RECENTLY, currencies across Turkey, India, South Africa, Indonesia and Malaysia have depreciated upon tapering and, eventually, the end of easy money from the US Federal Reserve’s quantitative easing programme (QE). Some of the money from the QE flew into emerging markets as these countries recovered earlier from the global crisis. That money has since flown back home to a buoyant economy and stock market.
Such is the nature of hot-money streams that they flow in search of better returns only to leave the host countries in a pickle upon exit. This year alone capital flight has caused the ringgit to depreciate against the US dollar by as much as 15 per cent — a five-year low; not to mention the pounding our financial markets have taken.
A falling currency leaves borrowers to fork out more of their currency to meet dollar-denominated debt. Foreigners hold about 50 per cent of Malaysia’s government bond — an exceptionally high figure among emerging markets in Asia. It places the ringgit in a vulnerable position.
To protect against a further depreciation of their currencies, Nigeria, Indonesia, Turkey, India and South Africa have hiked their interest rates this year. The heavier reliance on crude oil for 75 per cent of government revenue and 95 per cent of exports yawns Nigeria’s budget hole ever deeper given the 40 per cent drop in crude oil prices this year. The widening budget deficit will in turn put greater pressure on its naira even as Nigeria’s central bank draws down heavily its foreign reserves to contain the 10 per cent fall against the US dollar. With foreign reserves down more than 50 per cent since its open market operations, Nigeria’s central bank had to increase its interest rate to 13 per cent this year to check niara’s slide.
Similarly, in Indonesia a 30 per cent hike in fuel prices, after fuel subsidies were partially removed, saw inflation climb from 4.8 per cent to 6.2 per cent last month causing the rupiah to depreciate some 6 per cent. That depreciation and expectation of inflation hitting 8 per cent by the year-end triggered an increase in the benchmark interest rate to 7.75 per cent last month. Are the circumstances similar in Malaysia to warrant Bank Negara Malaysia to increase its benchmark interest rate?
We have had fiscal deficits for the past 16 years. With 30 per cent of government revenue coming from oil, the 40 per cent fall in oil prices will effectively reduce oil revenues by some RM25 billion. It will, therefore, totally wipe out the RM18 billion savings from removing fuel subsidies. And it will surely dent the government’s efforts at reducing the fiscal deficit to 3.5 per cent of GDP this year.
If we were to incur a trade deficit as well, we might risk further capital flight which would further depreciate the ringgit. Such was the case with India and Indonesia in 2013. Their twin deficits (budget and trade) caused a massive pummelling of their financial markets and currencies as investors withdrew their investments as they deemed these countries to be structurally weak.
Our weakened ringgit would raise the cost of imports and encourage Malaysians to substitute locally produced goods and services for imported ones. It will also stimulate exports thereby enlarging the trade surplus. However, this positive impact may not come about for three reasons.
FIRST, quantitative easing and zero or reduced interest rates of our key trading partners — EU, China, South Korea and Japan — will depreciate their currencies further. It will negate the benefits accruing from our ringgit depreciation by making our exports relatively uncompetitive and our imports less expensive. Further, their stalling or deflating economies do not inspire strong demand for our exports.
SECOND, falling oil prices are a boon for the country’s trade balance, as Malaysia imports about RM26 billion annually of crude oil and petroleum products. However, the sharply depreciated ringgit will trim these savings from cheaper imports.
THIRD, the sharp crude oil price fall will reduce our earnings from oil exports which comprise one-fifth of Malaysia’s exports.
Combined, the whole impact is estimated to shave RM1.5 billion off the trade surplus and, all else being the same, reduce that surplus to RM6 billion in the fourth quarter of 2014 — the smallest gap since June 2013. And, if oil prices continue to fall (especially if sanctions against Iran are lifted) or remain depressed at the US$75 level for a year or so as forecasts suggest it would, the risk of twin deficits will loom even larger.
India and Indonesia have reversed their capital flight this year with interest rate rises. Bank Negara could do likewise to staunch capital outflow, arrest the slide of the ringgit and check inflation from ringgit depreciation. With the US expected to increase its interest rate in 2015, inaction by Bank Negara might invite further, and perhaps, heavier selling of the ringgit.
But then, should Bank Negara act? How much more can the ringgit fall? A small interest-rate increase to boost the ringgit would not do much to persuade foreign investors to keep their money in Malaysia. A strategy to build confidence in the ringgit by open market operations (selling more US dollars) can work for a country like India or Brazil. These countries have significant foreign exchange reserves that are nearly three times that of Malaysia.
The economy is fundamentally strong. It will grow stronger should commodity prices including that of oil, rise. We are not as reliant on oil as Nigeria. So, we can weather the fall in crude oil prices. At 3 per cent, inflation is tame although the GST will cause a one-off price spike in 2015. That is not a worry as the spike eventually will fizzle out as the GST withdraws money from the economy. The GST will enrich the government coffers by a net RM5 billion after discounting the loss from sales and services taxes.
To appreciate the ringgit when other currencies of our regional neighbours are depreciating may hurt our exports. Bank Negara had increased its benchmark interest rate to 3.25 per cent in July this year. To hike it up again will dampen our growth.
It is best that Bank Negara do nothing for now.