This article first appeared in Forum, The Edge Malaysia Weekly on July 1, 2024 - July 7, 2024
The ringgit has depreciated against the US dollar in the run-up to 2024. In May last year, Bank Negara Malaysia raised interest rates to 3%, following the US Federal Reserve’s rate hike and to curb inflation. The central bank is expected to maintain this rate throughout the year to support the weakening ringgit. With inflation having stabilised in recent months, it is crucial to examine the economic and trade implications of the ringgit’s depreciation. We will begin by exploring the common theoretical framework regarding the impact of currency depreciation on export competitiveness, followed by a review of new evidence that could better guide our future actions.
Many nations employ a strategic approach to enhance their exports on a global scale: they allow their currency to depreciate. This may seem counterintuitive, but a weaker currency translates into cheaper products for international buyers. This in turn can trigger a surge in demand for these exports, thereby boosting the country’s economy and potentially reducing trade gaps.
China’s currency devaluation strategy back in 2015 serves as a compelling illustration of the effectiveness of this approach. Faced with slowing economic growth and the need to boost its export sector, China opted to weaken the yuan. This decision made Chinese goods cheaper and more attractive to international buyers, aiding its manufacturing industry and solidifying its position as a global export leader. By devaluing the yuan, China was able to offset rising labour costs and other internal economic pressures, allowing it to preserve its export-reliant growth model.
Bringing it back to Malaysia, a depreciation of the ringgit could have profound implications for its export-oriented sectors. As the ringgit weakens, Malaysian production costs become comparatively lower than those of foreign competitors, enhancing the affordability of the country’s goods and services in the global market. This competitive advantage has the potential to stimulate demand significantly across key export industries such as semiconductors, electronics, palm oil and rubber. The anticipated increase in demand could theoretically drive up production levels, potentially leading to job creation and fostering overall economic growth.
While currency depreciation can be a useful tool to boost export competitiveness, it presents a double-edged sword. It makes imports more expensive, potentially leading to higher inflation and increased costs for businesses that rely on imported goods and services. Furthermore, sustained depreciation can erode investor confidence, triggering capital outflows and exacerbating economic instability.
This is particularly relevant for Malaysia, which imports a substantial amount of raw materials and intermediate goods for its manufacturing sector. The increased import costs due to a weaker ringgit could significantly offset the gains from higher export competitiveness.
While devaluing the ringgit might seem like a tempting strategy to boost exports in the short term, recent economic research suggests a more complex reality. Traditionally, the logic has been to weaken the currency and make exports cheaper, then strengthen it later to improve purchasing power. However, this approach may be flawed due to the disproportionate effect of currency fluctuations on exports.
If we were to follow this framework, we should devalue our currency to boost our exports and strengthen it again when our economy is strong to boost purchasing power. However, the new and revised evidence shows that currency depreciation and appreciation have a disproportionate effect.
As highlighted in a recent World Bank blog post citing a case study of Malawi and Pakistan, exports often respond weakly to depreciation but steeply decline with appreciation. The study found that a 10% depreciation only yielded a 7.7% and 6.2% increase in exports for Malawi and Pakistan respectively, in the next year. Conversely, a similar magnitude of appreciation led to a significant drop of 23.5% and 22.6% in exports for these countries.
The study reveals that currency depreciation doesn’t always lead to a significant increase in exports for two main reasons. First, the lack of information about foreign markets makes it difficult for companies to quickly establish new trade relationships. This is particularly challenging for exporters of specialised products, which require strong relationships with buyers and a deep understanding of market demand. In contrast, exporters of standardised goods can easily find new markets when prices drop. Since Malaysia’s export sector is largely composed of specialised manufacturing products, currency depreciation is unlikely to have a significant positive impact on exports in the short term.
A second factor that hinders the effectiveness of currency depreciation in boosting exports is the presence of supply constraints. Companies that rely heavily on physical capital and financial resources face significant obstacles in scaling up their operations, even if production costs decrease. This can be due to limited access to necessary equipment, infrastructure and financing options. For instance, manufacturing industries may struggle to quickly increase production due to the high costs and time required to acquire and install new machinery. Similarly, sectors with high operational complexity, such as pharmaceuticals, chip manufacturing and energy, are particularly susceptible to project completion delays due to the intricate nature of their work and the immense capital investment required. While lower production costs can be beneficial, overcoming these supply constraints is crucial for achieving sustainable and rapid growth in these industries.
This evidence suggests that while currency depreciation can provide a short-term boost to export competitiveness, the long-term impacts may not be as significant. Moreover, the negative effects of currency appreciation on exports are much more pronounced. Therefore, while the weakening of the ringgit could offer immediate relief and support for the export sector, it is crucial to address underlying economic fundamentals to ensure sustained economic growth and stability. This includes enhancing productivity, diversifying the economy and improving the business environment to attract and retain investment.
Since currency devaluation does not significantly enhance export competitiveness but rather increases the cost of imports, the recent weakening of the ringgit poses considerable harm to our economy. Recently, the central bank has utilised currency forwards to stabilise and potentially strengthen the ringgit, a positive step forward. However, it is crucial to prioritise efforts that boost business and investor confidence. Continued commitment to enhancing our fundamentals, including improvement in our business environment and infrastructure, and implementing sound policies, remain paramount for sustaining Malaysia’s long-term competitiveness.
An economist and public policy thinker at IDEAS Malaysia, Doris Liew regularly observes Asean’s economic development, policy frameworks and regional and international trade dynamics
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