THE strong US-dollar narrative backed by the US Federal Reserve’s (Fed) aggressive rate hiking has put some advanced economies and many emerging markets’ currencies, including the Malaysian ringgit under considerable pressures since March 2022.
The strong US dollar will have spillover effects on emerging economies via trade and financial channels. The spillover via financial channel is disproportionate in terms of credit supply and liquidity conditions, volatile capital flows, the impact of tightening monetary policy on investment and consumption as well as on the stock market.
Some emerging-market economies have typically felt pressure to raise their interest rates higher to defend their currencies but this comes with cost implications for domestic investment spending and consumption via increased borrowing costs.
There are two key factors that make a strong US dollar and higher US interest rate problematic for governments to finance their budgetary needs and companies for their investment financing.
Malaysia’s deficit-budget financing needs are predominantly financed domestically via the issuance of ringgit-denominated bonds known as Malaysia Government Securities (MGS) while external loans (in foreign currencies) only constituted 2.2% of total debt.
Hence, the strong US dollar and high US interest rates have a small impact on the government’s debt servicing. Foreign exchange risk is minimal.
However, as foreign holdings of the ringgit bonds stood at RM281.5bil or 24.6% of the country’s total debt as of June 2023, a reduction in the holding of domestic bonds as investors seek better returns on investments due to higher yield differentials between Malaysia’s 10-year MGS at 4.22% and the 4.875% of 10-year US Treasuries, would exert downward pressures on the ringgit.
The external borrowings of the private sector increased moderately by 2.9% a year to RM479.9bil as of end-December 2022 from RM427.6bil at the end of 2018.
Malaysians have to brace for some painful adjustments through the ringgit’s volatility and weakness for a longer while.
There will be winners and losers in the domestic economy when the ringgit depreciates on a sustained basis as it would influence the decisions of households and businesses when it comes to consumption and investment.
Silver lining
The magnitude of the impact on economic sectors varies, depending on the import content, and local and foreign sales orientation. The export-oriented sectors, especially palm oil, benefit from higher export earnings in ringgit terms.
While tourism also stands to benefit from the cheap ringgit, the government has to create the right policies, including reviews of restrictive visa policies, building tourism infrastructure, enhancing tourism products, and their marketing, and ensure a safe environment for tourism to thrive.
For businesses and investors, the ringgit’s depreciation will mean costlier imported inputs and capital goods such as equipment and machinery, while imported consumer goods and services will be more expensive, leading to a rise in the overall cost of living.
Malaysians not only have to spend more on travelling abroad but also incur higher costs for sending their children abroad to study.
Under a flexible-exchange-rate regime, the focus of economic and financial management policies is to ensure the overall economy is resilient and domestic financial system is strong enough to absorb exchange rate shocks. The adjustments against extreme exchange-rate movements must be facilitated in an orderly manner for ensuring continued economic and investment activity.
The effects of expenditure-switching relative to exchange-rate movements would help to minimise the spillover effect of the stronger US dollar on economic output, trade, consumption and investment as well as inflation.
For instance, producers could substitute imported intermediate and capital goods to domestically produced alternatives while the lowering of import duties on machinery and equipment as well as on consumer products helps to ease cost pressures faced by businesses and households. Malaysians can help to reduce pressure on the ringgit by travelling locally; and studying in local institutions of higher learning or twining programmes.
Higher volatility and interest rates across the globe have raised the cost of hedging currency risk, as well as the risks of not hedging. Currency hedging helps businesses to protect themselves against losses caused by fluctuations in exchange rates.
Some businesses benefit from natural hedges, for example having both revenue and expenses in local currencies.
The strong US dollar is a global trend and not generally indicative of significant fundamental weaknesses in our domestic economy.
It is widely acknowledged that external forces are the main culprit driving the ringgit’s depreciation. These forces include expectations for the US interest rates to remaining higher for longer; capital outflows to seek better return on investment due to rising yield differentials between Malaysia bonds and US Treasuries; investors’ concerns about China’s economy; and increasing concerns about conflict in the Middle East.
The policy responses to the ringgit’s depreciation require a focus on the drivers of changing exchange rates while preventing market and liquidity disruptions to domestic economic activity.
Obviously, rapidly rising US interest rates and the resilient US economy are major factors in the strength of the US dollar.
While Bank Negara can undertake intermittent intervention to stem excessive exchange-rate swings from triggering financial risk, foreign exchange intervention must not substitute for warranted adjustment to macroeconomic policies.
Sound fundamentals
Our economic and financial fundamentals have not weakened significantly compared with previous economic shocks. Nevertheless, we have to enhance economic resilience and address the vulnerabilities that could place our country on the risk horizon, including severe capital outflows due to a loss of appetite for emerging-market assets in favour of safe-haven assets.
We reckon there are no quick fixes to strengthen the ringgit in the short-term due to the mighty US dollar’s strength.
The government has to work together with Bank Negara to strengthen economic resilience by reducing the fiscal deficit and debt levels; address structural weaknesses to increase economic growth, and improve competitiveness to draw higher inflows of foreign direct investment while encouraging more domestic direct investment. Our exports should also be expanded to increase the ringgit’s value proposition.
Malaysia’s current account surplus has been shrinking fast from between minus 15.7% and minus 10.9% of gross domestic product (GDP) between 2009 and 2011 to low single-digit of between 2.2% and 5.2% of GDP in 2012-2022.
From 2010 to 2022, financial capital has recorded net outflows in most years except 2011, 2018, and 2021-2022.
Malaysia must preserve the accumulation of foreign reserves, which stood at US$108.9bil as of mid-Oct 2023, to deal with potentially worse outflows and turmoil in the future.
We are comforted by the Bank Negara governor’s recent remarks that the central bank will do whatever is necessary to ensure the ringgit continues to adjust in an orderly manner. He said the central bank has a number of market measures that can be deployed to boost the ringgit if needed.
In our view, any changes to foreign exchange administration (FEA) policies must be temporary and also take into consideration while taking into consideration the facilitation of financial and trade transactions with minimal cost and ease of administration.
Under the current FEA policies, the period of repatriation of export proceeds is currently within six months from the date of shipment with the repatriation timeline able to be extended up to 24 months for permitted reasons; and a resident exporter can freely retain any amount of export proceeds in either the ringgit or foreign currency accounts.
Equally important is to ensure a stable political environment to sustain both domestic and foreign investors’ confidence in the government’s credibility and commitment to raising the bar for Malaysia under the Madani Economy framework in order to restructure the economy so that the country rises to become an Asian economic leader while also improving the quality of life for all Malaysians.
Lee Heng Guie is Socio-Economic Research Centre’s executive director. The views expressed here are the writer’s own.
