The State of the Nation: Ringgit weighed down by ‘psychological fears’

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SPOOKED BY Fitch Ratings’ warning of a “more than 50% chance” of it downgrading Malaysia’s sovereign ratings by June, the ringgit fell to a new six-year low of 3.7350 against the US dollar shortly before the closing bell last Friday, before ending the week 1.3% lower at 3.7333. It weakened 0.7% on Friday alone, just ahead of the release of Bank Negara Malaysia’s latest foreign reserves figures for mid-March.

Not only is the ringgit closer to the 3.80 level now, at which the local currency was once pegged to the greenback, but at least three investment bank-backed research houses now think the ringgit will touch 3.90-levels within the year.

Macquarie Research expects the ringgit to weaken to 3.95 by September. Forex experts at Bank of America Merrill Lynch (BaML) are saying 3.93 by year-end while RBC Capital Markets expects the ringgit to reach 3.90 in the fourth quarter.

More importantly, the 3.80 to the US dollar level “is psychologically important for residents”, observes Citi Research economists Kit Wei Zheng and Yap Kim Leng.

“Weakening confidence over the ringgit may not just trigger more capital outflows from residents but is also politically problematic as it raises the price of imports and cost of living for many middle-class residents,” they wrote in a March 20 note in which they told clients that a weaker ringgit reduces the need for Bank Negara to cut its policy rates, but went on to say that “an overly weak ringgit may hurt domestic confidence”.

The negative perception surrounding 1Malaysia Development Bhd (1MDB) does not help.

“The news out of Malaysia is bad. The ringgit is the worst performing currency in Asia this year and we expect it to depreciate to 3.95 to the US dollar by September 2015. Prime Minister [Datuk Seri] Najib Razak, a paragon of reform at the start of his term, is bogged down by the opacity surrounding 1MDB,” Macquarie Research’s Asean economist, PK Basu, writes in a March 18 note.

But what could come under closer watch in the coming weeks is the strength of Bank Negara’s reserves — specifically if the rate of its decline is picking up again.

The latest Bank Negara data released last Friday showed that its foreign reserves have fallen even nearer to the US$100 billion-level that BaML deems as another “psychological threshold” that could cause further bearishness on the ground in Malaysia.

“We think the US$100 billion is a psychological threshold, and a fall below [that] will likely trigger increasing concern about the currency,” BaML head of Emerging Asia Economics Chua Hak Bin writes in a recent note.

“Divergent monetary policies — the eventual rate hikes from the US Federal Reserve versus an increasingly probable Bank Negara rate cut — will also weigh on the ringgit’s prospects,” Chua tells The Edge via email.

tsotn-table_1059Bank Negara’s reserves stood at US$109.2 billion (RM381.5 billion) as at March 13, 2015 — down US$1.3 billion (RM4.5 billion) over two weeks from US$110.5 billion (RM386 billion) as at end-February 2015, suggesting that the central bank is again lending its support to the currency after stepping back in February when its reserves were almost unchanged from the previous month.

Despite Bank Negara’s support, the ringgit slipped 2.26% from 3.6042 to the US dollar on Feb 27 to 3.6855 on March 13.

The ringgit is already the worst performing currency among Bloom­berg’s selection of 12 Asian currencies, having depreciated 6.32% year to date. Measured over 12 months, the ringgit has slipped 11.65% versus the greenback, making it the third worst performer among Bloomberg’s basket of 12 Asian currencies.

It remains to be seen if the rate of decline of Bank Negara’s reserves for the whole of February would again match what was seen in November and December last year and January this year when US$17.52 billion was used up. If it does, reserves could slip below the US$100 billion psychological threshold.

Apart from net portfolio outflows and foreign selling of Malaysian Government Securities, some of the decline in Bank Negara’s reserves in the past half year — from US$128.1 billion in October 2014 to US$110.5 billion in February 2015 — is also due to the large non-US dollar weighting in those reserves, causing their US dollar value to decline more sharply as other currencies depreciated against the greenback, Macquarie’s Basu says.

The decline in reserves totalled US$22.84 billion (RM42.7 billion) over 6½ months, if measured from the US$132.04 billion (RM424.2 billion) Bank Negara’s reserves stood at as at end-August 2014.

“But not all is bad,” Basu adds, pointing to January’s inflation of 1%. Inflation for February was even lower at 0.1%, as a drop in fuel prices during the month trumped the effects of the usually higher prices during festivities. According to him, the impending implementation of the Goods and Services Tax (GST) from April 1 would boost Malaysia’s national savings rate by capturing transactions that previously fell through the tax cracks, thus bolstering the country’s current account surplus. “The current account balance can be re-written as national savings minus national investments,” he says.

While Basu expects real gross domestic product (GDP) to decelerate to 4.5% this year, he observes that Malaysia’s terms of trade “have not actually deteriorated” due to a weaker ringgit. “Consequently, a depreciated ringgit will shore up private consumption and allow manufactured exports to rebound in 2016,” he says, adding that he expects Bank Negara to cut interest rates by 25 basis points to 3% in the second quarter of this year.

“Periods of large depreciation of ringgit have been relatively rare over the last 20 years. But when the ringgit has depreciated 8% to 10% year on year, there has typically been a rebound in exports and the trade surplus widens after about six months,” he says, pointing out that the ringgit’s largest depreciation was in 1998 and exports and trade surplus “rebounded dramatically” in 1999 and 2000.

“With interest rates set to decline, the slump in money supply (M1) should begin to turn around by mid-year, just as nominal GDP bottoms out. The resulting improvement in free liquidity should allow the stock market index to rebound in the second half of 2015.

“In 2016, we expect Malaysia’s manufactured exports (still over 60% of the total) to strengthen, and low interest rates should spur an investment-led acceleration to 6.1% real GDP growth,” he says, pointing out that US new orders for electronic products made here are growing at a moderate pace “suggesting there are no cyclical headwinds standing in the way of Malaysia’s likely export recovery in the period ahead”.

Basu’s 6.1% real GDP growth projection for 2016 is above the consensus forecast of 5% expansion next year, according to Bloomberg data at the time of writing. For now, most economists also think the central bank will likely keep rates on hold rather than move them higher or lower.

In any case, Nomura Research offered another positive spin on the weak ringgit by declaring Malaysia as “Asia’s cheapest shopping destination”, trumping Hong Kong, Singapore and Japan, even after taking into account the impact of a 6% GST. “We expect the weak ringgit and relatively attractive pricing of goods and services in Malaysia to attract more visitors, especially for shopping,” Nomura declares in a March 20 note.

BaML’s Chua is less sanguine. “A weaker ringgit will help boost tourism and exports, but the impact comes with a lag and may not be as pronounced as in the past,” he says.

Bank Negara’s reserves for March 31, 2015, will be released on April 7.



This article first appeared in The Edge Malaysia Weekly, on March 23 - 29, 2015.