IN
examining Myanmar Kyat/US dollar exchange rate (FX), various factors have been
discussed in local newspapers: Kyemon and The Global New Light of Myanmar
(GNLM) in September, 2018. Major factors indicate economic fundamentals and
conditions, trade deficit, seasonal demand for dollar especially from July to
December, speculation in the FX market, and the practice of re-export scheme in
Myanmar, in which demand for dollar increased substantially in local market,
however, dollar earnings from these re-exports are uncertain due to various
loopholes. This article examines the fluctuation of Kyat/US dollar exchange
rates since April 2012 when Myanmar commenced it ‘managed float in exchange
rate’ system and draws policy implications of monetary and fiscal policies.
There
are three widely used approaches in explaining the factors determining FX and
these can be summarized as follows:
(i)
traditional approach developed before 1970s,
(ii)
the asset market approach emerged in the 1970s and
(iii)
the development of market microstructure approach initiated since mid-1990s.
The
first two approaches are commonly known as macro-approach, while the last one
indicates the micro-approach to FX. The development of financial market, in
particular, stock market in the 1990s has enabled firms to hold/invest in
various assets (portfolios). The process in turn has affected the country’s FX.
It pointed out the need for the asset market approach to FX determination since
the traditional approach alone is insufficient to explain FX fluctuation.
The
‘traditional approach’ to FX is known as ‘goods market approach’ in which
demand for foreign currencies depends on the purchase and sales of goods i.e.
exports and imports of the country. Thus trade balances influence the FX, in
particular, trade deficits (i.e. total imports are greater than total exports)
tend to depreciate domestic currency, in contrast, trade surpluses tend to
appreciate domestic currency.
The
second approach namely the asset market approach has provided various forms of
the model that emerged since the 1970s and emphasized the role of nominal
exchange rate as ‘asset price’ of the durable assets. The first well- known
model is purchasing power parity (PPP) theory explanation to FX. It asserts
that the FX equals the ratio of two price levels (relative price) of related
countries in the non-arbitrage condition. In comparison, the uncovered interest
parity (UIP) theory explains that FX change is based on the relation between
expected returns on short-term interest-bearing assets denominated in different
currencies.
The
‘asset market approach to exchange rate’ refers to models in which the exchange
rate is determined by not only present fundamentals and shocks but also
discounted sum of expected future fundamentals and unobserved shocks. In other
words, macroeconomic fundamentals of standard exchange rate (FX) theory
explains that FX is influenced by the macroeconomic fundamentals such as
relative money supplies, outputs, inflations, interest rates and expectation of
FX. Under floating rates, the FX models of asset market approach have explained
well the change in FX in line with theory in the long term. However, the
empirical research in mid-1990 has shown that the approach fails to explain
short term FX changes. The evidence shows that FX movement indicates random
walk model, indicating that these models fail to forecast changes in FX in the
short term. Some studies also point out that the most critical determinants of
exchange rate volatility are not macroeconomics.
The
market microstructure approach is based primarily on microstructure finance
theories. It is generally defined as the process and outcomes of exchanging
assets under explicit trading rules. Two variables (i) foreign currency ‘order
flow’, i.e. demand for dollar and (ii) spread (bid-ask) constitute major
powerful tools of microstructure approach. The market microstructure approach
can be found in my article published by the Economic Association in its
Economic Journal, vol. 2. No.1.
In
regard to recent depreciation of Myanmar Kyat against dollar, a summary of
report of related institution on the FX situations and intervention practices
in FX was reported in The GLM, 28 September issue as follows:
“Analyzing
the depreciation of Myanmar Kyat, although it started with the external
impacts, the domestic factors that include, but are not limited to, weak
economic fundamentals and structural issues have significant impacts on the
exchange rate. Looking at trade, the trade deficit was US$3.8 billion in
2017-18 and it is actually lower than previous years. In 2016-2017, trade
deficit was US$5.2 billion and it was US$5.4 billion in 2015-2016. It is
evident that these deficits have had a lot of pressure on the domestic
currency. Second, changes in seasonal foreign currency demands have also had
impacts on the exchange rate. Especially during the period from July to
December, demands for foreign currency had been usually high. In order to
reduce the trade deficit, to strengthen the domestic economy and to be
resilient, and to withstand various impacts, the Union government has been
going through various reform processes in cooperation with the private sector
stakeholders.”
In
addition, the interview with CB’s official on the FX reported in these newspapers
can be summarized in the following. CB has made a ‘cushion’ by selling more US
dollars in the foreign exchange market in these days because Myanmar Kyat/US$
rate depreciated relatively large due to seasonal demand and speculations in
dollar. However, it expressed the limit of the existence of CB’s intervention
in this supervision process. The expression of CB also pointed out the major
factors affecting Kyat/dollar rate as follows: (1) trade deficit (balance of
payment, current account deficit), (2) interest rate, (3) inflation and (4)
country’s development status and potential. The re-export system constituted as
a triggering factor in kyat depreciation since the demand for dollar in local
market is relative high to import goods under the re-export scheme, but the
bringing of dollar earnings obtained from re-export market into local FE market
were uncertain due to various loopholes. CB also has expressed its intention on
the use of currency SWAP and FX Auction System to sell adequate dollar in the market.
Analysis
of Kyat-Dollar Exchange Rate Fluctuation using Fuggy Model
Fuzzy
Matric technique is one of the widely used methods in Engineering for detecting
pattern classification and information processing. It can be used to identify
clear pattern of dynamically moving blurred image and sound through filtering
method. It analyzes the pattern of observations making clusters of observation
using fuzzy set/logic theory. In this article, Kyat-Dollar rates for the
period: from August 2013 to October 2018 are grouped into six clusters. To
identify clear pattern of Kyat-Dollar rate, exchange rate for 1 $ in Myanmar
Kyat from 960 to 990 are grouped into cluster 1, Kyat from 991 to 1065 is
formed as cluster 2, Kyat 1066-1180 as cluster 3 etc. and six clusters are
generated. Finally the model allows to make forecasting FX for next six months
using fuzzy time series model.
Six
clusters of Kyat-dollar monthly rates are shown in Figures 1 and 2.
Interestingly, Figure 1 highlights that Kyat-Dollar rate is not only
fluctuating seasonally, but also shifting towards higher levels as shown by 6
cluster-levels. Connecting each of six clusters (partitions), yields Figure 2:
FX historical trend. In Figure 4, EXCHM denotes monthly Kyat-Dollar rate and
‘projection’ indicates forecast values of FX. The FX fluctuation for the period
under study is far more than seasonal phenomena and it has major implications
in monetary and fiscal policies. Figure 3 provides FX fluctuations in the
context of July-cycles that indicate the need of monetary and fiscal policy
coordination through budgetary surveillance system where the private sectors
can contribute for the betterment of macroeconomic system.
Central
Bank’s Intervention in the FX Market
FX
intervention is regarded as an important instrument for Central Bank (CB) in
developing countries as CB received almost all information on FX. However, in
developed and emerging market economies, intervention has been no longer used
or gradually reduced. Major reasons for removing CB’s intervention are that it
can affect credibility of bank and scare foreign exchange research at risk. The
effectiveness of CB’s intervention depends not only CB’s policy and activities
but also those of government ministries and private sector. To make CB’s intervention
success, policies of CB and government ministries need to align in one
direction. Thus ineffectiveness of CB’s intervention in developing countries
indicates (i) the existence of trade-offs among economic policies due to a lack
of alignment in policies and practices of CB and government ministries, and
(ii) the operational issues. The term ‘intervention’ in this article is based
on the commonly used one: ‘sterilized’ intervention. It refers to CB’s purchase
and sales of foreign exchange that do not affect domestic monetary conditions
(based money or short term interest rate).
In
assessing success of implementation and its effectiveness, FX intervention has
four main objectives:
(1)Correct
misalignment or stabilize the exchange rate at predetermined levels or within
targeted rates of change,
(2)Calm
disorderly markets, including exchange rate volatility and market illiquidity,
(3)Accumulate
foreign exchange reserve and
(4)Supply
foreign exchange to the market. In the following section, effectiveness of CB’s
intervention is discussed in the framework of collaboration among the
government, CB and private sector.
From
CB perspectives, the determinants of effectiveness of intervention reflect: (i)
amount and timing of intervention, (ii) degree of transparency, and (iii)
markets and counterparts. As discussed in the beginning of this article,
markets and counterparts may comprise at least 3 types depending on development
of financial sector in the country. The effectiveness of intervention and tools
may depend on the degree to what international trade transactions and financial
transactions (eg. Spot or forward contracts etc.) are conducted.
Summary
of Determinants of FX in the Long-Run
Generally,
the linking between short-run policy and long-run policy is contingent upon the
sustainability of the former. Seasonal fluctuation of Kyat-Dollar rate reflects
the short-run phenomenon while shifting of FX from one level to another
constitutes long-run one.
There
are 2 widely used theories as follows:
(i)
The law of one price. It asserts that identical goods sold in different
countries must sell for the same price when their prices are expressed in terms
of the same currency.
(ii)
Purchasing power parity (PPP). It predicts that exchange rates will adjust to
relative price level changes, to differential inflation rates between two
countries. It is due to relative differences in productivity, trade barriers,
and import and export demand between 2 countries under study.
Long-run
determinants of FX indicate relative price levels, trade barriers and traction
costs, differentials in interest rates, current account deficits, differential
in inflation money supply and labor productivity.
From
the Ministries and Private Sector perspectives, the coordination may include
surveillance of expenditure and revenue, output, employment, and labor
productivity to obtain macroeconomic stability.
Surveillance
System using Output Gap Monitoring
The
output gap approach indicates a relatively powerful tool to monitor the
inter-connection among: total factor productivity, output gap, structural
budget balance, unemployment and inflation and coordinate the economic
activities across ministries and or sectors. The output gap is defined as the
difference between the actual output of an economy and its potential output
that is expressed in percentage of potential output. In European Economy, the
output gap approach is monitored by “Output Gap Working Group” under the EU’s Economic
Policy Committee. It administered together with other measures to monitor and
coordinate cyclical nature of its member states in the framework of Growth and
Stability Pact (GSP). The production methodology approach to output gap is
widely used as operational ‘Surveillance Tool’ and Government Budgetary
Surveillance purpose to monitor structural budget balances.
From
the monetary policy perspectives, the below-potential performance case signals
a central bank to adopt a monetary policy designed to stimulate economic growth
by lowering interest rates, for example, to boost demand and prevent inflation
from falling below the central bank’s inflation rate target. In overheating
case which generates upward pressure on inflation and may signal the central
bank to “cool” the economy by raising interest rates.
From
the fiscal policy perspectives, Government can design to close or narrow the
output gap using expansionary fiscal policy such as spending or lowering taxes
that would raise aggregate demand. When there is a positive output gap, it
signals government to adopt contractionary or tight fiscal policy to reduce
demand and combat inflation through lower spending and/or higher taxes.
Monetary and fiscal surveillance system using output gap monitoring can be
found in Author’s article published in Myanmar Economic Bulletin, vol.1 July
2018 and can be downloaded at www.mdi.org.mm. In conclusion, macroeconomic
stability can be performed based on general equilibrium in good market,
financial market and foreign exchange market.
References
The
Global New Light of Myanmar (2018), “Depreciation of Myanmar Kyat”, Daily
Newspaper, Friday 28 September, Nay Pyi Taw.
Nyunt,
Khin Maung (2018), “Developments in Microstructure Approach to Exchange Rate
Determination and Implications for Monetary Policy”, Journal of Economics,
Myanmar Economic Association, No 1 vol 3., Yangon, July.
Nyunt,
Khin Maung (2018), “Labour Productivity, Potential Output and Output Gap: The
Useful Tool Implications for Budgetary Surveillance and Fiscal Policy of
Myanmar”, Myanmar Economic Bulletin, Myanmar Development Institute, vol. 1, Nay
Pyi Taw, July.
Nyunt,
Khin Maung (2016), “Exchange Rate Intervention Practices, Tactics and Policies
in Emerging Market Economies” in The Global New Light of Myanmar, 3 Jan. Nay
Pyi Taw.
Canales-Kriljenko,
Jorge Ivan, Roberto Guimaraes, and Cem Karacadag (2003), “Official Intervention
in the Foreign Exchange Market: Elements of Best Practice” IMF Working Paper
wp/03/152.
Dr.
Khin Maung Nyunt is a Senior Research Fellow at Myanmar Development Institute
(MDI) which is a Public Economic Think Tank established by the Government of
the Republic of the Union of Myanmar in February through Cabinet Notification
No. 9/2017. Priori to this position, he worked as a Senior Economist
(2010-2016), ASEAN-Australia Development Cooperation Program Phase 2, at the
ASEAN Secretariat, Jakarta. He also has had academic positions at Mae Fah Luang
Royal Thai Government University, and Chulalongkorn University in Thailand and
ASEAN Economic Research Unit at Institute of Southeast Studies (ISEAS) in
Singapore. He holds a Ph.D degree in Economics from the University of Sydney,
Australia and Master’s degree in Finance from University of Cambridge, UK.
The
opinions expressed in this article are those of the author and do not
necessarily reflect the views of the Global New Light of Myanmar.—Ed
Ref;
The Global New Light of Myanmar
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