A Case for Ringgit Malaysia to find its Fair Value!

Last weekend, I re-run my quantitative models on various Asian currencies, guided by a set of fundamental economic variables determining these internal and external equilibriums. For those that want to pursue this matter, please read MacDonald, R. (2004), ‘The Long Run Real Effective Exchange Rate of Singapore: A Behavioural Approach’ Monetary Authority of Singapore Staff Paper No. 36.

On average, Asian currencies are at least 9% undervalued against the USD based on 2Q08 data. The mostly undervalued currencies are PHP, THB, MYR, and KRW in the range of 12-15% respectively despite the fact that these countries have shown quite significant improvement in both output and current account gaps over the years. On the other hand, my results show that INR, SGD, TWD, and HKD – are the ones with smaller degree of undervaluation.

Compared to the period in the first half of this decade, it is obvious that we have a good case of a much undervaluation of Asian currencies now.

China has placed its currency under a managed float recently, and given the fact that China has the world’s largest trade surplus and FX reserves, the FX direction is definitely one-way. It has also loosened controls in the capital market by allowing Chinese companies to retain FX income in designated financial institutions. At the same time, companies are allowed off-shore forex holding, whereas before these had to be remitted home. There is also greater flexibility for Chinese companies and individuals to invest directly overseas and to issue and trade overseas securities and derivatives. Similarly, foreign companies and individuals can also issue and trade Chinese securities and derivatives. In short, China is making a good progress to be more integrated with the global economy.

Perhaps, this could a step closer for the internationalization of Ringgit Malaysia (RM), and if it is happening, it will at a time when we most need our currency to be a stronger one. Malaysia banned offshore trading of the RM in 1998 and pegged the currency to the dollar as regional currencies collapsed during the Asian financial crisis. The offshore trading ban is the last remnant of those controls. I believe that removing the last capital controls would be the latest measure to attract investment that includes tax breaks and easing of race-based rules for foreign companies in some parts of the country.