Allowing gradual depreciation of the currency should be a policy priority for Bangladesh and this is one of the lessons that the country could learn from Sri Lanka's worst economic crisis, said a top economist of the island nation.

"If you don't allow the exchange rate to adjust in line with the external sector pressure, once you start running down your reserve, you find yourself in a balance of payments crisis," said Dushni Weerakoon, executive director of the Institute of Policy Studies of Sri Lanka.

She spoke to The Daily Star on the sidelines of the 14th South Asia Economic Summit in Dhaka last week.

According to the economist, ensuring a reserve level that can pay for import bills for three months is a rule of thumb.

"If your reserve starts hitting less than three months of imports, then you are entering a balance of payments of crisis."

Her comments came at a time when Bangladesh's reserves have halved in a span of two years owing to higher import bills against lower remittance and export receipts.

Latest data showed that Bangladesh's capacity to clear import bills has fallen below four months, albeit higher than the International Monetary Fund's benchmark of a minimum reserve for three months.

Weerakoon thinks selling US dollars to keep the exchange rate stable is not a tenable policy in the long term unless a country's foreign earnings are high.

"And it will come to a point where you can't keep supporting your currency."

"I would say that you must have a realistic exchange rate. If there are external sector pressures, there is no point of spending your reserves to maintain a fixed exchange rate."

Bangladesh's taka has lost its value by about 30 percent against the US dollar in the past 18 months amid the fast depletion of the reserves.

Weerakoon, who also worked for the monetary board of the Central Bank of Sri Lanka and the Board of Investment of Sri Lanka, praised Bangladesh's prompt action in approaching the IMF before falling into a crisis amid falling reserves.

"Bangladesh did something very sensible that we didn't do. Before you got into a challenging position, Bangladesh had approached the IMF."

When asked if the Sri Lankan crisis has helped Bangladesh take faster action, she answered affirmatively.

She said Bangladesh is now well-positioned thanks to the IMF's loan programme.

"That means investors are more confident and Bangladesh doesn't have much commercial foreign borrowing and it is manageable. As an LDC (least-developed country), you have access to concessional loans and grants."

She extensively spoke about how Sri Lanka descended into the crisis.

The country had been running a large fiscal deficit and a large external current account deficit.

"We had been living beyond one's means. We had been borrowing from external sources to fund expenditures."

The difficulty for Sri Lanka, the economist said, was since it became a middle-income country in 2010, most of its borrowings were on commercial terms.

When a new government took over in 2019, it wanted to stimulate the economy, so it cut taxes sharply. The fiscal deficit started widening and international credit rating agencies downgraded Sri Lanka's sovereign credit ratings.

"This meant Colombo was not able to access the capital market and roll over debt repayments. And then Covid-19 hit," Weerakoon said.

In Sri Lanka's case, she said, there were governance failures and those who were in charge of economic policy management had thought that they could manage the situation without turning to the IMF since the country could borrow more from China and India.

"But that was not possible. The economic situation came to the crunch and we were not able to service our debt and we defaulted in April 2022."

She said the Lankan government responded by approaching the IMF and carried out the macroeconomic adjustments by raising the interest rate and allowing the exchange rate to float, among other measures.

As a result, inflation rocketed to 70 percent and the exchange rate plunged by more than 80 percent. There were no dollars to import fuel and power cuts were frequent.

"Since we had very few policy options, we have had to initiate this kind of measures to stabilise the economy. We will have to sustain this over the next six to 12 months. And it will not be easy because there is an election next year."

"The election is generating some uncertainty on continuing the policy that is helping recovery."

Sri Lanka has managed to stabilise the macroeconomic scenario and the situation has been improving for the past 12 months. But Weerakoon says the country is still not out of the crisis.

Although there are no shortages of supply and no power outages, people's living standards have fallen.

The economy is expected to contract by 3 percent this year, so employment generation has not been strong.

"Many Sri Lankans are migrating and are leaving the country in search of jobs abroad," Weerakoon added.