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Monday, December 26, 2016

Malaysia ringgit Asia's worst-performing currency for second year running

It was a feat not to repeat, but the ringgit remains one of Asia’s worst-performing currencies for the second year running this year. The local currency has fallen 21.7% to the US dollar over the past two years, closing at 4.4657 last Thursday. Blaming external factors and harping on domestic resilience are beginning to ring hollow.

After all, the biggest external headwind affecting the ringgit has died down. Year to date, oil prices have rebounded 44.9% to US$54.02 per barrel as at Dec 15. In contrast, the ringgit lost 3.88% of its value during the same period, making it the third worst-performing currency in the region behind the Philippine peso and the renminbi.

In fact, oil prices are likely to stabilise further to around US$60 a barrel with members of the Organization of the Petroleum Exporting Countries (Opec) agreeing to cut production by 1.2 million barrels a day for six months, while non-Opec members will cut production by 558,000 barrels a day.

Arguably, the current crude price is still substantially lower than the US$110 per barrel highs of 2013. In addition, there is still the bugbear of US shale oil production flooding the market, which could bring oil prices crashing back down.

But at current levels, crude oil prices should allow Petroliam Nasional Bhd to generate sufficient petroleum revenue to bolster the national finances, especially with the 6% Goods and Services Tax now in place.

Hence, the continued slide of the ringgit, while crude oil prices recover, suggests that the two have decoupled.

Another major external factor affecting the ringgit are the diverging interest rates between Malaysia and the US. Back when the US was undertaking quantitative easing in 2008/09, there was a flood of hot money into emerging markets. At the time, Malaysia held its overnight policy rate (OPR) steady, attracting funds looking for yield.

The trend has reversed today. Last week, the US Federal Reserve raised its benchmark interest rate by 25 basis points (bps) to 3%. It was a long-anticipated decision that also signals growing confidence in the recovery of the US economy. On the other end of the spectrum, there is strong expectation that Bank Negara Malaysia will trim its key interest rate by 25bps to 50bps next year to accommodate decelerating growth.

The central bank has already cut rates by 25bps this year, bringing the OPR to 3%. As the spread between Malaysian and US interest rates narrows, the ringgit will continue to depreciate as foreign funds withdraw in search of better yields and lower risks.

Donald Trump’s surprise win in the US presidential election added further selling pressure on emerging market currencies as capital flowed back to the US in anticipation of better growth prospects.

The ringgit was the second worst-performing Asian currency post-Trump’s win, losing 6.38% since Nov 1. Only the yen lost more, declining 11.87% against the US dollar in the same period.

The currencies of our neighbours such as Singapore, Thailand, Indonesia and the Philippines lost less than 4% in the same period, prompting the question as to why Malaysia consistently underperforms its regional peers.

What happened to resilient domestic economy?

For one, Bank Negara has time and time again stressed that the country’s fundamentals are intact. Yet, the better-than-expected 4.3% gross domestic product growth in the fourth quarter has done little for the currency. The federal government’s efforts to rein in the 2017 budget deficit to 3% and allay concerns over the country’s sovereign credit risk have also had little effect.

Another improvement to fundamentals was the 27.2% rebound in crude palm oil prices this year to RM3,156 per tonne.

So, it would seem that confidence in the ringgit, or the lack of it, plays a major role in its direction.

The divergence between fundamentals and confidence came to a head on Nov 11, when the offshore exchange rate plunged from 4.28 to 4.60 against the US dollar. As money changers adopted similar rates, a shockwave of panic spread across the market.

Yet, the onshore official rate remained stubbornly low. A lack of offers from local banks brought trading to a near halt on Nov 11, fuelling concerns of tighter capital controls by the central bank.

Based on Bank Negara’s international reserves during the period, it appears that there was little direct market intervention — buying back the ringgit with the reserves. Bank Negara’s international reserves were US$96.4 billion as at Nov 30.

The chaos was short-lived, but the uncharacteristic response by Bank Negara added to the growing unease among foreign institutional funds invested in the country. As the ringgit continued to approach levels last seen in 1997, so did the fears of capital controls.

Fortunately, Bank Negara’s hand steadied in the following weeks.

The central bank rolled out several new measures to help stabilise the ringgit, none of which would affect foreign investors. Instead, a key regulation change now requires Malaysian exporters to convert 75% of their foreign currency proceeds back to ringgit.

Previously, less than 1% of the trade surplus was converted back to ringgit, Bank Negara reported.

Based on the trade surplus, which hovers at RM92 billion, a 75% conversion would introduce an additional real demand of RM69 billion to the ringgit money market each year.

In addition, Bank Negara requires that all payments between residents are concluded in ringgit.

Since introducing the measures, however, the ringgit has continued to weaken. Arguably, these measures are designed to reduce speculative activity and boost short-term liquidity in the ringgit market to reduce volatility. This is far from a long-term fix.

But Bank Negara should not have to intervene with a heavy hand if it were right about the ringgit being undervalued.

One broad indicator of currency value at least, seems to agree. Based on The Economist’s Big Mac Index, the ringgit was undervalued by 60.6% as at July 2016. That makes Malaysia the second most undervalued currency in the world, second only to the Ukraine’s hryvnia. In contrast, the Singapore dollar is only undervalued by 20.4%.

Looking back, the ringgit was undervalued by only 46.12% in January 2012. However, the Big Mac index is far from a perfect indicator as it fails to capture many other external factors.

But it does give a glimmer of hope that the currency markets may yet wake up to the true value of the ringgit, and the currency will rebound.

The alternative would be hard to swallow — that the ringgit today is fairly valued.

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