Friday, September 24, 2010

Ringgit In The News Again

The second piece of news over the last couple of weeks I want to over is the internationalisation of the Ringgit, which was brought up by the PM in an interview just after Eid. This prompted quite a bit of feedback, notably this broadside:

He’s right…and wrong of course (hit this link for the original article in The Star). Much as I respect our former PM, characterising what happened in 1997-98 purely as a result of speculative attacks on the Ringgit is shallow analysis and displays a victim mentality (one fine day, I’ll get around to posting about 1997). Or, in the words of the immortal Han Solo, “It’s not my fault!”. But he does have a point over the scale of forex flows relative to the Malaysian market (see this post for the real source of that info).

The manufacturers are of course against the internationalisation idea – they want a return to the old pegged regime (emphasis mine):

FMM against offshore trading of ringgit
But others say manufacturers need to come to terms with it

PETALING JAYA: The Federation of Malaysian Manufacturers (FMM) has expressed concern about the strong ringgit and its possible internationalisation, saying that stability in the currency’s exchange rate is of “utmost importance”…

…FMM added that a strengthening ringgit should not be used as a primary indicator of the strength of the economy.

“The ringgit should reflect true economic fundamentals. We need to remind ourselves of the debilitating experience of the 1997 financial crisis which taught the nation that unbridled speculation and inflows of hot money impact not only directly on financial markets but also on activities in the real economy,” FMM said in the statement...

...But the FMM said that “resource-based, export-oriented industries in particular would be most adversely affected by a strong ringgit. In addition, a strong ringgit would raise domestic demand for imports instead of locally-manufactured goods and services, leading to deficits in the current account of the balance of payments.”

FMM said it “cautions against rushing into the internationalisation of the ringgit.”

The best I can say is that FMM must be living in another country –this is a confused and confusing mish-mash of ideas. Don’t look now FMM, but the Ringgit has been floating freely the last five years and is going to get stronger whether it is internationalised or not. They’re also misrepresenting the impact of the terms of trade on the exchange rate – the empirical evidence suggests that terms of trade shocks drive the exchange rate, not the other way around. In layman terms, increased prices of commodities are causing the exchange rate to rise – I think the resource based industries should do just fine, thank you.

I’m not fully in favour of internationalisation either, but my concerns are rather different. Since the level of the Ringgit is more or less market determined under the current regulatory regime, there’s no real fear of a major speculative attack on the currency. Whether that will continue to hold depends on whether you accept that the market is efficient, which given the long swings that major currencies have away their fundamental equilibrium values isn’t likely. But the difference this time vis-a-vis 1997-98 is that there’s almost zero risk of a sudden stop, capital flight scenario like 1997 due to the absence of the one-way-bet nature of a pegged exchange rate regime. The worst that could happen is something along the lines of what occurred to the GBP these past two years, which lost something like 40% of its value, but in an orderly manner and without the accompanying wailing and teeth-gnashing that went with say the Hungarian Forint. In the best case scenario, all we’ll see is some relatively gentle appreciations and depreciations, where people will have time to adjust to changing currency values.

But getting back to why I’m waffling over the idea, I’m primarily concerned with financial flows – I’m not convinced this is in Malaysia’s long term interest. We’ve already liberalised forex rules fully for trade, and there’s no restrictions on currency exchange for portfolio investment either. In other words, the level of the Ringgit is about as fundamentally driven as you can get, and having Singapore and Hong Kong in the game won’t necessarily help matters.

Internationalisation would add more players and trade volume to the market, but I think that would only create more “noise” than “signal” – volatility will increase, but without necessarily improving the ability of the Ringgit to converge to its fundamental equilibrium value. Unlike stocks or bonds, there’s no issue of liquidity, as BNM can supply as much Ringgit as anyone wants, so there’s little benefit from attracting more players to enhance market depth. And trade volume in the local Ringgit market, even without internationalisation, is already pretty decent:


And the point about attracting further portfolio investors might benefit existing investors on Bursa Malaysia, but I’m not convinced that’s a good idea either over the long term, for much the same reasons – more volatility, but not necessarily more efficiency.

Thankfully, the Governor is pretty cool to the idea, so we’re not facing this anytime soon.

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