The dramatic fall in the value of kyat in recent months has raised alarms and left many baffled. The irony is that it was not so long ago a strong kyat caused exporters and those with earnings in foreign currencies to grieve.
Apparently neither a strong nor a weak kyat is pleasing and it is not an easy task to keep people on both sides happy. Nonetheless, wide fluctuations in exchange rates erode confidence and harm growth, something Myanmar cannot afford. Meanwhile, some of the most important questions remain largely unanswered.
What factors contributed to this decline? What is the future of the kyat? And what are the policy implications?
A search of local and international media offers some insights into why the kyat might have fallen so dramatically since it was floated in April 2012. While there is plenty of speculation, there are few concrete answers. One of the most commonly cited reasons is the construction boom and surge in imports, both of which drive demand for the dollar. Some also attribute the decline of the kyat to falling gold prices, while others blame currency speculation and hoarding of the dollar, something many in Myanmar are accustomed to. Perhaps any of these, or all in conjunction, could have contributed to the fall in the kyat. However, one still needs to scrutinise the economic reasoning behind these drivers to address the potential policy implications and the future of the kyat.
What determines exchange rates? An exchange rate, like the price of any asset, is determined by its demand and supply. This generally applies to all currencies. Exchange rate regimes do not remain fixed forever and even values of currencies that are supposedly “fixed” could change – and usually during currency crises, such as Thailand in 1997.
Demand for kyat primarily comes from exports and from those purchasing kyat-denominated assets. Apparently, demand for dollars primarily comes from imports. Did the import-driven dollar demand contribute to the decline of the kyat? The short answer appears to be yes. International Monetary Fund (IMF) data indicates that Myanmar’s current account – which is the difference between imports and exports for Myanmar because its service sector is negligible – was mostly balanced for 1980 and 2010. However, while exports grew in 2011 and 2012, imports grew much faster, causing the country to have current account deficits of 4.2 percent of gross domestic product and 4.5pc respectively. The expected current account deficits for 2013-14 are 5.1pc and 5.8pc.
Economic theory dictates that exchange rates are self-correcting. A weak local currency promotes exports while it deters imports. Stronger exports would increase demand for kyat and given sufficient time this should eventually change the course of the kyat’s decline. Nonetheless, it is possible for countries – one prominent example is the United States – to run persistently large current account deficits as long as these deficits can be financed by other types of capital inflows, mainly from foreign investments. Myanmar currently does not have active financial markets so its foreign investment mostly takes the form of investment in real assets. In Myanmar’s case, the flows from foreign investments exceed the deficit resulting from imports. A recent IMF report indicates that “international reserves will continue rising as foreign direct investment inflows outweigh a widening current account deficit”. Given prospective foreign investors’ interest in Myanmar it is perceivable that this situation will continue into the foreseeable future. In other words, the central bank should possess sufficient reserves to intervene should it decide to do so.
How serious is Myanmar’s current account deficit? It is not unusual for emerging economies to run large current account deficits as greater openness and the drive for economic growth accelerate imports. Comparison with some neighbours that have similar development patterns make one suspect that the recent decline in the kyat could be solely attributed to the trade deficits.
One more avenue worth exploring is the budget deficit. Budget deficits cause the governments to borrow – or worse, print – money. This increases the money supply, which in turn creates inflation and reduces the value of the currency. The Asian Development Bank (ADB) indicates that Myanmar’s budget deficit for 2012 is 5.4pc of GDP. An active and liquid government bond market (a mechanism for government borrowing) does not exist in Myanmar so a large deficit would undoubtedly put pressure on the value of the kyat. Instituting a more autonomous central bank would calm fears on this part. How does Myanmar fare compared to her peers? ADB data indicate that Cambodia’s fiscal deficit as of 2012 is 5.2pc of GDP. The numbers are -7.9pc and -6.9pc for Laos and Vietnam respectively.
Another reason cited is declining gold prices. During times of uncertainties, gold serves as a hedge against inflation and an alternative form of investment. Gold is also considered a safe haven when the banking system is fragile and other investment opportunities are scarce. It is useful to recall that Myanmar has lowered savings rate since the beginning of the period and property prices have spiked. With the decline in gold prices, gold has become an attractive investment. Internationally gold is priced in US dollars and its value has declined by more than 20pc in the past year. Large-scale speculative purchases of gold increase the demand for dollars and, when the dust settles, it worsens the country’s current account deficit. The world’s largest importer of gold, India, faces this issue. Due to the rising trade deficit, the Indian rupee has depreciated by approximately 10pc over the past two months, which parallels the decline in the kyat. India responded by raising import duties on gold.
While it is not easy to predict the movement in gold prices, it is unlikely that this trend will continue for an extended period of time. That being said, should saving rates (and gold prices) decline further, this might add pressure on the kyat. While gold prices are volatile and are beyond the control of the local central bank, low inflation could serve as a defence mechanism. A recent IMF report indicates that the expected inflation in Myanmar is 5.5pc for the fiscal year 2013-14. This can be considered low by Myanmar’s historical standards. As financial reforms strengthen Myanmar’s financial institutions and financial markets are further developed, investment would gradually shift away from gold.
One overlooked aspect is the impact of the slowdown in the Chinese economy and the drastic fall in Chinese investment in Myanmar in recent years. Chinese investment in Myanmar reportedly fell to about US$400 million in 2012, down from $4 billion and $8 billion in the previous two years. This decline will have had a negative impact on the country’s capital accounts. While the slack will eventually be picked up by other countries, the short-term effects will linger. Slowdowns in China will also affect Myanmar’s exports and therefore the kyat. However, the effect will be minimal as Myanmar runs a large trade deficit with China (approximately $3.5 billion in 2011). Myanmar’s biggest export market is Thailand (39pc), followed by China (approximately 20pc). However, Chinese products account for nearly 39pc of Myanmar’s imports. Kyat depreciation and yuan appreciation is desirable from this perspective.
How about the strength of the US dollar? It is also doubtful that this could explain the magnitude of the kyat’s decline. The US Dollar Index, a measure of the value of the dollar relative to a basket of six major foreign currencies, is little changed from a year ago. Neither has the dollar appreciated much compared to Myanmar’s neighbouring and trading partners.
There are some other questions important to the currency’s depreciation. Did Myanmar adopt an appropriate exchange rate regime? Did Myanmar float the kyat too early? These are not easy to answer. The exchange rate regime that is most likely to suit a country’s economic interests depends on specific circumstances, such as the size and openness of the country to trade and financial flows. Political conditions and the credibility of its policy makers and institutions are also important factors. There is no single ideal exchange rate regime that is appropriate for all countries. Extreme volatilities cannot be avoided with some floating exchange rate regimes. For countries that are dependent on foreign trade – and have fragile economies and banking systems – extreme volatilities can be a threat to stability.
One final question remains: Is the kyat in crisis? It might be a bit premature to say that. Currencies appreciate, depreciate, devalue, and revalue, and most countries, especially the less developed ones, are not immune to it. It should also be noted that Myanmar’s exchange rate market is relatively young and illiquid with thin trading. As a result, a relatively large trade volume could create wide swings in prices. However, it would serve the country well to dampen the extreme volatility and speculation that is occurring. It is the central bank’s job to instil confidence in the local currency by adopting sound policies and taking a proactive approach to curb speculation. This would require better disclosure practices and defending the currency if necessary during times of crisis. Silence is not always golden. Recent history has taught us that excessive speculation is as dangerous as bad fundamentals themselves.
Min Thu Maung is an assistant professor of finance in the Department of Finance and Management Science at the University of Saskatchewan, Canada. Reza Chowdhury is an assistant professor and chair in the Department of Finance and Banking at the University of Dubai, United Arab Emirates.