India–Bangladesh Trade Deficit and Misaligned Bilateral Exchange Rate: Can Bangladesh Draw Lessons from Indonesia?

Abstract

This paper enquires into the persistent trade deficit against Bangladesh in India–Bangladesh bilateral trade. For this purpose, the paper examines the extent of trade similarities and complementarities between the two countries with the help of RCA indices and Cosine measures. The results show that Bangladesh exports match with Indian exports and not with Indian imports. The paper also calculates G-L indices to measure the extent of intra-industry trade between the two countries and finds that this trade, albeit small, is growing in importance. The paper then makes an econometric study of the demand for Bangladeshi goods in the Indian market with long run time series data and finds that removal of Indian trade restrictions beyond a certain level stimulates export. While analyzing the trade deficit, the paper observes an inverse relation between exchange rate and trade deficit at the bilateral level and finds remittance-driven misalignment and overvaluation in the taka against the rupee, with the possibility of Dutch disease syndrome. As Bangladesh can draw lessons from the success story of Indonesia in avoiding Dutch disease, the paper studies econometrically the management of foreign exchange earning in Indonesia during the oil boom and finds the necessity for policy-induced adjustment in the exchange rate, which can help the Bangladesh economy to diversify and register better export performance in the future.

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