Almost all of India’s neighbours – Pakistan, Sri Lanka, Bangladesh, and Nepal – are facing balance of payments issues. Bangladesh is struggling to pay for its fuel imports, due to a shortage of US dollars[1]. Sri Lanka has already defaulted on its international commitments, and Pakistan is on the verge. While the commodity price shock caused by the Russia-Ukraine conflict was a trigger, some of this pain is self-inflicted, due to bad exchange-rate policies.
A glance at the historical exchange rates of the Pakistani Rupee (PKR), the Sri Lankan Rupee (SLR) and the Bangladeshi Taka (BDT) shows that these had a fixed exchange rate versus the US dollar in all but name. All the three countries import fuel, food and fertilizer, so a ‘strong’ exchange rate also kept prices of imported goods low. An artificially strong exchange rate makes exports uncompetitive – and is not sustainable.
However, these countries have another export which is stickier than product exports – human labor. All of South Asia (including India) is a major source of migration of labour abroad – about 43 million[2] of 164 million migrants globally – and a recipient of inward remittances. The World Bank estimates that 20%[3] of the global remittances of $815 billion in 2023 will come from South Asians working abroad. In 2021[4] remittances at $157 billion were three times the Foreign Direct Investment (FDI) for the region. Pakistan, Bangladesh and Sri Lanka are much more reliant on remittances than is as India.
The inward remittances have allowed the other South Asian countries to maintain ‘strong’ exchange rates, against market realities. Very often, these countries have two exchange rates – an “official” rate and a “market” rate which is significantly higher. Workers sending money via banking channels have to use the lower official rate – in effect subsidizing the government. When the divergence between the two rates becomes too wide, as it has in the past two years, remittances start to decrease. A large and sustained gap between the official and the market exchange rate leads to the use of informal channels such as hawala, legal in the UAE[5] where many such workers are based.
| South Asia: Goods Exports vs Inward Remittances (FY22 data) | ||
| Total Exports ($ billion) | Inward Remittances ($ billion) | |
| Pakistan[6] | 31.48 | 31.28 |
| Bangladesh[7] | 52.08 | 21.03 |
| Sri Lanka (2020 – pre default)[8] | 10.05 | 7.1 |
| India | 422 | 89.1 |
| Source: Central banks of Pakistan, Bangladesh, Sri Lanka, India | ||
The use of hawala and/or informal channels was visible in Sri Lanka in the second half of 2021, when it was clear that the exchange rate was unsustainable, and a default was inevitable. Inward remittances during that time in 2021 were $2.1 billion, a drop of almost 50% compared to the same period last year.[9] Sri Lanka has over 1 million overseas workers, many of whom stopped using official channels, making the default more likely and the consequences much worse. During early 2022, the official exchange rate was around SLR 200 to a dollar, while the market-rate was over 20% higher than that. Eventually, post the default, the Sri Lankan rupee stabilized at 360 to a dollar.
The Pakistani rupee, which has fallen by over 40% against the US dollar in the past year, still trades in the open market at a significant discount to the official exchange rate. To preserve its meagre currency reserves, Pakistan has instead cut down on imports, forcing industries to shutter and hurting its economy further. Pakistan’s exports have fallen 19% during the Jan-Mar 2023 quarter, as many export-oriented industries are unable to import crucial input material. Inward remittances to Pakistan have also taken a hit. During the first 10 months of the current financial year, remittances are down to $22.7 billion, compared to $26.1 billion for the same period last year, a drop of 13%, according to the State Bank of Pakistan.[10] The ongoing political turmoil will accelerate the decline. Pakistan’s current forex reserves are sufficient for two weeks of imports and a default is a matter of when, not if. Pakistan’s economy will take a long time to emerge from the turmoil of the past year.
Compared to the other two, Bangladesh took corrective action as its forex reserves started to plummet in 2022, but were still at a comfortable level of $35 billion. It approached the IMF for a rescue package in mid-2022, which was finally approved in early 2023[11]. Bangladesh had to devalue its currency by almost 25% over this period. One of the factors that drove the government to act was the fall in remittances: in the second half of 2022, Bangladesh received inward remittances of $8.69 billion, down 16% over the same period of 2021.[12]. However, Bangladesh’s forex reserves have continued to decline – meaning that a further devaluation of the currency is likely.
In all these cases, governments were able to maintain an artificially strong exchange rate because of the strong money flows from the millions of expatriates/overseas workers. This policy is unsustainable in the long run. India too, is a major recipient of remittances – $89 billion per year[13] – but these are a fraction of India’s goods and services exports. India sensibly abandoned fixed exchange rates in 1992 and has allowed its currency to find its true level, high or low. Its south Asian neighbours will be wise to do the same.
Amit Bhandari is Senior Fellow for Energy, Investment and Connectivity, Gateway House.
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References
[1] Ruma Paul, ‘Bangladesh struggling to pay for fuel due to dollar shortage,’ Reuters, 22 May 2023, https://www.reuters.com/world/asia-pacific/bangladesh-struggles-pay-fuel-imports-dollar-crisis-worsens-letters-2023-05-22/
[2] ‘Migration Data in southern Asia,’ Migration Data Portal, https://www.migrationdataportal.org/regional-data-overview/southern-asia.
[3] ‘Migration and Development Brief 37: Remittances Brave Global Headwinds,’ Knomad, https://www.knomad.org/publication/migration-and-development-brief-37.
[4] ‘Remittances to Reach $630 billion in 2022 with Record Flows into Ukraine,’ The World Bank, 11 May 2022, https://www.worldbank.org/en/news/press-release/2022/05/11/remittances-to-reach-630-billion-in-2022-with-record-flows-into-ukraine.
[5] Deepthi Nair, ‘UAE Central Bank unveils awareness campaign for hawala remittances,’ The National News, 14 July 2022, https://www.thenationalnews.com/business/money/2022/07/14/uae-central-bank-unveils-awareness-campaign-for-hawala-remittances/#:~:text=The%20regulator%20permits%20legitimate%20hawala,which%20was%20issued%20in%202019.
[6] State Bank of Pakistan, https://www.sbp.org.pk/index.html.
[7] Central Bank of Bangladesh, https://www.bb.org.bd/en/.
[8] Central Bank of Sri Lanka, https://www.cbsl.gov.lk/en.
[9] ‘Worker Remittances: Statistics,’ Central Bank of Sri Lanka, https://www.cbsl.gov.lk/workers-remittances/statistics.
[10] ‘Country-wise Workers’ Remittances,’ State Bank of Pakistan, https://www.sbp.org.pk/ecodata/homeremit.pdf.
[11] ‘IMF Executive Board Approves US$3.3 Billion Under the Extended Credit Facility/Extended Fund Facility and US$1.4 Billion Under the Resilience and Sustainability Facility for Bangladesh,’ International Monetary Fund, 30 January 2023, https://www.imf.org/en/News/Articles/2023/01/30/pr2325-bangladesh-imf-executive-board-approves-usd-ecf-eff-and-usd-under-rsf.
[12] ‘Monthly data of wage earner’s remittance,’ Central Bank of Bangladesh, https://www.bb.org.bd/en/index.php/econdata/wageremitance.
[13] Ministry of Finance, ‘ India received highest ever foreign inward remittances in a single year of $89,127 million in FY 2021-22,’ Press Information Bureau, 7 Feb 2023, https://pib.gov.in/PressReleasePage.aspx?PRID=1897036.