This article first appeared in Capital, The Edge Malaysia Weekly on May 1, 2023 - May 7, 2023

THE ringgit has seen continuous weakness against the US dollar since late 2016, even prior to the US Federal Reserve’s aggressive monetary tightening that sent many global currencies reeling.

Recent developments such as the Fed decelerating its interest rate hike campaign, bank failures in the US and Europe, the better economic outlook in Southeast Asia with China’s economy rebounding, and the improving local political landscape saw the ringgit getting a reprieve.

But ringgit bears who expect Bank Negara Malaysia to continue holding off on its monetary tightening campaign after two pauses in January and March have bought into Malaysian bonds while shorting the ringgit against the US dollar for additional yield pickup. All things being unchanged, higher rates make a currency more attractive, and vice versa.

Bloomberg reported that foreign investors such as BlackRock Inc had poured US$983 million (RM4.4 billion) into Malaysian debt in March, the most since January 2022, as inflation stabilised and the Fed came closer to a pause. Investors spooked by bank failures in the West also see Malaysian bonds as a safe refuge.

Both Bank Negara and the Fed have key rate decision meetings this week. While many economists expect Bank Negara to resume its monetary tightening only in the second half of the year, many see a hike of another 25 basis points (bps) by the Fed, despite the easing of inflationary pressure.

According to a Bloomberg poll of analysts and economists, Bank Negara is expected to maintain its overnight policy rate (OPR) at 2.75% this week. Meanwhile, in the US, Bloomberg data shows that a 25bps hike by the Fed is on the cards, which would bring the federal funds rate to between 5% and 5.25%.

Against this backdrop, where is the ringgit headed, especially with the widening of the interest rate differential?

The weakness in the ringgit, along with other regional currencies since early last year, has been due partly to the Fed’s aggressive rate hikes since March 2022. In contrast, Bank Negara has put its rate hike campaign on ice since early 2023 to ensure economic stability.

In the past, Bank Negara would typically “follow” in the footsteps of the Fed in adjusting the benchmark interest rate to maintain a certain level of interest rate differential to avoid any massive outflow of funds that could weaken the ringgit.

Currently, the interest rate differential stands at between 200bps and 225bps.

Despite the huge gap, foreign funds mopped up ringgit-denominated debt securities — mainly Malaysian Government Securities (MGS) — worth RM11.4 billion between January and March this year, a reversal from the net outflows of RM8.2 billion during the same period in 2022 as well as the largest quarterly net purchase in two years, according to UOB Global Economics and Markets Research.

“Malaysia’s rate outlook is deemed to be more stable, given that Bank Negara has raised rates at a more gradual and cautious pace, while opting for a pause in January and March to assess the impact of last year’s 100bps of rate hikes from May 2022. The OPR is deemed to be near its neutral level, with room for one more hike,” the research house says in an April 10 report.

Meanwhile, CIMB Group co-CEO of group wholesale banking Chu Kok Wei suggests that the interest rate differential’s effect on the US dollar-ringgit exchange rate has largely run its course.

“Incremental action by Bank Negara on the OPR, which could be between 0bps and 25bps, would not affect the ringgit exchange rate in any significant manner. Instead, factors such as the risk of a global recession, Opec (Organization of the Petroleum Exporting Countries) action, Ukraine, Sino-US tensions and other factors could affect the US dollar in a more significant manner,” Chu tells The Edge.

He expects the ringgit to gradually strengthen towards the 4.29 level by year’s end on the prospect of the Fed reaching the end of its interest rate tightening cycle.

“We are in the similar market consensus camp that the Fed’s rate hike cycle is nearing its end. The US rate hikes have come a long way, with a cumulative increase of 475bps. Any incremental forecast difference would likely be small and less impactful as an isolated factor in driving foreign exchange rate movements,” Chu adds.

Note that the Fed is expected to ease off the pedal in its monetary tightening campaign, undertaken since the first quarter of 2022, in response to red-hot inflation that peaked at 9.1% in June last year. The Fed’s challenge has been to bring inflation down without pushing the US economy into recession.

At the last two meetings in February and March, the Federal Open Market Committee (FOMC) raised rates by a smaller quantum of 25bps, compared to four 75bps hikes in June, July, September and November 2022. A 50bps hike was done last December.

Inflation continued to trend lower in March, falling to 5% year on year from 6% in February but still above the Fed’s target of 2%.

Recall that last November, the ringgit almost touched 4.80 to the US dollar — the weakest it has ever been since the 1997/98 Asian financial crisis.

Since then, the ringgit has strengthened against the greenback, reaching 4.24 in late January this year. But the rally was short-lived, with the local currency weakening against the US dollar by 3.8% to 4.46 last Thursday, from the recent high of 4.24 on Jan 30.

Foreign exchange strategists and economists contacted by The Edge see the ringgit stabilising between 4.20 and 4.40 against the greenback this year.

Standard Chartered Bank head of Asean and South Asia FX research Divya Devesh tells The Edge: “In our baseline scenario, we expect the US dollar-ringgit to remain above the key 4.00 level. However, if we were to see sharp weakness in the US dollar triggered by a reversal in the Fed’s monetary policy, in that scenario, we could see the ringgit appreciate meaningfully.”

Divya expects the federal funds rate to reach its peak soon, which would provide support to the ringgit’s strength moving forward.

“We expect interest rate differentials to remain broadly stable and supportive of the ringgit, given that the global rate hiking cycle is likely approaching an end. Also, Malaysia’s current account surplus remains a key support for the ringgit,” he says.

The ringgit breached the level of 4.00 to the US dollar in early 2016 and has not dipped below it since 2018. Between Dec 15, 2016, and June 14, 2018, the Fed raised its interest rate by a total of 150bps to between 1.75% and 2%, resulting in the interest rate differential between Bank Negara and the Fed narrowing to 150bps from 225bps.

Maybank regional head of forex research Saktiandi Supaat expects a bigger gain for the ringgit at 4.10 to the US dollar on the view of a stronger China and regional economic recovery, supportive global crude oil prices, another 25bps rate hike by Bank Negara, and a better local political landscape.

“We continue to maintain a cautiously positive outlook for the ringgit even amid the sharp climb in the USDMYR pair since mid-January,” he says.

“A few factors recently have been weighing on the ringgit, which include a rebound in the US dollar driven by anxiety about the pace of US inflation earlier and, more recently, US dollar support amid global financial stability concerns and fading optimism from China’s initial reopening.

“However, our view on US inflation stays intact. We expect it to keep moving in a bumpy downward trajectory and we think the financial concerns may linger but be contained in its global contagion effects.”

Despite expectations of Fed rates rising to between 5% and 5.25% this year, the ringgit is expected to see positive support from China’s reopening, which is set to boost the outlook for Asian currencies this year, with the ringgit benefiting on the back of its strong trade links to the world’s second-largest economy.

Areca Capital Sdn Bhd CEO Danny Wong says a surging US dollar has benefited Southeast Asia’s exports over the past years, making exporters, especially semiconductor players, more competitive.

“Besides, those who have high foreign currency income or reserves would benefit,” he adds.

Similarly, Bank Muamalat Malaysia Bhd chief economist Dr Mohd Afzanizam Abdul Rashid says companies in the machinery, electrical and electronics, petroleum product, equipment manufacturer and palm oil product sectors are among the beneficiaries of the weak ringgit.

He points out that Malaysia’s total exports had expanded “at a robust rate” between 2017 and 2022, except in 2019 and 2022, owing to the pandemic.

“Total exports grew at a rate of 18.8% and 7.3% in 2017 and 2018 respectively, before declining by -0.8% and -1.1% in 2019 and 2020. Total exports then grew again by 26.1% and 25.0% in 2021 and 2022 respectively,” he says.

Mohd Afzanizam says, however, the weak ringgit has been a bane for importers, causing a spike in food prices, with some seeing almost a 60% surge.

“Total imports for the agrofood sector grew by 18.8% in 2022, from 14.7% in the preceding year, to RM75.6 billion. This was largely contributed by meat products (59.9% in 2022 versus 6.3% in 2021), animal feed (21.9% in 2022 versus 21.1% in 2021) and dairy products and eggs (26.2% in 2022 versus 12.6% in 2021), to name a few. Consequently, we could see inflation for food and non-alcoholic beverages rise substantially to 5.8% in 2022 from 1.7% in 2021,” he explains.

The greenback has dominated global trade and capital flows for many decades, but many countries are looking for an alternative to reduce their dependence on the US dollar.

In March, China and Brazil struck a deal to settle trade in each other’s currencies, building up the strength of the renminbi, or yuan, to challenge the US dollar’s dominance in the international monetary system.

Experts say, however, that the US dollar is likely to remain the top global currency for a long time.

“The de-dollarisation will not be a sharp move, but could still take some time to materialise. It will likely be a slow grind for a move away from US dollar settlements and asset purchases,” says Maybank’s Saktiandi.

He adds that it will probably take a while to dethrone the US dollar as a trading, invoicing and financial as well as payment settlement currency in the financial and trade markets.

Although Standard Chartered’s Divya expects the US to continue to maintain its dominant role in global trade, he foresees that the US dollar will face some weakness in the medium to long term. “[This is] given its expensive valuations and investors likely increasing their non-US dollar exposure,” he says.

Meanwhile, CIMB Group’s Chu reckons that with emerging market (EM) countries still delivering higher economic growth rates than advanced economies, an increasing global acceptance of EM currencies for trade settlements would be natural.

“This is an inevitable trend that reflects economic convergence, rather than de-dollarisation, which has a more geopolitical connotation. If the trend continues, the US dollar will indeed lose some of its ‘shine’ as the safe haven, flight-to-quality option for investors. However, this process is gradual and slow,” he says.

According to Reuters, the yuan became the most widely used currency for cross-border transactions in China in March, overtaking the US dollar for the first time. The yuan was used in 48.4% of all cross-border transactions, Reuters calculated, while the US dollar’s share declined to 46.7%, from 48.6% a month earlier.

The yuan’s use in global trade finance remains low at 4.5%, although it has shown steady increases, while the US dollar accounts for 83.71%. 

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