Research Proposal

of
“The Impact of Foreign Exchange Rate
on The Inflation of Bangladesh”

Course Title : Research Methodology and Empirical Studies

Course Code: Econ 409

Submitted to

Dr. Mohammad Jahangir Alam

Professor
Department of Economics
Jahangirnagar University

Submitted by

Name Roll
Nadima Din 447
Najia Tasnim 452
Rubaiya Zahan Mim 453
Shahrin Siddika Chaity 454
Mst. Farhana Khatun 463
Rifah Tasfia Ishadi 468
Mst.Nazmin Akter 475
Shaloya Zabin 2244

46 Batch
Department of Economics
Jahangirnagar University

Submission Date: 22 April, 2022.

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 Table of Contents

Page No.

List of Acronyms……………………....…………………………………………….... 3

Title …..………………………………………………………………………………... 4

Statement of the Problem and Hypothesis ……………………....…………………… 4

List of Variables and Objectives………………………………………………………… 5

Literature Review……………………………………………………...……………… 6

Rationale and Scope of the Study…………………….………….…………………….. 8

Methodology of the Study…………………………………..………………….…….. 9

Implementation of the Study and Work Plan …………..……………………………. 10

Financial Budget and Time Frame……………………………………….…………… 11

References………………………………………………….……………………………. 12

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 List of Acronyms:

Acronyms/ Abbreviation Explanation

INF Inflation Rate

EXR Exchange Rate

BBS Bangladesh Bureau of Statistics

GDP Gross Domestic Product

FDI Foreign Direct Investment

DSE Dhaka Stock Exchange

PPP Purchasing Power Parity

Turkish Lira Exchange Rates in terms of

TL/Pound rate, TL/Dollar, TL/Euro, TL/Yen
Pound rate, Dollar, Euro, Yen

STATA Statistical software for data science

ARCH Auto Regressive Conditionally Heteroscedastic

Generalized Auto Regressive Conditionally

GARCH
Heteroscedastic

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 I. Title of the Research

The Impact of Foreign Exchange Rate on the Inflation of Bangladesh

II. Statement of the Problem

Bangladesh's economy is heavily dependent on foreign cash due to remittance, freelancing,

and export-import transactions. Bangladesh's rate of inflation in 2021 was 5.56 percent higher
than the previous year. In February 2022, Bangladesh's annual inflation rate rose to 6.17
percent, up from 5.86 percent the previous month. It was the highest rate of inflation since
October 2021, primarily to increasing food costs. Bangladesh Bank (Bangladesh Bank,
2022.)

At the same time, exchange rate has been varied from 84.80 TK/US$ to 86.00 TK/US$,
revealing the highest rate at February, 2022 (Bangladesh Bank, 2022). It shows both the
inflation rate and exchange rate has been increased, indicating a positive relationship between
the two.

Inflation has been increasing in recent days as the prices of most commodities have increased
on global markets as a result of increased demand, comparatively high shipping costs, and
supply limits. For a developing country like Bangladesh, the exchange rate is critical in
international finance and trade. This is because currency rate changes have an impact on
multinationals' profitability and increase the risk of exchange for businesses and financial
institutions.

As a result, it can be said that the foreign exchange rate has an effect on the domestic
currency, i.e., the inflationary or deflationary scenario. Through this research we will try to
probe through that.

III. Formulation of Hypothesis

Marcelo Sanchez has shown in his 2005 research under European Central Bank that, the
foreign exchange and the rate of inflation have many common in-between factors, we expect
both the rate to be correlated and show a predictable regression line for the forecasting
purposes in future. In case of Bangladesh we are assuming this relationship to hold true.

3.1. Specifying the Model:

We express our model as follows because of the relation between exchange rate and inflation
rate according to the hypotheses:

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 INF = β0 + β1 EXR + ui

where,
Ŷ = β0 + β1 X
β1 = SPxy /SSx
= Σ(xi-x̄)(yi-ȳ)/ Σ(xi-x̄)2
And, β0 = ȳ - β1x̄

3.2. List of Variables and Definition:

Variables Definition

INF
Independent Variable
(Inflation)

EXR
Dependent Variable
(Exchange Rate)

INF (Inflation) is the dependent variable in the model. The independent variable is EXR
(Exchange Rate), and the Intercept is β0. β1 is the equation's slope, and The error term, ui, has
a normal distribution with a constant variance and a zero mean.

IV. Concrete Objectives of the Study

Main objectives of this paper are:

i. To see if the declining value of the Taka in recent years can be explained by the
movements in exchange rates.

ii. To investigate and analyze the impact of an increase in the inflation rate on the
change in the country’s exchange rate.

iii. To identify what changes Bangladesh might take to ensure a stable exchange rate,
rapid economic growth, and control inflation.

These are our probable research questions regarding the study.

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 V. Literature Review

5.1. Case Study: Bangladesh

Bangladesh's experience transitioning from a currency board system to a floating regime
since 2003 is instructive. They discover that under fixed exchange rates, inflation levels and
variability are significantly lower. Inflation could not be kept under control, and between
1976 and 1980, it stayed above 10%. Between 2003 and 2006, the Taka lost 13% of its value
against the US dollar, while GDP growth stayed below 4%. In 2007 and 2008, inflation
appeared uncontrolled. (Siddiki,2002) The influence of the exchange rate system on a
country's price level is extensive. (Hossain,2002)

S. Mahzabeen (2017) worked with data of the Dhaka Stock Exchange (DSE) on 144 variables
during a period of twelve years, from January 2001 to December 2012. The Granger causality
test clearly demonstrates that the short-term interest rate has only a little association with the
long-term interest rate. When monetary policy is expansionary, debtors find investment
options less expensive and individuals with more money to spend, according to this study.

Inflation has an influence on the stock market because it reduces the buying power of money.
According to the report, Bangladesh's stock market is inefficient and does not respond to
changes in monetary factors such as broad money and interest rates. The percentage change
of the index is virtually unaffected by the money supply or inflation. When it comes to
establishing interest rates, the Bangladesh Bank should be more cautious. There were a
number of ideas that may be made to improve the market's efficiency. If this is done, the
chances of having an anomalous return will be reduced. (Mahzabeen,2017)

Bangladesh's inflation rate was 6.6 percent in 1996 and 1.6 percent in 2001. Bangladesh's
current currency rate policy has suited the country well. Bangladesh, according to the study,
maintains an active exchange rate management within the context of an adjustable basket peg
regime. (Khan,2021)

5.1.1. Literature Gap:

We haven't found any rigorous study focused on building direct relationship between the
inflation rate and exchange rate according to recent empirical data. However, similar study
focused on direct relationship has been found in case of other countries.

5.2. Case study: Other Countries

Flexible exchange rates, according to modern economists, give more protection from external
shocks. In 2001, Sri Lanka implemented a free-floating currency rate regime. The currency
rate volatility spiked immediately after the float, resulting in a huge fall of the Lanka rupee.
(Hossain, 2002)

Some nations, such as Canada and Malaysia, have lower inflation rates than Australia,
boosting their relative tourist pricing competitiveness. Four Asian origin nations witnessed
their domestic tourism become more price competitive in contrast to international travel
between 1993 and 1998. Exchange rate reductions boosted the outcomes of the last three

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nations, while Japan's inflation rates were considerably lower. This study looks into the
viability of developing pricing competitiveness indexes. (Dwyer, Forsyth, and Rao, 2002)

Many academics argue that transition nations should employ fixed exchange rates or peg
their currency rates to their primary trading partners' currencies. From 1996 to 2014, inflation
in Western Balkan nations was in the single digits. The empirical data on the exchange rate's
usefulness as a shock-absorbing device is inconclusive. The fundamental rationale for
maintaining a fixed exchange rate is because developing countries suffer from "fear of float"
(Edwards, 2006). From 1996 to 2014, inflation in Western Balkan nations was in the single
digits. The empirical evidence on the exchange rate's usefulness as a shock-absorbing device
is varied.

In the Czech Republic, Hungary, Poland, and Slovenia, Coricelli et al. (2005) found little
evidence of exchange rates acting as shock absorbers. Borghijs and Kuijs (2004) revealed that
exchange rates are a less efficient propagator of monetary and financial shocks in Central
European countries. A fixed exchange rate has a limited influence on output, and during the
crisis, growth remained stagnant. Exchange rate flexibility, according to Adler and Tovar
(2012), can reduce the impact of financial shocks. (Fetai, Koku, Caushi and Fetai, 2016)

If there are no significant short-term economic rewards, the approach might quickly disrupt
macroeconomic stability. In the Western Balkans, exchange rates have had a significant
impact on maintaining price stability. Before determining whether or not to establish a
flexible exchange rate system, the authors believe that authorities in the area should assess
the costs and advantages. Changes in the exchange rate have a considerable influence on
inflation, according to the study's major result. (Fetai, Koku, Caushi and Fetai, 2016)

For a long time, Turkey has endured high inflation. Following the 2001 crisis, the
government was able to reduce its inflation rate to a single digit by implementing significant
anti-inflation measures. Turkey's inflation was the 15th highest in the world at the end of
2014, while remaining in the single digits. In Turkey, the rate of inflation is particularly
significant. Inflationary pressures and big gains in foreign currency have increased the need
to learn more about their link. (Özen et al., 2020)

PPP variations are not random since ARCH and GARCH are incorporated in the link.
Instead, they follow a pattern. The disparity might be caused by a number of factors,
including transaction costs, government restrictions, product specialization, and other
pertinent factors. The focus of the investigations was on data from Turkey and the United
Kingdom. Other countries, such as the United States, Japan, and the European Union, may be
included in the study. In addition to the TL/Pound rate, the TL/Dollar, TL/Euro, and TL/Yen
rates may all be used to get the TL/Pound rate. This will help us to have a clearer idea of the
differences and their causes. (Özen, Özdemir and Grima, 2020)

5.2.1. Literature Gap:

This section has discussed the inflation and exchange rate scenario of foreign countries. We
reviewed these papers to infer analytical steps and use it on the premises of Bangladesh so
that we can establish the relationship between these two variables in the context of
Bangladesh.

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5.3. General Observations

The currency rate has a significant positive relationship with FDI in both the short and long
term. Inflation has a significant negative impact on FDI over time, but has minimal effect in
the short term. (Fetai, Koku, Caushi, and Fetai,2016) Other nations might be included in the
research, such as the United States, Japan, and the European Union. You may compare the
TL/Dollar, TL/Euro, and TL/Yen rates instead of only the TL/Pound rate. This offers you a
more comprehensive understanding of the differences and what's generating them. Sri Lanka
adopted a free-floating exchange rate policy in 2001. (MANGIR, 2020)

Another study by Dwyer, Forsyth and Rao (2002) says, price differentials and exchange rate
movements are all part of the concept of competitiveness. Destinations vary in price
competitiveness due to varying buying behaviors of different kinds of visitors based on their
vacation intent. Price competitiveness indices may be used to track how a location's
competitiveness evolves over time. The pricing competitiveness of a tourism destination is
linked to travel reasons. Price competitiveness indices may be used to track how a location's
competitiveness evolves over time. Behind the price indices, little attempt was made to
explore the basic causes of price competitiveness or their impact on destination price
competitiveness over time. Price competitiveness indices may be used to investigate how
destination competitiveness changes over time and what influences it.

The studies found a positive relationship among GDP growth rate, exchange rate and export
in Bangladesh. It was observed that a 1% push in exchange rate and export value will result
into 844% and .163% increase in GDP respectively. (Islam, 2003)

VI. Rationale of the Study

A significant change in the exchange rate is almost certain to change the domestic pricing of
tradable goods. Changes in the pricing of tradable inputs eventually impact the prices of non-
tradable commodities as well. Changes in input prices can cause supply shocks, which can
lead to inflation.

Exchange rates also influence FDI in countries, which has a further impact on inflationary
conditions. Studies show that inflation also leads to currency devaluation, i.e. a decline in the
trade-weighted nominal effective exchange rate. (Ben Cheikh,2012)

VII. Scope of the Study

The general purpose of the study is to establish a relationship between Inflation Rate and
Exchange Rate according to the stated hypothesis in section II. We intend to use recent
empirical data of these two variables from authentic secondary data sources like, World
Bank, Bangladesh Bank, Bangladesh Bureau of Statistics etc.

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The timeline we want to consider will not exceed 5 years before, i.e. from 2018 to 2022.
Depending on the availability of data, we intend to work with monthly data of these years, so
we can have approximately 50-52 entries, from January 2018 to February/April 2022. Our
study will not cover foreign sector in case of fluctuations in the selected variables. We are
only considering domestic fluctuations in the scope of the research.

VIII. Research Method Selection

8.1. Data Source

The main data source were secondary data collected from authorized websites of different
leading organizations like the World Bank, IMF, ADB, Bangladesh Bank, Bangladesh
Bureau of Statistics (BBS) and so on.

Secondary literature in the relevant field, such as standard national and international
publications, journals, government policy report bulletins, and so on, are being studied for the
preparation of this paper, and websites of various writers on relevant themes will be visited.
An intensive study will be conducted on the process of collecting and analyzing this
secondary data to sort through the conclusion. Through content analysis and regression
conducted on the collected empirical data, we will gradually build the discussion over the
following consecutive sections.

8.2. Tools of Analysis

Simple regression analysis will be applied in this study. Regression analysis can investigate
the causal link between one or more independent factors and one or more economic variables
to be explained (the dependent variable). It enables us to spot trends and make predictions
both outside and within a set of data.

To analyze data and information, both qualitative and quantitative research approaches, such
as analytical statistical models like correlation and regression analysis and the statistical
software for data science (STATA), will be used. Correlation and regression models will be
used to examine the relationship between the exchange rate and inflation, and to contemplate
the comparison between datasets in order to establish the trend revealing our intended
correlations by interpreting accordingly.

8.3. Limitations of the Study

Firstly, our research demands data on inflation rates and currency exchange rates at the
national level. Therefore, we will use secondary data from reliable and prominent national
sources. We will not use any primary data and won’t go through any survey or interview for
our research purposes.

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Secondly, the unavailability of data can be the biggest limitation when it comes to secondary
data analysis. Unavailability of the data can significantly hamper our intended objectives.

IX. Implementation of the Study

If we can find our intended relationship between the two variables, INF and EXR, according
to our model,

INF = β0 + β1 EXR + ui

then it can prove that the traditional factor of exchange rate scenario is responsible behind the
fluctuations in the rate of inflation when it comes to Bangladesh. If our research shows that
the model is incorrect, we may conclude that additional variables other than the exchange rate
are at play in Bangladesh's inflation rate variations, which are not described by our model.

From the value of β1 we will be able to draw how much of the change in exchange rate is
directly affecting the inflation rate. With the value of β0 we can find the autonomous level of
inflation rate that are in action irrespective of the presence of exchange rate.

X. Work Plan

10.1. Data Collection

This study is primarily based on secondary data. The monthly data of exchange rate and
inflation rate from January 2018- February 2022 can be collected from respective secondary
data source like Bangladesh Bank database, World Bank, IMF, ADB, Bangladesh Bureau of
Statistics (BBS) and so on.

10.2. Regression Analysis

Then we can run regression analysis with our described method at 8.2. This should leave us
with the value of the parameters which will give us our intended specification of the model
with appropriate value of t-statistic and F-statistic so that we can evaluate the significance of
the model.

10.3. Interpretation of the Result

We will interpret the following points:

i. Y and X relationship
What is the correlation between the INF and EXR? If the value of the correlation coefficient
is below 0.3, it will be interpreted as weak correlation. If it is between 0.3 to 0.7 it will show
a moderate correlation. If it exceeds 0.7, it will show strong correlation between the two.

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 ii. Goodness of fit
The value of R2, t-statistic will be interpreted in this section an F-test will be explained. The F
statistic's value will be utilized to determine our model’s overall significance. At a certain
significance level, such as 10%, we can compare the value of the F-statistic with the critical
value of F collected from F-table of distribution. We will use the p value to determine if the
coefficient is significant statistically or not (if the value of the p is less than the value of the
significance level, we call it significant). Otherwise, same can be done with the t-statistic and
critical value from t-table.

iii. Residual normality

For residual errors, the linear regression model should prescribe normality. The data is
expected to be regularly distributed.

iv. Outliers
Residual outliers from √MSE should show a lower value in standard deviation, to ensure that
there are no outliers in the data.

Finally, we can interpret the output from economic perspectives and draw some proper policy
recommendations and conclusions based on that interpretations.

XI. Financial Budget and Time Frame

Unless the secondary data source is not free to access, we should not incur much financial
cost to conduct the research. The time accessing and processing the data should not take
much of time. Within days, these data can be collected and regressed with appropriate
software by inputting them in data editing window of the software.

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 XII. References

Bangladesh Bank. (z.d.). Bangladesh Bank. Geraadpleegd op 7 April 2022, van

https://www.bb.org.bd/en/index.php/econdata/exchangerate
Bangladesh Bank. (z.d.). Bangladesh Bank. Geraadpleegd op 7 April 2022, van
https://www.bb.org.bd/en/index.php/econdata/inflation
Bangladesh Inflation Rate - Forecast. (z.d.). Trading Economics. Geraadpleegd op 13 April

2022, van https://tradingeconomics.com/bangladesh/inflation-

cpi?embed/forecast#:%7E:text=Inflation%20Rate%20in%20Bangladesh%20is,accord

ing%20to%20our%20econometric%20models

Ben Cheikh, Nidhaleddine. (2012). Asymmetric Exchange Rate Pass-Through in the Euro
Area: New Evidence from Smooth Transition Models. Economics: The Open-Access,
Open-Assessment E-Journal. Vol. 6. 2012-39. 10.5018/economics-ejournal.ja.2012
39.
Dwyer, L., Forsyth, P. and Rao, P., 2002. Destination Price Competitiveness: Exchange Rate
Changes versus Domestic Inflation. Journal of Travel Research, 40(3), pp.328-336.
Fetai, B., Koku, P., Caushi, A. and Fetai, A., 2016. The relationship between
exchange rate and inflation: the case of Western Balkans Countries. Pressacademia,
5(4), pp.360-364.
The Financial Express. (z.d.). Inflation climbs to 6.17pc indicating harsh food price in

Bangladesh. Geraadpleegd op 13 April 2022, van

https://thefinancialexpress.com.bd/economy/inflation-climbs-to-617pc-indicating-

harsh-food-price-in-bangladesh-

1647869850?fbclid=IwAR1IpiuUgUJVrCrTgy7_Xbo2SOfjmZsXK0FfQiWpXfWiCx

XuYMHrLK-yls8

Hossain, M., 2002. Exchange Rate Responses to Inflation in Bangladesh. IMF Working
Papers, 02(166), p.1.
Islam, M., 2003. Exchange rate policy of Bangladesh: Not floating does not mean sinking.

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 Asia-Pacific Development Journal, 9(2), pp.1-15.
Islam, S. M. M., & Biswas, S. (2009, December). Exchange Rate and Its Impacts On GDP
and Inflation in Bangladesh. ASA University Review, Vol. 3 No. 2,
https://www.semanticscholar.org/paper/Exchange-Rate-and-Its-Impacts-On-GDP-
and-Inflation-Mohammed-Islam/
Khan, M., 2021. Impact of Exchange Rate on Economic Growth of Bangladesh. European
Journal of Business and Management Research, 6(3), pp.173-175.
Mahzabeen, S., 2017. Impact of Money, Interest Rate and Inflation on Dhaka Stock
Exchange (DSE) of Bangladesh. Journal of Business and Technology (Dhaka),
pp.41-54.
MANGIR, A., 2020. The Relationship between Inflation and Inflation Uncertainty: Empirical
Evidence from Turkey. International Journal of Academic Value Studies (Javstudies
JAVS), 4(4), pp.331-340.
Sanchez, Marcelo, The Link between Interest Rates and Exchange Rates: Do Contractionary
Depreciations Make a Difference? (November 2005). ECB Working Paper No. 548,
Available at SSRN: https://ssrn.com/abstract=839229 or
http://dx.doi.org/10.2139/ssrn.839229
Siddiki, J., 2002. UNOFFICIAL EXCHANGE RATES IN BANGLADESH: A
COINTEGRATION ANALYSIS. Contemporary Economic Policy, 20(3),
pp.288-300.
Özen, E., Özdemir, L. and Grima, S., 2020. The Relationship between the Exchange Rate,
Interest Rate and Inflation: The Case of Turkey. Scientific Annals of Economics and
Business, 67(2), pp.259-275.

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