This article first appeared in Forum, The Edge Malaysia Weekly on May 2, 2022 - May 8, 2022

The Covid-19 pandemic and the floods that ravaged our country in 2020 and 2021 will be remembered for many years. In response to these challenges, the government has implemented eight economic stimulus and assistance packages, as well as two expansionary budgets for 2021 and 2022. We have also implemented, for the first time ever, a flood relief package to help victims rebuild their lives.

As a result, the country’s economy grew 3.1% in 2021, compared to a 5.6% decline in 2020. Since the fourth quarter of 2021, various economic indicators have shown signs of recovery. In February 2022, the unemployment rate was 4.1%, versus 5.3% in May 2020, thanks to the implementation of wage subsidy programmes worth over RM20 billion and successful job creation initiatives like JanaKerja and JaminKerja. Other signs of recovery include our total external trade, which surpassed RM2 trillion, and net foreign direct investments of nearly RM55 billion.

However, the steady pace of post-pandemic growth is now disrupted by geopolitical tensions arising from the Ukraine-Russia conflict. After the global economy grew 6.1% in 2021, the International Monetary Fund (IMF) recently revised the forecast downwards for 2022 to 3.6%, from 4.4% previously.

Global supply chains have been disrupted, causing higher crude oil and food prices. Worse, China’s zero-Covid strategy has further aggravated disrupted supply chains, driving up commodity prices. The IMF reduced China’s growth forecast from 8.1% in 2021 to 4.4% this year, the lowest since 1992 (excluding the pandemic period). The IMF also predicts that inflation will rise by 5.7% in developed countries and 8.7% in developing countries this year. These issues were hotly debated during the World Bank-IMF Spring Meetings in Washington which I attended.

As an open economy with external trade accounting for nearly 120% of GDP, Malaysia has also been impacted by recent geopolitical tensions, a slowing in China’s economic growth, and supply chain disruptions. This was reflected in Bank Negara Malaysia’s revision of our GDP growth this year to 5.3%-6.3%, down from the original projection of 5.5%-6.5%.

A sharp rise in inflation can affect inflation expectations, reduce public spending and demand and, as a result, economic growth. This will also impact the labour market, as a weak economy can increase unemployment, resulting in reduced economic activity. This is called “stagflation”, which is a high rate of inflation combined with less economic activity.

The government acknowledges the impact of inflation on the economy and households, and has taken various measures to help the nation face these challenges.

Apart from establishing the National Action Council on Cost of Living (NACCOL) to address and control rising prices of essential goods and people’s cost of living, the government has also implemented measures such as the Festive Season Maximum Price Scheme to contain excessive price increases and prevent profiteering during high demand periods.

Fuel and other basic food items also continue to be subsidised. The RM31 billion subsidy allocation for Budget 2022 is inadequate and will rise this year, especially for the RON95 oil subsidy.

a. The RON95 subsidy alone is expected to exceed RM30 billion this year due to an increase in Brent oil prices to over US$100 per barrel. The RON95 subsidy is provided through Malaysia’s implementation of the retail price ceiling. Because of this, our petrol prices are lower than those of oil-producing or neighbouring countries like Saudi Arabia (RM2.71), the UAE (RM4.30), Indonesia (RM4.98), Thailand (RM5.99), Singapore (RM9.29) and Norway (RM10.37 per litre). Other countries’ rising retail fuel prices have also pushed up prices. Singapore, for example, expects inflation to rise 4.5%-5.5% this year, compared to 2.3%-3.2% in Malaysia.

b.    Over RM500 million has been allocated for chicken and egg subsidies from February to May this year. The current price of chicken in Malaysia (RM8.90/kg) is lower than those in Indonesia (RM11.17/kg), Thailand (RM11.35/kg) and Singapore (RM28.90/kg).

c.  Over RM700 million of subsidies for electricity tariff rates have been allocated for the first half of this year. This is expected to rise considerably as coal prices have risen more than 200% this year, and natural gas prices, nearly 100%.

Coal and natural gas currently generate 95% of our country’s electricity. (This is also why it is important to increase our non-fossil fuel sources in our energy mix, which also supports our target to become carbon-neutral by 2050.)

It is due to all these decisive measures that the country’s inflation rate has remained at 2.2% in March 2022, as per the month prior, and among the lowest compared to the US (8.5% in March 2022, the highest since 1981), the UK (7%, the highest since 1992), Australia (4.5% for 1Q2022), and our neighbours such as Thailand (5.7%), Singapore (5.4%) and Indonesia (2.6%).

In short, various subsidies, including RON95, have also limited the impact of ringgit depreciation on inflation this year. For example, if fuel prices are set based on market prices, currency fluctuations would typically have a direct impact on inflation.

As effective as these subsidies are in containing inflation, we must also acknowledge that blanket subsidies disproportionately benefit the wealthy. For example, the RON95 subsidy clearly benefits them as they are more likely to own multiple vehicles, including luxury ones. Similarly, chicken and electricity subsidies benefit those who are bigger consumers.

According to Bank Negara, for every RM1 of RON95 petrol subsidy, the T20 receives 53 sen, while the B40 receives only 15 sen. This means that the T20 will receive more than RM15 billion of the total RM30 billion expected to be spent, while the B40 will receive only RM4.5 billion. In fact, the subsidy allocation of RM30 billion far outweighs our RM22 billion social assistance allocation. Is this fair?

Clearly, long-term implementation of blanket subsidies will have an impact on the country’s financial position. That is why the government is considering a more targeted subsidy mechanism, so the savings can be redistributed to benefit the vulnerable and underprivileged, as well as development programmes.

Another fact to acknowledge is that the movement of any currency, including the ringgit, is closely related to inflation rates and monetary policies.

For example, various economies have already tightened or will tighten their monetary policies to contain rising inflation. The US Federal Reserve is expected to raise rates by 50 basis points in May. Singapore has raised their policy rates three times in the last six months, while South Korea, twice this year. The UK, Canada, Australia and the European Union have all signalled that interest rates will be raised in the near future to combat inflation.

Expectations of the US Federal Reserve’s more aggressive monetary policy has seen the baht fall by 3.4%, the Singapore dollar by 2.2%, and the rupiah by 1.1%. Other currencies, including the ringgit, have fallen significantly from previous years. This includes the yen, which has fallen by 9.9% (its lowest value in 20 years), and the euro, by 6.6% (lowest value since 2017). The pound sterling, Korean won, and Chinese yuan all fell by 7.1%, 6% and 3.1%, respectively.

As China is one of Malaysia’s main trading partners, the yuan’s depreciation has also impacted the ringgit. Malaysia’s exports to China are equivalent to 12.4% of GDP, compared to Indonesia’s (3.8% of GDP) and Thailand’s (0.7% of GDP).

Furthermore, Malaysia’s interest rates, which have remained unchanged since September 2020, have increased the valuation gap between Malaysian assets and those of other countries. The current yield differential between the 10-year Malaysian Government Securities and 10-year US Treasury bills has narrowed to 148 basis points, down from 207 basis points at end-2021. This makes investing in the US or in US-dollar assets more appealing.

During global economic uncertainties, the international investment community tends to be more risk-averse, causing them to shift to less risky assets such as those denominated in US dollars. Generally, this puts pressure on other currencies, including the ringgit.

Subject to the current state of the country’s financial markets and economy, any further narrowing of the yield differential between US and ringgit assets could be a factor in tightening our monetary policy by Bank Negara’s Monetary Policy Committee (MPC), an independent committee in charge of determining the policy rates of Malaysia.

Overall, as mentioned earlier, due to various government subsidies, including setting the price ceiling for RON95, the impact of ringgit depreciation on inflation is also expected to be limited this year.

Of late, various analysts and economists have given their views on the benefits and drawbacks of ringgit fluctuations.

Objectively speaking, when the ringgit falls, certain parties will benefit, while others will suffer. I would also like to stress that generally, rather than “controlling” the movement of the ringgit, it is better to allow some flexibility for the currency to work alongside other policy levers, with the ultimate aim of achieving a balance between say, containing inflation, ensuring imports are not too expensive and ensuring our exports remain competitive.

In general, for every 10-sen depreciation of the ringgit against the US dollar:

a.     The GDP is expected to rise by up to 0.05 percentage points;

b.     Exports and the current account surplus are expected to grow by RM30.5 billion and RM800 million, respectively; and

c.     Government-linked investment companies (GLICs) with overseas investments will benefit from foreign exchange or translation gains of up to RM7 billion, as the weaker ringgit acts as a buffer for the returns on their foreign investment portfolios.

The government is also aware of the negative impact of the ringgit’s prolonged depreciation. A lower ringgit benefits exporters and increases GDP, but it also raises costs and inputs for imported goods. In fact, every 5% depreciation of the ringgit could increase goods’ prices by 0.5%, or around RM20 per household. This could further affect consumers and producers already hit by rising commodity prices.

However, imported inputs are only one component of the total production cost affected by currency fluctuations, including the ringgit. Other factors that could also impact production prices include labour and transportation, which may also contain imported components.

To strengthen the ringgit and control inflation, some have suggested that Bank Negara raise interest rates and tighten our monetary policy. Such measures are deemed ineffective against a backdrop of global supply shortages due to geopolitical tensions, because a tighter monetary policy cannot guarantee more supply of goods like oil, computer chips and other necessities.

In March 2022, the MPC maintained the policy rate, deeming it appropriate to maintain the economic recovery momentum while ensuring the stability of the prices of goods.

Moreover, as we allow some flexibility for the ringgit to be subject to market forces (for example, supply-demand driven), we can expect fluctuations in the ringgit in response to changes in the global/domestic economic and financial environments. Bank Negara also recently iterated that its monetary policy is centred on maintaining orderly market conditions, allowing the ringgit to adjust to the flow of demand and supply. This flexibility is critical to enable the real economy in adapting to and surviving external shocks.

Raising our policy rates may increase the ringgit’s value. However, this will also increase the repayment value of financing such as mortgages and property loans. Inevitably, this will burden borrowers and could also jeopardise the nascent recovery momentum.

Some people have also expressed their concerns that the weakening of ringgit could mean we will have difficulty repaying our external debts. This is highly unlikely, given our expected current account surplus of RM75 billion this year. We export more than we import. It also means that we are receiving more foreign currency than we are exchanging.

Malaysia is also a net creditor to the rest of the world. We now have more foreign assets than liabilities, compared to during the Asian financial crisis of 1997 and the global financial crisis of 2008. As a result, despite recent ringgit fluctuations, Malaysia should be able to meet its foreign currency obligations.

For now, what is more important is the strength of our economic fundamentals that are able to support the stability of the ringgit from external shocks and capital outflows. A well-diversified economy, sustained current account surpluses and projected recovery will also make Malaysia a more attractive investment destination among peers.

Moreover, the availability and use of foreign exchange hedging by corporates and Bank Negara should help the economy prepare for any volatility.

The IMF, which just concluded its Article IV assessment of Malaysia on April 28, also reflects this. Our well-developed financial market, as well as a large and diverse domestic investor base, will help mitigate the impact of tighter global financial conditions on capital flows and domestic interest rates.

The assessment also affirms that our financial market and institution’s depth is comparable to advanced economies’. More than 60% of our sovereign debt is held by domestic investors, with social security institutions accounting for roughly a third.

Moreover, only 3% of our sovereign debt is issued in foreign currencies. In the past, during periods of high capital outflows, active support by domestic institutional investors helped Malaysia avoid excessive interest rate changes and fluctuations of the ringgit.

In summary, every policy decision involves trade-offs, and some parties may benefit while others may not. Therefore, the government must carefully weigh and thoroughly examine the impact of each policy decision.

Rather than focusing on a specific ringgit policy, the priority should be to implement structural reforms that will strengthen our economic potential and prospects, to make Malaysia a more appealing investment destination. What will support the ringgit are increased FDI, portfolio inflows and GDP growth. As such, we must prioritise the development of a more robust economy premised on sustainable principles to build our resilience and a more inclusive economic development for all. Finally, rest assured that the government and relevant agencies will constantly monitor the various risks to our economy and ensure our policies will effectively manage any external shocks that could affect the overall well-being of our people and businesses.

Tengku Datuk Seri Zafrul Tengku Abdul Aziz is Finance Minister of Malaysia

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