Saturday, April 24, 2010

Malaysia Ringgit still have upside, but likely be limited

The ringgit had a spectacular performance this year. It was the best performer among regional peers by strengthening 6.6% year-to-date against the USD. The second best performer was India Rupee which strengthened by 4.5% against USD, followed by Korea Won and Indonesian Rupiah which rose by 4.2% and 4.1% respectively against USD.

There were several factors which contributed to the stellar performance of the ringgit. Amongst them include Malaysia’s better than expected economic recovery, the central bank’s monetary tightening policies, the New Economic Model (NEM), speculation on revaluation of China’s yuan coupled with speculative funds inflow into Malaysia’s financial system.

Ringgit supported by firm economic fundamentals

The ringgit was supported by Malaysia’s stronger economic fundamentals, as evidenced by the recent economic statistical releases. Malaysia’s economy showed a significant turnaround in 4Q 2009. Its 4Q 2009 GDP beat analysts’ estimates considerably by posting a 4.5% year-on-year growth, backed by improving external and domestic demand. Macroeconomic numbers are improving as well, with exports and manufacturing sales seeing double-digit growth. In addition, MIER’s (Malaysia’s Institute of Economic Research) CSI (Consumer Sentiments Index) and BCI (Business Conditions Index) continued to trend upwards by rising for the third and fourth consecutive quarter respectively in 1Q 2010, indicating brighter days ahead for private expenditure, which will be driving the economy this year.

In conjunction with the optimistic economic recovery, the central bank started tightening its monetary policy by hiking OPR (Overnight Policy Rate) by 25 basis points on 4th Mar 2010 to 2.25%. This was later followed by the unveiling of the NEM (New Economic Model) on 30th Mar 2010 which proposed economic reforms aimed at alleviating Malaysia into a high income economy. Both have somewhat influenced the recent surge in the ringgit.

China’s yuan appreciation could further strengthen the ringgit

Speculation of China’s yuan revaluation further added to the strength of Asian currencies, including the ringgit. Pressure on China’s yuan revaluation is mounting as global imbalances resurface again, caused by faster economic growth in the Asian region as compared to the developed nations amidst a recovering world economy. As a result, the US and European countries are blaming Asian countries, especially China, for suppressing the strength of their currencies to give their exports an unfair cost advantage. In the recent Nuclear Summit held in Washington, US President Barack Obama once again urged China to let the yuan rise at a faster pace.

A higher yuan could actually spell good times for the Asian currencies. Historical data has shown that Asian currencies actually benefitted from yuan appreciation, mainly due to China’s rising position as a major trading partner among the Asian countries. To recap, Chinese government allowed its yuan to appreciate against USD in July 2005. The yuan had since appreciated by 1.6% over the next twelve months, giving rise to the appreciation of Asian currencies. Consequently, the Singapore dollar, Indonesian rupiah and Malaysian ringgit appreciated by 5.1%, 7.0% and 2.7% respectively during the same period.

Further appreciation in the ringgit on cards, but upside will be limited

The uptrend of the ringgit is likely to remain intact over the next six months as the ringgit appears undervalued. Based on The Economist’s Big Mac Index published on 17 March, it suggested that the ringgit is the second most undervalued currency under its coverage as the ringgit is still 40.8% below its fair value benchmark against the USD. In addition, the ringgit seems undervalued based on analysts' REER (Real Effective Exchange Rate) for the ringgit. As such, there is a high likelihood for the ringgit to appreciate further.

In addition, the ringgit will be supported by the widening interest rate differential between Malaysia and the US as Bank Negara is expected to hike OPR possibly by another 50 basis points by the end of 2010 while US Fed is likely to retain interest rates at low levels for an extended period of time. This could lead to higher capital inflows, thus supporting the ringgit.

Nonetheless, the ringgit’s upside might be somewhat limited. Malaysia being an export-oriented economy could be hurt by a surging ringgit. This is in addition to the resultant capital inflows which could lead to imbalances in pricing of certain asset classes. In view of this, the central bank might intervene to limit gains in the ringgit to ensure Malaysia’s exports remain competitive and prevent any asset bubbles from occurring. Consequently, any gains in the ringgit should be modest, which is in line with consensus view that the ringgit will hover at around 3.15 to 3.24 level against USD in the next six months. One way to monitor the intervention by the central bank is to look at the international reserves which should increase if the central bank wants to absorb the upward pressure on the ringgit.

Mixed effects on equities from higher ringgit. Economy to benefit?

Overall, a higher ringgit has mixed effects on Malaysian equities. On one hand, a higher ringgit environment will benefit sectors like automotive and food producers which have lower costs of imports while utilities companies such as Tenaga Nasional could benefit owing to its sizeable foreign debt coupled with lower coal costs. On the other hand, exporters such as glove manufacturers, E&E (Electrical & electronic) manufacturers and plantation companies might be adversely affected by the higher ringgit. Having said that, glove manufacturers at the moment seem to be able to pass the higher costs to the customers owing to the rising demand for gloves. As for plantation companies, they could have a natural hedge against forex risks as imports of fertilizers from overseas will be cheaper which could offset the higher palm oil export prices.

Notwithstanding its effects on the equities, a higher domestic currency could actually help Malaysia to move its economy to a higher growth path focused on knowledge and value-adding in addition to attracting foreign talents and retaining local ones. In view of this, a higher ringgit seems to fit in well with NEM’s objective to move Malaysia into a high-income economy. However, this is still dependent on the government's ability to see through their intended economic reforms.

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