The State of the Nation: Ringgit strengthens but external woes still a concern

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This article first appeared in The Edge Malaysia Weekly, on February 22-28, 2016

The ringgit’s strength against the US dollar over the last few weeks seems to suggest that the battered currency has finally bottomed out. Year to date, the ringgit has climbed 2.86% against the greenback as it closed at 4.17 last Thursday, making it the second best performing regional currency after the rupiah.

In 2015, the ringgit fell 22.82% against the US dollar, hitting 4.48 on Sept 29, 2015, the lowest seen since the Asian financial crisis in 1998, as potential US interest rate hikes drove investors out of Asia while Malaysia’s domestic issues caused further turmoil for the ringgit.

But now, the tune is changing with the expectation of interest rate hikes in the US diminishing due to concerns that the global slowdown could hurt its economic recovery while local political issues seem to have simmered down.

“More traders expect that there is less chance of US interest rates being hiked four times a year, as signalled earlier, because of the global slowdown. This change in expectation has provided relief for regional currencies, including the ringgit,” says RHB Research economist Peck Boon Soon, who is of the view that the ringgit may have bottomed out.

UOB Kay Hian economist Julia Goh opines that other factors that have aided the ringgit’s gains include the repatriated funds from the sale of 1Malaysia Development Bhd assets, the reduction of statutory reserve requirements (SRR) in January to boost domestic liquidity and a stable renminbi. She says the government’s action to address the impact of oil weakness on the country’s fiscal position and growth, in addition to the relative US dollar weakness amid market expectations of fewer US rate hikes this year, also gave it a boost.

However, some do not think that the ringgit’s stability will last long. Standard Chartered Bank’s Asia foreign exchange strategist Divya Devesh believes the US dollar/ringgit exchange rate will remain relatively rangebound this year, although in a wide range.

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“The 4.10 to 4.20 range for the US dollar/ringgit is unlikely to be sustainable for too long. Yes, we do think that the ringgit has bottomed out. However, external risk sentiment still remains fragile. As such, we believe it is still possible to see a retest of the recent highs of the US dollar/ringgit above 4.40,” he says.

Meanwhile, independent interest rate and forex strategist Dr Suresh Ramanathan is of the view that the ringgit has not touched bottom. He believes it may see renewed pressure when economic and corporate earnings results for the first quarter of 2016 are released in April and May.

“The first quarter [2016] has pushed the economy closer to a slowdown, while gross domestic product for the fourth quarter of 2015 has shown a slowdown, and this will continue in the first quarter of 2016 as well. Naturally, this will renew pressure on the currency,” says Ramanathan.

Meanwhile, the crude oil price remains a wild card for the ringgit because of its bleak outlook. The ringgit’s decline against the greenback in 2015 was also strongly tied to the fall in crude oil price, as the government derived a sizable portion of its revenue from oil. The contribution from oil was as high as 41% in 2009.

However, the volatility between the ringgit and crude oil price seems to have subsided a little of late.

“Despite sharp swings in oil prices, the US dollar/ringgit has remained relatively stable. We think it is a reflection of market positioning, which was already short on the ringgit,” comments Devesh.

One other key risk that will keep everyone on their toes is any unexpected depreciation of the renminbi. This, says Peck, would also impact the ringgit, causing selling pressure.

While many agree that the noise on the political front that impacted the ringgit in the past year has simmered down somewhat, Peck says the change in the central bank governor could have some impact on the currency.

Goh agrees, saying that this is a key risk event to watch. “Given that markets are still speculating on who the new governor will be, I think it has not yet been priced in,” she says.

That said, the common sentiment is that the ringgit remains undervalued at current levels. Devesh says the local currency is undervalued from a real effective exchange rate perspective. As at end-January, the ringgit’s real effective exchange rate was still more than 12% below the past five-year average.

Ramanathan agrees that the ringgit should not be trading at current valuations and says it is a case of a lack of significant policy measures to arrest its decline.

“Given the magnitude of external headwinds and lack of policy measures to arrest the lack of liquidity in the onshore market for ringgit trading, it has exacerbated the weakness in the currency.

“The saving grace is the SRR reduction that has provided some form of stability currently, but it is still too early to gauge the effect. The April to May period will be a true test of the ringgit’s performance and it is the period the ringgit usually undergoes a lull historically,” Ramanathan says.