Despite being one of the most successful developing nations in the ASEAN region in recent years, Malaysia has undergone a year of shake-ups in its government, domestic economy, trade conditions and international relations.
Its currency, once one of the strongest in terms of purchasing power, has fallen drastically to Asia’s worst performing due to factors that largely seem beyond the nation’s control. However, with minimal price movements since the beginning of 2017, brighter times may lie ahead for the ringgit.
Unexpected Monetary Loosening
Malaysia’s national central bank, Bank Negara, took the nation by surprise when a 25-basis point rate cut was announced in mid-July, the first in seven years. This was largely motivated by desire, rather than need, to provide an additional stimulus aimed at reversing a year-on-year, falling trend in GDP growth from 6% in 2014, to 5% in 2015, to a forecasted 4.5% in 2016. This appeared to be a sound idea despite the Brexit vote outcome triggering a 0.8% drop against the dollar, bringing a period of appreciation over May and June to a close.
This represented only a minor alarm as the ringgit made gains against the dollar unlike other emerging market economies from the middle to the end of July. Primarily spurred by inflows from overseas investors feeling wary about the political future of the UK and US, optimism was short-lived as new economic figures revealed Malaysia’s slowest quarterly growth rate in seven years.
The central bank’s decision to maintain its stance on interest rates in September was the trade-off between boosting currency attractiveness as it surpassed the 4.1 ringgit/dollar mark and supporting the domestic economy.
Confidence in the nation and its currency was surely not helped by suspicions that Prime Minister Najib Razak may have been involved in a scandal involving state investment fund 1Malaysia Development. At present Malaysian citizens feel dissatisfied with the government, and major changes are unlikely to have been priced in since the BN Coalition remains a clear favourite for the next general election in late 2017 or early 2018.
On the other hand, with a worrying budget deficit of over 3% in October 2016, a weakening ringgit would worsen the situation by making consumer imports from Western countries more expensive. Fortunately, a recovery in oil prices in late 2016 alleviated this effect by increasing the competitiveness of exports.
Trump’s election certainly had a negative impact on all emerging market currencies and economies, but arguably struck Malaysia harder than expected, with the ringgit suffering a 4.7% depreciation over just ten days.
The influence of overseas investors in the offshore market became evident at that point. Their trading activities were labelled by Bank Negara as ‘speculative and damaging’. The resurgence of a non-deliverable forwards (NDF) market for the currency had brought benefits in the past, but would likely pose a problem in coming months as shorting through derivatives quickly caused the ringgit to hit its weakest point since the 1998 Asian financial crisis on November 24th.
Regulation Curbing Currency Trading
As Bank Negara kept rates unchanged contrary to the Fed’s aggressive tightening agenda, it demanded offshore NDF trading to stop and started intervening in the Foreign Exchange market with its reserves in November, which brought relief to the ringgit as it appreciated slightly in December. The currency’s volatility also greatly decreased after the big swings experienced in the previous three months.
Another measure that discouraged trading was a cap imposed on export proceeds companies can hold in foreign currency. While probably representing just a short-term measure to protect the ringgit, this made exports less competitive initially even with oil prices rising but was beneficial in alleviating credits on the country’s balance of payments.
By the beginning of February 2017, the liquidity of the ringgit spot market had dropped considerably as many overseas investment funds were deterred from holding the currency if not permitted to hedge exposure against depreciation through NDF contracts. Offshore trading in ringgit NDFs dropped by 70% by the end of March.
The side effect of this was that as foreign demand for the currency fell, Bank Negara had no choice but to use up a significant portion of its reserves to prevent the currency from returning to the low of 4.5 ringgit/dollar rate reached in January 2017. Considering the ringgit’s incredibly low volatility levels in recent months, the central bank introduced new measures encouraging global funds to hedge their currency exposure onshore through the purchase of government bonds.
An Unsustainable Devaluation
Investors may have reservations regarding long-term uncertainty surrounding the development of Malaysia due to its reliance on global trade. A temporary shadow was cast on the ASEAN region when Trump pulled out of the Trans-Pacific Partnership in January 2017, but more clarity has transpired that the impact would not be radical. One valid outstanding issue is that with China being its biggest export partner, Malaysia remains exposed to its structural weaknesses due to inefficient state-owned enterprises, as American multinationals are pressured to move back to the US.
All this is, however, likely to be more than compensated for with the current account surplus improving, and confidence in the Malaysian economy being revived as recent figures (GDP growth of 4.5% year-on-year) revealed an economic comeback.
The sell-off by overseas investors is likely to stop as regulations, and unrealised fears about Trump isolating his country from the outside world dampen, and investors regain faith in Malaysia’s position as one of the most promising emerging markets in Asia.