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Analysis
Malaysia governor on need for 'earthquake' defence

Malaysia governor on need for 'earthquake' defence

Connally's 1971 dollar jibe still valid

by OMFIF authors in Kuala Lumpur

Fri 2 Jun 2017

Muhammad bin Ibrahim, governor of Bank Negara Malaysia, warned Asian governments and central banks to protect themselves against erratic capital flows in a volatile multicurrency world affected by fluctuating monetary policies in the two biggest economies, the US and China.

Speaking at a joint meeting of the 20-nation South East Asian Central Banks organisation (Seacen) and OMFIF in Kuala Lumpur, Ibrahim described the international monetary system as 'unstable, prone to shocks, and broken.' Ibrahim suggested Asia requires 'earthquake-proof' protection through capital market regulations analogous to the high-resilience carbon fibre technology shielding Japanese buildings from tremors.

Ibrahim, who took over the head of one of Asia's most high-profile central banks last year, singled out Kuala Lumpur foreign investment on countries' bond markets as a possible source of instability. This demands vigilance, since international holders of ringgit bonds could withdraw funds relatively quickly and easily in reaction to negative economic or political news.

Malaysia's capital market has grown into one of the largest and most open in Asia. Foreign investors regard it as a focal point for cross-border transactions which can be reversed depending on fluctuating risks and returns elsewhere. This can lead to heightened vulnerability, Ibrahim said.

He described this as one of the 'unintended repercussions' of reinforcement of bond markets among the Association of Southeast Asian Nations since the Asian financial crisis of 1997-98. Asian countries 20 years ago were 'at the mercy of the original sin' of extended foreign currency borrowing, leading to 'currency mismatches' and a vicious cycle of currency depreciation, short-term outflows, default and instability.

In trying to rectify that challenge through developing local currency bond markets, Asean countries created another problem through exposure to international capital shifts once non-resident holdings passed 'a certain threshold'. Ibrahim is curbing holdings of offshore ringgit to prevent speculation against the currency, continuing the strict line of his predecessor Zeti Akhtar Aziz, who retired last year after 16 years in the job.

The governor's analysis of Malaysia's external capital flank ties in with statistics from the Asean Plus Three Monetary Research Office (Amro). This Singapore-based body was set up in the aftermath of the 1997-98 crisis and the Chiang Mai reserve pooling agreement to provide an early warning of regional economies suffering strains.

The Amro statistics single out Malaysia and China as having suffered a sharp deterioration since 2008 in the coverage ratio of foreign reserves against short-term foreign debt (in local and foreign currency). This highlights how higher leverage in both countries portends balance of payments pressures.

Ibrahim said countries had learned the lessons of the Asian crisis but had to watch out for fast-moving cross-border capital flows now that the world had entered a multicurrency system where a range of currencies played a role in international transactions and reserves as well as the dollar. The US currency's 'dominance' continues unabated, he said, even though others – the yen, the euro and now the renminbi – were put forward over the years as potential replacements.

Other countries remain susceptible to dollar shocks and the export of US economic problems. The governor added that the well-known quote from John Connally, President Richard Nixon's Treasury secretary in 1971 – 'The dollar is our currency, but your problem' – is as valid as ever.

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