ALONG with tumbling equities and plummeting markets across the globe, most currencies have taken a huge beating. Even with the Malaysian economy considered more insulated, the ringgit hasn’t been spared.
Earlier this year, Malaysians rejoiced when the ringgit hit its high of 3.1320 against the dollar on April 23. Since then, however, as a result of the US financial crisis, the ringgit has weakened to a low of 3.64 on Dec 4.
Evidently, during the second half of 2008, foreign funds were desperately trying to get their money out of emerging markets.
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| Lee equates currency strength to purchasing power |
The selling of the ringgit as foreign funds embarked on their redemptions and selling of assets was just as fierce.
Malaysia’s international reserves, which were at a high of US$125.1bil on July 15, tumbled to US$97.7bil as of Nov 28.
The reserves position is sufficient to finance 7.9 months of retained imports and is 3.5 times the short-term external debt. The pace has certainly slowed and, anecdotally, observers say about 70% to 90% of the redemptions are over with. Still, there are reservations that more downside might come.
On Tuesday, when the US Federal Reserve cut interest rates to 0.25%, key Asian currencies rallied the following day, led by the South Korean won and the Indonesian rupiah.
Nine of the 10 most active Asian currencies outside Japan strengthened as a rally in global stock markets stoked optimism the US rate cut will boost investor confidence worldwide.
The ringgit rose to the highest level in two months to 3.4625 per dollar on Thursday. The Singapore dollar strengthened 0.06% to 1.4592 against the US currency and the won rose 2.1% to 1,321.50 per dollar.
Commodities received a boost from a weaker dollar, with the crude palm oil up RM24 to RM1,569 and oil rising above US$44 a barrel on expectations the Organisation of Petroleum Exporting Countries (Opec) will cut supplies further.
Still the question arises: With an impending global recession and impoverished appetite for nearly all asset classes, will this see the ringgit depreciate more or has it actually reached its bottom?
Back to fundamentals
In the third quarter of 2008, Malaysia’s real gross domestic product (GDP) growth moderated to 4.7% from a revised growth rate of 6.7% in the previous quarter.
There was an obvious contraction in the manufacturing sector largely owing to contraction in the export oriented industries due to weaker production in the electronics and electrical (E&E) industry.
Output from resource-based industries such as petroleum and rubber products also registered a sharp slowdown in the third quarter.
On the demand side, domestic demand grew at 6.5% in the third quarter, compared with the 8.3% increase in the second quarter.
This slowdown was caused by higher consumer prices and lower consumer sentiment.
Broad money, M3, expanded at a slower year-on-year rate of 13.5% as at end-September 2008, compared with the 14.7% increase as at end-June 2008.
Net capital outflows led to a decline in net foreign assets of Bank Negara and banking institutions, which in turn exerted a contractionary impact on M3.
Room for weakening ringgit
Economically, these factors point to a slowdown in the economy.
While lower commodity prices bode well for both producers and consumers, it also reflects a rapid decline in demand. Industrial production, particularly in the export oriented industries, is expected to slow down sharply in the fourth quarter.
In economics, the quantity theory of money shows a correlation between long-term price inflation and the supply of money.
Put simply, if the money supply were to moderate, so would prices hence the currency would appreciate.
The fact that Bank Negara is anticipated to cut interest rates next year also demonstrates an anticipation of lower export revenues, hence the government is taking preventive measures to spur the economy.
CIMB Group deputy chief executive officer Group Treasury and Investments Lee Kok Kwan feels the ringgit is looking steady.
“The ringgit has been holding firm against regional currencies and strengthening against most Western currencies such as the pound sterling, euro and, in particular, against the Aussie and Kiwi dollar.
“The main exception has been against the US dollar which is likely to be temporary as there has been a massive repatriation of capital and liquidation of assets globally.
“Global asset managers (hedge funds, banks and multinational companies) are just selling assets worldwide where they can, and thereafter selling the local currency proceeds for US dollar to meet their capital and margin calls back home and to pay down their debt,” he says.
On a more positive note, Lee feels that the repatriation witnessed over the past three quarters has waned.
“Once the repatriation finishes, the dollar’s strength will severely weaken as the US economy is in a bad shape and it is the underlying source of weakness for the global economy. Also, the US cannot afford to have a strong currency as its export base is currently getting hammered, apart from its other economic problems,” says Lee.
He explains that in the US, most people’s wealth are tied up in real estate as opposed to cash savings.
This is due to their mortgage interest expense being tax deductible while interest and dividend incomes are taxable.
“As US residential property prices are weakening substantially, and their 401k retirement savings funds have significantly eroded in value, the deterioration of the real wealth of Americans will be very severe this time around.”
He foresees the dollar to perhaps maintain its current level for the next few months (as repatriations are still going on) before weakening significantly, perhaps to the RM3.30 to RM3.40 level.
Lee says it is an issue of relative strength: “Yes, our economy is slowing down, but other countries are slowing down much more, especially the Western economies. Also, the ringgit interest rates might be declining but the interest rates in the Western economies are declining much faster. So we have better relative strength.”
He equates currency strength to purchasing power. A country which has huge cash surplus has more purchasing power, hence what they can buy increases.
Volatile trading
An economist from RHB Research feels that all the negative sentiments in the economy are already being priced into the ringgit.
Over the near term, he sees some weakness in the ringgit, but come end 2009, he sees the ringgit ending at the RM3.30 level.
For the immediate term (less than three months), he says there is a possibility that the ringgit may even weaken to the 3.65 level.
By next year, he foresees the ballooning US budget deficit to become a problem. By then investors will turn negative and look elsewhere for returns.
“We’ve seen a reversing trend in the ringgit since May as investors repatriate their funds back to the US and risk of investing in emerging markets is seen as high. There could also still be some short coverings for the dollar,” he says.
So would he invest in the ringgit now? “No, I would wait until early next year,” he says.
Aseambankers chief economist Suhaimi Ilias opines that the ringgit is likely to be volatile, and trade between a big range of 3.50 to 3.65 over the next three months.
While the ringgit has strengthened this week, Suhaimi says this does not imply a reversal in risk appetite.
“It is purely because of the weakness of the dollar, there is no sudden shift in risk aversion,” he says.
On this note, Suhaimi says that the pace of redemptions has slowed significantly. The external drop in November has been much lower.
He however does not discard the likelihood of hedge funds making short-term investments from time to time, and this will continue to affect the ringgit’s strength.
“In the past few years, the strength of our ringgit has been dictated by these short-term outflow of such funds,” says Suhaimi.
OSK Investment Bank Bhd director and head of treasury Yeo Chin Tiong says the ringgit is basically reacting to the weakness in the US dollar.
“The US dollar’s strength may be bottoming. We may have seen the best of the US dollar, and with the Fed cutting rates, there is even more room for the ringgit to strengthen,” he says.
Yeo expects the volatility in the ringgit to continue, but more towards an upside bias.
Yeo explains that initially, the strengthening of the US dollar was because of great uncertainties due to the financial and economic crisis. Nonetheless, with aggressive measures taken by the US government, the economy is beginning to show signs of stabilisation.
“Once this happens, people will start looking at yields again. They will start looking at other asset class es which yield higher returns and switch out of the US dollar,” he says.
No big matter
Fundamentally, Lee says Malaysia is going into the global crisis much better prepared compared with 1997.
The country has strong foreign exchange reserves, low foreign currency indebtedness and enjoys surpluses in its current and trading accounts.
“As an example of how severe the global liquidity squeeze is, it is now very difficult for anyone to obtain a mortgage or a car loan in London or California while Malaysians have no such problems,” he says.
However, Malaysia won’t be immune to second-order effects of slowing exports and much lower commodity prices.
Corporate gearing is low and more importantly, with the success of the ringgit bond and loan markets since the 1997/98 crisis, there is very little reliance by Malaysian corporates and government on foreign currency borrowings.
“It became clear from the crisis that reliance on foreign currency borrowing is toxic. Malaysia does not have this problem. Many other countries are severely afflicted by this issue today,” he says.
With that, the central bank has considerable flexibility in adjusting its monetary policies. There is high expectations that Bank Negara will cut rates by some 50 basis points next year.
If that happens, an economist says the rate cut will only affect the ringgit’s movement by some 5%.
On the other hand, Yeo points out that the interest rate has never been a deciding factor for the ringgit.
“If investors or speculators want to get out of a currency, they will just sell and not be influenced by the level of interest rate offered. Malaysia is not yet a mature market like the US, where an interest rate has a huge effect on the value of the currency,” he adds.
