Saturday, November 01, 2008

The value of the riel and how it affects the economy

In the last few weeks major currencies have fallen against the US dollar. The BBC on Tuesday reported the British pound lost 26% of its value against the USD (a year ago, the pound would have got you USD2.10; now it is USD1.55). The Australian dollar lost 25% of its value two weeks ago and the Korean won is at its lowest in a almost a decade.

One currency has remained unscathed—Cambodia’s local currency, the riel.

Take a moment to consider the implications for the Cambodian economy. Other currencies are now cheaper compared to the US dollar, while the riel remains the same. Cambodia is now in a very uncompetitive position. It means that goods made in Cambodia are now 25% higher for an Australian, 26% higher for a Briton and so on and so forth.

Which means foreigners will think twice before buying Cambodian products or visiting Cambodia. Why would they, since Vietnam and Thailand, whose currencies have also devalued, are now offering foreigners more bang for their buck.

One way to remain competitive is for businesses to lower their prices. So a restaurant dish that costs USD3.50 may have to go down to USD2.50. We already see this happening with beer prices on Pub Street. In the last month, at least three restaurants have started offering draft beer for USD0.50 a mug, where previously it was sold at USD0.75-USD1 a mug (a 30%-50% reduction). The price war will only continue.

The other thing businesses will do to stay afloat is to cut costs. You can bet that already the big companies are looking at their monthly bills and thinking where can they cut costs. In the case of restaurants, ingredients are one area, so you can expect cheaper ingredients like onions and long beans to replace cauliflower in your stir-fried vegetables. In fact, I’ve already noticed some restaurants doing this.

The other major cost, is of course, salaries. But the problem is most workers are already on survival rates. So workers may choose the lower wages or they may choose to return to the provinces, as those in the garment industry have done. According to Cambodia’s Free Trade Union, about 27,000 garment workers have quit in the last year in search of higher pay. “Some have gone to look for work in rural areas where the cost of living is lower, while others have found work at karaoke parlours where they're in danger of falling into prostitution, says FTU president Chea Mony.” (“Cambodian garment workers worry about future prospects”, Jul 13, 2008, AFP)

Because rents, wages are paid in dollars, the cost of doing business in Cambodia will still remain relatively high. And this is the problem with the riel tied to the dollar: it does not matter whether businesses pay in dollars or riels, the net effect will be the same.

Which is why I wonder why the value of the riel has not fallen like other currencies (like the Thai Baht and the Vietnamese Dong)? Why isn’t the value of the riel determined by market forces?

There was some talk back a few years ago on de-dollarising the Cambodian economy. At the Cambodia Economic Forum on 17 January 2006, Finance Minister Keat Chhon said “However, it should be seen that the Royal Government is now implementing de-dollarization. The pace should be consistent with and follows market principles and nature. Our economy must be based on national currency, which should be based on a basket of foreign currencies and consistent with the integration of our economy into regional and world economy.”

Almost three years down the road and nothing has happened. What happened to that plan?

Ideally, the government should make the riel the only legal tender in this country, that is, anyone who wants to buy things in Cambodia has to pay in riel. Just like in other countries where foreign currency is not accepted in shops—you have to change your USD or pounds etc into the local currency before you can spend it.

Under this system, the riel would by now be valued at 5,000 or 6,000 instead of 4,100 as demand for the riel (from tourists and businessmen) falls. The devaluation of the currency would make the country more competitive.

The alternative, the one mentioned by Cambodia’s finance minister is to link the riel with a basket of currencies—Singapore’s method.

“Initially, the Singapore dollar was pegged to the British pound sterling at a rate of S$60 = £7. This peg lasted until the demise of the Sterling Area in the early 1970s, after which the Singapore dollar was linked to the US dollar for a short period of time. As Singapore's economy grew and its trade links diversified to many other countries and regions, Singapore moved towards pegging its currency against a fixed and undisclosed trade-weighted basket of currencies from 1973-1985. From 1985 onwards, Singapore adopted a more market-oriented exchange regime - classified as a Monitoring Band - in which the Singapore dollar is allowed to float (within an undisclosed bandwidth of a central parity) but closely monitored by the Monetary Authority of Singapore (MAS) against a concealed basket of currencies of Singapore's major trading partners and competitors. This in theory allows the Singaporean government to have more control over imported inflation and to ensure that Singapore's exports remain competitive. All issued Singapore dollar currency in circulation is fully backed by international assets to maintain public confidence.” Wikipedia on the Singapore dollar

The last point is crucial- public confidence in the currency.

This is why I think Cambodia is stuck between a rock and a hard place. Having a dollar economy makes the country uncompetitive in such times, yet there is no confidence in the local currency because there is no confidence in the government's management of money, to put it politely.

This Sept 2008 report by the Asian Development Bank notes: “The IMF estimates the share of dollars in currency in circulation at about 90%, little changed from what it was a decade ago. The National Bank of Cambodia estimates the share of foreign currency deposits (FCDs) in broad money (M2) to have risen to its highest level ever, at 75% in 2006, significantly higher than the 54% recorded in 1998 (Table 1). Currently, about 97% of banking deposits are in US dollars.” ADB

In fact, I think Cambodia could go the way of Zimbabwe, if the riel was made the only legal tender--the riel would be worthless and there would be a black market of hard currency (see my other post on "Zimbabwe's 100 billion dollar note").

I see no way for the Cambodian government to help the economy. Factories are just going to shut as Cambodia becomes less competitive than Vietnam, Indonesia or China. The terribly sad thing is that it is very hard to rebuild industries once they are gone.

On the positive side, because Cambodia is largely a peasant economy, farmers and other people who live in the countryside will not feel the pressure. They will still farm and feed themselves and barter. The people who will suffer are those in the cities, who depend on jobs for a living.

Still, I don’t think it is all doom and gloom. I think the US dollar is a weak currency and its value will just continue to fall. It may take 2 or 3 years, or however long, but I think it will fall. The reason is because Americans live beyond their means. They also have a fiscally irresponsible government. It may change if Obama gets in, but I think it is unlikely.

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