Reserves, Capital Flows and the Ringgit

Confession time: ten years ago, I’d have probably made the same analysis…and I’d be just as wrong. But with age comes wisdom, I hope.

Two statements in yesterday’s paper caught my eye. First from RAM Holdings chief economist Dr Yeah Kim Leng:

Ringgit is getting stronger, US$ to continue decline

...“With the ringgit strengthening, our manufacturers will be forced to become more productive and innovative.

“This will help get us out of the industrialisation trap,” Yeah said...

…and then from CIMB Investment Bank head of economics Lee Heng Guie:

M'sian international reserves hit record level

…CIMB Research in a note yesterday said reserves were boosted by substantial inflows of short term money and that positive economic vibes had contributed to the fundamental reasons for such inflows…

It’s nice to note that there’s some corroboration for my interpretation of BNM’s intervention in the forex markets last month. But to deal with these statements:

1. The Ringgit hasn’t actually strengthened much, if at all. This is USD weakness, not Ringgit strength. If our currency appreciates faster than that of our competitors, then there’s some basis for the opinion that producers would be forced to increase capital intensity (and thus worker productivity). But that’s simply not the case right now (index numbers; nominal and real effective exchange rates; 2000=100):
   
   On a trade weighted basis, the Ringgit has barely budged since April 2010. That means that from a competitive standpoint, there’s been no relative change in terms of the external pricing of Malaysia’s exports, and hence no pressure on exporters to change their ways.
   
2. There’s no direct link between international reserves and capital flows (or any kind of external money flows) unless you’re operating a fixed exchange rate regime. With certain exceptions (most spectacularly last month), BNM has let the Ringgit float. Changes in international reserves requires active intervention by the central bank - there's no passive conduit directly from external inflows or outflows into BNM's foreign currency reserves. Maybe old habits of thinking die hard…but I expected better of CIMB.