Tuesday, March 21, 2006

Tun Mahathir's Solution: Raise Exchange Rate

Title: Tun Mahathir’s Solution: Raise Exchange Rate
I admire Tun Mahathir for suggesting a solution of our petrol price hike. It sounds compelling and easy; let our ringgit rise in value, and there will not be any need to subsidize petrol.
Let examine the facts that ours is an open economy with free floating exchange rate to some extent (managed float, whereby Bank Negara intervene to promote stability). There are several ways of raising the real exchange rate some of which I shall outline here:
1. Increase local investment, or in economic terms, fiscal expansion without monetary expansion. Government shall borrow money in local market and invest in infrastructure, school, hospital etc. As a result, interest rate will rise, and foreigners will be attracted to invest in local money market, as money flows in, real exchange rate will rise.
2. Monetary tightening, as opposed to loose monetary policy at the moment. Bank Negara will increase interest rate well above the world market, and again as a result, foreigners will invest in our higher returns, and real exchange rate will rise.
3. Bank Negara would simply bid up our ringgit and spend our foreign reserve, which can be done under the guise of managing our free floating ringgit.
All of the above methods will result in higher exchange rate, but will result in lower export, because higher exchange rate will render our exports less competitive. Our balance of payment might result in deficit in the future. That is still okay, but our uncompetitive firms might also lose business and close down, which would eventually result in higher unemployment.
Another side effect of the first two is higher interest rate, which will result in lower private investment and cool down the economy in the medium term. Individuals would postpone their investment in housing and durable goods (stuff that you have to borrow money to buy), demand slows down and inflation would be lower. Some people in the export sector might lose jobs, as our exports become less competitive.
As for Bank Negara bidding up our ringgit in the foreign exchange market, that is a risky proposition, currency speculators would have a field day once our intention is known.
One possible way to raise exchange rate that is contrary to our commitment to WTO and AFTA is to erect protectionist trade policies such as a ban on imported cars, textile, electronics goods etc. For example a ban on imported beef would result in higher local prices for beef. This in turn would encourage local farmers to produce more beef. Because we saved money on beef which otherwise would have been imported, the demand for net export would rise, hence exchange rate would rise as well. When exchange rate is higher, some export sector would be uncompetitive and lose business. This would result in unchanged net export position. Resource allocation would shift to protected industries. Instead of moving forward and liberalizing our trade policies, we would be moving backward.

Whether the government spend money subsidizing our petrol or we spend a larger chunk of our pay packet, in total sum the country spend the same amount, provided that the total consumption is still the same. Let see this petrol price hike as it is, resource reallocation. We the rakyat have less to spend on other things if we spend more on petrol. If we collectively spend less on chicken, fish and vegetables, while the production of those items stays the same, eventually the real prices of chicken, fish and vegetables would be lower, ceteris paribus.

I would instead suggest to the government to give more help to the poor, needy, disabled and the unemployed. Let’s ask for social welfare payment or at least income top up for the low income group. For example, if a disable person couldn’t work, government should give a living allowance of at least RM800. (I do not know if this is enough living allowance for one person, should it be higher?) As for low income families, government could give a top up for their income, straight to their account.
We should also work toward minimum wage legislation. A worker should get at least RM1200 a month based on 48 hour work week, or RM5.70 per hour. No employer should pay an employee less than that, because that is hardly enough to pay for rent, food and transportation in main urban areas.

Noor Yahaya Hamzah
Email: nooryahaya@yahoo.com

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