PETALING JAYA: The ringgit is back with a bang, closing at RM4.36 to the US dollar last Tuesday, its best in almost 20 months.
That was a 5.3% gain over a 12-month period, making it the best performing Asian currency.
This recovery is nothing short of amazing given the downward spiral that sent it to a 26-year low in May that then led to worries about the stability of the Malaysian economy.
But by early August, it had made a turnaround, rallying to a 14-month high, beating all other Southeast Asian currencies against the US dollar.
How did this happen?
The ringgit’s rapid recovery can be attributed to two factors — narrowing interest rate differentials and better economic prospects.
Every central bank sets its interest rate based on factors such as inflation.
The gap in the interest rates between two countries — commonly known as “interest rate differential” — has an impact on each country’s currency.
More recently, advanced economies such as the UK and Europe have reduced their interest rates, also known as policy rates, while the markets expect the US to do the same in September.
For instance, the European Central Bank and the Bank of England reduced their interest rates by 25 basis points (0.25%) each in June and August respectively.
The federal open market committee of the US Federal Reserve, which decides on the US interest rates or policy rates, is expected to go for a cut when it meets in September.
On the other hand, Bank Negara Malaysia (BNM) has kept its overnight policy rate (OPR) at 3% since May last year.
As the gap narrows, the benefit of keeping the US dollar over other currencies like the ringgit becomes less significant.
This leads to an increase in the demand for the ringgit and other currencies, giving their value a boost.
Over and above that the vast improvement in the Malaysian economy has widened economic prospects, which has raised investor confidence.
The country’s gross domestic product grew by 5.9% in the second quarter (Q2) of this year, up from 4.2% in the first quarter (Q1), exceeding analysts’ and market expectations.
Comparing Q2 and Q1, growth in household spending rose to 6% from 4.7%, exports rose to 5.8% from 2% and tourist arrivals rose to six million from 5.8 million.
The country also attracted more investments. Construction activities saw a boost and so did the electrical and electronics (E&E) sector. Investments in data centres nationwide rose by 17.3% in Q2 compared with 11.9% in Q1.
Continued policy support in the shape of the Budi Madani assistance and EPF Account 3 also kept the economy humming, helping in the ringgit’s recovery.
The improvement in investor confidence also led to more foreign direct investments in the local markets, infrastructure, manufacturing activities and government debt.
This increase in demand for ringgit assets also helped to strengthen the currency, contributing to the currency’s recovery.
Solid support
The government and BNM must also be credited for the ringgit’s rebound.
Both took important steps and coordinated actions to encourage government-linked companies (GLCs) and government-linked investment companies (GLICs) to repatriate their earnings from abroad and convert them to ringgit.
The government and BNM have also doubled their engagements with other businesses to encourage them to take the same steps as the GLCs and GLICs.
This will lead to a higher demand for the ringgit, thus raising its value.
Currencies: candles in the wind?
Like all currencies in a free market economy, the fate of the ringgit changes with what goes on around the world. For instance wars, geopolitical tensions and other developments abroad can give the currency a boost or take a toll on it.
Like a candle in the wind, it can be rather fragile.
Given such a factor, is it fair to judge the health of a country’s economy by the value of its currency? Aren’t the fundamentals equally significant?
Common sense dictates that raising productivity, attracting high-value investments and creating more high-paying jobs go a longer way to strengthening the economy.
Improved economic performance means better prospects which, in turn, will draw more investors to Malaysia.
This will increase the demand for Malaysian goods and services and ringgit-denominated assets such as stocks and debts.
Collectively they will raise demand for the ringgit, thus boosting its value.
Why structural reforms are vital
The ringgit may have regained strength but will its momentum keep going?
This is where structural reforms are key. What is needed now is to lock in the gains in value and investor interest.
But putting reforms in place is not easy. There will be short-term costs and a long wait for the desired effect.
That aside, reforms are vital and there is no better time to start than now.
What reforms are needed?
These are some of them:
1. Commitment to fiscal sustainability, which must include subsidy rationalisation;
2. Upskilling and reskilling of the workforce;
3. Attracting high-value-added investments, and
4. Orderly and just climate transitions.
Structural reforms will raise Malaysia’s competitiveness, driving strong interest in what it can offer as a nation. In the end, this will be the most stable and lasting support for the economy, and the ringgit.
Like a boat out in the open sea, the ringgit will rise and fall with the waves of world events.
The storms come and go, the seas may be rough or smooth, but if the boat is strong and solid, it will weather the storms and be steady on its course.
In the same way, if the economy is strong and stable, Malaysia can stay focused on progress, unaffected by the ringgit’s rise or fall.
