Monday, June 29, 2009

Engineering A Strengthening Of The Ringgit: Strategic Considerations

Let's us go into policy considerations - which must necessarily be strategic in nature.

With nearly RM1 trillion in the money stock, the foreign reserves of RM318 billion is insufficient to hold the ringgit at current rates should half the ringgit stock decides to exit this economy altogether.

If this capital outflow happens, the consequences will be as follows:
1. The central bank can try to support the ringgit at its current equilibrium rate as let the foreign reserves dwindle. This is not a bad thing as the outflow will actually reduce the excess liquidity and hopefully gives the central bank the reason to give some interest rates to the poor deposits which cannot go elsewhere.
2. The central bank can let the forex market go and let the ringgit collapse with the capital outflows. In this way, the central gets the keep as much of the foreign reserves as it can.

The people taking the money out do not actually have to be the original importers. They can be anybody who have ringgit, as they can just buy the foreign currencies from the banks or the central bank.

The money could wish to flow out for several reasons:
1. Zero deposit rate
2. weak currency i.e. currency with a tendency to weaken than to strengthen
3. No investment opportunities
4. No business opportunities
5. Weak stock market - because weak corporate sector
6. Lack of confidence in the system

I have written at some length in the previous posts on some of these issues.

In the recent posts, I am trying to suggest that, in addition, we could try to engineer a strengthening of the ringgit or to let the ringgit strengthen or to show that the ringgit can strengthen on a more steady basis - why - because we have had an external surplus.

The external surplus is an opportunity to let the ringgit strengthen - because it is justified on fundamentals.

Should the foreign reserves fail to accumulate further and the ringgit remains weak (even if in equilibrium), then I think we may be in for a rollercoastal ride.

I have been suggesting that the strategy of have a stronger ringgit may that be all that bad for the economy.

In fact, I argued that it might even do it good. If the trade surplus is due to good global prices, a stronger ringgit merely reduce some of the profits - and of course cut some of the trade surplus. In return, we can have:
1. Reduced liquidity and hence less inflationary pressures
2. Reduced gap between domestic salaries and imported salaries
3. Better retention or attraction of skilled and experienced workers who will then help to make the economy more efficient and productive and hopefully more innovative.

In this way, we hope to be able to do the following:
1. Have positive deposit rates because of the reduced liquidity
2. Currency with a tendency to strengthen rather than to weaken
3. Confidence in the system and hence the keenness to look for business opportunities.

Once the corporate sector improves, there may be hope for the stock market. In the meantime, its all sideway with the nose dipped.

3 comments:

Nehemiah said...

Is having a trade surplus justification for a stronger currency?

Japan, Germany once had huge trade surpluses and yet their currencies were weak. Australia had trade deficits and yet the Aussie was rising.

If we are to shift to a services-oriented economy, then we should not focus on the merchandise trade surplus/deficit.

besides, how does having a higher currency translate into higher doemstic salaries? I think u need to work the link through higher productivity, etc.

The key impediment to productivity and human capital enrichment is the total removal of the NEP. And based on Najib's measures today, he is still half-hearted about it as if hedging his political bets.

Read more at http://asianeconomies.blogspot.com/2009/06/high-income-society-needs-first-class.html

etheorist said...

Nehemiah,

No necessarily. It is a question of policy. It makes the policy implementable.

Decent blog you have.

control valves said...

I believe construction of such projects requires knowledge of engineering and management principles and business procedures, economics, and human behavior.