Wednesday, February 09, 2005

A letter to the Minister of Finance; Unpegging, when and how.

We loath those people who profits from our predicaments; the currency speculators. After all, the reason that we pegged the ringgit in the first place was to frustrate the currency speculators and give the ringgit its fair value. We don’t want to give away the profits of our hard work of the past 7 years, the savings and reserves that we salted away to the currency speculators by unpegging and appreciating the ringgit. The currency speculators made at least a hundred billion ringgit bet ( the difference between our total current account surplus for the past 7 years or so and our total foreign reserves) that the ringgit will be unpegged one day and they stand to make a windfall.
How come, you might ask? For every dollar, euro or yen of foreign currency that flows in, whether as foreign direct investment, export earnings or mere speculative hot money to park in a local bank to earn interest, Bank Negara has to print ringgit to an equivalent amount and lock away that foreign currency in a vault as reserve – because one day the foreigner will eventually want to sell back his/her ringgit for dollar, euro or yen.
This is the problem with pegged currency, theoretically, for every ringgit in circulation there must be an equivalent amount of reserve. Sounds like my late grandmother salting away her money under the pillow – even though it is safe and secure, it doesn’t earn interest or income, no benefit to anyone and worse has a contracting effect on the rest of the world economy. In reality, most central banks would put their reserves in gold, and other currencies – usually USD and euros. While reserves in USD and euros may earn interest if they are in deposit form (T-Bills and bonds), gold reserve doesn’t earn interest.
My suggestion is: instead of hoarding away the reserves against imagined future attack by currency speculators, we should invest the money for future productivity and well being of our citizens, meaning fiscal expansion. Fiscal expansion increase income, hence increase our future tax base. Mankiw explained it better that in small open economy with fixed exchange rate like ours, only fiscal expansion would be effective to increase income. We could invest in infrastructure, housing, education and skill upgrade for our people, not to mention the necessary spending on welfare for our less fortunate citizens and retirees. While fiscal expansion might eat away our reserves and reduce current account surplus (through increase import), it has much greater benefits to our citizens than ‘the security of knowing bountiful reserves’. The fiscal expansion will channel the benefits of reserves to our citizens.
Of course, if we suddenly unpeg tomorrow, the ringgit will almost certainly appreciate because of continued current account surplus, this will transfer benefits of reserves to those who hold ringgit – including speculators. For our citizens, the benefits tend to be minimal in the short term, asset prices tend to be sticky and stay high, and some of us might even lose jobs through export industries relocating to lower cost countries.
When and how to unpeg? Set a target date well in advance – say 6 month to one year from date of announcement. Let everyone get ready and prepared. In the meantime continue the program of fiscal expansion. Use the fiscal measure to achieve internal targets; unemployment, income, higher savings rate that match investment rate and better living condition. Knowing that the ringgit will appreciate upon free float will dampen inflationary expectations – provided there is no barrier to import.
Meet any speculative large inflow of capital by printing more ringgit; monetary expansion. This will lower interest rate and increase investment. More benefit to our citizens.
Aim for the ringgit reaching equilibrium exchange rate upon free float.
What if the ringgit depreciates upon free float? This will make us even more competitive in the world market, and Bank Negara could always mop up excess liquidity using open market operation.


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