At the present time of writing, there is a substantial argumentative basis to the claim that the most powerful man on the face of this Earth is not the President of the United States of America, President Joe Biden, but the Chair of the Federal Reserve, Jerome Powell. Over the course of this article, I will try to demystify the Power of the Federal Reserve, and why the Central Bank of the United States of America has the power to make or break emerging market economies. Subsequently, policy prescriptions are proposed to mitigate the twin foreign reserve and inflationary crisis.  

What caused the 1997 Asian Financial Crisis? 

Let us revisit in time and decipher the causes of the Asian Financial Crisis of 1997. In no way shape or form does the author claim that the Federal Reserve manufactured the currency crisis, however, there is tangible economic reasoning to suggest that the Fed was integral to the crisis unfolding. 

One of the key factors leading up to the Asian Financial Crisis was a surge of capital inflows into Asian economies, particularly in the form of foreign direct investment and portfolio investments. This capital influx led to a rapid expansion of credit and asset prices in these economies, which in turn fueled further investment and borrowing.

The Federal Reserve’s monetary policy kept interest rates relatively low in the United States during the mid-to-late 1990s – this encouraged global investors and notable currency speculators to seek higher returns elsewhere, predominantly in Asian economies, where interest rates were significantly higher. 

However, Federal Reserve’s decision to hike interest rates in 1997 and 1998, in response to concerns about inflation and the potential for overheating in the US economy, without a shadow of a doubt, exacerbated the crisis. This policy move made it more expensive for Asian borrowers to service their debts, contributing to the exodus of capital from Asian Tiger Economies, back to the United States. 

The Thai baht was one of the first currencies to come under pressure, with speculators betting against the currency and pushing it to devalue in July 1997. The Thai government attempted to defend the baht by raising interest rates and intervening in the currency markets, but these measures were ultimately unsuccessful. The baht lost more than half of its value against the US dollar over the course of 1997.

The devaluation of the Thai baht triggered a wave of contagion, as investors began to flee other Asian currencies as well. The Malaysian Ringgit and the Indonesian Rupiah both saw sharp devaluations in the following months, and the South Korean Won also came under increased pressure by currency speculators.

The crisis also had ripple effects beyond Asia, as investors became increasingly concerned about the exposure of global financial institutions to Asian debt. This led to a wider sell-off of emerging market assets, including in Latin America and Russia.

The Russian Ruble, in particular, came under pressure in August 1998, as investors became concerned about the country’s ability to service its debts. The Russian government eventually defaulted on its debt in August 1998, leading to a wave of bankruptcies and a severe economic contraction in the country.

In the latter part of 1997 and early 1998, the IMF provided $36 billion to support reform programs in the three worst-hit countries—Indonesia, Korea, and Thailand. 

Ghosts of the Past

Fast forward to 2023, and history is repeating itself. In March 2022, after a period of sustained Quantitative Easing, for well over a decade, the Federal Reserve started hiking rates – a stringent measure of Quantitative Tightening.  

Figure 1: Timeline of Fed’s Interest Rate Hikes

Refer to Figure 1; you will observe 3 instances in the past 30 years in which the Federal Reserve has hiked interest rates. The first Fed Rate hike in the 30-year horizon was initiated in Jan 1994. What ensues in the subsequent years was a catastrophic currency crisis in emerging Asian economies known as the Asian Financial Crisis of 1997. The second rate hike was initiated in June 2004. What followed in subsequent years is known as the Great Financial Recession. Finally, in March 2022, the Fed initiated a series of rate hikes after nearly a decade of low-interest rates. 

Since the Fed Rate hikes were initiated in March 2022, the Bangladeshi Taka has lost nearly 25% of value against the US dollar, foreign exchange reserves plummeting from $48 bn to $32 bn as import costs and debt-servicing becomes more expensive; inflation soaring. 

Consider the example of Pakistan and Sri Lanka in the same time period. The Pakistani Rupee has lost nearly 45% of value against the US dollar; the economy is on the verge of a collapse as inflation soars, and foreign reserves continue to plummet to record lows; foreign reserves as low as $3bn. The Sri Lankan Rupee plummeted nearly 50%, ultimately bankrupting the economy, as dollar-denominated debt could no longer be serviced due to the tremendous loss in value of the Sri Lankan Rupee, and import bills could no longer be met.  

There are 90 countries around the world that are faced with a foreign reserve crisis, intertwined with high inflation, this is a remedy for a total economic and socio economic catastrophe. 

Remedies of Exogenous Shocks: Fate of Bangladesh in 2024

There are undeniable structural fallacies within the fiscal and monetary institutions that govern Bangladesh. However, the present foreign reserve crisis is not one of Bangladesh’s creation. There are tremendous economic and political implications with regards to how Bangladesh meanders the present twin foreign reserve and inflationary crisis. In order to preserve both the economic and political sovereignty of Bangladesh, policymakers must enact the following policy measures with immediate effect:  

1. Bangladesh Central Bank Must Hike Interest Rates: The Bangladesh Central Bank must hike interest rates effective immediately. The rate hikes in Bangladesh should have been initiated from March 2022, at the onset of the Federal Reserve’s Interest rate hikes, to go tête-à-tête with US monetary policy, and to preserve the value of the Bangladeshi Taka against the USD. Note that the Bangladeshi Taka has already lost 25% of its value against the US Dollar, making debt servicing and import bills fundamentally more expensive; note that import bills rose due to the deprecation of the BDT against the USD, thereby inflating production costs, which subsequently causes a spurious effect on retail prices, which is ultimately borne by the consumer. 
2. Curbing the Trade Deficit: The last fiscal year exhibited a growth in exports of around 33%, while imports grew 42% YOY. Exports stood at $52 bn, whereas imports stood at $82 bn. There is a notable trade deficit of $30 bn that must be curbed at all costs. While understandably, due to soaring energy costs exacerbated by the Russia-Ukraine War, and due to the fact that Bangladesh cannot rely on domestic energy reserves, a bulk of the imports is attributed to ensuring domestic energy demands. However, there are other imported goods that have domestic substitutes, for instance, consumer products, that are readily imported from overseas nations. Without incentivizing domestic producers sufficiently, particularly in the form of levying taxes on foreign imports of consumer goods, the consumer cannot be incentivized to purchase the locally made products. For an emerging growth hub like Bangladesh, it cannot thrive without establishing the Made in Bangladesh motto at the policy level. 
3. Fulfilling Agrarian Self Sufficiency – Controlling the Agrarian Supply Chain: 45% of Bangladesh’s workforce is affiliated with agriculture. It begs the question, why are Bangladeshi’s still relying on overseas trading partners, for essential agricultural commodities? Faced with a twin foreign reserve and an inflationary crisis, prudent measures must be taken to ensure there is no reliance on imports to service the agrarian supply chain. For example, the notable rise in broiler chicken prices over the past year was predominantly due to the dependence on importing chicken feed from overseas countries. As the BDT lost value against the USD, imports became increasingly expensive; with increased production costs, the price of broiler chicken rose to record highs. 
4. Remittance Tax: The aforementioned trade deficit signifies the importance of the Bangladeshi diaspora in bridging the gap between imports and exports. Remittance, particularly in the onset of the foreign reserve crisis, has never been more important for the Bangladeshi economy. For instance, Bangladeshi workers residing in Malaysia have to pay a “remittance tax” equivalent to -6.25% when remitting funds to their families. Banking channels offer 24 BDT/MYR, whereas illegal channels are offering a far more lucrative rate, at 25.5 BDT/MYR. It deters remitters from using banking channels to remit funds back home, and consequentially, these funds are not added to our CB reserves. The Bangladeshi CB must not allow bureaucracy to shackle fluid transmission of funds, exchange rates must be adjusted to global competitive standards, on a daily basis. 
5. Private Debt Bubble – Overhaul of the Banking Sector: In Bangladesh, there is a tendency to judge a business on the basis of turnover/revenue figures. The fundamental barometer in assessing the financial health of an institution is the free cash blow and the balance sheet. A glance at the DSE listed entities will show that there are over 120+ companies that are on the verge of bankruptcy. Without a shadow of a doubt, there is an underlying private sector debt bubble; growth that has predominantly driven by compounding of private sector debt, a phenomenon in economics known as the “snowball effect” – a direct result of lack of prudency in sanctioning of debt. These non-performing loans or bad loans sanctioned to overly leveraged entities has undeniably strained the state of a multitude of private and government owned banks. Note that Silicon Valley Bank had to be bailed out by the US Federal Reserve; it had deposits north of $200 bn. The largest private bank in Bangladesh, Islami Bank, has deposits north of $15 bn. It is to be understood that no bank in the world is immune to a collapse. The government must ensure all private and government banks are insulated through prudent regulatory measures. Furthermore, panic induced deposit withdrawals must be shackled at all costs, thereby investor and depositor confidence are both quintessential. 

The article was originally published by The Confluence and is republished on the Industry Insider with authorized approval.