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Sunday, October 18, 2015

Malaysian Economy and Currency

During the recent depreciation of RM, many were quick to blame the nation's leadership without understanding what actually caused the depreciation.

Many did not, or rather choose not to see that the depreciation was largely caused by external factors and further worsened by some internal factors. 

External Factors

External factors here means that the then upcoming revision of US Federal Reserve Bank's bank borrowing rate.

Let's look into the picture. During Bush Jr's administration, US had ran into a state of recession. Which in turn got worse because of the subprime crisis.

In order to stimulate the economy, the Federal Reserve had lowered the interest rates to make it cheaper for businesses to borrow funds.

Similarly, businesses with excess funds would be tempted to invest their funds rather than to save the funds to further stimulate the economy as banks' interest rate would now be lower.

This of course is a simplistic look into the whole economy. You may argue that these US companies could just invest their excess funds in other countries. And there's issue of corporate tax. But barring all these circumstances, the move worked to create more jobs in the US. This, my friends, is how Keynesian-based economy works. (Obama was noted to have departed away from laissez-faire economy which was strongly expounded by Republicans).

As the economy begins to thrive, it runs the risk of overheating. To prevent this, interest rate needs to be increased. And that was supposed to happen this Sept/Oct.

At the same time, a major portion of US Treasury 30-year bond is expiring. Because of this, many business organisations held onto USD. Thus pushing up USD value. This is why global currency had depreciated against USD, including our RM.

Concurrent to this appreciation of USD are also appreciation of currencies tagged to USD; SGD, HKD are the two examples I can think of. As these currency are tagged to USD, THE currency value had increased. For Hong Kong, they have China to back them up. Thus, the effect may be not as apparent.

Singapore's Case

But Singapore is seriously affected. As USD appreciates, SGD appreciated too. This in turn makes their products and services more expensive. This in turn will result in lower sales, especially for business that sells products that have alternatives. Product switching will occur, and in turn, Singapore's economy is hurt.

Of course, import of goods do get cheaper. But you can't run a business by relying on cheaper raw material alone.

Yesterday's announcement that Singapore had just managed to avoid a technical recession with a 0.1% GDP growth is the evidence of this. What many people missed out was also yesterday's Monetary Authority of Singapore (MAS) announcement that they will ease up their economy with quantitative easing by deliberate weakening of SGD. This move is expected to make Singapore's services and products as cheaper again to their customers.

The above is one of the external factors that had pushed the depreciation of RM. 

Hot Money

Next, let's look into the presence of hot money in Malaysia. Undeniably, the last couple of years Malaysia has had attracted a large amount of hot money.

Hot money refers to fund that are invested by short-term investors. Unlike long-term investors that invest both in infrastructure and value creation, short-term investors are in the market for profit only. The depreciation of RM causes these short-term investors to lose money. Thus, they choose to exit.

Without capital controls (like the one that Tun Mahathir implemented in 1998), these opportunists fled the market on first signs of trouble.

While the loss of these investors resulted in a huge drop of foreign investment in Malaysia, this is actually better for Malaysia. The drop in RM value allows long-term investors to further invest in Malaysia.

Another reason to be happy about the fact that hot money has largely left the country is that US Treasury will be reevaluating if they can increase their interest rate somewhere again in March/April next year. As the market has little or no hot money left by then, there will be less exodus that could be misinterpreted by the market.

Petroleum Price

Another factor which was critical in affecting our currency is petroleum. The drop in petroleum price earlier this year had wiped out values from oil and gas companies worldwide. Depending on who are you listening to, the reasons for the drop in the petroleum price had been attributed to:
  1. US' move to weaken Da'ish (I refused to call them as Islamic State as they are an ideological movement that misuse religion) as Da'ish had tapped into the oil fields of the regions under their control. They had been found selling petroleum into black market. 
  2. US' move to counter the rise of Russia. Russia has been very dependent on petroleum export and is said to have between 30% to 45% of their revenue being generated from petroleum export. 
  3. Saudi Arabia's move to counter US from further investing in shale petroleum. Due to increase of petrol price somewhere in 2013 has made it economically viable to invest into production of shale oil. Shale oil is oil found in the rocky formation which is more difficult to extract. While we do have the technology, the cost is prohibitive. If the petrol price is low, there will be less incentive to invest into the technology. Thus, maintaining Saudi's control over petroleum.
Which of the above scenario is true remains to be seen. It could also be the combination of the above factors. But what we can be sure is the drop in petroleum price has affected our economy.

While I don't have the exact statistics, I believe petroleum export nowadays account less than 20% of our GDP (someone verify this please). But fact remains is Malaysians (and many foreign investors) still believe that our economy is largely dependent on petroleum export. With the drop of petroleum price, do expect this to drop even further.

Internal Factors
I will classify internal factors into 2 factors. Political, and regulatory intervention.

Political Dimension
These lately, I have commented less on political situation of Malaysia. No doubt, this has a large bearing on the economy. I will not go into details for 2 reasons. 

One, Malaysians are too politicised. We failed to see how our political masters are pulling the strings. And when I say political masters, I am referring to both sides.

I will not comment further on the political dimension as I am legally bound not to touch specific topics. Suffice to say, politicisation of Malaysian lives have brought about political instability in our country that has had affected our currency.

Regulatory Intervention
Malaysian government's economic school of thought is more that of hybrid between Keynesian economics and socialist economic. Let's not dwell into the socialist economy as that is not the point of contention.

Recently, a leading newspaper had published an article about Malaysians' growing mistrust of our currency, the RM. The writer had insinuated that the increase of foreign currency deposit accounts is an evidence of growing mistrust of our RM.
The truth for the matter is the writer's assumption is flawed. Rather, the increase is largely due to increasing value of our import and export.

BNM has allowed Malaysians to open foreign currency deposits to attract back these deposits which had been placed in a foreign country.  Another factor that was not factored in is FEAR.

Yes, we have FEAR too. But no, it is not First Encounter Assault Recon (name of a fictional military unit in a game). FEAR means Foreign Exchange Administration Rule. FEAR is implemented by Bank Negara Malaysia to administer the usage of foreign currency by Malaysian entities and individuals.

The rules was introduced with dual-purpose, though not many understands. The first purpose was to ensure that RM will not be abandoned by Malaysian firms and individuals for transactions conducted within Malaysia. Penalty for breaching this can be prosecuted under Section 141 of Financial Services Act 2010, which carries the penalty of RM50 million or 10 years jail, or both.

The second purpose of the rule was the impending reclassification of Malaysia's foreign debt in accordance to World Bank's definition. Under the new rule which was implemented in 2012, loans issued by private entities are now classified as part of Malaysia's financial obligation. That being said, debt instruments held by foreign entities that are issued by Malaysian entities, be it by Govt, private sectors, or individuals are now reclassified as Malaysia's financial obligation to foreign entities.

If you recall, the implementation of World Bank's definition in 2012 had resulted in a huge jump in Malaysian debt. This was largely politicized to show as if the Govt was inept in handling financial matters. Fact to the matter is to the contrary.

It is not a surprise even many bankers were not able to see how the implementation of FEAR is actually related to the above two reasons. The rules are rather difficult to read, and on surface, the rules seems more to govern the usage of foreign currency by Malaysians and usage of Ringgit by non-Malaysians.

For a better picture, you may read the rules here.…

Would it be better for Malaysia to implement 1998 measure of currency pegging and capital control to stabilize RM?
This is a hard question. Many Malaysians hold onto the fact that in 1998, the currency pegging and capital control has had worked.

But let me quote William Cohen, who was US Defence Secretary from 1997 to 2001. He was famously quoted saying that a firm that continues to employ a previously successful strategy eventually and inevitably falls victim to a competitor.

The strategy had worked before. However, for the strategy to work again, the conditions that had made the strategy work must also be present in the current situation. The strategic equation must be similar.
To understand better, I suggest reading of McKinsey's 7-S model to be read in concurrent with strategic equation. In this model, there are 7 values that would affect the strategic equation of a firm, in our case, Malaysia. These are:
  1. Strategy;
  2. Skills;
  3. Structure;
  4. Style;
  5. System;
  6. Staff;
  7. Shared values.
Since the time of Tun Mahathir, variety of changes had occurred in nearly every values. These changes have resulted in a shift of our strategic equation, and making the strategy that was once implemented by Tun Mahathir no longer fit for Malaysia. It is no longer a strategic fit for Malaysia.

What would happen if we still go ahead to implement capital control and currency pegging?
It is not the question that we do not have sufficient reserve to conduct currency pegging. Our current international reserves is sufficient to finance at least 9 months of sustained imports, which is far above international standards of 3 months.

However, the issue is more to that of investors' confidence. Investors do not like to have their access to their investments to be blocked. They want to be able to withdraw their funds whenever they want, whenever they need it. And loss due to foreign currency exposure is just part of the equation.

Put yourself in the shoes of the investors. Assume the bank where you save your money is Malaysia. Would you be happy if the bank tells you that you can only withdraw your fund in 2 years from now? Likely, you would be looking for another bank which do not have such rules.

I guess that should be all for my rambling for now. My ideas are running dry and the coffee I had in the evening is taking its toll.

Go Read Paul Krugman

One last request. What I had just shared, don't take it as gospel truth. Don't just take my word for it. Go verify it. Read it from the actual source. Compare it with real economists. Economists like Paul Krugman. Not politician-becoming-economist-wannabe. We have more than enough of those.

The article was first published in 3 series of article on my Facebook wall.

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