LETTER | Ringgit has recently hit a 26-year low against the US dollar at about RM4.80 to a dollar.

What drove the persistently weak performance of the ringgit against the dollar over the recent years?

While it is true that the ringgit performance is impacted by external factors such as a strong dollar, there are also internal factors that drive the ringgit performance.

For instance, over the past ten years as of September 2023, the ringgit was down 31 percent against the US dollar whereas the Thai baht was down -15 percent against the US dollar. One ringgit is now worth about 7.5 baht. Against the mighty US dollar, the Singapore dollar has depreciated by about 8.5 percent.

Policymakers, economists, and experts often primarily attribute the decline in ringgit value against the dollar to the interest rate differential between the US and Malaysia. However, the interest rate in Malaysia was three percent whereas that of Thailand was two percent by 2023. Hence, the interest rate differential alone cannot fully explain why the ringgit is weak.

In my humble opinion, internal factors such as the level of foreign exchange reserves and external debts have a huge impact on the performance of a local currency.

There is strong evidence to suggest that a high level of foreign exchange reserves can help an emerging country to keep its currency value more stable.

For instance, the foreign exchange reserves to GDP for Singapore are estimated to range from 60 percent to 100 percent. The figure for Thailand and Malaysia is 45 percent and 28 percent respectively.

A country that has large foreign reserves can use them to defend its currency and/or meet capital outflows. It is thus less likely to have a severe currency depreciation.

Importantly, a country that has large foreign exchange reserves would have the capability to help its domestic banks or important companies should they run into some dollar liabilities crisis. This is reassuring to foreign investors and lenders.

During global financial turmoil or recession, US dollar funding could suddenly come to a halt. This would leave domestic commercial banks in limbo without access to dollar funding.

Another way to look at a country’s foreign exchange reserves is the coverage of several months of imports and external debt within one year.

According to our central bank, Malaysia’s reserves generally cover 5.5 months of imports and 1 times the short-term external debt.

Based on data provided by the World Bank and IMF, Thailand’s reserves cover 7 months of imports and 2.3 times the short-term external debt.

Again, those figures go to show that Thailand‘s foreign exchange reserves position is better than that of Malaysia and hence Thailand experienced less severe currency depreciation against the US dollar.

It is to be noted that during the 1997/98 Asian Financial Crisis, crisis-hit Asian countries only had reserves that covered 3.8 months of imports and 0.7 times short-term external debt at the onset of the crisis

Going forward, if we want to have a strong ringgit, we will need to have a robust foreign exchange reserves and a relatively low level of external debt

The Global Financial Crisis in 2008/2009 serves as a good example. Though there was a rapid US dollar appreciation in 2008, Malaysia’s currency value was relatively unscathed. In 2008, our country’s foreign reserves covered about 8 months of imports and 4 times the short-term external debt. The foreign exchange reserves to GDP were about 40 percent.

By the way, a common narrative offered by our policymakers or experts is that once the US cut its interest rate, the ringgit is expected to strengthen due to the narrowing interest rate differential between the US and Malaysia. Is that true?

The US usually cuts its interest rates to combat a recession and the US dollar often tends to rally in a recession. This is because, during a global recession, the US dollar plays the role of haven as capitals usually flow to the US treasury bonds. You might want to call it the dollar trap or dollar hegemony as there are still no viable global alternatives yet.

For instance, during the Global Financial Crisis in 2008/2009, the US interest rates were brought down to almost nought. Paradoxically, the US Dollar Index rose by about 24 percent even though the US was the epicentre of the Global Financial Crisis.

The magnitude of the rise is comparable to the recent one in 2022/2023 when the US hiked interest rates rapidly as it was clearly behind the curve in managing inflation.

As of now, we do not know if the US will face a soft landing or a hard landing (recession). A sensible strategy for Asian governments is not to count on a singular outcome but to prepare for all the likely scenarios.

Last but not least, the ringgit's recent performance is also impacted by the export earnings contraction, global US dollar funding stress, and capital outflows.

Malaysia’s trade was down for many months currently and export earnings have shrunk quite significantly.

Meanwhile, the demand for the dollar is still there as it must serve its huge external debt obligations and pay for imports mostly in the US dollar. Also, the country needs to meet its capital outflows such as foreign companies repatriating their profits made in Malaysia and portfolio capital outflows and they are often denominated in the US dollar

As in economics, when the demand for the US dollar far exceeds the supply, the price tends to go up. In this case, the price is the exchange rate of the US dollar against the ringgit.

The views expressed here are those of the author/contributor and do not necessarily represent the views of Malaysiakini.