The Ringgit is depreciating but should we lose trust in it?

by Dr. Abey P. Philip

Wait a second. Before we start to worry about the value of the Ringgit going down, let us analyse why it is happening.

Even Marxist economists might agree to the fact that the economic growth experienced by Asian countries in the last decades was the result of wise and timely use of opportunities provided by globalisation and liberalisation, although socialists might consider this a temporary phenomenon.

As a result of globalisation, previously closed economies opened up their markets and capital inflows and outflows began to be determined by each country’s respective interest rates. Almost all the Asian countries used their trade advantage and gained large capital inflows into their economies.

During the global financial crisis, the United States and European Union implemented an easing of monetary policies to stabilise their economies. That led to a drastic reduction in real interest rate in these large economies. The interest rate prevalent in the US and EU led to capital outflow to Asian countries, which enjoyed high interest rates.

These countries invested in the Asian countries through two different types of investments – Foreign Direct Investment (FDI) and Foreign Institutional Investor (FII). If they invested more in FDI, then they could not withdraw their money anytime soon. However, if they invested in FII, the investors could withdraw their investments whenever they pleased.

In FII, companies only get registered in the stock exchange to make investments. FII is also known as ‘hot money’ as the investors have the autonomy to sell or take it back. But FDI is an investment that a parent company makes in a foreign country. In FDI, the capital inflow is metamorphosed into additional production, for example, Shell in Malaysia.

In the recent past, the United States was concerned about the continuous progress of Asian countries. However, the recession and the depression trends of the US economy has not negatively influenced the Asian countries, which for US policy makers, heralds the emergence or the beginning of a new economic power shift from the West to the East.

Moreover, some Asian countries have effectively gained from the global financial crisis. This was identified by policy makers in the US who have realised the need to revive the power of the US dollar. More importantly, they do not have any other option.

As a result, the US has tightened its monetary policy and reduced the availability of the dollar, which subsequently increased interest rates. The US has yet to survive the crisis, and is in fact going to face more prominent issues by the end of the year.

The Guardian predicts that the US could default on its indebtednesses as early as this October if Washington fails to agree on the legislation to raise the government’s borrowing cap.

The US must approve a debt ceiling increase or otherwise, an independent think tank estimates the Treasury Department would not have enough cash inflow to pay all the country’s bills in full sometime between October and November. CNN Money expects that, after the so-called “X” date, barring a higher debt ceiling, the country would default on some of its obligations.

As a result of tightening monetary policy in the US, which I think was unwarranted and aimed only at upsetting the Asian financial market, the interest rate in the US started to get reinforced and that led to appreciation of the US dollar. Investors then started to withdraw their portfolios from Asian countries.

This process increased the dollar demand and led to further appreciation of the US dollar and depreciation of Asian currencies. Malaysia witnessed a capital outflow of RM17 billion due to the US Federal Reserve’s decision to tighten monetary policy.

Similar situations were encountered in 2008 and 2009 but Malaysia survived them. The country’s international reserve is about RM400 billion, which is more than enough to cover outflows due to the US federal bank policy. The depreciation will be accelerated because the capital outflow was concentrated on FII.

In such situations and if portfolio investments are withdrawn, the currency will depreciate accordingly. FDI is considered as safe custody and it cannot be withdrawn from the market as easily as FII.

So how long this depreciation last? If we analyse the US economy, we can observe that while the recession continues, the US is tightening monetary policy further to interrupt other financial markets such as those in Asia.

Its debt to GDP ratio has reached an all time high of 105% in 2013 and might climb further due to the expected increase in the debt ceiling by the end of the year. The ratio was only 61.3% in 2004.

The debt to GDP ratio in Malaysia is less than half that of the US – 51.76% in 2013 and 45.1% in 2004. Indeed, the ratios of almost all Asian countries remain below the danger point.

The current depreciation of the Ringgit should prevail anywhere from six months to one year and no more. The US economy may suffer long term losses in this process rather than make any short term gains as the primary objective seemed to be to make Asian countries miserable. However, the Asian countries have very low debt to GDP ratios and high saving rates – 38.23% in Malaysia (2013) compared to 11.62% in the US.

Whenever the Ringgit depreciates, the immediate effects are on exports and inflation. For a country with a depreciated currency, exports will increase in relation to imports as exports become cheaper and imports become more expensive.

Fortunately for Malaysia, its trade surplus is RM2.86 billion and it is going to increase due to currency depreciation. The depreciation of the Ringgit might increase the inflation rate and raise the cost of living somewhat, but the good news is that Malaysia has been maintaining a ‘safe-side inflation level’ of below 2% for quite some time.

So, what is the strategy of the US, or why did the US Federal Reserve resort to monetary policy tightening even though the US cannot escape from recession? It seems that the US simply wants to drag the Asian countries into a gloomy economic atmosphere.

However, if we can stay economically balanced and stable, we can be sure of a bright economic future no matter what happens elsewhere.

Dr. Abey. P. Philip is a senior lecturer of economics in Curtin Sarawak’s School of Business. His research interests include macroeconomics and monetary economics, prices, business fluctuations and cycles, government and the monetary system, international trade and economic integration, business economics and economic development, and he has published a number of journal articles and conference papers on such subjects. He can be reached at +60 85 443 945 or by e-mail to abeypp@curtin.edu.my

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