RINGGIT POSER for Finance Minister Najib Razak: Why is it so weak?

Over the past few months, the Malaysian ringgit has, at times, been the worst performing currency in Asia against the US dollar (dollar). On Jan 20, the ringgit hit a six-year low to close at 3.60 to the dollar which was the lowest it had been since April 2009. Since crude oil prices began their plunge in the latter half of June, the ringgit has dropped around 6.5% in value against the dollar.

Six years ago, the world had been in the midst of the Global Financial Crisis which began with the US subprime crisis which developed into a banking crisis and led to an overall global slowdown which took its toll on export dependent nations.

As the ringgit has depreciated against the greenback the ever present fears that another 1997/1998 Asian Financial Crisis or another 2008/2009 Global Financial Crisis might be at hand have resurfaced.

Bank Negara Malaysia (BNM) governor Zeti Akhtar Aziz however recently refuted that. She said “the ringgit’s weakness does not reflect Malaysia’s current fundamentals which are still strong.”

In this piece, KiniBiz looks at what drives a currency and what is causing the ringgit to depreciate against the dollar this time around.

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. Bank Negara Malaysia 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.

Inside story image Bank Negara Malaysia 270115 04Just like any other floated currency the value of 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.

According to Barclays Bank Plc’s regional economist for emerging markets Rahul Bajoria, 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.”

Rahul Bajoria

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 a 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 (net 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 balance of payments which show net inflow or outflow of funds. If there is inflow, there is higher demand for ringgit and if there is outflow then there is selling of 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.

Why is the ringgit weak?

So what is driving the ringgit down this time?

Containers filled with oil cleaned up from the oil spill site are seen at Beilianggang port in DalianThe short answer is mainly the falling price of crude oil which affects sentiment on the ringgit which is made worse by outflows of portfolio investments in anticipation of the Federal Reserve’s ongoing cutbacks of quantitative easing which refers to slowing down the rate of Treasury bills and bonds. This effectively lowers liquidity creation in the US market which implies less funds available for future investment in emerging markets.

The price of Brent crude oil per barrel began to fall sharply in the latter half of June 2014 on the back of a global oil supply glut. And it continued to drop after the major oil producing nations under the Organisation of Petroleum Exporting Countries (Opec) refused to scale back production.

To date, the Brent crude oil price has fallen some 45.6% from around US$114 on June 19, 2014 to around US$62 as at end February 2015 as a result.

Although Malaysia is technically a net crude oil importer, it still derives a large chunk of its national income from oil-based revenue. Furthermore Malaysia becomes a net energy exporter when liquified natural gas is factored in and therefore lower receipts from those exports will hit the current account.

From Chart 3 and Chart 4 it can be seen that the ringgit (indicated by the coloured lines) often falls in tandem with the price of crude oil.

When Budget 2015 was tabled in October 2014, the government’s budgetary plans were based on the assumption that Brent crude prices would be at the US$100 per barrel mark in 2015. Therefore the sharp drop in oil prices led to serious concerns over the government’s ability to meet its budgetary commitments and fiscal targets

In late January, the government moved to address these concerns by announcing a revised budget

Prime Minisiter Najib Abdul Razak said the revisions were “a reality check following, among others, declining global crude oil prices.” In the updated version, the government revised its plans based on the assumption that Brent crude would be at around US$55 per barrel.

Nonetheless despite the revision both the prime minister and other key economic figures have stated that the perceived importance of oil-based income for Malaysia has been overstated.

Inside story image najib putrajaya event 060215 06Najib has pointed out that the fall in oil prices have actually benefitted the Malaysian economy in some ways. For example, he said it enabled the government to lower the price of petrol and this had increased the amount of disposable income Malaysians had to spend. Domestic consumption has been an important driver of the economy over the past year.

BNM’s Zeti too has emphasised that Malaysia is less reliant on oil based income than it was before. She noted that overall energy based income will only account for 22% of government revenue in 2015 versus 30% in 2014 which has mitigated the impact of low energy prices.

Following a good set of figures for the fourth quarter of 2014, Zeti said the ringgit had been affected by portfolio outflows and much of it is event and sentiment driven and therefore the ringgit’s weakness was not a fair reflection of Malaysia’s current fundamentals which are still strong.

“When it stabilises and has greater clarity, we expect the ringgit then to reflect our underlying fundamentals,” she added.

Also traders who take positions against the ringgit will have to close them off at some point and this will also result in some strengthening of the ringgit.

Barclays’ Rahul Bajoria agreed that sentiment has played a role in the falling value of the ringgit. He said for example, that the impact of the falling oil prices had been more pronounced for Malaysia because it is the only net energy exporter among the emerging markets in the Asian region. And when it was viewed against other non energy producing emerging markets in the region the situation looked far worse by comparison.

“There are other energy exporting emerging markets which have also been similarly impacted in other regions, so Malaysia isn’t a standalone case,” said Bajoria.

However Bajoria said that sentiment cannot be ignored entirely as it will be based on some level of facts. He opined that while perhaps the impact of the oil price plunge had been overstated, there were legitimate concerns over how the government’s fiscal policy would be affected as a result.

In the second part of this series, KiniBiz will consider the impact of low oil prices on the government’s fiscal policies and ask if the ringgit is undervalued. - Kinibiz