This article first appeared in Forum, The Edge Malaysia Weekly on November 20, 2023 – November 26, 2023
As the country struggles with how to bring the value of the ringgit to an appropriate level, it is worth noting that the fight may be impossible in the current circumstances. Something big has to change.
The ringgit against the US dollar, the world’s most prevalent currency in terms of trade and usage, is down 8% or so for the year. Against neighbouring Singapore’s currency, the ringgit is down 6% or thereabouts. We are seeing the ringgit at multiyear lows right now. Both are huge movements, and as for the Singapore dollar, many older folk remember the time when the ringgit and Singapore dollar hit parity. How things have changed.
Is the US dollar overvalued against the ringgit? Well, here we come into some rather obscure valuation models, most of which have been proven to be as reliable and accurate as a wild guess. At the core of it all are the differences in interest rates between the two currencies. Malaysia’s key rate, the overnight policy rate (OPR) stands at 3%, whereas the US Federal Reserve’s (Fed) funds rate stands at 5.5%.
Based on interest rate parity calculations, which is the most used method of calculating forward foreign exchange rates by banks globally, with Malaysian interest rates at 3% and the US at 5.5%, and a spot rate of RM4.73 per USD, parity should be at around RM4.62 per USD. This implies an element of overbuying, and if one works backwards, then at RM4.73 per USD, the market has apparently factored in a US interest rate that is substantially higher, obviously expecting more interest rate hikes for the US in the future. (See our paper “How low can the Malaysian ringgit go” on our website for reference.)
Can Malaysia simply buat bodoh and ignore it? Buat bodoh, or simply acting dumb, is a typical human reaction when faced with unpleasant situations or questions. One can’t. The economic world continues to revolve around us and if we want to be an ostrich, well, the world will change without our participation, and clearly without our permission. We need to unsheathe our keris and join in the ongoing battle.
What are the forces that are involved? There is a model that captures this and, unsurprisingly, it is the main model used by the International Monetary Fund (IMF) in making decisions. It is also the main theoretical model for the formation of the European Union (EU) and it forms the general framework for economic policy there.
The model, called the Mundell-Fleming model, is a development of the IS-LM (investment-saving [IS] and liquidity preference-money supply [LM]) model that charts the balances of the money market, including currency markets (LM) and goods and services market (IS) based on a combination of interest rates and income. The IS-LM model is often called the General Equilibrium Model. Added to this IS-LM model is the BP, or balance of payments curve, that turns it into the Mundell-Fleming Model.
The IS-LM-BP model (what the Mundell-Fleming model is technically known as) gets very flexible and complicated from that point on. For a small, open economy like Malaysia’s, it states that we cannot have a deviation in interest rates against the “world” interest rate (for ease of reference, the US interest rates can be considered the world’s, given that its currency is the most dominant globally), or capital will flow out of Malaysia and the ringgit’s value will drop. This is the simple truth that Malaysia has to struggle against at all times.
The conundrum Malaysia is faced with is that there is little need to raise its interest rates, currently at 3% OPR, as inflation is at 1.9%. Whereas for the US, its interest rate is at 5.5% and inflation currently at 3.7%. America is in the starting phase of a stagflationary period, with the last one lasting from 1972 to 1987. Its interest rate hit a high of 18.9% and inflation was at 13.6% in 1980. Gross domestic product (GDP) was up 1.6%. Mind-boggling to economists was how strong inflation and economic growth was despite the stratospheric interest rates level. GDP did fall the following year (to -2.9%) but it took three years before inflation fell to 3.21%. This is most probably the scenario the Fed is looking at now.
The big question is, what is Malaysia going to do, and if it decides to do nothing, how low would it allow the ringgit to fall against the US dollar? We would be looking at a rate of more than RM5 per USD if Malaysia plays ostrich. Don’t forget the imported inflation spectre for Malaysia lurking thereabouts.
The ringgit certainly needs a champion, and there can be no fitter champion than Bank Negara Malaysia. One is, however, befuddled by the sparsity of market actions by the central bank. Instead, we have been stoically assured that the central bank will act to ensure an orderly market, whatever that means, given the volatility observed. Economics aims for stability, after all. Perhaps, the real reason is that Bank Negara is hamstrung by the provisions of the Central Bank Act of 2009, that provides for, where foreign exchange is concerned:
1. (a) to formulate and conduct monetary policy in Malaysia;
4. (d) to provide oversight over money and foreign exchange markets;
7. (g) to hold and manage the foreign reserves of Malaysia; and
8. (h) to promote an exchange rate regime consistent with the fundamentals of the economy.
From here one can see that foreign exchange is referred to several times in the Act, but only in the most general terms. Indeed, it is not even tied to anything else, and leaves too much room for wide interpretation.
Perhaps it is time to change that into one that ascribes a targeted, benchmark measurement in its objectives. The European Central Bank (ECB), perhaps the most recent central bank to be set up globally, managing an entire system of national central banks (some 27 of them in the eurozone), has the maintenance of price stability as its objective (and not financial or monetary stability like in Malaysia). That objective is an overriding one, over support of general economic policies, over working within an open market economy with free competition, and over favouring an efficient allocation of resources.
Needless to say, the euro is managed to ensure inflation does not go on a roller-coaster ride. The ECB’s objective is simply and famously, an inflation rate of 2%.
That, at the end of the day, is why there is so much worry over the volatility of the exchange rate, that imported inflation makes life miserable for the rakyat.
Huzaime Hamid is chairman and CEO of Ingenium Advisors, Malaysia’s financial macroeconomics advisory
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