In the debate over whether Malaysia chose the right monetary regime for itself – which became public when a former two-time Prime Minister became involved – we saw in Part 1 of this article (The Edge, June 27) How a free float regime is simply not applicable to a small open economy like Malaysia’s. In this final section, we examine the country’s experience with currency pegs (de facto and de jure) and managed floats.
Prior to 1996, Malaysia was well known to defend the ringgit at the RM/USD 2.50 level (this would be tantamount to “pegging” a currency, ie de facto pegging it). Then the Asian financial crisis happened and the ringgit rate fell from 2.52 RM/USD on January 2, 1997 to a low of 4.63 RM/USD on January 9, 1998, before the peg of 3 .80 RM/USD is fixed on September 2, 1998, as well as strict capital controls.
What has happened in terms of the cost to the country’s foreign exchange reserves is instructive: foreign exchange reserves started at $27.89 billion in 1996, according to World Bank figures, and fell to $21.47 billion in 1997 before the introduction of indexing, and recovered at
26.24 billion dollars in 1998. During the parity years, foreign exchange reserves strengthened further to reach 70.46 billion dollars at the end of 2005. In short, defending a fixed exchange rate proved expensive, especially in times of crisis, but the peg regime and the capital controls that went with it saw foreign exchange reserves triple.
Was peg the remedy for currency problems? Not quite – a few bad things happened. The first was that Malaysia had lost its monetary independence, which meant that Bank Negara Malaysia had to follow whatever the US Federal Reserve did or face another financial crisis.
The other problem that appeared was very interesting and totally unforeseen (see graphs 1 and 2).
It’s true. Due to the peg, Malaysia’s economic cycle, which was contrary to that of the United States, changed to follow it. Even 12 years after the ankle was removed in 2005, the same dance continues.
Do we have monetary independence these days?
Did the currency peg save Malaysia? Or was it capital controls? Or a combination? The jury is still out on that one, but for financial crises, capital controls seem to have worked their way into the list of legitimate defenses a country can employ.
What about managed float plans?
A managed float regime is one where exchange rates are allowed to fluctuate daily but whose movements are influenced by central banks to keep them stable. According to the International Monetary Fund, in 2014 about 82 countries, or 43% of all countries, use a managed float, making it the most popular in the world.
Bank Negara announced the adoption of a managed float regime for the ringgit in 2005, replacing the peg. This stands in stark contrast to the widely held belief that he allowed the ringgit to float freely and only intervenes to ensure an orderly market.
How good was Malaysia’s experience in float management? The hyper-volatility of the ringgit against the USD after the peg is concerning, up to 32.7% according to V-Lab calculations.
To make matters worse, the ringgit is a non-internationalized currency, which means speculative players cannot get it and play with it overseas. Imagine if they could.
What is the source of all this volatility? It’s a non-internationalized currency so that shouldn’t happen. Is it because the depth of the ringgit market is so thin that a big trade influences the market? If so, market deepening measures should be taken.
The gold standard for managed float regimes is Singapore. Its currency appreciation is enviable.
How is Singapore doing? According to Paul Yip in his book on the subject, four methods are used:
1. Singapore has chosen to manage its currency rather than manage its interest rates as its main monetary policy tool, given the amount the country has to import for its daily needs;
2. Huge foreign exchange reserves. Singapore’s reserves at the end of 2021 were 1.05 times its gross domestic product (Malaysia’s was 0.33 times over the same period, UK’s 0.01 times);
3. Close supervision of its banking system. Moral suasion and licensing of banks and/or approval of their boards/CEOs is done very seriously with national interests at heart; and
4. Manage liquidity levels in the economy through the Central Provident Fund (CPF) and the Monetary Authority of Singapore (MAS) open market operations. To put it simply, Singapore’s fiscal surpluses and contributions to the CPF “take” around 3% to 5% of its broad money supply, M3. This would normally cause a recession, but MAS replenishes liquidity by selling SGD and buying USD in the forex market. It is then a method of controlling liquidity, and the rarer a currency, the higher its value in general. It also means that he can weaken the currency as he wishes.
Why did Singapore choose to target exchange rates as an instrument of monetary policy? Based on his own research – and supported separately by the Mundell-Fleming model for small open economies – interest rate targeting would drive massive capital flows, impacting exchange rates, output (i.e. i.e. GDP), exports and inflation. Singapore seems to have chosen well.
Interestingly, research from the US National Bureau of Economic Research shows that the choice of exchange rate regime has no bearing on income distribution. Therefore, income equality programs, for example, should not be affected.
So, ultimately, how do the three different diets compare statistically in practice? Gosh, Gulde and Wolf in their 2002 book, Exchange Rate Regimes, noted these results:
1. Nominal exchange rate volatility is highest for free-float regimes compared to under-pegged or managed-float regimes;
2. Average inflation is highest in free float regimes, closely followed by managed float regimes and quite far below, indexed regimes; and
3. From a GDP growth perspective, managed float regimes perform best, with indexation and free float regimes roughly equal in the lower tiers.
An interesting finding was that under indexed regimes, monetary growth was tiny and fairly stable, leading to GDP growth that was fairly stable. The authors called it the “monetary discipline effect”.
The conclusion here is that Malaysia has chosen well to adopt the managed float regime given that the country is still a developing nation. What matters now is its implementation, as the volatility charts show. It’s time to tighten the nuts and bolts. More importantly, the expectations of and for national economic actors must be managed in such a way as to minimize surprises and adverse effects.
Huzaime Hamid is the Chief Executive Officer of Ingenium Advisors Sdn Bhd, the Malaysian financial macroeconomics advisory firm