Exchange Market Pressure and Degree of Intervention

1. Exchange Market Pressure and Degree of Intervention

2. Prof. Dr. Saadiah Mohamad Khalilah Zaghlol Institute of Business Excellence Faculty of Business Management Universiti Teknologi MARA, Shah Alam, MALAYSIA 37th FAEA @ Philippine International Convention Center, Manila28-29th November 2012

3. Content • Objective • Background • Problem & Motivation • Rationale • Literature Review • Methodology • Empirical Findings • Conclusion

4. Objective • To investigate into the exchange market behavior – Malaysia as a case study • To measure the degree of EMP • To look into the degree of intervention • To analyse the role of EMP & official forex intervention

5. Motivation & Problem • Activist approach to intervention supposedly has terminated, but the truth it that it has not ended … • Is yen intervention on the horizon? • The most recent world wide financial crisis that emerged in late ‘07 and reached its climax btw Aug ‘08 & Feb ’09 • Although it started with the subprime mortgage related crisis – it led to global liquidity crisis • Implications of QEs by the U.S. & the Fed & the easing policies in the Euro countries

6. Rationale • The importance of EMP • EMP can cover all spectrum of exchange rate regimes • EMP can integrate both theories: ER & BOP • EMP can be more relevant than just ER changes as a determinant of other phenomena • EMP better signals forex tensions • EMP also helps speculators to find profit opportunities • EMP can help policymakers to timely counteract contagion from other nations

7. Background • FOREX is the world’s largest market • Daily average trading volume: NYSE = USD16 bn; LSE = USD11 bn • Average daily turnover in global FOREX: Apr 2010 = USD3.98 tn; Apr 2007 = USD3.21 tn • We are basically measuring the external position by looking at changes in EMP • QE1, QE2 & QE3 – supply glut/flow of capital into the emerging economies (EMs) like Malaysia

8. Literature Review • Seminal paper of Girton & Roper (1977) • Connolly and De Silveira, 1979; Hodgson and Schneck; 1981; Roper and Turnovsky, 1980; Burdekin and Burkett, 1990; and Pentescost, Van Hooydonk and Van Poeck, 2001 • In developing countries: Brazilian dataset by Connolly and De Silveira, 1979; Modeste (1981) to Argentinian data; an empirical study on Korean data by Kim (1985); Thornton (1995) to Costa Rican database; Pontines and Siregar (2006) to Singaporean data; and Feridun (2009) to Turkish dataset

9. Literature Review • More recent studies: • by Aizenman and Hutchinson (2010) – a careful review on the impact of the unprecendented global crisis in 2007-2009 on EMP and • Bordo, Humpage, and Schwartz (April 2012) – an epiloque of forex operations in the 21st century

10. EMP index • EMP is in fact counterfactual • Definition: • Usage: a general measure of tensions on FOREX market • Also primarily utilized as a market pressure indicator which is most widely adopted to signal the susceptability/break up of a crisis

11. Data • Data Sample: Malaysia (domestic country) & USA (anchor country) • Data Span: January 1976 – February 2011 • 35 years, monthly frequency • Sources of data: IMF’s IFS, World Bank’s WDI • Variables: nominal ERs, interest rates and foreign exchange reserves

12. Methodology • EMP index • Eichengreen, Rose, and Wyplosz (1995, 1996) • Model-independent • EMP Formula: 3 components • The sum of the % chg in the exchange rate (+ve denote % depreciation), % loss of reserves and interest rates • High values denote greater external pressure

13. Methodology • EMP index: Augmented formula by Eichengreen, Rose, and Wyplosz(1995,1996) where: • e = exchange rates • r = foreign exchange reserves • i = interest rates

14. Empirical Findings • The ERW-EMP is further expressed as follows: • An increase shows higher tensions on the currency • For the weights: Volatility-smoothing approach

15. EMP • The EMP index is used as a general measure of tensions on the foreign exchange market and country’s susceptibility to crisis • As an indicator for market pressure/speculative pressure

16. Results • EMP index for Malaysia (1976-2011)

17. Results/ Findings • Pre-crisis 1997 period: > tranquil in 1980s – 1996 • mid May & July 1997: 2 major speculative attacks on MYR • Highly volatile EMP during crisis period – large depreciation of MYR, interest rate to 40%, 12% of reserves spent • 2007-2009: global crisis but EMP rather muted as compared to 1997

18. Conclusion • Imperative to monitor movements of EMP for not just policy makers • EMP an important tool for an economy • EMP can be more relevant than just ER changes as a determinant of other phenomena • EMP better signals forex tensions • EMP also helps speculators to find profit opportunities • EMP can help policymakers to timely counteract contagion from other nations • Fast fact: a WIP hence appreciates feedback!

19. End of Presentation Thank You