KUCHING: With several emerging market currencies now in crisis territory, analysts have raised the need to consider the possibility of introducing capital controls by countries experiencing growing market volatility as a pre-emptive measure to address any potential risk to the financial market.
According to the research arm at AmInvestment Bank Bhd (AmInvestment), this turmoil is partly a collateral damage from the trade war between the US and China, and partly a result of rising interest rates in the US and the consequent desire of global investors to chase yields due to low global interest rates.
“The option to use capital controls at the moment could be fairly premature.
“However, we should remain mindful about it, especially if global volatility remains strong or becomes stronger, resulting in a huge capital outflow.
“Added pressure on Malaysia will be the risk of rising fiscal deficit per gross domestic product (GDP) and the challenge to lower the public debt/GDP,” the research team said in its thematic report on Malaysia.
“Should the depreciation of the currencies turn out to be drastic, it will exert a strong pressure on countries exposed to high US dollar-denominated debt, including Malaysia. Such pressure may potentially provide justification for capital controls,” it added.
To recap, Malaysia introduced capital control on September 1, 1998 that caught everyone by surprise during the height of the 1997/98 Asian financial crisis.
AmInvestment noted that the move by Malaysia was widely criticised by the International Monetary Fund (IMF) who advised countries to liberalise their capital accounts and avoid imposing capital controls.
However, in 2012, the IMF adopted a more flexible approach by accepting temporary controls on capital flows if these are used to stem a crisis and in conjunction with sound fiscal and monetary policies.
Still, it noted that the IMF is cautious on capital controls and believes that controlling capital outflows in “non-crisis situations” can fuel capital flight while tarnishing a country’s credibility.
In 2016, Malaysia introduced some capital flow measures in a move to clamp down on ringgit trading in the offshore non-deliverable forwards market.
The research team noted that this was aimed at containing the currency’s fall amid an emerging market sell-off following the election of Donald Trump as US president.
AmInvestment believed that in the likelihood that Malaysia finds itself in a situation whereby it needs to peg its ringgit, the move would only provide short-term stability for the ringgit’s exchange rate.
However, it pointed out that the potential setback is an undervalued ringgit which would have repercussions on Malaysia’s trade in the medium to long-term.
“Among other factors, the level of reserves is crucial in determining whether a currency needs to be pegged. Focusing on Malaysia, the reserves level is currently around US$103bil, which is sufficient to finance 7.4 months of retained imports. The ringgit is trading around 4.15 against the US dollar.
“About RM17.7 billion was used for liquidity management via short position for forward and futures end August.
“From our assessment, should the level of reserves approach US$80 billion or six months of retained imports, the pressure is expected to pick up on the local currency to be pegged. Our estimation suggests the threshold is around five months retained imports or about US$70bil in reserves for the currency to be pegged,” it explained.
Source: Borneo Post Online