Introduction
2. I joined Bank Negara Malaysia (BNM) in September 1968. I was promoted to the post of Manager, Banking Department in 1986.
The Banking Department was responsible for external reserves management, regulation of the domestic money market, including the discount houses, development of Islamic banking, approval of domestic bond issues, managing the Export Credit Refinance Facility (ECR), development of new financial institutions and promoting trade by way of Bilateral Payment Arrangement (BPA) with other central banks in developing countries. When I resigned from BNM in April 1994, I held the post of Advisor. I re-joined BNM again, as an Advisor, in September 1998, after the implementation of the Unorthodox Measures, which I will describe later in my statement. I served in BNM in that capacity until April 2000. In May 2000, I was appointed as the Economic Advisor to the Prime Minister, and subsequently, in January 2004, I was appointed as the Minister of Finance II. In April 2009, I was appointed as Minister in the Prime Minister’s Department responsible for the Economic Planning Unit (EPU). I retired in May 2013, and joined Khazanah Nasional Berhad as Deputy Chairman in June 2013.
Policy imperatives of active external reserves management by BNM
3. Prior to 1985, BNM was not active in external reserves management, including forex trading, given the relative stability in the international foreign exchange market.
4. The situation changed in 1985. On 22 September 1985, five OECD countries, met in private at the Plaza Hotel in New York and decided among themselves, without consulting other countries, that the Yen and the German Deutsche Mark should be strengthened significantly against the US dollar by way of market intervention. This is known as the Plaza Accord. The Plaza Accord was historic because it was the first time central bankers agreed to intervene in the currency market in such a big way and the first time in history when governments set target foreign exchange rates to be achieved through active intervention.
5. One important outcome of the Plaza Accord was that the exchange rate of the Yen versus the US dollar strengthened sharply. (The Yen strengthened from 240 Yen to the dollar in 1985 to 120 Yen to the dollar by early 1988).
6. The strengthening of the Yen resulted in many developing countries suffering huge losses, since a significant portion of their external borrowings was denominated in Yen. The Malaysian Government, Government agencies, including GLCs, as well as the Malaysian private sector suffered significant forex losses on repayment of Yen loans and foreign exchange revaluation of Yen loans, following the sharp appreciation in the value of Yen arising from the Plaza Accord.
7. Malaysia’s borrowings in Yen during the early 1980s were mainly for infrastructure building. At that time, the Malaysian bond and sukuk markets were not yet developed to enable large amounts of borrowings for long periods to be obtained domestically in Ringgit. Given that infrastructure projects required long gestation period, the Malaysian government and its agencies chose to borrow in Yen, since, at that time, long term yen loans were available with low interest rates. The borrowings also coincided with the building of major infrastructure projects in the country.
8. Since the Plaza Accord of September 1985, the international forex market also became much more volatile, with sharp and sometimes erratic movements in the daily forex rates. While the Plaza Accord of September 1985 was intended to strengthen the Yen and the Deutsche Mark, another agreement, the Louvre Accord was signed on 22 February 1987 in Paris by six OECD countries, again without consulting other countries, to halt the over-appreciation of the Yen and the Deutsche Mark, and this created another round of turmoil in the foreign exchange market.
9. This was the background that led to the decision by BNM to begin active external reserves management. I understand that the Commissions attention has been drawn to Allahyarham Tan Sri Jaffar Hussein address in New Delhi, India on 5 December 1988. In that speech the Governor had publicly set out BNM’s rationale for the active external reserves management policy. Let me quote, extracts from that speech by Allahyarham Tan Sri Jaffar Hussein:
“Why are we so active in the market now, compared to before? There are a number of reasons. First, until recently, our external reserves were not large, being only US$4 billion at the end of 1984. This has now increased to US$7.8 billion, thus justifying a more active management of reserves.
Secondly, the exchange rate volatility since the Plaza Agreement of September 1985, had changed the stakes of the game. Whereas in the past an active management of reserves might have made a difference on yield of twenty basis points; it now makes a difference of maybe 500 basis points. So it is worth the trouble. Thirdly, forex trading is today a 24-hour business and there are opportunities throughout the day to deal…
I recall one occasion when some bankers made an attempt to speculate against the ringgit in off-shore centres on one of our national holidays, when they thought we would be closed for the day. To their surprise and cost, we opened up our dealing room during that national holiday and intervened in the off-shore centres to stabilize the ringgit and in the process taught those bear speculators a lesson they are not likely to forget…
…When I joined the Central Bank in 1985 from the private sector, I was informed that the main thrust of reserves management in Bank Negara was to preserve the value of what we have and the main considerations were safety and liquidity. To that, I have added a third and fourth dimension: profit optimization and market expertise.
I basically took the stance that risk-taking in reserves management included not only the risk of losses, but also the risk of falling behind inflation, of not earning as much with our scarce resources as we could. The primary motivation is still to preserve and conserve the value of what we have…
To me, in the last analysis, an active reserves management policy goes beyond the additional return and risks. A key advantage is that the active involvement has given us a greater feel of what is really going on in the foreign exchange and capital markets…
Central banking by decree and fiat can no longer budge markets, but market skills and influence of market psychology can do the trick…
I might also add that in a developing country, where foreign exchange trading skills are scarce, it is the duty of the Central Bank to be the provider of skilled manpower in the market, to be an educator of such technical skills and to be in the forefront of banking and computer technology…….I notice even the Bank of England is now actively adopting this policy”
10. The Governor’s main point was that the primary motive for the active external reserves management was the mitigation of the downside impact of major changes in foreign exchange rates on Malaysia’s foreign currency assets and liabilities.
11. Let me repeat what the Governor said in New Delhi: “the primary motivation is still to preserve and conserve the value of what we have.” We sought to acquire the skills to manage the external reserves better and also, in a broader context, to assist the nation when required. The larger deals, beyond the limits given to the forex traders, were to protect the external reserves and the value of the Ringgit, by way of diversification. At that time, BNM had no specific limit for such diversification deals.
12. To understand further the role of external reserves management in achieving the objectives of a central bank, please allow me to elaborate on the link between the stability of the Ringgit exchange rate, monetary policy and external reserves management.
Maintaining a stable Ringgit in the late 1980s to early 1990s
13. In the Malaysian domestic market, since the late 1980s, there was a continuous large inflow of US dollars by investors, including some short-term inflows or “hot money”. If BNM did nothing, the inflows would have resulted in the Ringgit strengthening significantly from the BNM policy range of between 2.50 and 2.80 against the US dollar. That would have created major implications for the economy, particularly since it would have reduced the competitiveness of Malaysian export sector.
This was an important consideration for a country which is one of the largest trading nations in the world.
14. In order to maintain the stability of the Ringgit, BNM had to buy the excess US dollars from the banks in Malaysia, in its role as the buyer of last resort for foreign currencies in the domestic market. This activity is termed as BNM’s foreign exchange intervention operations. The US dollars were then used by BNM mainly to purchase US Treasury Notes. The yield on the US Treasury Notes in the early 1990s was on average about 4.5 per cent p.a.
15. If BNM did nothing after mopping up the US dollars, there would be the issue of a large overhang of excess Ringgit in the system, since BNM would have paid Ringgit for its purchase of the US dollars. This large overhang of excess Ringgit in the system would adversely affect BNM’s monetary policy. It would cause the Ringgit interest rates to fall sharply (based on supply and demand), and create inflationary pressures. Therefore, BNM had to borrow back the Ringgit funds that it had provided to the banking system in its intervention operations. The purpose of BNM borrowing back the Ringgit funds from the banks is to neutralize the effect of the original forex intervention in the domestic money market. This is known as the sterilization operation. The borrowing rate that BNM had to incur (during the early 1990s) for the sterilization operation was about 7.5 % p.a.
16. Therefore, the combination of the BNM intervention and sterilization operations would cost about 3 % p.a. This is because the cost of borrowing back the Ringgit was higher than the yield of US Treasury Notes. This negative margin would be recorded as a loss in BNM’s books. In BNM’s active external reserves management, one consideration was to mitigate this loss.
17. The issue of moving into an active mode of external reserves management must also be seen in the context of Allahyarham Tan Sri Jaffar Hussein’s philosophy regarding Bank Negara’s role in national development. I need to elaborate on this point because Allahyarham Tan Sri Jaffar Hussein is no more with us, and it is important that we recognize the wisdom of this great man. The Governor believed that by active management of the external reserves, we will be able to acquire the skills, knowledge and experience required to serve the nation, when required, both in developmental activities as well as to overcome any financial crisis that the nation may face in the future. He termed this as “market expertise”.
Lessons for the 1997/1998 Asian Financial Crisis
18. Indeed, Allahyarham Tan Sri Jaffar Hussein’s foresight regarding market expertise saved the nation during the 1997/1998 financial crisis. In a strange twist of history, the skills, knowledge and experience acquired in BNM enabled the nation to implement the Unorthodox Measures of September 1998. It provided the nation with the ability to frustrate the foreign currency manipulators, whose intention was to destabilize Malaysia and cause chaos in the socio-economic fabric of the nation.
Unlike Thailand, Indonesia and South Korea, Malaysia was able to overcome the financial crisis of 1997/1998, without borrowing a single cent from the IMF or the World Bank or anyone else. We reset the Nation back on the growth trajectory without outside help. The Unorthodox Measures of September 1998 saved Malaysia from dire consequences, following the worst financial crisis in our history, and restored the sovereignty and dignity of our beloved nation.
19. In economic terms, the result of the Unorthodox Measures of September 1998 is substantial. Just to illustrate using one of many measures of economic gain, the Unorthodox Measures resulted in the market capitalization of the Malaysian stock market recovering from a low of RM 181.5 billion on September 1, 1998 to RM 579.2 billion on March 24, 1999, a gain of RM397.7 billion. The Stock Market Index jumped from 262.7 (September 1, 1998) to 851.7 (March 24, 1999), a multiple of 3.24 times.
20. Let me briefly illustrate how the skills, knowledge and experience that we acquired from the forex activities in Bank Negara became critical in formulating the Unorthodox Measures of September 1998:
i. There was great deal of confusion, during the early days of financial crisis of 1997/1998, on the concept of “Offshore Ringgit”. The initial view was that bags full of cash in Ringgit were taken out to Singapore and Malaysian customs officials at the border were instructed to check thoroughly the bags of Malaysians departing to Singapore. Obviously no big amount of cash was found.
I explained to the Prime Minister in 1997 and 1998 that the term “Offshore Ringgit” does not refer to Ringgit physically located outside Malaysia. The bulk of Ringgit will always remain in Malaysia. The term “Offshore Ringgit” refers to Ringgit (in Malaysia) which is owned by foreigners. The currency manipulators borrow the Ringgit, both local Ringgit owned by Malaysians or “Offshore Ringgit” owned by foreigners, to sell the Ringgit for US dollars. This is called short-selling. We knew from our forex trading days that on Black Wednesday (16 September 1992) when Pound Sterling crashed, Soros had borrowed £ 10 billion to short-sell the pound sterling. Therefore, an important aspect of Malaysia’s Unorthodox Measurers of September 1998 was to disallow foreigners from borrowing Ringgit to speculate. The concept of “Offshore Ringgit” is very complicated and it took me a few attempts to ensure that the Prime Minister fully understood the term, as you can read from the book
Notes to the Prime Minister by Wong Sulong published in 2011. I wrote 5 notes on this subject, namely Note 2 (October 13, 1997), Note 13 (December 12, 1997), Note 25 (May 19, 1998), Note 31 and Note 32 (both on June 29, 1998). Without the knowledge acquired at BNM’s forex desk, we would not have fully understood the concept of “Offshore Ringgit”, which was key to the implementation of the Unorthodox Measures;
ii. Malaysia initial response during the financial crisis was to increase the interest rate level to stabilize the Ringgit. This created chaos for the many business entities, pushing them to the verge of bankruptcy. We knew from experience that this does not work. During the Black Wednesday incident in United Kingdom, the British Government increased the interest rate from 10% p.a to 12 % p.a. in its desperate attempt to stabilize the pound. But this move was completely ineffective.
Therefore, our Unorthodox Measures involved, among others, bringing the interest rate down, rather than increasing the interest rates, after fixing the exchange rate at RM 3.80 to the dollar, and disallowing foreigners from borrowing the Ringgit for speculative purposes. This significant lowering of the interest rates, as well as our measures of implementing an expansionary monetary and fiscal policy, as part of the Unorthodox Measures, saved many corporations from becoming bankrupt and some banks from becoming insolvent; and
iii. When we pegged the Ringgit on 2 September 1998, we pegged it at RM 3.80 to the US dollar.
The 3.80 rate was on the weaker side since, based on fundamentals, we could have fixed the rate at 3.50. But we knew that it was better to fix the Ringgit at a slightly weaker rate, anticipating that the market players would feel that, at 3.80, the Ringgit was undervalued and they would therefore buy the Ringgit. We expected that this move would result in large inflow of funds into the country. This is exactly what happened. There were substantial inflows following the peg.
There were nooutflows, as the market players expected the Ringgit to subsequently strengthen, not weaken. This was something we learned at the forex desk in Bank Negara Malaysia.
21. In fact, the 45 notes that I wrote to the Prime Minister between October 1997 and August 1998 analysing in detail the 1997/1998 financial crisis and proposing the solution would not have been possible without the market expertise acquired at Bank Negara’s forex desk, thanks to Allahyarham Tan Sri Jaafar Hussein.
22. I should add that even after Allahyarham Tan Sri Jaafar Hussein and I left BNM, we kept closely in touch meeting regularly for long chats. The last time I met him was in July 1998, a month before he died. We spent two hours discussing about the financial crisis of 1997/1998. I informed Allahyarham that I was working with the Prime Minister to find a solution to the financial crisis, based on the knowledge the he made possible for me to acquire in Bank Negara. He was happy that he had made the right decision on the importance of market expertise and he was confident that we can overcome the crisis. I wrote about this meeting with Allahyarham on 21 August 1998 and it appears as Note 43 in the book “Notes to the Prime Minister” by Wong Sulong. Allahyarham Tan Sri Jaafar Hussein’s contribution to the nation is undoubtedly significant.
My role at BNM in external reserves management in the late 1980s and early 1990s
23. I was tasked with implementing the external reserves management policy as determined by the BNM’s Board having regard to the considerations I have mentioned above. In so doing, I reported both to the Governor and the External Reserves Committee (ERC). I spoke to the Governor on external reserves management regularly, and certainly whenever there was a large movement in the exchange rates. I also reported to the ERC whenever it met. The membership of the ERC comprised, amongst others, the Governor, Deputy Governor, and the Advisors. Further, there were weekly Senior Officers Meeting, where the external reserves matters were sometimes discussed.
These Senior Officers Meetings were chaired by the Governor, and were also attended by the Deputy Governor, Advisors and all Managers. I did not report to either the Finance Minister or the Prime Minister on any issues regarding external reserves management, as that was not my reporting line.
24. I was not involved in deciding on the accounting treatment of the losses. In fact, I have no knowledge whatsoever of the accounting treatment.
25. I was also very careful not to execute any trade by myself, although I had the authority to do so. It was always, without any exception, done by the staff. I did this for the purpose of transparency, so that there would always be more than one person aware of every trade.
26. BNM made significant gains from its trading activities in the 1980s. The loss does not include the gains made in the 1980s. Based on the period of 1985 to 1993, I believe that the total forex losses will be lower. The significant losses that were incurred in 1992 arose from two unexpected events:
i. The unexpected rejection in the Danish Referendum of 1992 of the Maastricht Treaty; and
ii. “Black Wednesday” on 16 September 1992, when the pound sterling was forced out of the European Exchange Rate Mechanism.
27. In the early 1990s, the European currencies started to gather strength on the basis of the then conventional wisdom that, given the potential for European integration, Europe was going to overtake the United States as the strongest economic power in the World. We subscribed to this view and bought the European currencies and the Pound Sterling.
28. Unfortunately, following the non-ratification of the Maastricht Treaty by Denmark in February 1992, the value of the European currencies crashed. This was compounded in September 1992 when both the Pound Sterling (and Italian Lira which we did not trade) were forced out of the European Exchange Rate Mechanism despite the best efforts of the far more powerful and wealthy European central banks.
29. As we were ‘long’ in the European currencies, including the Pound Sterling, we suffered significant losses. We were not the only central bank to have suffered significant forex losses as a result of these events.
30. Whenever we received information of large inflows of US Dollars from investors, both long-term and short-term, we would decide on whether or not to diversify these inflows into other currencies, depending on the anticipated exchange rate movements. If we expected the US Dollar to weaken, we would purchase European
currencies forward based on the expected US Dollar inflows. The size of the purchases would correspond to the anticipated size of the US Dollar inflows.
31. All the external reserves activities, including forex activities, were based on strategic considerations. Admittedly we misread the turn of the market. As staff of a central bank we naturally believed that the Bank of England would win in its fight against Soros. We had confidence in our fellow central banker and bought Pound Sterling. Unfortunately, the Bank of England lost.
Similarly, our best intelligence was that the Maastricht Treaty would be ratified in the referendum in Denmark in 1992, but unfortunately it was rejected.
32. We learnt a bitter lesson from these incidents. That lesson proved crucial in helping us formulate policies to defend the country against the currency attacks in the 1997/1998 Asian Financial Crisis, saving the nation hundreds of billions of Ringgit that would otherwise have been lost.
Conclusion
33. The forex losses happened. There is no denying it. There is also no denying my accountability for the forex losses. I accepted my fair share of the accountability for the forex losses and resigned from BNM. At that time, it appeared to me to be a sad end to my 25 years of service to the nation, through Bank Negara Malaysia.
34. However, with the Grace of Allah SWT, I was given the opportunity in 1997/1998 to contribute to King and Country during the financial crisis of 1997/1998. The important point is that the experience in the forex unit during those years proved extremely useful later in saving Malaysia from the devastating effects of the financial crisis of 1997/1998, which otherwise would have caused losses worth hundreds of billions of Ringgit for Malaysia and could have resulted in many Malaysian companies becoming bankrupt, with large scale unemployment and poverty spreading throughout the country. The political stability and the socio-economic framework of the nation would have been destroyed. It was an accident waiting to happen. It did not happen because of the Unorthodox Measures of September 1998, which in turn was conceived and implemented based on the knowledge, skills and experience acquired at the forex desk in Bank Negara Malaysia.
35. I also contributed to the nation during my second tour of duty in Bank Negara (September 1998 to April 2000) as well in my role as the Economic adviser to the Prime Minister (May 2000 to December 2003) and as a Federal Minister (January 2004 to May 2013). The record speaks for itself.
TAN SRI NOR MOHAMED YAKCOP
Wednesday, September 6, 2017
