Good grief. The Malaysian ringgit has fallen to levels not seen since the Asian Financial Crisis (AFC). One US dollar will now buy 4.78 Malaysian ringgits compared to 4.36 Malaysian ringgits just one year ago, and 3.3 Malaysian ringgits 10 years ago. In the depths of the AFC in 1988, one dollar could have bought 4.88 Malaysian ringgit.
A 30% depreciation in a country’s currency over a decade is not to be taken lightly. But nor should it be something to lose too much sleep over, either. Currencies fluctuate, and so they should in an open and free market.
The exchange rate should reflect what the market thinks a pair of currencies could be worth after weighing up a number of factors. Some of those factors such as the rate of inflation, economic growth, the trade balance, the budget deficit and interest-rate differentials are tangible. Others such as confidence in a country’s politics can be harder to express numerically. It is more touchy-feely.
At any point in time, the various factors that affect exchange rates can have disproportionate and unpredictable impacts. What’s worse is that what might drive a currency higher today, could have an opposite effect tomorrow.
Consider interest-rate differentials. The Malaysian Overnight Policy Rate is several hundred basis points lower than US Fed fund rate. That might help to explain why the ringgit has fallen out of favour against the greenback.
Could raising interest rates reverse the decline in the ringgit? It could by making bank deposits in Malaysia more attractive to investors. But a higher cost of borrowing and a stronger currency could slow economic growth, deter inward investments, and make exports more expensive.
Consequently, why would any of those things make the ringgit attractive over the long term? They probably wouldn’t. If anything, raising interest rates could even make matters worse for the ringgit and exacerbate its decline.
So, what should Bank Negara do? It could peg the ringgit against the US dollar and use its foreign reserves to actively defend the peg. But that might be a recipe for disaster. It could raise interest rates. But with the inflation rate at 1.5%, and the Overnight Policy Rate at 3%, a rate hike seems unnecessary.
It could intervene in the market by selling dollars and buy ringgits. It’s probably doing a bit of that already. However, with around US$100 billion in foreign reserve, the impact could be limited.
Probably, the best thing that Malaysia can do is to do nothing. A low currency doesn’t necessarily reflect weakness. It would be a terrible mistake to think that. There are many central bankers who would give their eyeteeth for a lower exchange rate.
Malaysia should bide its time. The fortunes of the ringgit could change with the direction of the Fed fund rate. Investors in Malaysian equities could bide their time, too. Focus on the things that we can control, and ignore the things we can’t. So, focus on identifying wonderful companies. Exchange rates will take care of themselves, eventually.
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Disclosure: David Kuo does not own any of the shares mentioned.
