Of higher rates and ringgit’s fate

Bloomberg reports that currency forwards are being used to prop up the ringgit without having to rely on foreign currency reserves. Reuters reported before Bank Negara’s May monetary policy meeting that the ringgit’s volatility remains the main concern. — GLENN GUAN/The Star

HIGHER-FOR-LONGER interest rates carry risks. For Malaysia, the most noticeable impact is on the ringgit, which continues to languish against the US dollar. In February, it even flirted with the 1997/1998 Asian financial crisis closing low.

The currency remains undervalued amid soaring US equities and risk-off sentiment brought on by a volatile geopolitical landscape, while the recent US Federal Reserve (Fed) decision to maintain the Federal Funds Rate (FFR) with only one rate cut expected towards the end of the year, rather than three, will continue to weigh on the ringgit’s outlook.

Bloomberg reports that currency forwards are being used to prop up the ringgit without having to rely on foreign currency reserves. Reuters reported before Bank Negara Malaysia’s May monetary policy meeting that the ringgit’s volatility remains the main concern.

Despite stubborn inflation, major central banks remain cautious about speeding up monetary easing. However, a move by US policymakers to cut interest rates will start the ball rolling, including in Malaysia, where Bank Negara has maintained the Overnight Policy Rate (OPR) at 3% despite easing inflation.

While economists do not expect tighter financing conditions to slow Malaysia’s growth, they are concerned that global interest rates will remain high for too long.

According to United Overseas Bank (M) Bhd senior economist Julia Goh, tighter financing conditions could hinder investments, squeeze borrowers and increase credit risks in the region, including Malaysia.

She says Malaysia’s growth path will not be affected by higher global rates for longer if the US economy has a soft landing.

“Markets have adjusted to the possibility that the Fed could keep its benchmark rate at 5.25% to 5.50% for a longer time.”

However, the possibility of the Fed hiking rates above 5.50% has not been priced in. Goh says that would be a risk.

To achieve a fine balance, policymakers must account for inflation, because a re-acceleration due to factors such as supply chain disruptions, geopolitics, or volatile commodity prices could be more concerning.

Indicators are mixed for now, with Personal Consumption Expenditures Price Index, the Fed’s preferred gauge of inflation, remaining unchanged in May from April while the labour market in May remained strong, defying expectations.

Due to the lag time between monetary policy measures and their impact, US interest rate policy is only now starting to take effect.

Mohd Afzanizam Abdul Rashid, chief economist at Bank Muamalat Malaysia Bhd, says US businesses may need to cut headcount to maintain profitability due to higher operating costs.

“Growth will be adversely affected if monetary policy remains tight for a long period of time.”

He says it won’t be long before major central banks, including the Fed, focus on maintaining growth, which means cutting interest rates.

Following the diesel subsidy rationalisation, there is a case for inflation in Malaysia to rise, although a rate hike may not be warranted.

There is also the planned rationalisation of the RON95 subsidy, which will result in inflation.

As Afzanizam points out, Malaysia’s inflation dynamic is somewhat different now due to the rationalisation of diesel subsidies.

“Despite the risk of an upward adjustment in the OPR, maintaining it at the current level seems more plausible since Bank Negara would want to strike the right balance between inflation and growth. This led me to predict that it will be a positive for ringgit, as the gap between FFR and OPR should narrow,” he says.

Barclays Bank senior economist Brian Tan writes in a June 20 report that Bank Negara will maintain its OPR throughout 2025, although a 25-basis point increase is possible.

“The rise in diesel prices will likely put Bank Negara on alert for signs of broader inflation pressures in the second round. Nonetheless, the continuation of subsidised diesel prices in certain industries should help to mitigate the second-round inflation pressures arising from the lifting of diesel prices.

“The adjustment of RON95 petrol prices would likely have much more significant effects on broader price pressures, but political challenges remain substantial on this front,” he says.

Carmelo Ferlito, CEO of the Centre for Market Education, believes interest rates have been overemphasised in shaping the direction of economies. He cites post-global financial crisis examples like Italy’s, where investments remained stagnant despite negative real interest rates.

“Profitability is the real driver of expectations. The economy will not grow if these expectations are depressed, regardless of how low interest rates are. Therefore, building an ecosystem that can arouse entrepreneurial spirit is more important than interest rates,” he says.

Without fiscal discipline, monetary policy cannot support currency strength. Ferlito says growth supported by fiscal policy is temporary, slowing down or ending once the support is withdrawn.

“Sustainable growth is built with the right set of pro-market rules that unleash entrepreneurial spirit, accompanied by policy stability and fiscal discipline,” he adds.

This article first appeared in Star Biz7 weekly edition.

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Interest rates , ringgit , subsidies , inflation , OPR


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