Will the Ringgit continue to slide in 2016?

The Ringgit has made a slight recovery, and is no longer at the low point it was previously. How will our northern neighbours’ currency fare in 2016?

By Paul Ho

Most, if not all, currencies in the world are currently Fiat currencies. This mean that the value of a currency is backed by the country, and its value is based on the confidence people have in the country. Malaysia’s currency, the Ringgit, is no different. It is also based on confidence, which stems from political stability, production capability, fiscal condition, export competitiveness and military power.

Malaysia itself has decent fundamentals. Its Gross Domestic Product (GDP) is growing at a healthy 4.7 percent (as of Q3, 2015). Malaysia is also registering fairly consistent trade surpluses on its books.

But Malaysia has also seen its fair share of problems in recent years. Its household debt levels are about 146 percent of GDP (according to McKinsey’s Q2 2015 figures), which is very high. The housing market’s prices are also elevated, providing ample fuel for a potential crisis. It is also running a budget deficit which stands at 3.5 percent of GDP.

Politically, Malaysia is also in a period of uncertainty, with its leadership currently facing allegations of scandal and corruption. Economic growth is also slowing down.

Fortunately, the value of a currency does not immediately impact the production capability of a nation. My opinion is that the currency devaluation of Malaysia is not justified, and is a form of price distortion. Did Malaysia, all of a sudden, become less competitive? I would say no.

Explaining the Ringgit’s decline

47 percent of Malaysia’s exports are technological goods, such as electrical machinery, office equipment, and telecoms apparatuses. While there have been numerous reports focusing on Malaysia’s fiscal weaknesses due to crude oil prices, these do not provide the full picture. Natural gas, petroleum and petroleum products account for only 14 percent of Malaysia’s exports. If we were to include palm oil, which accounts for approximately seven percent, these products would still only make up 21 percent of the country’s total exports.

At the same time, Malaysia also imports petroleum products to the tune of 17 percent of all its imports. The effect of lowered crude oil prices and revenues also results in lower import prices for Malaysia.

It is my opinion therefore, that the weakened Ringgit is largely a function of speculative forces at play, coupled with the near perfect timing of political uncertainty, slowing economic growth, weakening palm oil and crude oil prices, as well as an impending credit rating downgrade by the rating agencies.

A history lesson

During the 1997/1998 financial crisis, then Prime Minister Dr. Mahathir imposed currency controls, by pegging the Ringgit to the US dollar, at the rate of USD1 to RM3.80. That stabilized the ringgit within one to two years and foreign reserves recovered.

In the post mortem of the 1997/1998 financial crisis, some researchers have pointed out that portfolio funds (holdings by fund managers) invested in the capital markets (stock markets) led the way in capital outflows. Portfolio funds sold their holdings in the stock markets in large quantities, then exchanged their Ringgit for US dollars, leading to a rapid devaluation of the Ringgit and a series of financial crises.

If portfolio funds really wanted to preserve the value of their holdings upon exit for maximum gains, they should have done it gradually, without causing a stock market crash. Hence the rapid rate of exit could potentially point to some mischief.

After the crisis of the late nineties, Ringgit trading can only be done onshore, a practice still maintained today. This has reduced some level of currency speculation.

Trying to rob Malaysia

Speculators have plenty of leverage to “long” or “short” a country’s market or currency. These anonymous speculators often include the major banks’ proprietary trading desks, with access to hundreds of billions of dollars and some say even in the low trillions of dollars. They have the ability to bring down a country through currency manipulation. The currency controls implemented by Dr Mahathir were therefore a prudent measure to curb rampant speculation.

However there is still another mechanism available to currency speculators – the forward markets. Forward markets are meant for exporters and importers to hedge their risks, but have become a haven for speculators. A deliverable forward contract is an agreement by two parties to buy or sell currency at a specified future date, but agreeing on the rates today. For instance, this could be a bank agreeing today, to deliver to an exporter the Ringgit on 10 Dec 2016 at the rate of RM4.2 to USD1. This allows an exporter a little more surety, knowing that their goods would not suddenly lose value due to sudden movement in the currency markets.

However, for less internationally circulated currencies, there is another mechanism to speculate the Ringgit, offshore away from Malaysia. This is the Non-Deliverable Forward (NDF), which is traded in international financial centers like Singapore, London and New York. Unlike a deliverable forward, no actual currency is exchanged.

Currencies are deemed overvalued or undervalued against the USD using the implied NDF yield spread. A yield spread of greater than 1 percent indicates weakness against the USD. Banks of financial institutions in international as well as domestic Malaysian markets can then execute these trades. Through this indirect mechanism, speculators can drive down the Ringgit in the NDF market that hurts the Ringgit valuation.

While this might be technical and a little difficult to take in, the bottom line is that this points to the Ringgit being under speculative attacks.

Should I invest in Malaysia?

With the USD growing in strength from capital in-flows and US interest rate hikes, the Ringgit and many emerging economies will come under threat from the withdrawal of funds. This might last two to three years, as a US economic cycle usually lasts three to four years.

Malaysia needs to find its own steady and safe path. It has a lot of natural resources and food production. After weathering one round of financial crisis, it should have already developed better immunity against speculators this time round.

For foreign investors of Malaysian assets, it is a selective buy as the Ringgit may continue to be attacked. At some stage, currency controls may be re-imposed. Investors should take a five to 10 year view of their investment, when they could possibly be sitting on a recovering Ringgit. It would be good to pick up hard assets such as production capabilities and daily staple related plantations which can better withstand currency fluctuations.

For those holding Singapore dollars, they need to weigh SGD trends against ringgit so as to ensure that they will not lose money after currency conversion.

Mr Paul Ho is the Founder of www.icompareloan.com

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