Fundamentals, not the OPR, will support the ringgit

 

Last week the financial markets committee (FMC) at Bank Negara Malaysia (BNM) made very clear that the transitory weakness in the ringgit against the US dollar is driven by market news and sentiment and does not reflect economic fundamentals.

They are right.

The economy grew by 8.7% in 2022 and by 5.7% in Q1 2023 with 4% to 5% forecast for the full year. Inflation is now around 2.8% and will fall toward 2.5% in the next few months.

Interest rates are now in the normal range of around 3.0%, still accommodative for underlying growth.

This is largely because BNM has stuck to its mandate and used the OPR to maintain price stability, financial stability and sustainable growth rather than to chase market sentiments on the ringgit.

Compare this to Singapore and Hong Kong where monetary policy targets the exchange rate.

In Singapore, interest rates are up 3.20% since March 2022. This is in defence of the Singapore dollar following the move by the US Federal Reserve to raise interest rates.

Inflation is 5.1% and the economy grew at 3.6% in 2022, less than half the rate of Malaysia. It actually contracted on a quarterly basis in Q1 2023, the first stage of a technical recession.

In Hong Kong, the economy contracted in every quarter of 2022 and fell by 3.5% overall as interest rates rose on 15 occasions by 5.0% to maintain the exchange rate.

If BNM had defended the currency by matching the US Federal Reserve hikes, the OPR would be 6.75% instead of 3.0%. This would crush borrowers and risk recession as we have seen in Hong Kong and may see in Singapore.

The damage to underlying fundamentals would severely harm the ringgit and we would get exactly the opposite of what was intended.

Last week BNM said it would intervene only in line with its mandate if movements in the exchange rate were excessive.

This means that intervention is only justified if volatility in the ringgit affects the mandate of price stability, financial sector stability and sustainable growth.

There is nothing in the current exchange movements that would affect this mandate because inflation is falling, the financial sector is stable and the economy is expected to grow at 4% to 5%.

Also, intervention does not mean a hike in the OPR. BNM has other tools available to support the ringgit.

For example it is encouraging exporters to repatriate their dollar proceeds. This will enable them and others holding dollars to benefit from converting to ringgit now or risk losing some value if they wait.

BNM noted that the market expects the ringgit to be lower, at around RM4.50, by year-end.

Since the FMC statement, the ringgit has been stable for more than a week. BNM has stemmed the decline, reducing the need for interest rates to change at the upcoming MPC meeting.

Apart from this, BNM can do very little if anything to systematically influence the ringgit in the short-term as we have seen from recent hikes in the OPR.

Foreign currency reserves are too low to intervene for long and increasing the OPR has very short-term impact and could damage the ringgit in the long-term.

So maintaining an independent policy stance, keeping to its mandate and promoting fundamentals is the best option for BNM.

Neither the ringgit nor the stock market should be taken as barometers of the economy and the underlying value of the ringgit will be stronger as markets look at the strength of Malaysia’s fundamentals, especially compared to regional peers.

For now it is fundamentals, not the OPR, that will eventually determine the correct level of the ringgit.

There is no need to raise the OPR based on those fundamentals. - FMT

The views expressed are those of the writer and do not necessarily reflect those of MMKtT.