Wednesday, September 20, 2017

Historical Revisionism: The MYR and SGD in the 1980s

I came across this a couple of weeks ago, but didn’t have time to address it then (excerpt):

A kleptocracy premium for the ringgit
P Gunasegaram

A QUESTION OF BUSINESS | Without a doubt the ringgit is historically rather weak even if the economy still continues to grow at a relatively healthy pace – the latest figures show a good growth of 5.8% for the second quarter of the year….

…So why does the ringgit remain weak, trading at levels which are weaker than at the height of the 1997/98 Asian financial crisis? What is it that is happening that keeps the ringgit level depressed? Perhaps it is due to a risk premium on the ringgit following the emergence of kleptocracy (re: 1MDB where as much as RM40 billion could be at risk, as thieves dip their fingers into money borrowed by a government company via bond issues) or apprehension over the ongoing spate of mega projects (re: the RM55 billion East Coast Rail Link whose cost may go to over RM100 billion….

…The movement of the ringgit over the years tells an interesting, compelling story. Up until the early '70s, the exchange rate of the ringgit was fixed, but when the world moved largely to floating rates, the ringgit as well as the Singapore dollar actually performed well initially – up to about 1980.

The chart and the table show that in 1980, the ringgit and the Singapore dollar had nearly the same value as the ringgit. But that changed as Dr Mahathir Mohamad became prime minister in 1981 which saw a precipitous decline of the ringgit relative to the Singapore dollar, even though it held steady against the US dollar until the 1998 Asian financial crisis.

That meant the Singapore dollar was appreciating against the US dollar. Singapore obviously did not pursue a weak currency policy, and allowed its currency to appreciate in the belief that the economy could compensate by having higher value-added industries and services.

Malaysia under Mahathir, however, opted for cheap labour, allowing unrestricted imports of labour, often illegal, from Indonesia, Philippines, and later Bangladesh. Manufacturing tended to be on lower value-added, such as assembly of electronics….

…While the Singaporean and Malaysian currencies were on par right up to around 1980 – indeed in the two countries, they were exchangeable for one another – it changed after that. Over the next 37 years or so, the two currencies moved terribly out of line and the Singapore dollar is now worth over three times the ringgit.

This has broadly reflected the widening gap in economic development between Malaysia and Singapore, with Singapore far outpacing Malaysia in all areas including educational levels, infrastructure, GDP per capita, quality of life etc...

I don't have a subscription to Malaysia Kini, and I don't intend to start one just to get the whole article, so I'll only address what's outside the paywall.

The story spun here sounds good, until you dig into the details of the difference between Malaysia and Singapore’s approaches to exchange rate policy.

The first and most crucial point – apart from some very short periods, neither the MYR nor the SGD were floating exchange rates. For the MYR specifically, there were only two free float periods between the collapse of the Bretton Woods system and the depeg in 2005. The first was on the initial collapse, which was swiftly followed by an intial peg to the GBP, and subsequently to the USD. There was some experimentation in the 1970s of the exact mechanism of the peg, but the fact remains that the MYR was never under a free float. The second was in 1997-1998, between BNM abandoning the USD peg and the repeg in September 1998. The SGD on the other hand, to my knowledge has NEVER been a free floating currency.

If currencies are not free floating, and are pegged to some other currency or basket of currencies (and there are many variations on those arrangements), the notion of currency performance = economic performance falls flat on its face. Pegged exchange rates do not reflect economic fundamentals, but policy objectives.

Take for instance the simple fact that despite having a GDP per capita 3x larger than Malaysia, the SGD and MYR traded at par for most of the 1970s. So the real question to ask is: what were the policy changes that caused the exchange rates to diverge.

For this, let’s refer to one of the paragraphs of Tan Sri Nor Mohamed Yakcop’s statement at the recent RCI (excerpt):

13. In the Malaysian domestic market, since the late-1980s, there was a continuous large inflow of US dollars by investors, including some short-term inflows or “hot money”. If BNM did nothing, the inflows would have resulted in the ringgit strengthening significantly from the BNM policy range of between 2.50 and 2.80 against the US dollar. That would have created major implications for the economy, particularly since it would have reduced the competitiveness of Malaysian export sector.

Or in other words, BNM essentially pegged the MYR to the USD within a range, rather than a specific value. Nevertheless, a range target isn’t much different from a hard peg, with any fluctuations contained within a band. BNM maintains the target by the buying and selling of MYR versus the USD, with obvious ramifications on international reserves. The MAS on the other hand, shifted to targeting the nominal effective exchange rate of the SGD at the turn of the decade, or the proverbial “basket of currencies” that people talk about without really understanding the full implications.

Here’s why this seemingly innoucous policy difference caused such a large divergence between the two currencies, again with reference to TSNMY’s testimony (excerpt, emphasis added):

4. The situation changed in 1985. On 22 September 1985, five OECD countries, met in private at the Plaza Hotel in New York and decided among themselves, without consulting other countries, that the yen and the German Deutsche mark should be strengthened significantly against the US dollar by way of market intervention. This is known as the Plaza Accord. The Plaza Accord was historic because it was the first time central bankers agreed to intervene in the currency market in such a big way and the first time in history when governments set target foreign exchange rates to be achieved through active intervention.

5. One important outcome of the Plaza Accord was that the exchange rate of the yen versus the US dollar strengthened sharply. (The yen strengthened from 240 yen to the dollar in 1985 to 120 yen to the dollar by early 1988)….

6. The strengthening of the yen resulted in many developing countries suffering huge losses, since a significant portion of their external borrowings was denominated in yen. The Malaysian government, government agencies, including GLCs, as well as the Malaysian private sector suffered significant forex losses on repayment of yen loans and foreign exchange revaluation of yen loans, following the sharp appreciation in the value of yen arising from the Plaza Accord.

7. Malaysia’s borrowings in Yen during the early 1980s were mainly for infrastructure building. At that time, the Malaysian bond and sukuk markets were not yet developed to enable large amounts of borrowings for long periods to be obtained domestically in ringgit. Given that infrastructure projects required long gestation period, the Malaysian government and its agencies chose to borrow in yen, since, at that time, long term yen loans were available with low interest rates. The borrowings also coincided with the building of major infrastructure projects in the country.

8. Since the Plaza Accord of September 1985, the international forex market also became much more volatile, with sharp and sometimes erratic movements in the daily forex rates. While the Plaza Accord of September 1985 was intended to strengthen the yen and the Deutsche mark, another agreement, the Louvre Accord was signed on 22 February 1987 in Paris by six OECD countries, again without consulting other countries, to halt the over-appreciation of the yen and the Deutsche mark, and this created another round of turmoil in the foreign exchange market.

I’d really encourage reading the whole thing, as its as succinct and lucid description of exchange rate and reserve management as you’ll ever read…but I digress.

The important point here is that the Plaza Accord effectively caused an appreciation of the DMK and JPY against the USD, which had the following effect:

  1. The MYR, targeting a soft peg to the USD, stayed relatively stable versus the USD but depreciated against the DMK and JPY.
  2. The SGD, which was pegged against its NEER which included both the DMK and JPY and not just the USD, very obviously followed them up and appreciated versus the USD.

Different policy framework, different real world results. You don’t need a cock and bull story about differences in economic performance to explain the differences in these exchange rates. At no point did any of these currencies (including the G3) reflect “economic fundamentals”.

I’d also add that at some stage in the 1980s, and its unclear when exactly this happened, Singapore shifted from a straightforward level peg against the NEER, to an appreciating one (for details of the framework, read it from the horse’s mouth). What this means: the SGD will, over time, be forced to follow a gradual path of appreciation against the currencies of its trade partners. I say forced, because if you look at the level of the MAS’ international reserves, it’s fairly obvious that for most of the last 3 decades, the MAS has been doing its level best to slow the appreciation of the SGD (largely due to Singapore’s role as a tax haven, which incentivised constant inflows of capital), and not “allow” it to rise.

That explains much of the “performance” of the SGD versus the MYR (and incidentally, against everyone else) since the Asian Financial Crisis. It’s NOT related to differences of economic performance, or structure, or strategy. It’s because the appreciation was a deliberate policy choice and policy objective by the Singaporean authorities. The MYR meanwhile, was pegged to the USD between 1998 and 2005, and only allowed to float thereafter. Very obviously, given these different policy settings, the SGD would have consistently risen against the MYR regardless of the performance of either economy. In fact, for much of this period, the appreciation of the SGD against the MYR was so steady and so consistent, that it looked more like the MAS was targeting the MYR, rather than a full basket of currencies.

Moreover, the article implicitly presumes that the USD is itself a stable currency and store of value, from which comparisons can be made. It very obviously was not and is not, something we should be more aware of given the events of the last three years. I’ll bet that the rest of the article will expand on the point that there’s a risk premium on the MYR due to 1MDB and the like. As I pointed out before, there’s no evidence that this applies anymore.

One last thing that puzzles me: given the circumstances in the 1980s, why was no thought given to abandoning the USD peg and either free float the MYR, or use an alternative peg arrangement?

Malaysia’s debt denominated in JPY caused a massive external asset-liability mismatch, and required the government to pull back on spending to such a degree that it caused a two year recession. Why not then peg to the JPY or the NEER? That would have made more sense from a financial standpoint, and moreover was in keeping with the government’s Look East policy.

The mid-1980s recession effectively killed Malaysia’s economic progress for that whole decade, a setback far greater than the RM30+ billion later lost in the forex markets, since it cost not just money, but jobs, businesses and time. Korea and Taiwan basically overtook us because of it, and we’ve been trying to catch up ever since. Let me be clear here: this was a recession caused by a deliberate policy choice, not an externally imposed or naturally occuring one.


  1. Excellent work. What do you think of the current level of Ringgit vs USD as well as SGD. Is there any possibility of ringgit depreciate further vs USD if FED starts to shrink their balance sheet? Do you think ringgit is trading at an artificially low level against other basket of currency. Why BNM has deliberately slow down the appreciation of ringgit recently if it can decrease the inflation rate in Malaysia.

    Thank you so much for answering my rather long question. I have always admired ur work. :)

    1. @Zhi Hao

      1. Personally, I don't put much stock in what any given value of the exchange rate is. However, the general consensus is that the Ringgit is undervalued against the USD, and probably also the SGD. Where I probably differ with my peers is that I don't think the undervaluation is that significant anymore.

      2. On the second part, I think the USD cycle has turned, and regardless of what the Fed does, the USD will continue to depreciate.

      3. No. Or to be more precise, its not entirely artificial. Currencies are known to "overshoot" and deviate substantially from fair valuation for extended periods of time.

      4. They are trying to rebuild their reserves first, which puts some downward pressure on the exchange rate

  2. Excellent insight Hisham. Thanks for sharing.

  3. malaysia on the verge of Economic Collapse and so Ringgit will Depreciate like Zimbabwe Dollar..... Malaysia is Bankrupt with $1 Trillion Debt.....Good luck to those who still have Faith in the Ringgit....Better Park your money in Foreign Curreny and Sell all your Property and asset...Collapse is coming for a Failed Nation and IS radical Islam emergence.....No Islam Bias nation is ANY good in this World!!

    1. Stop skipping English classes, please.

  4. Thank you for the article En Hisham. I learned something new today. A question if you don't mind: What do you think drove them to stay with the greenback? Couldn't they have figured it would have been a good move to change? Thanks up front En Hisham

    1. @zapa

      I think the reason was ideological inertia. The USD was the anchor for the entire international monetary system from 1944-1971. Habits are difficult to change

  5. Thank you for the interesting read. Could you elaborate further on your view that the SGD’s appreciation is related to Singapore’s status as a tax haven? I attributed SGD’s performance to its consistently strong current account surplus. A CA surplus could be attributed to economic structure.

    Historically current account differential between Malaysia and Singapore seems to support this. Which would suggest that the SGD has quite a bit left to go.

    Alternatively, you could connect it in the form of CA = -KA (current account = -capital account? So the capital flows would stimulate CA surplus? I admit my understanding on this issue is still somewhat shaky.

    1. @MN

      SGD's appreciation doesn't necessarily have anything to do with Singapore being a tax haven. It's still primarily a result of being a policy objective (particularly the slope of appreciation).

      Being a tax haven however does help support that objective, by ensuring consistent inflows of capital i.e. they don't have to expend reserves to support the appreciation.

      Also, given these characteristics, the current account differential has nothing to say about the performance of either currency, but more the ability to accumulate reserves, or lack thereof.

      On the capital account issue, -KA is actually net outflows of capital, not inflows. But this outflow can be either private (via increased private holdings of foreign assets) or public (increase in international reserves).

      On that basis, for covering Singapore, looking at the FX reserve level is more important than looking at the exchange rate.

    2. @MN

      Also, you might want to read this:

  6. Hi En Hisham, so glad to stumble upon your blog. I have been Googling quite frequently recently on the difference in economic performance between Malaysia and Singapore. Definitely looking forward to read through all your blog posts on my bus trip back to KL later.

    I have no background in economics beyond Econ 101. While I understand that lower exchange rate helps with exports/trade etc., I am a bit more curious as to how it affects brain drain/gain and ultimately local economic growth. On the ground, I have seen quite a few more peers/friends moving to work in Singapore now especially since 2010s. These are high-skilled workers whose expertise could have helped M'sia.
    I wonder what your thought is on this topic and how should a layman like me frame my thinking on this?

    1. @Vic

      Don't read too much into it. The per capita brain drain from Singapore is actually higher than Malaysia's rate.

      High skilled labour will follow the money regardless. Singapore is just convenient because its next door.

  7. I didn't read your whole article but just using some policy change that coincide with the moves of the currencies do not explain why the currencies depart. BECAUSE you can't be sure if there is a cause-and-consequence relation. so, you are just bullshitting.

    In general, we don't want the products produced in malaysia so we don't buy from it and the ringgit drops, adding bribery take away its US$ reserves. On the other hand, we like singapore, we are more willing to pay for it, so the S$ goes up. that is ALL.

    1. 1. 25 years worth of research (and one Nobel prize) on the measurement and direction of causality, suggests I'm not the one who's bullshitting here;

      2. You're also saying in effect that generations of analysts covering Singapore must be wrong, since they all insist the SGD exchange rate is being managed;

      3. MAS must be totally deluded about their FX policy, since they seem to be under the illusion that there is a cause and effect between that policy and the SGD FX rate.

  8. Furthermore: hard proof is that during holiday seasons, visitors do not want to go to Malaysia/kuala lumpur comparing with SG or thailand. malaysia vacation is dirt cheap but still not attraction. you can ask any 10 people/visitors and can immediately confirm. Hag? you are visiting kl in christmas? why? why don't go sg or bangkok?

    ... silent... speechless...

    so, how can ringgit be strong???

    1. Tourist arrivals in Malaysia average close to twice as high as Singapore, so how is your statement "hard proof"?

      A sample size of 10 has an error rate of 31%, pretty far off from the standard 1%-2%. Not very scientific.

  9. I sometimes read some new articles if I find them interesting on MYR and SGD. And I found this one pretty fascinating and it should go into my collection. Very good work!
    KLSE stock Advisory

  10. Hi Hisham
    Recently Thailand central bank has been pursuing a baht appreciation policy. This is evident in the forex reserve as at today. My question is why cant Malaysia pursue the same appreciation monetary policy instead? With our current rate of gdp growth, we may still reach high income country status after 2025 but if we are to pursue RM appreciation policy it would be much faster.