Sunday May 29, 2005

Malaysia in Tight Spot on Currency Revamp

Associated Press Writer

Speculators betting on a revaluation of the Malaysian ringgit pegged to the dollar may be in for a long wait amid mixed signals in recent weeks over the seven-year-old fixed exchange rate policy.
Most analysts agree that the ringgit, fixed at 3.80 to the dollar since 1998 after the Asian financial crisis, is undervalued by around 10 percent and should be allowed to strengthen.
But the question is whether Prime Minister Abdullah Ahmad Badawi -- only two years into office -- will risk upsetting the currency regime in what could prove an unpopular move.
"The general sense we get is that Malaysia is seriously considering doing away with the peg regime but is holding back due to political inertia," said Ramya Ramachandran, economist with Singapore-based IDEAglobal. "We still assign a 60 percent chance of a de-peg this year."
A strengthened ringgit would make exports -- the mainstay of the country's economy -- more expensive and expose businesses for at least the short term to volatile currency, something that the government is reluctant to allow, especially in an uncertain economic climate.
Gross domestic product growth this year is expected to ease to 5-6 percent, down sharply from 7.1 percent in 2004. Also, the government is tightening its belt on public spending to cut its budget deficit.
Economists say speculation since late last year about currency reform has led to an influx of foreign investment in ringgit-denominated assets as investors flock to the market hoping for a quick profit.
Credit Suisse First Boston's senior regional economist Sailesh Jha said portfolio flows as a percentage of GDP have surged to 8 percent last year from 2.8 percent in 2003.
But inflationary pressures were still benign and the central bank has adequate reserves to cope with any capital flight in case of a ringgit re-peg.
Some economists believed Malaysia's decision on the ringgit is tied to China's foreign exchange policy. If the yuan is loosened, Malaysia is expected to follow suit to ensure it remains competitive in the export markets for electrical and electronic products.
However, CSFB said in a recent report after meeting senior Malaysian officials and bankers that it believed Malaysia would stick to the peg this year even if China allowed its yuan to appreciate by 3 percent to 5 percent by mid-2005.
The central bank last week reiterated the ringgit was still fairly valued and ruled out any moves to free-float the currency because it could lead to volatility. However, it left open the possibility for a "better exchange mechanism."
Abdullah, who is also finance minister, has indicated the government was prepared to take action if necessary when China moves.
"We have many options already that we have thought of," he said last week. "When the time comes, we can take the decision," he said, adding that the government wanted the ringgit "to be stable, and to be a strong currency."
Abdullah took over in October 2003 from Mahathir Mohamad, who imposed the peg as part of capital controls in September 1998 to protect the economy during the Asian financial crisis. But even Mahathir has also joined in calls for a ringgit revaluation.
The Malaysian Institute of Economic Research said the country's large trade and current account surpluses suggested a serious exchange rate misalignment, and warned the peg was already hurting the economy as seen in large speculative inflows in the money market, a soaring import bill and rising inflation.
It noted some foreign investors were delaying investments pending anticipated exchange rate changes. It warned that competitiveness based on a cheap currency cannot be sustained, and urged the government to pre-empt China to avoid bigger losses.
"If China were to do it first, there will be massive capital inflows into Malaysia ... China, with its huge domestic market to fall back on, can afford to make mistake, but not Malaysia with a small domestic economy," it said.
IDEAglobal's Ramachandran said the key challenge was to ensure that changes were gradual and systematic to deter speculation but this could be done by letting the ringgit trade within a narrow band initially, and widening the band every month or quarter before benchmarking it to a basket of currencies.

Parent site: "Focus on Malaysia"