Thursday, September 21, 2017

Let the kyat fall

As the spread between the official and unofficial foreign exchange rate widens, economists argue the central bank should relax controls and allow the kyat to depreciate to the market rate.

Since the Central Bank of Myanmar floated the currency at K818 to the US dollar in April 2012, it has depreciated by 32 percent. At first, the market rate remained largely in line with the reference rate, but over the past three months, the spread has widened.

Two weeks ago, the Central Bank issued a directive to Myanmar’s licenced financial institutions, forbidding them to trade outside a 0.8pc band around its official reference rate. The official rate is published each day by the Central Bank. Since the directive was issued, this figure has remained unchanged at K1082. Meanwhile, the unofficial rate has fallen to K1180 and small money changers in Yangon continue to offer the weaker rate.

The Central Bank is enforcing restrictions on trading foreign exchange to increase stability in the local currency, according to a Central Bank official. “We don’t have a pre-determined exchange rate, our role is to intervene to ensure there is no volatility or fluctuation,” he said. However, experts say the wide spread between official and unofficial rates is actually increasing volatility.

“The kyat intra-day trading range has soared, reflecting a highly volatile daily trading environment. This has underscored the significant level of risk in holding the still-fledgling currency,” said a May 13 report by BMI Research. BMI has downgraded its end-2015 forecast for the currency to K1120 from K1060.

If the gap between the official and unofficial rate persists, it could lead to distortions in the market, said Koji Kubo, research fellow at the Japan External Trade Organization in Bangkok. “In such a context, targeting the exchange rate in a certain level or range could distort the foreign exchange market, resulting in outflows of the Central Bank’s foreign reserves or the emergence of multiple exchange rates,” he said.

However, some fear that if the Central Bank allows the currency to devalue freely it may lead to increased inflation. While a strong US dollar accounts for some of the currency weakness, it is mostly due to a growing trade deficit that shows no signs of reversing.

“This country is susceptible to imported inflation given the impact of a fast devaluing currency on a rapidly expanding import bill,” said Vikram Kumar, resident representative for Myanmar at the International Finance Corporation.

Myanmar’s trade deficit has risen quickly since fiscal year 2012, when the country recorded a surplus of US$100 million. In FY2013, the deficit was $91 million, rising to $2.6 billion in FY2014, according to statistics published by the Central Statistical Organisation. In FY2015, the deficit jumped another 88pc to over $4.6 billion, according to the Global New Light of Myanmar.

Year-on-year inflation this January was 7.39pc according to the CSO. The Asian Development Bank’s (ADB) fiscal year 2015 figure is 8.4pc. Rising inflation is a concern, particularly as those with the lowest incomes will be hurt the most.

Furthermore, downward pressure on the kyat is likely to increase. Gas is one of Myanmar’s major exports, and in many cases the sales price is indexed to gas prices with a one-year lag, so the full impact of falling global gas prices has not yet been felt in Myanmar, according to Mr Kumar. “On the other hand, imports are galloping to feed a hungry economy,” he said.

Adding to the pressure is the fact that illegal sales of timber, gems and drugs are often made in kyat, with the proceeds converted into US dollars. Speculation can also weaken the currency.

On the other hand, a weaker kyat means that Myanmar’s exports become more competitive, a positive outcome for local exporters of commodities such as rice, pulses and beans, marine products, and also garments.

“The kyat does not need ‘support’, partly because we do not know if it is under- or over-valued. Two years ago, there was much commentary about it being ‘too strong’ and that it should devalue to support Myanmar exporters. Maybe it is at equilibrium now, maybe not, but I don’t think it is way out of line,” said Adam McCarty, chief economist at Mekong Economics.

A useful indictor for export competitiveness is the real exchange rate, said Mr Kubo. This shows how many more times something can be bought overseas after conversion into a foreign currency, than in the local market for the same price.

“Two points are notable. First, in the past 12 months, real exchange rates compared to the US dollar and Thai baht did not depreciate markedly despite the depreciation of the kyat in nominal terms,” he said. This is largely because inflation in Myanmar is higher than in the US and Thailand.

“Second, the real exchange rates remain appreciated compared to levels in the pre-reform period. For Myanmar’s non-resource export sectors to recover their competitiveness level in 2010, we still need an additional 5pc to 10pc depreciation.”

Furthermore, Mr Kubo believes depreciation in the kyat won’t translate into increased inflation. “The depreciation of kyat might bring in inflation via two channels. One is a rise in prices of imported goods in terms of kyat. The other is through increased exports of rice and tradable goods, leading to a rise in prices of these goods in the local market,” he said.

Based on the connection between prices and exchange rates in Myanmar in the past, there is no clear link between the exchange rate and the Consumer Price Index (CPI) or the rice price, he said.

“On the contrary, the trend of CPI is largely influenced by the rice price, due to the way it is composed. Roughly speaking, CPI is a weighted average of the prices of a bundle of consumption goods. In that bundle, rice usually accounts for a high weight, whereas imported goods do not in the case of Myanmar,” he said.

This suggests that rice price stability is more important than the stabilisation of the exchange rate for ordinary households in Myanmar, he said.

On the other hand, the profitability of import businesses and foreign companies operating in Myanmar is likely to be hurt by the depreciating currency. This could be mitigated by the introduction of hedging facilities such as forward contracts, which some of the international banks are reportedly looking to establish.

Meanwhile, instead of enforcing controls that may lead to distortions and foreign reserve outflows, the government should focus on encouraging long-term foreign direct investment (FDI), said Mr Kumar.

“This is the only way to offset the current account deficit and this should help stabilise the currency over the medium term,” he said.

“There is significant FDI coming into resource intensive sectors like oil, gas and mining and potentially into real estate, but not much into other key sectors like infrastructure, agriculture, and financial markets, sectors that would underpin the long-term growth story for Myanmar.”