There’s quite a bit of gloom in the air these last few weeks. The plunge in oil and other commodity prices, capital pulling out of emerging markets, and currency turmoil, have people getting very worried about growth prospects next year. There doesn’t appear to be a bottom yet on oil prices, and it’s anybody’s guess where all this will end up.
In Malaysia’s case, oil price depreciation and Ringgit depreciation seems like one piling on the other – the latter is making things worse (Malaysians feel relatively poorer), on top of the drop in oil and gas revenues. But conflating the two like this is wrong. The depreciation of the currency is in fact a required and necessary result of the drop in oil prices.
If the Ringgit had stayed where it had been (about MYR3.20-3.30 to the USD), the full drop in oil prices would have been transmitted directly and with full force into the domestic economy. The approximate 8% depreciation of the Ringgit over the past few months partially mitigates that income shock. Since sales of oil (and gas) are denominated in USD terms on the international markets, a cheaper Ringgit partially cushions the revenue drop in local currency terms.
Consider that oil & gas make up about 20% of Malaysian exports; commodities as a whole about a third. That means that the drop in oil prices and the depreciation of the Ringgit have been nearly symmetrical. If anything, the Ringgit hasn’t dropped far enough – my estimate is that it should be at least 3%-5% weaker. Or to put it another way, the Ringgit is rather counter-intuitively, stronger than it should be. Or not – 80% of Malaysia’s oil & gas exports are either LNG or downstream petroleum products, which are less sensitive to crude oil prices or only follow with a substantial lag.
Note also that the NEER (nominal effective exchange rate for the uninitiated) has not dropped anywhere near as much as the USDMYR (USDMYR and NEER indexes; 2000=100):
That suggests the last few months currency action has largely been a USD movement rather than weakness in the MYR.
There’s also the flip side that the lower Ringgit should in theory provide a boost to non-commodity exports. In this case though, I’m a bit leery of depending on this as global demand growth outside the US and UK is pretty weak, and because again this is largely a case of Dollar strength more than Ringgit weakness.
The last point I want to raise is this: Bank Negara’s international reserves have been slowly declining over the last few months (RM billion):
Some have been interpreting this as central bank intervention to support the Ringgit value. (As an aside, reserves actually rose in October; don’t sweat it, BNM marks its reserves to market every quarter, and a decline in the Ringgit would boost reserves in local currency terms). My view is a little more nuanced – the drop in reserves is just too small to make that conclusion (change in reserves as ratio to FX turnover 2000-2014):
Contrasted with the pegged FX regime of the early ‘00s, reserve movements over the past four years are just too minor to affect the FX market. Rather, what I think is going on here is that BNM is simply trying to ensure that there’s enough USD (and other currency) liquidity in the interbank market to ensure, in their words, “orderly” market conditions.
From a practical perspective, I think they’re targeting the USD bid-offer spread rather than the level of the Ringgit. For the layman, what this boils down to is this: you are able to buy any currency you want, without the banks or money changers gouging you (too much) on the difference between buying and selling prices. Alternatively, it could be viewed as they’re simply supplying USD to the market if the banks start running short.
The bottom line is that BNM is not and will not be “defending” any level of the Ringgit. And if they’re not willing to spend reserves on it, you can forget the interest rate defense (which doesn’t work anyway).