PREFERENCES in currency convertibility are often shaped by current economic challenges.

Prior to Asian currency crashes and the 1997 financial crisis, financial liberalisation was the dominant paradigm in policy ideology.

When the sacred economic idea of which unrestricted mobility of resources results in Pareto-efficient equilibrium (aka: you can’t get better than that without hurting someone else’s interest) met the narrative of “the government is the problem, not the solution” during the Reagan-Thatcher era and later the collapse of the Soviet Union, capital account and currency convertibility orchestrated the end of that history.

The convertibility found political convenience in Malaysia.

The 90s were when we urgently needed massive foreign participation in capital markets, partly due to privatisation and partly due to the divorce of the Kuala Lumpur Stock Exchange from its Singapore counterpart.

Today’s preferences towards inconvertibility are beyond doubt the legacy of the Asian financial crisis. The offshore availability of ringgit became a bullet for currency speculators that brought down the ringgit, and hence the economy.

When looking back, restricting the offshore use of ringgit wasn’t an unreasonable policy response.

The Asian financial crisis left massive scars. Although we are no longer who we were – we don’t maintain a pseudo peg, there is no excessive dollar debt, external trade has been in surplus, macroeconomic policies and adjustment mechanisms are in good shape – currency inconvertibility, at least partially, is still preferred today.

But I’m afraid currency inconvertibility has already outlived its usefulness.

One of the most important lessons we learnt from the Asian financial crisis is the currency and maturity mismatch – too much dollar borrowing and too short of a borrowing maturity term.

Just look at our government debt; it is mostly ringgit denominated and has long-term maturity.

But overcoming currency mismatch doesn’t eliminate currency risk. It simply shifts the risk from borrowers to lenders when the dollar appreciates.

Likewise, while longer maturities mitigate rollover risk for borrowers, it comes at the expense of greater sensitivity of bond prices to yield changes due to the greater duration risk for the lenders.

No wonder foreign investors show the greatest redemption activity, generating a larger outflow of ringgit bonds that magnify ringgit depreciation when the dollar appreciates.

Although the currency and duration risk are borne by foreign investors in the first instance, the larger capital reversal inevitably causes the ringgit to overshoot and bond yields to rise.

It is the residents who ultimately bear the macro risks, unless they’re able to share the risk with both residents and non-residents offshore.

When the ringgit depreciates, residents who draw the ringgit-denominated credit line to pay for the dollar-denominated imported inputs will find the credit burden increasingly heavier, while non-residents who borrow in dollars to carry operations domestically would find the ringgit revenue mismatches their dollar debt burden.

If residents can raise ringgit funding and simultaneously enter a currency swap with non-residents who raise dollar fundings offshore, residents would pay interest in dollars and receive interest in ringgit, whereas non-residents pay interest in ringgit and receive interest in dollars.

While ringgit depreciation elevates the currency risk facing both parties, currency swap eliminates the macro risk.

Although there is little evidence that exchange risk diminished after convertibility, it enables international risk sharing, improving the funding efficiency for global operations, be it residents going global or non-residents investing in Malaysia, and hence enhancing cross-border trade and financial exchanges.

Doesn’t it sound exactly like the mechanism we need to realise the mission of Ekonomi Madani that emphasises domestic companies going regional if not global, integration of local production into regional supply chains, positioning Malaysia as a leader in Islamic finance as well as the destination for high-quality foreign investment?

After all, we can’t be the world’s 30th-largest economy when the ringgit has no place in the world’s convertible currencies.

And we can’t call for de-dollarisation for greater use of the ringgit in trade invoicing when we don’t even allow trade settlement in the local currency.

What would happen if the ringgit convertibility were reintroduced? No one knows for sure.

Historically, however, it didn’t trigger a run on the currency, but took place unexpectedly smoothly in terms of market reaction. And neither the pound’s convertibility in 1958 nor the yen’s internationalisation in 1984 made waves.

What’s for sure, should the new economic environment and challenges call for a change, we need to respond. At least we should reimagine the possibility of the ringgit’s re-internationalisation. – August 3, 2023.

* Wong Chin Yoong is a professor of economics at Universiti Tunku Abdul Rahman, Kampar campus.