Wednesday, October 21, 2009

Strong Vs Weak Ringgit Again

Izwan Idris asks if we should have a stronger Ringgit:

"One theory why the ringgit is limping behind its regional peers is that the ringgit basket is US dollar-heavy.

This explains why the currency continues to track the US dollar movement closely under the current 'managed float' system, rather than reflecting Malaysia’s own economic health.

Typically, a weak ringgit, in a way, works as a subsidy for local exporters by way of keeping export prices “competitive” against manufacturers based in other countries. This strategy helps local manufacturers earn more ringgit for every dollar sold but, on the flip side, Malaysians will have to pay more in ringgit for imported goods and services."

There are so many problems with this post I don't even know where to begin (and I'm not even going to comment on the grammar and tense usage mistakes).

So from the top (my comments in blue for legibility):

1. "The ringgit was officially de-pegged against the US dollar from a fixed rate of 3.80 on July 21, 2005 and, like the Singapore dollar, is currently under a float system tied to a basket of currencies."

Plain wrong. MAS follow an explicit exchange rate policy with interest rates and money supply free to vary (within limits), so that part is correct. BNM focuses on short term interest rates (the Official Policy Rate or OPR), with the exchange rate and money supply free to vary within limits in terms of volatility - so that part is false.


2. "Economists estimate that the United States accounts for about 20% of Malaysia’s total trade, but as much of 80% of the country’s foreign transactions are denominated in US dollar."

I'll concede the latter statement (in the absence of firm evidence), but the former needs to be substantiated. Malaysia's direct trade with the US was last at 20% of total trade 10 years ago (the peak was 20.9% in 1998). As of last year, the US trade share has fallen to 11.8% - behind Singapore and approximately on par with Japan and China.

Big fail.

3. "One theory why the ringgit is limping behind its regional peers is that the ringgit basket is US dollar-heavy.

This explains why the currency continues to track the US dollar movement closely under the current “managed float” system, rather than reflecting Malaysia’s own economic health."

This is not a theory - it's a hypothesis, and an easily disproved one at that. First, as I pointed out in point 1. above, officially the Ringgit is in a free-float system, with the policy focus on interest rates rather than the exchange rate.

Second, if the Ringgit is truly tracking the USD then from a statistical perspective the MYRUSD rate should have a smaller standard deviation compared to other MYR cross rates. Out of the currencies of our major trading partners (sample 2005:6 to 2009:9, daily frequencies), the USD only ranks a distant third behind EUR and SGD, and only very marginally in front of CAD, GBP and SWF. Hardly conclusive evidence that we have a de facto peg to a USD-heavy basket.

Looking at the period when BNM was actively managing the exchange rate back in the 1980s bears this result out. For the sample 1980:1 to 1989:12 (again, daily frequencies), the USDMYR standard deviation was far and away the lowest by a couple of orders of magnitude, followed distantly by CAD and GBP, and even more distantly by the SGD, AUD, and ECU.

[Edit]: I should also point out that current MYRUSD volatility (as measured by the standard deviation) is 5x greater than it was in the 1980s.

Given relative movements and volatility in currencies against MYR over the past four years, if BNM is using a currency basket to "manage" the Ringgit, it's a very, very strange one.

Again, fail.

4. "The US dollar had fallen 15% against a basket of six major currencies since March, based on the performance of the US dollar index traded in New York. During this period, the won shot up 34% against the US dollar, followed by the rupiah’s 27% appreciation over the same period. The rupee gained 12%, while the Singapore dollar strengthened by 11%.

The ringgit lagged behind with a 10% rise, which was slightly better than the baht’s 9% advance."

This appears to imply (rather disingenuously) that MYR is being deliberately kept weak as regional currencies have advanced more than the MYR. In academic economic circles, this is an example of "data-mining" - selecting the data or the model that best supports your hypothesis or preconceptions, and hang the bigger picture.

To show what I mean, here are the percentage movements in the 2008:9 to 2009:2 timeframe (i.e. from the beginning of the financial meltdown to approximately the lowest point):

a. USD Major Currencies Index = +13.1%
b. KRW = -40.8%
c. IDR = -30.8%
d. INR = -17.6%
e. SGD = -9.1%
f. MYR = -9.2%
g. THB = -5.6%

We have an almost mirror image from the statistics quoted in the article. MYR hasn't gained much in the last six months or so, for the simple reason that it didn't fall as much during the worse of the crisis.

As Benjamin Disraeli was once purported to have said, "There are three kinds of lies: lies, damned lies, and statistics."


5. "At near-0% interest, the US dollar is a cheap currency to borrow, but yields almost nothing to keep. Savvy international investors lend money in the United States and use the cash to buy assets elsewhere."

Let's be charitable - I can only think of this (emphasis mine) as a typo. It should be borrow not lend.

6. "Commodities and Asian equities are the big winners. Gold, which is the traditional hedge, is now trading at record high of US$1,065 an ounce.

Indonesian stocks have the highest return in US dollar terms year-to-date. The Jakarta Composite Index rose 84% in its local currency, but shot up 122% if the gains are reflected in US dollar.

At 1,265 points yesterday, the FBM KL Composite’s 48% rise year-to-date was the least among other regional stock indices."

Same as point 4 above - we haven't risen as much, because we didn't lose so much during the depths of the crisis either. Using the same sample period as my currency example (Oct 2008-Feb 2009), the JKSE fell 40.6% during that period and was 54.6% off its all time high. The KLCI by comparison fell just 19.1%, and was 41.3% off its all time high. A more regional comparison also holds - the KLCI was among the better performers in terms of holding its value in the past two years.

Do I sense a pattern here? Fail.

7. "High income equals to high purchasing power. To achieve this, it will require shifting the whole economy away from its current low-cost manufacturing base to a more service-oriented one, which is more or less what Singaporeans had done."

Finally a sensible statement - which unfortunately completely missed the connection between a stronger exchange value and having a services-based, high income economy. The latter begets the former, not the other way around. Singapore has an appreciating currency vis-à-vis Malaysia, because they have a stronger services (non-tradables) sector. There's also the demographic angle: countries with higher youth dependency ratios tend to have "weaker" currencies, and Singapore is "aging" faster than Malaysia is.

Going for a strong currency policy without improvement in the non-tradables sector is a triumph of form over substance.

8. "Keeping the ringgit undervalue against its regional counterpart may be counter-productive in the longer run, as it will only fuel our addiction to cheap exports industries that only attract unskilled foreign labour."

What's truly ironic is that having a "cheap" currency is not necessarily an advantage when you have low-value added export industries (i.e. with high import content), and especially not when a portion of your exports is commodity based. I'll touch on this when I get around to posting on trade elasticities. He made the point earlier when talking about the effect of exchange rates on exports and imports (see quote at the top of this post), but again missed the connection.

But as I've extensively written on before (for instance here, here, and here), I do not believe the Ringgit is substantially undervalued based on Malaysia's economic structure and current fundamentals (like terms of trade, services/exports shares, trade barriers, capital and financial stocks and flows etc). Nor do I believe that there is an implicit policy to keep the MYR undervalued relative to any currency. As far as I'm concerned, MYR is close to its trade-weighted fair value with a bias towards appreciation as the country increasingly shifts towards services as the growth sector.

Technical Notes:
1. MYRUSD exchange rates and MYR cross rates against other currencies derived from the Federal Reserve's Report H.10, except for IDR, where data was sourced from Pacific Exchange Rate Service.

2. Stock market index data from Yahoo! Finance.


  1. Oh I read the article this morning and just KNEW you'd have something to say about it..
    Fails all around eh :D

  2. LOL, the temptation to respond to this article was too great to resist.

  3. When Ringgit keeps on falling day after day , We, Johoreans will feel the pinch more than anyone in Malaysia. Prices of houses are beyond the reach of many Johoreans as our salaries are pretty low campared with Spore. Food items are on the rise and inflation due to higher import content will definitely dealt a deadly blow to all....Life is hard n pretty tough nowadays.

  4. Leslie,

    The perception of the Ringgit falling vis-a-vis the SGD, is because Singapore uses the exchange rate to regultate monetary polciy. This requires a steady appreciation of the SGD relative to the currencies of Singapore's trading partners, of which Malaysia is a major part. Hence, there is a deliberate policy on the part of Singapore to appreciate the SGD against the Ringgit. We on the other hand use an interest rate target rather than a forex target because of our deeper and more diversified economy. There's pros and cons to either approach, but personally I think Singapore is reaching the limits of their policy given their domestic monetary conditions.

  5. Hi, I'm currently a secondary school student and have always been curious about this..May I know how to improve the economy in Malaysia ? thanks!