A ringgit peg would not work

by **Cals** Mon 10 Aug 2015, 01:11

A ringgit peg would not work

Saturday, 8 August 2015
By: M. SHANMUGAM

EVEN Selangor Mentri Besar Azmin Ali is talking about the ringgit being pegged as an option to stem its decline. He was reported to have even said that this was something that should be discussed in Parliament.
That comes as a surprise because if a currency is to be pegged, it should be done without the market getting wind of it. The element of surprise is crucial. Pegging the ringgit is not something that would be debated in Parliament, especially before its implementation.
Nevertheless, Azmin is not the only one talking about the ringgit being pegged. Some traders in the capital markets are also talking about it. This came about after Bank Negara called traders for a meeting a few weeks ago and told them not to enter into any contracts that would result in the ringgit weakening.
Some traders recall that in 1998, before the ringgit was pegged, they were warned of not entering into any contracts to sell or buy the ringgit that would cause it to weaken.
But the situation in 1998 and now is very different. Pegging the ringgit is not something that would work in the current environment.
There are several reasons for this. Topping the list is Malaysia’s falling reserves. The latest announcement by Bank Negara shows that the total international reserves are at US$96.7bil, of which the foreign currency reserves are at US$88.7bil.
A month ago, the international reserves were at US$105.5bil, of which the foreign currency reserve portion was at US$96.9bil. What this means is that in the last one month, Bank Negara has seen an outflow of US$8.6bil.
Just for comparison, in 2013, the international reserves were at US$140bil.
Malaysia also has a high level of foreigners holding ringgit-denominated bonds – about 40% amounting to RM206.8bil. Any tinkering of the foreign exchange rules at the moment will cause a significant outflow.
And we don’t have the reserves to defend the ringgit if there was a peg put in place – unless the peg is at some ridiculous level like RM4.50 or RM5 to the US dollar.
Secondly, the action to peg the ringgit in isolation cannot stem the depreciation of the currency. It has to be accompanied by other measures to prevent the conversion of the local currency to other denominations and outflow of the ringgit.
Dual currency accounts
Local banks now offer a variety of instruments that allow investors to hedge in foreign currencies. Dual currency accounts that allow depositors to convert their currency into foreign currencies are quite popular among investors.
For instance, a depositor with a child studying overseas or with a payment for a property overseas can open a dual currency account to buy foreign currencies.
Only high net-worth individuals are allowed to open such dual currency accounts. It is an instrument available to hedge their foreign exposure.
When the ringgit was at 5.40 to the pound sterling before the UK elections in May this year, there were many who had children studying there or a property mortgage to pay that had utilised the dual currency account to buy more of the foreign currency. They are lucky as the exchange rate today is RM6.05 to one sterling pound.
Another instrument available in local banks and brokerages are unit trust funds that invest money for their clients overseas.
The China funds were quite popular in 2009. Those who had invested then and exited two years later would have made a pile.
All such instruments that came about after 2005 when Malaysia relaxed capital controls will have to be dismantled.
A pegging of the ringgit will have to be accompanied by capital controls again. And imposing capital controls would not bring about an effect to the country’s reserves as it had done in 1998.
In 1998, the ringgit was an international tender and there were lots of it outside the domestic market. But after capital controls were imposed, within two weeks, the money came back, hence shoring up the reserves.
Offshore markets
Since then, there is not much ringgit in the offshore markets. Although the capital controls were relaxed in 2005, Bank Negara has in place rules and mechanisms that do not allow large-scale outflows of the ringgit.
The ringgit cannot be taken outside the country except for genuine trade reasons, such as for importers or exporters. And it is supposed to be brought back within three months.
The ringgit is falling now because of the appreciation of the US dollar. It is not only the ringgit that has depreciated. Almost all regional currencies have depreciated as well.
It is a result of capitals flowing back to developed countries such as the US and the UK where asset prices are cheaper and returns could be higher. The possibility of the US raising interest rates next month is very real.
Emerging markets such as Malaysia are facing the brunt of the outflow of funds from emerging economies and the fall in the price of crude oil.
The falling ringgit is a reflection of the economy. There is no reason for Bank Negara to intervene.
The outlook for the commodities market is bearish. From gold to coal to crude palm oil, the downward trend is expected to continue until China sees some recovery in its economy.
Since late 2011, China’s economy has been trending below 10%. The outlook is not looking good at least for this year and next. This year, the growth is estimated at 7.3% and the OECD has estimated growth to be 6.9% next year.
Nobody can tell for sure if China will find a bottom soon.
Oil prices are also at a low. Brent crude, which is the international benchmark, is at below US$50 per barrel.
The combination of falling commodity prices and falling crude oil prices has resulted in Malaysia’s economy slacking.
To compound matters, Malaysia like most other countries in the region is having a slowdown in the property sector.
Pegging the ringgit will not cure the country of its ills. Fixing the economy and showing that public funds are well accounted for will cure the ringgit.