Malaysia: Ringgit makes a comeback but beware of risks

  • With improving crude oil prices, stable inflation, an anticipated interest rate hike, a strong trade surplus and a narrowing budget deficit — and you have a strong case for the recovery of the ringgit.
  • In 2017, it gained 9.1% against the US dollar, making it the second best performing currency in the region, losing to the South Korean won by a thin margin.
  • It helps that the ringgit is coming off a low base. In Dec 16, it was one of the worst-performing currencies in the region – falling almost 22% in the preceding two years.
  • While improving fundamentals certainly underpinned the ringgit’s rebound, market interventions should be credited with improving the liquidity and demand for the currency. For one, there is Bank Negara Malaysia’s policy that requires exporters to convert 75% of their proceeds back to ringgit.
  • In addition, BNM required all payments between residents to be concluded in ringgit. While it may have created some friction for exporters, it was a good move by the central bank as it did not put pressure on its relatively low foreign reserves.
  • Stronger export numbers have also acted as a multiplier force for BNM’s policy. As at Oct 17, export growth averaged 21.3% y/y, compared with 1.4% y/y in 2016. It also helps that the government has managed to keep the budget deficit within target – 3% in 2017 and on track to hit 2.8% by 2018.
  • Structural concerns could hold the Ringgit back. Expectations for 2018 have been revised in the light of a strong 2017, but surprising on the upside may be tougher given the base effects.
  • The second concern would be inflation, which has picked up in 2017 to average 3.9% y/y as of Nov 17, compared with 2.1% y/y in 2016. The third risk to the ringgit would be crude oil prices. Currently, crude oil is trading at near post-glut highs – around USD65 a barrel.
  • This has largely been the product of the production cut agreement between the OPEC and some non-Opec members, like Russia. Currently, the deal is set to last till end-2018. However, history has shown that maintaining such cooperative production cuts is the only thing that is more difficult than agreeing to them in the first place. Factors that could test the agreement include geo-political tension in the Middle East, as well as a resurgence in shale oil production in the US.
  • While the implementation of the GST has helped to reduce reliance on oil revenue, a sharp fall in oil prices would certainly put pressure on the government’s fiscal position, in turn hurting the ringgit.

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