By Stephanie Jacob
A combination of uncertainty over when the US Federal Reserve Bank would raise rates and the plunging oil prices created a perfect storm which has weakened the ringgit against the US dollar in 2015. Year to date, the local note has depreciated about 25% against the greenback. But where will it go from here?
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Over the past year, the Malaysian ringgit has hit many unfortunate milestones. On Aug 12, 2015, it dropped below RM4 versus the US dollar for the first time since 1998 during the Asian Financial Crisis when the ringgit hit an all-time low of 4.885 to the US dollar.
The ringgit has been one of the worst hit currencies against the US dollar and at times this year it has been the worst performer against the greenback in Asia. Year to date, the local note has depreciated about 25% against the greenback.
Now with the US Federal Reserve (the Fed) raised rates during their Dec 15-16 meeting, there are concerns that the ringgit might weaken even further and in a worst-case scenario even cross the RM5 to the US dollar mark going into next year.
Zeti Akhtar Aziz
Nonetheless, Bank Negara Malaysia (BNM) governor Zeti Akhtar Aziz has repeatedly said that at its current levels the local note is significantly undervalued, attributing its weakness to primarily external factors and also to domestic uncertainties.
At a press conference in conjunction with the third quarter of 2015 (3Q15) result, the governor said that at its current levels the ringgit “does not reflect the country’s fundamentals as the current account remains in surplus, unemployment remains low and inflation is within Malaysia’s long-term average”.
Why is the ringgit so undervalued?
According to the governor, “the exchange rate movement is due to a number of external factors as well as some domestic factors”.
She said external factors such as the uncertainty over when the Fed would raise its interest rates and the slowdown in China’s economy are having an impact on the currency, as are declining oil and commodity prices as the market has not factored in the increasingly diversified nature of Malaysia’s economy.
Of these, the uncertainty on when the Fed would raise rates and the plunge in oil prices have had a particularly significant impact. The governor noted that during the Fed quantitative easing programme, there had been a significant inflow of funds into the Malaysian economy, more so than into other countries. Now that the interest rates are set to rise in the US, some of the money which came in is being pulled out. And because Malaysia saw larger inflows it is also similarly seeing larger outflows, said Zeti.
This, coupled with the low oil prices, has taken its toll. The market reacted, and many analysts say overreacted, to the impact of the low prices on Malaysia’s balance of payments.
According to the government, Malaysia is a nett importer of crude oil and petroleum products although it is overall a nett energy exporter when liquefied natural gas (LNG) is taken into account.
Nonetheless, concern that the lower exports receipts coming from these sources would affect the country’s current account (goods and services exports less imports) has played a significant part in weakening the ringgit.
The combination of these two factors and other issues such as the general adverse sentiment towards emerging markets and domestic political uncertainties have all combined to drag the ringgit down.
What determines the value of a currency?
The ringgit is a “managed float currency”, which means that its exchange rate is allowed to appreciate and depreciate against other currencies according to market conditions. BNM will occasionally intervene to stabilise the currency in either direction when it sees fit but it does so without fixing or pegging the ringgit to a particular level to trade at.
Just like any other floated currency, the value of the ringgit is determined by the interaction of its demand and supply in the international financial market. It is worth noting that a currency either appreciating or depreciating does not necessarily have a fixed meaning, such as if it appreciates it is good and if it depreciates it is bad.
For instance, an appreciating currency will mean that exports earn more money but as they are more expensive, buyers might also look away from Malaysian exports to cheaper sources. It might be cheaper for Malaysians to travel overseas but would make travel in Malaysia more expensive for foreigners.
So a central bank will occasionally take steps to stabilise the ringgit’s position, and BNM has said in the past that it will only intervene to ensure orderly market conditions. More recently, the governor emphasised that the central bank’s intermediation would focus on supporting economic growth.
Rahul Bajoria
In comments made to KINIBIZ earlier this year, Barclays Bank Plc’s regional economist for emerging markets Rahul Bajoria explained that there are three main factors which play a role in a currency’s valuation. The first factor is a country’s growth and inflation rates which will affect its monetary policy.
The second is real effective exchange rates or REER, which according to Investopedia is “the weighted average of a country’s currency relative to an index or basket of other major currencies adjusted for the effects of inflation. The weights are determined by comparing the relative trade balances, in terms of one country’s currency, with each other country within the index”.
And the third factor is productivity, which is an abstract measure but can be viewed as a way to determine if there will be stronger growth ahead, said Bajoria.
He added that a particular currency’s perceived strength or weakness is largely a reflection of a nation’s balance of payments (BOP), which consists of the current account (goods and services exports less imports) and the capital account (nett result of public and private international investments flowing in and out of a country).
Essentially, the value of the ringgit will depend on supply and demand, and the long-term impact of this is reflected in the overall BOP which shows net inflow or outflow of funds. If there is inflow, there is higher demand for the ringgit, and if there is outflow then there is selling of the ringgit to raise foreign exchange.
However, short-term demand and supply factors may not reflect long-term flows as they tend to be very volatile.
Sentiment also can play a significant part in a currency’s strength or weakness. The global adverse sentiment towards emerging markets and Malaysia’s domestic uncertainties has also had a pronounced impact.
When asked how much political uncertainty was affecting the ringgit, Zeti said: “The financial markets to some extent thrive on uncertainty and when there are tensions prevailing in the political environment, it will contribute to affecting sentiment.”
Zeti opined that the ringgit would trend closer to its fundamentals once there is more clarity in the monetary policy of major economies and when there is a conclusion to domestic uncertainties.
But when can we expect that clarity to come and how will the ringgit react after the Fed raised rates? And how much of an impact will internal issues continue to have on the ringgit in 2016?
In part two, KINIBIZ speaks to analysts and economists to get their outlook on the ringgit in 2016.
Tomorrow: Fed decision, oil prices threaten ringgit recovery
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