PLUNGE in ringgit value draws attention

THE two reports issued by Bank Negara on the state of the economy and its forecasts and also a report on the banking system are not what most people are talking about.

The two subjects that generally dominate conversations are the ringgit's decline against the US dollar ever since oil prices started to tumble, and problems with 1Malaysia Development Bhd (1MDB).

Both have been addressed by the central bank, one directly and the other indirectly, and their impact and consequences on the economy and the banking sector.

Bank Negara has gone to some length to discuss the flagging ringgit, which, in a nutshell, it says is a situation that has happened before. The other point it has stressed, and has done so repeatedly of late, is that the ringgit is undervalued.

In 2009, the ringgit fell during the global financial crisis against the dollar, as funds fled emerging market currencies back to the sanctuary of the US dollar. Flows of capital that came into Malaysia prior to that left and that weakened the ringgit to RM3.70 (S$1.40) to the dollar.

The US dollar's rise against the ringgit is not in isolation. Its strength against a basket of currencies is translated through the dollar index, which is at a 12-year high. Different readings on weaknesses against the dollar will depend on which point currencies are being compared to the dollar.

But against a basket of currencies in Asia over the past 12 months, the Philippine peso is the only currency, apart from the Hong Kong dollar which is pegged against the greenback, that has appreciated against the dollar.

"The dollar is extremely strong and a lot of that is because of the expected hike in US interest rates in the middle of the year," says Suresh Ramanathan, head of regional interest rates and foreign exchange (forex) strategy at CIMB Investment Bank.

The Japanese yen, Indonesian rupiah and the ringgit are the three weakest currencies, all of which are at multi-year lows against the dollar.

For Malaysia, the ringgit's weakness has seen it crawl towards the RM3.80-to-the-dollar level, which can be seen as a psychological level against the dollar rather than what the rate signifies. That was the rate the ringgit had been pegged against the dollar during the Asian financial crisis nearly two decades ago, subsequently being lifted in July 2005.

The ringgit's current weakness, which is now trading at around RM3.70 to the dollar, has been somewhat blamed on two factors. The first is the overall strength of the dollar following the end of its quantitative easing, an improving US economy and the prospects of interest rates normalising from the middle of this year.

The second external event has been the price of crude oil. There has been a rough correlation between the ringgit's movement and the price of crude oil. When crude oil prices go up, the ringgit will follow.

That link has been fractured of late when oil made a climb from US$45 a barrel to around US$60 a barrel, during which the ringgit continued its slide against the dollar.

Bank Negara governor Tan Sri Dr Zeti Akhtar Aziz said at a briefing for editors this week that the ringgit's weakness was down to perception issues rather than economic factors.

For one, the central bank has expoused the strength of the economy, the health of the current account and also the depth of the banking system.

It maintains that Malaysia's economy is not commodity-dependent but exports lots of commodities, where oil and gas (O&G) and crude palm oil are two big components of exports apart from manufactured goods.

The services and manufacturing sector accounts for the bulk of the economy, and mining, which houses the O&G sector, 8 per cent.

Direction of the ringgit

The big question is whether the ringgit will reach the RM3.80 level. Whether that happens will depend on just how far trading in the ringgit overshoots its current trading environment because as it stands, the ringgit based on real effective exchange rate valuations point to it being undervalued to the dollar.

"We still expect the ringgit's weakness to persist on a combination of factors, including a strong US dollar trend, soft oil prices for an extended period, vulnerability to foreign fund outflows and heightened risk of a ratings downgrade following contingent liability exposure, lower fiscal revenue," says a forex report by Maybank Investment Bank.

The biggest risk to the ringgit, and a host of other currencies, is the likely hike in US interest rates. Economists say that as time moves towards that decision by the US Fed in June, the US dollar is expected to strengthen and the momentum flow of capital to the US is expected to continue.

"The shrinking current account surplus, coupled with a sizeable capital outflow, will likely contribute to a decline in the country's forex reserves, putting pressure on the ringgit," RHB Research Institute said in a note after the Bank Negara reports were issued this week.

"The ringgit continues to weaken to around RM3.70 per US dollar of late, weighed down by a stronger US dollar vis-à-vis major currencies and a sharp fall in oil prices that will likely impact the country's current account position and fiscal deficit."

The weak ringgit will help the exports of manufactured goods, which accounts for 77 per cent of total exports. Just how much it will benefit exporters will also depend on the competitiveness of exporters and the value of other currencies that have dropped against the dollar.

The weak ringgit, though, could be a drag on the economy, as it will affect the price of imported components and goods in Malaysia.

As it stands, estimates from private sector economists differ from what the central bank thinks about the growth in domestic consumption. Official estimates see private consumption rising by 6 per cent this year, but some economists think it will be lower than that. The low price of oil will free up cash among households, but price increases from the upcoming goods and services tax will weigh against that. Just how the scales will be balanced will be watched.

The other factor that helps consumption is the low unemployment rate. But with job creation expected to increase marginally after a fall two years ago, and with the number of vacancies slowly decreasing, that is not a good sign for employment creation and wage inflation.

Weakness in domestic demand will put pressure on the ringgit.

Stress test

With 1MDB a hot conversation within business circles and influencing perception, Bank Negara, in its financial stability and payment systems report issued together with the annual report, published details of the stress test it had conducted on banks.

In one of its assumptions on credit risk shocks, it says it analysed a default of selected corporations with large exposures to the banking system.

The parameter of that assumption is that such corporations are under a watchlist and are susceptible to volatile exchange rate movements and a prolonged stressed economic environment.

Zeti said that corporations with loans exceeding RM2bil are classified as large borrowers. Although she didn't directly say whether the stress test was conducted specifically on 1MDB, she said that in the event of a default by large borrowers, the banks' capital ratios would still be above the minimum requirement under Basel III standards, but that the profitability of the banking sector will be hurt.

She added that Bank Negara had the experience in dealing with borrowings of large corporations.

"This is the lesson we have learnt from the Asian financial crisis. It is nothing new and that experience has provided us with what lessons to pay attention to when it comes to large borrowers," she said.

Zeti said the central bank would be alert to the potential effects of large loans going sour and that it would try to pre-empt such developments. One example she gave was that Bank Negara had stepped in to help restructure loans of a large corporation which had debts of RM9bil two years ago. She did not name the corporation, but said that the debt situation was now stable.

In its stress test, Bank Negara said that defaults by large corporate borrowers constituted between 10 per cent and 20 per cent of total credit losses.

The other criteria in its credit risk shock for such a situation is a probability of 12 per cent of business loans and 9 per cent of household loans defaulting. - Asiaone