Uncertainties cloud ringgit’s true value

True value: Eventually, the fundamentals of the economy will begin to reflect the value of the ringgit.

ASK any currency or fixed income strategist in town and they will tell you that the ratio between the local currency and the US dollar should be about RM3.68 to US$1. Now the official conversion rate is closer to RM3.80 for US$1.

There are several reasons for the ringgit not living up to its valuation.

It ranges from turmoil in emerging economies, starting with China and Brazil and the possibility of capital flowing back to the United States on the expectations of interest rates rising by end of this quarter. In 2013, emerging markets had a taste of what it would mean and it was called “taper-tantrum”. The next flow of capital back to the United States is being described as “super taper tantrum”.

But in the case of Malaysia, the tendency of capital flowing back to the United States is not the determinant that is causing the currency to underperform. Malaysian government bonds with yields to maturity at almost 4% for short tenures and higher for longer tenures offer decent returns.

In most developed countries, the base interest rate is less than 0.5%.

Some are even in negative territory, meaning the value deteriorates if left in the bank. In the United States, the rate is 0.25%. So a yield of 4% or more is decent by any standards.

But that is not good enough when it comes to Malaysia. It is because of the political uncertainties.

Political uncertainties bring about a myriad of questions such as whether policies announced will be maintained, or changed. Projects undertaken will be continued, or dismantled. Or key people in the civil service, who implement policies, will remain or be removed.

The list just goes on.

This is something investors do not like and demand a premium for holding ringgit based-assets such as stocks or bonds. This premium demanded is among the reasons why the ringgit is underperforming.

In January this year, Bank Negara governor Tan Sri Dr Zeti Akhtar Aziz had said that the ringgit was undervalued. But the ringgit continued to fall against the US dollar. So did other currencies such as the Australian dollar.

Then the reasons were different.

There were uncertainties if Malaysia would continue with its subsidy rationalisation programme, where the Government has to take the painful decision of raising fuel prices. The objective of reducing subsidy is to allow the Federal Government’s coffers to be channelled to more productive areas.

The other uncertainty was whether the goods and services tax (GST) – a tax system that would change the way taxes are collected – would be carried out. Implementing the GST is another painful decision because it raises the prices of goods and is generally unpopular with the people. Because the GST is a consumption-based tax, it affects a broad base of people. True enough, when GST was implemented in April this year, there was a slowdown in consumption. Businesses were affected and continue to be affected. This impacted domestic demand, which is one of the pillars of economic growth.

The fall in oil prices last year also affected sentiments on the ringgit and other commodity dependent countries such as Australia. Oil prices continued to be depressed.

But the positive part about the depressed global oil price is that it has allowed governments to adopt a subsidy-free fuel price model in their countries.

If oil prices had been US$100 per barrel, the fuel price adjustment would have been a painful process, and possibly a shock to the economic system.

Countries such as Malaysia and Indonesia took advantage of the depressed oil prices to remove subsidy from domestic fuel prices.

Now, it has been more than 100 days since the GST has been implemented.

The results have been astounding. The initial target was that only some 150,000 companies would register as GST compliant and pay the dues to the Customs Department.

But when the GST started in April this year, more than 350,000 had registered.

Under the original forecast of 150,000 companies being GST compliant, the collection was estimated at RM23.2bil, based on the Budget 2015. But now the amount should be more than RM30bil.

With the additional funds, the Government can keep its budget deficit at 3.2% of the country’s total output, something that is known as the ratio of Federal Government deficit as a percentage of Gross Domestic Product (GDP) without having to cut down funds for development.This is something that will endear to rating agencies and enhance the credit worthiness of the country.

Eventually, the fundamentals of the economy will begin to reflect the value of the ringgit. But the currency will only be able to live up to its true value when the other components come into play – such as political stability, policy certainties and governance in handling public funds that is growing.