Obviously, while the ringgit is in a broad downtrend over the long term, there are periods where it strengthens, driven by short-term factors such as differences in timing of economic cycles, interest rate differentials and investor confidence. For instance, over the long term, there is a close positive correlation between Malaysia’s current account balance (as a percentage of GDP) — that tracks import-export of goods and services as well as net investment income — and the value of the ringgit (against the US dollar). But the sharp depreciation since mid-2022 was driven by narrowing interest rate differentials between ringgit and US dollar deposits (the US Federal Reserve raised interest rate by much more than Bank Negara Malaysia). Back in around 2014-2015, the steep devaluation of the ringgit was due to 1MDB, as the scope of the corruption scandal became increasingly clear. Billions of ringgit were stolen from the country, which must be repaid, weakening Malaysia’s balance sheet. (See Chart)
That’s why we also wrote that the ringgit could rebound in the near term in a sidebar article back in March (see Flashback), due to short-term factors. But to reverse the secular decline, there must be policies to address the underlying structural issues.
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Some of these short-term factors have since come to pass. Although the trade balance has yet to improve (exports are higher but then so are imports), current account surplus was sharply higher in 1Q2024, thanks to the strong recovery in tourist arrivals. Foreign direct investment (FDI) too has risen, underpinned by digital investments notably in data centres and the result of trade diversion from China. The ringgit’s improvement is also due, in part, to a reversal in domestic deposits held in foreign currencies, which have fallen slightly from the recent peak in March 2024 on encouragement from the government to repatriate and convert foreign earnings into ringgit. Though there is a limit on such policy intervention.
And most critically, there are now growing expectations that the Fed will make its first interest rate cut in September, bolstered by evidence of cooling US economy and inflation. Higher unemployment rate, 4.1% in June, decline in job openings and slowing wage growth all point to a labour market that is coming off the boil. This raises the downside risks to the economy and, thus, the odds of lower interest rates. The Fed has two mandates — maintain stable prices and full employment. This, perhaps more than any other factor, is what’s driving the latest bout of ringgit strength, or rather the US dollar weakness. The US Dollar Index, which tracks the strength of the greenback against a basket of major currencies, is off its recent peak.
Therefore, whether the ringgit can continue to strengthen against the US dollar in the near term depends on how fast and deep the Fed cuts interest rate — and whether Bank Negara keeps its overnight policy rate (OPR) unchanged. When the Fed begins cutting, it will give room for other central banks to follow suit. Lowering the OPR will, of course, provide relief to indebted households and businesses — but also offsets the positive impact from the Fed’s rate cuts on the ringgit. As we said, every decision in life involves a trade-off.
In any case, as we explained, interest rate differential is but a short-term factor. To reverse the ringgit’s secular decline, there must be real economic structural and political reforms. Trade competitiveness (that will lead to sustainably higher wages and income levels) must be underpinned by continuous productivity gains at a rate that is at least comparable with competitors. This can be achieved by reducing the cost of doing business, especially for MSME (micro, small and medium enterprises) — remove rent-seeking, minimise leakages, wastages and corruption. Improving the education system will raise the knowledge and skill set of the workforce required for them to move up the value chain. And ending state capture will create an environment that fosters fair competition and spurs entrepreneurship and importantly, indigenous (as opposed to imported) innovation.
We have read narratives proclaiming Malaysia’s significant economic reforms and improved economic outlook. There’s no better time to fact check that.
Fiscal discipline or bigger budget deficit?
The most obvious fiscal reform, so far, has been the rollback of diesel subsidies. The effort is estimated to save RM4 billion, mainly from clamping down on smuggling after netting off the many hand-backs for transport and logistic businesses (to minimise cost inflation) and cash assistance for low-income households. Case in point, the government just announced an additional RM100 million allocation to Felda to cover higher operating costs due to diesel. Even so, we are still seeing some inflationary impact, for instance, prices for construction materials are reportedly up 30%. The full impact will become clearer over the coming months.
At the same time though, the government also announced a “highest ever” increment (>13%) for civil servants (starting December 2024), that is estimated to add RM10 billion to emolument expenditure, which already accounts for about a quarter of the total annual budget. Emoluments and retirement charges were sharply higher in 1Q2024 compared to the previous corresponding period.
The government has also implemented several new taxes, including the low-value goods and luxury goods taxes and capital gains tax, and raised the tax rate for selected services — to diversify its tax base. Even so, tax revenue is down 8.2% y-o-y in 1Q2024, despite the 4.2% GDP growth, dragged down by lower corporate, individual and petroleum tax receipts.
Much of the higher taxes are being borne by consumers. Some 3.16 million Employees Provident Fund (EPF) members (24.3% of total members under the age of 55) have chosen to withdraw RM7.8 billion from Account 3 in the first six weeks since the restructuring of the EPF accounts — suggesting households (especially the middle class) are struggling to cope with rising living costs. Inflation would no doubt be worse when subsidies for petrol are removed — planned but not yet announced. The subsidy removal for petrol is expected to have a substantially larger impact on inflation than that of diesel.
One major problem is that past FDI were overly focused on labour intensive, low-skill low value-added manufacturing. There was little knowledge and technology transfers from the foreign-owned ventures and limited domestic economic linkages. It bears mentioning that data centres, in itself, are low quality investments with low value-added and creates few jobs — aside from the spillover construction activities at the outset — though they are critical to enable the digital transformation in enterprises. In other words, the real value-added effects — and higher paying jobs — will only come from follow-through investments and R&D, whether in terms of cost savings from higher productivity or innovation from new products and applications. If and when this materialises remains to be seen.
We have already written about the risks of direct policy intervention in the private job market (Progressive Wage Policy) that could end up costing the nation investments and jobs. Forcing wages higher without corresponding productivity gains will only lead to even faster erosion of competitiveness in the global market. To compete, the ringgit would have to continue depreciating. To be honest, we have yet to see any of the necessary structural reforms — besides giving good sound bites — that would reverse the ringgit’s long-term depreciation against major currencies.
The Malaysian Portfolio gained 2.9% for the week ended July 17, outperforming the benchmark FBM KLCI, which was up 0.9%. Leading the gainers list are Insas Bhd — Warrants C (+13.3%), Insas (+6.3%) and KSL Holdings (+5.3%) while UOA Development Bhd (-0.5%) was the sole losing stock last week. Total portfolio returns now stand at 224.1% since inception. This portfolio is outperforming the benchmark FBM KLCI, which is down 10.7%, by a long, long way.
Meanwhile, the Absolute Returns Portfolio was up 2.5% last week, lifting total returns since inception to 5.9%. Shares for DR Horton (+12.8%), Home Depot (+8.1%) and Berkshire Hathaway (+7.7%) surged on the back of rising hopes for lower interest rates as well as rotation out of tech stocks. The three losing stocks last week were Microsoft (-4.9%), DBS (-1.7%) and Tencent (-1.5%).
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/ or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
