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This article first appeared in Capital, The Edge Malaysia Weekly on December 18, 2017 - December 24, 2017

THE ringgit saw a rapid recovery recently, strengthening from historic lows of 4.48 against the US dollar earlier in the year. This was driven by higher-than-expected economic growth in the third quarter, an expected hike in the overnight policy rate (OPR) next year and stabilising oil prices.

Bloomberg data shows that at the time of writing the local currency was the third highest year-to-date gainer against the US dollar among a basket of Asian currencies, with a 9.76% gain. The South Korean won and baht were the top gainers, strengthening 10.74% and 9.87% respectively. The Singapore dollar gained 7.45%; the Taiwan dollar rose 7.43%; the renminbi 5.47%; and the Indian rupee 5.41%.

“A major reason for the ringgit’s recovery in 2017 is that the country was horribly oversold last year,” FXTM research analyst Lukman Otunuga tells The Edge.

The ringgit saw a short-lived recovery in early 2016, trading below the 4.00 mark, amid a rebound in crude oil prices. However, it weakened amid news of 1Malaysia Development Bhd’s default on its US$1.75 billion bond.

External factors — such as the UK’s decision to leave the European Union and expectations for US interest rates — exacerbated the weakness of the ringgit, with the currency trading at 4.48 by end-2016.

Otunuga says the outlook is brighter for 2018 as the country’s fundamentals improve steadily.

“With the gross domestic product expanding at its fastest pace in more than three years during the third quarter of 2017, at 6.2%, the economic outlook continues to be encouraging.

“Keeping in mind how expectations are mounting over an OPR hike by Bank Negara Malaysia next year in an effort to support growth, further upside could be on the cards for the local currency,” he says.

Most analysts expect at least one 25-basis-point hike in the OPR by the central bank next year, to 3.25%, while others suggest the possibility of two rate hikes if the growth momentum remains strong.

However, investors should keep a weather eye on developments in the US, which pose downside risks to the ringgit, such as the Federal Reserve’s tightening move, says Otunuga.

Last Wednesday, the Fed raised the federal funds rate by 25bps, to a range of 1.25% to 1.5%, and forecast three more hikes next year.

Otunuga also notes that emerging market currencies could come under renewed selling pressure next year if the passing of the Trump administration’s tax bill elevates the greenback.

“A resurgent dollar may spark capital outflows from emerging markets and, therefore, has the potential to expose the ringgit to downside losses,” he says.

While higher rates would be negative for the ringgit — along with other emerging market currencies — he says the growing confidence in Malaysia’s economy and the overall encouraging outlook will support the currency’s strength.

“All in all, there is no real reason to be concerned that the ringgit could decline back to its historic lows,” he adds.

CIMB Investment Bank Bhd group head of treasury and markets Chu Kok Wei expects the ringgit to strengthen to 4.05 against the US dollar by end-2017 and 3.95 by end-2018.

He says the local currency will be driven by internal fundamentals, such as the increasing current account surplus, rising foreign exchange reserves, higher gross domestic product growth and relatively hawkish interest rate policy versus peers in the region like Thailand and Indonesia.

Chu adds that the risk of capital outflows from emerging markets could be limited as the political climate in the US and European Union  as well as the expansionary policy adopted by Japan suggest a limit to higher rates in these regions.

Moreover, he explains that the previous above-4.00 levels were due to initial fears of the taper tantrum, reduction in the current account surplus and declining share of foreign holdings in local bonds. These fears have since faded.

“The fair value of the ringgit should be below 4.00 and this value is likely to be unlocked over the next 12 months,” says Chu.

“Nonetheless, we are in the mature stage of the economic and markets cycle, hence a risk factor is mean reversion in risky asset valuations, leading to an increase in cash weights by investors, particularly if gains in emerging markets are to be locked in.”

He points out that the recent gains in the ringgit have been rapid and he, therefore, expects a more gradual strengthening of the currency throughout 2018.

Nevertheless, ringgit assets continue to provide a positive yield above developed markets, which will be a continuing theme in 2018,” he says.

Similarly, AmBank Research expects the ringgit to trade at 3.98 by end-2018 and the currency to average 4.12 against the US dollar in 2018, versus a forecast average of 4.30 in 2017.

“These [forecasts] would still be at a discount to our fair values of 3.76, based on the real effective exchange rate model, and 3.96, based on fundamental analysis,” writes the research house in a recent note.

This echoes Deputy Finance Minister I Datuk Wira Othman Aziz’s view. He recently said the ringgit should breach the 4.00 psychological level against the US dollar, barring unforeseen circumstances.

Besides the improving fundamentals, AmBank Research says, the rebound in foreign holdings of Malaysia Government Securities (MGS) and recovery in Bank Negara’s international reserves to US$101.5 billion as at mid-November will support the ringgit.

The recent strengthening in the ringgit fuelled a rally in MGS, with foreign holdings surging 4.6% month on month to RM160.3 billion, or 44.3% of total outstanding issuances in November, from 42.7% in the previous month.

“There was a greater flow of foreign funds into the local bond market in November as foreign investors became net buyers.

“Foreign inflows into MGS were spurred by the outperformance of the ringgit as it continues to hit new highs in 2017,” says Malaysian Rating Corp chief economist Nor Zahidi Alias.

He adds that the ringgit’s strength was also supported by firmer crude oil prices amid the anti-corruption crackdown in Saudi Arabia and optimism on an extension of supply cuts by the Organization of the Petroleum Exporting Countries.

At the time of writing, Brent crude futures traded at US$62.41 per barrel, compared to levels around US$45 per barrel seen in mid-2017.

The ringgit has also gained significant ground against other major currencies since September, including the euro, pound sterling, yen and Singapore dollar, notes Nor Zahidi.

UOB Malaysia senior vice-president of global economics and markets research  Julia Goh also sees upside to the ringgit next year as she deems it undervalued and lagging behind key regional peers.

“Our technical indicator points to further ringgit strength ahead. We see the ringgit trading at 4.05 against the greenback in the first quarter of 2018, 4.02 in the second quarter, 3.97 in the third quarter and 3.95 in the fourth quarter.

“Needless to say, key risks to our positive ringgit view are a more aggressive pace of US Fed rate hikes or renewed weakness in crude oil prices,” she says.

 

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