THE Malaysian ringgit is undergoing a transition period of a weakening pace against the US dollar, the world’s dominant currency for trade and financial settlement.
The faster pace of the Federal Reserve’s (Fed) tightening monetary policy starting in March 2022 had caused a strong appreciation of the US dollar and directly suppressed emerging markets’ currencies, including the ringgit.
Exchange rate pressures stem from both global and domestic factors and relative interest rate differentials are one of the dominant factors.
Other fundamental factors influencing the behaviour of exchange rates are relative price levels (inflation), balance of payments (in a simpler term, exports more than imports), government’s budget balance and debt, as well as other non-economic risks (political condition and governance).
The challenge is to understand how changes in these fundamental factors influence market psychology or sentiment or expectations about the ringgit’s movement against the US dollar in particular, and other regional currencies in general.
In our assessment, the ringgit faced significant exchange rate pressures driven predominantly by external factors.
These include a combination of aggressive monetary policy tightening in advanced economies and tighter financing conditions, as well as greater global risk aversion (concerns over rising interest rates and strong US dollar negative spillover effects on emerging markets; stuttering China’s recovery) reducing net capital inflows into the region and pricing out emerging economies, including Malaysia from the international capital market.
Under a managed float system against a basket of currencies, the ringgit exchange rate is largely determined by the ringgit demand and supply in the foreign exchange market.
The Malaysian economy doesn’t operate in isolation from the rest of the world. While the goals of monetary policy are very much domestic consideration in terms of economic growth, inflation and employment, the influence on the monetary management is both domestic and global.
On the global influence on the setting of monetary policy, the probably obvious point is that Malaysia’s overnight policy rate (OPR) of 3% is lower by between 200 basis points and 225 basis points compared to the Fed funds rate (5%-5.25%).
On a regional comparison basis, our OPR is the second lowest in the region after Thailand.
This negative interest rate gap (Malaysia-US differential) was partly induced by the outflow of financial capital to the country with the relatively higher real interest rate as investors piled in seeking a higher rate of return.
Capital outflows induced the ringgit’s depreciation against the US dollar and other currencies. Other regional currencies also suffered the same fate.
The gradual normalisation of domestic interest rates (as benchmarked by the OPR) to an appropriate level is a pre-emptive move to support the economy whilst keeping inflation at bay.
It is not intended to cause an over-adjustment of the economy amid concerns about the downside risks to the global economy.
Under a flexible exchange rate regime and freer capital mobility, the ringgit will fluctuate in a volatile manner, and will overshoot to levels in times of uncertainty and weak market sentiment.
A flexible exchange rate is prone to misalignment with its underlying fundamentals; and will eventually revert to its fair or fundamental value when negative sentiments fade with rational expectations.
In our view, the ringgit exchange rate overshooting does not reflect the nation’s underlying economic and financial fundamentals.
> Positive initial economic conditions. The Malaysian economy ended 2022 with a strong economic growth of 8.9% and registered a 5.6% expansion in the first quarter of 2023 (1Q23).
Amid concerns about the global economy, we expect the domestic economy to continue growing, albeit at a moderate pace in recent months due to falling exports.
Growth in domestic demand though will continue to normalise – it should continue to hold up the economy.
> Keeping inflation at bay. Headline inflation has been easing steadily to 2.8% in May from 4.7% in August 2022.
However, core inflation remains persistent. Labour market conditions remain stable with unemployment rate steadying at 3.5% in May 2023.
> Still running comfortable trade and current account surplus, albeit narrowing. The current account surplus is projected to range between 2% and 3% of gross domestic product (GDP) in 2023 (2.6% of GDP in 2022).
Net foreign direct investment (FDI) inflows have expanded higher to RM74.6bil in 2022 and RM50.4bil in 2021 compared to RM13.2bil in 2020. In 1Q23, net FDI inflows amounted to RM12bil.
Higher approved investment projects of RM71.4bil were seen in 1Q23 and an average of RM288.6bil per year in 2021-2022.
> The banking system remained well-capitalised, bolstering banks’ capacity to support lending activity and absorb unexpected losses.
The banking system’s total capital ratio remained strong at 18.8% in December 2022, with capital buffers of RM134.8bil in excess of the regulatory minimum.
The domestic capital market is deep and efficient to mitigate the impact of capital-flow volatility. Malaysia’s participation in regional and global international financial adds another layer of buffer against foreign currency liquidity crisis.
> The sustainability of reserves accumulation is important. Foreign reserves were at US$111.4bil (RM508bil) as at end-June 2023, covering five months of retained imports and one times of short-term debt.
Excluding forwards position of foreign currencies of US$23.7bil (RM108bil) in May, foreign reserves remain comfortable at US$87.7bil (RM399.7bil).
> The government must remain committed to consolidate its budget and rebuild fiscal space through revenue enhancement, expenditure rationalisation and restraint as well as debt containment under the Medium-Term Fiscal Framework (MTFF).
The budget deficit is estimated to reduce to 5% of GDP in 2023 from 5.6% in 2022; and further to 4.1% of GDP in 2024 and 3.2% of GDP in 2025 on an assumption of about 5% GDP growth per annum for a five-year period.
Bank Negara’s foreign exchange intervention focuses on maintaining orderly foreign exchange market conditions.
Foreign exchange intervention is to contain excessive movements in the ringgit; to counter short-term trends or volatility in the exchange rate; and to bring a misaligned exchange rate back onto its fundamental path.
In an independent monetary policy regime, the exchange rate will act as a shock absorber in the face of asymmetric shocks most of the time and under most circumstances.
Letting the exchange rate depreciate is necessary to facilitate adjustment to external shocks that are durable, such as higher interest rates in advanced economies; risk aversion; and portfolio flows are that sensitive to market sentiment.
These are main factors influencing the ringgit’s volatility, and very often it overshoots to beyond the fundamentals.
Exchange rate adjustments provide price signals that help all economic agents in the economy to adjust and adapt.
Experience has shown that Bank Negara was capable of mitigating the ringgit volatility, maintaining orderly market functioning and reducing any destabilising effects on the real economy.
We have been able to withstand the ringgit’s volatility reasonably well though there will be transitory impact of the weakening ringgit on households and businesses in the form higher imported inflation and imported raw materials, respectively.
The cost of servicing foreign currency- denominated borrowings will increase.
Malaysia has experienced several episodes of large and volatile capital flow reversals, which had impacted the international reserves and ringgit.
The 2008-2009 Global Financial Crisis saw portfolio outflows of US$26bil (RM119bil) from 3Q08 to 1Q09, which saw the ringgit depreciate by 28% while the 2014-2015 oil price shock saw portfolio outflows which amounted to US$13.7bil (RM62.4bil) between 3Q14 and 3Q15.
Since 2015, when the Fed had increased its policy rate nine times by 225 basis points, the ringgit depreciated by about 50% from RM2.9675 per US dollar in May 2013 to the trough of RM4.4995 per US dollar subsequently.
Post-Covid-19 pandemic, since the Fed began its aggressive rate hikes cycle in March 2022 to fight soaring inflation, the ringgit swung as much as 11.5% between end-March to early November, before appreciating towards the year-end.
For the period of March 2022 till end-June 2023, the ringgit depreciated by 10.2% against the US dollar.
The US dollar index is now weakening as easing inflation strengthens the case for the Fed to pause its rate-hike campaign in the coming months.
However, there are arguments in favour of renewed strength in the dollar, which include the Fed keeping rates higher for longer if inflation does not fall back within its target; and global risk aversion may cause investors to seek shelter in the dollar.
The strength of the ringgit will depend on how well Malaysia sustains its economic growth in an environment of price and financial stability; mend the budget deficit and contain debt and liabilities; rebuild both domestic and foreign investors’ confidence; revitalise domestic investment; and attract the inflows of dependable long-term FDI as well as make domestic equities market appealing to portfolio investors.
We must continue to focus on strengthening economic resilience against external shocks through stronger fundamentals and pursue structural reforms to keep the Malaysian economy sustainable competitive and support the ringgit.
Lee Heng Guie is Socio-Economic Research Centre executive director. The views expressed here are the writer’s own.
