Most nations have experienced turmoil since the early months of 2020. But in Malaysia, this has been exacerbated by political divisions as wide as the 400 or so miles separating the two regions that form this Southeast Asian country.
At the conclusion of their latest consultation with Malaysia, the International Monetary Fund (IMF) executive board referred to Malaysia’s well-coordinated policy response to coronavirus. However, they also highlighted the potential for domestic policy uncertainty to dampen business confidence and investment.
The resignation of former prime minister Muhyiddin Yassin in August was merely the culmination of a period during which a ruling coalition cobbled together from across the political spectrum fell apart amid claims of poor governance.
A new way of thinking needed
This sentiment was summed up in a single sentence in the July 2021 report Exit and Rebuild: a need for a focused strategy from Malaysian think tank IMAN Research – “we need a new way of thinking on public policy”.
This cautious positivity has been maintained according to Saizi Xiao, a research fellow at the Malaysian Institute of Economic Research (MIER). “Between January and August the ringgit depreciated more than 5% against USD,” she says.
“However, since the government lifted the restriction on interstate travel it has climbed approximately 2% due to the rebound in the economy and improved Covid-19 management.”
Political instability affected the MYR
Jeffrey Halley, Asia-Pacific senior market analyst at Oanda agrees that political instability has been a headwind for the ringgit in 2021, but reckons its impact has been felt more acutely in equity and bond markets than foreign exchange ones and describes the double-dip virus induced recession and stronger US dollar as more telling factors.
He credits the Malaysian king for easing the political crisis, suggesting that he “knocked heads together in parliament and told MPs (members of parliament) to do their job for the country instead of chasing their own selfish agendas.”
Despite the political turmoil during the early parts of 2021, the USD/MYR has moved in line with US Dollar Index and JP Morgan’s Asian Dollar Index, suggesting the ringgit’s weakness against the greenback is more of a result of a strengthening US dollar from higher rates expectations.
MYR up against Asean FX
That is the view of Mingze Wu, FX trader at StoneX’s global payments division, who notes that the ringgit has also not moved significantly from its neighbours Singapore dollar and Indonesian rupiah and even has strengthened against Thai baht on a year-to-date basis.
Stronger commodity prices and the strength of the US dollar are beneficial to the Malaysian government’s current account, which is largely funded by revenue from Petronas.
This allowed the government to announce the largest budget (in ringgit terms) in recent history, supported by a bipartisan deal with the main opposition coalition which means parliament cannot be dissolved before the end of July 2022.
Despite this budgetary largesse, the fiscal deficit is expected to shrink from 6.5 to 6% of gross domestic product and revenue is expected to increase even as the federal government provides additional tax reliefs to individuals and businesses. On top of tax relief, the government is expanding financial support programmes for house purchases and microloans for businesses.
Government takes an expansionary approach
All these expansionary policies will help to push Malaysian assets higher and increase economic activities, says Wu.
“The fall in the Kuala Lumpur Composite Index [following the publication of the budget] could be a reflection of market participants not convinced of the feasibility of the federal government’s plan, or simply a function of funds choosing to exit higher risk Asian markets and re-entering the US to partake in yet another stupendous bull run in S&P and DJIA,” he says.
“Nonetheless, if the Malaysian government manages to hit its budget targets the net impact on the economy will undoubtedly be bullish in the long run,” adds Wu.
As noted above, the fiscal 2022 budget prompted a 31 point fall on the Malaysian bourse as investors evaluated the government’s proposals - which include the implementation of a special one-off tax on companies that report annual taxable income of more than MYR100m.
Big spending budget
“Banks and large plantation companies appear to be the most significant targets of this prosperity tax,” says MIER’s Xiao. “However, I think this negative reaction might be cushioned by the economic recovery and increases in commodity prices.”
According to Halley, currency markets were largely unmoved by the measures announced.
“Although the big-spending budget will deteriorate state financials and thus be a negative for the MYR, the currency has found new vigour as a recovery play as it emerges from the depths of the delta variant wave,” he says. “More importantly, the huge run-up in commodity prices - notably oil and gas, but also palm oil - has created a positive inflow into the current account.”
Halley reckons both Malaysia and Indonesia should continue benefitting from this state of play into the first quarter of next year.
Malaysia looks to deepen FX markets
The IMF executive board also referenced the country’s continued efforts to deepen domestic FX markets through the expanded availability of hedging instruments and other initiatives and encouraged the authorities to continue allowing the exchange rate to cushion shocks to the economy.
With crude oil prices at a seven year high and Covid cases having fallen by almost 80% since late August, Xiao expects the MYR/USD to strengthen towards 4.1% over the remainder of 2021.
Julia Goh, senior economist UOB Malaysia, is more circumspect though, despite acknowledging that high oil prices may start to be a tailwind for the Malaysian ringgit and offset some of the depreciation pressure brought about by the US Federal Reserve’s monetary normalisation process.
“Together with the reopening of the Malaysian economy gaining pace, downside risks to the MYR are reduced,” she says. “As such, while we continue to expect MYR weakness we have lowered our USD/MYR forecasts to 4.18 in 4Q21 (fourth quarter of 2021), 4.20 in 1Q22, 4.23 in 2Q22 and 4.25 in 3Q22.”
US policy critical to MYR
In addition to electronics, the ringgit is favourably linked to demand for crude oil and palm oil. But Halley reckons the commodity boom will only provide a limited amount of support to the ringgit.
While accepting that the reopening of international borders is a supportive factor, he agrees that the ringgit - and the other ASEAN currencies, which he suggests are often viewed in isolation rather than as a group - are highly sensitive to the direction of US monetary policy.
“With interest rates at record lows, any indication of a tightening stance by the Federal Reserve will be a heavy weight to bear for the MYR and regional currencies as a whole,” adds Halley. “If expectations on US monetary policy lead to higher US yields and a stronger dollar, the MYR will certainly fall with USD/MYR potentially testing 4.25 into the year-end.”
The boom in commodity prices should support the ringgit against sharp declines as exporters will always be looking out for levels to hedge or convert their US dollars. However, Wu agrees that the broad trend is still at the mercy of the US dollar’s direction and that will be the bigger determinant of where the exchange rates end up by the end of the year.
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