Earth Trends by Martin Khor

Monday 23 April 2001

TO RE-PEG THE RINGGIT OR NOT?

BLURB:   Should the system of pegging the ringgit to the dollar at a fixed rate continue, and if so should it remain at 3.80 or move lower to 4.00 or even 4.20?  Earth Trends examines the issues behind the recent debate on the currency system and the currency rate. 

----------------------

Should the ringgit be re-pegged at a lower rate to the US dollar?

This question is still being debated, a few weeks after it appeared.

The first issue is the system of "pegging" itself.

So far, it has worked well.  When the fixed exchange rate system was introduced in September 1998, there was skepticism  whether it would work or could continue.

This was natural, since the IMF-backed thinking was that following the Asian crisis of 1997, currencies should be left to float. 

The renowned American economist Paul Krugman bucked the orthodoxy and advocated a fixed exchange rate system in Fortune magazine just a week before Malaysia introduced its policy. But even he was doubtful whether it would work in Malaysia's case.

After more than two years of the system, disaster has not struck.  The advantages of the "pegging" is that speculators are unable to influence or manipulate the currency level.

The financial authorities are able to bring down the interest rate or boost public spending through deficit financing, without being constrained by how the currency markets will react.  

The ability to regain a large measure of national control over financial and macro-economic policy, which has been essential to counter recession, has been the major benefit of the currency peg.

Another benefit is that business people are able to import and export products at prices fixed either in the US dollar or the ringgit, with certainty as to how much these prices will be worth in terms of the other currency.

Without this predictability, it had been very difficult to conduct trade. For example, a trading firm may contract to import pens for a US dollar a pen, when the dollar is equivalent to MR 3.00, and to pay on delivery.  

But six weeks later when the pens arrive, the exchange rate may have changed to 5 ringgit to a dollar.  The trader would have to foot out much more in ringgit to pay for his consignment of pens, and at the same time he would find it much harder to sell the pens locally as their price in ringgit would have shot up.

Since most of Malaysia's trade is conducted in US dollars, the fixing of the ringgit to the dollar brought much more predictability in avoiding the kind of problem above.

In Indonesia, which has a mainly floating currency system (which the IMF has insisted on as a condition for continuing their loans), there is a lot of currency instability, with the local currency moving from 8,000 rupiah to the dollar to 11,000 rupiah to the dollar in a few months.  It is very hard to predict what the level will be a week or two weeks hence.

Given the advantages, and so far no major disadvantages, there is a strong case to maintain the system of pegging.

But should there be a re-pegging?  Many analysts believe the ringgit is "over-valued" as other regional currencies like the rupiah, the baht and the yen have depreciated against the dollar since the start of the year, whilst the ringgit has maintained its level with the dollar.

The fear is that Malaysian exports would now be less competitive than those of the neighbours.  Some analysts advocate a re-pegging from the current RM 3.80 to RM 4.00 or RM4.20 to the dollar.

However there are disadvantages of a re-pegging exercise.  If the ringgit is re-pegged too often, then the unpredictability factor would return, and there would be speculation as to whether there will be another re-pegging in future.  Thus, re-pegging should be done, if at all, only as a last resort when the situation really warrants it.

Further, the global currency trade is very volatile and is not even properly based on "fundamentals" like the relative strengths of the various economies. 

It is very hard to accurately predict what the relative exchange rates between the major currencies will be like even in the near future, and thus whether the ringgit's present level is "too high" or "too low."

Just a few months ago, the predominant thinking among economists and analysts was that the ringgit was under-valued and there was "market talk" that the government may re-value the exchange rate to RM3.20 to the dollar.

At present, the "talk" is that the ringgit's value should be around RM4.20.

This is based on the fact that the US dollar has remained strong or even strengthened against the yen and euro, even though there was a strong belief some weeks back that the dollar would weaken due to the weakening of its stock market indices and of its economy.

It is unclear whether in the next few weeks the dollar will maintain its position, or strengthen further, or decline.

Would a devaluation of the ringgit help the Malaysian economy?  There are plus and minus factors. 

Exporters would gain, as they may receive more revenue in ringgit terms.

Thus, oil revenues would go up, and the incomes of rubber and oil palm smallholders may increase.

However, it is unlikely that a ringgit devaluation would have such a major effect in increasing the demand and volume of exports overall.  This is because the demand for many of our major export items (for example, petroleum, palm oil, rubber) are not dependent on the ringgit prices.  The demand for commodities depends more on the state of economic growth in the major countries.

In the case of manufacturing, the reported decline in demand for computer parts is caused mainly by the economic slowdown in the US and Japan.

Lowering the ringgit's level would not have any significant effect on the demand for computers and computer parts.

It is true that if the ringgit is much over-valued and over a long period, foreign investors may perceive this to contribute to this being a "higher cost country" in which to operate.

However if the over-valuation is not very significant, and if there are other factors that attract foreign investors to the country, then that would not be a serious problem.

There are, on the other hand, some disadvantages arising from a devaluation.  There will be pressures for higher inflation.  Consumers will find that imported consumer goods such as food items will cost more. 

Producers will also find their cost of production rising due to the increased cost of imported inputs and parts. A large portion of the intermediate goods that are used for production in this country are imported.  The producers will pass on their increased cost and will jack up the prices of their final products, adding to consumer-price inflation.

A devaluation would also cause the level of foreign debt to go up. Whilst the level of the debt will remain the same when counted in the foreign currencies in which they were contracted, it would increase in terms of ringgit.

At the end of 2000, the country's external debt level was US$ 41.3 billion, or RM 157 billion at the exchange rate of RM 3.80 to the dollar.  If the ringgit is devalued to 4.20, the external debt would jump to RM 173 billion.  And if the ringgit were devalued by 20 percent, it would rise further to RM 188 billion.  

A devaluation would thus make it more difficult for both the public and private sectors to service their foreign loans, and the steeper the depreciation, the more serious the difficulty.  Companies with foreign-exchange loans would be in trouble, and a larger share of the government's expenses would have to be allocated to servicing its foreign debt.

Having a strong local currency assists in paying off the foreign debt easier whilst a devaluation works in the opposite direction.

Thus there are pros and cons to devaluing the ringgit,  just as there are advantages and disadvantages to retaining a fixed exchange rate system.

The fixed-rate system has helped the economy so far, with no significant adverse side effects, and should be retained. As for re-pegging, it may be wiser to let the present rate remain, for as long as possible.