Discuss the rationale to maintain the foreign exchange rate.

Question : Discuss the rationale to maintain the foreign exchange rate.

            Exchange rate can be defined as the standard of our country’s currency compared to others currency (Amadeo, 2018). In other words, a foreign exchange rate is an exchange of funds in one currency for funds in another currency at an agreed rate and arranged basis. For example, the latest rate of currency for 1 US Dollar is equal to 4.14 Malaysian Ringgit. This exchange rate is a dynamic rate which fluctuate from day-to-day, minute-to-minute, and second-to-second depending upon a variety of factors (Bharti, n.d.). Among the factors that will affect the exchange rate are events like war, terrorism, changes to the political situation, as well as economic problems (Anlas, 2012).

In managing the exchange rate, there are two regimes involved. The first one is fixed exchange rate. According to CNB National Bank (2018), a fixed exchange rate is a rate that is set by the central bank with the respect to a foreign currency. When the country was hit with Asian financial crisis during the year of 1997-1998, Malaysia had introduced the usage of fixed exchange rate. Bank Negara Malaysia (BNM) decided to administer the domestic interest rate. For example, before April 1997, a ringgit was interchangeable to 2.42 of the US Dollar, however it became RM4.88 to 1 US Dollar on January 7, 1998 (Aziz, n.d.). Hence, BNM has taken an initiative to introduced on 1 September 1998 to peg the foreign exchange rate at RM3.80 per 1 US Dollar (Seong, 2013). On the other hand, a floating exchange rate is defined depending on demand and supply and it generally fluctuate constantly (CNB National Bank, 2018). Once the country has achieved stability in the economic growth, the exchange rate to the USD was changed to float system. We can see the effectiveness of this float system when Ringgit Malaysia has shown an increase in its value to RM3.43 per 1 USD in 2009 (Malaysia Country Monitor, 2012).

It is important to maintain the exchange rate as it helps to bring benefits to one’s country. The first rationale to maintain foreign exchange rate is it helps the country to track the record of previous economic condition. It is vital for the country to track the previous performance and set a benchmark for the country’s future planning. When there are records of the past, government and related parties can form their own expectations for the economic decision making (Mitchell & Pearce, 2005). An accurate forecast will help the country to preserve their economic growth. This will be helpful especially to the developing countries. For example, a data from the 1997 recession was recorded and from there, economists can predict when the next economic problem will occur. Hence, the impact can be minimized. The exchange rate is also recorded daily to make it easier for the government to track the previous data accurately. This will be very beneficial for them in designing a policy pertaining to Malaysia economy.

The second rationale in maintaining the exchange rate is because it affects the cost of production depending on the currency value. The effect of cost of production can mainly be seen among business entities who export goods and import raw materials into the country. Accoding to Pettinger (2017), a slump in currency value will benefit exporting firms as the export price will be cheaper. In contrast, firms who import raw materials from other countries will bear higher cost of import. For example, BNM (2010) had conducted a survey to examine the impact of ringgit appreciation to the export and import firms. The survey which covers 177 companies had shown a negative result to their cost of production.

Last but not least, the rationale of maintaining the foreign exchange rate is to encourage the investors to invest in our country. Foreign investment is crucial in developing an emerging market countries. This is because, the companies need the multinational funding and expertise to broaden their international sales (Amadeo, 2018). Investors prefer to invest in a country that has a stable exchange rate. A stable economic condition creates a favourable nature for the investors to earn high return on investment (Lee et al., 2016). The most significant event that highlight this point can be seen during the catastrophic event happened in 2014 where Malaysia Airlines (MAS) lost the trust of their investors after two of their planes encountered an unfortunate occurrence. This can be proven according to statistics from the Bank of England (2014), where the exchange rate before the incident was recorded at RM3.258 per 1USD and the value of the currency after the incident declined to RM3.282 per 1USD.

In short, it is important for the country to maintain their exchange rate. There are many factors that contribute to the rise and fall of exchange rate such as natural disaster, unemployment, war, and many more. The monetary authority of Malaysia, BNM can also take appropriate actions in order to control the flow of the money in the market by imposing monetary and fiscal policy depending on the economic condition. As the exchange rate change from time to time, it is the responsibility of the financial institutions to keep updated from the central bank on which action to be taken.

Contributors

  1. INTAN FARHANA BINTI NAZRI  2016421866

  2. NUR FARAH AISYA BINTI AZMAN  2016419508

  3. NUR SYAZA NIZA BINTI AMIRUN NIZA  2016421678

  4. NUR NISHAREENA BINTI ABDUL HAMID  2016419506