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FROM Nov 28 to Dec 15, Bank Negara Malaysia’s foreign exchange reserves fell 4.3%, or the equivalent of RM17.6 billion, to RM394.1 billion as the local currency came under selling pressure.

In the same period, the ringgit depreciated 3.36% to 3.498 to the US dollar due to concerns that the plunge in oil prices will hurt government finances and the country’s current account.

Foreign exchange traders said Bank Negara had stepped in to sell dollars and buy ringgit to slow down the depreciation. On Dec 19, the ringgit recovered a little to 3.478 to the dollar, but it came under selling pressure again and was back to 3.497 on Dec 23.

With the ringgit poised to end the year at its lowest level in five years, many are pondering on the ramifications of a prolonged weakness in the currency. Some even say the current state of emerging market currencies bears a resemblance to the 1997-98 Asian financial crisis, which led to capital controls and Malaysia pegging the ringgit at 3.80 to the dollar.

While most analysts expect short-term ringgit weakness, they do not as yet see any likelihood of a repeat of the financial crisis that ravaged Asia.

AmBank Group’s foreign exchange strategist Wong Chee Seng points out that the 10 Asean countries enjoy the protection of the Chiang Mai Initiative, which is a multilateral currency swap arrangement to address short-term financial liquidity problems.

With a pool of US$240 billion, the money is intended as a means of support should any member country face a financial crisis.

“There are many lessons learnt from 1997-98, particularly when it comes to preventing a ‘domino effect’, which saw the rapid devaluation of Asean currencies back then. Our central bank will continue to remain focused on dealing with inflationary expectations, as opposed to managing the ringgit via a direct intervention,” Wong says.

In a Dec 23 note, UOB Research says Asean economies are now in a much better position to accommodate external shocks.

“Not only are the currencies floated and thus able to adjust in value — compared with 1998 when most were pegged to the dollar — but foreign exchange reserves across Asean are also multiple times higher than they were back then. Corporate leverage is reduced now and debt is mostly denominated in local currencies, thereby reducing currency mismatches,” says the research house.

At the moment, Malaysia’s economic fundamentals remain intact. Two key indicators — the current account balance and trade balance — are still in surplus, compared with deficits recorded back in 1998.

Analysts say low crude oil prices and continued outflow of foreign capital can cause the trade and current account surpluses to narrow, albeit not to deficit levels.

In a Dec 10 note, UBS Research says a confluence of factors contributed to the weakening of the ringgit.

“The ringgit’s fall is due to a combination of factors — a stronger US dollar, lower oil prices and slowing growth momentum, which implies weak growth. These fundamentals probably drove asset sales by foreign investors, which in turn depressed the currency,” it says.

Falling oil prices will prove to be detrimental to the government’s revenue collection as the country is a net oil exporter. In spite of the scrapping of fuel subsidies, the drop in petroleum earnings by Petronas could still add pressure to the government’s plans to reduce its fiscal deficit to 3.5% this year and 3% in 2015.

Moreover, the rouble’s decline of more than 66% against the dollar to date is stoking investors’ concerns over the economic standing of oil-producing countries, which derive a major chunk of their revenue from fuel exports.

While a depreciating ringgit is likely to boost exports, the potential increase in trade activity between Malaysia and its partners is largely dependent on an uptick in demand from overseas for the nation’s goods and services. With its major trading partners, such as China, showing signs of an economic slowdown, Malaysia’s track record of reporting trade surpluses may come under pressure.

Maybank IB Research, in a Dec 18 note, outlines various scenarios on the impact of different levels of crude oil prices on the ringgit.

A maximum downside of 3.63 to the dollar is projected should crude oil prices remain at around US$60 per barrel by the third quarter of 2015. Under the best-case scenario, in which crude oil rebounds to US$100, the ringgit could be worth 3.20 to the dollar by the end of next year.

“We expect the ringgit to remain volatile, and lower crude oil prices mean the government needs to reset fast and work on controlling the fiscal deficit. This will happen against an uncertain backdrop, as there is uneven growth in the global economy and a widening divergence in global monetary policies,” says Maybank IB Research’s chief economist Suhaimi Ilias.

AmBank’s Wong foresees that the ringgit could reach the 3.55 mark in the near future, but is optimistic of a recovery in 2015.

“Our fundamentals are still intact, but external factors, such as the US dollar, will continue to have a bearing on the ringgit. The timing of the US Federal Reserve’s planned interest rate hike will also be keenly watched,” he says.

Apart from weak crude oil prices, a US interest rate hike is the biggest downside risk for the ringgit, as it would trigger fund managers to sell their large holdings of Malaysian government bonds.

Since 2008, foreign ownership of these bonds has increased from 20% to 45%, or RM147 billion, as Malaysia’s appetite to borrow coincided with demand for higher yields by international investors because interest rates were at virtually zero in the US.

With the US economy getting stronger, its third-quarter gross domestic product growth came in at a seasonally adjusted annual rate of 5% — its fastest pace in over a decade — the current bet is that interest rates will start rising by mid-2015.

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This article first appeared in The Edge Malaysia Weekly, on December 29, 2014 - January 04, 2015.

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