By Stephanie Jacob
Although the ringgit is at a six year low, analysts believe the factors contributing to it appear to be short-term and that this has led to it being undervalued.
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The value of any currency is determined by its demand and supply, and the long-term effect of these movements are reflected in the nation’s overall balance of payments which show net inflow or outflow of funds. If there is an inflow then there is a higher demand for ringgit and if there is an outflow then there is selling of the ringgit. Selling of the ringgit will weaken the currency.
However over the shorter term, demand and supply factors may not adequately reflect these overall flows. This is because currency valuations in the short term tend to be very volatile as they are largely event or sentiment driven.
So while over the past three months the ringgit has been trading at six-year lows, the question is whether this is being caused by long-term flows or short term volatility.
The short term cause for the ringgit’s recent weakening is clear – it is the unexpectedly low price of crude oil and the concern over the impact of this on Malaysia’s balance of payments. Malaysia is a net energy exporter (when liquified natural gas or LNG is taken into account) and therefore the lower exports receipts coming from these sources will affect the country’s current account (goods and services exports less imports).
However analysts believe the perceived impact expected to come from the crude oil plunge caused an overreaction in the market. As one head of fixed income research at a local bank said “on the oil issue, I believe the market has overshot and it sometimes tends to do.”
Although he believed the ringgit was unlikely to strengthen without some catalyst from crude oil prices he also said he does not expect the current oil prices to continue to push the ringgit in the other direction either.
Are foreign fund outflows a cause for concern?
The other big concern has been the pace of foreign fund outflows out of Malaysia since the US Federal Reserve announced it would begin to end its bond buying programme in October last year.
That led to the fear that foreign investment funds would start to pull out of emerging markets like Malaysia, as the US Fed phased out its quantitative easing programme and in anticipation that a rate hike would quickly follow.
Those fears seemed to be playing out in December when rising bond yields appeared to suggest significant foreign fund selling. However several analysts speaking to KiniBiz dismissed the suggestion saying the levels of selling were not indicative of massive outflows.
An analyst at a local research house said while there had been some selling it was not en masse as was being suggested. He pointed out that most of the foreign funds invested in Malaysia’s bond market were sovereign wealth funds. And added, “these funds track the bond index and use it as a guide, so, as long as Malaysia remains rated on that index, they do not panic.”
He opined the sell down likely was done by speculators dealing in the “hot money” or short-term instruments such as Bank Negara Malaysia bills. And said that the “real money” or longer-term bonds such as Malaysian Government Securities (MGS) tended to have more long-term investors.
According to Barclays Bank Plc’s regional economist for emerging markets Rahul Bajoria, the same pattern seems to have repeated itself over the past few months. He acknowledged that the pace of outflows had increased but said that this was to be expected.
“Yes, the pace of outflows has been increased but it is a chicken and egg situation. Currency depreciation will result in currency outflows and visa versa. But the outflows have been seen in the short term notes rather than the longer term Malaysian Government Securities (MGS) markets,” explained Bajoria. He added that in fact, the level of outflows has started to stabilise more recently.
This view was shared by CIMB Group’s head of fixed income research Ahmad Mukharriz who said “foreign capital outflows recently appeared to involve mostly investments in short term securities like notes and bills with less than 1-year maturity.”
He said “nobody likes outflows from their markets, but if you track the capital markets the flows have been more short term which are likely to be more sporadic and volatile.” And added that over the longer term, foreign fund participation had been sustainable and the quantum of outflows were not too worrisome.
Ahmad Mukharriz also stated that foreign holdings of long-tenure government bonds were higher than compared to a year ago. “According to the most recent data longer term foreign investors are still coming in and on a day-to-day basis, bonds are still being picked up by foreign buyers,” he said.
Is the ringgit undervalued?
So is the ringgit is undervalued?
Bajoria believes that the ringgit at its current valuations is undervalued. However he opined that the period of it being undervalued “appeared to be done and would unlikely continue for much longer.”
Nonetheless he cautioned that how the government handles the impact of the low oil prices through its fiscal policy over the longer term will be important. He said the fiscal deficit still remained significant despite the fact it had been falling and there were still lingering concerns over debt-to-gross domestic product (GDP).
“Longer term concerns that must be addressed remain the country’s fiscal policies. The fiscal deficit must be managed and the government has to be very disciplined in their spending. It should encourage more privatisation of big projects to reduce its on spending,” he opined.
Rahul Bajoria
While acknowledging that the government could not simply slash spending, Bajoria said “it must be pragmatic in which areas need to be prioritised and which can be cut. This is for the long-term benefits for all, as short-term moves are not good enough. Prudent spending and good fiscal policies will help over the longer term.”
The ringgit may be around six-year lows now but it is worth remembering that the earlier lows were in 2009 in the aftermath of the World Financial Crisis. That would also put the ringgit at its lowest since it was refloated in 2005 in the aftermath of the Asian Financial Crisis of 1997/98.
Malaysia imposed capital controls in 1998, fixing the exchange rate of the ringgit at 3.8 to the US dollar. This was the rate at which it was refloated and since then the currency has traded mostly in line with market trends, according to Bank Negara Malaysia.
Its governor Dr Zeti Akhtar Aziz now maintains that the ringgit does not reflect the country’s underlying economic fundamentals. She may well be right.
Recall that post 2009, following large inflows of US funds into Asian markets as a result of excess liquidity in the US, the ringgit climbed back to record levels post refloatation in 2005.
Yesterday : Why is the ringgit so weak?
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