Determinants of parallel exchange rate in Myanmar.(Report)

Publication: ASEAN Economic Bulletin

Publication Date: 01-DEC-07

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COPYRIGHT 2007 Institute of Southeast Asian Studies (ISEAS)

I. Introduction

Myanmar practices dual or multiple foreign exchange system. The official rate has been pegged to the special drawing right (SDR) of the International Monetary Fund (IMF), and it has not been devalued for more than two decades, shifting around 6 kyat per U.S. dollar. In contrast, parallel exchange rates have depreciated chronically from approximately 120 kyat per U.S. dollar in January 1996 to 1,300 kyat in August 2007. In terms of disparity between the official and parallel rates, this is one of the worst cases among countries that carry out parallel foreign exchange systems. Nevertheless, few studies have thoroughly investigated Myanmar's foreign exchange system. (1) One of the reasons for such a cavity in the literature is the poor quality of macroeconomic data (Mya Than and Myat Thein 2007, pp. 99100). With due recognition to the problem of data, we make an attempt to quantitatively investigate the determinants of parallel exchange rates with available statistics.

While parallel exchange rates exhibit a depreciation trend in a long term, there was a remarkable change in this trend during the period between October 2002 and the early 2005. Figure 1 depicts the developments in a parallel exchange rate and the consumer price index. This figure illustrates that inflation has mostly accompanied depreciation, conforming to the general perception that the monetization of fiscal deficits causes inflation and results in the chronic depreciation (Mya Than and Myat Thein 2007, pp. 101-102). For the period between late 2002 and early 2005, however, the parallel exchange rate mostly tended to appreciate in spite of the sustained, though rather low, inflation.

[FIGURE 1 OMITTED]

The Myanmar economy is faced with at least two significant changes that might account for this appreciation trend. One is the natural gas exploration that has wiped off the current account deficit since 2002. The other is the banking crisis in February 2003. The banking crisis led to a severe recession, (2) and it had taken almost two years before the total deposit of the aggregate banking sector recovered to the pre-crisis level. Through an analysis on determinants of parallel exchange rates, we try to identify the background to the appreciation in this period.

We take into account the regulations on foreign exchange and trade that characterize parallel exchange markets. There are numerous regulations in Myanmar such as import/export licensing and controls on foreign exchange. We shed light on the relationship between the official and parallel exchange rates. We will illustrate how the official exchange rate exerts little impact on the private sector.

Our analysis on determinants of parallel exchange rates will contribute to better understanding of the economic structure of Myanmar. We can also make use of this analysis to predict the impacts of natural gas export revenues on parallel exchange rates. Furthermore, we expect that this study offers a basis for policy discussions on prospective economic reforms on the foreign exchange system.

The organization of this paper is as follows. Section II reviews the recent developments in macroeconomic variables that appear to be related with parallel exchange rates. These include the money supply and the consumer price index, the current account balance and foreign reserves, and outstanding deposits as an index of economic fluctuations especially for the period after the banking crisis. Section HI illustrates the structure of dual foreign exchange system. In section IV, we perform time series analyses of the parallel exchange rate. Based on the results of empirical analysis, section V offers a perspective on parallel exchange rates, and deduces implications for economic reform. Section VI summarizes the analysis and concludes.

II. Recent Macroeconomic Developments

II.1 Monetization of Fiscal Deficits

First, we illustrate the relationship among the money supply, the price level, and the parallel exchange rate. Every year fiscal deficits have amounted to around 5 per cent of GDP. The bulk of them have been financed by printing money. It is a widespread perception that the monetization of fiscal deficits causes chronic depreciation as well as high inflation (Mya Than and Myat Thein 2007, pp. 101-102).

[FIGURE 2 OMITTED]

Figure 2 plots year-to-year changes in the reserve money, the consumer price index (CPI), and the parallel exchange rate. The CPI reported in the govemment publication, Selected Monthly Economic Indicators, is considered as dubious statistics. On the other hand, the parallel exchange rate used in this paper is based on the data collected by a foreign embassy and a foreign bank's representative office in Myanmar. (3) Figure 1 in the previous section compares this parallel exchange rate with the CPI, showing they are moving mostly in parallel with each other. From the viewpoint of purchasing power parity, this implies that the CPI may not be excessively arbitrarily falsified.

In Figure 2, we can observe moderate correlations among these variables. Higher growth rate in the reserve money from 2001 accompanied higher inflation and depreciation, whereas the decline in the growth rate of the reserve money from 2004 coincided with lower inflation and depreciation. This observation forms a basis to relate the chronic depreciation with inflation and the excess money supply.

II.2 Natural Gas Exploration

We now look into developments in the balance of payments. Figure 3 summarizes selected indices of the balance of payments. Myanmar's foreign trade has expanded rapidly since 1989 in the course of its transition from a planned economy to a market-oriented one. Partial liberalization of trade stimulated imports more than exports, which brought large trade deficits in the late 1990s. While restrictive measures on imports contained trade deficits to some extent, it was not until the start of natural gas exports in 2001 that the current account has come to balance. In 2004, natural gas exports accounted for approximately 30 per cent of aggregated exports of the economy. (4)

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The improvement in the current account balance due to natural gas exports is reflected on official foreign reserves. Figure 4 depicts the development in foreign reserves. Foreign reserves...

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