This article first appeared in Capital, The Edge Malaysia Weekly on September 10, 2018 - September 16, 2018

SENTIMENT on emerging markets (EM) worsened over fears of a trade war and the strong US dollar, and investors opted out of developing economies, sparking a selldown in their currencies and raising worries of crisis in developing economies.

The bleak outlook has caused steep declines in the Turkish lira and Argentine peso, and other emerging markets are now feeling the heat. The Indian rupee, rand, rupiah and the ringgit are among the other currencies that have tumbled.

Some countries have resorted to unusual measures to support their local currency, such as Indonesia, which is planning to raise import taxes by up to 10% on 1,147 goods in a bid to cut imports and support a weak rupiah, which has plunged to its weakest level since the 1998 Asian financial crisis.

At the time of writing, the rupiah was trading at 14,905.25 against the US dollar, while the Turkish lira and Argentine peso traded at 6.5717 and 38.4793 respectively. The ringgit continued its decline, trading at 4.1455 against the greenback.

Despite Malaysia’s stable fundamentals and current account surplus, UOB Malaysia senior economist Julia Goh says the contagion impact on the ringgit is inevitable.

“We think the weakness will persist as threats of further US-China tariffs loom, less accommodative G3 monetary policy and EM contagion risks weigh on the ringgit. Moreover, the country faces prospects of slower growth, fiscal risks and near-term domestic policy uncertainty,” Goh tells The Edge.

Meanwhile, others have pointed out that the ringgit is depreciating at a relatively slower pace than other EM currencies.

FXTM research analyst Lukman Otunuga says it was a “brutal” trading week for most major EM currencies and the ringgit continues to be heavily influenced by external forces — including global trade tensions, the strength of the greenback and expectations of a US rate hike — but he adds that the losses may not be as severe as those of other currencies.

“The ringgit could weaken further in the near term amid risk aversion and dollar strength. However, with Malaysia boasting a current account surplus, the ringgit’s losses may not be as severe as those for currencies belonging to markets with high current account deficits,” he says.

Malaysian Rating Corp chief economist Nor Zahidi Alias points out that Malaysia’s situation differs from that of other EMs such as Indonesia and India, both of which are saddled with the problem of twin deficits.

He says this is a major factor behind rapid swings in portfolio capital in the two countries, which in turn increases the volatility of their currencies.

“Malaysia, on the other hand, is still recording a current account surplus of more than 3% of gross national income in 2017, despite having budget deficits in the past two decades,” says Nor Zahidi.

Although Malaysia and Indonesia have high foreign holdings of local currency bonds — making the two economies vulnerable to a sudden exit of foreign portfolio capital — Malaysia’s macroeconomics are more favourable in terms of the smaller size of government foreign currency-denominated debt, while its growth and inflation metrics are better than Indonesia’s, he explains.

Nor Zahidi also highlights that Malaysia’s real effective exchange rate has barely changed and that the major reason behind the ringgit’s recent depreciation is the strengthening of the US dollar, which has appreciated 6% against major currencies from April to July.

Apart from that, he says the depreciation of the renminbi against the greenback is adding to the pressure on EM currencies, including the ringgit.

“We estimate that a 1% depreciation of the renminbi against the greenback is consistent with a 1.3% depreciation of the ringgit,” he says.

CIMB Investment Bank regional head of treasury and markets research, Ray Choy, says the ringgit remains fundamentally undervalued, adding that the ringgit market offers great value from healthy credit spreads above safe-haven markets like the US, Japan and Germany.

“A feel-good Malaysia budget in November, adequate reserves, prospects for positive institutional changes in Malaysia, the potential for China stimulus measures and risks to the US dollar’s extended period of outperformance so far may eventually support appreciation of the ringgit by year end,” he says.

Similarly, Affin Hwang Capital Research chief economist Alan Tan expects the ringgit to recover to by year end, driven by external and domestic factors. He says none of the EM countries will be spared the selling pressure but adds that countries with stronger fundamentals will weather the headwinds better.

On the external side, he expects the US and China to come to a compromise by end November, thus avoiding a global trade war, pointing to the upcoming meeting between US President Donald Trump and China Premier Xi Jinping slated for Nov 30.

“The current strong dollar will have peaked going into the fourth quarter this year. We think emerging market currencies will likely stabilise in the fourth quarter and we will see the ringgit continue to strengthen into the first half of 2019,” he says.

Domestically, apart from the country’s strong fundamentals, Tan says the mid-term review of the 11th Malaysia Plan and the announcement of Budget 2019 in November will provide further clarity on the fiscal position and the direction of the economy in the medium to long term, thus supporting the ringgit.

“We had a year-end ringgit forecast of 3.80 but that was before the Turkish lira’s weakness. Now we are expecting the ringgit to hover around 3.95 to 4.00 by the end of this year. The 3.80 level is still possible but that will likely be towards the end of 2019,” says Tan.

In the near term, however, the ringgit is expected to continue to be under pressure and be exposed to downside risks.

FXTM’s Lukman says the ringgit will continue to be heavily influenced by external forces, such as global trade tensions, dollar strength and US rate hike expectations.

“Technical trade will continue to closely observe how prices behave around the 4.150 level. The dollar-ringgit rate has scope to venture towards 4.180 and 4.200 in the short to medium term if a weekly close above 4.150 is achieved,” he says.

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