This document analyzes the effects of exchange rate changes on economic growth in Bangladesh. It uses econometric analysis and data from 1981-2013 to estimate the relationship between GDP growth, exchange rates, and exports. The results show that in the long run, a 10% depreciation of the real exchange rate is associated with a 3.2% rise in GDP. However, in the short run the same depreciation results in about a 0.5% decline in GDP. The document recommends Bangladesh pursue exchange rate policies that allow for gradual depreciation to avoid short-term contraction while enabling long-term competitiveness and growth.

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An Econometric Analysis on Exchange Rates and Economic Growth in Bangladesh
Course Title: Macroeconomics
Course Code: F-208
Prepared to:
Shahadat Hussain
Lecturer
Finance & Banking Department
University of Barisal
Prepared By:
Mahmudur Rahman
ID: 16FIN067
3rd
Batch
Date: 7th
January 2018

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Abstract:
This paper aims to understand the effects of exchange rate changes on economic growth in
Bangladesh. It makes use of a Keynesian analytical framework to derive an empirical
specification, carefully constructs a real exchange rate series, and employs cointegration
techniques to determine the output response to taka depreciations. The results show that in
the long run a 10 per cent depreciation of the real exchange rate is associated with a 3.2 per
cent rise in aggregate output. A contractionary effect is however observed in the short-run
so that the same magnitude of real depreciation would result in about half a per cent
decline in GDP. While the long-run expansionary effect of real depreciations may appeal for
considering the role of exchange rate policy as a development strategy, the evidence of very
high degree of exchange rate pass-through to consumer prices would severely constrain
such an option. For Bangladesh the need for maintaining external competitiveness and
promoting growth remains a delicate task for policymakers as it involves managing an
exchange rate regime accompanied by other consistent macroeconomic policies.
Notwithstanding, rather than pursuing an effectively fixed nominal exchange rate until
external imbalances become unsustainable, a more pragmatic approach will be to tolerate
creeping depreciations that would avoid any significant contractionary effect in the short
run while allowing for improved competitiveness and output growth in the long run.
Introduction:
During the two-year period ending in July 2012, Bangladesh experienced an almost 20 per
cent fall in the value of its currency with respect to the US dollar. Unlike many other
developing countries, Bangladesh has been successful in avoiding large and abrupt rise in
nominal exchange rates. Therefore, although a 15-taka rise in dollar price within the period
mentioned above may not appear to be inordinate in comparison with other country
experiences, such a magnitude of depreciation over a comparable period has been
unprecedented in Bangladesh.1 At the same time, the country’s macroeconomic situations
had also come under some strain because of rising prices on the one hand, and growing
deficit in the trade account of the balance of payments on the other. This put the
policymakers in a dilemma: while the depreciation of taka to boost export competitiveness,
attract remittances, and discourage imports should be a natural response to correct the
balance of payments problems, such an option was likely to feed into the inflationary
pressure. The management of the exchange rate is considered to be a major policy objective in
Bangladesh to achieve a set of diverse objectives of economic growth, containment of inflation
and maintenance of external. Policy discussions regularly emphasize on it as the academic
literature provides compelling evidence to suggest that a wrongly managed exchange rate regime
can be a major impediment for improved economic performance. Reform of the exchange rate
management was an important component of trade liberalization measures that Bangladesh
undertook, eventually replacing the earlier ‘fixed rate’ system with a ‘freely-floating’ regime.
Despite putting in place a supposed-to-be market based mechanism in 2003, Bangladesh’s
exchange rate regime continues to be characterized widespread interventions (Hossain and
Ahmed, 2009). One important reason for not allowing market forces to work is the concern about
the inflationary pressure impinged through currency depreciations. Indeed, attempts
have apparently been made to maintain the nominal exchange rate effectively fixed for as
long as possible before external imbalances become unsustainable. This in the process has
disregarded the policy emphasis on maintaining the country’s external competitiveness.
The apprehension about currency depreciation is well-understood. For a small country
devaluations will lead to increase in import prices and subsequently prices of other products
and services through feedback effects. However, the growth implications of currency

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adjustments are generally overlooked. According to the ‘orthodox’ economic theory,
devaluation of a country’s currency triggers an “expenditure switching” mechanism, which
leads to domestic demand away from imports to locally produced import-competing goods.
It also improves international competitiveness thereby boosting exports. These two effects
together exert an expansionary effect on overall economic activity. In contrast, there are
several reasons why devaluation can decrease an economy’s output growth. Amongst them,
the rise of prices of imports affecting the domestic production is the most dominant one.
The empirical evidence on the effects of currency adjustments on output is mixed and
consequently country-specific case studies are the best possible option to guide policy
directions.
Literature review:
Devaluation of the domestic currency has been an important component of the orthodox
stabilization program leading to trade policy reforms. By raising the domestic currency
price of foreign exchange devaluation increases the price of traded goods relative to nontrade ones.
This causes a reallocation of resources resulting in increased production in
import competing sectors. Devaluations are also believed to contribute to the enhancement
of external competitiveness stimulating production in the export sector. There are a number of
theoretical reasons for a contractionary effect of devaluation.3 First,
devaluation increases the price of traded goods, which feeds into the general price level
rendering a negative real balance effect. Increased exports and reduced
imports are expected to improve the external trade balance, and many developing countries
have relied upon devaluations to correct fundamental disequilibria in their balance of
payments.2 It is argued that by expanding the production of the traded sector in general
and exports in particular, devaluation should have an expansionary effect on the overall
economy.
Objectives of the study:
The objectives of this study are referring as follows:
1. To investigate the exchange rate policy of the government of Bangladesh and to
analyze its impact on growth of the economy i.e. GDP
2. To give some possible solutions and recommendation based on the empirical
result of this study.

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Methodology:
This study is primarily based on secondary data. To conduct this study annual data of exchange
rate, export and GDP growth from 1981-2013 are collected from Bangladesh Economic Review
and Bangladesh Bank Monthly Economic Trend. In this work, simple linear regression analysis
has been used. Regression analysis studies the causal relationship between one economic variable
to be explained (the dependent variable) and one or more independent variables. It helps us to see
the trend and make predictions outside or within a given data. Due to the linear relationship
between GDP growth rate; and exchange rate and export our model specification is stated of the
form:
GDP = β0 + β1EXR + β2EXP + Ui
In this equation GDP (Gross Domestic Product) is the dependent variable. EXR and EXP are the
independent variable and denote exchange rate and export respectively. Also, β0 is the intercept
and β1, and β2, are the slope of the GDP growth equation. Ui denotes the error term which is
normally distributed with a zero mean and a constant variance. The values of β0, β1, β2 and β3
will be obtained by using the ordinary least squares estimation technique by the help of SPSS
(Statistical Package for the Social Sciences). The value of the F statistic is used to ascertain the
overall significance of the GDP growth rate equation. We compare the value of the F statistic.
with the value of the critical value of F at a given significance level usually 5%. If the value of the
F statistic is greater than the value of the F critical, then the overall GDP growth rate equation is
statistically significant or otherwise. The statistical significance of the parameters will be
established. In testing for the statistical significance of the parameters, we use the rule of thumb
and the t-test. The rule of thumb states that for a parameter to be statistically significant, the
absolute value of the t-statistic should be greater than or equal to two. Using the t-test, the t- critical
value is compared with the t-statistic at a given significance level (5%). If the t-statistic is greater
than the t-critical value, then, the parameter in question is statistically significant. If otherwise,
then, the parameter is not statistically significant. The t-critical value is given by (n = number of
observations, and k is the number of parameters); where n-k is the degree of freedom and α is the
level of significance. The critical value of t is obtained from the t distribution table.

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Result Analysis:
An estimated regression result of econometric model is shown in the following tabular form:
Table-1; Model: GDP = β0 + β1EXR + β2EXP + Ui
To test for heteroscedasticity, using spearman’s rank correlation, we obtained the correlation
coefficients between considering independent variable and residual for three models are shown in
the following tabular form –
In this table all the values of spearman’s rank correlation (r) are less than .05. That means very low
rank correlation. This indicates the absence of heteroscedasticity in the estimated model.
Using the Durbin –Watson test formula, we obtain d= 1.149. Based on the decision rule (n =32
and k = 3, from the Durbin-Watson table, dL = 1.24 and dU= 1.65; n=32 k=2, from the Durbin-
Watson table, dL = 1.31 and dU= 1.57) we accept H0 and reject H1 because d=1.149 lies within
the acceptance range which means that there is no autocorrelation.
It is seen that in table-1the value of VIF for both exchange rate and import is 5.681which is less
than 10; that indicates estimated result of econometric model is free from multicollinearity.
In table-1 the R2 given from the regression analysis is 0.988; which is approximately 98.8%.
Statistically, econometric model is a very good fit. Economically, it means that about 98.8% of the
total variation in the GDP growth rate is attributed to or explained by the exchange rate and export
in Bangladesh. R 2 value is statistically significant since F ratio (1.202E3) > F critical (2.9340).
The unexplained variation is 1.2%. From the regression results in table -1, if exchange rate (EXR)
and export are zero, then the GDP of Bangladesh is increased by 12305.536%. The value of the
constant term is statistically significant since its t statistic is greater than 2. Based on the t-test, β0
is also statistically significant at 5% level of significance. Based on economic theory and
experience, it is expected that there will be a positive relationship among GDP growth rate,
exchange rate and export in Bangladesh. In the estimated model the slope of exchange rate variable
is 0.844 and the slope of the export variable is 0.163. This means that a 1% increase in exchange
rate and export volume will cause GDP is increase by 0.844% and 0.163% respectively. Using the

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rule of thumb which states that if the absolute value of t-statistic is greater than 2; then, the
parameter in question is statistically significant. From the regression results, in table-1 the t-
statistic of exchange rate variable is 17.465 and export variable is 3.369; which are greater than 2.
This implies that β1 and β2 are statistically significant in the estimated model. This means that
exchange rate and export are key determinant of GDP growth rate in Bangladesh. Here too, we
can conclude that there is a positive relationship among GDP growth rate and exchange rate and
export in Bangladesh. As seen from the literature, this can only happen in the short–run. The
analysis and discussion of the results in section 5 all confirm the conclusion that gross domestic
product in Bangladesh is influenced significantly by the exchange rate and export volume.
However, this is true in the short–run.
Recommendation:
This study attempted to examine the relationship among GDP growth rate and exchange rate and
export in Bangladesh for the period 1981 to 2013. The paper estimates the simple linear regression
using OLS. Further tests were performed to ascertain the presence of autocorrelation,
heteroscedasticity and multicollinearity. Autocorrelation and heteroscedasticity and
multicollinearity were found to be absent but. The regression results were also found to be very
sensible since the DW > R2. Also, the regression results showed that there is a positive relationship
among GDP growth rate and exchange rate and export in Bangladesh and the regression results
are statistically significant since t-value (6.594 > 1.70). In the long run, the authorities of
Bangladesh should emphasis stable monetary and fiscal policies. They should intervene in the
foreign exchange market as needed to prevent excessive volatility in the nominal and hence, the
real exchange rate. However, they should not attempt to influence its level. Policy makers should
also ensure that resources are put to maximum use under the correct and right avenues such as
technical education, better incentive and motivation for effective and efficient performance. This
will allow massive output expansion to meet the demands of Bangladeshis and then export the
surpluses to other countries to obtain foreign exchange, instead of importing goods and services
from other countries. In the long run, the authorities of Bangladesh should emphasis stable
monetary and fiscal policies. They should intervene in the foreign exchange market as needed to
prevent excessive volatility in the nominal and hence, the real exchange rate. However, they should
not attempt to influence its level. Policy makers should also ensure that resources are put to
maximum use under the correct and right avenues such as technical education, better incentive and
motivation for effective and efficient performance. This will allow massive output expansion to
meet the demands of Bangladeshis and then export the surpluses to other countries to obtain
foreign exchange, instead of importing goods and services from other countries.

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References
1) Ahmed, A and Uddin, M (2009) M Export, Imports, Remittance and Growth in
Bangladesh: An Empirical Analysis”; Trade and Development Review; Vol. 2, Issue 2,
PP-79-92. 2)
2) Agenor, P.R. (1991). “Output, Devaluation and the Real Exchange Rate in Developing
Countries,” Review of World Economics, Weltwirtschaftliches Archive, Bd. 127, H. 1
(1991), pp. 18-41
3) Akther,M and Sarker, M.I. (2013), “ Sources of Exchange Rate Fluctuations in
Bangladesh”, Working Paper Series 1305
4) Begum, S and Abul, F.M (1998); “Export and Economic Growth in Bangladesh”. The
Journal of Development Studies; Volume, 35; Issue 1.