KL in dilemma over managing influx of funds

KL in dilemma over managing influx of funds

KUALA LUMPUR (Reuter): Two years after it was forced to stop a
heavy inflow of international funds through drastic capital
control measures, Malaysia's central bank, Bank Negara, is once
again facing a problem of plenty.

It is in a dilemma over how to manage funds international
investors have been pouring into the country over the past three
weeks to take advantage of higher interest rates and a booming
stock market, economists said yesterday.

"It is indeed a dilemma for Bank Negara. It does not have many
options available to it in terms of a policy response to the
inflows," said Desmond Supple, regional economist with
independent research firm I.D.E.A. in Singapore.

The ringgit has surged 1.6 percent to around 2.50 against the
U.S. dollar over the past few weeks after Bank Negara promised to
maintain a tight monetary policy and as many international funds
relocated due to signs of central bank unease over similar
problems in more popular destinations -- Thailand and Indonesia.

Speculators had sold down the ringgit in late 1995 and early
this year fearing that fast-growing Malaysia, now in its ninth
year of over eight percent growth, was overheating.

While the ringgit's rise is widely viewed as a show of renewed
international confidence, it has brought with it money Malaysia
can do well without, economists said.

They said much of the inflow was "hot money", or funds looking
for quick returns, which could destabilize the economy and derail
the monetary policy.

The inflow has caused huge liquidity in the banking system and
is pressuring interbank interest rates downwards at a time when
the nation is battling rising inflation and a bulging current
account deficit.

Malaysia reported a current account imbalance of 17.8 billion
ringgit (US$7.13 billion) in 1995 and forecasts it will be 17
billion ($6.8 billion) this year.

Economists estimate that excess liquidity in the already flush
Malaysian banking system was around 8-10 billion ringgit against
two-three billion a few weeks ago.

"Monetary tightening is vital if it (Bank Negara) is to dampen
overheated domestic demand," Supple of I.D.E.A. said.

He said if Bank Negara struck back by imposing capital
controls, as in 1993/94, it would alienate investors. If it tried
to mop up funds from the open market to reduce liquidity, it
would be at great cost to its reserves.

In 1993/94, when its raising interest rates attracted "hot
money", Bank Negara imposed, among other measures, negative
interest rates on foreign-held ringgit accounts and banned the
sale of government paper to foreigners.

Bank Negara regularly intervenes in the interbank market
through an open tender system to either mop up excess liquidity
or set interest rates.

Other economists said even if the central bank attempted to
stop the rise by buying dollars, the ringgit it would sell could
end up increasing liquidity in the domestic market.

"The rise of the ringgit is a double-edged sword. While it
would lower the cost of imports, it will also stimulate
additional demand," said Andy Tan, economist with MMS
International in Singapore.

"If that happens the current account deficit will worsen," he
said, adding that a stronger currency would also affect much
needed export growth.

He said in the near term the ringgit's rise may give an
impression of helping improve the current account deficit, but in
the long term, if not accompanied by an interest rate hike, the
situation would worsen.

And an interest rate hike in the present market was difficult
to sustain. "By the end of the year interest rates will still go
up by another 50 basis points. It will perhaps be postponed
slightly by the present volatility," Tan said.

The benchmark three-month interbank rate in Malaysia is at
7.10 percent, against around 5.5 percent in the United States,
2.1 percent in Singapore and under one percent in Japan.

Economists said a good solution for Bank Negara would be to
have a mix of aggressive market intervention, selective capital
curbs and raising of banks' statutory reserve requirement (SRR).

"I think there is a good chance they will raise the reserve
requirement from 12.5 percent to 13.5 in a month from today. It
is a cheaper and more effective long-term policy," Tan said.

Under SRR, banks have to place a certain percentage of their
deposits and other liabilities interest-free with the central
bank.

According to Supple at I.D.E.A, a one percentage point
increase in SRR would absorb three billion ringgit.

But, that alone would not help. "In fact, unless Bank Negara
intervenes heavily in the money market over the next few weeks,
despite the growing cost of these operations, (interest) rates
will fall in Malaysia," I.D.E.A. said in a report.

It said a large number of maturing loans and bills and the
continuing flow of funds from Japan and the United States would
add to the market's liquidity woes in the next few days.