YANGON UNIVERSITY OF ECONOMICS

DEPARTMENT OF COMMERCE

MASTER OF BANKING AND FINANCE PROGRAMME

CENTRAL BANK INTERVENTION ON FOREIGN EXCHANGE

VOLATILITY IN MYANMAR

KHIN SOE MYAT

(MBF DAY – 1ST BATCH)

DECEMBER, 2019
 CENTRAL BANK INTERVENTION ON FOREIGN EXCHANGE
VOLATILITY IN MYANMAR

This thesis is summitted to the Board of Examiners in partial fulfilment of the

requirements for degree of Master of Banking and Finance (MBF)

Supervised by: Submitted by:

Professor Dr. Tin Tin Htwe Khin Soe Myat
Department of Commerce Roll No. 33
Yangon University of Economics MBF Day 1st Batch

DECEMBER, 2019
 ABSTRACT

This study tries to examine Central Bank intervention on exchange and interbank
market and to analyze the effectiveness of Central Bank intervention on exchange rate
volatility in Myanmar. This study is used to analyze effectiveness of Central Bank
intervention on exchange rate volatility by using GARCH model. The data was collected
by using weekly observations of Myanmar Kyat against US Dollar, spanning the period
from 2016 to 2018 after the adoption of floating exchange rate regime. The model
includes two exogenous variables as they can contribute to the exchange rate volatility;
interest rate differentials and trade balance. This implies that the CBM’s net sales of
foreign exchange via auctions were associated with volatility of the Myanmar kyat
against the US dollar. The results found that the net sale is positively signed, meaning
that it seems if there is more CBM intervention through FX Auction, there is more
exchange rate volatility in Myanmar. It is because FX auction is just a mechanism for
setting reference exchange rate. However, data is not significant. In addition, the interest
rate differential between Myanmar and US treasury bill is negative sign and it is
statistically significance which means interest rate had not moved the exchange rate in
the desired direction as there is no perfect capital mobility. The coefficient of trade
balance is positive sign and it is significant. Thus, increase in trade performance leads to
increase in volatility as managed float exchange rate regime is used. Therefore, Central
Bank shout find solutions to trade deficits to encourage exports and tackle down imports
can hinder exchange rate volatility in Myanmar.

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 ACKNOWLEDEMENTS

First of all, I would like to express my deep gratitude to Prof. Dr. Tin Win, Rector
of Yangon University of Economics and Prof. Dr. Ni Lar Myint Htoo, Pro-Rector for
giving me the opportunity to attend the Master course until the thesis.
I am also heartily thankful to Prof. Dr. Daw Soe Thu, Programme Director of
MBF Programme and Head of the Department of Commerce, Yangon University of
Economics.
My deepest thanks go to Prof. Dr. Tin Tin Htwe, Department of Commerce and
Prof. Dr. Su Su Myat, Department of Applied Economics for their extensive and
constructive suggestions, her supporting excellence lecturers and comments to complete
this thesis. I am heartily grateful for her guidance, advice and encouragement in
preparing to complete this study successfully.
I would like to express my sincere gratitude to all the teachers, and visiting
lecturers who have made their grateful efforts in rendering knowledge sharing of MBF
Programme during these two years.
I would like to express my heartfelt indebtedness to all Professors, Associate
Professors and Lecturers who provided supervision and fortitude to help me achieve the
course objective of the programme. In addition, I would like to extend my appreciation to
the faculty and all the staffs in the Department of Commerce who have provided me with
any administrative support and strength during my academic years.
Finally, I would like to express my gratitude to my beloved parents, family and
friends from MBF Day 1st Batch for their continuous support and patience throughout the
course of my study.

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 Table of Contents
Page
Abstract i
Acknowledgements ii
Table of Contents iii
List of Tables v
List of Figures vi
List of Abbreviations vii

Chapter I Introduction 1
1.1 Rationale of the Study 2
1.2 Objectives of the Study 3
1.3 Scope and Method of the Study 3
1.4 Organization of the Study 4

Chapter II Literature Review 5

2.1 Roles and Functions of Central Banking 5
2.2 Central Bank Policies 6
2.3 Intervention Channels for Foreign Exchange Rate 8
2.4 Intervention Operations 11
2.5 Previous Studies 14

Chapter III Central Bank Intervention on Foreign Exchange Market

in Myanmar 16
3.1 Roles of Central Bank of Myanmar 16
3.2 Foreign Exchange Market in Myanmar 17
3.3 Analysis on Foreign Exchange Rate 21
3.4 Central Bank Intervention on Interbank Market 22

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Chapter IV Analysis on The Effectiveness of Central Bank
Intervention on Foreign 26
Exchange Volatility in Myanmar
4.1 Research Methodology 26
4.2 Trade Balance of Myanmar 26
Interest Rate Trend of the Treasury Bill of Myanmar
4.3
and US 28
Analysis of Central Bank Intervention on Foreign
4.4
Exchange Rate Volatility 29

Chapter V Conclusion 34
5.1 Findings 34
5.2 Suggestions 35
5.3 Need for Further Study 36

References
Appendices

iv
 List of Tables

Table No. Description Page

3.1 Purchasing and Selling Times in FX Auction 24

4.1 Unit Root Test Statistics 30

4.2 GARCH Estimation of the Exchange Rate Volatility 32

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 List of Figures
Figure
Description Page
No.
Comparison between CBM Reference Rate and Interbank Market
3.1 21
Rate

3.2 Exchange Rate Volatility in Interbank Spot Rate 22

3.3 Selling and Purchasing Amount in FX Auction 23

3.4 Number of Transactions in FX Auction 24

4.1 Trade Balance in Myanmar 27

4.2 Interest Rate Trend of the Treasury Bill of Myanmar and US 28

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 List of Abbreviations

ARCH Autoregressive Conditional Heteroscedasticity

BIS Bank for International Settlements
CBM Central Bank of Myanmar
EID Trade Balance
FEC Foreign Exchange Currency
FX Foreign Exchange
GARCH Generalized Autoregressive Conditional Heteroscedasticity
GDP Gross Domestic Product
IRD Interest Rate Differential
MMK Myanmar Kyat
MOPF Ministry of Planning and Finance
NSALE Net Sale
OTC Over-the-Counter
SDR Special Drawing Right
USD United States Dollar

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 Chapter I
Introduction

The central bank is nowadays primarily regulatory for monetary policy. The
structure of Central bank roles, the responsibilities, and the functions vary between
countries. Among these roles, monetary stability is also important for economic growth in
which exchange rate policy is crucial to consider as a tool to sterilize the growth. To
stabilize the monetary policy, foreign intervention is one of the monetary policies of
central banks.
With regard to foreign intervention, the collapse of the Bretton Woods system in
1970s brought major changes and broad variety of choices for exchange rate regimes
each country had been free to choose any form of exchange arrangement, varying from
pure free floating to intermediate regimes, hard pegs, crawling pegs, currency unions and
flexible exchange rate. The determination of an exchange rate regime is key factor for
countries’ macroeconomic stability. Both fixed and flexible regimes have their pros and
cons.
Intervention is defined as official purchases and sales of foreign exchange to
moderate exchange rate fluctuations, to correct misalignment and disordered market
conditions, to accumulate foreign reserves, to supply foreign exchange to market, to
control inflation, to prevent speculation and to maintain monetary and financial stability.
Moreover, successful intervention depends on the choice of instruments, markets and
timing to maximize the impact on the exchange rate.
Intervention may affect the exchange rate through many channels. Under the
signaling channel, market participants may adjust their exchange rate expectations when
they perceive intervention as signaling a change in future monetary policy. Under the
portfolio balance channel, the change in the currency composition of asset portfolios
associated with the sterilized intervention generates a change in the risk premium, which
triggers an exchange rate adjustment as agents rebalance their portfolio with monetary
policy, to stabilize market expectations, calm disorderly markets and limit unwarranted
exchange rate movements resulting from temporary shocks.

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 One view criticized that the exchange rate should be freely determined by market
forces, independently of any intervention or targeting by Central Bank’s monetary policy,
other view confirming the Central Bank intervention and control Michael, M., Masson,
P., Swoboda, A., Jadresic, E., Mauro, P., Berg, A. (2000). Therefore, the choice of an
exchange rate regime is a critical aspect to ensure competitiveness and economic growth.
Floating exchange rate has been regarded as an automatic stabilizer, which is able in
some cases to rebalance the unbalanced economy.

1.1 Rationale of the Study

In the global, the foreign exchange market is the largest, most globally integrated
and most active financial market in the world. The foreign exchange market trades on
various jurisdictions, time zones and types of market participants. This gives it the unique
ability to provide signals as to how market participants are interpreting or responding to
developments taking place in other markets or in the real economy.
According to Central Bank Survey of foreign exchange and derivatives market
activity conducted by the Bank for International Settlements (BIS, 2016) across 53
countries in April 2016, total global average daily turnover across over-the-counter
(OTC) foreign exchange instruments –including spot, forward, swap and option
transactions –was estimated to be USD 5.1 trillion, its first decline since 2001. With
respect to Myanmar, Central Bank of Myanmar was separated from Ministry of Planning
and Finance (MOPF) according to Central Bank Law (2013). CBM stood independently
from MOPF. CBM firstly enacted Foreign Exchange Management Law in 2012. In this
law, CBM partially liberalized restriction on foreign exchange and foreign currency
holding in public.
According to the new government administration, exchange rate unification in
Myanmar started on April, 2012 and the managed floating exchange rate regime and
adopted. The reference exchange rate with US Dollar is determined based on the auction
mechanism which reflects the market demand and supply. Exchange level is not targeted
as exchange rate is market determined and intervention is to avoid volatility. CBM has
conducted daily foreign exchange auction on every business day since April, 2012. Then,
CBM launched renew Foreign Exchange Management Law (FEM Law) (2015).

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 Since one of the main CBM’s policies is to reduce the exchange rate volatility,
including some monetary policy variables in the model allows addressing the issue of
how effective they are. Therefore, this study will examine the Central Bank intervention
on foreign exchange and will analyze whether Central Bank intervention can reduce
exchange volatility in Myanmar. However, as only CBM intervention is not enough to
stable exchange rate, this study also analyzes the other factors like domestic interest rate
and trade balance of the country.
The interest rate differential between MMK and US Dollar is also major
determinant of exchange rate. In trade balance, if export exceeds import, the country will
be trade surplus and domestic currency will also be appreciated. In developing countries,
trade balance is mostly likely trade deficit because developing countries need to build up
new infrastructures which are mostly imported from other countries. Therefore, the CBM,
regulator, needs to monitor closely the trade balance, interest rate, foreign exchange
inflow and outflow to sterilize the exchange rate in stabilization.

1.2 Objectives of the Study

The objectives of this study are as follows:
(1) To examine Central Bank intervention in foreign exchange rate and
interbank market
(2) To analyze the effectiveness of Central Bank intervention on exchange
rate volatility

1.3 Scope and Method of the Study

In this study, secondary data is used to explore the volatility of the exchange rate
in Myanmar, this study employs weekly data. The data set concludes the exchange rate of
the Myanmar Kyat against USD spanning from January 2016 to December 2018 that is a
total of 157 observations because managed float exchange rate regime was used since
2012 in Myanmar. In addition, observations are enough to carry out time series analysis.
Descriptive statistics of variables used in weekly analysis.
Exchange rate data is obtained from website of Central Bank of Myanmar.
Moreover, the nominal weekly weighted average spot MMK/USD and weekly

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intervention in interbank market are used to analyze central bank intervention on
exchange rate volatility and other influencing factors. In this study, the intervention data
series are net sales (sales less purchases) in millions of USD. This study is also used not
only CBM reference rate but also spot dealing in interbank market because the condition
of market is reflected by spot rate of interbank market. Data are obtained from CBM,
Bloomberg and Thomson Reuter.
In order to analyze Central Bank intervention on exchange rate volatility by
contributing of two exogenous variables: interest rate differentials and trade balance by
using the generalized autoregressive conditional heteroskedasticity (GARCH) process
which is often used by financial modeling professionals because it provides a more
realistic condition to predict the prices and rates of financial instruments.

1.4 Organization of the Study

In this study, chapter (1) is introduction which contains rationale, objectives,
scope, method and organization of the study. Chapter (2) discusses literature review on
roles, functions and strategy of central banks, intervention channels and operations and
previous studies. Chapter (3) explores the roles of Central Bank of Myanmar, foreign
exchange market and analysis on foreign exchange rate and interbank market in
Myanmar. Chapter (4) analyzes the effectiveness of central bank intervention on foreign
exchange volatility in Myanmar. Chapter (5) concludes finding, suggestion and needs for
further study.

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 Chapter II
Literature Review

This chapter presented the roles and functions of central banks, central policies,
intervention channel, intervention operations and previous studies.

2.1 Roles and Functions of Central Banking

Before the commencement of the 20th Century, there had been no clearly concept
of central banking, Central banking has become an entirely separate branch of banking,
as distinct from the functions and operations of commercial banks, industrial banks,
agricultural banks, saving banks and investment banks. Central banks have developed
their own code of rules and practices which can be described as the art of central banking.
A clearly-defined concept has been evolved, a central bank being generally
recognized as a bank which constitutes the apex of the monetary and banking structure of
its country and which performs, as best it can in the national economic interest, the
following functions:
1. The sole right to issue note or at least a partial monopoly.
2. The serving general banking and agency services for the state.
3. The custody of the cash reserves of the commercial banks.
4. The custody and management of the nation’s reserves of international
currency.
5. The responsibility of lender of last resort.
6. The settlement of clearance balances between the banks and
7. The imposing monetary policy
A true central bank should always be ready to perform any of the functions
enumerated above if the conditions and circumstances in its area of operation render it
necessary or desirable for it to do so. The guiding principle for a central bank, whether
function or group of functions it performs at any particular moment, is that it should act
only in the public interest and it does not orient to get profit. In the primary objectives of
central banking, exchange control is also important.

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2.2 Central Bank Policies
Central banks conduct in ensuring economic and financial stability. They also
play as important role for monetary policy to achieve low and stable inflation. Therefore,
Central banks adequate policy frameworks to achieve their objectives. However,
operational processes of Central Bank tailored to situation of each country to enhance the
effectiveness of the central banks’ policies. Therefore, this section explains central bank
policies which includes monetary policies, foreign exchange regimes policies,
macroprudential policies (International Monetary Fund Factsheet, 2017).

2.2.1 Monetary Policy

There are three basic types of monetary policy strategies, each of which uses a
different nominal anchor: 1) exchange-rate targeting; 2) monetary targeting; and 3)
inflation targeting. Emerging market countries also have used monetary targeting as it a
successful strategy. The monetary policy frameworks of most emerging countries’ central
banks have used the information conveyed by a monetary aggregate to conduct monetary
policy. However, the instability of the money-inflation relationship also has been very
visible by monetary targeting in emerging market countries. Therefore, monetary
targeting has not been attracted very seriously in these countries (International Monetary
Fund Factsheet, 2017).
With respect to exchange-rate targeting, it has been an effective way of reducing
inflation quickly in both industrialized and emerging market countries. However,
exchange-rate targeting can lose of independent monetary policy. Therefore, exchange-
rate targets may lead to higher volatility. There are two types of Exchange-rate targeting.
They are soft pegs and hard pegs. Soft pegs is the commitment to the peg is not
institutionalized, and hard peg is the institutional commitment comes either from
establishment of a currency board or from dollarization (International Monetary Fund
Factsheet, 2017).
Inflation targeting is a recent monetary policy strategy. It contains five main
elements. They are the public announcement of medium-term numerical targets for
inflation, an institutional commitment to price stability, an information inclusive strategy,
an increased transparency of the monetary policy strategy and an increased accountability

6
of the central bank for attaining its inflation objectives (International Monetary Fund
Factsheet, 2017).

2.2.2 Foreign Exchange Regimes Policies

A monetary framework is closely linked to the exchange rate regime. When a

country that has a fixed exchange rate, it will have limited scope for an independent
monetary policy. When a country used a flexible exchange rate, it will have dependent
monetary policy. Although some countries do not fix the exchange rate, they still try to
manage its level, which could involve a trade-off with the objective of price stability. An
effective inflation targeting framework is supported by a fully flexible exchange rate
regime (Sebastian Fristedt, 2016)
A fixed exchange-rate, commonly referred to as a peg, can be defined as a regime
that holds a fixed currency, either to the currency of another country, a currency basket or
any other measure of value. The exchange-rate is determined by the monetary authority
of that country, whom commits to buy(sell) the home currency at a specific price. The
central bank maintains this predetermined price level by intervention in the foreign-
exchange market and/or adapting the interest rates (Sebastian Fristedt, 2016).
Crawling bands, crawling pegs and horizontal bands are often referred to as
intermediate exchange-rate regimes. These regimes attempt to combine flexibility and
stability by implementing a rule-based system for adjusting the par value, typically
through a band of rates or as a function of inflation discrepancies. A flexible exchange-
rate entails a currency with an exchange-rate that is determined exclusively by the global
market forces of supply and demand, and are not pegged nor controlled by any monetary
authority. There are two different types of flexible exchange-rates, pure floats and
managed floats (Sebastian Fristedt, 2016)

2.2.3 Macroprudential Policy

The global financial crisis showed that countries need to contain risks to the
financial systems a whole with dedicated financial policies. Many central banks have
responsibilities to promote financial stability by upgrading their financial stability
frameworks and establishing macro prudential policy frameworks. Macroprudential
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policy needs a strong institutional framework to work effectively. Central banks are well
placed to conduct macro prudential policy because they have the capacity to analyze
systemic risk. In many countries, legislators have assigned the macro prudential mandate
to the central bank or to a dedicated committee within the central bank (International
Monetary Fund Factsheet, 2017).
If macroprudential is used, the institution should be strong to counter opposition
from the financial industry and political pressures. Policy makers need to be clear
objectives and to get the necessary legal powers, and to foster cooperation on the part of
other supervisory and regulatory agencies (International Monetary Fund Factsheet, 2017).

2.3 Intervention Channels for Foreign Exchange Rate

Intervention can affect the exchange rate through various channels. Under the
signaling channel, market participants may adjust their exchange rate expectations when
they perceive intervention as signaling a change in future monetary policy. Under the
portfolio balance channel, the change in the currency composition of asset portfolios
associated with sterilized intervention generates a change in the risk premium, which
triggers an exchange rate adjustment as agents rebalance their portfolios. Under the
microstructure approach, dealers are the price setters and base their pricing decisions in
part on the order flow they observe, which is private information (Shogo Ishii, Jorge Iván
Canales-Kriljenko, Roberto Guimarães, and Cem Karacadag, 2006).

2.3.1 The Signalling Channel

Under the signaling channel, intervention can be effective if it is perceived as a

signal of the future stance of monetary policy. In models that support this channel, the
exchange rate is treated as an asset price, and is a function of the expected path of money
supply. To the extent that intervention, even when sterilized, influences market
expectations on future money supply, it can influence the exchange rate. A central bank
has an incentive to follow through with policy actions that justify intervention ex post to
safeguard its credibility and avoid financial losses. The central bank puts its reputation
and capital at stake either because it wants to signal a policy change that would not be

8
credible otherwise or because it believes, based on its information advantage, that the
level and direction of the exchange rate are unwarranted (Shogo Ishii et al., 2006).
The signaling channel depends in part on the institutional and policy credibility of
the central bank. The effectiveness of intervention through signaling relies on influencing
market expectations by transmitting information on fundamentals or future policy
actions. The signaling channel is most effective when interventions are publicly
announced, which enhances the visibility of intervention, thus strengthening the central
bank’s policy signal (Shogo Ishii et al., 2006).
The signaling channel, however, may be less effective in developing countries.
First, central banks in many developing economies are at a disadvantage with respect to
institutional and policy credibility. They tend to lack the record of prudent
macroeconomic management that underpins the strong credibility of monetary authorities
in advanced economies. Ongoing structural shifts in many developing economies—
among them financial deepening, economic opening, private sector orientation, and shifts
in the exchange rate regime—make it difficult to establish predictable and stable links
between real and financial variables and, therefore, between intervention and future
monetary policies Shogo Ishii et al., (2006).

2.3.2 The Portfolio Balance Channel

Intervention can be effective by altering the currency composition of agents’

portfolios. The key assumptions are that domestic and foreign currency–denominated
government securities are imperfect substitutes and that market participants are risk
averse. As a result, investors demand a risk premium on the bonds denominated in the
riskier currency. A sterilized intervention operation changes the relative supply of
domestic versus foreign currency securities. It leads agents to rebalance their portfolios to
adjust risk and returns. Therefore, these changes cause a change in the exchange rate
through the portfolio balance channel (Shogo Ishii et al., 2006).
Unlike the signaling channel, the portfolio balance channel does not require
credibility as a precondition for effectiveness. As such, it potentially can be more potent
in some developing economies, where policy credibility tends to be lower, domestic

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currency debt is an imperfect substitute for foreign currency debt, and interventions are
large relative to foreign exchange market turnover (Shogo Ishii et al., 2006).

2.3.3 The Microstructure Channel

The microstructure channel provides a new window into the functioning of
foreign exchange markets and the effectiveness of intervention (Lyons, 2001).
Microstructure finance analyzes the impact of order flow on exchange rates. Aggregate
order flow is the balance of buyer-initiated and seller-initiated orders; as such, it is a
measure of net buying pressure in the foreign exchange market (Evans, 2002) and
(Lyons, 2005). In this framework, analyses of the effectiveness of interventions focus on
the extent to which central bank trades affect aggregate order flow (Shogo Ishii et al.,
2006).
According to the microstructure approach, central banks are uniquely positioned
to affect the transmission of fundamentals to the exchange rate through order flow.
Central bank intervention can cause market participants to change their expectations on
the future path of the exchange rate and lead them to modify their net open foreign
exchange positions. The impact of official intervention on order flow and exchange rates
can be greater in the presence of noise traders, which follow past trends, and often trade
in a correlated fashion (Hung, 1997). Central bank intervenes by small amounts which
can trigger a tide of buy or sell orders by trend-chasing traders. Interventions need not be
announced and should be timed to maximize the exchange rate impact. Intervention in
this context may also lead to higher volatility, which can help promote a sense of two-
way risk in the market (Shogo Ishii et al., 2006).
When central banks are perceived to be more knowledgeable about future
monetary and exchange rate policies or better equipped to monitor and interpret
fundamentals, such as balance of payments trends, market participants may try to learn
from central bank trades. In this context, central bank intervention emits information to
the market. Stated differently, order flow serves as the vehicle through which the market
aggregates information (Shogo Ishii et al., 2006).
To the extent that central bank–initiated order flow transmits information, it can
potentially ignite an even greater flow of foreign exchange orders. The microstructure

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channel also emphasizes that the size of intervention relative to market turnover
determines the effectiveness of that intervention. In principle, the larger the intervention
relative to market turnover, the higher its effect on the exchange rate. Thus, intervention
has the potential to be more effective in developing countries, where foreign exchange
markets are less liquid (Shogo Ishii et al., 2006).

2.4 Intervention Operations

Intervention operations involve a number of technical issues, including the choice
of markets and counterparties. In choosing a market for intervention, the authorities must
decide on the intervention instrument (or type of foreign exchange contract), meaning
either spot, forward, or other derivatives markets; the trading location (onshore or
offshore); the currency in which to intervene; and whether to intervene in the wholesale
transfer market or retail cash market.

2.4.1 Choice of Markets

Intervention generally should take place in the spot market rather than in the
forward market when the goal is to affect the spot exchange rate Shogo Ishii et al.,
(2006). The reasons are as follows:
a) Spot market intervention directly affects the spot exchange rate. Forward market
intervention relies on the transmission mechanism from forward to spot market
rates, which is affected by money market conditions as well as exchange and
capital controls.
b) Spot market intervention is less susceptible to liquidity risk. Spot markets are
usually more liquid and less constrained by counterparty limits than are forward
markets.

2.4.2 Trading Location: Onshore or Offshore Markets

Intervention should normally take place in onshore markets where the bulk of
foreign exchange trading takes place. Concentrating interventions in the domestic market
helps maintain the primacy of the domestic market and may give the central bank greater
access to market information and intelligence. In addition, central banks can effectively
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address the order flow imbalance created offshore by intervening onshore. In some cases,
intervention in offshore currency markets may play a useful role (Shogo Ishii et al., 2006)
In particular, the central bank may intervene in offshore currency markets when
the local currency trades offshore beyond the normal working hours in the onshore
market, exchange rate pressures emerge in offshore markets, and secret intervention is
preferred and easier to conduct offshore. Several operational issues must be addressed
when intervening in offshore markets. The central bank may have to appoint an agent to
act on its behalf, which can be a foreign central bank, the Bank for International
Settlements, or a foreign or domestic commercial bank. The central bank or its agent
would have to abide by the rules and regulations of the markets in which intervention
takes place (Shogo Ishii et al., 2006)

2.4.3 Currency Intervention

The principal intervention currency should be the international currency most
widely traded against the domestic currency to reduce costs and facilitate settlement in
countries following flexible exchange rate regimes. Intervening in the most widely traded
currency pair makes it easier for the central bank to find counterparties and reduces
transaction costs as measured by bid-offer spreads. In addition, settlement facilities are
usually more reliable. For most developing economies, the intervention currency is the
U.S. dollar, because foreign exchange trading is concentrated in the dollar (Canales-
Kriljenko, 2004).
The central bank should intervene in one foreign currency at a time to avoid the
risk of cross-currency fluctuations. Intervening in many currencies complicates foreign
exchange operations and exposes the central bank to exchange rate risk. Operationally,
the central bank should announce a limited number of currencies in which it will conduct
intervention, and that it will intervene in only one currency at a time (Shogo Ishii et al.,
2006).

2.4.3 Wholesale Transfers or Retail Cash Markets

In the absence of exchange controls, central banks should intervene only in the
wholesale market for transfers. Wholesale transfers reduce transaction costs by

12
economies of scale and by avoiding transportation and warehousing costs. In the presence
of exchange controls, however, central bank intervention in the retail cash market may
rein in unwarranted depreciation expectations (Shogo Ishii et al., 2006).
The retail cash market, which is often linked to the parallel market rate, can
become the center for price discovery and the formation of exchange rate expectations,
even if it is a small fraction of trading and highly volatile. Therefore, intervention in cash
markets, including parallel markets, can sometimes help prevent unwarranted shifts in
exchange rate expectations (Shogo Ishii et al., 2006)

2.4.4 Choice of Counterparties

The central bank should establish objective and transparent criteria for choosing
counterparties for intervention. More generally, the central bank should trade mainly with
market makers, but it may find it useful to extend the range of its counterparties when
exchange controls are present or there is little competition. In competitive environments
without foreign exchange controls, the central bank should trade mainly with market
makers.
First, the central bank can promote the development of a fledgling interbank
foreign exchange market when it trades only with market makers that provide liquidity to
the market by offering two-way (buying and selling) exchange rates on demand. Second,
market makers can efficiently distribute the foreign exchange provided by the central
bank by standing ready to trade with other authorized dealers. Third, market makers are
usually able to handle large trading volumes, avoiding the need for the central bank to
conduct many foreign exchange operations. Fourth, the central bank minimizes the
chances of dealing with lesser-quality counterparties. Finally, trading with market makers
that routinely interact with other market participants can provide greater control to the
central bank on the degree of transparency of its foreign exchange operations.
The central bank should make special settlement arrangements to protect itself
against credit risk. When there is little competition, the central bank may consider
directly trading with the public at large to increase competition in the foreign exchange
market. When the market is thin and a few authorized dealers account for the bulk of

13
trading and are not willing to offer two-way quotes, the central bank’s direct participation
can intensify competition.

2.5 Previous Studies

The various channels through intervention affects the exchange rate, some studies
have found mixed evidence for the portfolio balance and signaling channels. Under the
signaling channel, (Dominguez, 1998) estimated the impact of intervention on current
and future exchange rate and found that intervention had a significant impact on
expectations. In terms of the portfolio balance effect, (Obstfeld, 1990) finds that the
portfolio balance effects are significant but small. The portfolio-balance channel of
intervention, (Dominguez, 1998) has lost its appeal because the amounts involved seem
too small compared to the size of transactions on the foreign exchange market to induce a
significant readjustment in agents’ portfolios. The signaling channel came too readily to
be confused with one of its specific cases where the signal refers to future monetary
policy.
Within the context of a flexible exchange rate regime, the signaling view argues
that exchange rates would be influenced by interventions since the latter are used by
central banks to enlarge the market’s information set by providing it with private central
bank information. The literature on the impact of central bank intervention in developing
countries is continuously growing with the availability of high frequency data. Unlike in
developed countries, the evidence is more clear-cut with respect to the volatility than the
exchange rate level (Simwaka and Mkandawire, 2004). These studies indicate that the
volatility was increased due to greater market uncertainty.
There are several reasons for these overwhelming results. They are foreign
exchange markets in developing and emerging economies are shallow (low turnover) and
many countries intervene in amounts that are largely relative to market turnover and
besides foreign exchange intervention, the central banks in the developing and emerging
countries also supplement these interventions through foreign exchange controls,
monetary instruments and banking regulations that effectively increase the efficacy of
their foreign exchange interventions. The literature comprises studies which investigate

14
the impact of foreign exchange intervention on exchange rate volatility (Baillie, 1992)
and (Dominguez, 1998).
Most of these studies look at the conditional exchange rate volatility by estimating
the Generalized Autoregressive Conditional Heteroscedastic (GARCH) models. Results
of these studies indicate mixed trend and some studies suggest that central bank
intervention tends to increase the conditional exchange rate volatility (Dominguez, 1998),
while other studies show that foreign exchange intervention tends to reduce exchange rate
volatility (Dominguez, 1998). In contrast, there are some studies shown that while the
impact of foreign exchange intervention on exchange rate volatility, there was no impact
of central bank interventions on exchange rate volatility (Baillie, 1992).
According to (Marwa A. Elsberif, 2016), he studied that exchange rate vitality
and central bank actions in Egypt by using GARCH in which three variables interest rate,
trade balance and official reserves were used. Results found that central bank action
impacted positively in exchange rate vitality.
Therefore, this study is based on previous studies to analyzed whether Central
Bank of Myanmar actions influence exchange rate volatility by using GARCH by using
weekly observations of Myanmar Kyat against US Dollar, spanning the period from 2016
to 2018 after the adoption of floating exchange rate regime.

15
 Chapter III
Central Bank Intervention on Foreign Exchange Market in Myanmar

This chapter will discuss on roles and functions of Central Bank of Myanmar,
foreign exchange market reform before 2012 and after 2012. In addition, foreign
exchange market revolution and intervention in Myanmar.

3.1 Roles of Central Bank of Myanmar

In 19948, the Union Bank of Burma was established as per Act of Union Bank of
Burma 1947 and it was a branch of the Reserve Bank of India. However, the Union Bank
of Burma Act was renewed in July 1952. Since Myanmar adopted the socialist economic
system in 1962, all banks were nationalized. In addition, a monolithic bank was
established under the People’s Bank of the Union of Burma Act 1967. (Central Bank of
Myanmar’s Website)
After 1988, Myanma economic system has been transformed from the closed to
opened economy. Therefore, the government tried to develop the financial system which
is in line with the market oriented, and to promote the efficiency of financial activities by
enacting the Central Bank of Myanmar Law, 1990. After the new government was
formed in 2011, Central Bank of Myanmar needs independent monetary policy to control
the price stability in domestic market. (Central Bank of Myanmar’s Website)
The main aim of the Central Bank is to control the price stabilities in domestic
market and to preserve the internal and external value of the Myanmar Currency. The
Central Bank try to get its objectives by promoting efficient payments mechanisms, by
monitoring the liquidity, solvency, and well-functioning financial system and by fostering
monetary, credit. The main responsibilities of the Central Bank of Myanmar are (Central
Bank of Myanmar’s Website):
a) to issue sole domestic currency and to act as a banker to the Government;
b) to advise to the Government with regard to economic condition;
c) to inspect and supervise the financial institutions;
d) to take action as a banker for the financial institutions

16
 e) to manage the foreign reserves of the State and to make the transactions on
behalf of the State in intergovernmental organization and
f) to undertake all the responsibilities in the name of the Government in dealing
with the aforesaid organizations on behalf of the Government.
Moreover, the CBM promotes:
a) price stability through the proper conduct of monetary policy;
b) financial stability through prudent banking supervision and regulation; and
c) an efficient payments and settlements system.
Central Bank of Myanmar used monetary targeting monetary policy framework in
2012. Under monetary targeting regime, the central bank target money supply as
intermediate and reserve money is operating target to ensure macroeconomic consistency
and to get the ultimate objective of price stability. Central Bank makes decision how
much liquidity need to inject or absorb into the market by using liquidity forecasting
framework.
In addition, CBM tried to develop Capital Market on behalf of the Government
and to give the public more opportunities to save. Therefore, the CBM has issued and
sold 3-year and 5-year Government Treasury Bonds in 1993. The Central Bank of
Myanmar has formulated and implemented the monetary policy which is consistent with
economic and production growth rates.
The CBM has been actively engaged as an independent central bank, advising and
support legislative changes related to Myanmar’s financial system as per Central Bank of
Myanmar Law (2013). Currently, the Central Bank of Myanmar mainly uses monetary
policy instruments such as reserves requirements, interest rate policy and limited open-
market operation to get financial sector stability.

3.2 Foreign Exchange Market in Myanmar

From 1977 until the recent reforms 2012, The government employed a fixed
exchange rate system, and the official exchange rate was pegged to the special drawing
right (SDR) of the IMF at 8.5 kyat per SDR. Under fixed exchange rate regime, the
official rate was applied to the public sector only, and there was no formal channel for the
private sector to convert currencies. In April 2012, Myanmar changed from the fixed

17
exchange rate system to a managed floating exchange rate system. Therefore, the below
sections present about situation of before and after reform of foreign exchange in
Myanmar.

3.2.1 Foreign Exchange Situation Before Reform

From 1977 until the recent reforms 2012, the official kyat exchange rate was fixed
to the value of the International Monetary Fund’s Special Drawing Rights. However,
Myanmar’s economy operated with a de facto multiple exchange rate system which
distorted the allocation system of foreign exchange operated by the state banks and
forced the private sector to rely on informal markets for foreign exchange because of the
unrealistic level of the official exchange rate and strict controls on foreign exchange.
Therefore, the government unified the exchange rate market by replacing the old system
with a managed float to eliminate these distortions. Kubo Koji, (2015)
However, the informal foreign exchange market and the informal fund transfer
system are a legacy of the restrictive regulations in the past. Foreign trade was legalized
for the private sector in September 1989, but there was no official channel for private
firms to convert export revenues into the local currency, the kyat. Myanmar’s citizens
were not allowed to hold foreign currency note in previous foreign exchange regulation
did not permit to hold foreign currency notes. At that time, private exporters were
required to make foreign currency transactions at two state owned banks, MFTB, MICB
by opening foreign currency deposits account. Additionally, foreign exchange certificates
(FECs) issued in 1, 5 and 10 denominations to limit circulation of US currency. Local
citizens can also use FECs, however, bank charge a 10 percent as a service fee and they
can only withdraw in kyat. The fixed exchange is end in August 2003 and the FECs was
discontinued in 2013.
Over time, the official pegged exchange became more and more divorced from
the exchange rate used by the general public in the parallel exchange markets that have
grown due to the heavily regulated use of foreign exchange in the formal market. The
parallel market eventually became the dominant medium for the Myanmar public to
satisfy their needs for foreign exchange. As this parallel market was not an official
market, the government had little ability to interact and influence the exchange rate in

18
Myanmar. Replacing the official peg to the SDR with a market-determined exchange rate
removed the large discrepancy between the official rate and the real market exchange
rates. Therefore, CBM needs to intervene in some circumstance to maintain exchange
rate stable in foreign exchange market.
In all these areas, the CBM and other Myanmar authorities worked together to
ensure that the changes are smooth and did not cause any market disruptions. Since the
official exchange rate has been used by the public sector only, while the private sector
has been already using the informal market exchange rate, any significant impact of this
change on the private sector did not found. All these areas, the CBM, domestic and
international concerned agencies are working together to ensure that the changes were
smooth.
In April, 2012, Foreign Exchange Management Law lifts restrictions on
transactions on exports and imports of goods and services. In August, 2012, Foreign
Exchange Management Law introduces managed float system. In addition, in August,
2013, Interbank foreign exchange market opened for all private banks. And in November,
2013, Financial Institutions of Myanmar Law was revised to install more efficient
banking system. In 2014, a new Banking and Financial Institutions Law reached the final
stage of drafting.

3.2.2 Foreign Exchange Situation After Reform

After a decision by the Government of Republic of the Union of Myanmar to

change the exchange rate system to a managed floating regime, the CBM in consultation
with the Ministry of Finance and Revenue has made changes to the existing exchange
arrangements. Effective 2012, the CBM has implemented a managed floating exchange
rate regime in Myanmar. The external value of the national currency, the Myanmar kyat,
to be determined by supply and demand conditions in the exchange market. In line with
the new exchange rate regime, reference Foreign Exchange Rate will be publicized daily
by CBM.
Under this new exchange rate regime, the CBM’s basic exchange policy will be
targeted towards stabilizing the value of the kyat in the market with no officially
specified binding limits. The CBM retains discretionary power to intervene in the foreign

19
exchange market to influence the market exchange rate, when the CBM finds this
necessary. The kyat exchange rate versus a range of trading partner currencies will be
market determined and publicized daily by both the CBM and authorized FX dealers.
This decision was part of the reform program for modernizing the economy that the new
Government of Myanmar initiated in the second half of 2011. This program aimed to
unify the various exchange rates and gradually eliminate restrictions on current
international payments and transfers abroad.
Until February, 2019, the CBM is setting the reference exchange rate based on the
cut-off rate of its two-way foreign exchange daily auction, which was introduced in 2012.
It was in order to facilitate the development of the foreign exchange market. The two-
way foreign exchange auction worked to develop foreign exchange market and to
discover price. The size of the interbank market increased from 2013-2014 financial year
to 2017-2018 financial year. Therefore, the Central Bank of Myanmar try to setup new
development which is to determine reference exchange rate as market-based weighted
average rate in line with the international best practices of the central banks.
The market-based weighted average rate is calculated the volume weighted
average exchange rate of interbank and bank-customer deals during the day. This new
mechanism was developed to avoid this misalignment and it reference rate publishes in
the same day to reflect current market condition. According to the CBM Instruction No.
5/2019 (dated February 4, 2019), the Reference Exchange Rate of the Myanmar Kyat
equivalent to one unit of the US Dollar is computed and published by the Central Bank of
Myanmar on its website every bank business day at 16:00.
The reference exchange rate is calculated based on weighted average exchange
rate of the spot trades by the banks from 9:00 to 15:00 of that day. The trade deals
include: (i) Spot interbank trades conducted between the Authorized Dealer Licensed
banks (interbank trades); (ii) Spot trades conducted between the Authorized Dealer
Licensed banks and their customers (bank-customers trades).
The Reference Exchange Rate is calculated as 60 percent weighted from weighted
average exchange rate of the interbank trades and 40 percent weighted from the bank-
customers’ trade when the total amount of interbank trades is more than three (3) million
U.S. Dollar on that day.

20
 The relative weights in calculation of the Reference Exchange Rate is reviewed
update to up based on the share of interbank trades. CBM announced that the Reference
Exchange Rate is just an indicative rate. Participants in the foreign exchange market are
not required compulsory to use it in their foreign exchange transactions.

3.3 Analysis on Foreign Exchange Rate

Under this new exchange rate regime, the CBM is currently setting the reference
exchange rate based on the cut-off rate of its two-way foreign exchange auction, which
was introduced in 2012, According to research data from CBM and Bloomberg, the
reference exchange rate and interbank market rate are shown in Figure (3.1). The
exchange rate of MMK/USD is depreciated from 2016 to 2018. However, in second and
third quarter of year 2016, MMK/USD is appreciated when comparing with other
periods. However, starting from second quarter of year 2018, the exchange rate is
significantly depreciated about 23% from 2017. According to survey period, in 2018,
Myanmar kyats is highest depreciation.

Figure (3.1) Comparison between CBM Reference And Interbank Market Rate
1,700

1,600
Exchange Rate

1,500

1,400

1,300

1,200

1,100
I II III IV I II III IV I II III IV

2016 2017 2018

CBM Reference Rate

CBM Reference Data
Interbank Spot Rate Interbank SPOT Rate

Source: Central Bank of Myanmar and Bloomberg

21
 As per data show in Figure (3.1), CBM reference rate was reflected interbank spot
rate at market as there was not significant different. However, fourth quarter of 2018,
CBM reference rate is above the interbank spot rate because the CBM also abolished the
trading band (Reference rate +/-0.8%) in August 2018.
Figure (3.2) illustrates volatility of exchange rate in interbank spot rate. Exchange
rate of MMK/USD is highly volatility in first and second quarter of 2016, first quarter of
2017 and third and fourth quarter of 2018. The sign was holding MMK to convert USD
was risk as volatile from -3 to 3 which was wide range. In addition, for exporter and
importer from Myanmar was suffered exchange risk.

ERM1
Figure (3.2) Exchange Rate Volatility in Interbank Spot Rate
4
Daily Return of the USD against MMK percent

-1

-2

-3
I II III IV I II III IV I II III IV

2016 2017 2018

Source: Calculating data by using eview (Data is from CBM and

Bloomberg)

3.4 Central Bank Intervention on Interbank Market

Figure (3.3) shows the invention amount through FX Auction by CBM to formal
market. According to data, Central Bank purchased USD 315.43 million from private
banks from 2016 to 2018. Central Bank intervened large amount in 2016 by purchasing
USD 157.41 million and selling USD 41.97 million, net purchasing is USD 115.44
million through FX Auction from private banks. In 2017, purchase USD 122.82 million,
sale USD 0.01 million and net purchase USD 122.81 million. In 2018, purchase USD

22
96.83 million, sale USD 19.65 million and net purchase USD 77.18 million. According to
data from survey period, CBM intervened by absorbing USD liquidity in market.
As the foreign exchange auctions are two–way, they can lead to either
accumulation or dissipation of foreign reserves. In survey period, the daily sales and
purchases of foreign exchange were net purchase USD 315.43 million, net inflow of USD
to CBM.

Figure (3.3) Selling and Purchasing Amount in FX Auction

200
USD Millions

157.41
150
122.82
96.83
100

41.97 Sum of Purchasing

50
19.65
0.01 Sum of Selling
0 Sum of NSALE
2016 2017 2018
-50

-100 -77.18

-115.44 -122.81
-150

Source: Central Bank of Myanmar

In 2016, MMK was appreciated and CBM bought USD 115.44 million from
interbank market which mean market had excess USD supply. Moreover, in 2018, MMK
was depreciated and highest deprecation MMK along survey period and CBM purchased
USD 77.88 million. Although intervention amount was low in 2018, intervention times
was high because CBM sold USD in FX Auction to determine CBM daily reference rate
to reflect the market.
Figure (3.4) indicates intervention times in interbank through FX Auction.
According to data, Central Bank intervene 146 times in purchasing and 512 times selling
from 2016 to 2018.

23
 Figure (3.4) Number of Transactions in FX Auction
600
512
500

No. of Transactions
400

300 251

200 143 146

118
100 66 50
30
0
2016 2017 2018 Total

Purchasing Selling

Source: Central Bank of Myanmar

As exhibited by Table (3.1), CBM has intervened on approximately 25% for

purchasing and 96% for selling in FX auction of all trading days from January to
December 2016. In 2017, 11% for purchasing and 45% for selling in FX auction of all
trading days are intervened. The intervention times were decreased twice from 2016 to
2017. However, CBM purchased more reserves from market in 2017.

Table (3.1) Purchasing and Selling Times in FX Auction

Purchasing Selling
Year Purchasing Proportion by Selling Proportion by
Business Days Business Days
2016 66 25% 251 96%
2017 30 11% 118 45%
2018 50 19% 143 54%
Source: Central Bank of Myanmar

In 2018, 19% for purchasing and 54% for selling in FX auction of all trading days
are intervened. The single largest daily intervention, USD 37 million, occurred in fourth
quarter of 2018, and the largest yearly average intervention occurred in 2017 with USD
122.81 million. The data also suggests an asymmetry in the nature of CBM’s intervention

24
operations as there are fewer foreign exchange sales. Specifically, net sales of foreign
exchange are less frequent within 2017 and 2018.
Within 2016 and 2018, CBM intervened in market. CBM heavily purchased any
excess supply of dollars. This not only protected the export competitiveness but also
enabled CBM to build foreign exchange reserves. The total purchase amount was USD
315.43 million and exchange rate depreciated by 20.26%. Since one of the main CBM’s
policies is to reduce the exchange rate volatility, including some monetary policy
variables in the model allows addressing the issue of how effective they are.

25
 Chapter IV
Analysis on the Effectiveness of Central Bank Intervention on Foreign
Exchange Volatility in Myanmar

This chapter briefly highlights the methods and procedures that were used in
carrying out the study. It includes the following; CBM intervention through FX Auction,
comparison of interest rate for US Treasury bill and Myanmar government bill,
descriptive analysis of export and import of Myanmar.

4.1 Research Methodology

In this study, secondary data was obtained from various Monthly Bulletin, daily
FX Auction announcement published by the CBM web page. The study used daily data
of exchange rate traded. The interest rate for US Treasury and Myanmar Government
bill, export and import data of Myanmar and interbank foreign exchange market rate are
used by Bloomberg Professional Database.
To explore the volatility of the exchange rate in Myanmar, this study employs
weekly data. The data set concludes the exchange rate of MMK against USD spanning
from January 2016 to December 2018 that is a total of 157 observations. Thus,
observations are enough to carry out time series analysis, weekly data period starts by
2016 with the adoption of managed float exchange rate regime. To measure exchange
rate volatility in this study, standard deviation of exchange rates fluctuations is measured.
This study used generalized autoregressive conditional heteroscedasticity (GARCH)
models pioneered by Engle (1982).

4.2 Trade Balance of Myanmar

In theoretically, excessive exchange rate volatility tends to have adverse effects
on international financial flows, external trade, investment and output. More specifically,
exchange rate volatility may discourage international investment flows as higher
exchange rate risks reduce the expected return on these foreign investment flows.
Similarly, higher exchange rate volatility increases investment risks by creating
uncertainty about revenue earnings from external trade. The inclusion of the risk
26
premium in the costs of goods leads to higher prices which could impair the comparative
advantage of these goods.

Figure (4.1) Trade Balance in Myanmar

2,000

1,500

1,000
USD in Million

500

-500

-1,000
I II III IV I II III IV I II III IV

2016 2017 2018

EID EX IM
NX

Note: NX = Trade Balance, EX = Export, IM = Import (USD in Million)

Source: Bloomberg

Trade balance investigating if export and import performances have significant

influence on exchange rate volatility, the degree of commercial liberalization and trade
barriers affecting the degree of country’s trade openness, capital flow and hence,
exchange rate. Some variables were excluded from this study such as inflation
differentials and public debt as trials investigated the existence of multicollinearity
problem. Therefore, this research is analyzed trade balance in Myanmar which is shown
in figure (4.1).
According to data from 2016 and 2018, Myanmar had trade deficit in each year.
However, there was trade surplus in some quarter such as third quarter of 2017 and 2018.
As per survey data, the trade deficit was reduced in 2018 when comparing with 2016 and
2017.

27
4.3 Interest Rate Trend of the Treasury Bill of Myanmar and US
From a theoretical standpoint, the increased in short-term interest rate causes
exchange rate appreciation. The interest differential is chances for arbitragers and it
induces markets to create liquidity, then raise volatility in the short period, however, it is
insignificant in the longer prospect. Therefore, greater interest rate differential, more
likely to increase exchange rate volatility Kocenda and Valachy, (2006).
Therefore, controlling for short-term interest rate and Comforting exchange
holding are desirable while investigating the effectiveness of CBM’s intervention. In this
study, the interest rate for 3 months US Treasury bill and Myanmar Government bill were
used to analyze how short-term interest rate will affect to exchange rate volatility.
According to data, the interest rate for US Treasury bill was 0.81% to 2.41% from 2016
to 2018. With regard to Myanmar Government Bill, the interest rate was 3.1% to 7.91%
from 2016 to 2018.

Figure (4.2) Interest Rate Trend of the Treasury Bill of Myanmar and US
9

6
Interest Rate (%)

0
I II III IV I II III IV I II III IV

2016 2017 2018

MMT 3M UST 3M

Note: MMT3M = Myanmar Treasury Bill 3 months

UST3M – US Treasury Bill 3 months
Source: Central Bank of Myanmar and US Treasury Department
Although short-term interest rate of US Treasury bill was accelerating from 2016
to 2018, Myanmar Government Bill rate was stable along 2016 to 2018. However,
according to data, the interest rate of Myanmar bill had seasonal effect as the interest rate
28
at third Quarter for each year was lower than other quarters because MMK liquidity was
high in this period by banks. Figure (4.2) shows the comparison between interest rate
trend of US treasury bill and Myanmar government bill.

4.4 Analysis of Central Bank Intervention on Foreign Exchange Rate Volatility

A country’s currency is more valuable when interest rate is high. From a foreign
investor’s perspective, saving or investing in that country is more likely to yield better
returns. Thus, this would increase the demand for that country’s currency. To take
advantage of the high rates offered, they would move their funds there. When demand for
a currency is high, it is said to be appreciated. A strong currency exchange rate is good
for its importers and bad for its exporters. In addition, increase in the interest rate of the
home currency will increase the number of home currency deposits. Thus, it means the
demand for home currency will increases. These situations lead to an appreciation of
domestics currency relative to foreign currency.
When the domestics exchange rate is appreciates, residents will purchase more
goods from abroad country because the foreign good is cheaper for them. As a result, the
size of import will increase whereas the quantity of export will decrease. In this context,
the trade balance is the relationship between nation’s export and import of merchandise
over a period of time. Trade balance is export less import. A trade balance is trade surplus
when the export is more than import and the trade balance is deficit when import is more
than export. As a result, the value of exchange rate decrease while demand for currency
also reduce.
In a free market, the equilibrium of exchange rate occurs when quantity of
demand is equal the quantity of supply of the foreign currency. The factors cause the
supply and demand of exchange rate change is economies variables such as export,
import, domestic and foreign income, internal political stability, inflation, the overall
balance of trade, gross domestic product (GDP) and government debt are equally
important.
Therefore, to explore the volatility of the exchange rate in Myanmar, Central
Bank intervention in foreign exchange market is not enough to determine. Thus, this
study is considered the interest rate and trade balance as influencing variables.

29
4.6.1 Unit Root Test
Many economic and financial time series show trending behavior or non-
stationarity in the mean. When the data are trending, then some form of trend removal is
required. Unit root tests can be used to decide when trending data should be first
differenced or regressed on deterministic functions of time to render the data stationary.

Table (4.1) Unit Root Test Statistics

Variable Level 1st Difference Critical Value

1% 5% 10 %
ADF Prob ADF Prob
Level Level Level
ERM -1.7677731 0.7157 -8.927104 * 0.0000 -4.018349 -3.439075 -3.143887

NSALE -4.647162 * 0.0002 -17.53181 * 0.0000 -3.473096 -2.880211 -2.576805

NX -2.940909 ** 0.0431 -9.271102 * 0.0000 -3.473672 -2.880463 -2.576939

IRD -1.74692 0.4057 -6.644884 * 0.0000 -3.472813 -2.880088 -2.576739

Note: * Result is significant at 1% level. ** Result is significant at 5% level

ADF: Augmented Dickey–Fuller
Source: Calculating data by using eview (Data is from CBM and Bloomberg)

To investigate whether the variables are stationary and to determine the order of
integration of the variables, the augmented Dickey– Fuller (ADF) test is employed.
Variables are tested in both level and 1st difference forms, with intercept The ADF test
results in Table (4.1) strongly reject the null hypothesis of a unit root (variables are
stationary) for 1st difference. The evidence of unit root test shows that return on net sale
and trade balance are stationary at level while on exchange rate, net sale, trade balance
and interest rate differential are stationary at first difference at 1% level of significance.

4.6.2 GARCH Estimation of the Exchange Rate Volatility

This study employs weekly data from January 2016 to December 2018 that is a
total of 157 observations. Thus, weekly data period starts by 2016 with the adoption of
managed float exchange rate regime. Most recent empirical studies are modeling

30
volatility by adopting the use of generalized autoregressive conditional heteroscedasticity
(GARCH) models pioneered by Engle (1982). Since then volatility can be estimated
using time series econometric techniques. GARCH family is used by many researchers
worldwide, demonstrating that there exists temporal clustering in the variances of the
exchange rate changes. Following these previous studies, this work applies GARCH
analysis to model the exchange rate volatility and how effective the Central Bank actions
throughout study period 2016-2018.
GARCH (1,1) model is used to investigate volatility characteristics using weekly
data (January 2016 to December 2018). In order to analyze Central Bank intervention on
exchange rate volatility by contributing of two exogenous variables: interest rate
differentials and trade balance by using the generalized autoregressive conditional
heteroskedasticity (GARCH) process which is often used by financial modeling
professionals because it provides a more realistic condition to predict the prices and rates
of financial instruments. GARCH (1,1) model for the weekly data is as follows;

erm = c1+c2NSALEt-1+εt (1)

Where,
erm = the log of average weekly interbank rate (MMK/USD)
c1 = the constant term
NSALE = the difference between sale and purchase of USD in Auction
c2 = coefficient of the lagged of NSALEt−1
εt = the error term

erm is calculated by log of weekly exchange rate which indicates the volatility of
exchange rate and NSALE is sale less purchase in FX Auction by CBM from private
banks. Residual derived from mean Equation (1) is used in forming variance Equation
(2), for the variance equation. The model specification of this study is as follows:

σt2 = α + β1 ε2t−1+ β2 σt−12 +Ὺ1IRD + Ὺ2NX (2)

σ t2 = the volatility of exchange rate in Myanmar

α, = the constant term of the variance equation

31
ε2t−1 = the lagged squared residual derived from Equation (1)
σt−12 = the lagged conditional variance
IRD = the difference between Myanmar and US interest rates of 3-month
treasury bills
NX = the difference between merchandized value of exports and
merchandized value of imports in Myanmar (calculated in billion
USD)
β1 and β2 = coefficients of ε2t−1 and of σt−12respectively
ϒ1 and ϒ2 = coefficients of IRD and EID

According to equation (2), IRD is the difference between Myanmar and US

interest rates of 3-month treasury bill and NX is net export or trade balance of Myanmar
which is calculated by export less import USD in million.
The result is shown in Table (4.2) and detail information was provided in annex
(2). The coefficient of NSALE (Net Sale) is positive and it seems if there is more CBM
intervention through FX Auction, there is more exchange rate volatility in Myanmar.
However, insignificantly positive sign proves that CBM intervention in FE market does
not influence on exchange rate volatility. It is because FX auction is just a mechanism
for setting reference exchange rate.
Table (4.2) GARCH Estimation of the Exchange Rate Volatility

Variables Coefficient Prob.

C 7.214214* 0.0000
NSALE 8.73E-10 0.8971

NX 2.14E-06** 0.0381
IRD -0.000248** 0.0365

Dependent Variable: ERM

Note: * Significant at 1% level, ** Significant at 5% level
Source: Calculating data by using eview (Data is from CBM and Bloomberg)

32
 The coefficient of IRD is negative and it is significant. Theoretically, in the
country where is liberalized capital mobilization, when interest rate differential is high, it
leads to high exchange rate volatility. However, in this study, the results found that high
interest rate difference causes low exchange rate volatility. It is because Myanmar does
not have perfect capital mobilization. In addition, domestic and foreign investors do not
response based on sensitivity of interest rate. The reasons are investors from Myanmar
may invest within countries as domestic interest rate is higher than foreign interest rate
and foreign investors may not be interested to invest in less attractive financial markets.

With regard to net export, the coefficient of NX is positive and it is statistically

significant. It is important to note that increase in trade performance tends to lead
increase in volatility. It is noteworthy that exchange rate volatility reflects a small swing
in exchange rate movement because of managed float exchange rate regime adopted in
Myanmar.

33
 Chapter V
Conclusion

This study analyzes empirically the impact of Central Bank actions through IRD
as well as trade balance on exchange rate volatility in Myanmar using GARCH
framework. The main results are as follows; volatility clustering exists during study
period, IRDs and trade deficits accelerates exchange rate volatility. Therefore, this
chapter presents the finding, suggestion and need for further study.

5.1 Findings
After the official peg was abolished, managed float is used since April 2012. As
per new mechanism, the Central Bank of Myanmar has operated daily foreign exchange
auctions. These auctions have had three functions: (1) providing the CBM with a market–
determined exchange rate, (2) supplying or absorbing foreign exchange in interbank
market, and (3) serving as a policy instrument to intervene in the foreign exchange
market.
According to analysis on data, MMK was depreciated 20.26% from 2016 to 2018.
Although CBM try to stable the exchange rate, the volatility of exchange rate was
continuously high in 2017 and 2018. With respect to CBM intervention on market, CBM
made net purchased from private banks through FX Auction from 2016 and 2018 to
control exchange rate volatility because CBM needed to absorb liquidity from FE market.
In addition, trade balance in Myanmar was deficit along 2016, 2017 and 2018.
Although amount of trade deficit was high in 2016 and 2017, amount of trade deficit was
declined in 2018. However, the result found that export was exceeded in first quarter of
2017 and fourth quarter of 2018. Moreover, when the interest rate differential between
US and Myanmar is analyzed, differential amount is large. The result found that US
treasury interest was constantly increasing and Myanmar Treasury Bill interest rate was
fluctuated overtime because US is developed and stable in financial market, but,
Myanmar is started trying to build financial market especially in capital market and
money market.

34
 Using daily data on auctions and exchange rates for the period 2016 – 2018, the
FX auctions impacts on foreign exchange rate. The GARCH model incorporating the
variables indicate that the NSALE in FX auction is positive and it is insignificant.
Therefore, it can conclude that CBM intervention in FE market does not influence on
exchange rate volatility and CBM intervention through FX auction made to discover the
daily reference exchange rate.
Trade balance of Myanmar is positive and it is significant. It indicates that when
net export of Myanmar is high, exchange rate volatility is high. Therefore, as trade deficit
in Myanmar occurred along 2016 to 2018, exchange rate volatility is high. When IRD is
tested whether it influenced on foreign exchange rate volatility, the coefficient was
negative and it is significant. Therefore, high interest rate difference leads to low
exchange rate volatility in Myanmar because capital mobilization in Myanmar is some
extent and it is not fully liberalized. In addition, financial markets in Myanmar does not
develop well to attract the investors.
Therefore, the effectiveness of intervention on exchange rate is more difficult to
assess, since the exchange rate is more susceptible to multi-dimensional indicators and
market reactions to them. In addition, the results imply that the FX auction works as a
means of setting up reference exchange rate. According to this study, FX auction have
caused increasing the official foreign reserves. Thus, foreign exchange auctions should be
recognized as a transitory arrangement that should operate only until the interbank
foreign exchange market is developed.

5.2 Suggestions
According to analysis, MMK was depreciated and the volatility of exchange rate
is high and the demand for USD is high in end of year because the exchange rate
fluctuation has seasonal effect. Therefore, CBM should intervene to control exchange
rate volatility by injecting or absorbing foreign currency in FE market with cumulating
foreign reserves of CBM.
In the economy of developed country, interest rate differential between other
countries shall affect the value of currency. However, with regard to Myanmar, the
interest rate differential was negative on exchange rate volatility because CBM does not

35
allow perfect capital mobilization and foreign investors do not interest to invest in less
liquid market. Thus, when CBM liberalizes interest rate and ease on FDI flow, the
interest rate differential may affect the exchange rate in Myanmar. Therefore, CBM
should prepare to maintain less exchange rate volatility at that time.
With regard to trade balance in Myanmar, as domestic consumers spend more on
foreign products than domestic producers sell to foreign consumers, it can cause a trade
deficit. However, in Myanmar, demand for foreign currency is vary from the season.
When the weather is good to conduct business, the demand for foreign currency is high.
Moreover, the demand for USD is low in rainy season as farming business are run and
the export agriculture products. Therefore, CBM should monitor to balance the demand
and supply of foreign currency in country in order to stable exchange rate.
Therefore, when CBM tends to decrease exchange rate volatility, it is highly
recommended that mitigate IRDs and it is important to find solutions for trade deficit that
Myanmar encounter for long time through import substitution or export promotion trade
policies.

5.3 Need for Further Study

This study considered that exchange volatility is influenced by CBM intervention,
trade balance and interest rate differential of Myanmar and US. However, there are other
variables to be considered as the influencing factors on exchange volatility such as
foreign reserve level of country, FDI, and GDP. In addition, researchers should also
analyze on how will cause on exchange rate in Myanmar if capital account and interest
rate are liberalized.

36
 References
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Journal of International Money and Finance 16(6), 909–919
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4. Canales-Krilienko, Jorge Ivan, 2003a, “Foreign Exchange Intervention in
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16. Marwa A. Elsberif (2016). Exchange Rate Volatility and Central Bank Actions in
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 Appendices
(1) Number of Transactions and Amount Intervention in FX Auction

Purchase Sale Sale Intervention Intervention

Quarter Purchase
Amount Times Amount Times Amount
Times

2016 66.00 157,410,000.00 251.00 41,966,200.00 317.00 (115,443,800.00)

Qtr1 24.00 98,700,000.00 57.00 31,160,000.00 81.00 (67,540,000.00)

Qtr2 33.00 55,200,000.00 63.00 10,020,000.00 96.00 (45,180,000.00)

Qtr3 8.00 3,500,000.00 66.00 683,000.00 74.00 (2,817,000.00)

Qtr4 1.00 10,000.00 65.00 103,200.00 66.00 93,200.00

2017 30.00 122,820,000.00 118.00 13,800.00 148.00 (122,806,200.00)

Qtr1 4.00 1,810,000.00 45.00 6,200.00 49.00 (1,803,800.00)

Qtr2 - 34.00 3,700.00 34.00 3,700.00

Qtr3 9.00 25,310,000.00 23.00 2,300.00 32.00 (25,307,700.00)

Qtr4 17.00 95,700,000.00 16.00 1,600.00 33.00 (95,698,400.00)

2018 50.00 96,830,000.00 143.00 19,646,400.00 193.00 (77,183,600.00)

Qtr1 10.00 31,800,000.00 22.00 2,200.00 32.00 (31,797,800.00)

Qtr2 14.00 7,630,000.00 44.00 7,004,500.00 58.00 (625,500.00)

Qtr3 7.00 1,200,000.00 40.00 8,253,200.00 47.00 7,053,200.00

Qtr4 19.00 56,200,000.00 37.00 4,386,500.00 56.00 (51,813,500.00)

Grand
146.00 377,060,000.00 512.00 61,626,400.00 658.00 (315,433,600.00)
Total

Source: Central Bank of Myanmar

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 (2) GARCH estimation of the exchange rate Volatility
Dependent Variable : ERM
Method : ML ARCH- Normal distribution (BFGS/Marquardt steps)
Date: 11/19/2019 Time : 22:04
Sample : 1/01/2016 12/28/2018
Included obervations: 157
Failure to improve likelihood (non-zero gradients) after 32 iterations
Coefficient covariance computed using outer product of gradients
Per sample variance: back cast (parameter = 0.7)
GRACH = C(3) + C(4) *RESID (-1)^2 + C(5)* GARCH (-1)+
C(6)*EID + C(7) * IRD

Variable Coefficient Std. Error z-Statistic Prob.

C 7.214214 0.004916 1467.52 0.0000

NSALE 8.73E-10 6.75E-09 0.12936 0.8971

Variance Equation

C 0.003613 5.46E-05 66.11017 0

RESID (-1)^2 0.389673 0.237941 1.637686 0.1015
GARCH(-1) 0.208314 0.281601 0.073975 0.4595
NX 2.14E-06 1.03E-06 2.073694 0.0381
IRD -0.000248 0.000118 -2.091325 0.0365

R-squared -0.075343 Mean dependent var 7.194161

Adjusted R-
squared -0.08228 S.D dependent var 0.073
S.E. of regression 0.075944 Akaike info criterion -3.389775
Sum squared resid 0.893961 Schwarz criterion -3.253509
Log likelihood 273.0973 Hannan-Quinn criter -3.334433
Durbin-Watson
Stat 0.010745
Source: Calculated data by using eview (Data is from CBM and Bloomberg)

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