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Monday, November 30, 2015

The ringgit crash – Low Jin Wu

Image result for ringgit malaysia

Ringgit has fallen at a rate of about 20% of its value one year ago, and it has since become the focal point of widespread criticism towards policymakers.
This is an attempt to project my views of the reasons behind the weakness of our currency.
I believe that although 1Malaysia Development Berhad (1MDB) has a part to play in this instance, its role is much more insignificant than what most people perceive it to be.

The oil price plunge
Malaysia relies largely on oil revenues and the fall in oil prices has impacted our economy significantly.
According to historical data, the plunge in oil prices is very much negatively correlated to the strength of the ringgit and positively correlated to that of the USD.
Hence, it corroborates to the fact that the ringgit will definitely take a dip if oil prices go down.
Take the graph below for instance, we can see that the trend of the ringgit goes down in tandem with that of crude oil Brent futures.
Line chart between MYR/USD and Crude Oil Brent Futures (CO1). – Source from Bloomberg, November 30, 2015.Line chart between MYR/USD and Crude Oil Brent Futures (CO1). – Source from Bloomberg, November 30, 2015.Also, the plunge in oil prices is another huge factor that is affecting commodity prices worldwide.
Malaysia being one of the most commodity-orientated economy, is very susceptible and vulnerable to commodity shocks.
It took the biggest hit in Asean when oil prices fell unlike its other Asean counterparts, which saw their current account positions improving as oil prices went down.
The devaluation of the yuan
Another huge factor affecting the strength of the ringgit is the devaluation of the Yuan and the decrease in trade with China due to their faltering economic growth, which is predicted to be less than 7% this quarter.
The devaluation of the yuan will put downward pressures on the currency of countries that are big exporters to China like Malaysia, as China is Malaysia’s largest trade partner and the biggest consumer of commodities in the world.
There has to be an adjustment mechanism since exporting to China would be more expensive when the exporting country’s currency appreciates against the yuan.

Fed rate hike
The underlying uncertainty of a fed rate hike has caused enough turmoil already in financial markets.
It is nevertheless a key driver in the weakening of the ringgit as people will see the USD as a stable and strong currency and will therefore stock up on it to reduce the downside risks of their local currencies.
Currency speculators will also buy USD to hold in hopes of selling it at a higher value when it appreciates.
Contrary to the uncovered interest rate parity theory where a currency of a country is supposed to appreciate in value when its interest rate rises, the USD has a good tendency to depreciate right after a fed rate hike happens.
This could be explained by the rise in the sale of bonds when there is a rise in interest rates, as people/institutions will try to liquidate their bonds when bond prices fall.

The most common misconception
Through the endless political propagandas and social media ramblings, it is no surprise that most people will have the perception that the corruption scandal surrounding 1MDB is the main cause of the fall in the ringgit.
Although it might have an exacerbating effect on our capital flows, it is not the biggest driver of our currency’s weakness.
Take commodity driven economies as an example, if you were to compare Malaysia with that of very commodity driven economies like Australia or Canada, you will notice a same trend where all these currencies have been steadily depreciating in value against the USD. 
The line chart below further fortifies my point that countries that are very export orientated or oil reliant are the countries that are taking the biggest hit in terms of the strength of their currencies.
Although 1MDB is not the biggest driver in our currency’s weakness, it might be able to explain the larger magnitude of the depreciation in our currency when compared to other currencies of commodity trade centric economies like Australia and Canada.Line chart between MYR, Australian Dollar, Canadian Dollar (CAD), USD. – Source from Bloomberg, November 30, 2015.Line chart between MYR, Australian Dollar, Canadian Dollar (CAD), USD. – Source from Bloomberg, November 30, 2015.
Conclusion
On a brighter note, the weaker ringgit does increase our competitiveness of exports.
Our economy is also expected to do better if the strength of the USD declines with a fed rate hike.
Most importantly, people need to know that the decline in the strength of currencies against the USD right now is a global phenomenon that is affecting most commodity trade orientated economies.
I concede to the fact that it might look as if I am trying to defend the wrongdoings of 1MDB, but it is totally untrue as I opine that justice has to be served for those who have a part to play in the scandal that caused so much political unrest.
However, in terms of the effect that it has on our currency, there is so much more than meets the eye than 1MDB. – lowjinwu.blogspot.com,

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