Exchange Rate Depreciation and Its Connection to Falling Reserves in Bangladesh: Evaluating the Domino Effect

This study examines the relationship between exchange rate depreciation and foreign exchange reserves in Bangladesh, with particular attention to whether declining reserves exert systematic pressure on the exchange rate—often described as a “domino effect.” Using annual data from 1973 to 2022 and applying the Autoregressive Distributed Lag (ARDL) bounds testing approach, the analysis evaluates both short- and long-run dynamics among the exchange rate, inflation, per capita GDP, and foreign exchange reserves. The results indicate strong short-run persistence in exchange rate movements, while the effects of inflation and reserves on exchange rate depreciation are statistically weak. Per capita GDP exhibits short-run significance, though this relationship does not persist in the long run. The bounds test confirms the existence of a long-run equilibrium relationship among the variables; however, the estimated long-run coefficients are not statistically significant, suggesting that reserves have limited explanatory power for sustained exchange rate depreciation. The findings do not provide strong empirical support for a reserve-driven “domino effect” in the Bangladeshi context. Instead, the results suggest that exchange rate dynamics are influenced more by internal persistence than by reserve depletion alone. The study contributes to the literature by offering evidence from a long-horizon time-series analysis and highlights the importance of cautious interpretation when linking reserve movements directly to exchange rate depreciation in emerging economies.