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.