THE weakening of the ringgit, which is heading for its biggest monthly loss in more than five years, raises the issue of whether Malaysia should rewire the economy via a strong or perhaps more stable ringgit policy.

       This is especially so as the country aims to be a high-income economy.

       “Currency acts as a status symbol of a country. It is seen as strong if it is becoming more valuable relative to another country’s currency. Conversely, a currency is considered weak if it is becoming less valuable versus another country’s currency,” says AmBank Group chief economist Anthony Dass.

       In the current environment, most major currencies including the ringgit are weakening against the US dollar due to expectations of aggressive monetary tightening measures from the US Federal Reserve (Fed). The potential interest rate differential resulted in the recent outflow of funds seeking higher yields.

       In April, the ringgit has fallen 3.6% against the US dollar to trade at around 4.363 per US dollar at press time versus 4.204 at end-March. While a weak ringgit is a boon for exporters, imports become expensive and will affect households’ financial resources.

       Should Malaysia advocate a strong ringgit policy?

       AmBank’s Dass explains that there are many factors involved in currency trading.

       “It is rather complicated, so the answer isn’t exactly black and white. However, three crucial factors influence a currency’s strength – interest rates, economic policies and stability of the government,” he adds.

       In response to StarBizWeek’s query, Bank Negara says the ringgit exchange rate is market-determined. “Bank Negara’s stance is not to target or advocate for any specific levels of the ringgit. Fluctuations in the ringgit should be expected from time to time, in response to changes in the economic and financial environment, globally and domestically.

       “Rather, our policy aims to ensure orderly market conditions for the ringgit, which will enable the ringgit to adjust to the flow of ringgit demand and supply in the market. The flexibility of the ringgit is important to help the real economy adapt and withstand external shocks,’ the central bank says.

       Bank Negara

       It adds that rather than focusing on a specific ringgit policy, the priority should be on implementing structural reforms to strengthen the country’s growth potential and economic prospects.

       “This would make Malaysia a more attractive investment destination. As a consequence, the larger foreign direct investment and portfolio inflows, and higher output generated will naturally support the ringgit. We must therefore focus on building a stronger, more sustainable economy with improvement in living standards,” adds Bank Negara.

       Across the causeway, the Singapore dollar is considered one of the strongest currencies in the world. The city-state has a unique approach that uses the exchange rate to guide the Singapore dollar higher or lower. This is unlike most central banks, including Malaysia, that manage monetary policy through the interest rate. The Hong Kong Monetary Authority pegs the Hong Kong dollar against the US dollar, while the Brunei currency is pegged against Singapore dollar.

       The framework is centred on managing the exchange rate against a trade-weighted basket of currencies, which has worked well for Singapore in keeping inflation low and stable since its introduction in 1981.UOB Malaysia senior economist Julia Goh explains that the use of the exchange rate is deemed more effective for Singapore because it is a small and open economy.

       “Exports and imports account for more than 300% of gross domestic product (GDP) versus domestic demand that accounts for 70% of GDP,” she says.

       UOB Malaysia senior economist Julia Goh explains that the use of the exchange rate is deemed more effective for Singapore because it is a small and open economy.

       Additionally, Singapore has no natural resources and is dependent on imports for necessities like food and energy. Its import reliance is close to 160% of GDP. Being an international financial centre with a large offshore banking centre that deals with major currencies, it is also more susceptible to large and rapid movements of capital.

       This model, according to her, may not be appropriate for Malaysia for three reasons.

       Firstly is the structure of the economy. Malaysia’s exports and imports account for 130% of GDP, while domestic demand accounts for 93%.

       Secondly, it will require a sizable amount of official foreign reserves to effectively conduct foreign exchange (forex) intervention operations. As at mid-April, Bank Negara’s foreign reserves stood at US$114.4bil (RM499.13bil) versus Singapore’s US$381bil (RM1662.3bil). Thirdly, and perhaps most pertinent to the man on the street, she adds, is that a managed exchange rate policy reduces the scope for using interest rates as a tool.

       “Thus in the situation today, adopting a strong currency policy implies that Malaysia’s interest rates will have to rise in tandem with US Fed interest rates.

       “Given expectations that the Fed will be raising rates faster and higher this year by at least 2%, domestic rates would then be expected to increase by a similar magnitude if Malaysia adopted a strong ringgit policy, which we think is not suitable,” says Julia.

       Similarly, Bank Islam Malaysia Bhd chief economist Mohd Afzanizam Abdul Rashid says that targeting a specific level of exchange rate “may not do the trick” considering the various subsidies and price control mechanism in place, which may impede the transmission from the exchange rate to prices.

       OPR serves the purpose

       “So far, the overnight policy rate (OPR) is serving its purpose and Bank Negara would intervene in the forex market to smoothen any volatility,” he adds. However, he believes that the policy will continue to evolve. He recalls that in the 1980s, the country’s monetary policy was based on targeting the monetary aggregate or the money supply. But Malaysia was also connected to the outside world whereby international fund flows could come in and out from the system easily, the policy was then shifted to interest rate targeting in the 90s.

       From September 1998 to May 2005, the government imposed capital controls and pegged the ringgit at 3.8 per US dollar to counter currency attacks and sharp depreciation during the 1997-1998 Asian Financial Crisis (AFC).

       Back to the present, if the ringgit is set at a value that is different from what the markets expect, the currency will be subject to intense arbitrage trading, says Sunway University Business School economics professor Dr Yeah Kim Leng.

       This will likely invite speculative attacks that could ultimately drain the country’s foreign reserves as had happened to Thailand and South Korea when the central banks attempted to defend their currencies during the AFC.

       Market forces

       “Malaysia’s currency regime is classified as a ‘managed float’ system whereby the central bank only tries to dampen excessive fluctuations but not to set a particular level. However, the level or the value traded will be determined by market forces which are inherently prone to wide swings as well as prolonged periods of misalignments due to volatile market sentiments and confidence, noisy information and news, and economic uncertainties,” Yeah explains. AmBank’s Dass says that while higher interest rates can attract foreign capital, and strengthen the ringgit performance, it could hurt businesses and households, which are recovering from the impact of the Covid-19 pandemic.

       “With the manner of the US Fed’s aggressive monetary policy tightening, Malaysia may risk falling into the aggressive tightening should we continue to suffer from the interest rate differential that is taking a toll on the weakening ringgit,” he adds.

       Hypothetically speaking, he says a strong ringgit policy is not impossible, “but would need bold and radical measures across the board with strong discipline”.

       The big picture

       In the bigger scheme of things, since a currency value reflects the country’s growth potential, it is imperative that the recovery momentum, which was relatively weak in 2021 be strengthened to exceed market expectations for this year, say economists.

       “A positive surprise will underpin the rise in ringgit value. If inflation can be lower than 2% to 3%, the ringgit will more likely appreciate against the currencies of countries facing high inflation especially the United States and Europe,” says Yeah. He adds that if the inflation differential is not wide enough, then interest rates may need to be raised to keep pace. If foreign exchange earnings continue to rise due to high crude palm oil and crude oil prices, then the ringgit is expected to retrace its loss value due to global risk aversion and foreign capital outflows.

       Non-economic factors also have an outsized influence on currency sentiments and confidence.

       “Hence, if political instability, policy uncertainties and other confidence shaking factors such as corruption scandals and lapses in governance and administrative competency are lessened, the ringgit will better reflect the country’s underlying fundamentals and not be as under-valued as in the present situation,” Yeah adds.

       UOB’s Julia says despite the weakness in ringgit, Malaysia’s fundamentals remain strong with a positive growth outlook this year supported by the transition to endemicity, reopening of international borders, and further normalisation of domestic demand.