ISAS Working Paper
No. 85 – Date: 7 September 2009
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An Economic Analysis of Bangladesh’s Foreign Exchange Reserves M. Shahidul Islam 1
Executive Summary Following the rapid accumulation of foreign exchange reserves in recent months, there has been a growing interest in Bangladesh on the alternative uses of its reserves. However, different reserves adequacy measures based on global best practices confirm that its reserves holding is not markedly higher than what is required. The country’s reserves stand higher than the adequate level only when one considers the current account aspects of reserves benchmark which is perhaps appropriate for the country as its financial system is still autarkic. The dynamics in its balance of payments account also supports the fact. The paper highlights the fact that Bangladesh’s reserves build-up is the result of an ‘investment drought’ in the country. This is partly due to its underdeveloped financial systems, and partly due to other structural problems in the economy – entailing difficulties in properly channelling national savings to investments. As the Bangladesh central bank’s sterilised intervention increases, so will its cost of reserves accumulation. The reason is the interest rate arbitrage between Bangladesh and the United States. The United States government securities market, that absorbs the lion’s share of developing economies reserves, has been offering lower yields following the collapse in interest rate in the country in recent times. Nevertheless, the apparent spread between the United States Treasury and Bangladesh Treasury rates might be not that high in real terms if one weighs in Bangladesh’s certain benefits of reserves holding, particularly