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The Malaysian Currency Crisis

Question:

A number of currency crises have affected certain countries, which have also resulted in contagion in the sense that the crises affected neighboring countries. In a critical essay, select a country (or countries) affected by a speci?c currency crisis. Analyze the source of the crisis and the speci?c resolution of the issue. Indicate whether the International Monetary Fund (IMF) or another sovereign state or country provided intervention. Has the country's economy recovered since the conclusion of the crisis?

Candelon, Dumitrescu & Hurlin (2014) mentioned that Currency crisis refers to the condition in which doubts arise with the sufficient amount of foreign exchange reserves which is required to maintain the country’s foreign exchange rates. Such crisis might start in one country but the effect can be felt in the neighboring countries too. Currency crisis might be accompanied by provisional hit in the foreign exchange market. There might be a number of causes behind currency crisis. The basic general cause of currency crisis is the failure of central bank to continue with a fixed rate in the floating condition of foreign currency. This particular essay will deal with the currency crisis of Zimbabwe and Malaysia by focusing on the sources and methods of mitigation. The decline in the value of a country’s currency affects the national economy in a negative way because instability occurs in the rate of exchange. It can be simply stated that the currency crisis takes place as an interface between the expectations of the investors and the probable outcome of those expectations (Abdullah & Chan, 2016).


One of the most important incidents in the history of Malaysian economy was the Asian Financial Crisis. Baharumshah, MacDonald & Mohd (2017) stated that this event had resulted in the shrinking of Malaysia’s GDP to a great extent. In 1996 the country’s GDP was US$ 100.8 billion but it was declined to US$72.2 billion within two years. As a result of that, Bank Negara in Malaysia had attached the Malaysian ringgit at 3.80 to US$ to put on capital controls. The Malaysian currency crisis occurred in 1997-98 which had three prime options. These variations were- moral hazard driven lending, currency crisis due to bank run and the implication of balance sheet in currency depreciation.

The main causes of the Malaysian crisis can be categorized as following-

  • Macroeconomic disparity and structural deformation
  • Abrupt shifts in market potential and assurance
  • Deficiency in current account and composition of foreign liabilities
  • Constant exchange rates and the overvalue of currencies
  • No proper state model
  • Unexpected alteration in external environment
  • No proper supervision or norms and policies about the country’s finance
  • Ethical risk
  • Innate defects in the worldwide economic structure (Ramli, Ismail & Wooi, 2015)

The causes mentioned above were widely discussed by Yang (2013) after the Malaysian currency crisis which had put an impact on the neighboring countries of Indonesia, Philippines and Thailand. The short term debt of these countries as a percentage of total debt became 61, 58 and 65 respectively. Similarly their current account deficit became -3.62, -6.02 and -2.35 in 1997. In terms of foreign reserves, the short term debt as percentage became 176.59, 79.45 and 99.69 in 1996.

In the course of discussion regarding the currency crisis the conditionality of IMF or International Monetary Fund was taken into consideration. Harvie & Van Hoa (2016) reflected that the International Monetary Fund intervened in the crisis situation by giving suggestions to tighten the macroeconomic policies, financial sector reform and real sector reform. The government had taken up three measures to resolve the issue of currency crisis- freezing the external ringgit account, introduction of the 12- month rule and adjusting the exchange rate at 3.80 RM/$.

Causes of the Malaysian Crisis


It has been two decades since the financial crisis in Malaysia but the causes of the crisis are still debatable. According to Goh & McNown (2015) in the year 1997 during the financial crisis, the Bank of Thailand had refused to intervene in the matter in order to protect the Thai currency Baht from the US$. At that point of time the foreign reserves tremendously declined which opened way for the Malaysian crisis. With the occurrence of the crisis, there were differences in the reaction and approach initiated for resolving the crisis situation. Majority of the population was ready to respond to the financial crisis but there were some who did not take the situation seriously by mentioning about the sound financial system in the bank.

Establishment of Danaharta as an asset management company was one of the preventative measures taken in response to the crisis. It was set up with the intention of regaining profits by the bank by removing the bad assets and integrating the good parts of the bank with other banks. Malaysia had made use of a distinctive feature which had allowed them to pay a very low amount of penalty for the crisis. They had not only dealt with the financial institutions but also discussed with the borrowers regarding the restricting of debts in the country.

Pouresmaeili (2015) agreed that the cost of the crisis in Malaysia was really low due to the defensive action that was taken. Moreover, they did not increase the rate of interest as suggested by the International Monetary Fund. The country had to go through a lot of pressure for raising the interest rates by 5% but they did not consider it as a potential solution because it did not involve the approximate hit on the currency. Due to the rejection of the IMF’s suggestion Malaysia was also saved from the huge extent of economic loss which could have destroyed them otherwise. The measures that the country took in face of the crisis increased their economy by 7 percent in 1999.


At present Malaysia has both capacity and ability. They have got hold of their surveillance mechanism which has helped them to get a prior idea about the source of fund flow. Twenty years back they did not have access to such information and that is why they could not resist the crisis of currency. Currently, the Malaysian currency ringgit has come back to the range of 4 which is below the ringgit 3- 80 peg (Yang, 2013). The ringgit does not hamper the basics if the financial structure nowadays but there might be other factors such as confidence and contamination. With regard to the financial crisis, it can be stated that Malaysia has attained a significant progress by implementing the changes better than other countries that have also faced similar disaster. The approaches that were accepted by Malaysia to alleviate the issues of bad loans and reshape the banks indulged government policies and thus pace and consistency were counted as benefits.

Measures Taken to Overcome the Crisis

Even though the financial crisis of Malaysia became a major event but the currency crisis of Zimbabwe was no less in comparison. Within the same time frame of 1991- 1996, the Rhodesian Dollar was replaced by the Zimbabwean dollar at par value. At that time period, President Robert Mugabe went for the Economic Structural Adjustment Program or ESAP in the government of Zimbabwean Zanu-PF to put negative impact on the country’s economy (Abel & Mudzonga, 2016).

Currency crisis in the two countries totally juxtapose each other. The banking sector always plays the role of an agent in the country’s economy and this process is known as financial mediation. Yang (2013) mentioned that this term refers to the collection of extra deposits and lending to the borrowers. These extra deposits can either be short term, medium term, long term, definite or flexible with call. Therefore the total banking system is strictly supervised by the Reserve bank for keeping a track of the economic stability and assurance in the banking system.  

To discuss ad compare between the two crises about the finance and banking of Zimbabwe the probable causes of the financial crisis in the country has been found out (Brixiová & Ncube, 2014). The reasons behind the loss of trust in the banking sector are given as follows-

  • Indigenization: The dispute in the government regarding the policy of indigenization and almost no consistency about the matter aroused panic and fear among the investors as well as the depositors.
  • Payment of war veteran transfers: Mugabe had to avoid a probable deadly situation and paid an unemployment benefit of $6.4 million for the children of the war veterans.
  • Tobacco farmers: With the beginning of the tobacco marketing season the government had implemented the rule of opening of bank accounts for all the farmers. Those bank accounts were then hit with funds to fulfill the recurrent expenditure including the spread out payment of bonus and incentives.
  • The Lima agreement: An agreement was signed with the International Monetary Fund, World Bank and AfDB in the capital of Peru where Finance Minister of Zimbabwe, Chinamasa promised to pay the amount of $1.8 billion arrears in the next 3 months.
  • Real Time Gross Settlement or RTGS: The government had hit on all the funds at the Reserve Bank for paying off the financial liabilities thus affecting the liquidity of banking sector (Chidakwa & Chigumira, 2016).
  • Public borrowing: The government has issued treasury bills of amount $2 billion but the entire amount was rolled over at maturity which affected the cash flow of the banks.
  • Illegal financial outflow: The combination of corruption, lack of clarity and transparency and liability pricked the financial revenue.
  • Weak revenue performance: With the shutting down of the companies there were fluctuations in revenue collections. The growth was stagnant and production was also hampered.
  • Zanu PF implosion: The infighting of Zanu PF has not at all been beneficial for the situation rather it has resulted in risk of functionality of the government and the national economy was left to freeze.
  • Weakening trade deficit: the current national balance had been affected due to the devaluation of Rand. The twin relationship of trade and budget deficit has posed to be a problem.

Levy (2014) opposed that the government has experienced insignificant revenues which had way out of excessive borrowing and make use of the overdraft facility that was introduced by the Treasury Bills to raise funds. The effect of this system was explained by IMF as there will be increase in banking deposits due to these transactions. However, the transactions would increase without an associated increase in the amount of US dollars that will be available in cash. The Zimbabwean government’s stretchable economic policies are responsible for the shortage in national cash. 


The Reserve Bank of New Zealand has found out the major problem to be the lack of political influence in the operational activities. Kararach & Otieno (2016) contradicted that the central bank can come up with policies which are meant for reviving the economy and not helping the political agendas. To resolve the currency issues Zimbabwe must make a clear decision on the use of currency in order to prevent the ongoing issue of liquidity in the country.

The International Monetary fund has played its role in the global financial crisis and made strategic implications for being the international lender and handle issues of the economically affected countries such as Zimbabwe. The IMF has reacted to the global crisis and has set up financial help within an economy for those who seek financial assistance (Dube & Chipumho, 2016). The neighboring countries of Zimbabwe have also faced the impact of currency crisis such as Zambia, South Africa and Botswana. The steps taken by the International Monetary Fund created sustainable solutions for further lending among the countries going through major financial distress. Similar to Malaysia, Zimbabwe had also participated in the ESAF structure of IMF. The reform programs that were developed by the government had a negative impact on the agro, social, traditional sector of the country and also affected the foreign exchange.

Stoeffler et al., (2016) went against the former crisis as the IMF policies were not helpful for Zimbabwe as it could not improve the economic condition. This has resulted in the decline of the country’s GDP and per capita income and experienced huge debt. Even in the present day, poverty and unemployment have been the dominant factors in the country. Poverty rates in 2007 were about 80% whereas unemployment rate of 95% was world’s highest in 2009. In 2017 too, the economic imbalances lie in the heart of the country’s financial crisis. The cash deficit was mostly financed from the domestic markets because the external arrears stopped Zimbabwe from accessing the international markets of capitalization. Financial expansion in 2015- 16 enhanced only short term growth but the resources to aid long term development were reduced. Zimbabwe is still lagging behind in terms of development due to their financial crisis (Ngwenya et al., 2016). There it can be summed up by pointing out the two extreme effects of the two countries due to currency crisis.

References

  1. Candelon, B., Dumitrescu, E. I., & Hurlin, C. (2014). Currency crisis early warning systems: Why they should be dynamic. International Journal of Forecasting, 30(4), 1016-1029.
  2. Abdullah, M. A., & Chan, R. K. (2016). Foreign Labor In The Midst Of The Asian Economic Crisis: Early Experiences From Malaysia, Hong Kong, Taiwan And Singapore. Jurnal Kinabalu (eJK), 4.
  3. Baharumshah, A. Z., MacDonald, R., & Mohd, S. H. (2017). Exchange rates in Singapore and Malaysia: are they driven by the same fundamentals?. Malaysian Journal of Economic Studies, 47(2), 123-141.
  4. Ramli, N. A., Ismail, M. T., & Wooi, H. C. (2015). Measuring the accuracy of currency crisis prediction with combined classifiers in designing early warning system. Machine Learning, 101(1-3), 85-103.
  5. Yang, L. (2013). Volatility spillovers among the US and Asian stock markets: A comparison between the periods of Asian currency crisis and subprime credit crisis.
  6. Harvie, C., & Van Hoa, T. (2016). The causes and impact of the Asian financial crisis. Springer.
  7. Goh, S. K., & McNown, R. (2015). Examining the exchange rate regime–monetary policy autonomy nexus: Evidence from Malaysia. International Review of Economics & Finance, 35, 292-303.
  8. Pouresmaeili, H. (2015). Malaysia's commodity export performance during Asian currency crisis and US subprime mortgage crisis. International Journal of Trade and Global Markets, 8(1), 27-41.
  9. Abel, S., & Mudzonga, E. (2016). The Performance of the Tourism Sector in Zimbabwe during the 2000–08 Economic Crisis. Economic Management in a Hyperinflationary Environment: The Political Economy of Zimbabwe, 1980-2008, 85.
  10. Brixiová, Z., & Ncube, M. (2014). The Real Exchange Rate and Growth in Zimbabwe: Does the Currency Regime Matter?.
  11. Chidakwa, A. M., & Chigumira, G. (2016). Pre-crisis macroeconomic performance and triggers of the economic crisis in Zimbabwe. Economic Management in a Hyperinflationary Environment: The Political Economy of Zimbabwe, 1980-2008, 23.
  12. Levy, L. K. (2014). Sanctions against Zimbabwe. Assessing Barack Obama’s Africa Policy: Suggestions for Him and African Leaders, 175.
  13. Kararach, G., & Otieno, R. O. (Eds.). (2016). Economic Management in a Hyperinflationary Environment: The Political Economy of Zimbabwe, 1980-2008. Oxford University Press.
  14. Dube, C., & Chipumho, E. (2016). Response of the Manufacturing Sector to the Zimbabwe Economic Crisis. Economic Management in a Hyperinflationary Environment: The Political Economy of Zimbabwe, 1980-2008, 55.
  15. Stoeffler, Q., Alwang, J., Mills, B., & Taruvinga, N. (2016). Multidimensional poverty in crisis: Lessons from Zimbabwe. The Journal of Development Studies, 52(3), 428-446.
  16. Ngwenya, B., Chiwawa, D., Ngwenya, B., & Chiwawa, D. (2016). Impact of liquidity crisis on bank’s response towards corporate social responsibility: A Case Study of Commercial Bank of Zimbabwe (CBZ) Ltd Harare period (2009-2014). Int J Res Rep, 2(2), 55-64.
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