Analysis: No pressure to unpeg Malay currency

SINGAPORE, Nov. 23 (UPI) -- Ever since the Malaysian ringgit peg to the U.S. dollar was introduced in September 1998, speculation on when it would go has been rife. After 6 long years, conditions appear to be ripe for such a shift, especially as China is readying to let go of its own currency peg. Recent large capital inflows into Malaysia are pointing to how investors are placing their bet, but they are likely to be disappointed by a government, that again and again has stressed the peg has served the country well.

In recent weeks, the Malaysian stock market has been rising on growing expectations the government will soon abandon the peg and the Kuala Lumpur Composite Index (KLCI) is now 16.4 percent higher than its low point of 770 points in May.

Foreign exchange reserves have also surged $1.4 billion to $60.9 billion in the first two weeks of November, the second strongest fortnightly increase in eight months. These reserves are currently sufficient to finance 7.5 months of retained imports and are 5.6 times of short-term external debt.

Economists have been getting out their crystal balls and their readings can vary a lot.

In one camp, some believe that there remain little immediate pressures for Bank Negara to abandon the peg. The currency is not seriously misaligned, the economy has scope for more exchange rate competitiveness to boost exports without driving macro imbalances and the current currency arrangement allows the authorities to maintain low interest rates at the cost of greater volatility in foreign exchange reserves, they argue.

"While prudence will dictate a ringgit review following a yuan move, Malaysia will likely retain a wait-and-see approach to first assess the macroeconomic implications of the move. We see risks (if any) building for a ringgit move only toward end-2005," JP Morgan said in a research note.

In the other camp, economists believe a yuan revaluation or band-widening increase the probably of a ringgit revaluation, pointing that the Malaysian currency is fast approaching the critical euro (1.40) and yen (100) thresholds, at which Second Finance Minister Tan Sri Nor Muhamed Yakcop warned a serious review of the peg may be required.

"We think there is a high probability over the next 6 months that Malaysia will abandon the ringgit peg regime, in favor of a managed exchange rate regime based on a weighted basket of currencies," said DBS economist Wong Chee Seng.

The general belief is that the subsequent avalanche effect of yuan revaluation on regional currencies would pressure the ringgit peg.

Asian governments appear now more tolerant of stronger currencies to contain oil-induced inflationary pressures. However, the Malaysian government is giving conflicting signals to the market on their plans.

On Monday, Prime Minister Abdullah Badawi tried to backtrack from his earlier comments linking a change in the ringgit peg to a change in the Chinese exchange rate regime, saying changes in Malaysia would be independent of changes in China. His earlier remark, saying the government was following developments in China closely, with a keen eye in particular, on moves towards the yuan, had attracted significant hot money inflows, which have driven interest rates on government bills and bonds sharply lower and the stock market sharply higher

"This statement seems designed to decouple the two decisions, which previous official statements over the last year or so had suggested were linked," noted Michael Spencer, head of Asian research at Deutsche Bank.

"He also said that the RMB peg helped provide stability to the Chinese economy - by inference, we can assume that he thinks the same about the ringgit," Spencer added.

Actually, the two regimes cannot be linked easily because Malaysia is far more dependent on exports than China. The renewed accumulation of reserves suggests that the MYR will be under pressure to appreciate at a time that exports may well be slowing, notes Sanjee Sanyal, Deutsche Bank economist.

"Indeed, the pressure is likely to be exacerbated by speculative flows during the yuan change. This would not be an easy environment for an export dependent economy to change its currency regime. In short, it is far from certain that the Malaysian would move just because the yuan peg has been changed," Snyal adds.

Tim Condon, economist at ING Financial Markets, believes the authorities' commitment to the ringgit peg is lower now that former prime minister Mahathir Mohamed has stepped down. "Investors do not like it, the rating agencies have urged abandoning it and we expect the ringgit peg's days will be numbered once China changes its currency policy," Condon said.

Malaysia has started to see a modest increase in inflation, following cuts in fuel subsidies. The stronger than expected CPI of 2.1 percent in Oct (after 1.6 percent in Sep) suggests that oil prices and the weak ringgit are starting to have a material impact on inflation pressures. "This raises the probability that Malaysia will abandon the ringgit peg regime in the near future, possibly within the next 6 months," argued Wong.

But other economists believe inflationary pressures are still within acceptable limits, with the underlying inflation rate at still around 1 percent year on year. "Therefore, we do not think that the authorities will be particularly concerned by this increase in inflation. This also means that they are under no immediate pressure to change the exchange rate regime," said Sanyal.