The ringgit is among the best-performing currencies in the world against the US dollar so far this year (see Chart 1). Without question, this is a remarkable turnaround, from having fallen to as low as 4.80 to the greenback (the weakest since the Asian financial crisis) earlier in the year.
The ringgit’s rebound is due to the confluence of various short-term factors, which we had written about in an article in March, including improved tourist arrival numbers and foreign direct investment (FDI), encouragement from the government to repatriate and convert foreign earnings into ringgit, and, of course, expectations for lower US interest rates.
Almost all analysts are currently predicting further strengthening of the ringgit, based on their expectations of an imminent interest rate reduction by the US Federal Reserve and that Bank Negara Malaysia will keep its overnight policy rate (OPR) unchanged for the rest of 2024. In effect, this would mean a widening of ringgit versus US dollar yields (the interest rate differential) and accordingly make it more attractive for investors to hold ringgit and ringgit-denominated assets. Stronger demand will cause the currency to appreciate — and, for most, this would be a desirable outcome. Except it is not. We think the rationale to use interest rates to drive the ringgit’s appreciation is amiss.
Don’t get us wrong. A stronger ringgit is good, as it means greater purchasing power for the people. Our contention is that interest rate differentials will affect exchange rates in the short term, but monetary policies must be based on economic fundamentals.
Raising interest rates — or keeping interest rates high — primarily to raise the value of your currency is usually the textbook response to shore up faltering demand, for instance, during crisis times when confidence in the country’s economic fundamentals deteriorates. Higher interest rates relative to the rest of the world (better returns) will attract investors and short-term capital inflows — but maintaining them comes at a cost. High interest rates reduce borrowings, investments and spending, and ultimately leads to weaker domestic economic growth.
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Sustainable appreciation of the ringgit must come about not because we kept interest rates high (relative to others) but because we are more productive and, therefore, more competitive in the global market. Higher productivity will translate into higher wages and greater ability to consume. This, in turn, means businesses can raise prices, make profits and reinvest (including in R&D) to become more efficient, innovative and generate even higher productivity. This creates a virtuous cycle. It is why more productive countries tend to have stronger currencies and higher wages. In other words, demand for their currencies is driven by economic strength and trade competitiveness. A classic example is the Singapore dollar.
The end point is the same — a stronger currency — but the journey is completely different, as are the consequences.
The Fed is all but certain to cut interest rates come September on the back of declining inflation and a slowing economy. As we said, monetary policies are made based on underlying economic fundamentals. This would give room for central banks in the rest of the world to follow suit. We believe the Malaysian economy would benefit from lower domestic interest rates.
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Lower OPR and higher minimum wage will help Malaysian households and support consumption
We wrote about how higher oil and gas, and to a lesser extent crude palm oil, prices are boosting export revenue — and current account surplus — and is the key factor behind Malaysia’s strengthening growth in 1Q2024 and 2Q2024 GDP numbers. Bear in mind, though, that commodity prices are inherently unpredictable and undependable. Should oil and gas prices weaken again, they would create drag on economic growth, as they did between 4Q2022 and 3Q2023 (which we articulated in our piece last week [“GDP is a political number — what drives it is what matters”, The Edge, Aug 12]). GDP data also showed that while private consumption is expanding, it is still growing at a much slower pace than the pre-pandemic trend (see Chart 2).
Private consumption is the biggest contributor to, and most consistent driver of, the Malaysian economy. This is why, on balance, we think the Malaysian economy would benefit more from lower domestic interest rates — even though this might halt, or perhaps even reverse, the recent ringgit gains.
Obviously, there are winners and losers if the ringgit appreciates further — should Bank Negara keep the OPR unchanged — depending on the sector you are operating in and whether you are a consumer, importer or exporter, and so on.
A stronger ringgit will reduce imported inflation and cost of living, which would be good. Realistically, however, we think consumer prices have already baked in the higher import costs following the steep ringgit depreciation earlier in the year. And prices are always extremely sticky on the downside. We doubt a stronger ringgit now would lead to any material price reductions for consumers, even if the imported costs fall.
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On the other hand, lower borrowing costs will surely help consumers and support the Malaysian economy amid heightened uncertainties in global demand, with the US economic slowdown, while China’s consumption remains weak on the back of sagging consumer confidence. (Most recent data suggests slowing new orders and global manufacturing output.) Malaysia’s household debt remains elevated, at 84.2% of GDP, one of the highest in the region. Chart 3 shows the composition of household debt from the banking system (69.5% of GDP), excluding borrowings from other non-bank financial institutions (14.7% of GDP).
Yes, the bulk of borrowings are for home purchases (mortgages), which is an asset that generally appreciates in value over the long term. But rising debt servicing cost is eating into disposable incomes and capping consumption growth and/or leading to falling savings rate for large sections of the population. Case in point: Savings as a percentage of GDP has now fallen below that of Indonesia, Singapore, China and Vietnam and is similar to the Philippines and only marginally higher than in Thailand (see Chart 4).
Unlike in the US, Malaysian mortgages are based on variable interest rates, that is, the mortgage rate moves in tandem with the OPR and the banks’ cost of funds. Lowering the OPR, therefore, would immediately reduce monthly mortgage payments and boost disposable incomes for Malaysians. Lower interest rates would also reduce the interest payments on outstanding credit card balances and other forms of credit.
In addition, even though wage growth has been relatively strong post-pandemic, for many people, incomes have yet to catch up with the surge in prices and cost of living. As we explained last week, real median wage fell during the pandemic and, despite the strong year-on-year growth, is not much higher than it was in 2019 — and not where it would have been if the pandemic had not happened (based on the longterm growth trajectory). The pandemic has been particularly damaging for lower-income households.
An effective policy to directly address this issue would be to raise the minimum wage threshold. Raising the minimum wage would apply across all sectors of the economy, with maximum impact. It is simple, easy to implement and far more efficient than the progressive wage policy, where the process and approval are convoluted and which has limited application on a voluntary basis and is for only an initial 12-month period. What happens after the test period? Pay cuts?
As we like to say, every decision in life necessarily involves a trade-off. Lowering interest rates is likely to come at the expense of the ringgit. But cheaper borrowings will immediately boost disposable incomes and help consumers cope with the rising cost of living. It is certainly a better alternative than encouraging continued withdrawals from the Employees Provident Fund and exacerbating the nation’s declining savings rate. Similarly, raising the minimum wage will increase costs for enterprises, hurt profitability and competitiveness — unless they can simultaneously push productivity higher. It may have other side effects, such as higher inflation. But, ultimately, stronger domestic consumption will sustain growth in the Malaysian economy. This is especially critical in view of the slow recovery in exports, unpredictable commodity prices and increasing probability of a global economic slowdown and recession.
Conclusion
When the Fed cuts interest rates, we have two options:
- Do nothing. Allow the interest rate differential between the US dollar and ringgit to compress. That should lead to a stronger ringgit; or
- Cut the OPR in tandem. This will immediately reduce borrowing costs, put money into the people’s pockets and alleviate some pressure from the rising cost of living. We believe this is the better option at this point, given that consumption growth remains below pre-pandemic levels.
To further boost disposable incomes, and therefore consumption, raise the minimum wage threshold instead of toying with progressive wage experimentation.
Box Article: Flashback (The Edge, March 4, 2024) — The ringgit can rebound in the near term
What we have articulated in the main article are the long-term decline in the value of the ringgit, the reasons behind it and what needs to be done to reverse this secular trend. Within this broad downtrend, however, there will be short periods in which the ringgit will strengthen. The following are some positives that could drive a near-term ringgit rebound.
Better domestic economic growth outlook
Bank Negara Malaysia forecasts gross domestic product growth of 4% to 5% in 2024 (3.7% in 2023) on the back of:
- Recovery in exports. Expectations for a stronger global economy and trade are positive for Malaysia’s manufacturing and exports. In January, the International Monetary Fund raised its global economic growth forecast to 3.1%, from 2.9% in October 2023. Global trade is also projected to rebound to 3.3%, from 0.4% last year. Importantly, global semiconductor sales — an important sector for Malaysia — are turning around.
- Higher tourist arrivals. Arrival numbers are expected to increase to 27.3 million this year, from 20.1 million in 2023. The tourism sector is planning measures to attract more tourists, and promote longer stays and higher spending.
Higher current account surplus
The recovery in exports and growth in tourism should boost the current account surplus, estimated at 3.2% of gross national income in 2024, up from 1.3% last year.
More investments to drive growth
These include key infrastructure projects such as the East Coast Rail Link, Johor Bahru–Singapore Rapid Transit System Link and MyDIGITAL as well as healthy pipeline projects. The Malaysian Investment Development Authority has approved a record level of planned investments of more than RM300 billion.
Federal Reserve interest rate cuts
US interest rates are expected to fall in the coming months. The resulting narrowing in interest rate differentials should attract capital flows to Asia, including Malaysia.
Greater fiscal discipline
Plans to reduce the fiscal deficit, including through subsidy rationalisation and the enactment of the Public Finance and Fiscal Responsibility Act. The government intends for subsidy rationalisation to release more funds for education and infrastructure, which would bode well for Malaysia’s long-term economic potential and productivity.
— End of Box Article —
The Malaysian Portfolio fell 0.7% for the week ended Aug 21. Insas Bhd — Warrants C (2.2%) was the only gainer. The big losers were IOI Properties Group (-4.7%) and KSL Holdings (-4.5%). Our cash holdings remain around 70%. Total portfolio returns now stand at 196.9% since inception. This portfolio is outperforming the benchmark FBM KLCI, which is down 10.6%, by a long, long way.
Meanwhile, the Absolute Returns Portfolio performed far better, gaining 2.7% last week and lifting total returns since inception to 7.1%. The top three gainers for the week were DR Horton (+7%), Airbus (+4.5%) and DBS Group Holdings (+4.2%). Tencent Holdings (-0.6%) was the only losing stock. We added CRH to our portfolio. The company is a leading provider of building materials, products and solutions with opera tions primarily in North America and Europe. The US accounts for about two-thirds of total revenue.
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