INTRODUCTION
According to study performed by Jeffrey A. Frankel, 2005 exchange rate is defined as the price of foreign currency. For instance, the exchange rate between Malaysian Ringgit and Dollar is generally expressed in dollar per Ringgit ($/RM). The exchange rate acts a major role in the country economy growth and easily being affected by the economy crisis. Since independent of the Malaysia in 31st August 1957, the country has faced and experienced four major crises. The first crisis is in 1971 to 1973 because the end of the Bretton Woods System and the oil crisis. The second crisis happened in 1980 to 1981 due to the decline in commodity prices together with the second oil crisis. Followed by the third crisis between 1985 and 1986 due to the electronic crisis. The fourth scenario happened during 1997 and 1998 due to financial crisis (Ming-Yu Cheng & Sayed Hossain, 2001). The financial crisis has given huge impact on the country economic growth and subsequently touch the country’s exchange rate. Although, depreciation of the Malaysia’s currency has pros and cons, the current state of affairs has recognized that the weakening of Ringgit in the world market results in more negative than positive consequences especially to citizens. Thus, it is essential for us to identify and understand the determination of exchange rate and the effect to the state, so that we can control the volatility of exchange rate and shorten the impact to the nation.
DETERMINANTS OF VALUE OF RINGGIT
We divided the factors contributing to the value of Ringgit in three sections. Firstly, the economic factors, secondly, the politic factors and lastly the external factors of the Ringgit.
ECONOMIC FACTORS
Interest Rate
According to Kevin James, 1998, one of the ways to attract foreign direct investment or capital inflow is by increasing interest rate of the country. High interest rate implies that the investor will gain high profit from their investment, hence this will attract more investor to invest in our state. As a consequence, the country balance of payment will be in surplus and the country currency will begin to revalue. This show that interest rate and exchange rate are positively related, higher interest rate can lead to the appreciation value of the Ringgit while low interest rate will lead to depreciation value of Ringgit. According to research performed by Hans Jarle Kind & Mohd Nazari Ismail, 2001, expansionary fiscal policy by government will create the demand for currency and hence contribute to increase in interest rate of the country. When interest rate rises, the country currency will begin to appreciate as well. Whereas, when government increase the tax levy to public, the country consumption will simultaneously decrease, thus interest rate of the nation likely to reduce, this latter will result in the derogation of the country currency.
Inflation
According to Elizabeth Chua Siew Eng & John G. Bauer, another element that can affect the Malaysia exchange rate is inflation. High inflation will make the country currency to devalue, while low inflation will give positive impact to the country by appreciating in country currency. In 1970s, Ringgit has appreciated against the US Dollar because of the higher inflation in the US as compared to Malaysia. In late 1991 and early 1992, Bank Negara Malaysia (BNM) policy of combating inflation by a stringent monetary policy outcomes in higher interest rate along wirh large capital inflow to the country. This had caused the Ringgit to appreciate. Increases in tax imposed on nitizen of the nation will likely cause the spending to lessen because of higher inflation. For instance, when the government of Malaysia imposed GST (good and services sector) in April 2015, retail spending or consumption decline because purchasing power of the people decrease. As demonstrated, the sales of European brands in automotive sector have recorded tremendous drop as soon as the GST is being visited. GST also predicted to cause inflation to come about in Malaysia. Governor of Malaysia Central Bank, Tan Sri Dr Zeti Akhtar Aziz also recognizes that GST will cause inflation.
Capital Inflow
Capital inflow is the factor to determine the value of Ringgit. This phenomenon can be seen during Asian crises between 1997 and 1998. It was not coming from neither misaligned exchange rates, mistaken domestic policy, nor lack of transparency in the banking sector, but it was vastly attributed to a combination of an excessively rapid rise of capital inflows as well as the falling global demand for the exports from the region that arose from a global economy. This view supported by Fumitaka Furuoka, Beatrice Lim, Catherine Jikunan and Lo May Chiun. Contempt of this crisis, they indicate that it changing the marketplace principle that leads Ringgit to depreciate. According to Ooi Sang Kuang, in the first five months of 2006, because of the favourable economic fundamental by the government of Malaysia such as new investment incentive packages and further liberalisation of foreign exchange administration measures and also the release of Ringgit pegged to US Dollar, capital inflows is relatively increasing and Ringgit is appreciated compared to US Dollar by 5.5% reaching the highest in May by 3.5825. Also, in 1986 because of the inflow of foreign exchange to Malaysia due to export and foreign direct investment and also because of the trade deficit in US, Malaysian Ringgit shows appreciation trend compared to USD (Elizabeth Chua Siew Eng & John G. Bauer). The worst financial crisis happens after independence started in mid-1997 when the capital inflows happen in Malaysia. Generally, capital inflows will enhance the pace of economic development, nevertheless, in Malaysia case; it modifies the perception on country’s economic prospects. It losses of confidence in Malaysia’s ability to confront the challenges ahead involve the economic performance. It bulged out when there is a sudden withdrawal of short-term capital from the country and followed by Thai’s Bath floating in July 1997(Cheng and Sayed, 2001). According to Cheng and Sayed (2001), this withdrawal has created uncertainty and volatility in the foreign exchange and equity marketplaces. They emphasize that panic-stricken investors started to extract out the heavy scale of short-term capital, which resulting in a sharp depreciation of currency and boost the interest rates.
Investors Speculation
Before Asian Financial Crisis 1997, Malaysian Ringgit is strong because of Malaysia’s strong trade position. This made Bank Negara to have a policy not to support the exchange rate, but to maintain it. Unfortunately, Ringgit has been attacked by foreign investor speculator (Dr. Tarek H. Selim), due to that, Malaysian Ringgit experienced a vast loss of currency. According to Gale Raj, Yanice Colón, Silvana Kostembaum and Robert Cordova, as foreigners hold a large Ringgit because of high offshore interest rate, it established liabilities for the Malaysian banking system. Thus, potential offshore speculators do not have enough currency to destabilize the Malaysian banking system. However, when the financial crisis started, much speculative pressures happens in Malaysia which cause to an increase of Ringgit credit demands, rose of short-term interest rate, putting forward pressure on the currency, and creates huge capital outflows that automatically leads to depreciation of Ringgit.
POLITIC FACTORS
Political Stability
Political stability also is one of the components that influence the value of the Ringgit. According to Saleena Saleem (2015), the political crisis in Malaysia can worsen the economic condition whereby strong and credible leadership is indispensable to encourage investor and consumer trust. There is term in political factor as stated by Nordhaus (1975), cited by Pepinsky (2007), “Political business cycles (PBCs) are politically induced fluctuations in economic indicators such as spending, unemployment, inflation that corresponds to a country’s electoral cycle”. Current controversial issue of 1 Malaysia Development Berhad (1MDB) scandal has reported weakening the value of the Ringgit.
Lack of transparency in IMDB investigation has increased the capital outflow resulting from a diminishing number of investors that turn out to impacted Ringgit. In July 2015 when the IMDB accusation against the Prime Minister, Najib Razak, Malaysia’s foreign reserves fell by about 5% of central bank when they failed in an attempt to sustain the Ringgit RM3.80 per US dollar in two weeks (Saleena Saleem, 2015). Make it worse; there is a sharp fall in foreign reserves parallel to publicity over 1MDB trouble. Malaysia’s foreign reserves now stand below US$100 billion, raising fears over its power to guard against further currency shocks. Financial analysts also suggest that capital outflows will continue contributing to further Ringgit weakening (Saleena Saleem, 2015).
The lack of transparency in managing the crisis has strengthened the study by Pepinsky (2007) that Malaysia has political institutions under authoritarian rule. According to Saleena Saleem (2015), the Prime Minister Najib Razak and the regime must have credible and transparent solutions to guide the country through its looming economic challenges.
EXTERNAL FACTORS
Oil Price
One of the elements that determine the value of Ringgit is oil price. The oil price started to show the downward trend in the market since June 2014. The cause behind this move was because of oversupply along with weak demand from buyers. Despite our state as a net-oil importer, oil-related industries are a third major contribution in revenue. According to Bergvall (2004) as cited by Wong Hock Tsen (2010), an increase in the oil price could appreciate the exchange rate of the oil exporting country and depreciate exchange rate of the oil importing country.
China’s Economic Slowdown
Based on this author, Saleena Saleem views, in order for China to be competitive in the global marketplace, they purposely devalue their currency, the Yuan, mainly to boost exports that will obviously stimulate the economy growth. Yet, according to this author, their strategy to shift its export-driven growth in consumer spending was totally ruined. The result of the devaluation of the currency, leads to plummet in the stock market.
Still, the pros of devaluation of currency in China, they tend to export more and subsequently, demand for China’s products relatively higher as compared to Malaysia in the global market. This is because, in the worldwide market, China’s products relatively cheaper than Malaysia. Malaysia continuous decline in trade surplus in June 2015 with an expansion of oil-gas exports to China. Given the low oil prices, this may be in China’s interest, but reduction in Chinese demand will contribute to a decline in Malaysia’s primary exports to China. Malaysia will not be able to ride on Chinese demand as it has been doing for the past ten.
IMPACT OF DEPRECIATION OF CURRENCY
Instead of focused on the impact of appreciation of Ringgit, we focused on the impact if our currency depreciate like we experienced now.There are numerous impacts faced by the government of Malaysia during economic crises. Asian crises in 1997 and 1998 as well as financial crises in 2000 and current situation gave a huge impact towards Malaysian Economy. It leads our economy in a bad scenario because our currency tends to depreciate.
The impact of depreciating in currency makes the price automatically become higher than before. Price pressure can be relatively high as compared to before. This statement is supported by Amir Hashim (2009), where he concludes that the depreciation of the Ringgit affect the price to increase based on his study in Asean crises 1997. Therefore, our purchasing power will be less than before. Unfortunately, the rising consumer prices also triggered real household income along with real wages to fall.
Furthermore, depreciating in Ringgit also reduce private investment generally. According to Amir Hashim (2009), this is primarily due to suspicions arising from volatile exchange rates, the diminution in both local and external demand, the existence of extra capacity and tight liquidity position encountered, as well as low business confidence. If this tendency continues, consequence of this is the economic growth pace will also be affected and worsened.
Moreover, instability and continuously depreciating in Ringgit makes the international investors mainly, loses confidence to invest in our state. They preferred to be risk averse than risk lover in this critical situation. By this perception from international investors, the stock prices obviously will make a downward movement on the Kuala Lumpur Stock Exchange (KLSE). This scenario had been discussed by (Jomo), foreign capital inflows conversely affect the factor payment outflows, export and import propensities, and the terms of trade and ensuing in the balance of payments. At this time, the investor’s loss confidence to put investment because of the capital reversals. Increasing foreign capital inflows has reduced foreign exchange constraints, allowing the financing of additional imports, but thereby as well, resulting in reducing current account surpluses, adversely generating deficits.
The impact of continuing decline in the value of the Ringgit leads to increased unemployment in Malaysia. Depreciation in Ringgit results in contraction in the economic system and subsequently contributes to higher unemployment in Malaysia. As the economy contracted, there were limited employment and income-earning opportunities as well.
Financial crisis in 1997 has a great impact on the Malaysian economy. Foremost, the value of Ringgit fall almost 50%, which is the highest RM4.88 per US Dollar on January 7, 1998 from only RM2.42 per US Dollar on April 1997. Second, among the Asian states, Malaysia was affected the most in the stock market plunge where the composite index of the KLSE fell to 262.7 points in September 1997 from 1’077.3 in June 1997. Third, there was a worsening tendency in the Foreign Direct Investment (FDI) from January-December 1998. It demonstrates that to avoid losses during the crisis, investors have reduced their investment in Malaysia. Lastly, the crisis also affects the public sector. This is when the government attempting to cut the expenditure and investment planned such as cancelling or postponing the mega project, burning off 10% pay cut for ministers and frozen the increase in pay for higher classes of civil servants. (Zaherawati Zakaria et.al, 2010)
Before the crisis, Malaysian poverty cases in rural and urban areas shows a decline until 1997. Yet, in one case there is a financial crisis, it occurs that the poverty for both citizens and non-citizens increased by 399,100 from 346,000 due to increase in inflation rate by 6%. Meanwhile, in terms of income distribution, there is a slight reduction on the household income in urban areas (20%). Concurrently, income from agriculture sector grow at a faster pace because of higher prices for palm oil and food crop production as a response to higher import costs. Therefore, the average income of families in rural areas especially remained stable as a result of ability to diversify the source of income. (Zaherawati Zakaria et.al, 2010)
Besides that, in an education sector, depreciation in Ringgit affected the students to pursue their education in overseas. This is due to sharply increased in the cost of education to overseas. Likewise, the shock of this scenario, institutions offering financial aid for education abroad, including the government either stop or cut back drastically. This will make students become discouraged and less motivates as well as mentally broke down to achieve their dreams to study overseas. Thus, there is an increase of students in local universities as what happened during Asian crises in 1997.
SOLUTION
During the Asian crisis, instead of borrowing money from the IMF (International Monetary Fund) to handle the economy, our erstwhile Prime Minister Tun Dr. Mahathir Mohamad had imposed capital control as a new economic program that merely for the purpose to halt the outsider from controlling the movement of Ringgit even though the idea was differ with the central bank proposal (Mitchell and Joseph, 2009). According to this design, Malaysian Government declared that all Ringgits held outside of Malaysia had to be turned back, which meant that Ringgit trading would be managed solely inside the country’s own borders. Zeti Akhtar Aziz said this measure can minimize the impact of the possible economic crisis and a breakdown in the international financial scheme. Apart from that, foreigners were no longer permitted to trade stocks and repatriate funds, unless a year has elapsed since the time of purchase. Therefore, the Ringgit was officially determined at an interchange rate of RM 3.80 to the U.S. dollar. This strategy was intended to isolate Malaysia’s economy from the international currency speculators as well as traders whom he blamed for causing the country’s economic crisis. Malaysia refuses to get a loan from IMF like another state such as South Korea, Indonesia and Thailand. This Malaysia initiative has shown that there are still another method to capital account liberalization which opposing the market fundamentalism and IMF neo-liberalism (Jomo). However, in Mitchell and Joseph (2009) quoted from Rodrik (2002), Malaysian recovery can be better off if they do not practice capital controls by comparing the recovery method with country that borrow IMF loans. According to (Jomo), “Malaysia’s recovery (6.1 percent in 1999 and 8.3 per cent in 2000) was more modest than South Korea’s (10.9 per cent in 1999 and 9.3 per cent in 2000)”.
This policy was supported by prominent economist and Nobel Laureate, Paul Krugman, who recommend the concept of capital controls as it allowed Malaysian authorities to bring down interest rates to counteract the recession without causing the Ringgit to downfall whereas Dani Rodrik and Ethan Kaplan (2001) as cited by Furuoka et. al (2012) said that, by using this method, it leads the economic faster than receiving the financial aid from the IMF.
CONCLUSION
As a conclusion, there a bunch of genes that decides the value of the Ringgit. “The East Asian currency crisis forced many economies in the region to switch away from de facto dollar-pegged regimes to more flexible exchange rate regimes” (Masahiro Kawai). Malaysia has used by selective capital and foreign exchange controls that undermined the market confidence, because the action chosen by Bank Negara was perceived as a reversal in the country’s commitment towards financial liberalization. The nation was caught off guard and self-initiated measures proved insufficient to rectify the contagious global capital outflows. In short, Malaysia has yet a meaningful countermeasures that can protect the country from the imbalances and structural weaknesses that attributed to the destructive contagious global capital outflows (Anuar Haji Wahab, 2003).