On April 2 the resource-rich Myanmar embarked on a very bold move to open up its insular and dysfunctional banking system by floating the kyat. For 35 years it had been pegged to the International Monetary Fund’s special drawing rights at 6.4 kyat to the US dollar but now it is set at a reference rate of 818 kyat, roughly in line with where it trades in the black market.
The kyat will still remain non-convertible and non-negotiable outside Myanmar but, crucially, the central bank will allow it to move as much as 2% either side of the reference rate.
Having a tight band is a brassy decision and one, if maintained, that will provide much needed currency stability to Myanmar and make the central bank credible.
But its success hangs very much in the balance. Maintaining a band is no easy task; it requires very active buying and selling of the currency.
The timing of the float is good, intentionally or otherwise. It’s not often you will read this, but the complete lack of a liquid bond or stock market will help matters in the short to medium term. The less potential there is for hot money to get in and out of the country the better. Most investment has to come in the form of foreign direct investment into sticky, highly-regulated industries.
At present the pressure on the kyat is an upward one. The huge surge of FDI in the 2010-2011 financial year reached $20 billion, according to OCBC Bank. This is the same amount as Indonesia received in 2011.
That’s okay for Indonesia; it has more than $100 billion in foreign reserves to combat currency volatility. Myanmar has approximately $4 billion. Any sudden capital movement out of the country — a result of a bad headline perhaps — could place a great strain on the central bank to maintain the band.
The risk is one of inflation as the country’s economic capacity fills up. This will have its benefits. As investors pour their money into the country the central bank will have to print more kyat to exchange. In return it gets to build up its FX reserves to far healthier levels. It would do well to insist that most investment is made in dollars.
Myanmar is a dollarised economy but as more kyat flows into it the central bank it will have to start considering ways of dealing with the kyat before it has a damaging inflationary impact. The country’s GDP growth is 5.5% with an estimated 6.7% average inflation rate. The country has room to allow inflation to grow but at some stage the central bank would do well to issue monetary stabilisation bonds to mop up any excess kyat liquidity.
Without a functioning bond market to speak of, it is likely the state banks will be directed to come in and buy up the debt in the early stages. This is some way up the line but if the central bank and the government aren’t already thinking this way then they should be. It would certainly do no harm in the formation of an interbank bond market.
In that time, hopefully the development of a fully functioning stock market will take place. There is already talk a stock exchange will go live in 2015 (as it happens Myanmar already has one; possibly the smallest in the world).
“Myanmar’s potential is enormous,” noted Hak Bin Chua a strategist at Bank of America Merrill Lynch in a March research note. “It sits at the crossroads of some of the largest and fastest growing Asian economies… is rich in oil, natural gas, timber and gems… the population base is relatively young and the British left behind a legal system better developed than the rest of Indochina.”
To ensure the country doesn’t squander this great opportunity, the central bank’s early performance is crucial. If it can control the currency effectively, then it will both nurture the growth of a more sophisticated banking industry and buy time for the development of a healthy capital market.