RESEARCH ARTICLE

European Journal of Business and Management Research

www.ejbmr.org

Impact of Exchange Rate on Economic Growth

of Bangladesh
Md. Fazlul Huq Khan

ABSTRACT
This paper investigates the impact of inflation, nominal exchange rate, foreign
direct investment, and unexpected event shock on the economic growth of Submitted : May 18, 2021
Bangladesh by using the time series data from 1990 through 2020. Augmented Published : June 10, 2021
Dickey-Fuller and Phillips-Perron Unit Root Test used to identify unit-roots
ISSN: 2507-1076
existence and check the stationary of variables. The Ordinary Least Squares
method is applied to determine the relationship between the dependent DOI: 10.24018/ejbmr.2021.6.3.891
variable and independent variables. The results revealed that the exchange
rate and foreign direct investment have significantly affected the country's Md. Fazlul Huq Khan
economic growth. Inflation, FDI, and exchange rate positive impact, whereas School of International Trade and
unexpected events like Covid-19, natural disasters, etc., negatively affect the Economics, University of International
economic development of Bangladesh. The study can be helpful for the policy Business and Economics, Beijing, China.
makers to identify, formulate and implement the effect policies for the (e-mail: fazlul.khan@outlook.com)
economic growth of the country.

Keywords: GDP, Inflation, Bangladesh, Exchange rate, COVID-19.

of Bangladesh remains negative for many years, but due to a

I. INTRODUCTION large remittance flow, the current account remains positive.
The relationship between the exchange rate and the Bangladesh adopted the floating exchange rate system on
economic rate is one of the substantial fields of study in May 30, 2003, by abandoning the adjustable pegged system.
economics. The exchange rate is defined as the value of one The transition to the floating regime was smooth,
nation's currency compared to other nations' value. The experiencing a depreciation of less than 1 percent from June
exchange rate measures the amount of foreign product 2003 to April 2004. The market forces played a critical role
purchase using domestic currency. The nominal exchange in determining and stabilizing the exchange rate in later years.
rate is adjusted for inflation, whereas the real exchange rate The adaption of the floating exchange rate has a positive
is not. The exchange rate can be expressed in bilateral and impact on the country’s foreign trade. Exporters and
multilateral terms. The real exchange rate measures the short- importers can adjust prices and costs following global events,
term volatility of the exchange rate. Most of the countries which affects the exchange rate. The Bangladeshi TAKA
have floating exchange rates where market forces determine depreciated very slowly over the years to support the
the exchange rate. In a fixed exchange rate, the country's exporters and enhance economic growth. Bangladesh is
central bank fixes a certain rate in which foreign currencies experiencing a stable exchange rate over the years that results
are exchanged against domestic currency. The combination in exponential economic growth and prosperity.
of the fixed and floating exchange rate is known as managed
floating exchange rate. 90,00 9
The primary objective of this paper is to identify the 80,00 8
relationship between the exchange rate and the economic 70,00 7
growth of Bangladesh. The article also discussed the impact 60,00 6
of COVID-19 on the exchange rate and economic growth. 50,00 5
This pandemic outbreak has significantly affected economic
40,00 4
sectors all over the world, and Bangladesh is no exception. In
30,00 3
theory, it is assumed that there is a positive relationship
20,00 2
between the exchange rate and economic growth. The
devaluation of domestic currency fuels economic growth and 10,00 1
encourages exporters. Bangladesh is one of the top exporters 0,00 0
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31
of Readymade Garments (RMG) globally, and over 80% of
its total export revenues come from the sector. Although the GDP Growth Rate Exchange Rate
imports are also relatively high for the country, it is
witnessing a declining trend in recent years. The trade balance Fig. 1. Economic Growth VS Exchange Rate in Bangladesh.

DOI: http://dx.doi.org/10.24018/ejbmr.2021.6.3.891 Vol 6 | Issue 3 | June 2021 173

 RESEARCH ARTICLE
European Journal of Business and Management Research
www.ejbmr.org

II. LITERATURE REVIEW and around 1.9 million people have died worldwide. This
Several researchers try to understand the relationship unprecedented event can have a substantial impact on
between foreign exchange and economic growth. All these economic growth and prosperity. The unemployment rate has
papers are conducted in various timeframes and geography. skyrocketed, and businesses were forced to shut down due to
Ahmad [1] examines the relationship between GDP and a liquidity crisis [3]. Bangladesh's economy also took a direct
total investment in Pakistan for 1971-2011. The author uses hit from this pandemic, and the growth rate dropped
time-series data and conducts ordinary least square regression substantially in 2020. Firms always search for the
to identify the relationship where he finds a significant optimization of profits with highest efficiency. [22]. When
positive relationship between the two variables. The author the foreign exchange rate is favorable, foreign direct
concludes that foreign and domestic investment are major investment increases. In recent years, Bangladesh faced a
economic growth factors, and a stable exchange rate refugee crisis from the neighboring state Myanmar. This
facilitates foreign direct investments. unexpected event can trigger a social, political, and economic
He [9] researches to find out the relationship between crisis for the country [17].
exchange rate and economic growth in China. The author
concludes that due to fixed exchange rate policy adopted by
the People's Bank of China enhances the country's economic III. DATA AND METHODOLOGY
growth. He also finds that exchange rate volatility fuels long-
A. Data
run productivity and economic growth. The result is similar
to what Hussain [10] but contrary to Musyoki [19] finds. The research used secondary data collected from the
Bakaar [5] investigates the impact of real effective Bangladesh Bank, World Bank, and International Monetary
exchange rate on the economic growth of Sierra Leone by Fund database for 1990-2020. The GDP growth rate is the
using quarterly data of 1990-2006. Using Granger causality dependent variable, and the Nominal Exchange rate, Foreign
tests, he revealed a positive correlation between the country's Direct Investment, inflation, and a dummy variable for a
real effective exchange rate and economic growth. Exploring pandemic has been used. These variables are used in the
similar research in five Asian countries, Yin-Wong [23] also majority of the prior studies.
finds similar results. Jinzhao [13] uses data from 1992 B. Empirical Model
through 2008 to point out the exchange rate and economic
In this study, the time series data estimations allow to
growth correlation within 28 Chinese provinces. The authors
control for observable and unobservable heterogeneity. The
conclude that there exists a significant positive relationship
specification of the empirical model is:
between these two variables.
Inflation is also closely correlated with the volatility of the GDPj = β0+ β1INFj +β2EXHj +β3FDIj +β4PANj +ej
exchange rate and economic growth. Ahmad [2] researches to
find the relation between inflation and gross domestic product where GDP implies Economic growth rate, INF is the
of Pakistan for 1971-2011. He identifies that inflation has a inflation rate, EXH indicates the nominal exchange rate and
positive impact on GDP growth by encouraging productivity FDI means foreign direct investment as percentage of GDP.
and output. The author also finds that moderate inflation is To linearize the model all the variables are converted in the
better for economic advancement. Hussain [11], Naseer [20], natural log form.
Mubarik [18] and Alam, et.al. [4] also conclude similar The study used Augmented Dickey-Fuller Test and
remarks in their studies. However, Bruno and Easterly [7], Phillips-Perron Unit Root Test to identify unit-roots
Huybens and Smith [12], Quartey [24], Gosh [8], and Barro existence. Phillips and Perron have generalized the
[6] found a negative but significant correlation between these Augmented Dickey-Fuller tests to the situations where the
two variables. In another study, Ahmad [2] concludes that disturbance process in error term is serially correlated. The
there is no relationship between inflation and economic Phillips-Perron test is intended to add a 'Correction Factor' to
growth. the Augmented Dickey-Fuller test statistic.
Foreign direct investment is crucial for the growth of the
economy. The majority of the researchers found that FDI has C. Empirical Results and Analysis
a strong and positive impact on economic growth. Ahmad [1] The Augmented Dickey-Fuller Test and Phillips-Perron
conducted research in Pakistan to identify the impact of FDI Unit Root Test find that the variables are stationary and
on economic advancement. The study found that the flow of automatically cointegrated. So there exists a relationship
FDI is crucial for the sustainable growth of the country. The between the independent and dependent variables. The p
author finds a significant positive relation between FDI and values for both variables in ADF and PP tests are less than the
economic growth. Similar results were found by Mahmood significance level of 5%. As a result, we reject the null
[15], Khaliq [14], Niazi [21] and Mohammad, & Mohammad hypothesis of non-stationarity. All the variables are integrated
[16] in their research. of order zero, so the Ordinary Least Square method is
The economic growth of a country can also be impacted by appropriate for the analysis.
an unexpected event like a pandemic, natural disasters, etc. In The results of the OLS exhibits that inflation have a
December 2019, an infectious disease named Coronavirus positive but insignificant relationship with GDP growth.
disease 2019 (COVID-19) originated from China affected the Several studies have found that moderate inflation is good for
global arena. Over 200 countries and territories around the the economy and encourages local producers. The nominal
world have been affected by this infectious disease. So far, exchange rate has a positive and significant impact on
around 150 million people have been affected by COVID-19, economic growth. The weakened domestic currency attracts

DOI: http://dx.doi.org/10.24018/ejbmr.2021.6.3.891 Vol 6 | Issue 3 | June 2021 174

 RESEARCH ARTICLE
European Journal of Business and Management Research
www.ejbmr.org

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policymakers should focus on formulating and adjusting the
necessary policies required to enhance economic growth and Md. Fazlul Huq Khan is a Ph.D. candidate at the
development. School of International Trade and Economics,
University of International Business and
Economics, Beijing, China. He has ten years of
experience working in the Central bank of
Bangladesh. The author possesses the expertise of
formulating and implementing the economic
policies of the country. Previously he did Bachelor
of Business Administration (B.B.A.) in Management and Master Of
Business Administration (M.B.A.) in Human Resources Management
from the University of Dhaka.

DOI: http://dx.doi.org/10.24018/ejbmr.2021.6.3.891 Vol 6 | Issue 3 | June 2021 175