Farewell Sweet Peg

Malaysia

Economic News

22 Jul 2010
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Since the announcement late on July 21 that Malaysia would change its currency regime to a managed float, discussions of the likely impact have dominated the business and political community.



The news came minutes after an announcement from the Central Bank of China that it would also be abandoning the yuan's fixed peg to the US dollar. Although the two events came within a short space of time, senior Malaysian government figures denied that this came as a result of ongoing communications with their Chinese counterparts, although they said the Malaysian central bank, Bank Negara, had been watching Chinese movements carefully.



Following the lead of Asia's giant is an essential move. In a world economic environment that has seen the dollar depreciate, many currencies pegged to it, including the Malaysian ringgit, are widely viewed as undervalued.



The result of the move could be speculative capital flows into Malaysia, a likelihood that would have increased dramatically had Bank Negara not followed the Chinese lead swiftly. Indeed it was such speculation that was blamed for the effects of the 1997 Asian financial crisis in Malaysia, and which resulted in the former prime minister, Mahathir Mohamad, introducing the currency peg.



Ties to the weak dollar have constrained some in Malaysia, particularly importers who buy goods in currencies that are not linked to the greenback. Exporters have benefited to some degree, and may be sad to see the regime go since the monetary environment has made their goods cheaper overseas.



Indeed, some say the fact that Malaysian exports would have become uncompetitive against Chinese equivalents if the value of the currency were allowed to rise before the yuan was a deciding factor in letting the Chinese go first.



With the peg gone, the ringgit rose for the first time in seven years on Friday 22 July. Bank Negara was thought to be stemming the currency's rise to stave off potential overshooting. By 5.00 pm the ringgit was up 0.7% against the dollar, but Malaysia-based brokers were all offering their own two cents worth of analysis for the future.



The consensus of opinion tends to say that the currency will rise 5% over the next 12 months, although different commentators produce different margins of error around that figure.



ECM Libra reported that it believes the ringgit will appreciate between 5 and 8%, boosting private consumption, lifting GDP by between 0.3 and 0.4 percentage points, stimulating investment and eroding the cost of imports.



On the other hand Citigroup Global Markets anticipated that the rise in value will be below 5% by the end of the year, despite the scope for an increase in value being larger than that. They believe that the authorities would maintain a cautious stance in a bid to preserve export competitiveness.



Brokers have marked the palm oil industry as likely to bear the brunt of the de-pegging. Many of the firms who own large tracts of palm oil plantations are exposed to fluctuations in the dollar, the currency in which most of their revenue comes.



One industry observer was quoted in local press as saying that a 5% increase in the ringgit's value will reduce the value of crude palm oil (CPO) by RM70 ($18.53), based on a price level of RM1400 ($370.60) per tonne.



Firms who are particularly exposed to plantation ownership are expected to be hit worse than those with more diversified or integrated operations. Whilst costs are expected to be reduced overall, the industry is expected to suffer negative top-line growth as a result of CPO being denominated in dollars, according to a report from Mayban Securities.



Whilst the erosion of international competitiveness is an issue that concerns many, the benefits of the managed float will ideally balance or overcome any potential losses in the economy.



Stronger purchasing power is expected to drive consumption, particularly with private consumption stimulating imports and domestic manufacturing. A stronger ringgit will also make foreign-denominated debt cheaper to service whilst lowering the cost of raising funds abroad.



Indeed, pressure for the move had been swelling over recent months as many felt that the undervaluation was constraining these potential gains. Opposition parties were particularly welcoming of the move.



"Certainly it is a correct decision. We had called the unpegging to be done much earlier," said one former minister of finance, Anwar Ibrahim, in an interview with news web site MalaysiaKini. "Naturally, the delay to unpeg may have some repercussions on the economy. Notwithstanding that, the decision by the government is timely and necessary for the economy."



When considering the political implications of the move, some have even seen it as indicative of a new strand of policy for Prime Minister Abdullah Ahmed Badawi.



"Abdullah unpegged himself from Mahathir's policies," said Zainon Ahmad, a political writer quoted by Reuters, who sees a new pattern of policy that removes subsidies and improves the country's competitive edge.



However, exactly how far this is really a detachment from the former prime minister's own policy idea is debateable given that Mahathir was also calling for the currency regime to be re-evaluated in January this year.



"The weak dollar has caused the Malaysian ringgit to depreciate against major currencies," Mahathir said at the time. "I feel the time has come for us to review because we have lost a lot as the value of our currency has fallen."



The economic implications of the move are likely to be one of the major factors in determining the economic success of the upcoming Ninth Malaysia Plan, which will define national development policy for the next four years.



With new monetary policy tools for the government - although trading restrictions on the currency remain in place - many hope the new currency regime will support its plans. However, these policies will have to lead away from subsidies and towards sharper competition if Malaysia is to weather the vagaries of currency movements and keep pace with the global economy.

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