Possible floating of the Malaysian Ringgit?

April 14 (Bloomberg) -- Nor Mohamed Yakcop recalls being summoned to fly from Kuala Lumpur to Buenos Aires by Malaysian Prime Minister Mahathir Mohamad in September 1997. The ringgit was sinking amid the Asian financial crisis and Mahathir, on a state tour of South America, wanted Nor to explain why.

``I told him, `Sir, how much time do you have?''' says Nor, a former central-bank adviser. Mahathir, after listening for two hours, asked Nor to write up the briefing and see him in 12 hours, says Nor, 57. ``I didn't sleep for three days.''

A plan hatched by the pair after that meeting fixed the ringgit at 3.8 to the dollar the next year, halting speculator bets that had helped it plunge 31 percent in 12 months against the U.S. currency. Malaysia also imposed controls to curb ringgit trading. While the International Monetary Fund called the policy ``a step back,'' the country's economy since 1998 has grown by 5.2 percent on average each year -- a pace bettered only by China and South Korea in East Asia.

Now Nor, the country's second finance minister, may need to take charge of dismantling the peg. The market speculators Malaysia tried to thwart are returning as the U.S. pressures China to let the yuan appreciate and the dollar falls worldwide. They are betting that the value of their Malaysian assets will rise with the currency once the peg is removed.

Malaysia's economy expanded last year at 7.1 percent, the fastest pace in four years. Inflation is at a five-year high, while lending rates are at their lowest level since 1990.

``The economic fundamentals clearly suggest that Malaysia's currency is ready to move,'' says Stephen Green, 32, a senior economist in Shanghai at Standard Chartered Plc.

`Hot Money'

Malaysia became the only country to outpace China last year in boosting foreign-exchange reserves as a percentage of gross domestic product as new investment flowed in, Green says. Malaysia's reserves last year rose by about 14 percent of GDP, compared with 11 percent to 12 percent in China.

In the seven months ended March 15, the amount of foreign currency held by Malaysia's central bank surged by more than a third to a record $73.2 billion, bank figures show. Investors abroad bought $2.9 billion of ringgit-denominated assets in the last three months of 2004, including a record $1.3 billion of government bonds and $1.1 billion of stocks.

``The hot money has increased in the last few months,'' says Philippe Sachs, a country analyst at Standard & Poor's in Singapore. Malaysia should de-link now before pressure builds further, he says. ``It's probably best to make a move before your hand is forced.''

The central bank, Bank Negara, will have trouble controlling the flow of capital coming in and managing inflation at the same time, Ong Sin Beng, an economist at JPMorgan Chase & Co. in Singapore, said in a report last week.

Stability

Investors may raise their stakes in Malaysia even more if the bank increases interest rates in a bid to damp rising prices, Ong said. Inflation accelerated to 2.4 percent in January and February from 1.4 percent on average in 2004.

Phoon Chiong-Tuck says he's bought ringgit bonds on expectations the currency will be allowed to appreciate in the next six months to a year. He probably will raise his bets if China moves first to unchain its decade-long peg of about 8.3 yuan to the dollar, he says. Phoon, who helps oversee $45 billion for Frankfurt-based Deutsche Bank AG's asset-management unit in Singapore, declined to say how much he's invested.

Malaysia's peg provides stability, says Joseph Stiglitz, a former World Bank chief economist and winner of the 2001 Nobel Prize for economics, who supported Mahathir's plan. Flexible exchange rates can hurt exports and slow growth, he says.

`Brilliant'

Stiglitz, 62, visited Malaysia in January. He met both Prime Minister Abdullah Ahmad Badawi and Mahathir, 79, who retired in 2003 after 22 years in power.

``The way Malaysia managed its controls was brilliant because they were able to stop the speculative flows without impeding foreign direct investment,'' says Stiglitz, now an economics professor at Columbia University in New York.

In addition to pegging the ringgit, Malaysia imposed controls that trapped $18 billion of international funds in the country. It also restricted currency transfers between offshore accounts and limited how much Malaysians took overseas. The result: a halt to capital flight, which had wiped 67 percent from the Kuala Lumpur Composite Index in the 12 months through Sept. 1, 1998.

Starting this month, overseas and local investors can enter into foreign-currency forward contracts to reduce exchange-rate risks, Bank Negara Governor Zeti Akhtar Aziz said on March 23. She also eased restrictions on Malaysian exporters, fund managers and individuals investing abroad.

Borrowing Surge

``The key message the administration wants to send to the market is that they are removing the controls they put in 1998,'' says Irene Cheung, head of Asian sovereign and currency strategy in Singapore at ABN Amro Holding NV. ``The ringgit peg is the last piece to go.''

Even so, Governor Zeti also said March 23 the peg would stay. Malaysia's returns on its reserves are covering borrowing costs, she said on March 1. The bank can manage the inflows and won't need to raise interest rates, she said.

Bank Negara has borrowed more than 50 billion ringgit ($13 billion), up from less than 8 billion ringgit in September, to mop up excess funds, JPMorgan's Ong said in a Feb. 25 report. The bank's balance sheet last showed a similar surge during the Asian crisis, he said.

Malaysia was one of the few emerging-market countries in Asia that didn't have to seek IMF help during the crisis. Thailand, South Korea and Indonesia received bailouts totaling about $100 billion as their currencies and markets plummeted.

IMF Recants

After its initial criticism of Mahathir's plan, the IMF recanted. Managing Director Michel Camdessus endorsed the idea of capital controls at a conference in Hong Kong on May 17, 1999.

``Consensus seems to be emerging that controls may have a place when there's risk of a crisis, but only as a breathing space while other fundamental measures can take effect,'' he said. An IMF report that year said the capital controls had helped Malaysia and the pegged exchange rate was ``more appropriate'' than a flexible rate.

Nor calls the plan devised during seven months of almost daily meetings with Mahathir in 1997-1998 unorthodox. It took an additional five months for Mahathir to persuade his officials to set it in motion, Nor says.

Casualties included central bank Governor Ahmad Mohd Don and Deputy Governor Fong Weng Phak, who both quit after their advice to raise interest rates was ignored. Mahathir also fired Deputy Prime Minister and Finance Minister Anwar Ibrahim on Sept. 2, 1998, the day the peg was announced. Anwar, who later was jailed on corruption charges, had favored increasing rates.

Dollar's Decline

Nor says economists estimate the ringgit now is undervalued by 5 percent to 7 percent, which is not enough to warrant loosening the peg. Sani Hamid, an economist at Forecast Ltd. in Singapore, says it's more like 11 percent. Zurich-based UBS AG and Charlotte, North Carolina-based Bank of America Corp. forecast the currency will appreciate 8 percent to 11 percent against the dollar by the end of the year.

The ringgit has mirrored the dollar's 7.7 percent decline against the euro in the past 12 months, according to data compiled by Bloomberg. By contrast, the Thai baht gained 13.4 percent on the dollar in the three years through 2004, Indonesia's rupiah 12.3 percent and South Korea's won 27 percent.

The U.S. Federal Reserve on March 22 raised its benchmark interest rate a quarter point to 2.75 percent, higher than Malaysia's overnight policy rate of 2.70 percent for the first time in 11 months.

Lose Control?

``As long you are pegged to some other country's currency, your monetary policy is still following that place,'' says Bryan Yip, who manages about $3 billion at Standard Life Investments in Hong Kong. ``Basically you lose your own control.''

In addition, the time is right for China to adjust its exchange-rate policy, according to He Fan, a senior economist at the state-run Institute of World Economics and Politics at the Beijing-based Chinese Academy of Social Sciences. The daily Shanghai Securities News reported his comments on April 1.

The U.S. Senate last week approved debate on a proposal to levy a tariff on all Chinese-made goods unless China allows the yuan to appreciate.

An economics graduate with a master's in business administration from Belgium's Catholic University of Leuven, Nor quit as a central-bank adviser in 1994 after the bank lost $3.9 billion on currency bets in 1992 and 1993.

He returned to Bank Negara as an adviser in September 1998, then served from 2000 to 2004 as an adviser to the prime minister's office. Prime Minister Abdullah, who is also finance minister, appointed Nor second finance minister in January 2004.

The dollar will remain Malaysia's preferred anchor for the ringgit, Nor says. While officials will continue to monitor the rate, there's no need for change at the moment, he says.

``In a pegged regime, the changes should be far apart and infrequent,'' Nor says. ``There's a principle involved.''

To contact the reporter on this story:

Stephanie Phang in Kuala Lumpur at sphang@bloomberg.net.

To contact the editors responsible for this story:
Adrian Kennedy adkennedy@bloomberg.net;
Anne Swardson at aswardson@bloomberg.net.