Stable currency is a must for the economy
The weakening of currency goes beyond costlier overseas holidays or foreign brands.
THE 1997 Asian Financial Crisis (AFC) was especially painful for the baby boomers. Whenever the topic of economic crisis is brought up in conversations, most would agree that the AFC is the worst our country has ever seen. Although two decades have since passed, the traumatic experience remains deeply seared in the mind of those who have been through the tumultuous period.
One of the hallmark moments from the AFC was the record plunge of ringgit from RM2.50 to RM4.88 against the US dollar, the lowest level that ringgit has recorded in history even till today. The consequence of this was the slew of rating downgrades and sell-off of stocks with the composite index of the then the Kuala Lumpur Stock Exchange plunging to a low of 262 points on Sept 1, 1998. This ultimately led to a series of currency control measures including the pegging of the ringgit at 3.80 against the US dollar by then Prime Minister Tun Dr Mahathir Mohamad.
We must remember that the crux of the AFC was due to highly leverage economies with large foreign denominated debts but without sufficient foreign reserves. When the foreign funds started to pull out from the region, it kickstarted a series of defaults by corporates and governments.
Coupled with massive devaluation of currency within a short span of time, the economy collapsed and spiralled out of control. This episode signified the importance of stability for a country’s currency in the context of its economic health.
Implications of a weak ringgit
With our currency making new lows, chorus of dissatisfactions can be heard daily. The weakening of currency goes beyond costlier overseas holidays or foreign brands. These are first world problems. My concern with a weak and volatile currency has always been about the deeper structural impact to the economy as a whole. With a weak currency, it brings forth imported inflation.
A good instance is the poultry sector. In my conversation with the board member of a listed poultry company, as chickens are controlled item with a ceiling price, whenever the exchange rate of ringgit against US dollar goes above RM4.20, they would face substantial cost pressure due to the high cost of feed.
The only way to alleviate the cost pressure is either through support by the government via subsidy programme or allowing the increase of ceiling price.
Otherwise, not only profit margins will be eroded, losses becomes an eventuality. At today’s exchange rate, if the government did not support the sector, many of these poultry players probably would have gone out of business.
On the debt side, during a period of foreign exchange weakness, borrowings or bonds denominated in foreign currency are detrimental to companies. When the cost of financing increases sharply, it impacts cashflow of companies.
Much of the revenue will go towards repaying loans and debts rather than productive investments or business expansion. This in turn affects growth of businesses, affect employment, and potentially lead to defaults. It is a vicious cycle.
Factors affecting the currency
With all these said, what then are the reasons contributing to a weak ringgit? We have read conflicting views which argue that our ringgit is only weaker to the US dollar and Singapore dollar but stronger against other basket of currencies such as yen, euro, British pound amongst others.
The explanation given by proponents of such view is the hawkish US Federal Reserve which is bent on increasing interest rates substantially within the next six months until it reaches a terminal rate of 4.6%.
They argue that ringgit is only weak because our interest rate did not match the pace of US rate hike.
However, it is important to note that ringgit has been on a prolonged declined not only in the past one year but since 2014 following the oil crash.
What does this mean? In fact, this highlights the problem of our currency cannot be solely attributed to US rate hike alone. There are varying number of reasons including our country’s increasing debt level (fiscal deficit has grown from 3% to 4% to 6% to 7% in the past two years), foreign fund outflow and decreasing domestic direct investments.
Fund flow and demand
A currency’s strength has always been a good indicator of fund movements. It all comes down to the supply and demand.
Unlike the United States where quantitative easing such as printing money is an easy task due to US dollar’s high demand and global acceptance as a choice reserve currency, the ringgit do not enjoy such luxury.
So, the supply of ringgit is not something we can easily tamper with.
Hence, our policymakers have always focused on the demand side of the ringgit such as encouraging foreign direct investments and tourism.
The two have always been the low hanging fruit with direct correlation to improving currency strength.
The problem arises when Malaysia started to lose it allure as the main foreign direct investment (FDI) and tourism destination in South-east Asia.
Regional countries have been working hard to fight for FDI and tourism income over the years and I must say, the landscape is far more competitive today compared with the 1990s.
The rise of countries like Vietnam, Indonesia and Thailand have redirected fund flows which would otherwise land in our shores. This scenario did not happen only in the past two years, thus it is imperative for us to ask ourselves why.
Is our country’s economy losing competitiveness or our regional peers stepping up? Being business-friendly has always been a strong boon for Malaysia and if being business-friendly isn’t enough, what other policy measures should we adopt to enhance our attractiveness?
Domestic direct investments
Based on the data from Malaysian Investment Development Authority, our country’s domestic direct investments (DDIS) have continuously decline for the past eight years.
At its peak in 2014 where DDIS hit Rm175.1bil, they have declined every single year since and arrived at Rm98mil in 2021.
Emphasis are often placed on FDI but our country’s FDI quantum have always been within the stable range of Rm60bil to Rm70bil per annum. It is the DDI that our government has yet to be able to arrest in terms of its decline.
The DDI decline shows the lack of confidence by local businesses which refuse to increase their investments by reinvesting profits into the local economy.
In fact, it may also represent an underlying trend where profits and income from local businesses are being moved abroad and away from our domestic economy.
While in the near term we are not able to control the movement of currencies due to larger macroeconomic forces at play, it is crucial for us to address the structural issues plaguing our country.
Budget 2023 is less than one week away. We have always known that a populist budget is not in the best interest for the development of the country.
With an increasing fiscal deficit due to rising operating expenditure and debt servicing instead of development expenditure, herein lies the crux of the problem caused by archaic economy policies.
To turn things around, we need policymakers who have the courage to recognise the problem and address it head on instead of kicking the can down the road for the sake of political expediency.
Currency and economic health
As I run my own business, my friends frequently remark how fortunate I am to have not witnessed the AFC first hand. I supposed there is much truth to it.
Even though the stock market has been on a downtrend since the peak of the FBM KLCI at 1,874 points in June 2014 and the property market remains in a doldrum, the economic health is still a far cry from the depressed levels of 1997/98. Yet, in comparison to many markets regionally, the lack of progress and growth is indeed worrying.
A currency performance may not paint the full picture of a country’s economic health but there is no doubt a direct correlation between a healthy economy and sustained currency strength. If there is sustained strength in a currency, it simply means there is sustained demand. The demand of a country’s currency goes a long way in building reserves. So, there is absolutely no incentive to ignore prolonged weakness in a currency. A stable currency is a must for the economy.
Quoting Steve Forbes from the recent Forbes Global CEO Conference 2022 held in Singapore: “The real cure is to stabilise the currency. You don’t have to make people poor to conquer inflation.”