Determinants of Exchange Rate in Malaysia

Chapter 1: Introduction

1.0 Introduction

As the world develops and getting more integrated, business trading or even international trading has became a very common activity. Currency or most commonly known as money is use or circulation to pay in exchange for goods and services, money are use as a medium of exchange. There are two kinds of money form, the banknotes and the coins. Banknotes are more commonly used because of its convenience. Money is indeed a very important invention in human kind history.

As times goes by, more and more different kind are introduced by countries and these different currency are controlled and printed by their national banks. As the world getting more integrated, the relationship of these currencies is getting more complicated. The dominating currencies include the US dollar, British Pound Sterling and the Euro Dollar.

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Malaysia is a developing country located at the South East Asian; Kuala Lumpur is the capital city for Malaysia. Malaysia has gain independent from the British colonist in the year 1957. In 1967, the National Bank of Malaysia had introduced the Malaysia dollar and it had been using it as the official currency to trade in Malaysia. During the decades, the currency had developed and minor changes were made. Now, the currency is already known as the Ringgit Malaysia (RM).

Ringgit Malaysia (RM) had always been stable and developing during the course of decades. However, during the Asian currency crisis, Ringgit Malaysia (RM) was badly affected and the volatility of the currency is severe. Due to the effect of the Asian currency crisis, the Ringgit Malaysia (RM) is fluctuating between 3.80 and 4.40 a US dollar. The Malaysia currency was implying the floating rate regime until end of 1998, the government of Malaysia decided to peg Malaysian Ringgit to US dollar at a rate of RM3.80 to a US dollar.

In this research, a study will be conduct with a topic of “The determinants of exchange rate in Ringgit Malaysia.” In this chapter, brief explanation will be done for background of study, problem statement, research question, research objective, significant of study and outline research. The other chapters of literature review, data and methodology, data analysis and also conclusion.

For Malaysia, exchange rate is one of the most important factors affecting the development of the countries’ economy. It will influence the interest of investors because exchange rate risk plays will affect the profitability of their investments. Many studies had on exchange rate but very little is about the Ringgit Malaysia. However the factors influence the movements of Ringgit Malaysia that will be discussed in this research are Inflation rate, Interest rate, Gross domestic product, and Balance of Payment.

1.1 Background of Study

On the day of June 1967, it is an historical moment for the Malaysian history because the new central bank of Malaysia, Bank Negara Malaysia had introduced the Malaysian dollar. The Malaysian dollar was use to replace the Malaya and British Borneo dollar.

The word ringgit means “pointy” inBahasa Malaysia. It came from the idea of the serrated edges of silver Spanish dollars. Silver Spanish dollars was commonly spread in area the 16th and 17th century throughout the area during Portuguese colonial era. The word “Ringgit” means dollar in Malay, Singapore dollar and Brunei dollar are sometimes also referred as the ringgit. In August 1975, ringgit and sen were formally used as the official names. The sign used “$” (or “M$”) is finally replaced by “RM” (Ringgit Malaysia) in around 1997, “MYR” is being used internationally as the code for Ringgit Malaysia. The ringgit is separated into 100 sen. As for Malaysian coins, the denominations will be 1 sen, 5 sen, 10 sen, 20 sen, 50 sen, and RM 1. For the denominations for banknotes, it will be RM 1, RM 2, RM 5, RM 10, RM 20, RM 50, RM 100, RM 500 and RM 1000.

Ringgit Malaysian had replaced the Malaya and British Borneo dollar, the new currency was initially priced to British pound with the ratio of 1 sterling to RM 8.57 as same as the old currency. Five months from the launching of the new Ringgit Malaysia in November 1967, the pound sterling had depreciated approximately 14%. The Ringgit Malaysia was not influenced much as it is not pegged to pound sterling but the value of Malaya and Brunei dollar fall in value too.

Despite of the appearance of the new currencies in Malaysia, the three neighbors countries which includes Malaysia, Singapore and Brunei still keep the Interchangeable Agreement which stated the currency union that Malaysian Dollar was able to change at the equality with the Brunei Dollar and Singapore dollar. Yet in May 1973, the Malaysia government decided to withdraw from the agreement, Malaysia Ringgit will no longer pegged to Singapore dollar or Brunei dollar. However, the Monetary Authority of Singapore and Brunei Currency and Monetary Board still preserved the interchangeable of their two currencies.

In the 1990s, Malaysia experienced a economy boost. A lot of investors were making tons and tons of money from the Malaysia Capital Market. However, when the Asian Currency Crisis happened in 1997, the unanticipated wave kept many investors stocked, they wasnt prepare to face such ciao. The currency market was badly affected, ringgit was much affected too. Many economists came out and analysted the reason behind this crisis, many even put the blame on the famous speculator, Mr George Soros.

At that period, Ringgit Malaysia was valued between 3.80 and 4.40 to the US Dollar,the former Malaysia Prime Minister, Tun Dr Mahathir decides to peg the national currency to the US dollar in September 1998, fixed its 3.80 to the US Dollar. This peg lasted as long as seven years. After the crisis, Ringgit Malaysia had yet to regain its value against most major currencies. During 2004, ringgit seems to be undervalued by 15 to 20 percent. In the same year, because of the depreciation of US dollar, ringgit was weakens by 17.9 percent against euro and 10.2 percent against Japanese Yen.

In July 2005, China had announced that the Chinese’s currency, Renminbi will no longer peg to US dollar. After the announcement, Malaysia also announced the end of the peg of Ringgit Malaysia with US dollar. According to Bank Negara, Malaysia will now allow the currency to float in a managed range against numerous major currencies. This has made the price of the ringgit increasing closer to its supposed market value, the national bank has intervened to maintain the stability of Ringgit and not to allow too much fluctuation.

After following the free float regime, the ringgit value went upto as high as RM3.16 to a U.S. dollar in April 2008. On 24 April 2010, TheStar online reported, the ringgit value has increased about 6.7 percent yearly against US dollar. According to Business Times, January 15, 2011, ringgit had hit almost a 14 years high of RM3.052 for a US dollar. Ringgit Malaysia shows a movement of appreciation year by year. It is also a good sign of stability of economy in Malaysia.

1.1.1 Development of Ringgit Malaysia

1.1.1. a. Development of Bank Notes

First series of Malaysian Dollar

Malaysian dollar banknotes were initially issued by Bank Negara Malaysia on 6 June 1967. The dollar banknotes are denominated in $1, $5, $10, $50 and $100. On September 1968, the Malaysian national bank, Bank NegaraMalaysia had also issued $1000. Additionally, the image of Tunku Abdul Rahman, the first Yang di-Pertuan Agong of Malaysia was printed on the first banknote of Malaysian dollar. Also, Tun Ismail bin Mohamed Ali’s signature was printed on the first dollar note of Malaysia who was the Malaysian Governor of Bank Negara at that moment. On 16 August 1972, Bank Negara Malaysia adopted an new administrator to include the national language, Bahasa Malaysia into the printing of the new banknotes while remaining the old designs. (Jack, H. 2008)

Second series of Malaysian Dollar

In 1982, Bank Negara Malaysia had designed and issued the second series of Malaysian Dollar, the Malaysian traditional decorative was used as design on the new Malaysian dollar. The second series of Malaysian dollars come in $1, $5, $10, $20, $50, $100, $500, and $1000. However, the numbers of $20 bank notes were less compare to the other amount of the currency. In 1997 when the Asian Financial Crisis happened, large amount of number of $500 and $1000 were transferred out of the country. In about 1993, $1 coin was introduced to substitute the $1 notes. Since then, $1 notes were discontinued.

Third series of Malaysian Dollar

In 1996, in the spirit of Wawasan 2020 Bank Negara Malaysia had issued the third series of Ringgit Malaysia. They are denominated in RM2, RM5, RM10, RM50 and RM100. To deter and avoid counterfeiters, additional hologram strip was added on the RM50 and RM100 notes. A new series of RM10 note was issued by Bank Negara Malaysia in 2004. Security features previously implied in RM50 and RM100 notes like the holographic strip is added to the new series of RM10 note. Also, RM 5 note with distinctive transparent window designed was introduced; they are made in polymer material which was never had in Malaysia. Bank Negara Malaysia also suggested all paper notes will be replaced by polymer notes in the future.

Fourth series of Malaysian Dollar

Bank Negara Malaysia had released a new design of RM50 banknote which will enter the circulation at the beginning of January, 2008. The banknote RM50 remained the unique colour of green-blue but changed a new design. The new design is to support the national mission which expresses the moving up of value chain for economy of the country. Malaysia economy is under the transformation of higher value-added activities such as agriculture, manufacturing and services. One the right of the currency, the first Yang di-Pertuan Agong, Tuanku Abdul Rahman is remained. The national flower, hibiscus is also designed to present at the centre of the banknotes. To celebrate the 50th Anniversary of Independence day, the logo of 50^th Anniversary and features Malaysia’s first Prime Minister, Tunku Abdul Rahman declaring independence is also printed on the reverse of the banknotes. New security features include a watermarked portrait of the Yang di-Pertuan Agong, a security thread, fluorescent elements, and multi coloured latent were also added to prevent counterfeiting. On 2011, Bank Negara Malaysia announced the re-introduction of RM20 banknote.

1.1.1. b. Development of Coinage

First series of Malaysian Coinage

In 1967, the first series of Malaysian sen coins were introduced. They are denominated in 1 sen, 5 sen, 10 sen, 20 sen, and 50 sen. After that, in 1971 the 1 Ringgit Malaysian coin was introduced to the public. First, the Ringgit Malaysian coins are varied by diameters. Practically all the coins were minted in almost consistent obverse and reverse designs. The frontage is depicting the Malaysian Houses of Parliament, the official star and crescent moon from the Malaysian flag, Jalur Gemilang. Malaysian coins are all minted from cupronickel with the only exception of 1 sen. The 1 sen coin was minted in bronze in the year 1967 to 1972. From 1973 onwards, the national bank of Malaysia minted the 1 sen coin with steel clad combined copper. Redesigning was made on the50 sen coin. For the 50 sen coin, minor modification was made to add the “Bank Negara Malaysia” letterings at the edge of it. The first Malaysian coins series was halted in 1989 because the second series of Malaysian coins was introduced. The first series of Malaysian coins are still in the circulation till now, but the number had reduced significantly.

Second series of Malaysian Coinage

In 1989, the second series of Malaysian sen coins was introduced and entered into the circulation. Second series of Malaysian coins was redesigned, but principally retaining the design of edges, diameters and composition of the previous series. However, changes were made for the 1 Ringgit Malaysian coin. Modification include drawing of Malay cultural items on the front of the coin. On the upper half of the bank of the coin, the the national flower, Hibiscus was printed. The designer of this series of coins was Mr Low Yee Kheng. The size of the 1 ringgit coin was also changed, from the original diameter of 33mm to 24mm. It was then minted from an alloy of copper,zincandtin. On December 2005, Bank Negara Malaysia decided to withdrawn the 1 ringgit coin from circulation because it was demonetised. The standardisation of the 1 ringgit coin from the two different versions was the problem behind it.

Bank Negara Malaysia announced that a rounding mechanism of prices to the nearest 5 sen will apply to all the billing all around the country. This policy will start effective from April 1, 2008 onwards. With the latest policy from Bank Negara Malaysia made the 1sen 1 sen coin irrelevant. Items selling are still allowed to be priced in multiples of 1 sen, but the total bill will be rounded to the nearest 5 sen.

Third series of Malaysian Coinage

On 25 July 2011, the third series of Malaysian coins is being announced by the Bank Negara Malaysia. The new series of coins are released on 2012. The third series of Malaysian coins are being issued as commemorative coins. A theme “Distinctively Malaysia” is carried by the third series of Malaysian coins. Motifs of flora and fauna drawn are used in the design in this series of coins also the various cultures in Malaysia. It also reflects the diversity and richness of Malaysia’s national identity. These coins are denominated in 5 sen, 10 sen, 20 sen and 50 sen. According to Deputy Finance Minister Datuk Donald Lim, the productions of the coins are reduced by approximately 50% because of the change in metal composition. The diameter of the coins have also changed, colour on the 20 cent and 50 cent had changed from silver to yellowish gold. New designs like the fourteen dots symbolizing the thirteen states and the Federal of Malaysia are included in the new series. The five horizontal lines on the coins indicate the five principles ofRukunegara. As for the 50 cent, the round shape of the coins with nine indentations represents the original “BANK NEGARA MALAYSIA” lettering. Besides, the 50 cents from the third series will have a latent image security feature. When the 50 cent coins are tilted slightly, denomination “50” and “SEN” can be seen.

1.2 Problem Statement

Exchange rate risk is a one of the key risk that international investors will take account when evaluating an investment. Therefore, determinates of exchange rate is a very important topic. Factors affecting the exchange rate are critical in determining the price of Ringgit Malaysia. A stable and predictable exchange rate will help the economy of a country to grow. If we know the significant factors affecting the exchange rate, we will be able to predict and determent what is the price of Ringgit Malaysia. Many studies have been conducted to determine the determinants of exchange rate and most studies are done used different methods and approaches on how to evaluate the exchange rate. However, the results obtain by some of these studies such as Louis Kujis (1998), Eiteman et al (2001), Otuori, O. H. (2013) and Fracis Fong (2006) differs. This is due to the fact that the results are influenced by the changes of countries’ internal conditions and the macroeconomic environment. Unfortunately, most of the studies concentrate only on major currencies like US dollar and pound sterling but not Ringgit Malaysia. Furthermore, Ringgit Malaysia had also shown potential and its immunization against financial crisis like the sub-prime mortgage in mid 2008. However, there has been little reference when analyzing the Ringgit Malaysia’s price determinates. Besides that, by using the same determinants and quantitative methods, the result for Ringgit Malaysia might differ from the result obtain towards the major currencies, as there could possibly be other factors not important in the developed countries that affects the Ringgit Malaysia or vice versa. Therefore, this paper is to attempt to fill in the gap by investigating determinates of Ringgit Malaysia hence make it possible to predict the price of Ringgit Malaysia.

1.3 Research Question

The key research question asked is thus:

“What are the factors affecting the exchange rate of Ringgit Malaysia against US dollar?”

1.4 Research Objective

• To explore the determinates of Ringgit Malaysia
• To evaluate the relationship between price of Ringgit Malaysia and major macroeconomic variables

1.5 Significant of Study

Many studies had done to investigate the factors affecting the exchange rate. It had no doubt that exchange rate will an important topic to study. Exchange rate is influence by both countries’ internal conditions and also the macroeconomic variables. Most studies done are concentrating the major currencies like the US dollar, Euro dollar and British Pound Sterling. The result obtained from this research will be compare and check with these prior researches. Furthermore, most of these prior studies are done on developed countries’ currencies; this paper will also attempt to check for any similarity or differences between the currencies from developed countries and developing countries. In conjunction, the lack of studies done concerning the exchange rate of Ringgit Malaysia, this paper is done with the hope of assisting and helping more research that will be done on exchange rate of Ringgit Malaysia in the future.

1.6 Scope of Study

This paper studies the impact of interest rate, inflation rate, Gross Domestic Product (GDP) and Balance of Payment (BOP) toward the exchange rate of Ringgit Malaysia. Quarterly data are used in this paper. 40 observations were used to carry on this study. However, due to the lack of data point from some variables, the sample size of this study had readjusted to 32 with a sample period of 2006 to 2013.

1.7 Outline Research

Chapter 1 consists of the general background and aim of this paper. Besides, this chapter has briefly explained the problem to be investigated, the objectives and the significance of this study.

Chapter 2 provides the literature review and more detailed facts about how the investigation will be carried. Hence, prior research theories that are related to this topic are presented. Using the theories previous discovered by other researchers, a framework will be constructed to analyze the volatility of exchange rate of Ringgit Malaysia from the data collected. The journals collected are from different sources; there include the online databases, journal articles and books.

Chapter 3 presents the methodology and the data used in this research for analyzing the volatility of exchange rate of Ringgit Malaysia. Here, this chapter also explains how the investigating had been done. Furthermore, this chapter is divided into parts such as theoretical framework, sample of analysis and the hypothesis-testing framework.

Chapter 4 describes and explains the empirical results and data analysis of the result obtained. It consists of statistical reports, and how do these reports related to the topic studied. Above all, this chapter mainly analyzes the relationship between the dependent variables and its determinants.

Chapter 5 will summarizes and highlights all the key finding of the study. The conclusion will be a summary of the overall analysis and investigation done in the study.