Tuesday 26 Sep 2023
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This article first appeared in The Edge Malaysia Weekly on May 2, 2022 - May 8, 2022

MANY in Malaysia watched with sinking hearts last week as the ringgit dropped precipitously against the US dollar to 4.36 — the lowest level in the last two years.

The ringgit was not the sole decliner, as other major currencies also depreciated against the greenback. Among Southeast Asian countries, however, the local unit was the hardest hit, down 4.74% since the start of the year.

Its depreciation against the Singapore dollar was also steep, hitting 3.17 last week. Year-to-date, the ringgit has fallen 2.76% against the SGD. The drastic decline prompted many to scoop up the ringgit and money changers across the Causeway reported they had run out of the currency.

The SGD’s appreciation against the ringgit is due to the increase in its nominal effective exchange rate (NEER). OCBC Bank rate strategist Frances Cheung says because Singapore manages the SGD by a gradual appreciation in the currency’s NEER, it has shown relative resilience.

“The SGD outperformed other regional peers, including the [Chinese] renminbi (RMB) and Korean won, over the past week and, as such, is not something specifically pertaining to ringgit characteristics,” says Cheung.

As for the weakness against the US dollar, a large part of it is due to the strengthening of the greenback as investors pencilled in a larger quantum of rate hikes this year by the US Federal Reserve, which is expected to raise interest rates, as inflation rose 8.5% in March.

Some have also tied the currency’s weakness to the depreciation of the RMB against the greenback, which has come about because of capital outflows and negative yield differentials with the US as China’s economic outlook turns cloudy, given the sudden surge in Covid-19 cases. Malaysia’s strong trade linkages to China is another reason for the ringgit’s weakness, experts say.

HSBC Global Research says the ringgit weakness could also have been prompted partly by foreign bond investors selling Malaysian government securities amid the global bond rout as well as negative domestic developments such as large withdrawals from the Employees Provident Fund under a scheme approved by the government to boost consumption.

Interestingly, the research house also pointed out that Malaysian residents may have contributed to the ringgit’s decline as onshore foreign exchange deposits climbed in recent months.

“Residents’ views on the ringgit were probably negatively affected by broad US dollar strength as well as the RMB’s depreciation — there are a lot of Chinese corporates using Malaysia as a manufacturing hub. Outflows and foreign currency deposit hoarding explain why the ringgit has not really benefitted from a robust trade balance and very strong foreign direct investments inflows — the strongest in Asean recently, overtaking Vietnam,” says the research house.

Many believe the ringgit will correct itself in the second half of the year. HSBC Global Research says the ringgit will see a modest correction in 2H2022 when sentiment surrounding China stabilises, but it acknowledges that the ringgit is likely to remain undervalued while political uncertainty lingers.

Nevertheless, there is also concern among many that the ringgit weakness may persist longer than expected.

If it persists, what would it mean for the country?

Mounting inflationary pressure

Inflation has been a hot topic since the height of Covid-19. The pandemic and subsequent lockdowns across the globe resulted in supply chain disruptions that continue to this day.

Covid-19 disruptions were not the only reason, however, as other factors such as drought or frost compounded the shortage of crops, which has been further exacerbated by the war in Ukraine.

Globally, commodity prices have soared, as crude oil, metals and even basic crops such as wheat are in short supply.

The surge in commodity prices has inevitably resulted in a rise in inflation, which has been more apparent in developed nations. In March, UK inflation topped 7%, the highest in 30 years, and the eurozone’s was at 7.4%. US inflation was even more alarming at 8.5%, a 40-year high.

In Malaysia, the effects of inflation have been less severe than in developed nations, capped largely by the fuel subsidy and ceiling prices set by the government as well as price controls on basic food items.

Inflation in March increased by 2.2% year on year, a relatively modest increase even though the food and non-alcoholic beverages category registered a 4% y-o-y rise versus 3.7% in February.

The increase in the sub-category was due largely to an increase in the component for “food at home”, which rose 4.3% versus 4.1% in the previous month while “food away from home” also increased 4% in March.

Many consumers are feeling the pinch. Despite price controls on selected basic food necessities, the price of a packet of noodles or cup of teh tarik has crept up. A current concern is that a prolonged period of a weak ringgit, coupled with a rise in commodity and food prices, will lead to added inflationary pressures.

“Manufacturers are already saying that potential pass-through of higher costs could raise prices by up to 10%. Around 8% of total imports are consumption imports. Malaysia also imported around RM8 billion worth of vegetable oils and fats from Indonesia last year,” says UOB Malaysia senior economist Julia Goh.

Indonesia recently announced a palm oil export ban from crude palm oil to refined palm oil, a move that is expected to drive up the price of edible oil globally.

Malaysia imports a significant amount of its food — RM51.4 billion in food products compared to RM38.7 billion in exports in 2021. This resulted in a trade deficit in food products of RM12.7 billion for the year.

Economists anticipate food inflation to increase for some time. CGS-CIMB Research head of economics Ahmad Nazmi Idrus notes that some components in the food basket have seen moderation, specifically vegetables, fruits and seafood, following the government’s effort to rein in prices, but other components have continued to remain on an uptrend.

Nazmi believes the rise in food prices will remain within the range of 4% and 5% y-o-y before easing off towards year-end.

The Associated Chinese Chambers of Commerce and Industry of Malaysia’s (ACCCIM) Socio-economic Research Centre executive director Lee Heng Guie projects food inflation will continue to rise as consumer demand — usually higher during festive celebrations — outpaces the country’s ability to supply products.

Although a weaker currency could inadvertently nudge up inflation, OCBC economist Wellian Wiranto believes it will be more muted for Malaysia than other economies. “For one, the price effect of commodities is more contained because Malaysia is a net commodities exporter, particularly for hydrocarbons. The fact that subsidies remain very much in place should help blunt some of these effects as well,” he says.

Nevertheless, he adds that some cate­gories of food inflation bear watching, especially given how prices of meat items such as chicken, a staple in Malaysian consumers’ diets, have crept up significantly so far this year and could run up further if the Ukraine war drags on and results in further feed supply disruption.

In an interview with Bernama recently, Bank Negara Malaysia governor Tan Sri Nor Shamsiah Mohd Yunus said Malaysia would not experience hyperinflation, as policies such as the fuel price ceiling and price controls on essential items help keep prices stable and mitigate cost pressures. Income transfers to vulnerable households also help soften the impact.

Having said that, the ringgit’s trend in the months ahead will be keenly watched, as a persistently soft currency will add a layer of cost for businesses buying imported intermediate goods (56% of total imports) and capital goods (9.6% of total imports). Consumers will also see higher prices of goods and services, as imports of consumption goods make up 8.5% of total imports.

For now, producers usually hedge against ringgit volatility in the short term, says Nazmi. If the ringgit can claw back its losses over the next few weeks, he adds, the impact on importers’ bottom line will be minimal.

He believes the ringgit needs to weaken for a longer period of time before the cost trickles down to the Consumer Price Index (CPI).

Potential speed bumps for economic recovery

The country’s gross domestic product (GDP) for 2022 is projected to grow between 5.3% and 6.3%, according to the central bank, with a large part of growth predicated upon a stronger revival in domestic demand, especially from private consumption and public investment.

Higher inflation, coupled with a flaccid ringgit, could result in the crimping of consumer spending power, thus hampering private consumption, especially as the economy is only beginning to recover from the pandemic.

Economic recovery could be affected, as inflation disproportionately hurts low- and middle-income households, which spend a significant portion of their income on essential goods and services such as food, utilities, health and communications.

CGS-CIMB’s Nazmi thinks it is still too early to say whether the impact of the ringgit will be significant.

“Assuming that the local currency persistently weakens, it will be reflected in the CPI and cost of living. Should both factors be high, then consumers may start to limit their spending and this will dampen the private consumption component for the GDP and hence economic growth,” says Nazmi.

What is important now, says UOB Malaysia’s Goh, is stability in the ringgit and its relative movement against other currencies. She points out that all Asian foreign currencies have currently weakened against the USD.

Goh believes the cost-conscious consumer is likely to turn to cheaper options and seek out locally produced items, which could benefit domestic industries. She adds that the release of pent-up demand, lower unemployment and higher wages are likely to sustain the robust trend of consumption growth.

In the Bernama interview, Bank Negara governor Shamsiah highlighted that 36% of Malaysian workers and 42% of labour income in Malaysia were part of export-oriented sectors.

A weaker ringgit is likely to make Malaysian exports more competitive, as it makes them relatively cheaper, she said.

“Firms in these sectors also see their net revenues increasing in ringgit terms, especially when they have little imports or if their imports are priced in the same currency of their exports. These would help benefit jobs and incomes in these sectors,” she maintained.

Another saving grace for the country could be its transition to endemicity, which has seen the reopening of borders and more relaxed rules surrounding Covid-19.

SERC’s Lee says a weak ringgit would mean that the tourism and retail sectors could see more foreign tourists spending in the domestic economy, although increased prices locally would somewhat reduce their purchasing power. He cites, for example, how a weak ringgit against the SGD is likely to spur Singaporeans to cross the causeway and spend in popular places such as Johor and Melaka, thereby helping to boost the local economy.

Nonetheless, Malaysia’s tourism sector also relies heavily on tourists from China, who are now still restricted by closed borders. About 11% of international tourists in 2019 were from China.

The export sectors are likely to benefit most from the weak ringgit. Industries that are export-oriented with high local content as well as resource-based have already been benefiting from the surge in commodity prices and, with a weakening ringgit now, are likely to see even higher revenue value.

While OCBC’s Wellian expects to continue to see exports being largely supported, it is not so much from the angle of currency competitiveness.

“It will be more of a testament to the twin support coming from semiconductors and commodities. Demand softness, especially in major economies such as the US and China, is a risk factor in the months ahead, but thus far, the trade numbers have been staying on the robust side, signalling that there is still more ‘juice’ left, especially given the in-demand product mix that Malaysian exporters offer,” he says.

In the first quarter of 2022, export growth was strong at 22.2% y-o-y. Still, some believe a moderation could be ahead, owing partly to the base effect. The export numbers would also depend on how severe the cost pressures are and on the growth prospects of Malaysia’s key trading partners, such as the US, EU and China.

UOB Malaysia’s Goh expects to see a current account surplus of RM16 billion for 1Q2022, higher than the RM15.2 billion recorded in 4Q2021. She adds that a balance of factors could tilt the trade surplus in the coming months, including higher contribution from net exports of liquefied natural gas, crude oil and palm oil, amid the sharp rise in commodity prices.

“However, Malaysia’s high share of imports of intermediate (56% of total imports) and consumption (8.3% of total imports) goods may climb higher in coming months as import prices adjust to reflect the spike in commodity prices and input costs.

“For now, we maintain our forecast for a current account surplus of 2% of GDP in 2022 (2021: 3.5%), pending the actual 1Q2022 current account data that will be released on May 13,” she says.

Subsidies a big dent in the government’s fiscal position

Malaysia has long subsidised fuel for its people. Subsidies no doubt keep the rakyat happy, as the measure alleviates the cost burden and keeps inflation in check, especially during times when crude oil prices have risen substantially in the past year.

While crude oil prices have risen significantly in recent times, Malaysians have continued to enjoy a retail fuel price of RM2.05 per litre for RON95 — the most commonly used fuel — and RM2.15 per litre for diesel. Only the price of unleaded RON97 has risen in line with global crude oil prices.

There are no official numbers on how much exactly the government subsidises fuel each year. The RM17.35 billion “subsidy and social assistance” budgeted for 2022 by the federal government includes cash handouts, a cooking oil stabilisation scheme, education assistance and scholarships, subsidies on interest rates, electricity, paddy plantations, flour and liquefied petroleum gas, as well as farmer, fisherman and livestock incentives.

The figure does not provide a detailed breakdown of the sub-categories.

Economists have their own estimates of the government’s fuel subsidy bill, which range from RM12 billion to RM28 billion, based on their average forecast of Brent crude prices.

Nonetheless, with the ringgit weakening against the greenback, the fuel subsidy bill could increase further as fuel import costs increase, especially if the current subsidy is maintained at the present rate.

While the weakening of the ringgit would also mean that the federal government could collect more from fuel and fuel-related revenue, economists think the impact on the fiscal balance is negative, given the higher subsidy bill.

Goh believes the government will prioritise price stability. To reach its fiscal deficit target of 6% of GDP, she says there may be a moderate adjustment to the fuel ceiling price, additional revenues from higher oil prices and rationalising other expenditure.

There have been mutterings of a targeted subsidy mechanism but no details or timeline has been given on its introduction, although an increase in fuel prices will affect inflation.

Another aspect of the federal government’s financial position that has also come into question with a weakening ringgit is the possibility of higher debt service payments for foreign currency-denominated borrowings.

Nevertheless, SERC’s Lee does not see this as a concern, given that these loans are small and the export proceeds generated are more than enough to service external loans.

As at end-December 2021, the federal government’s external loans, including foreign holdings of ringgit-denominated bonds amounted to RM240.4 billion, or 27.1% of total debt outstanding.

The ringgit loans, being Malaysia bonds held by non-residents, made up 97% of total external borrowings, followed by loans denominated in the USD, at 1.8%, and Japanese yen, at 1.2%.

In the Bernama interview, Nor Shamsiah also stressed that Malaysia was “nowhere near that position” of having trouble paying its external debts.

“We are expected to record a current account surplus exceeding RM75 billion in 2022. We are exporting more than we are importing. It also means that we are getting more foreign currency than we are paying out. Besides that, Malaysia is a net creditor to the world.

“Today, we have more foreign assets than foreign liabilities — unlike during the Asian financial crisis. Because of that, there should be no concerns that Malaysia might not be able to meet our foreign currency obligations, given the recent fluctuations in the ringgit,” she emphasised.


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