Since the start of the currency
crisis, the ringgit has been volatile, fluctuating by the day, if not by the hour.
There are many external and internal forces influencing the exchange rate. This has
made business planning and investment decisions difficult, since what may now be
a good business decision may turn out to be disastrous later because of unfavourable
exchange rate movements. The wider the exchange rate fluctuates, the more would businesses
and individuals have to hedge against future ringgit movements in order to reduce
In the midst of this, currency traders thrive on the uncertainties
and takes advantage of the volatility as an opportunity for profit making, without
regard for the hardship it causes for the economy and people.
It has become a matter of vital importance for the nation to
have a stable ringgit. A strong, stable ringgit is interlinked with restoring confidence,
maintaining financial and capital markets stability, as well as enabling the real
economy to recover and grow.
Three areas of action to strengthen the ringgit are proposed
below. In addition, the other measures for restoring market confidence, maintaining
financial markets stability, strengthening economic fundamentals, and restoring the
sectors adversely affected by the crisis, will also help to boost confidence in the
- Appropriate choice of exchange rate regime
- Increase external reserves
- Reduce an over-dependence on the US dollar
- Adopt a balanced interest rate policy
1: Appropriate Choice of Exchange Rate Regime
Since 21 June 1973, Malaysia has adopted the flexible exchange
rate regime. Bank Negara exercises the option to intervene when deemed necessary
in order to even out sharp exchange rate fluctuations. Since mid-July 1997, Bank
Negara had allowed the ringgit to be determined by market forces, but started intervening
again in early January 1998 in order to stop market panic, following the free fall
of the rupiah. In money market interventions, the Central Bank had to exercise great
care to ensure that the timing of the interventions is just right, which is not always
easy to achieve.
The basic argument in favour of flexible exchange rates is
that an economy can adjust easily to external shocks. In addition, monetary policy
can be used for domestic ends, such as price stability, rather than having to use
interest rates to keep the exchange rate on target. The most important disadvantage
is that flexible exchange rates can be volatile and, on occasion, grossly misaligned.
This can hinder trade and upset the economy.
On the other hand, a return to fixed rates in todayís world
of highly mobile capital is unsuitable. A fixed peg is also a fixed target for speculators.
The situation would not improve with the adoption of a currency board in place
of a central bank.
Unlike a conventional central bank, which can print money at
will, a currency board issues domestic notes and coins only when there are foreign-exchange
reserves to back it, one-to-one. Under a strict currency board regime, interest rates
carry the burden of adjustment and are not determined by the government. In other
words, the government loses the lever of an independent monetary policy. Although
a currency board has the advantage of predictability and rule-based nature, the currency
is still pegged to another currency and can be attacked, as in the case of the Hong
Kong dollar that survived two attacks in 1997.
To avert future attacks on the ringgit, the following measures
are to be adopted:
- Adopt an exchange-rate regime for Malaysia that provides flexibility
but reduces volatility. It may be necessary for the ringgit to move within an exchange-rate
band against a trade-weighted basket of currencies that is reviewed regularly, at
least every three years.
- Establish an early warning system to be monitored among key
government agencies that identify negative developments within the financial and
currency markets well ahead of time.
- Continue with the roadshows to encourage investors from countries,
such as Japan, Taiwan, Europe and the United States, to invest in Malaysia.
- Work towards getting an international agreement for more transparency
and greater disclosure in the operations of investment funds, such as pension funds,
currency funds, and hedge funds.
- Better macroeconomic coordination and exchange of information
among countries to detect signs of growing financial instability and currency crises.
- Strengthen international surveillance for an orderly international
monetary system that is based on sound banking and financial system.
2: Reduce an Over-Dependence on the US Dollar
Although 18 per cent of Malaysiaís overall trade is with the
United States, about 70 per cent of its trade settlements are conducted in the US
dollar, which has appreciated against most currencies. Only about 15 per cent of
Malaysiaís total trade settlements are in ringgit and 6.5 per cent in yen. There
is a need to reduce an over-dependence on the US dollar in Malaysiaís trade with
other countries and build up reserves of different foreign currencies.
- Encourage quotations of Malaysiaís exports in the currency
of the country concerned.
- An expert group should examine the details on the mechanics
and operation of bilateral and multilateral payment arrangements for trade among
- A study should be conducted on the feasibility and prerequisites
of adopting an ASEAN currency at a future date. This would have to be examined within
the context of intra-ASEAN trade as well as trade between ASEAN and other trading
Although currency attacks cannot be entirely prevented, large
external reserves can help to deter such attacks from occurring. As shown in Figure
6, the international reserves held by Bank Negara as at 15 May 1998 was around
RM57.4 billion, sufficient to finance 3.4 months of retained imports. The reserves
will need to be increased to enhance the countryís "war chest" for confidence
building in the ringgit. The measures to increase external reserves include:
- Raise Malaysiaís reserves equivalent to at least 5 months
of retained imports.
- Urge Malaysian individuals and large corporations to sell
off part of their assets overseas and bring back the funds to strengthen the ringgit.
- Reduce or suspend reverse investment temporarily with the
assurance that overseas investment would be allowed when things improve.
- Get registered immigrant workers to contribute to SOCSO or
EPF and make necessary amendments to relevant Acts to expedite the matter. This measure
should be accompanied with better monitoring of foreign workers in order to ensure
that they are not driven underground in order to escape this requirement.
- Increase exports, reduce imports, improve the services account
balance, and increase foreign direct investment.
- Consider using loans, issue of bonds or other means to augment
the reserves. This includes a financing package to raise funds with short maturity
averaging three years.
- Continue with prepayments of external debts to reduce their
size, and ensure that they are smaller than the external reserves.
4: Adopt a Balanced Interest Rate Policy
The Government recognises the problems associated with low
interest rates, which are as follows:
- Low interest rates will allow banks to delay the balance sheet
adjustment, but liquidity will be frozen in non-performing assets.
- The lack of value adjustment will prevent market clearing
and limit investment opportunities for both local as well as foreign investors.
- In the initial stage, low interest rates will lead to credit
growth of the poorest quality (distress borrowing), adding to banksí NPL problems.
Over time, though, a weak economy and ongoing bad loan problems will make banks reluctant
to extend new loans, leading to a credit crunch despite low interest rates.
On the other hand, some arguments have been forwarded against
high interest rates. They are as follows:
- Many businesses, even well-managed ones, will fail if the
interest rates continue to increase, resulting in a recession. The poorly-managed
businesses have already been punished by the market, but why kill off the good companies?
- High interest rates will not necessarily attract inflows of
funds. In the face of currency volatility, investors are more attracted to currency
stability and value appreciation than interest yield.
- High interest rates may not really encourage domestic savings
if the ringgit is weak. The rich could always park their money offshore. High interest
rate is often regarded as more risky and a symptom of weakness in the economic system.
In view of the above, the Government should adopt a balanced
approach to interest rates since a sharp and prolonged increase in interest rate
would be untenable. This would fuel inflationary expectations through higher cost
On the other hand, nominal interest rates should be kept above
the inflation rate so that the real interest rate does not become negative. This
is to ensure that savers receive a positive rate of return for their deposits, and
funds do not go offshore in search higher returns. While interest rates are allowed
to rise to underpin currency stability, care should be taken that they are not prohibitive
and damaging to the private sector.