Can the ringgit peg remain sustainable?

Can the ringgit peg remain sustainable?

By Simon Cameron-Moore

KUALA LUMPUR (Reuters): Malaysia has delivered a fiscal stimulus at the right time, but analysts are unsure whether it can induce enough growth to save the ringgit peg if a weak yen sparks competitive depreciations round the region.

Satisfaction with the peg, fixed at 3.8 per dollar in 1998 to staunch capital outflows during Asian crisis, is riding high.

Prime Minister Mahathir Mohamad can rightly boast the economy has fared better than any of the southeast Asian nations which opted for free-float International Monetary Fund prescriptions.

But after the question of what happens when 75-year-old Mahathir finally steps aside, the ringgit peg's sustainability is seen by fund managers as Malaysia's next biggest risk factor.

On Tuesday, as he unveiled a near US$800 million stimulus package, Mahathir declared the ringgit peg will be kept to ensure a continued environment of predictability and certainty.

But even Malaysia's independent-minded policy makers will struggle to duck a squeeze likely to be exerted soon by global economic forces.

A $5.5 billion fall in Malaysia's international currency reserves in the nine months through February, down to $28.99 billion, has drawn a lot of comment from analysts, saying that at this rate of erosion the peg will need adjusting in late 2001.

Malaysia could opt for a sovereign bond issue to raise funds and give its international currency reserves a little filip.

But others believe the pressure on the economy will trigger a readjustment before the reserve levels become alarming.

"Our scenario is not for a balance of payments crisis. The bigger threat is likely to come from export competitiveness if yen weakness is here to stay and regional currencies are dragged down," Vincent Low, Merrill Lynch's Singapore-based regional economist, told Reuters.

A U.S. slowdown, twinned with a wobbly yen spells trouble ahead, which domestic spending can only partially deflect.

Pump-priming helps domestic demand, and in Malaysia public consumption only accounts for only around 12 percent of GDP, while the value of exports exceeds that of GDP.

Around 40 percent of exports are telecommunications equipment and semiconductors, and new orders from the U.S., Malaysia's main market, have dried up.

Throw Japan's problems into the mix, with widespread predictions of a weaker yen, and the danger of Asian currencies sliding into a cycle of depreciations becomes a real risk.

Tuesday's fiscal package aims to add 1.1 percent to GDP growth, which analysts had earlier expected to slow to five to six percent this year after 2000's runaway 8.5 percent expansion.

It certainly will boost this year's growth, but maybe not as much as the government thinks, analysts say.

The cut announced in Employee Provident Fund contributions was expected to result in higher consumer spending, which would deliver nearly half the growth expected from the fiscal booster.

But, with the economy slowing, Malaysians may prefer the safety of fixed deposits rather than going on a spending spree.

"It seems ambitious. There's nothing to say consumers won't put their money in a savings account," Arjuna Mahendran, head of research at SG Securities, told Reuters.

With a savings rate of 40 percent last year, Finance Minister Daim Zainuddin says he doesn't want Malaysians saving more, so a critical element of the package was to get banks to increase lending by 8 percent.

"The whole thing hinges on that. It will be a very positive spin off if consumer access to finance becomes easier," Mahendran said.

As for the planned spending on projects, the government will have to make sure the money filters down to sub-contractors if the public-sector multiplier effect is to be maximized, he said.

"The more they spend on development projects the more that is likely to leak into imports thereby diluting the stimulatory impact," UBS Warburg said in a note to clients on Wednesday.

Malaysia can easily pay for its booster, helped by reserves accumulated from budget surpluses run up pre-1997.

The fiscal deficit was targeted to fall to 4.9 percent of GDP this year, but now it looks like overshooting slightly.

"It's only a modest increase in the deficit," Merrill's Low said, pointing to low interest rates and a liquid banking system as other reasons the "fisc" can be taken care of comfortably.