The ringgit has been strengthening against most of the world’s major currencies since early this year. But will this trend sustain?
ZAINAL Azhar has been shopping for the best rates to swap ringgit for euros for his upcoming business trip to Germany. The 40-year-old businessman from Kuala Lumpur says he has been buying euros in phases in preparation for the visit next month.
His friends, Susan Lee and Albert John, are also watching how the ringgit is faring against other currencies. Lee, a financial analyst in her 30s, has been waiting for months to score a “cheaper” vacation to the United States, while sixtysomething John is sending his youngest son to Britain for further studies.
The trio are hoping to get the most bang for their bucks when they exchange their ringgit for other currencies.
So, the recent rise of the ringgit bodes well for individuals like them – not to mention for those who like to shop online for overseas products. Since early this year, the ringgit has been strengthening against most of the world’s major currencies.
On nominal terms, the ringgit has appreciated about 6.7% year-to-date against the US dollar. The ringgit is now hovering at a two-year high against the greenback at 3.19, compared with 3.42 at the start of the year, and last year’s peak of 3.72 recorded in March.
Against the British pounds, the ringgit has strengthened from 5.5 early this year to around 4.9 currently. The ringgit has also risen against the euro from 4.88 early this year to about 4.28 currently.
Against the yuan, the ringgit has reached almost a two-year high over the week to 46.79 sen from 50.15 sen early this year, while against the yen, the ringgit has appreciated 6.9% year-to-date and 8.6% year-on-year to hover around 3.749 per 100 yen.
Other regional currencies are also trending similarly, including the Singapore dollar (which has just been revalued by the country’s government) and the Indonesian ruppiah.
Driving factors
Compared with other regional currencies, the ringgit has nominally gained the most against the US dollar since the start of the year.
Says Affin Investment Bank chief economist Alan Tan: “The ringgit is playing catch-up in the first half of this year as it lagged for most of the second half of 2009. Other regional currencies started gaining strength then.”
As most economists see it, the recent strengthening of the ringgit – and most Asian currencies for that matter – is mainly due to three factors: strong economic recovery and growth prospects for the Asian region, wide interest rate differentials between the US and Asia as some countries in the region have started to normalise their monetary policies and the widespread expectation that China’s lawmakers will allow the yuan to appreciate.
Amid the mounting pressure on China, there are growing expectations that the country will let its yuan appreciate against the US dollar in the second half of the year.
The correlation between the Chinese currency and regional currencies is strong – a rallying yuan will usually lift the regional currencies.
For example, the lifting of the ringgit peg to the US dollar in July 2005. This took place shortlty after China’s central bank revalued its yuan and shifted to a managed float.
(The yuan was pegged at 8.27 per US dollar from 1995 until mid-2005, when it was revalued upwards to 8.11 per US dollar and allowed to float against a basket of currencies, including the US dollar, euro and yen. In July 2008, the yuan appreciated 21% against the US dollar, and its value has since been pegged at around 6.83 per US dollar to this day.)
“The dollar will flow into high-growth regions, driving their currencies to appreciate,” OSK-DMG economist Enrico Tanuwidjaja tells StarBizWeek.
The World Bank expects developing East Asia (which includes Malaysia, China and Indonesia) to register 8.7% growth in gross domestic product (GDP) in 2010.
The Asian Development Bank’s projection is slightly lower at 7.5%.. Malaysia’s GDP growth forecast ranges from 5% to 7%. “The expectations of good growth rates are a major boost to investor sentiment,” says Alan.
More to gain or lose?
A recent CIMB Investment Bank report says that “the interplay of currency revaluation expectations and interest rate differentials will trigger more speculative inflows into the region.”
Malaysia’s move in raising interest rates since early this year has attracted some foreign fund inflows. This has led to the strengthening of the ringgit against major world currencies.
In March, Bank Negara raised the overnight policy rate (OPR) from a record low of 2% to 2.25%. The central bank is expected to raise the OPR again in the months ahead as part of the rate normalisation process.
This will widen the interest rate differentials between Malaysia and other developed nations, especially the US, that have been keeping and intend to keep their rates low for a longer period.
Economists say the widening interest rate differentials will continue to attract private funds to Malaysia as investors seek higher returns.
According to CIMB Investment Bank, the Malaysian equity market could “get a leg up from further OPR hikes.”
Foreign investors are seen to be taking a bet on asset reflation caused by a strengthening ringgit. Market analysts believe that in such instances, the most likely beneficiaries are blue chips such as banking and plantation stocks, among others.
ECM Libra Investment Bank says companies that derive their income mainly from the domestic or regional markets but have input costs or liabilities denominated in G3 (the US, Japan, and euro) currencies will gain.
Those in this category include Tenaga Nasional Bhd, UMW Holdings Bhd, AirAsia Bhd, Malaysia Airlines Bhd, Tan Chong Motor Holdings Bhd, QL Resources Bhd and KFC Holdings (M) Bhd.
Conversely, the strengthening of the ringgit will not bode well for exporters or companies that earn their income mainly in G3 currencies, and have input costs or liabilities denominated in the local currency. Fitting into this category, as analysts point out, are rubber glove and semiconductor companies.
From the international trade perspective, a stronger ringgit tends to make the country’s exports of goods and services costlier for overseas customers. In theory, this would inadvertently lead to lower demand for Malaysia’s products.
But economist Prof Datuk Dr Mohamed Ariff opines that the current appreciation of the ringgit will not significantly impact Malaysia’s export competitiveness because other regional currencies are also rising at the same time.
Says Tanuwidjaja: “Current external demand is driven mainly by intra-regional trade, while demand from developed nations remain relatively weak. The country will benefit more from the lower costs of imports and capital expenditure with a stronger currency.”
Bracing for volatility
Malaysian exports generally have high import content, and this could help mitigate the effects of a stronger ringgit on exporters.
It is estimated that for every RM1 of exports, 70% are intermediate goods imported from overseas. So, a stronger ringgit will help reduce production costs and help exporters maintain price competitiveness.
Will the ringgit’s uptrend continue? Based on current economic indicators, most economists say the trend is unlikely to continue.
They believe the ringgit is already near the tail end of an appreciating trend. They say the upside potential for the ringgit is somewhat limited and that some form of weakness will likely arise in the second half of the year.
Analysts believe the market should brace for volatility ahead as the ringgit’s appreciation is still vulnerable to the movements of international short-term capital.
“The outlook for the first half of the year is clearly an appreciating trend for the ringgit but uncertainties will set in by the second half of the year. Hence, the belief that the strengthening of the ringgit, and other Asian currencies for that matter, will not be sustainable in the latter part of 2010,” says Tanuwidjaja.
Economists believe the growth of Asian economies will be less vibrant in the second half, compared with the first half.
In addition, there is the possibility of policy change by developed nations, particularly the US, as the recovery of their economies gathers pace in the second half of the year.
It is widely speculated that the second half of 2010 will mark the end of the “extended period” for record low interest rates for the US.
Interest rate differentials between the US and other Asian economies will likely be narrower then. This will result in funds flowing back into the country, and the US dollar is likely to react favourably and regain its strength against other currencies.
Taking into account the possibility of this scenario, several local research houses have ascribed a year-end target for the ringgit against the US dollar at between 3.20 and 3.30.
Then again, what about the possible revaluation of the yuan?
Says Alan of Affin: “The market has already priced in such possibility, and even if there’s really a change in the yuan policy, we believe it will be gradual and moderate. We don’t think there will be any sharp or surprise movement in the yuan, so as to minimise the impact on China’s export competitiveness.”
Significantly undervalued?
It is generally perceived that several Asian currencies, including the ringgit and the yuan, are significantly undervalued against the US dollar.
Foreign studies claim that the exchange rate misalignment, in terms of undervaluation against the US dollar at the end of last year, for the yuan was as much as 40.7%.
For the ringgit, it was around 30.5%, while the Hong Kong dollar and the Singapore dollar were misaligned by as much as 32.2% and 24.7%, respectively.
While many Asian currencies have strengthened against the US dollar, their recent appreciation were merely nominal gains. Measured in real terms, that is, after adjusting for inflation, the gains of Asian currencies were only marginal.
The ringgit, in real effective exchange rate, has only strengthened by a mere 1% against the US dollar year-to-date, and less than 3% from mid-2005, when its peg to the US dollar was lifted.
Hence, some quarters argue that there is scope for the ringgit to strengthen further against the US dollar.
But Bank Negara has previously stressed that the value of the ringgit is determined by market forces and that its present value is already reflective of the country’s economic fundamentals.
“To be a domestic and consumption-based economy, a strong ringgit is needed. But let’s be realistic here. Many industries in Malaysia are still export-driven, and a strong ringgit over the short term will definitely hurt them,” says Alan.
He says the ringgit has already appreciated to a level where some manufacturers are beginning to feel a bit uneasy and anxious over the possible loss of competitiveness.
Economists argue that any form of intervention by the central bank in the ringgit exchange should be focused on smoothing out the sharp volatilities that could cause instability in the financial markets, instead of managing the ringgit’s value against other currencies.
Otherwise, says Ariff, “any attempt by the monetary authorities to rein in the ringgit, except under exceptional circumstances, would cause serious price distortions and contribute to inefficient allocation of resources.”
Towards high income
Having a strong currency is in line with any nation’s ambition to be a high-income economy.
“Strong” currency in this sense refers to one that is well demanded and has a stable value, with its exchange rate driven by economic fundamentals.
There are compelling benefits for Malaysia to aim for a stronger ringgit in line with its ambition to be a high-income nation.
For one, a stronger ringgit will make travelling abroad more affordable for Malaysians, hence enhancing their scope for leisure.
A stronger ringgit will also encourage the import of capital goods, which contributes to the innovation and automation of industries in the country.
Above all, a stronger ringgit will help improve the living standards of the people by increasing their purchasing power through cheaper imports and lower inflationary pressure.
Malaysian Rating Corp Bhd chief economist Nor Zahidi Alias says that unless profiteering activities are thwarted, a stronger ringgit may not necessarily lead to cheaper imported goods for Malaysians.
The benefits aside, “a stronger ringgit per se should not be the over-riding objective,” says Prof Dr Tan Eu Chye of University Malaya’s Faculty of Economics and Administration.
“A stronger ringgit must be consistent with the fundamentals of the country’s economy. If fundamentals dictate that the ringgit should strengthen, then it should be allowed to appreciate,” he says.
For the ringgit’s advancement to sustain over the longer term, the implementation and execution of Malaysia’s New Economic Model (NEM) is critical, says Maybank Investment Bank.
Although the first part of the NEM has already been unveiled, many are waiting for more clarification and details of the plan to gain a clearer picture of the changing fundamentals of the Malaysian economy.
The consensus view is that there isn’t any material change in the key economic fundamentals of Malaysia yet. Hence, the unveiling of the second part of the NEM will be critical.
The World Bank says that as long as a stronger ringgit is justified by improved fundamentals, it can help the country gain mileage towards becoming a high-income nation.
“Otherwise, complacency may set in and we may not be able to sustain the high-income status eventually,” says Eu Chye.
