing to the problem they are meant to solve.
• The debt-service saving is a transfer from savers and from exchange-rate stability to the treasury. If depreciation continues, the foreign-currency debt service rises in taka terms, which can dwarf the domestic saving.
• Credibility has a price: a central bank that visibly subordinates rates to the fiscal authority will be punished by markets with a higher risk premium, raising future borrowing costs anyway.

Recommended package.

1. Raise the policy rate in credible steps toward a positive real rate. This anchors expectations, makes taka assets competitive, and discourages delayed repatriation.
2. Allow faster, orderly depreciation and stop defending a level. Use intervention only to smooth disorderly moves. This removes the one-way bet.
3. Sequence import measures carefully. Administrative import controls can help the reserve position quickly, but blanket controls protect inefficient production and invite rent-seeking. Target luxury and non-essential imports, and pair controls with a credible plan to expand domestic fuel and food supply.
4. Coordinate with fiscal policy. The government should trim non-development expenditure and remove untargeted price caps, which are themselves adding to the fiscal deficit and to import demand. A price cap on fuel with a fixed import price simply converts a price problem into a subsidy problem.
5. Communicate a nominal anchor. Announce a reserve-cover target and a path, so expectations can stabilise.

Judgement. The debt-service argument is a reason to lengthen debt maturity and deepen the domestic bond market, not a reason to keep real rates negative during a reserve crisis.