PETALING JAYA: Blaming the government for the fall of the ringgit may be fashionable but it is not the only factor that determines the value of the local currency.
In reality, the recent spell of depreciation, particularly against the US dollar, has less to do with the political mood than some may think.
Free fall
Exchange rates are relative. This means that when demand for the ringgit drops and supply rises, the value of the currency falls against other currencies.
Similarly, if demand for other currencies rises, those currencies will also strengthen against the ringgit.
So why has the demand for the ringgit fallen lately?
Interest rates play a major role. With inflation wreaking economic havoc everywhere, central banks such as the US Federal Reserve tend to raise interest rates to bring prices down.
Higher interest rate is a boon for lenders but bad news for borrowers given that they now have to pay more for their loans.
Countries like the US now offer higher interest rates, therefore higher returns, than Malaysia. Hence, investors clamour to buy and lend US dollars over the ringgit.
Plus, the world is on the verge of an economic downturn. The International Monetary Fund expects global economic growth of only 2.9% for 2023 while the World Bank has slashed its forecast for global gross domestic product (GDP) growth from 3% to 1.9%.
Economic slowdown drives up demand for the greenback and other currencies like the Singapore dollar to a smaller degree because they are safe haven currencies.
Given the status of the US as the world’s most robust economy, investors are usually confident that the dollar and dollar-denominated investments will retain their value or even appreciate during the tough times.
Lastly, the ringgit dips with other currencies it is positively correlated to, such as the Chinese yuan.
When China, Malaysia’s largest trading partner, sees an uptick in exports and investments, the yuan appreciates, enabling it to buy more from other countries, including Malaysia, thus helping the ringgit to appreciate. Conversely, when the yuan weakens, so does the ringgit.
However, geopolitical tensions such as the US-China tiff could send the yuan tumbling even when China’s economy is roaring. This also puts pressure on the ringgit.
Value judgment
Generally, economists are not concerned about the ringgit being in freefall.
Mostly, the market self-corrects. For instance, if the dollar gets too expensive because of diminishing supply, the US Federal Reserve pauses interest rate hikes, as it did in September 2023. The demand for the dollar then tapers off and its value automatically readjusts itself.
The ringgit actually appreciated against the greenback to 4.4125 as recently as March 31 on cooling US inflation forecasts, only to weaken to 4.7958 per dollar last week, the weakest in more than 25 years. The ringgit has since clawed back some of its losses to close at 4.7600 yesterday.
Even the decision by the US Federal Reserve to pause interest rate hikes failed to give the ringgit a boost.
Earlier in the year, the speculation was that it could strengthen to RM4.20 to RM4.30 against the dollar by end-2023, but the sentiment now is very different. The market is already bracing itself for a rate of RM5 to the dollar.
So, what does it mean for the economy?
For the average Malaysian, the price of imported goods rises, thus raising the cost of living. But exporters may sell more because the exchange rate is now in their favour as long as their products do not contain imported parts and components.
Band-aid solution
Of course, this does not mean that we can’t prevent the ringgit from depreciating.
Aggressively raising our interest rate to match that of other countries will prop up the ringgit, somewhat. However, it also discourages borrowing and by extension business expansion, which is undesirable going into an economic downturn.
There is also market intervention. Governments can buy more of their own currency to keep its value within a desired range.
But given that Malaysia adopts a managed float rather than a free float approach, it is not desirable for Bank Negara to intervene. The country simply cannot afford it.
As of December 2022, Malaysia’s foreign exchange reserves had fallen to US$114 billion (RM542.9 billion), sufficient to cover 5.2 months of imports. This is also equivalent to the country’s short-term external debt.
Besides, burning through billions for short-term appreciation of the ringgit would be missing the forest for the trees. At the end of the day, a weak ringgit is a symptom, not the disease.
A strong currency partly stems from having a robust and competitive economy that inspires investor confidence.
There is not much we can do about the increased demand for the greenback, Singapore dollar or euro. But there is room to improve Malaysia’s economic fundamentals and ensure political stability.
This entails moving away from cheap labour-driven growth Malaysia has been leaning on for decades. It means attracting more high-value foreign direct investments because that makes labour and industry more productive.
Consequently, exports become more competitive based on product innovation and complexity rather than price. This leads to more exports, thus boosting the value of the ringgit.
This is something the country needs more than ever, according to the World Bank.
It is critical to strengthen the ringgit to remedy some of Malaysia’s most alarming ills, from falling investments to unsustainable GDP growth thanks to years of myopic economic policies.