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In 1998 Ringit 3:80 = $1 2014 Ringit 3:47 = $1
PPP GDP $750 billion
Exports 2014 $250 billion
Imports 2014 $200 billion
Per capita income PPP 2014 $25,000
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A Malaysian Alternative Strategy for Russia?
Let me get to a quiz:
What are the problems with the Russian economy: lack of credit, high interest rate, printing-press based Ruble emission, reduction in the volume of money inside Russia, lack of government investment, etc.?
Lastly, maybe you could explain why so many incompetent/anti-Russian people are working in Russia banking and the government?
First of all, let say , that reforms of Russian economy since 1990s were merely based on introduction of Williamson's ten points or so-called "Washington consensus".
1. Fiscal discipline (avoidance of large deficits relative to GDP)
2. Redirection of public spending from subsidies to education, health care, infrastructure
3. Tax reform (broadening tax base), moderate tax rate
4. Interest rates - determined by market, moderate, but positive
5. Competitive exchange rates
6. Trade liberalization
7. Liberalization of foreign direct investments
8. Privatization of state enterprises
9. Deregulation: abolition of regulations that impede market entry or restrict competition
10. Legal security for property rights
All sounds great and logical, isn't it? Government has to implement it one by one and their job was to translate these rules and practically implement. Simple!
This is were the mantras of ministers are coming from ( fiscal discipline- "no extra budget spending!", interest rates hikes - it must be "positive" , "privatization at all cost!", etc). For last 20 years same people were repeating the very same mantras, losing ability of critical thinking and becoming a quasi-religious sect. They had an easy job, not requiring from them any creativity nor intellectual efforts, just discipline!
Note: Key point here is p.5: competitive exchange rate.
De facto monetary policy in Russia is so called "currency board": when national money supply is always equal to the size of foreign currency reserves. This is a very much rigid design, which forces national money supply fluctuate on line with currency reserves and reserves to fluctuate in accordance with trade conditions. If the latter link between trade conditions and currency reserves is justified, former does not and make sense only for very small countries fully relying on foreign trade (like some African countries). Another words, national money supply growth can come from only 2 sources: export and foreign investments.
When there is lack of domestic money where enterprises and banks can get liquidity? They can borrow abroad, in Dollars, of course! This is why offshore economy was booming. To reduce borrowing rate corporation register HQ in offshore zone and direct its export revenue toward this HQ.
Monetization of Russian economy (Money volume to GDP, %) is way too low: in 2013 it was 47%, less then any other BRICS economy, next to Paraguay only with 46% monetization. For example, monetization in Brazil in 2012 was 81%, India - 76%, China -195% . Average monetization rate worldwide is 125%. Lets put it simple. Money is a blood of economy. In Russian economy there is not enough blood. That is why its too weak. It is prime source of high interest rates- high demand for rare commodity (money) makes it expensive. This is also source of monetary inflation. Yes, not exuberance of cash, but its deficit. Manufacturers transfer high interest borrowing costs to the prices. This subject is well researched by economists, and explain direct relationship between low monetization and inflation in Russia. Ruble free float exchange policy is even worse to Russian economy then previous policy of so called "dirty" exchange rate when Central Bank was intervening and sold foreign currency every time when ruble brake out of the artificial corridor set up by Central Bank itself. It was a channel to provide ruble liquidity by buying currency from market and supplying ruble to economy, increasing its monetization.
Author was participating in a close door event 2009 in Moscow - a financial conference of late Egor Gaidar and Nouriel Rubini (Dr. Doom) were even notorious Gaidar was making case for dirty-float of ruble, suggesting to "his friends and colleagues in the Government and Central Bank who determine the monetary policy" to let ruble depreciate while crude oil prices are falling - main source of foreign currency revenue! (oil prices then were in a free fall from $135 to $40). Central Bank then was trying hard to keep peg of ruble to currency basket (Euro+Dollar) i.e. fixed nominal exchange rate to basket. So, Gaidar made a conclusion, that for Russian economy, export oriented and commodity driven neither exchange policy is good : not free float nor fixed rate, only "dirty" or "manageable" rate (by whom? illuminated Central Bankers who know better?). Dr, Roubini tend to agree with him. Unfortunately, none of current bosses of Central Bank nor Ministery of Finance were not present at that function and Gaidar's advice was not delivered to them. Nobody at the conference even mention another policy tool: capital control (more on this below). Indeed, they were liberals and it was a total blasphemy, contradicting p.5 & 9 of Washington consensus !
Sufficient money supply is vital for low interest rates and boom in manufacturing and agriculture. Alas, Central Bank of Russia monetary policy is opposite to common sense and policy of other Central Banks.
Strange, isn't it? Are these people intentionally making harm to domestic economy or they are simply ignorant and incompetent? It seems there is a combination of both factors.
Last 20 years SysLibs (system liberals) had a comfortable life: they perfectly knew the agenda: what to say (see Williamson's ten points above) and what to do (same 10 points). Now they have an acute cognitive dissonance crisis. What their Boss (Putin) is saying them to do contradict to their credo.
When countries around the globe were facing currency crisis IMF has a standard prescription, sorry, common loan conditionality:
• Floating of the currency.
• The capital account should remain open, and in fact financial liberalization should be deepened. Capital controls were not allowed. Foreigners and locals were allowed to take out and bring in funds with no or little restriction.
• Sharp increase in the interest rate (to counter inflation and to maintain investor confidence in the local currency).
• Contractionary monetary policies.
• Austere fiscal policies.
• There should be no or minimal government financial assistance to local banks and companies facing difficulties. In Indonesia and Thailand, the governments were asked to take measures to close down several financial institutions.
• Liberalization of foreign ownership in local assets and companies, e.g. after 1998 crisis Thailand raised its limit on foreign ownership of local banks from 10 to 100 per cent; South Korea raised the foreign ownership limit in local companies listed on the stock exchange from 10 per cent eventually to 100 per cent, and Indonesia’s Letter of Intent specified allowing foreign ownership of plantations and wholesale trade.
• Privatization of state enterprises and agencies and state economic activities.
• Reduction or elimination of state subsidies
That is exactly what Central Bank/ FinMin of Russia are doing now.
Since May 2014 Central Bank of Russia (CBR) has a "hands-off" policy on forex market, hence CBR play important role of market-maker on MICEX USDRUB turnover - historical average is 10% of turnover, sometimes could be up to 60%. It was NOT participating in the market and made NO interventions from May to October 2014 (source: CBR, MICEX,research). Basically, Ruble was de facto in a free float since May till October 2014. Exchange rate was in a free fall accordingly due to open capital account, reduced foreign direct investments, capital outflow and speculative attack on Ruble.
Last week currency market in Russia was in "St. Vitus' dance mode". Intraday USD-Rub rate was easily in 10% swing and bid-offer spreads were between 1,5-5 Kopecks (to illustrate magnitude of change - in normal times this spread is 0,25 Kopecks- up to 20 times !!! ) spreads for retail bank client between offered rate and bid rate were 3 rubles !!! - unheard of since 1998 default. What is really going on with the Central Bank? Overall I had pretty good idea on theoretical side- what teaching Central bankers are using, since one of my tutors - professor of macroeconomics is lecturing central bankers on same absurd staff he taught us. When I was asking him "out of the box" questions or pointed fact of life that contradicts those theories he refused to answer or provide reasoning. It is a sect-like teaching,disconnected with real world, treating any doubt as blasphemy and considering alternative schools as heresy. This professor of macroeconomics now works at High School of Economics (HSE) in Moscow where Central Bank Governor's husband is Rector. It was not good enough. Last few days I spent talking to my friends in the banking to gain insight into the real-life story.
Central Bank's two ladies, who are in charge now, never worked at any commercial bank or real economy- they are theorists (perfected in absurd American "Economics" -like theories) and since appointment to the main Bank were getting advice from people from HSE and internal Central bank analytics.
They tried all classical prescriptions (IMF-orthodox, of course) to keep currency in check at the time of high capital outflow. They raised interest rates twice. They provided Dollar (sic!) liquidity (expensive) to the market, etc,etc. None of their advices from the book-shelf were helpful. These tricks simply did not work in the real world, especially in extraordinary situation. Then those geniuses had to turn (sic!) to commercial banking professionals: real-world experts and are getting advice from them, as of now.
However, in regulating the market the most important thing is confidence. Regulator has to be committed to the things he (she) is doing, his line has to be known to the market participants and market should learn in a hard way that this line will be enforced by "whatever it takes". It can begin with verbal intervention and then followed by using the set of instruments from usual market arsenal to administrative measures, even to restrictions of capital movement. Funny enough its there ready available. Like Central Bank Normative of obligatory sale of export revenue by exporters which was set to zero since 01.01. 2007.
Some of the experts are saying, that it looks like situation on the market is "beyond the repair". At list with those two charming ladies in charge. Nobody trust them. Market doesn't understand their policy , strategy nor tactics. Its total chaos.
May be weakness of local currency is good for economy, one could ask?
Currency depreciation has some sever negative effects.
First, an increase costs of external debt servicing for both banks and corporations, which borrowed in foreign currency (mostly USD), but making revenue in local currency (RUB). Total external debt of banks and corporations is higher than CBR currency reserves now (over $600 Bln. vs. $400Bln. However, intra-group loans and FX liquidity reserves not accounted in CBR statistics makes this picture not so gloomy. This is where so-called "offshorization" plays its positive role- some Russian group of companies maintain their head offices or branches or financial companies in tax havens or in Switzerland or UK or elsewhere, making them profit centers for the Group and building currency reserves overseas, then lending money to their Russian industrial divisions. In fact, nobody know how much of the foreign debt is due to genuine foreign creditors and how much for Russian business itself.) Second, permanent unpredictable and volatile change of currency rates are destabilizing for merchants and enterprises who are unable to do business in a predictable way as price for imported goods are changing. Third, persistent decline of currency contributed to sharp fall in value of shares on a stock market (MICEX) and lead to outflow of foreign portfolio funds from stock market. One positive effect was for exporters , who obtained higher revenue.
Another concern of even larger capital outflow, as a confidence of foreign and domestic business in economy.
Due to serious adverse effects of currency depreciation issue of stabilizing Ruble should be MAJOR concern of monetary and financial authorities.
Those negative effects "financial" in nature, not originating in economy itself.
First of all, let me explain how the speculation against a currency works.
Its pretty simple. Speculator sell Ruble "short" and buy US Dollar or Euro. There at least two ways of short-selling: a) sell it on a forward market at the current rate in view to deliver Ruble at future date; b) speculator borrow Ruble in order to sell it on spot market and keep the Dollar. Spot market for USDRUB exist on MICEX (exchange) which is transparent online or interbank market (also transparent via banks daily FX reporting) for CBR, while forward market is not and business conducted between banks and their clients or between the bank (onshore or offshore). Obviously, Bank in London can sell on offshore forward market Ruble and buy Dollar for future delivery and utilize only 5-10% of capital for such trade, i.e. deal with notional $100 mln. purchase would require $5 mln. Dollars of their capital allocation (don't mixed with outright payment). Weaker local currency is - better-off "short" -seller became, market value (mark-to-market) of their trade is increasing when RUB depreciating. This is self-fueling forest fire.
When the ruble depreciated, the speculators could reap the profit. In case a), the speculator delivers the agreed ruble amount at the previous rate and obtains the agreed Dollar amount, which in turn can now be exchanged for greater amounts of ruble (since the ruble has since depreciated). In case b), when the time comes for the speculator to repay his ruble denominated loan at the previous exchange rate, he needs to use only a part of the Dollars he has accumulated (as the ruble has now depreciated) and the balance of the Dollars is his profit. Speculation on the ruble is carried out not only in the local markets but also abroad (mostly in London).
Now, we came to a question:
Is there a plausible alternative to orthodox IMF-style policy in financial-economic crisis management?
Answer: Yes, indeed. There is an alternative, successful one. We can turn to the success story: Malaysian experience in financial-economic crisis management and make case study in a next Chapter.
Malaysian Alternative Strategy
During the crisis in 1998 as financial and economic situation deteriorated
Malaysian government decided to adopt a different strategy then IMF advised. Development of this strategy is usually attributed to The Prime Minister of Malaysia at that time, Dr. Mahathir Mohamad (by the way he is a doctor, not of nonsense "Economics", but doctor of medicine).
This new strategy was not adopted all at once, but stage by stage and part by part as developments unfolded.
Firstly, on the institutional side, a National Economic Action Council (NEAC) was formed in January 1998 to take overall charge of economic crisis management. Previously the Finance Ministry took the lead in managing the crisis, and now the decision-making centre shifted to the Prime Minister’s Department which hosted the NEAC. The Council was chaired by the Prime Minister and comprised several Federal Ministers, the Chief Ministers of the state governments, several government agencies, and representatives of industry. It had an executive committee led by the Prime Minister and included the Deputy Prime Minister, Finance Minister, Executive Director of the NEAC Secretariat and some key economics-related officials (including the Central Bank Governor, the Director General of the Economic Planning Unit and the Secretary General of the Treasury) and a few individuals. A new NEAC Secretariat was established in the Prime Minister’s Department, with an Executive Director and full-time staff drawn initially from the Economic Planning Unit (the country’s main planning agency), and it was also serviced by a Working Group of five individuals drawn from business and academia.
The establishment of this high-powered Council with almost over-riding authority to deal with the economic crisis on an emergency basis, was a central and structural aspect of the Malaysian model of crisis management. Eventually it was the NEAC that drew up an alternative medium-term strategy to deal with the crisis. But it also intensely monitored all aspects of the economy and made decisions on a day-to-day basis. The NEAC executive committee chaired by the Prime Minister met every day for several hours to receive feedback on the implementation and effects of policy decisions and to make decisions on new measures. The NEAC was also able to cut through the usual territorial compartmentalisation of the various Ministries and agencies, and take decisions in a coordinated way.
A National Economic Recovery Plan was then formulated and launched on 23 July 1998. Its objectives were to stabilize the currency, restore market confidence, maintain financial market stability, strengthen economic fundamentals, continue the equity and socio-economic agenda, and revitalize affected sectors.
On 1 September 1998, measures were announced by the then Prime Minister Dr Mahathir Mohamad relating to the currency and to mobility of capital flows. They were aimed at stabilizing the level of the local currency (through fixing of the exchange rate to the US Dollar); preventing overseas speculation on the value of the local currency and local shares (by banning the overseas trade in these); and reducing capital outflows (through selective capital controls). This set of measures was a watershed as until then it had been almost taboo for economists let alone governments to even discuss capital controls. By coincidence, a week earlier the American economist Paul Krugman had broken the intellectual taboo by advocating that Asian countries should adopt exchange controls, in an article in Fortune magazine.
The Malaysian move involved measures to regulate the international trade in its local currency and regulate movements of foreign exchange, aimed at reducing the country's exposure to financial speculators and the growing global financial turmoil. The policy package included officially fixing the Ringgit to the US Dollar, deinternationalising the trade in the Ringgit, a one-year moratorium on the outward transfer of foreign-owned funds invested in the local stock market, and strict limitations on the transfer of funds abroad by local residents.
The rationale for the move was explained by Dr Mahathir in a television interview on the day the measures were announced. Asked whether the exchange control measures were regressive, he said they were not so, but instead it was the present situation, where currency instability and manipulation was prevalent, which was regressive. He said that when the world moved away from the Bretton Woods fixed‑exchange system, it thought the floating rate system was a better way to evaluate currencies.
"But the market is now abused by currency traders who regard currencies as commodities which they trade in. They buy and sell currencies according to their own system and make profits from it but they cause poverty and damage to whole nations. That is very regressive and the world is not moving ahead but backwards." He added the Malaysian measures were a last resort. "We had asked the international agencies to regulate currency trading but they did not care, so we ourselves have to regulate our own currency. If the international community agrees to regulate currency trading and limit the range of currency fluctuations and enables countries to grow again, then we can return to the floating exchange rate system. But now we can see the damage this system has done throughout the world. It has destroyed the hard work of countries to cater to the interests of speculators as if their interests are so important that millions of people must suffer. This is regressive."
Dr. Mahathir added the Malaysian measures were aimed at putting a spanner in the works of speculators, and taking speculators out of currency trade. He said:
“The period of highest economic growth was during the Bretton Woods fixed exchange system. But the free market system that followed the Bretton Woods system has failed because of abuses. There are signs that people are now losing faith in this free market system, but some countries benefit from the abuses, their people make more money, so they don't see why the abuses should be curbed."
The elements of the Malaysian strategy included:
* Selective Capital Controls
It should also be noted that the ruling, in existence before the outbreak of the crisis, prohibiting local companies from obtaining foreign-currency-denominated loans from abroad unless these were for activities that earned foreign exchange, remained in force.
The capital controls were selective in that they covered movements of funds in the capital account. In the case of foreigners, they covered mainly some aspects of portfolio investment. In general, the Ringgit was still to be freely (or at least easily) convertible to foreign currencies for trade (export receipts and import payments), inward foreign direct investment (FDI), and repatriation of FDI-related capital and dividends by non-residents. In the case of local residents, the capital controls covered a wider range of activities, and in fact the aim of preventing the flight of local-owned capital was to be just as important (if not more) than the controls imposed on foreign-owned funds. However, there was no control on currency convertibility by local residents for purposes of trade. Convertibility up to a certain limit was also allowed for certain other purposes, such as the financing of children's education abroad. But convertibility for autonomous capital movements for several purposes not directly related to trade was to be prohibited or limited.
* Stabilizing the Currency and fixing the exchange rate.
Stabilizing the exchange rate became about the most important objective. The NEAC studied the experiences of many countries. It was decided to adopt a fixed exchange rate system, i.e., fixing the Ringgit to the US Dollar. This would NOT be done through a Currency Board system (as adopted by some other countries) because in this system the country’s money supply would be linked to the level of the country’s foreign reserves. In the Malaysian system, this linkage is not made. The exchange rate chosen was RM3.80 to US$1, which was about the rate at the time the then Prime Minister announced the adoption of a fixed exchange rate system in September 1998. The Central Bank uses this rate to exchange Dollars with Ringgit in its dealings with the commercial banks and other authorized financial institutions, and they in turn are required to use this rate in their currency dealings with the public. The Ringgit-Dollar rate has remained the same ever since. The government has announced several times its intention to stick to the same rate for as long as possible (i.e., if this does not cause the Ringgit to be too over-valued or too under-valued, especially in relation to concerns for export competitiveness) so that there will be a high degree of predictability. Up to now, there has not been any “black market” or parallel trade with a different rate. The predictions especially by international analysts (voiced when the Malaysian system was introduced) that a fixed exchange rate system would result in misalignment and a black market have not been borne out, at least till now.
The fixing of the exchange rate has been important for stabilizing the financial situation. Perhaps its most important role, however, is that it allows the government to take monetary and fiscal policies on the basis of their own merit without being constrained by fears of a fall in the value of the currency if the funds analysts do not approve of the measures. The exchange rate fixing also reduces the opportunity for speculation.
As stated by the then Prime Minister when introducing the measures in September 1998: “With the introduction of exchange controls, it would be possible to cut the link between interest rate and the exchange rate. We can reduce interest rates without speculators devaluing our currency. Our companies can revive.” PM Mahatir added the country would not be affected so much by external developments compared to the crisis in Russia." (Sic! - Malaysian PM said this in 1998. Now Russia is repeating the same monetary policy mistakes in 2014 as it did in 1998. Why? Because, it was and it is a man-made crisis and people in the Government who were responsible for that crisis and Government debt default then,.................... are still in charge now! )
Let me summarize the above mentioned measures in simple words :
If someone would like to have a comfortable temperature say between 20 and 22C in his home while winter is coming and its getting cold outside, what usually one does? One switch on heating system inside the house, once there is no inflow of warm air from outside and no sun light anymore penetrating through the windows and gently warming the rooms, while closing previously opened widows and insulating them from leaking valuable warm air. Winter is coming to Russia and no mantras will help to keep the place comfortable for its residents, but heating the house inside and insulating from the cold will.
Malaysia was able to manage the "climate control" very successfully since 1998. Can Russia navigate crisis now better then 1998? Who knows? Only time will tell us.
Diogenes a Russian technocrat with post-graduate education in economics and finance, with 20 years of experience of work in international and domestic banks and financial institutions.
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REFERENCES:
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Mahathir Mohamad, 2003. Globalisation and the New Realities. Pelanduk Publications, Kuala Lumpur.
Ministry of Finance Malaysia, 2001. Economic Report 2001/2002.
UNCTAD, 2000. Trade and Development Report 2000, and various other years. United Nations, Geneva.
Khor, Martin, 1998b. The Economic Crisis in East Asia: Causes, Effects, Lessons.
Economic Planning Unit, 1998. National Economic Recovery Plan: Agenda for Action. Prime Minister’s Department, Kuala Lumpur.
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Kaplan, Than and Dani Rodrik, 2000. Did the Malaysian Capital Controls Work?
