Since last decade Malaysia foreign exchange has undergone significant changes and has been subjected to few shocks.According to Ram N. Agarwal Exchange rate misalignment defined as the deviation of the real exchange rate from its long run equilibrium path that is, the basis of the Ricardian international trade and exchange rate volatility is defined as short-term exchange rate fluctuation measured by the conditional variance of the exchange rate believed inhibits the growth of trade.
Foreign investment, Crowley and Lee found a weak relationship between exchange rate volatility and foreign direct investment if the movement of exchange rate was stable but a strong relationship when the movement of exchange rate was volatile. According to the research,found that for developing country less flexible exchange rate regimes are associated with slower growth.
Base on the journal in 1997 KLSE Composite index above 1,200 and ringgit to dollar are above 2.50 the overnight rate was bellow 7%.In July 1997, after Thai baht devaluation Malaysian ringgit drop. The overnight rate rises from under 8% to over 40%, leading to rating downgrades and many sell the stock and currency markets.
At the end of 1997, ratings had fallen many notches from investment grade to junk, the KLSE had lost more than 50% from above 1,200 to under 600, and the ringgit had lost about 50% of its value, from above 2.50 to under 3.80 to the dollar.
First recession starts in 1998,where the output of the real economy declined for many years. The construction sector contracted 23.5% manufacturing shrunk 9% and the agriculture sector 5.9% Overall, the country’s gross domestic product plunged 6.2% in 1998. As the result , the ringgit plunged below 4.7 and the KLSE below 270. In September that 1998, various defensive measures were announced to overcome the crisis.
Bank Negara decides to fixed the ringgit at 3.8 to the dollar. However Malaysia asset values have not recovered . In 2005 the last of the crisis measures was removed as the ringgit was taken off the fixed exchange system.Malaysian economy generally prefer to follow more flexible exchange rate regime after the collapsed of Bretton Wood system in 1971–1973.
Real Exchange Rate, Trade and Economic Growth : Theory
The theory state that real exchange rate and its stability both matter for national economic growth. If the exchange rate becomes significantly overvalued or undervalued will affect the state import and exports.
Exchange rate volatility, trade and economic growth
This theory is assumed that there are no hedging possibilities either through the forward exchange market or through offsetting transactions. For advanced economies where there are well developed forward markets, specific transactions can be easily hedged, thus reducing exposure to unforeseen movements in exchange rates. But it needs to be recognized that such markets do not exist for the currencies of most developing countries. Moreover, even in advanced economies the decision to continue to export or import would appear to reflect a series of transactions over time where both the amount of foreign currency receipts and payments, as well are the forward rate, are not known with certainty. Moreover, there are numerous possibilities for reducing exposure to the risk of adverse exchange rate fluctuations other than forward currency markets. The key point is that for a multinational firm engaged in a wide variety of trade and financial transactions across a large number of countries, there are manifold opportunities to exploit offsetting movements in currencies and other variables.
Financial development and economic growth: theory
The efficiency of a financial system refers to how well a financial system performs the five core functions and financial development refers to an improvement in the efficiency of a financial system. These five core functions provide a clearer understanding of the nexus between financial development and economic growth.
First and foremost, financial systems produce information and allocate capital. The textbook world of scarce capital seamlessly flowing to the most productive firms and industries is a world that assumes away information costs. The intermediation of savings into investments depends on the quality
Then, financial systems monitor firm behavior and exert corporate governance. By improving corporate governance, financial intermediaries can have a positive effect on growth.
Third, financial instruments, intermediaries, and markets can facilitate the trading, hedging, and pooling of risk. By enabling risk diversification across firms and industries, financial systems can influence the allocation of resources and hence economic growth
Fourth, Financial systems that are better able to mobilize savings create a larger pool of savings that lead to higher aggregate investment, faster rate of capital accumulation, and hence faster economic growth.
Fifth, at a more fundamental level, financial instruments, intermediaries, and markets can stimulate specialization, innovation, and growth by reducing transactions costs.