The Covid pandemic has placed many countries into lockdown which slammed brake pedals of the global economy, putting many businesses and commercial activities into a grinding halt. The fear of the worst has resulted in many of the safe-haven assets to appreciate.
Fortunately, the unprecedented support given by policymakers has facilitated the recovery process as many economies have gradually begun to reopen, albeit with varying levels of social distancing measures still in place.
Although the improving sentiment has led riskier assets such as the Ringgit to recover modestly for the second quarter, the local currency has depreciated against most currencies on a year-to-date (YTD) basis.
As such, investors that have foreign currency exposure could be looking at better returns than expected. Economic activities were frozen temporarily as social distancing measures were implemented in efforts to combat the spread of the coronavirus.
Although the economic growth of most countries is slated to be in the negative territory for the year, 2021 numbers appear to be more comforting given the low base effect and the possible bottled demand in 2020.
A recovery in global growth could lead to businesses being more willing to invest in capital expenditure.
With multinational corporations increasingly look towards the east for growth avenues, Asian countries such as Malaysia stands to benefit. A higher inflow to Malaysian assets is likely to provide support to the ringgit.
Recovering oil price a boon to the ringgit
While the politics surrounding the Opec+ alliance could be fluid, recent actions by the alliance suggest an interest for higher oil prices. Significant oil production cuts were made at the end of the second quarter as the evaporated global aggregate demand caused a freefall in oil prices three months ago.
Given that petroleum forms around 12 and 10 per cents of Malaysia’s government revenue and exports respectively, the recovery of oil prices translates to higher current account surplus to help cushion rising fiscal deficit.
A country that has a consistently high fiscal deficit is essentially incurring more debts as the government spends more than it earns from taxes. Funding these debts are likely to come from the issuance of bonds, which may crowd out investments from the private sector.
The trickle-down effect of slower investment activities over the long term may affect economic growth and ultimately its currency. Therefore, a higher oil price that is able to cushion the Malaysian fiscal deficit is beneficial to the local currency.
Shortly after the rating agency Fitch’s revision of Malaysia’s outlook to negative, S&P Global Rating has also followed suit late last month.
The negative revision mainly reflects the expectation of a further fiscal deficit as well as the local political uncertainty.
The renewed political turmoil has caused foreign investors to stay on the sidelines throughout the year, indicated by the foreign fund outflows of both equity and debt. However, given the considerable net outflow that has occurred to-date, foreign outflow of a similar magnitude is debatable.
As such, while these events will likely dissuade foreigners from holding local assets, we opine that the extent of the impact on the Ringgit could be limited.
Aggressive rate cuts may be dialled down going forward
Bank Negara Malaysia (BNM) stepped in to mitigate the impact that Covid has inflicted on the economy. In 2020, BNM has undergone a series of rate cuts up to a total of 125 basis points (bps). The swift monetary easing could have further contributed to the ringgit’s downwards pressure.
BNM’s tone regarding the economy is less pessimistic compared to its previous statement as major economies relax containment measures leading to a gradual resumption in economic activities.
Locally, the number of red zones in Malaysia has gradually declined as new Covid cases taper off. Should the Covid situation remain under control, a similar aggressiveness in rate cuts we have seen so far is unlikely moving forward. Hence, the downside risk for the Ringgit has decreased.
The Covid pandemic has brought economic challenges and grief to many parts of the world, Malaysia included. Faced with various challenges, global rating agencies have revised the Malaysian outlook to negative, which could place downward pressure on the ringgit.
BNM demonstrating its willingness in supporting the economy via cutting rates has added to the pressure. Further downside risk to the local currency could also stem from an escalation of the Covid pandemic.
However, the situation appears to be better as economies have started to reopen gradually. Analysts’ estimation of 2021 GDP growth paints a decent recovery picture for many of the countries under our coverage.
Coupled with a recovering oil price, an increase in local export activities could also provide some support to Malaysia’s current account surplus. These positive elements are putting together a constructive picture of the local currency.
Should the ringgit appreciate, local investors that invest in assets denominated in foreign currencies may incur losses from currency translation. As such, investors can consider opting for ringgit-hedged class to mitigate upside risks from ringgit and reduce volatility stemming from currency movements.