[Rant Mode On]
Lim Sue Goan on the economy and the Ringgit (excerpt):
...The PM should put more focus on economy instead, in view of the plummeting international oil prices and a significantly weakened ringgit....
...Thirdly, the government should support the ringgit. The continuous fall of ringgit has brought up operating costs for many businesses resulting in import inflation. In the long run, the depreciating ringgit will harm the country's economic fundamentals.
Rafizi Ramli on petrol prices and the Ringgit (excerpt):
….Jika Dato’ Seri Najib Tun Razak menyalahkan pasaran minyak mentah dunia akibat turun naik harga minyak, beliau bertanggungjawab sepenuhnya kepada turun naik kadar matawang RM. Di bawah pentadbiran beliau sebagai Perdana Menteri dan Menteri Kewangan, kadar matawang RM kini jatuh ke paras terburuk sejak krisis kewangan Asia 1998.
Kenaikan harga petrol dan diesel yang akan dihadapi oleh rakyat Malaysia dalam bulan-bulan mendatang adalah akibat kegagalan beliau sebagai Perdana Menteri dan Menteri Kewangan.
What do these two (very different) commentators have in common? They both think the government, or more correctly Bank Negara, should do “something” about the Ringgit. They’re hardly alone, as I find this to be a common sentiment.
Here’s how I think the PM and the Governor should respond:
To be fair, exchange rates are confusing at the best of times, and I’ve been studying them for twenty years.
But what are the practical consequences of “supporting” the Ringgit? Well, Bank Negara could spend some of that hoard of foreign exchange it has (which for some strange reason some people think is kept in a cash vault in a subterranean basement at BNM) on buying up Ringgit. That would reduce the amount of Ringgit in circulation, which would drive up its value relative to the US Dollar. Simple, right?
Except reducing the Ringgit money supply increases its “price” (money demand will exceed money supply). All things equal, this equates to an increase in domestic interest rates.
But, as some of the more-in-the-know commentators might argue, they can always sterilise, right? Yes they can – by injecting more Ringgit into the market by buying up government securities and bills. But by doing so, they increase the amount of Ringgit in circulation again relative to the USD, and the foreign exchange rate goes back to square one. Sterilisation weakens and nullifies the original currency intervention.
Under the conditions of free capital mobility, you can only control either domestic interest rates OR the foreign exchange rate, but not both simultaneously. Trying to “support” the Ringgit is tantamount to giving up Malaysia’s hard won monetary policy credibility anchored on the OPR. The converse is true: there is no such thing as a currency defence if domestic interest rates do not rise. The interest rate defence and FX intervention approaches to maintaining a currency exchange rate are effectively the same thing; you can’t have one without the other.
A second problem is that if the market thinks the Ringgit’s market value should be weaker, you’ll have to continuously keep buying up Ringgit as long as the market rate is out of line with demand and supply. Eventually you’ll run out of FX reserves, but not before you’ve pumped up domestic interest rates to truly punitive levels.
To take an extreme recent example, Russia started off 2014 with a benchmark interest rate at under 6%. As oil began to crash and selling pressure built up on currencies of oil exporters, the central bank stepped in to buy Roubles against the USD. This is what happened:
Not pretty, and this is hardly the worse case I’ve seen. In Malaysia in 1997, overnight interest rates at one point hit 50% (!). Don't look now, but Brazil is also going down this route (the policy rate has been hiked 1% in just two months, despite a weakening economy).
So don’t worry about the Ringgit. It actually hasn’t dropped very much, and things could be much, much worse. Like, BNM could seriously be listening to Mr Lim, YB Rafizi, or worse, Mr Tong Kooi Ong. Then we’d really be in trouble,
Smile and wave, boys, smile and wave.
[Rant Mode Off]