Introduction

Malaysia has pegged their currency for almost five year after the Asian financial crisis. Does
this pegging really necessary for Malaysia in order to maintain the value of the currency?

Before knowing why, how or when the research will discuss more on the history of the
exchange rate system. History is the most important component in this report because it
shows how the currencies are managed and how it opened its gap towards speculative attack
on Malaysia currency thus creating the infamous Asian financial crisis in 1997.

Secondly, after knowing the history of Malaysia exchange system this research will take a
look into the current Malaysia exchange system. What is the implication that the government
and central bank imposed in order to avoid the history to repeat itself. To avoid this financial
crisis to occur again they have taken action by not floating the currency freely in the market.
If there any sign of undervalued occur the government and central bank will take an
immediate action to prevent it and closing the gap for another speculative attack.

Last but not least, the research will discuss on the background of Asian financial crisis. The
effect of this crisis are totalled which many have lost their jobs, inflation are at rise and the
political institution are at messy condition.
History of Malaysia Exchange Rate System.

The currency of Malaysia are called as Malaysian Ringgit (RM), it is formerly known as the
Malaysian Dollar (M$) in 12 June 1967. Prior to this date, the official currency was Dollar
Malaya which was also used by Singapore and Brunei. The value of Ringgit was “tied”
against the pound sterling at par value of 0.290299 grams of gold. After the Smithsonian
Agreement, the pound sterling appreciated due to increase in gold price from US 35 dollar to
US 38 dollar per ounce.This le to the increase in value of the Ringgit. When the pounds
sterling was floated on 23 June 1972, the Malaysian government was undecided in revaluing
the ringgit, but later the government decided to switch to the US dollar instead of the pounds
sterling as its ‘official currency’ in the foreign exchange market ( Talib, p. 14 ).

There is a very risky move to pegged one country’s currency upon another currency. During
the oil crisis in 1973, the US dollar became unstable. At the same time, the inflation rate in
Malaysia had skyrocketed ( Talib, p. 15 ). Which, forcing the Central Bank to take necessary
action to avoid fluctuation of RM, because one of the Central Bank function is to issue
monetary policy to safe guard the value of currency. Action taken by Central Bank is to float
the money by using “dirty float” principle. Dirty float can also be named as managed float
which its principle is the exchange rate can be intervened by the government in the
determination of the exchange rate. The mechanism used by Central bank managed to
maintain the value of ringgit that are supported with par value are stated around RM2.50 to
RM2.60 against US dollar, during 1986-90 the average value of RM/USD are stated with
RM2.63 and it shows a rise of RM from 1986-1995 with the average of RM2.60 for 1991-
1995 and RM 2.51 in 1996 ( Talib, p. 15 ). This regime had lasted until July 1997, when
BNM gave up sustaining the exchange rate in the wake of the Asian Crisis. Since September
2, 1998, the ringgit has been pegged to the US dollar at US$1.00=RM3.8010 ( Umezaki ,
2006 ).

Some insisted that the pegging was not necessary to overcome this financial crisis but some
does approve the action of our former Prime Minister Tun Dato’ Dr Muhammad. The
pegging done after 13months after the crisis began. During that time the Malaysia affected by
the crisis but it will be discussed more in the report under the title of Asian Financial Crisis.
Even after 13months we still able to stand on our feet with the crisis occurrence it shows that
Malaysia is a truly great country and are managed by one of the great Prime Minister of all
time in history of Malaysia.
Current Malaysia Exchange Rate System.

Malaysia pegged the RM to USD for almost the period of 1998/2005. This current year the
currency of Malaysia are free again. Even though it is free but it still not entirely free. The
ringgit is free but not floating freely. It is now under “managed” float. Cynics would
call it “dirty” float. To them, a “clean” float is synonymous with a “free” float. The latter
is labeled “clean” as the exchange rate under this mode is determined by supply and
demand for the currency without government interventions. In the economics literature,
there has always been a never-ending debate if the currency market should be left free or
be tempered. In practice, most governments do intervene, as it is too risky to let their
currencies to be exposed to the vagaries of market forces which tend to overshoot. Yet it
would be a costly mistake to ignore the market signals. Managed float provides a middle
ground where one can have the benefit of exchange rate flexibility without excessive
instability ( Ariff , 2005).

Furthermore, after RM try to float itself, it does not appreciate much in the market. Fret not
because the RM did appreciate against other major countries currencies. It is noted that RM
had appreciated by 12.5% against the Euro, 9.3% against Sterling, 9.2% against yen, and
7.4% against bhat between January and mid July of 2005. A gradual appreciation of the RM
against USD at latter time must be depreciate in the face of the ballooning deficit of balance-
of-payment in the United State ( Ariff , 2005).

In order to avoid history repeating itself, the Central Bank of Malaysia has set up a few rules
for both of the resident and for the non resident to be abide with. The objective should be able
to minimize exchange rate volatility without obstructing the secular trend. In other words, the
central bank’s role should not be to iron out short term fluctuations in exchange rates,
allowing the market forces of supply and demand determine the long run trends. This can
ensure that rate of the currency will always remain close to the equilibrium level ( Ariff ,
2005 ). The only mistake prior to financial crisis is letting the RM being overvalued to the
USD, thus making a speculative attack toward Malaysia’s currencies and dropped it to
become undervalued.
Rules that set up by BNM for resident:

Meaning of the resident here is that the person or organization that stays in Malaysia and
conducting transfer of exchange using RM as the home currency. Under resident rules set by
BNM there are divided into investment in foreign currency assets, borrowing onshore and
offshore, payment and receipts in foreign currency between residents, buying and selling of
currency, export of goods, foreign currency account, guarantees, securities, import and export
of currency and special status company.

There are no limit set up by the BNM where any resident who will try to invest in foreign
currency but there are only one rules that limit the RM, which is in the import and export of
the currency which it clearly stated that. Residents travelers are allowed to carry ringgit on
his person or in his baggage or in his possession, only up to USD10,000 equivalent upon
arrival or leaving Malaysia. ( BNM , 2013 ). This is to ensure that are no excess of money
demand from the market. Per say if the BNM did not set up this rule and travelers are allowed
to carry as much as they can, it would generate effect to the demand and supply of RM and
creating disequilibrium thus fluctuate the value of RM.

Companies which are called as are granted with Operational Headquarters ( OHQ ) and
Treasury Management Centre ( TMC ) are granted flexibility with the Foreign Exchange
Administration. Which OHQ Free to obtain any amount of foreign currency borrowing from
non-residents including financial institutions for own use in carrying out qualifying services
under their OHQ status ( BNM , 2013 ). For TMC there are many types of flexibility
provided by the BNM towards this granted company such as, free to undertake borrowing in
foreign currency and from any non-resident. The reasons behind this flexibility is to
encourage TMC to borrow from foreign which imposed low interest rate of borrowing and
invest the money in Malaysia.
Rules that set up by BNM for non-resident:

We already know that resident is person or organization that stays in Malaysia and
conducting transfer of exchange using RM as the home currency. The non-resident is vice
versa to its. Whereby non-resident is a person or organization that stays outside of Malaysia
and conducting transfer of exchange using their home currency against RM. Rules that are
provided by BNM towards non-resident is almost the same with resident rules with
investment in Malaysia, accessibility to domestic financing, settlement for trade in goods or
services, buying or selling of currency, foreign currency and ringgit accounts, securitie and
import and export of currency.

The non-resident rules are pretty strict rather than resident rules. Because the foreign
individual are capable of manipulate the value of currency if he/she possessed a lot of capital.
Event that can we take note is during the financial crisis where George Soros who are taking
advantage during fluctuation of RM and making profit towards it by just speculating the
prices of the RM value. Fret not because BNM are monitoring the value of RM and the RM is
not free floating in the market. If there any mass fluctuation in the market there would be
intervention from Malaysia government and Central Bank to float back the currency’s value.
Non-residents are free to buy or sell foreign currency against another foreign currency in
Malaysia only with a licensed onshore bank ( BNM , 2013 ). This rules are set to monitor the
inflows and outflows of the currency and there would be action taken if there any
manipulation of RM taken place. In contrast there are similarities of exporting and importing
currency with resident rules which is, Non-resident travelers are allowed to carry ringgit on
his person or in his baggage or in his possession, only up to USD10,000 equivalent upon
arrival or leaving Malaysia ( BNM , 2013 ).

Even with the rules available, the Malaysian markets are easily accessible by global
investors. There is free mobility for inflow and outflow of capital for investments in Malaysia
( BNM ,2013 ). Without investment from abroad how would Malaysia be a developed
county, even though with the strict rules amended by BNM there are still a gap available for
the manipulators to manipulate the currency but this rules is the blockage for them into taking
advantages of speculating and manipulating the value of one’s country currency.
The background of Asian Financial Crisis

East Asian Crisis was a financial crisis began in July 1997. It began in Thailand and then it
expanded and affected the other neighboring countries. It bring the asset’s prices to a record
low. The most affected are Indonesia, South Korea, and Thailand while Malaysia, Philippine,
Taiwan, and Laos had a moderate affect.

The crisis began on July 2, 1997 when the Thai Central Bank withdrew its support on its
currency Thai bhat which was ties to US dollar. Thai baht depreciated against US dollar as
soon as support from Thai Central Bank withdrawn. This made other region countries had the
same thing that happen and the financial crisis began. The first round of currency
depreciation happened in Thai baht, Malaysian ringgit, Philippine peso and Indonesian
rupiah. The second round of currency devaluation began with the Taiwan dollar, Brazilian
dollar, South Korean won, Singapore dollar and Hong Kong dollar.

An Investment Boom

In the mid of 1990s, SE Asia was having an investment boom with much of it financed by
borrowed money. Between 1990 and 1995 gross domestic investment grew by 16.3% per
annum in Indonesia, 16% per annum in Malaysia, 15.3% in Thailand, and 7.2% per annum in
South Korea. By comparison, investment grew by 4.1% per annum over the same period in
the US, and 0.8% per annum in all high income economies. Moreover, the rate of investment
accelerated in 1996. In Malaysia, for example, spending on investment accounted for a
remarkable 43% of GDP in 1996.

Excess capacity

As the investment volume booming up during the 1990s, so the quality of many of these
investments declined significantly. The investments were made on unrealistic future demand
projection. The result was the emerged of significant excess capacity.
The debt bomb

During early 1997, massive investment in industrial assets and property had created a
situation of excess capacity and price dropping and leaving the companies that had made the
investments groaning under huge debt. It becoming worst when much of borrowing made to
fund these investments happened in US dollars. At first, it was thought as a nice move, but if
the governments in the region could not maintain the dollar peg and their currencies started to
depreciated against the dollar, this would even make the debt become more bigger.
The Impact of Asian Financial Crisis

Impact on Economic :

The financial crisis indeed had made the value of Malaysian currencies depreciated. Before,
in April 1997 the ringgit was equivalent to 2.42 of the US dollar, later on it became RM4.88
to US dollar on January 7, 1998. Not only that, composite index (CI) of Kuala Lumpur Stock
Exchange (KLSE) also affected by falling down from 1,077.3 points in June 1997 to 262.7
points on September 1, 1997. Between July 1997 and mid-January 1998, approximately
US$225 billion of share values were wiped off and between July 1, 1997 and September 1,
1998, market capitalization in the KLSE fell by about 76% to RM 181.5 billion. Then,
Malaysia faced the biggest stock market plunge among all of other Asian countries. After
that, it led to a negative wealth effect which resulted in a general contraction of domestic
demand. Meanwhile, the increase in nonperforming loans (NPLs) of the financial sector was
reflected in a sharp downturn in borrowing and financing, bringing about tight liquidity.
Other than that, it displayed a declining trend over the period January until December 1998 in
foreign direct investment (FDI) level. So, it can be concluded from the information above that
investors tried to lower down the level of investment in order to avoid any lost during the
crisis. The decrease in both expenditure and investment of public sector was initially
expected, following the government’s intention of reducing the budget for operating expenses
by 18%, as well as cancelling or postponing several mega-projects. In order to reduce
government’s expenditure, civil servants’ salary were cut. Besides that, imports of luxury
goods had declined, as domestic demand slowed due to the depreciation of the ringgit.
Exports in the resource-based had increased, and resulted in a continued uptrend in ringgit
terms. However, when converted into U.S. dollar terms, most of the major export categories
displayed a downward trend.
Impact on society :

Inflation

Amidst the financial crisis, the inflation rate increased from 2.7 per cent in 1997 to 5.3
percent in 1998 (Syarisa Yanti, 2002). The main reason of increasing inflation rate was the
increase in food prices, as food items accounted for 34.9% of the weight in the overall
Consumer Price Index (CPI) basket. Roughly, there were 20% increased in the price of
controlled imported essential items. While there were 7.5% in total, increased of
miscellaneous goods and services and medical care and health expenses. For the second
largest sub-group, gross rent, fuel and power increased by 21.1% while clothing prices and
footwear increased by 0.4%. Lastly the third largest sub-group (transport prices and
communication) increased by 17.9%. The higher rate of inflation caused rising
unemployment rates, lower wages, and reduced real incomes.

Unemployment

Due to the financial crisis, Malaysia faced the problem of labor shortage, which made the
presence of migrant workers increased drastically. During the financial crisis, between
January and December 1998, the total number of workers retrenched was 83,865. Based on
data collected from January to September 1998, almost 88.1 per cent, or 52,834 of workers
were retrenched. According to Syarisa Yanti (2002), of

those retrenched between 1 January and 26 July 1998, 43,967 persons, or 89

per cent, were Malaysian workers, while the remaining 11 per cent consisted

of foreign workers.
Impact on Poverty and Income Distribution

Based on the findings of the Household Income and Expenditure Survey 1997, it can be
concluded that the incidences of poverty cases in Malaysia declined until 1997 but the real
household income started to decreased due to financial crisis in 1998 and poverty rate also
increased in 1998 from 6.8%(1997) to 8% in total while hard-core poverty increased from
1.4%(1997) to 1.7%. In the view of income distribution, in 1998, due to financial crisis, it
fell. the mean income of the bottom 40 per cent of households, especially in the rural areas,
remained stable, due to their ability to diversify their sources of income. Consequently, the
urban-rural income imbalance and overall income inequality improved slightly in 1998,
thereby reducing the widening gap experienced from 1996 until 1997.

Health

Public sector had always been bear the responsibility on health care of the people but during
the crisis, the demand of private sector hospitals and clinics drop of 15% to 50% due to
higher cost. Following the crisis, a 30 per cent rise in the cost of imported drugs, which
accounted for 60% of all drugs used in the country was recorded. Based on reports of
increased patient loads of about 18% until 20% experienced by government hospitals, it was
safe to conclude that a proportion of private sector patients transferred their patronage to the
public health care system.
Health

Crisis happened had disrupted the pattern of government expenditure on education, at least in
the short-term. Initially, the government announced a cutback of its expenditure by 2 per cent
as part of its strategy to handle the crisis; however, in December 1997, this cutback was
increased by an additional 18 per cent. The depreciated in value of ringgit also meant that
many family could not afford their child to study. According to the British Council survey,
the number of Malaysian students enrolled in British universities had fallen by over 44% in
1998, to 2,127 compared to 3,821 in 1997. At the same time, the government encouraged
students to stay in Malaysia for advanced studies, but Malaysian universities simply did not
have the capacity to absorb all of them. In 1998, 64 per cent of students applying for
university places were turned down in which there were 112,000 applications received for the
40,222 places that were available (Ching, 1999).

Impact on Political System

The political instability started by the split of deputy president of UMNO, Anwar Ibrahim
and the president, Tun Mahathir Mohammad and it then become more serious when the crisis
began. During the crisis, Anwar and his supporters tried to challenge Mahathir’s authority in
two ways. Firstly, Anwar’s supporters made the remark that Mahathir’s time was up and used
words such as like corruption, cronyism, and nepotism to make Mahathir step down as the
president of UMNO (Lee & Tham, 2007). Secondly, was the championing of Anwar by the
accepting international Monetary Fund (IMF) loans (Lee & Tham, 2007). The loan was
rejected by Tun Mahathir. Due to action by by Anwar, Mahathir responded by having Anwar
convicted of the sodomy and corruption (Lee & Tham, 2007). The charge of sodomy was
successful enough that it resulted in Anwar’s resignation. There was increased momentum in
the campaign for greater transparency, more political freedom, and abolition of the internal
Security Act, which permitted detention without trial (Colin & Francis, 2003, p.69).
Conclusion
As a conclusion, the Asian financial crisis was a period of financial crisis that gripped much
of East Asia beginning in July 1997 and raised fears of a worldwide economic meltdown due
to financial contagion. A speculative attack was the cause for the Asian financial crisis in
1997, in which Malaysia itself was caught in this crisis. Asian countries suffered heavily as a
result of the financial crisis in which none of them managed to completely evade from the
crisis. Later, severe economic problems; a number of the multinational companies and
enterprises had gone bankrupt and this increased the unemployment rate. The financial crisis
was worsened due to wrong policy responses, anti-market rhetoric, panic, and excessive risk-
taking which damaged the balance sheets of banks and corporate sectors. The financial crisis
affected the economy, society and politics in Malaysia, which made it hard to recover from
the slump in just a few years.
References
Abdul Latib Talib. Pegging The Ringgit Against The US Dollar : An Evaluation ( 2004 ).
Retrieved November 19, 2014 from
http://www.statistics.gov.my/portal/download_journals/files/2004/Volume1/Contents_Article
_abdul.pdf

Bank Negara Malaysia. Rules Applicable to Residents ( 2013 ).

Retrieved November 19. 2014 from
http://www.bnm.gov.my/microsites/fxadmin/new_fea_rules/FEA_rules_Part_1_Residents.pd
f

Bank Negara Malaysia. Rules Applicable to Non-Residents ( 2013 ).

Retrieved November 19. 2014 from
http://www.bnm.gov.my/microsites/fxadmin/new_fea_rules/FEA_rules_Part_2_Non-
residents.pdf

Emeritus Professor Dr Mohamed Ariff. THE RINGGIT’S NEW-FOUND FREEDOM

( August 1, 2005 ).
Retrieved November 19, 2014 from
http://www.cpiasia.net/v3/images/policy_papers/The%20Ringgit's%20New-
Found%20Freedom.pdf

Sayed Hossain (June 20, 2005). Freeweb. Retrieved from

http://www.freewebs.com/sayed_hossain/asianfinancialcrisis.htm
University of Washington.(n.d.). The Asian Financial Crisis.
Retrieved November 19, 2014 from http://www.wright.edu/~tdung/asiancrisis-hill.htm

So Umezaki. Monetary and Exchange Rate Policy

in Malaysia before the Asian Crisis ( December , 2006 ). Discussion Paper No.79

Zaherawati Zakaria, Zaliha Hj. Hussin, Nazni Noordin & Mohd Zoolhilmie Mohamed
Sawal (2010). Voice of Academia Vol.5 No.1, 80-87.