Pressure grows on Malaysia peg
Bloomberg News
April 14, 2005
Stephanie Phang  

Nor Mohamed Yakcop recalls being summoned to fly from Kuala Lumpur to Buenos Aires by Prime Minister Mahathir bin Mohamad of Malaysia in September 1997. The ringgit was sinking amid the Asian financial crisis and Mahathir, on a state tour of South America, wanted Nor to explain why.
 
"I told him, 'Sir, how much time do you have?"' says Nor, a former central bank adviser. Mahathir, after listening for two hours, asked Nor to write up the briefing and see him in 12 hours, says Nor. "I didn't sleep for three days."
 
A plan hatched by the pair after that meeting fixed the ringgit at 3.8 to the U.S. dollar the next year, halting speculator bets that had helped push it 31 percent lower against the dollar over 12 months. Malaysia also imposed controls to curb ringgit trading.
 
While the International Monetary Fund called the policy "a step back," the country's economy since 1998 has grown by 5.2 percent on average each year, a pace exceeded only by China and South Korea in East Asia.
 
Now Nor, the country's No. 2 finance minister, may need to take charge of dismantling the peg. The speculators that Malaysia tried to thwart are returning as the United States pressures China to let the yuan appreciate and the dollar falls worldwide. They are betting that the value of Malaysian assets will rise with the currency once the peg is removed.
 
Malaysia's economy expanded 7.1 percent last year, the fastest pace in four years. Inflation is at a five-year high, while lending rates are at their lowest level since 1990.
 
"The economic fundamentals clearly suggest that Malaysia's currency is ready to move," says Stephen Green, a senior economist in Shanghai at Standard Chartered.
 
Malaysia became the only country to outpace China last year in bolstering foreign-exchange reserves as a percentage of gross domestic product as new investment flowed in, Green says.
 
"The hot money has increased in the last few months," says Philippe Sachs, a country analyst at Standard & Poor's in Singapore. Malaysia should scrap the peg now before pressure builds further, he says. "It's probably best to make a move before your hand is forced."
 
The central bank, Bank Negara, will have trouble controlling the flow of capital coming in and managing inflation at the same time, Ong Sin Beng, an economist at J.P. Morgan Chase in Singapore, said in a report last week.
 
Investors may raise their stakes in Malaysia even more if the bank increases interest rates in a bid to damp rising prices, Ong said.
 
Inflation accelerated to 2.4 percent in January and February from an average of 1.4 percent in 2004.
 
Phoon Chiong Tuck, a fund manager at Deutsche Bank's asset-management unit in Singapore, says he has bought government bonds on expectations that the ringgit will be allowed to appreciate in the next six months to a year. He probably will raise his bets if China moves first to unchain the yuan's peg of about 8.3 to the dollar, he says.
 
Malaysia's peg provides stability, says Joseph Stiglitz, a former World Bank chief economist and winner of the 2001 Nobel Prize for economics, who supported Mahathir's plan from its inception. Flexible exchange rates can hurt exports and slow growth, he says.
 
"The way Malaysia managed its controls was brilliant because they were able to stop the speculative flows without impeding foreign direct investment," says Stiglitz, now an economics professor at Columbia University in New York.
 
In addition to pegging the ringgit, Malaysia imposed controls that trapped $18 billion of global funds in the country. It also restricted currency transfers between offshore accounts and limited how much Malaysians took overseas.
 
The result was a halt in capital flight, which had wiped 67 percent from the Kuala Lumpur Composite index in the 12 months through Sept. 1, 1998.
 
Starting this month, overseas and local investors can enter into foreign-currency forward contracts to reduce exchange-rate risks, the Bank Negara governor, Zeti Akhtar Aziz, said on March 23. She also eased restrictions on Malaysian exporters, fund managers and individuals investing abroad.
 
"The key message the administration wants to send to the market is that they are removing the controls they put in 1998," says Irene Cheung, head of Asian sovereign and currency strategy in Singapore at ABN AMRO Holding. "The ringgit peg is the last piece to go."
 
Even so, Zeti also said March 23 that the peg would stay. Malaysia's returns on its reserves are covering borrowing costs, she said on March 1. The bank can manage the inflows and will not need to raise interest rates, she said.

Malaysia was one of the few emerging-market countries in Asia that did not have to seek the International Monetary Fund's help during the crisis. After its initial criticism of Mahathir's plan, the monetary fund recanted. Managing Director Michel Camdessus endorsed the idea of capital controls in May 1999.
 
"Consensus seems to be emerging that controls may have a place when there's risk of a crisis, but only as a breathing space while other fundamental measures can take effect," he said.
 
An IMF report that year said that the capital controls had helped the nation and that the pegged exchange rate was "more appropriate" than a flexible rate.

Economists estimate that the ringgit is currently undervalued by 5 percent to 7 percent, which is not enough to warrant loosening the peg, Nor says.
 
The dollar will remain Malaysia's preferred anchor for the ringgit, Nor says. "In a pegged regime, the changes should be far apart and infrequent," he says. "There's a principle involved."

Copyright © 2006 the International Herald Tribune