This article first appeared in Forum, The Edge Malaysia Weekly on February 3, 2020 - February 9, 2020

The recent strengthening of Asian currencies has caught investors’ attention. The Indonesian rupiah, in particular, was in the limelight after strengthening 1.7% against the US dollar on a year-to-date basis in the third week of January. The Indian rupee gained 0.4% while the ringgit appreciated by roughly 0.7% against the greenback over the same period.

The ringgit’s appreciation caught observers by surprise as the currency lost 2% of its value against the greenback in 2018 and edged up a mere 1% in 2019, trailing regional currencies such as the Thai baht (+8.6%) and Philippine peso (+3.8%). Looking at cross-rates, the baht actually strengthened by 7.5% against the ringgit in 2019, while the peso and rupiah gained 2.7% against the ringgit. On a real effective exchange rate (REER) basis (the exchange rate against a weighted average of other currencies and adjusted for price deflators), the ringgit remained below its long-term mean since the first quarter of 2019.

Positive sentiment on the ringgit started in the final week of November 2019. Since then, the currency had gained 3%. The rebound was attributed to both external and internal factors such as a firmer Chinese renminbi, weaker US dollar and improved manufacturing activity in Malaysia. This rapid ascent sparked some optimism and speculation that the currency will, once again, test the RM4 per USD level in the near term. The last time it was trading at below RM4 was in mid-June 2018.

On an aggregate basis, the upward momentum in Asian currencies also started in late-

November 2019. Since then, the index that tracks Asian currencies has climbed 3.6% as a risk-on environment induced global investors to refocus on Asian emerging market economies. The rising optimism was, in part, due to the phase one trade deal between the US and China and more positive prospects painted by economists for emerging economies.

Investors paid close attention to phase one of the US-China trade agreement, which spells out the need for both countries to “refrain from competitive devaluations and the targeting of exchange rates for competitive purposes”. This is to prevent “effective balance of payments adjustments or gaining unfair competitive advantage in international trade”, as stated in The Omnibus Trade and Competitiveness Act of 1988.

This salient point brought some relief to those who were concerned about the possibility of a weaker renminbi, which had risen to above RMB7 per US dollar between August and October 2019. The agreement by both parties on resisting competitive devaluations boosted the overall sentiment for the renminbi and Asian currencies in general.

The rebound in sentiment for the renminbi (and Asian currencies in general) also came on the back of more favourable macro statistics in China. Growth in the fourth quarter, for instance, did not fall below 6% as some had expected. Although overall economic momentum in 2019 decelerated from the preceding year, high-frequency data suggests that the economy is slowly stabilising.

China’s official purchasing managers’ index (PMI), for instance, remained above the expansionary level for two consecutive months in November and December. Similarly, the index for small and medium manufacturing businesses expanded in the past two months, while new export orders — a gauge of future activity — rose above the 50-point threshold. On top of this, the latest forecast by the International Monetary Fund (IMF) shows an upward revision in China’s GDP by 0.2 percentage point to 6% for 2020, despite a downward revision in the global growth forecast.

The surge in Asian currencies is also related to the fact that the strength of the greenback is waning. In the last quarter of 2019, for instance, the US dollar index against its major currencies moderated by roughly 3% before rebounding slightly in January. The moderation in strength of the US dollar is attributable to, among others, weaker growth prospects in 2020 (the IMF in its latest forecast downgraded its growth projection by 0.1 percentage point from its October 2019 forecast). Some of the reasons for the slower growth would be the waning impact of US President Donald Trump’s tax cuts, declining business spending and diminishing support from further loosening of financial conditions.

Higher budget and current account deficits, coupled with concerns about high corporate debt and exuberance in the financial market, also weigh on the greenback’s prospects this year. US budget deficits, for instance, rose to a seven-year high in 2019, approaching 5% of the country’s GDP.

As for Malaysia, expectations for slightly firmer growth in emerging economies supported the ringgit in January. The recent turnaround in Malaysia’s PMI since September 2019 provides a boost to business sentiment. Rising foreign appetite for local bonds was also evidenced by a net inflow of almost RM16 billion into the bond market in the last quarter of 2019.

Going forward, the ringgit’s prospects against the USD hinges not only on the prospects of the economy in 2020, but also on factors such as global crude oil prices and financial market performance (that is, bond and equities), monetary policy stance and sovereign rating. Among these, the risk of a pronounced global financial market correction is one factor that will be closely watched by economists, given the strong linkages between global financial markets.

A surge in the US equity market to historical highs against a backdrop of a sluggish global economy has raised concerns that a significant correction could change the trend in global capital flows to favour the greenback again. Such an event, if it unfolds, will dent the prospects of emerging market currencies, including the ringgit.

Nor Zahidi Alias is chief economist at Malaysian Rating Corp Bhd. The views expressed here are his own.

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