Economists unravel reasons behind divergence
WHEN we compare the ringgit to currencies such as the Egyptian pound, the British pound and the Turkish lira, then perhaps we don’t feel so bad about the ringgit’s performance in 2016.
The Egyptian pound was down 58.84%, British pound 17.08% and the Turkish lira 17.22%. This was in comparison to the ringgit’s 5% fall.
However the three countries suffered financial crises. Egypt floated its currency because of its distressed economy. The UK was plagued with Brexit and Turkey had its debt and financial issues.
But in the ringgit’s case, it had crude oil. So, shouldn’t it be inching upward rather than the other way around? Just look at the Russian rouble. It was one of the best performers of 2016, up 21.31% as the oil market rebounded.
So this is the question on most people’s mind.
Now that oil prices have risen, why isn’t the ringgit recovering?
Over the last few decades, the ringgit has obediently tracked oil price movements. The ringgit has benefited because crude prices have been on an upward trajectory. Prior to mid-2014, oil prices have been on a slow but steady rise, which has also brought the ringgit to a high of RM2.939 to the US dollar on July 27, 2011.
The ringgit was strongly supported by high oil prices back then. From 2010 to 2014, oil prices were steadily at elevated levels of between US$80 to US$110.
With Malaysia being one of South-East Asia’s most dynamic owner of oil and gas reserves. Petronas is viewed as one of the world’s largest and most forward looking producers of LNG.
Petronas now holds some 23.2 billion barrels of oil equivalent (boe) within the country, with a further 10 billion boe abroad.
Hence where oil prices go, it matters a lot to the currency.
Thus not surprisingly, since oil prices crashed from the US$110 level in mid-2014 to its low of US$27 in January 2015, the ringgit also went into a headlong plummet.
However, as oil prices started recovering in mid-2016, the ringgit in fact weakened further. As of Wednesday, the ringgit has hit its psychological market level of 4.50 against the US dollar.
The ringgit is now down 42.8% at its current price of 4.4985 to the US dollar compared with Sept 1, 2014’s level when it was trading at 3.13 to the dollar.
So why isn’t the ringgit correlated to crude oil anymore?
Other factors at play
It is no secret that the ringgit is presently under siege by a toxic combination of interest rate hikes in the US, and a domestic confidence issue.
Furthermore, oil-related income used to make up about 30% of the government’s budget, but the slump in the price of crude oil have reduced its contribution to the early teens. Thus the sensitivity between oil prices and the currency has also reduced. Any increase in oil prices has less influence on Malaysia’s fortune.
More significantly, there is a global trend going on that is not going away. The Fed is looking to raise interest rates, and emerging markets in general will collectively be affected.
“The Fed is on a rate hike path. Trump’s policies are also very pro-US and pro-spending. While he may not implement all the things he said, he will implement some of it. The market is now pricing this to the extreme, and hence the dollar strength,” says Hong Leong Investment head of research Sia Ket Ee.
He says there will be some disappointment when Trump doesn’t implement all his policies, and that will be when the dollar takes a breather. Another breather could also be when US growth hits a speed bump in the first quarter this year. Nonetheless he does not see money flowing back to emerging markets in a big way because of the US rate hike trend.
Sia’s forecast for the ringgit is at the RM4.30-RM4.55 level. At this price, he has already incorporated US data weakness in the first quarter, disappointment over Trump policies, and resilient Malaysia growth.
Malaysia certainly isn’t the only country facing outflows as a result of the US starting its tightening monetary policy. All emerging markets have experienced outflows. The ringgit is the second worst performer after the Philippine peso.
The ringgit is perhaps more hurt by its high foreign bond holdings level.
As at the end of November 2016, foreign holdings of total outstanding Malaysian Government Securities (MGS) fell to 48.4% from 51.9% in the preceding month, while foreign holdings of total outstanding Government Investment Issue fell to 9.6% from 12.6%.
Meanwhile, a total of RM19.3bil of MGS are due to mature in the first quarter of this year, according to a recent report by Maybank Investment Bank.
Equity wise, the outflows in 2016 have reduced substantially from 2015, For 2016, the Malaysian market saw outflows of RM3.1bil, which is relatively low compared to the RM19.5bil outflow in 2015.
Having fallen from the peak of 25.2% in March 2013, foreign shareholding remains low at 22.6% as at November 2016.
“We opine that foreigners betting on a ringgit depreciation and worsening fundamentals have already left the country since 2015. Going forward, we expect foreign equity ownership to linger at the current levels in most of the first half of 2016 before increasing gradually in the second half of 2016,” says Sia.
In the meantime, Bank Negara has introduced a series of forex measures since mid-November to reduce ringgit speculative activities and rebalance the supply of onshore forex. Sia believes the collective measures are already working while incoming financial data will likely show gradual improvement.
What goes down must come up
Areca Capital chief executive officer Danny Wong says no negative issue can last forever.
“It doesn’t matter whether the ringgit is RM3.80 or RM4 or RM4.20. What people do not want is uncertainty,” says Wong.
He feels the ringgit will strengthen closer to RM4, once the production cut by Opec and non-Opec members kicks in, which is likely in six months time.
“We don’t expect oil producers to comply 100% with their production cuts. But if they can comply by 80% to 90%, we should be able to see some balance of supply over the next six months.”
Wong is of the opinion that once the market prices in the two to three rate hikes, and the confidence issue domestically starts to dissipate, then the selloff of the ringgit will also taper off.
“The dollar now is just supercharged. Over the near term, I think the ringgit will continue to be challenged, especially until Trump takes oath,” says AllianceDBS head of research Bernard Ching.
He feels the expectations of an interest rate hike and a strong dollar has outweighed the recovery in oil prices.
“Oil was coming from a low base, and its upside is capped at the US$60 to US$70 level, whereas the expectations of a strong US dollar is not capped,” explains Ching.
Ching says the market needs to have a more grounded view, both on the US economy and the dollar.
He says the euphoria needs to die down first, where the market starts to realise that a strong dollar will in fact hurt the economy. Perhaps then, can the US dollar start to weaken.
Analysts said speculation of another interest rate hike in the US and further easing by Bank Negara are now weighing on sentiment.
There are also concerns that the country will go into financial distress if oil prices are to stay at low levels for prolonged periods. The fall in crude oil prices has reduced the foreign exchange earning of the economy which in turn has affected its currency
Budgets 2015 and 2016 were recalibrated in January last year due to the slump in oil prices,
The original assumption for the 2016 Budget was that the price of oil would be US$48 per barrel, or a RM30bil reduction in government revenue. Later on, the government again revised oil prices to between US$30 and US$35 per barrel, which is an additional RM9bil reduction in revenue.
For 2017, the government has raised its Brent crude oil price assumption to US$45 per barrel for 2017.
The higher average Brent crude oil price assumption for next year is based on expectations that the commodity glut will abate.
Sia’s 2017 forecast for the ringgit is RM4.30-RM4.55 to the US dollar. At this price, he has already incorporated US data weakness in the first quarter, disappointment over Trump policies, and resilient Malaysia growth.
For the past two years, the Malaysian economy had gone through significant adjustment: lower oil prices, weaker ringgit and a higher cost of living and doing business.
“While the adjustment process comes with pain, macro indicators continue to prove that the economy is resilient and corporates in Malaysia have mostly evolved to become more cost-efficient due to the challenging operating environment,” says Sia in his 2017 outlook report.
While the external outlook remains uncertain, he believes investors should embrace the fact that the painful adjustment process that the country has undergone is almost complete. “GDP growth is envisaged to stabilise in 2017 with a line-up of massive infra projects and backing of firmer commodity outlook. In this regard, we opine that a brief strengthening of ringgit is what it takes to spice up sentiment towards Malaysian equities,” he says.
He adds that while GDP growth may only chart a marginal uptick to 4.5%, all sectors are expanding reinforced by all-time high construction project awards and firmer commodity outlook.
He adds that the damage of economic adjustment to lower oil prices and weaker ringgit has been well contained. The aftershock indicators such as the unemployment rate and net NPL ratio had remained healthy.
“We believe that macro fundamentals of the Malaysian economy remain largely intact to keep sovereign ratings unchanged despite the renewed threat of weakening ringgit,” he says.
Oil contribution to Malaysia this year
Contribution of oil-related revenue to total government revenue is expected to decline to 13.8% this year from 14.6% in 2016. This compared with 21.5% in 2015 and 30% in 2014.
In absolute terms, the total oil-related revenue for next year is expected to decline to RM30.3bil from the estimated RM31bil for 2016, and RM47.1bil last year.
Thanks to the expected rebound in global crude oil prices, collection from petroleum income tax (Pita) alone is expected to grow 24.9% to RM10.6bil in 2017 from RM8.5bil in 2016, which is based on an average crude oil price of US$40 per barrel.
In 2015, Pita collection stood at RM11.6bil based on an average Brent crude oil price of US$52 per barrel.
Collection from Pita is expected to account for 35% of oil-related revenue of the government, while dividend from national oil and gas company Petroliam Nasional Bhd (Petronas), already reeling from the effect of a prolonged slump in global crude oil prices, is expected to be on a downtrend.
Dividend from Petronas totalled RM16bil for 2016, compared with RM26bil the previous year.
Oil prices have strengthened substantially on the back of expectations of tighter supply once the first output cut deal between Opec and non-Opec producers in 15 years took effect Jan 1.
Brent crude oil and WTI crude oil have rallied by some 25% since mid-November on expectations of this historic deal draining out a cumulative 1.8 million barrels of oil inventories for a total global production cut of 2%.
Opec produces a third of the global oil, or around 33.6 million barrels per day.
The International Energy Agency says global oil supply rose 0.8 million barrels per day (mmbd) in October to 97.8 mmbd after producers in Opec and non-Opec opened the taps. World oil output was 0.8 mmbd above a year ago, with higher Opec supply offsetting non-Opec declines.
After declining by 0.9 mmbd in 2016, non-Opec production is expected to grow by 0.5 mmbd next year.