For many years there was nothing smooth about Myanmar's monetary policies. The kyat was pegged at a fixed rate of K8.5 to the dollar, a gross overvaluation that fueled a parallel informal economy which, some economists believe, equalled the formal economy in size.
In the dark alleys of Yangon, and especially around Bogyoke Aung San Market, dollars were sold on the black market for up to K1,000, and more. Savvy tricksters with quick fingers swindled tourists by the busload out of dollars. Foreigners had no alternative; the official rate was just too unattractive.
So when the Central Bank of Myanmar finally decided to float the exchange rate in April 2012, it was a major step. Since then a daily foreign auction to set the official exchange rate has been held by the 11 authorised private commercial banks. Buying and selling rates at the authorised banks are restricted within a band of 0.8 percent of the reference rate. The rate is set every working day.
"At first everybody wanted to change kyats to dollars, so the kyat weakened," said Joe Barker-Bennet, a consultant at Tun Foundation Bank who is modernising its processes and systems.
In the run-up to Thingyan the kyat strengthened, because of increased year end demand. "People were settling their bills and paying taxes. Secondly, a lot of investments have started to come into Myanmar. These dollars have to be converted in kyat, at least partly, to pay for things like salaries and transport," said Mr Barker-Bennett.
Since the Thingyan traditional new year festival, market volumes have declined, resulting in a weakening of the national currency to 962 to the dollar on May 7.
Trade volume at the daily foreign exchange auction is fairly limited, with only a few million dollars changing hands. But that is about to change, said Mr Barker-Bennett. "With telecom operators Ooredoo and Telenor and others investing billions in Myanmar, the trade volume at the auction is likely to increase."
The Central Bank planned to move the daily auction to the international standard – T+2 settlement (SPOT) – as of the beginning of May, with offshore settlement of US dollars in local banks' Singapore US dollar accounts. The launch has been delayed but is expected to be implemented soon.
Mr Barker-Bennett: "It used to be same-day settlement at the banks' accounts with the Central Bank. The new system will easy the ability of banks to move US dollars on and offshore for customers. This should also encourage banks to do more deals between themselves and will eliminate the onshore/offshore price differential, add greater liquidity and flexibility to the USD/Kyat foreign exchange market as imports and exports grow, which will help both banks and customers alike."
What are the main drivers of fluctuations in the exchange rate? Sean Turnell is a specialist on the Myanmar economy at Macquarie University in Australia.
"The major factors behind movements of the kyat are trade flows, primarily earnings from natural gas coming in, and capital flows," said Associate Professor Turnell, the author of "Fiery Dragons: Banks, Moneylenders and Microfinance in Burma".
"The latter represents foreign direct investment and remittances from abroad. But also a certain degree of capital flight; well connected people moving money offshore," he said.
An employee at a currency exchange business in Yangon's Kamaryut Township, who declined to be named, said there were also seasonal fluctuations in the value of the kyat.
"Just before Thingyan everybody changes dollars to kyat, so the kyat strengthens and the rate goes down," he said. "After Thingyan the rate goes up again. For us the holiday period just means losing profit, as we have to close for four days. Another factor that has influenced the exchange rate this year is the increase in the price of gold."
As anyone who has been harassed by unofficial money changers in downtown Yangon will be aware, the black market in currency has dwindled during the last 18 months, because it has become unprofitable. There's no reason to do business with nimble-fingered black market money changers when it's possible to change your dollars or euros or baht at an official exchange counter.
Koji Kubo of the Institute of Developing Economies, Japan External Trade Organisation (IDE-JETRO) researched the impact of the daily auctions on the black market exchange rate. In his paper he writes that the data suggested that the reference rate of the Central Bank of Myanmar followed the black market rate, to minimise the difference. "Thus the function of the foreign exchange auctions as a means of intervention was modest, whereas they incurred substantial costs on the CBM in terms of erosion of the official foreign reserves," Mr Kubo said.
He suggests that the Central Bank of Myanmar might need to reconsider the means of intervention. In this regard the recent institution of a foreign exchange interbank market is a step in the right direction, he believes. In time the interbank market should replace the auctions.
During the first three years of his tenure, President U Thein Sein's government introduced a number of monetary and financial (regulatory) reforms. Is the project nearly completed or are further steps needed?
Associate Professor Turnell looks forward to the revised Financial Institutions of Myanmar Law – currently before parliament – with great interest. "One hopes that the shackles which currently hold back the domestic banking system – interest rate caps and floors, excessive collateral requirements, restrictions on lending to farmers – will be lifted. Hopefully, too, foreign banks will be allowed in," he said.
Mr Barker-Bennett adds: "We need a [currency] SWAP window to allow banks to borrow US dollars and lend in kyat at a fixed repayment rate."
On the streets and in the teashops the kyat remains a hot topic, like the weather. Where will the kyat go, up or down? Both Mr Barker-Bennett and Associate Professor Turnell think the Myanmar economy is fairly stable. They expect little movement in the exchange rate.
"The growing demand for imports will probably counterbalance incoming investments," said Mr Barker-Bennett. "The kyat will remain in a similar range and if anything is more likely to strengthen ... if it moves, it is more likely to hit 925 than 1,000."
Is the kyat undervalued or overvalued? Associate Professor Turnell thinks it's the latter. "Gas earnings and tourism revenues keep the kyat at a rate at which manufacturing and farming are only borderline competitive," he said.
"Myanmar has to watch for so-called 'Dutch disease' effects, which is the economic term for the impact that resource revenues have in keeping an exchange rate above the level necessary for other parts of the economy to thrive in an open economy framework," said Associate Professor Turnell. "This effect was so named because of the effect North Sea gas revenues had on the economy of the Netherlands," he said.
"Personally I see a rate of 1,000 kyat to the dollar as being the maximum at which it should be trading at. But, under a free floating exchange rate you get what the market thinks."
This Article first appeared in the May 15, 2014 edition of Mizzima Business Weekly.
Mizzima Business Weekly is available in print in Yangon through Innwa Bookstore and through online subscription at www.mzineplus.com
Source: http://www.news.myanmaronlinecentre.com/2014/05/31/the-ups-and-downs-of-the-kyat/
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