When rating agency Fitch revised its outlook for Malaysia from negative to stable, many expected the ringgit, which has been at a 10-year low, to strengthen immediately. But economic fundamentals alone do not determine the exchange rate, as sentiment, perception and external factors all play a role, too.
WHEN Dr Zakaria Abdul Rashid was in Jakarta almost a year ago, he bought a pack of quality coffee beans for US$13.
The exchange rate then was RM3.10, so it came up to about RM40.
Recently he was in Jakarta again and the exchange rate was RM3.77. So when he forked out US$13 for the pack of coffee beans, it was a bit painful to find that the beans now cost him about RM49.
The depreciation of the ringgit has made it more costly for Malaysians to travel abroad and to buy things from overseas.
Those with children studying abroad are feeling the pinch, while those planning to send their children abroad are reconsidering their options, especially if the ringgit remains weak.
So how worried should Malaysians be about the ringgit depreciation?
Dr Zakaria, director of Malaysian Institute of Economic Research (MIER), says there are two types of products – the consumer product and the intermediate product.
For imported consumer goods, it is easy to see the direct impact when the ringgit is weak.
With the intermediate products, these are used as input to produce other products. So Dr Zakaria says, although the final product is local, there will still be an impact from the weaker ringgit because the intermediate products to make it are imported.
“So when we purchase the final product, we have to pay more to get the same product. Therefore the price of things in this country will go up.”
He points out that statistics show that the “intermediate and capital inputs” make up two-thirds of total imports to the country.
One notable fact for Dr Zakaria is that the consumption pattern in the urban areas has changed quite a bit over the years, with a lot of imported products coming in.
“For example, there are many types of cheese in the market today. And when you want to buy vegetables, you might want to buy broccoli instead of sawi or cabbage.
“We have changed our taste because our household income level has risen quite a bit,” he says.
He says there is a difference between rural and urban areas. Kampung folk, he says, can still source what they want from the rural area and their taste is not quite like those in the city.
“For example, they buy Planta margarine but those in the urban area want Australian butter,” he says.
Dr Zakaria adds that it is hard to say how much of the increase in domestic prices has to do with the Goods and Services Tax (GST), implemented in April, and how much with the ringgit depreciation.
“To me, the GST is a consumption tax so the impact is widespread. The ringgit depreciation too has widespread effect on the price of goods, so both effects are there and one is adding to the other and directly affecting our cost of living,” he says.
However, he says that a report from the Statistics Department shows that the rate of increase in household income is faster than the rate of increase in prices.
During the currency and financial crisis in 1998, Malaysia pegged its ringgit at RM3.80 against the dollar.
In 2005, it removed the peg and changed to a managed float instead. This seemed to have worked. The ringgit strengthened to RM3.10 and was inching upward until last September when it starting falling.
Today, even after Fitch revised its outlook for Malaysia to stable from negative, the ringgit is still looming around RM3.70 to the US dollar.
Why? Does this mean the economy is not stable and the fundamentals are weak?
No, say the economists.
Dr Zakaria says there are two elements in the demand and supply of a currency. One is the economic factor and the other the non-economic factor, he says.
“For the economic factor, it depends on our trade flows, import and export and so on.
“For the non-economic factors, it depends on the general feeling of speculators and currency traders and how they see the economy and their perception.
“Both are important. We have to manage the confidence,” he says.
Dr Zakaria feels Malaysia has taken the right steps to make its economy more resilient such as the GST, the rationalisation of the fuel subsidy and the minimum wage.
“These are non-populist reform measures but they are most welcome. It may not pay off in the short term but it will in the long term. We should give them a chance to work.”
For Prof Datuk Dr John Antony Xavier from the UKM graduate school of business, there is no real worry “respecting” the ringgit depreciation as it is a matter of economic forces and public sentiment.
He says the United States has been doing “quantitative easing”, which is printing money since 2008 to increase the supply to stimulate its economy and that greater supply caused the US dollar to have a lower value compared to the ringgit.
But that quantitative easing stopped in late 2014, he says, so the US dollar has strengthened.
“There is also renewed confidence in the US economy so money that had flown into other countries, including Malaysia, seeking better investment returns are now returning back to the US,” he says.
Plus there is the expectation that the United States is going to raise interest rates, which means they will earn better returns.
“So, this increased demand for US dollar to invest back in the US has caused the relative strengthening of the US dollar relative to the ringgit.”
Dr Xavier says the demand for the ringgit has been weaker because exports have been going down mainly due to the lower price of oil as Malaysia is a net exporter of oil.
He says foreigners are pulling out their short-term investments (or hot money) to invest in the US and offloading the ringgit which is causing an increase in the supply of ringgit in the foreign exchange market.
He claims they are also pulling out over fears of the failure of 1MDB to settle its debt.
If this happens, he says, the government debt position will swell beyond its self-imposed 55% statutory limit of the GDP. As it is, Malaysia’s debt to GDP is already nearing the statutory limit.
However, Dr Xavier says that even with the government guarantee of 15% of the RM42bil 1MDB debt and if all the government guarantees (contingent liability) of the loans taken out by GLCs and states are incorporated in the calculation of the public debt, the public debt situation will be about 70% of the GDP.
“This is not anywhere near the levels of that of Japan (240% of GDP), Greece (177%) or the US (108%).”
He says the GST would bring the Government an added revenue of about RM10bil a year, which will relieve pressure on the Government’s budget deficit. As for the current account balance (net export of goods and services), he notes that although it has reduced to 3/4% of the GDP, it is still in positive territory.
“Here we are doing better than the US (-2.4%), China (2.8%), and the Eurozone (2.3%),” he says.
But UM school of economics and management Assoc Prof Dr V. G. R. Chandran points out that while the Malaysian economy is well diversified and the fiscal reforms on GST and fuel rationalisation would improve the country’s fiscal balance and debt position, “confidence in the economy is still lacking, especially among foreign investors”.
“The concerns of enlarging fiscal deficits and narrowing current account surplus is bothering investors, which explains the capital outflows from the country,” he says.
MIER senior research fellow Md Saad Hashim says the currency moves up and down because of financial liberalisation and structural changes in the country’s exchange rate regime.
Participants in the foreign exchange market, he says, are not just traders, importers and exporters who trade on real goods and services but also hedgers, arbiters and speculators.
“They have different views, different reasons, different sentiments in doing their trading.
“When they trade the currency instantaneously and continuously, then perception and sentiment become very important. What are the things that feed on sentiment? News, rumours and other things,” he says.
Therefore, he says, confidence in the currency is important.
“That includes political stability, good governance and management of the economy,” he says.
Saad says the quarterly report from the Finance Ministry at the end of March show that Malaysia’s debt to ratio is RM596.8bil or equivalent to 52.1% of the GDP, which is below the self-imposed 55% statutory limit.
But he points out that in the first quarter 2014, it was 50.7% and in the first quarter 2013 it was 49.9% of the GDP.
“It is below our threshold but it is trending up. And the contingent liability (the government guarantees on debts of the GLCs) is also on the rise,” he says.
Dr Zakaria says that if that amount grows very rapidly, it will affect the people’s confidence.
“That is why people are asking whether we are putting ourselves at greater risk. If there are uncertainties and questions over good governance, and if the contingent liability figure is great, then people become worried. It affects sentiment and confidence,” he says.
He says nonetheless Malaysia’s economic fundamentals are stronger compared with some other countries in the region but their currencies have not depreciated as much as the ringgit.
“That means the non-economic factors are playing more influence. If we manage the confidence properly, I am sure we can be better off in the future. I have full confidence in the economy and it is going in the right direction provided all of us are patient.”
Dr Chandran believes the ringgit is trading below its fundamental value now.
“We expect in the near term for the ringgit to remain volatile.”