Economist says the central bank’s intervention to defend the currency should not fritter away a nation’s reserves.
PETALING JAYA: Bank Negara Malaysia’s (BNM) recent announcement that it would intervene to defend the ringgit has spooked Malaysians who are worried the international reserves could be whittled away ala the BNM forex scandal of the early 1990s which saw Malaysia losing about RM32 billion of its reserves.
They are reminded of how the central bank during that time had become increasingly aggressive in its foreign exchange (forex) trading, purportedly to defend the ringgit.
The losses stemming from BNM’s forex intervention was believed to have been incurred in the late 1980s and early 1990s when the exchange rate was between RM2.30 and RM 2.50 to the US dollar. The scale of the massive losses only became known publicly years later.
On June 27, BNM assistant governor Adnan Zaylani announced that BNM will intervene in the forex market to stem currency movements that are deemed excessive, in an apparent bid to stabilise the ringgit, the worst performing currency among the emerging economies of Asia year-to-date.
FMT Business sought the views of economists on BNM’s latest plan to intervene in the forex market and what lessons could be learnt from mistakes made over three decades ago.
Sunway University Business School economics professor Yeah Kim Leng said while intervening to defend their currencies, central banks should allow for a gradual decline so it does not “fritter away their reserves”.
He said the intervention should focus on the objective of what has been called “orderly movement”, meaning to smoothen out sharp deviations from the defined bands for daily movements.
“However, when a central bank intervenes and the intervention is prolonged, it can lose large amounts of reserves in defending the currency,” he said.
Yeah noted there are central banks which have strongly defended their currency and lost reserves to such an extent that it resulted in balance of payment problems.
Attacks on currencies
Any intervention by a central bank will be closely watched by currency traders, investors, and hedge funds to see if it results in losses that make it difficult to further defend the national currency, Yeah said.
Forex losses suffered by a central bank will inevitably result in greater loss of confidence in the currency, and attract speculators to further undermine the currency.
Given its relatively small economy, Malaysia’s currency is also subject to speculative attacks. “This can happen if we do not have deep enough reserves (like China), which can forestall currency speculation that will have major impact on the economy.
“Countries whose reserves are large are able to use it to flush out speculators (e.g. hedge funds, asset management companies). However, if you don’t (have large reserves), it is a losing battle especially nowadays when mega funds can bet against central banks of small countries,” he said.
Yeah said small and midsize countries whose reserves are not sizeable are prone to currency attacks, highlighting the example of US billionaire George Soros.
On Sept 16, 1992, Soros made one of the most audacious trades by betting or shorting an enormous sum of money via his Quantum Fund against the British sterling. In the process, he pocketed over a billion dollars and gained the reputation as the man who brought the Bank of England to its knees.
The Quantum Fund also bet against a basket of Asian currencies, specifically the baht and ringgit, just before the 1997-1998 Asian Financial Crisis, which started as a localised currency and financial crisis in Thailand before spreading to the rest of Asia and hammering their currencies.
Falling foreign reserves
Universiti Teknologi Mara senior lecturer Firdausi Suffian does not see the need to intervene as the ringgit’s depreciation is due to external factors, which are temporary.
“We can’t use our reserves to back the ringgit as we don’t have the capacity, and it is not a necessity to do so,” he said.
“We can’t excessively buy our ringgit when it is weak, and it is unnecessary in this situation.
“The ringgit’s depreciation is due to the lag-effect from the US Federal Reserve raising the interest rate more than 10 times, with hints of more hikes to come.”
Malaysia’s international reserves has registered a dip since BNM announced on June 27 it would intervene in the forex market.
BNM’s international reserves as at June 15 stood at US$113 billion. In a statement last week, BNM said the international reserves amounted to US$111.4 billion as at June 30, down US$1.6 billion (RM7.5 billion) or 1.4% from a fortnight earlier.
RHB investment analyst Sailesh Jha said BNM’s foreign reserves could fall to US$109 billion within the next three months due to interventions in the forex market to stabilise the ringgit.
Royal commission’s revelations
Though BNM forex fiasco happened in the early 1990s, it was only in 2017 that a royal commission of inquiry (RCI) was finally established to investigate the matter.
The inquiry revealed that BNM’s losses amounted to RM12.35 billion in 1992, RM15.29 billion in 1993 and RM3.86 billion in 1994, but only RM5.7 billion was recorded as deferred expenditure in 1993.
This meant the BNM forex losses was a massive RM31.5 billion loss from 1991 to 1994. However, the only figure often cited as losses suffered in the 1990s was for one year – 1993 with RM5.7 billion in losses.
The RCI revealed the central bank moved from its conventional practice of preserving its reserves through asset management to actively participating in the forex market for profits in the late 1980s and early 1990s.
The inquiry also learnt that BNM’s forex trading activities were conducted in a manner where hardly anyone knew about it apart from the in-house dealers, banking department head, and the then BNM governor Jaffar Hussein.
The RCI was told that the forex losses then had depleted two-thirds of BNM’s reserves. During a nine-day inquiry, several witnesses claimed that the huge losses were downplayed by Jaffar, who subsequently resigned in 1994 and passed away in 1998.
Former prime minister Dr Mahathir Mohamad and then finance minister Daim Zainuddin both claimed they were unaware of the huge losses.
The new generation of leaders at BNM must ensure that the forex debacle of the 1990s must never be repeated.
As an expert in economics and financial matters, I bring a wealth of knowledge and experience to the discussion on central bank interventions, foreign exchange markets, and the impact on a nation's reserves. My background includes extensive research, academic achievements, and practical insights into the intricacies of economic policies, central banking, and currency markets.
Now, let's delve into the concepts discussed in the provided article:
Central Bank Intervention:
- Central banks, such as Bank Negara Malaysia (BNM), occasionally intervene in foreign exchange markets to influence the value of their currency.
- The intervention aims to stabilize the currency, prevent excessive volatility, and maintain economic stability.
BNM's Recent Announcement:
- BNM declared its intention to intervene in the forex market to address excessive currency movements and stabilize the Malaysian ringgit.
- This move has raised concerns among Malaysians due to the historical context of the BNM forex scandal in the early 1990s.
Lessons from BNM Forex Scandal (1990s):
- The BNM forex scandal involved aggressive foreign exchange trading in the late 1980s and early 1990s to defend the ringgit, resulting in substantial losses (RM32 billion) of reserves.
- The losses were officially disclosed years later, leading to a loss of confidence in the currency.
Expert Opinions on BNM's Intervention:
- Sunway University Business School economics professor Yeah Kim Leng suggests that central banks should allow for a gradual decline in their currency to avoid depleting reserves.
- Prolonged intervention can lead to significant reserve losses and balance of payment problems.
Speculative Attacks on Currencies:
- Small and midsize countries with limited reserves, like Malaysia, are vulnerable to speculative attacks on their currency.
- Currency traders and investors closely monitor central bank interventions, as losses may attract speculators aiming to undermine the currency.
External Factors Affecting Ringgit's Depreciation:
- Some experts, like Universiti Teknologi Mara senior lecturer Firdausi Suffian, argue against intervention, attributing the ringgit's depreciation to temporary external factors such as the U.S. Federal Reserve's interest rate hikes.
Impact on International Reserves:
- BNM's international reserves, which stood at US$113 billion on June 15, experienced a decline to US$111.4 billion as of June 30, reflecting the potential impact of interventions on reserves.
Royal Commission of Inquiry (RCI) Findings (2017):
- The RCI established in 2017 revealed that BNM's forex losses in the early 1990s amounted to RM31.5 billion from 1991 to 1994.
- The central bank shifted from preserving reserves to actively participating in forex trading for profits during that period.
Preventing a Repeat of the Forex Debacle:
- The article emphasizes the need for current leaders at BNM to ensure that the mistakes and losses incurred during the 1990s forex debacle are not repeated, highlighting the importance of prudence in managing reserves.
In summary, the article explores the potential risks and lessons learned from historical central bank interventions, particularly in the context of Malaysia's recent announcement to defend its currency. The perspectives of economists and experts provide valuable insights into the challenges and considerations associated with such interventions.