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Thursday, 15 December 2016

Why Malaysia does not want to peg the Ringgit like it did in 1998

Malaysia was one of the only countries to impose capital controls during the 1997-98 Asian financial crisis by fixing the exchange rate and requiring the currency be held at least a year after the sale of Malaysian securities or assets in the country. It was widely viewed as a major contributing factor to its subsequent economic recovery.

At that time, Malaysia suddenly pegged the ringgit but it did not use the traditional route of a peg by using our Foreign Reserves to buy or sell foreign exchange to support the Ringgit at that level.  This was because our FOREX levels were very low then since Mahathir gambled and lost RM30 billion of our reserves by speculating in the FOREX markets.

So, what Malaysia did was to impose capital controls - meaning controlling the inflows and outflows of Ringgit and making it internationally non-tradeable. This essentially means it is easy for foreigners to bring money into Malaysia but once the money is in, it is very hard to bring back out.

However, although it had helped stablize our economy for the short-term then, the long-term damage of capital controls was immense and long-lasting - after all, who would want to invest in your country but once the money is in, I can'; bring it back out?

On Nov 18 2016, Bank Negara Malaysia (BNM) assistant governor Adnan Zaylani Mohamad Zahid said it has no intention of imposing capital controls and is merely clamping down hard on speculative activities on the ringgit,
Adnan assures that Malaysia remains an open economy and conditions do not warrant measures as drastic as capital controls, dismissing its one week old action against NDF trades, as merely tighter enforcement of existing rules.

"The situation and conditions are vastly different [from 1998 Asian financial crisis]. Now we have a very open economy. Investors come and go in our market... Even if we contemplate [capital controls], it is far too damaging and too risky for the economy... I just can't see that. So definitely no capital controls. There is no discussion of moving in that direction, but what we're trying to do is have a targeted measure to try and contain the offshore NDF market," he said.

"The ringgit being non-internationalised is one protection that we have and that would already prevent the kind of destabilising forex market that we had in 1998," he added, assuring there remains ample liquidity in the onshore market.
In fact, one of the reasons why the Ringgit spiked so much and so steeply after it passed RM3.80 was because foreign investors are afraid that we will take the easy way out and re-impose capital controls again.

Many investors would be suspicious of us since we had a track-record of doing this - hence they would rather sell their investments in Malaysia first and then bring it back out - which weakens the Ringgit - just in case we impose capital controls again and their money is stuck.

Local investors and wealthy individuals will also do the same and will quickly transfer their money overseas too. Who wants their money to be stuck?

That is why you see our country's leaders and BNM keep on making numerous repeated denials ever so often to deny we would implement capital controls.

This suspicion by investors that we will implement capital controls again is one of the long-term effect of what Mahathir did and it is still hurting us today.

If you look at the foreign investment inflows into Malaysia chart, you will see that foreign inflows suddenly spiked after 2005. Why is that?

That was because in May 2006, Pak Lah unpegged the Ringgit and relaxed the capital controls on our currency.

And because investments were weak - especially portfolio investments, Mahathir had to run high budget deficit rates to pump-prime the economy using government money to replace private and foreidn investments to keep Malaysia growing.

You can see that the budget deficit was above 5% of GDP, which is considered high for a sustained period of time until Mahathir retired in 2003.

Despite this, the economy also went into a serious slow-down in 2001 and was lack-luster for much of this period.

Malaysia would not have been able to survive if we continue to run high budget deficits of above 5% for a sustained period of time - as it would mean our govt debt spiking.

As a comparison, here is the budget deficit since 2008 after Najib took over.

As you can see, other than having a big deficit in 2009 and 2010 to save us from the Great Global Recession,  Najib has been able to maintain decent GDP growth since then while still reducing the budget deficit. In 2016, the budget deficit would be 3.1% and for 2017, it is budgeted for a deficit of 3%.

Let;s have a look at the effects on the government debt based on the information in the table given by the Economic Planning Unit.

It is clear from the graph above that such sustained big increases of government debt during the Mahathir last 7 years after he pegged the currency and imposed capital controls is a certain path to disaster.

Given the large deficits, poor growth and sustained high percentage growth in government debt during that period, we can easily say that those 7 years were "lost years" for Malaysia. Mahathir at that time probably did not understand or didn't care for the long-term damage at that time as he would be retiring anyway.

It must be noted that countries such as Korea, Thailand and Indonesia were affected worse than Malaysia but did not impose capital controls or pegged their currencies then. Only Malaysia did it.

These countries also subsequently recovered at the same time as Malaysia. And because confidence is intact, investment flows to those countries accelerated leaving Malaysia behind.

This is why Najib continues to resist pegging the currency by imposing capital controls and why BNM said the previous capital controls were "far too damaging" and risky to our economy.

After all, our govt knows that it is the USD that is at a 14 year strongest against most currencies and that our largest trading partner's currency, China, is at an 8 year low too.

Thus, pegging our currency at a strong position while our largest customers currencies and competing economies are weak is a certain recipe for disaster for Malaysia. And of course there is the long-term damage

The opposition leaders led by Mahathir keep attacking Najib's government using the Ringgit weakness as "proof" that Malaysia is going bankrupt.

But the easiest thing for Najib to do is to follow exactly what Mahathir did and re-impose capital controls and peg the ringgit. Problem solved.

Cannot be that Mahathir can do it but Najib cannot, right?

However, Najib and the current government knows how damaging for our long-term and he does not choose the easy cowardly way out - like what Mahathir did.


  1. I believed that capital controls were the only way to go back then rather than seeing our country go bankrap. But we kept it for far too long that, any iota of investor confidence in MY remaining were shot to pieces.

    If we had lifted it in 2000, investors might have come pouring in much earlier. I opined that the reason why it was not so, was cuz the economic institutions were still weak to the same attack as 97/98 and Tun lacked the balls to reform the institutions, being beholden to the Chinese towkays that had rescued him from Anwar back in 99. Them towkays would be badly affected by reforms (as they are now. Thats why they were so Anti-Najib).

  2. I believe there must be a solution to this. Why Malaysia/ASEAN do not joint BRICKS. Why are we so dependant on USD. Why Islamic countries do not trade in gold dinar. When less trading done in USD, it will automaticaly depreciate.

    1. You think The US will let you off the hook easily to weaken USD? Trading in gold dinar will trigger the ww3 in arab countries