Thursday, June 25, 2009

Engineering A Strengthening Of The Ringgit: Theoretical Underpinnings I

The theory is simple.

Consider a surplus on the external balance - where we are today.

Floating Exchange Rate Regime. There is an excess of demand for ringgit (from exports) over that of foreign currencies (for imports). The ringgit strengthens against foreign currencies. There is no change in the holdings of the foreign reserves of the central bank because the central bank is not involved in the forex market. It is truly free.

Fixed Exchange Rate Regime. The central bank does not want the exchange rate to change. The central bank issues more ringgit to buy the excess foreign currencies from the external surplus. The ringgit rate does not change. Foreign reserve holdings of the central bank increases. The quantity of ringgit in the economy increases.

Conclusion. To engineer a strengthening of the ringgit, just let the ringgit float (when there is an external surplus). It's a bit harder in a deficit situation, admittedly.


hishamh said...

It's not quite that simple. The trade surplus is but one source of ringgit demand and supply. The financial account is bigger and far more volatile.

etheorist said...

Theoretically still correct.

control valves said...

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

de minimis said...

The key point is that a floating exchange rate is difficult in a situation where fiscal budget is in deficit.

walla said...

hishamh said...

de minimis,

that only applies if the deficit is financed externally, which is not really the case here. Where foreigners are buying up Malaysian govt debt, they're doing it locally, which is Ringgit positive not negative.

walla, nice article.

I've been looking at the same numbers in the past couple of weeks. The aggregate numbers of unidentified capital outflows are massive: 2005:RM15b, 2006:RM14b, 2007:RM17b, 2008:RM25b. That's on top of annual seasonal portfolio outflows averaging over RM20b on the lifting of capital controls in 2005. Since the stock market didn't crash, nor yields on debt go up, I'm thinking this is primarily (save for 2008) repatriation of capital gains, as well as a result of the recent fashion for Malaysians to invest in foreign investment funds. BNM and SC have liberalised foreign investment rules for domestic funds three years running.

The flight to safety in 2H 2008 resulted in an additional RM138b in portfolio flows leaving the country. On that score, I'm frankly amazed the Ringgit held up at all.

oyster cove said...

The Ringgit is moving in the same basket with Thai Baht and Taiwanese Dollar.

hishamh said...

If it is, then it's a pretty strange basket. Volatility measurements of cross-rates since the float in July 2005 says otherwise.

THB:5.4%, TWD:4.2%. USD by comparison is 5.3%. The lowest measurement is against the SGD at 2.4% and EUR at 3.5%. Highest is KRW:14.9%.

THB:5.7%, TWD:3.9%, USD:5.9%, SGD: 2.8%, EUR: 4.4%. Highest is Vietnam Dong:16.2%.

I would expect a soft peg to move within a 2.5% range, and at most within 5% (BNM used 4.5% from 1975-1986). If MYR is moving in a currency basket with anyone, it's SGD, but even that is iffy.

Since Singapore uses the exchange rate as its primary monetary policy instrument, while Malaysia uses interest rates, I suspect the close correlation between MYR and SGD to be more a factor of MYR being in the SGD target currency basket, not the other way around.