Usd and Bdt Exchange Rate

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Bangladesh is an emerging country of the South Asian region that has been following the policy of fixed exchange rate with strict restriction on currency convertibility, which has been relaxed a few years ago. As reported in the Central bank’s (Bangladesh Bank) annual reports, Bangladesh has maintained a sustainable economic growth rate between 6 and 7 percents over past several years. The volume of foreign trade increased in 2008 significantly to 36 billion dollars with 22 billion dollars of imports and 14 billion dollars of exports. In addition, about 9 billion dollars of direct remittances sent by the work force working abroad. With sustainable economic growth, the country has been gradually integrating with the global economy. In addition, due to international pressures from WTO and other economic agencies (World Bank and IMF), the country undertakes liberalization of different economic policies including the exchange rate management. In 1994, the local currency 'Taka' was first declared as convertible currency for current account transactions, which laid the foundation of liberalized exchange rate management. After some structural adjustments, Taka has finally been made a free-floating currency in 2003. Since then exchange rates between Taka and other foreign currencies are to determine in market trading based on demand and supply. The Central bank does not involve in day to day transactions but occasionally purchase and sell currencies to maintain orderly market. Given the above background, this paper examines the role of relevant macro economic variables in determining the exchange rate of Bangladeshi Taka. This is important to know whether economic variables could drive desired changes in Taka exchange rate after Bangladesh has floated its currency. Ideally, a true exchange rate will emerge in free-floating system if necessary structural adjustments are taken place simultaneously. The major structural changes include free flow of foreign and local currencies, unrestricted imports and exports, and market driven interest rate policy. Although Bangladeshi Taka has been floated to market, necessary structural changes are yet to be adequately implemented. Therefore, a research interest has been emerged to examine whether relevant economic variables can play desired role in determining exchange rate of a free-floated currency of a developing country without adequate macroeconomic adjustments. In literature, International Fisher Effect (IFE) and Purchasing Power Parity (PPP) theories link the currency exchange rates with the interest and inflations differential between the home and foreign countries. It suggests that a future spot exchange rate is determined by the nominal interest rate differentials. In free market, the difference in nominal interest rates stems from the expected inflation differential as real interest rate is equalized globally due to arbitrage. The differences in anticipated inflations embedded in the nominal interest rates are expected to affect the future spot exchange rate. Therefore, it is expected that relative interest rate and relative inflation between the home and foreign countries become the influential factors in determining exchange rate if the exchange rate management is switched to free-float system. This is because relative interest and inflation rates are the major monetary and fiscal measures that supposed to affect demand and supply of home and foreign currencies in a free market system. Apart from the two primary factors e.g., interest and inflation rates, it is found that exchange rate can be significantly affected by the country’s balance of foreign trade, real growth rates, and equity flows (Foreign Exchange Consensus Forecasts 2008). Given the above background, this paper aims at examining the effect of interest and inflation differentials on the exchange rate between Bangladesh Taka (BDT) and United States Dollar (USD) after switching to floating exchange rate regime in...
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