Much has been written about the recent slump of the ringgit against the US dollar. It is a legitimate worry. The weak ringgit will worsen domestic inflationary pressures by increasing the cost of imported food, energy, goods and services — and further raise the cost of living.
In truth, there is little most countries can do in the current environment, where the US Federal Reserve is aggressively raising interest rates. The ringgit also hit an all-time low against the Singapore dollar this month due, in part, to the relatively more rapid monetary policy tightening by the Monetary Authority of Singapore. For many though, matching the Fed’s rate hikes in lockstep would risk damaging fragile post-pandemic economic recoveries. But slower rate hikes mean wider interest rate differentials and a weaker domestic currency.
In this, the ringgit is not alone. Most currencies in the world have fallen against the US dollar this year — and the ringgit is far from the worst-performing, faring better than the euro, pound sterling, South Korean won, Taiwanese dollar and Japanese yen. Very few currencies have appreciated against the greenback, and the best-performing is, ironically, the sanctions-hit Russian ruble, which we highlighted last week.
As we wrote earlier, a weaker domestic currency comes at a cost of its own. It leads to a higher cost of living, higher domestic inflation and ultimately, lower real — as opposed to nominal — economic growth. In other words, the perceived policy trade-off between higher interest rates and lower exchange rates leads to the same end result — without real changes to make the economy more productive.
Indeed, the far more ominous trend, which is far less widely articulated, is the long-term decline in the value of the ringgit. The ringgit has consistently fallen against the Singapore dollar, by a cumulative 32% over the last 20 years. Over the same period, it is down by 30% against the Chinese yuan, 29% against the Thai baht, 21% against the euro and 15% against the US dollar (see Chart 1). Why has the ringgit performed so poorly?
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The exchange rate (of a free-floating currency) is largely determined by aggregate demand and supply in the market, both domestic and foreign, which are driven by factors such as economic growth, political stability, public indebtedness, ease of doing business, economic and investment policies and integrity of legal system. The biggest sources of demand are net capital inflows and repatriated export earnings and investment incomes.
We have written extensively on Malaysia’s falling share of foreign direct investments (FDI) among its Asean neighbours, and the many reasons why, in a three-part series in June-July 2022. The country’s share of total FDI fell from 24% from 1977 to 1997, to a mere 8% in the two decades after the Asian financial crisis (2000 to 2020). In contrast, Singapore attracted the lion’s share of FDI, some 55% of Asean FDI between 2000 and 2020. The Singapore dollar strengthened against all major currencies, including the US dollar, euro, pound sterling and Japanese yen, over this period.
We have also discussed in depth the cascading repercussions of a reduced share of FDI and higher capital outflows by Malaysians (both institutional and retail) on overall investments in the domestic economy. Among others, they resulted in premature deindustrialisation and, subsequently, over-reliance on consumption as a driver of economic growth. Rising consumption then led to lower domestic savings, further depleting an important source of funding for investments. Slower investments hampered the pace of productive capacity expansion and acquisition of technology required to move up the value chain — all of which, in turn, affected export earnings. And, more importantly, the quality of export earnings (the value added for manufacturing exports).
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The failure to continuously move up the value chain meant that Malaysia remained highly dependent on export earnings from primary commodities, where prices are much more volatile. Additionally, petroleum and palm oil-related exports had an outsized impact on net exports — because manufacturing exports contain high import costs for intermediate goods.
Case in point, prior to the oil price crash in 2014, crude oil, liquified natural gas and petroleum products accounted for 22% of total gross exports, while 8% was contributed by palm oil and palm-oil based manufactured products. After the 2014 oil price collapse, Malaysia’s gross exports in US dollar terms fell and did not recover until seven years later. Net exports remained well below the peaks during the last two commodity booms. Chart 2 shows the close correlation between Malaysia’s exports and fluctuations in commodity prices (the Commodity Research Bureau Index).
Indeed, the ringgit’s fluctuations are closely correlated to those of other commodity currencies (of major commodity exporters) in the world, such as the Australian dollar and Canadian dollar (see Chart 3). In other words, despite decades of industrialisation, Malaysia’s transition from a commodities exporter to an industrialised economy has been slow. A significant portion of the country’s net exports is still derived from oil and gas, while the value added in manufacturing exports remains relatively low and insufficient to offset the cyclicality in commodity prices.
We did a simple, back-of-the-envelope estimate for the value added for manufacturing, by subtracting the value of intermediate goods imports from merchandise exports value using data published by World Trade Organization. For Malaysia, it was about 46% of merchandise exports value in 2018, which was down from 48% in 2009 and lower than the 53% for Singapore. These figures suggest that Malaysia’s manufacturing sectors had not increased the value added in products over the last decade. This is unsurprising as the majority of domestic companies remain heavily dependent on cheap and low-skilled foreign labour. They compete on prices in the global market rather than leveraging specialised know-how or intellectual property, effectively capping wages and productivity gains in the country.
This structural weakness is also reflected in deteriorating business profitability (and returns on capital), as competition in the global market heats up, with newer emerging economies and even cheaper labour. Corporate earnings — earnings per share or EPS for the benchmark FBM KLCI — slumped in the years following the 2014 oil crash and have yet to fully recover (see Chart 2). Declining corporate earnings is one of the major reasons why foreign investors have shunned the Chart 3 Malaysian equity market. Foreigners were net sellers in the local stock market in seven of the eight years between 2014 and 2021. Capital outflows translate into a weaker currency, all else being equal.
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The combination of lower FDI inflows, export earnings and portfolio investments contributed to the decline in demand for — and value of — the ringgit since the Asian financial crisis. Malaysia’s continued heavy dependence on commodities, primarily oil and gas, is a longer-term concern. Oil and gas are depletable natural resources. Plus, the world is moving away from fossil-based fuels.
The persistent decline of the ringgit is the clearest symptom of the huge challenges Malaysia now faces. Unless the country — that includes both the government and the people — has the will to address the underlying structural issues, there is no reason to think that the value of the ringgit in the next 20 years will be any different from that of the past two decades — it will continue to depreciate.
The Global Portfolio performed better in the week ended August 17, rising 1.1% compared with the MSCI World Net Return Index’s 0.8% gain. The biggest gainers were Chinasoft International (+5.4%), Yihai International Holding (+4.1%) and Apple (+3.1%) while DBS Group Holdings (-4%), Guangzhou Automobile Group Co (-1.5%) and Bank Rakyat Indonesia (-0.6%) were the three losing stocks. Last week’s gains lifted total portfolio returns since inception to 27.7%. This portfolio is trailing the benchmark index’s 45.3% returns over the same period.
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