2015 Case Study Eco

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PETALING JAYA: As the downward pressure on the ringgit mounts, Bank Negara has adopted gentle suasion methods to stem the decline.  

Senior executives of the central bank have had briefings with foreign exchange dealers from local and foreign financial institutions this week discouraging them from entering into transactions that result in selling the ringgit.

This comes as dealers get offers to enter into a “put” option for the ringgit at four to the US dollar over a period of between three and six months.
“If the ringgit hits RM4 against the US dollar, a lot of dealers stand to make a lot of money,” said a currency strategist.

Dealers told StarBiz that the central bank had in a recent briefing with them reiterated its stand that the ringgit would not be pegged against the US dollar, and that its value would be determined largely by market forces. Bank Negara had, however, expressed its concern that the ringgit had weakened far beyond Malaysia’s economic fundamentals.

Given the prevailing global economic conditions, the central bank argued that the “fair value” of the ringgit should be around 3.65 against the US dollar, according to dealers who had attended the briefing with Bank Negara.

The ringgit hit a fresh 17-year low of 3.8288 against the US dollar in intra-day trade yesterday before settling at 3.8190 against the greenback at the close.

That represented a depreciation of about 0.23% from the closing value of 3.8103 on Wednesday. Year-to-date, the ringgit has lost about 8.4% against the US dollar, making it the worst-performing currency in Asia.

Bank Negara is seen to have been intervening in the forex market to stem the decline of the ringgit in recent months based on the significant decline in the country’s forex reserves.  

As of July 15, Malaysia’s international reserves, that comprise the forex reserves, standard drawing rights and gold reserves, stood at a five-year low of US$100.5bil, down from US$131.9 bil a year ago. The forex reserves are now at US$92bil versus US$120.3bil a year ago.  

With Malaysia’s forex reserves on a declining trend, currency strategists said it was not surprising that Bank Negara would resort to other measures such as appealing to dealers to support the ringgit.

The downward pressure on the ringgit remained strong due to a combination of external and domestic uncertainties. Externally, the impending US interest rate hike has been causing massive capital outflows from emerging economies, including Malaysia.  

The pressure on the ringgit is compounded by Malaysia’s exposure to weak commodity prices such as that for crude oil, liquefied natural gas and crude palm oil, as well as renewed domestic political uncertainties and the scandal involving state investment fund 1Malaysia Development Bhd.

(Adapted from the Starbiz,”Bank Negara stemming the decline of the ringgit”, 31st July  2015)
http://www.thestar.com.my/busine ... emming-the-decline/

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E)   Explain ONE (1) external and ONE (1) domestic uncertainty that are  putting downward pressures on the Ringgit Malaysia.   (8 marks)

cc's standard guide:
Externally, the impending US interest rate hike has been causing massive capital outflows from Malaysia.
Also, the weak commodity prices such as that for crude oil, liquefied natural gas, crude palm oil etc.

Domestic factors are renewed domestic political uncertainties and the scandal involving state investment fund 1Malaysia Development Bhd.

Student Sample answer 1 :

There are many possible causes of price inflation in an economy for example  demand and supply-side causes, Inflation from internal and external sources , Inflationary effects of government / regulatory intervention in the economy External shocks will becommodity price fluctuations.
Depreciation in the exchange rate (higher import costs).
Acceleration in wages / unit labour costs in the labour, definitely effects of an increase in the cost of living.

In this era of globalization, goods from other countries are as commonplace, or sometimes even more commonplace, than those produced domestically. Exchange rates have a significant impact on the prices you pay for imported products.
A weaker domestic currency means that the price you pay for foreign goods will generally rise significantly. As a corollary, a stronger domestic currency may reduce the prices of foreign goods to some extent.
These phenomena affect Malaysian purchasing power of goods and services.
Consumer doesn’t spend on luxury item but only spend for necessity goods and services.
Definitely will affected the Malaysian economy due money floating in the market are less.

Student Sample answer 2 :

There are several uncertainties which will put a downward pressure on the Ringgit Malaysia. One external pressure is the expected global economic slowdown. Although Malaysia has diversify its trading partners to cushion the impact of economic slowdown but the world economic slowdown especially from China and America has impacted Malaysia’s trading partners thus it affects indirectly and also directly on Malaysia as both the strongest economy generally dictates the market and creates the disparity on the influx of exports and imports in Malaysia.

Another major concern will be the domestic uncertainty and the political turmoil that Malaysia is facing which will directly scare the direct foreign investors. We have discussed before that direct foreign investments contributes to the health of our capital account. Malaysia capital account has been fluctuating for the past several years and in 2015 it has seen one of the worst deficits in decades. The issue that is hovering on Malaysian economy is the state funded 1MDB issue which has scare many investors and creating a void which is very difficult to be filled in as the issue directly correlate to the money that was siphoned out of the country in a staggering amount which negatively indirectly impacts on the country’s currency exchange rate.

Student Sample answer 3 :

External uncertainties which put pressure on the Malaysian Ringgit raise US interest rates that apply to capital outflows and cause mass of developing countries, including Malaysia. The countries most vulnerable are Turkey, Indonesia, South Africa and Malaysia.

Uncertainty for domestic is compounded by Malaysia's exposure to weak commodity prices such as that for crude oil, liquefied natural gas and crude palm oil as well as renewed domestic political uncertainties and the scandal involving sate investment fund 1 Malaysia Development Berhad. At first, the 1MDB scandal has no impact on foreign investors because foreign investors prefer to invest up to a country that has a good rating and invest into companies that are fundamentally strong. But 1MDB scandal became public attention and have a major impact on the market in terms of investor confidence.

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D)   Discuss ONE (1) advantage and ONE (1) disadvantage of the type of exchange rate mentioned in the article.  (6 marks)

cc's standard guide:
1. The government can intervene in the exchange rate market to affect economic conditions, to prevent the rate from moving too much in a certain direction – either minimizing appreciation or depreciations.  
2. The central bank needs to have a sufficient supply of reserves to intervene in the exchange rate market.

Student Sample answer 1 :
The article has mention that the exchange rate was not governed or fixed by a specific financial institution. The exchange rate that we will be discussing will be the floating exchange rate. A floating exchange rate or fluctuating exchange rate is a type of exchange-rate regime in which a currency's value is allowed to fluctuate in response to foreign-exchange market mechanisms. A currency that uses a floating exchange rate is known as a floating currency. In Malaysia our exchange rate is left to float in the market to be exchanged freely. Our currency is evaluated against a bag of currencies which is our strongest trading partners.

Advantage of floating exchange rate is flexibility in financial markets. There is no need for elaborate capital flow restrictions: It is difficult to keep the parity intact in a fixed exchange rate regime while portfolio flows are moving in and out of the country. In a floating exchange rate regime, the macroeconomic fundamentals of countries affect the exchange rate in international markets, which, in turn, affect portfolio flows between countries. Therefore, floating exchange rate regimes enhance market efficiency.  There is also very minimal to none existent of intervention from central bank to regulate the exchange rate.

The disadvantage of floating exchange rate is volatility in the International trade. Floating exchange rate affects exports and imports directly and its tendency to worsen existing problems: Floating exchange rates may aggravate existing problems in the economy. If the country is already experiencing economic problems such as higher inflation or unemployment, floating exchange rates may make the situation worse.
For example, if the country suffers from higher inflation, depreciation of its currency may drive the inflation rate higher because of increased demand for its goods; however, the country’s current account may also worsen because of more expensive imports.

Student Sample answer 2 :

Anadvantage of foreign exchange rate is profitability.Beingan over the counter market, the trading done at forex can be known as “over thecounter” trading, wherein, a trader always buys one currency and sells of theother one in real time. There is no organizational prejudice in the market andevery investor has the equal prospects for profit in it.

Adisadvantage of foreign exchange rate is high leverage. Withsuch high levels of leverage available to traders in the Forex market, comes anequally high level of danger. This can be true for the high stake positionswhich carry along with them, too much risk, leading to margin calls. This iswhere efficient money management comes into play for playing safe.  

Student Sample answer 3 :

Afloating exchange rate is a regime where the currency price is set by the foremarket based on supply and demand compared with other currencies. This is incontrast to a fixed exchange rate, in which the government entirely orpredominantly determines the rate.

Floating exchange rate systems also meanthat while long-term adjustments reflect relative economic strength andinterest rate differentials between countries, short-term moves can reflectspeculation, rumors and disasters, either natural or man-made.

Extremeshort-term moves can result in intervention by central banks, even in afloating rate environment.

The advantages are market allows flexibility infinancial market due to floating exchange rate and the disadvantages to market areunstable environment for business field such as for export &export.

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C)  Suggest TWO (2) possible reasons for the declining country’s forex reserves (10 marks)

cc's standard guide:
1. Bank Negara Malaysia has been selling dollars to buy ringgit in an attempt to stem the ringgit's slide.
2. Weak commodity prices such as crude oil

Student Sample answer :
Malaysia can be considered as one of the most vulnerable economy that is susceptible to both internal and external exposure. This means our economy is elastic to sudden capital outflow which can cause detrimental damage to our economy.Who are on the losing side when they invest in local currency bonds especially when the   Ringgit is depreciating? Well foreign bond holders will be on the losing side. This is because when they exit the bond market they will be getting less USD when they convert their Ringgit to the USD. To ensure the bondholders do not exit at the same time, interest rates will have to rise as a form of compensation. The price of bonds is inversely related to the yield. When happens when foreign investors start selling? The price of bond will go down and the yield will go up. The nightmare every country has is a ‘bond run’. This happens when every bond holder starts rushing for the exit and this will cause a selloff in the bond market which in turn caused interest rates to rise substantially.

By now it is a known fact that our Ringgit has been on the downtrend since last year only recuperating some losses beginning of this year. However the slide begins again and it is likely that we have yet to see the worse. The following chart denotes the exchange rate between the USD and our Ringgit. As can be seen it is now fast approaching the 4.00 psychological level that was set back in 1998 during the Asian Financial Crisis.

Student Sample answer 2 :

The current account is an important indicator about an economy's health. It is defined as the sum of the balance of trade (goods and services exports less imports), net income from abroad and net current transfers. A positive current account balance indicates that the nation is a net lender to the rest of the world, while a negative current account balance indicates that it is a net borrower from the rest of the world. A current account surplus increases a nation’s net foreign assets by the amount of the surplus, and a current account deficit decreases it by that amount. The current account and the capital account are the two main components of a nation’s balance of payments.

A capital account shows the net change in physical or financial asset ownership for a nation and, together with the current account, constitutes a nation's balance of payments. The capital account includes foreign direct investment (FDI), portfolio and other investments, plus changes in the reserve account. A capital account may also refer to an account showing the net worth of a business at a specific point in time.

Two reasons for the declining in a country's forex reserves are deficit in both their accounts. In the United States of America the main culprit is their deficit in current account deficit. The U.S being the biggest consumer in the world has deficit trade balance in their current account as imports are more than exports.
The current account deficit in the United States is at USD 119.9 billion at 2.6% of the GDP.

In Malaysia, although we have a current account surplus but we currently are facing a steep decline in our capital account. Our deficit in capital account is standing at an alarming amount of -311,490,829 in usd as of 2015. In turn which affect our foreign exchange reserve.


Student Sample answer 3 :

1. Managing a Current Account Deficit
A country can reduce its current account deficit by increasing the value of its exports relative to the value of imports. It can place restrictions on imports, such as tariffs or quotas, or it can emphasize policies that promote exports, such as import substitution industrialization or policies that improve domestic companies' global competitiveness. The country can also use monetary policy to improve the domestic currency’s valuation relative to other currencies through devaluation, since this makes a country’s exports less expensive.

While a current account deficit can be considered akin to a country living “outside of its means," having a current account deficit is not inherently bad. If a country uses external debt to finance investments that have a higher return than the interest rate on the debt, it can remain solvent while running a current account deficit. If a country is unlikely to cover current debt levels with future revenue streams, however, it may become insolvent.
The pressure on the ringgit is compounded by an impending US interest rate hike, which has been causing massive capital outflows from emerging economies like Malaysia, and the country's exposure to weak commodity prices such as that for crude oil, liquefied natural gas and crude palm oil.

2. Political Stability and Economic Performance
Foreign investors inevitably seek out stable countries with strong economic performance in which to invest their capital. A country with such positive attributes will draw investment funds away from other countries perceived to have more political and economic risk.
For example, Malaysia's currency reserves fell US$5 billion in the two weeks to July 5 as the central bank defended the ringgit and analysts estimate a lot more could have been spent since as the political storm around Mr Najib intensified. Unstable of political issues can cause a loss of confidence in a currency and a movement of capital to the currencies of more stable countries.

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b) Suggest TWO (2) methods (other than stated in the article) which the Bank Negara can use to slow down the decline of Ringgit Malaysia. (12 marks)

cc's standard guide:
1. Bank Negara can enter the foreign exchange market and buy Ringgit Malaysia, this will reduce the amount of RM, DD RM shift to the right and  price of RM will rise.
2. Pegging the RM for a period.

Student Sample answer :
Bank Negara Malaysia can revise their monetary policies and implements restrictive monetary policies. Those countries with restrictive (hard) monetary policies will be decreasing the supply of their currency and the currency should appreciate. Note that exchange rates involve the currencies of two countries. If a nation's central bank is pursuing an expansionary monetary policy while its trading partners are pursuing monetary policies that are even more expansionary, the currency of that nation is expected to appreciate relative to the currencies of its trading partners. Bank Negara Malaysia can also make Ringgit Malaysia as legal tender in Malaysia only which prevents the money to flow out of the country reduces the risk of the money being traded openly which will also help in the appreciation of the money.
Bank Negara Malaysia can also use the approach of sterilization. Bank Negara Malaysia can adopt the sterilized intervention to prevent currency depreciation as long as Bank Negara Malaysia has enough foreign currency reserves as the lack of confidence in Malaysian market is due to the uncertainty of a state funded organization situation which is difficult to be resolved. The method which is adopted will be to regulate an economic approach to the ringgit namely “Snake in a Tunnel“. The snake in the tunnel was an approach as the first attempt at European monetary cooperation in the 1970s, aiming at limiting fluctuations between different European currencies. Bank Negara Malaysia has used this approach to stop the depreciation of Ringgit Malaysia further during the 1997/1998 financial crisis. Whenever the Ringgit reaches a certain depreciation threshold Bank Negara Malaysia will buy the Ringgit back with the foreign currency reserves and when the Ringgit has appreciated to a certain level Bank Negara Malaysia has to resupply it's foreign currency reserves by selling the Ringgit back out. The Bank Negara will have to regulate the Ringgit as to not allow it to continue depreciating.

An example diagram of how snake in a tunnel fluctuates in between RM 3.50 to RM 4.00 againts the USD as regulated by Bank Negara Malaysia in 36 months.

Student Sample answer 2 :

1.)As the downward pressure on the ringgit mounts, Bank Negara has adopted gentle suasion methods to stem the decline.
Senior executives of the central bank have had briefings with foreign exchange (forex) dealers from local and foreign financial institutions discouraging them from entering into transactions that result in selling the ringgit. Given the prevailing global economic conditions, the central bank argued that the “fair value” of the ringgit should be around 4.00 against the US dollar, according to dealers who had attended the briefing with Bank Negara.

2.) To make money as legal tender in Malaysia only i.e. locally trade.This measures help
Malaysia's forex reserves on a declining trend, currency strategists said it was not surprising that Bank Negara would resort to other measures such as appealing to dealers to support the  Malaysia's currency reserves fell US$5 billion in the two weeks to July 5 as the central bank defended the ringgit and analysts estimate a lot more could have been spent since as the political storm around Mr Najib intensified.
The significant decline in foreign reserves has put a constraint on Bank Negara's initiative to defend the ringgit, hence the central bank will have to adopt other means to double up the effort.


Student Sample answer 3 :

1. RM Pegged against major world liquidus such as USD, Yen, RMP, Euro to stabilize the RM flow, in export and import manner and this will decrease the fluctuation of RM against USD
2. Introduce new national debt with batter rate. This definitely will increase foreign investment capital

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a) Explain the method used by Bank Negara to slow down the decline of  Ringgit Malaysia stated in the article above. (5 marks)

CC's Standard answer

Gentle suasion methods, whereby senior executives of Bank Negara have had briefings with foreign exchange dealers from local and foreign financial institutions to discourage them from entering into transactions that result in selling the ringgit.

Student Best Answer 1:

Themethod used by Bank Negara to slow down the decline of Ringgit Malaysia(RM) isgentle suasion method & intervening forex market by:

·        Briefing local & foreign exchangedealer to decrease flow of RM in market

·        Strengthen foreign investment condition(RM is under value)

·        Reduce forex & gold reserve to buyback RM

Student Best Answer 2:

Bank Negara Malaysia (the Central Bank of Malaysia), is a statutory body which started operations on 26 January 1959. Bank Negara Malaysia is governed by the Central Bank of Malaysia Act 2009. The role of Bank Negara Malaysia is to promote monetary and financial stability. This is aimed at providing a conducive environment for the sustainable growth of the Malaysian economy. Bank Negara Malaysia are also responsible for financial system stability and apply monetary policy to maintain price stability while remaining supportive of growth.BankNegara Malaysia also plays an important role in implementing initiatives to deepen and strengthen the financial markets, including the foreign exchange market.
This is to ensure all economic sectors and segments of the society have access to financial services. In addition, Bank Negara Malaysia also oversees the nation’s payment systems infrastructure which emphasize on the efficiency and security of the financial systems.
As the banker and adviser to the Government, Bank Negara Malaysia provides advice on macroeconomic policies and the management of public debt. Bank Negara Malaysia is also the sole authority in issuing the national currency and in managing the country's international reserves.
The method that used by Bank Negara to slow down the decline are moral persuasion whereby BNM continued to monitor closely the lending activity of the banking institutions during the year in order to ensure adequate access to funding for viable and productive investments. At the same time, limits on the institutions’ exposure to the property sector and for the purchase of shares were maintained. BNM also issued guidelines on credit risk management and a consultative paper to propose further amendments to the scope and definition of credit facilities and a single customer. Given the crucial importance of developing competent personnel to manage and control credit risk within banking institutions, an accreditation programme was introduced. This would ensure that personnel involved in credit appraisal, approvals and credit review were properly trained

Student Best Answer 3:

A moral suasion is a persuasion tactic used by an authority to influence and pressure, but not force, banks into adhering to policy. Non-official' tool of monetary policy which governments employ to persuade (instead of coerce through law making power) financial institutions in following suggested guidelines on the availability and cost of credit. Moral suasion is used typically by making policy announcements to induce the desired response, before resorting to mandatory compliance through statutory regulations. Bank Negara is using moral suasion to slow down the decline of Ringgit Malaysia by going into negotiations with Forex dealers from local and foreign financial institutions.