At the end of May, I issued Part 1 of a series of statements on Managing the Economy entitled “Understanding Inflation & Supply Chain Challenges”. In Part 2 of this series, I want to address the issue of Bank Negara’s exchange rate policy and the need to update this policy to pursue a stronger Ringgit exchange rate regime.
Since the start of the year, the Ringgit has depreciated by 5.6% against the US dollar falling from RM4.17 to RM4.40 / 1US$. At the same time, the Ringgit has also depreciated by 2.7% against the Singapore dollar falling from RM3.09 to RM3.17 / 1SGD. The depreciation of the Ringgit has opened the door to discussions that the weaknesses of the economy and uncertainty in government policy have caused this to occur. The reality of the matter is that the short-term fluctuations and long term trends in the value of the Ringgit are caused by a number of factors such as the inflow of short term capital for the purchasing of equities and bonds and other financial assets, the inflow of longer term capital to set up factories and offices of multinational companies, the central bank’s interest rate and monetary policy and the repatriation of foreign exchange earned abroad by Malaysian companies, just to name a few. All of these factors interact with and cause changes in the value of the Ringgit in complex ways, much of which is not easily explainable to the larger public.
The institution which is best resourced to understand, explain and manage the exchange rate policy is, of course, Bank Negara Malaysia (BNM). While BNM has done a credible job in managing various challenges in the financial system and the parts of the economy it has some influence on, it has not been up to par when it comes to managing our exchange rate policy, including and especially in terms of public communication and expectations management. In other words, the forward guidance of BNM in terms of setting expectations on the future outlook of the country’s monetary policy has not been clear.
One example of the mixed signals is the reporting in the lead up to the BNM’s Monetary Policy Committee Meeting on the 11th of May 2022. Bloomberg was reporting that the Overnight Policy Rate (OPR) would likely remain at 1.75% while other economists were speculating that there could be a 25-basis point hike, which was eventually announced by BNM. Another mixed signal on the part of BNM earlier this year was the highlighting of cost-of-living pressures being experienced in the country during the release of the BNM’s 2021 Annual Report on the 30th of March 2022 but the downplaying of inflationary pressures and the impact of imported inflation from a weakening ringgit by the BNM governor, Nor Shamsiah Mohd Yunos, in an interview with BERNAMA on the 28th of April 2022.
In the same interview with BERNAMA, the BNM governor emphasized that a weaker ringgit helped the export sector by making their products more price competitive and by increasing the Ringgit earnings of these companies. The narrative of a weaker ringgit helping the export sector has been played many times. It is an increasingly weak and less relevant narrative for the country moving forward. Firstly, Malaysia’s growth in exports in the past 2 years have largely been driven by the boom in the Electronics and Electrical (E&E) sector as a result of the increase in global demand for various electronic devices during the global lockdown and, secondarily, by the increase in the price of oil & gas and commodities. The exports of the E&E sector would have grown even with an appreciating ringgit. Secondly, many of the inputs for the E&E sector are imported semi-finished components that are priced in foreign currency. A weaker ringgit would also cause the cost of imports to increase thus negating the potential benefits of a depreciating currency. Thirdly, the export sector in Malaysia SHOULD NOT be reliant on a weak currency to boost its competitiveness artificially! Our export competitiveness should be based on productivity, innovation and upskilling. Germany, a global export powerhouse, did not see its exports shrink as a result of a strong Deutschemark and later a strong EURO. Instead, many of its manufacturers, especially the small and mid-sized companies (the “Mittelstand”), pushed the barriers of productivity and innovation and improved on the already impressive workers training and upskilling process that has led to German factory workers earning almost 16 EUROS an hour. Closer across the border, despite a strong Singapore dollar, Singapore has managed to reverse the trend of a declining share of manufacturing activity as a % of GDP by pivoting to more highly automated factories which also results in higher wages among factory workers across the board.
BNM should also be clear in its communication with regards to the impact of increases in imported inflation as a result of a depreciating ringgit. While BNM is probably right in writing, way back in 2011, that there is not a one-to-one relationship between the ringgit’s exchange rate and the impact of the prices of imported goods into Malaysia, it should show clearly the current and future impact of a weakening ringgit on prices of various imported items. For example, how much did the depreciating ringgit contribute to the increase in the cost of animal feed, most of which have to be imported?
There should be a serious discussion within BNM, together with the Ministry of Finance, on the merits of having a stronger exchange rate policy, to ‘manage’ the ringgit so that it can be allowed to slowly appreciate over the medium to long term. This kind of policy must be conducted carefully and transparently so as to avoid any possibility of repeating the significant forex losses experience by BNM in the 1990s which probably still scars the bank to this day. I am not asking for BNM to signal to currency speculators that it is willing to spend its forex reserves in order to defend the ringgit at 4RM : 1US$, as an example, but more of a forward guidance to let the market know that various policy measures will be considered as part of a longer term strategy to allow the ringgit to slowly appreciate.
To this end, BNM should also be clear in its discussion on the basket of currencies which it is measuring the ringgit’s performance against. While the spotlight has been on the ringgit’s performance against the US$ and SGD$, what has been less discussed is the fact that the ringgit has actually appreciated by 2% against the EURO, 0.3% against the Chinese Yuan and 11% against the Japanese Yen since the start of the year. The ringgit, when measured using the nominal effective exchange rate (NEER) of the ringgit or a trade weighted exchange rate of the ringgit, would show a better performance than when compared to just the US$ or the SGD$. While the RM:US$ exchange rate still plays an oversized role both in terms of the public psyche on the strength or weakness of the ringgit, as well as the fact that much of the global trade is conducted using US$ quotations, it is important to keep in mind the ringgit’s valuation against other countries who are also our major trading partners – China, the EU and Japan, and also other ASEAN countries.
As part of this proposed strategy to have a stronger ringgit moving forward, BNM also needs to discuss the ways in which it can increase its foreign reserves to provide greater flexibility for BNM to manage the exchange rate. Even though Malaysia has been running a current account surplus for more than two decades, our foreign reserves have been fluctuating within a narrow range of approximately US$100 billion over the past decade. Despite soaring exports and health current account surpluses in 2021 totalling almost RM60 billion, BNM’s reserves only grew by US$9.1 billion from US$107.8 billion in January 2021 to US$116.9 billion in December 2021. Since then, it has fallen to US$109.2 billion as of June 2022. By contrast, Singapore, which has a similar size economy to Malaysia, has forex reserves of US$345 billion as of May 2022 and this is down from US$426 billion in February 2022.
To what extent is BNM’s limitations in increasing its forex reserves a result of companies not wanting to bring back their forex earnings back to Malaysia because of policy uncertainty in the country? Is this hesitancy to repatriate corporate earnings in foreign currency partly due to BNM’s ban on offshore trading of the ringgit through non-deliverable forward (NDF) contracts? To what extent is this a reflection of possible illicit money outflows from the country including through the practice of trade mis-invoicing where Malaysia has been identified as one of the top 5 affected countries by Global Financial Integrity (GFI)? What is the correlation between the “Net Errors and Omissions” in the Balance of Payment accounts which totalled RM25.5 billion in 2021 and possible illicit outflows of money from Malaysia? We need to have more transparent discussions on these issues and these discussions must be led by BNM, since it is the official gatekeeper of financial flows in and out of the country.
To recap, while it may not feasible or even advisable to “talk up the ringgit” in the short term, there are other measures which BNM can undertake to pursue a stronger exchange rate policy in the medium to long term. These include:
(i) Having clearer forward guidance on the monetary policy / interest rate policy moving forward. This would include publishing the minutes of the Monetary Policy Committee (MPC) which is the practice of the Federal Reserve in the United States.
(ii) NOT furthering the narrative of the having a weak ringgit to help the export sector of the economy
(iii) Be transparent about the discussion on inflationary pressures in the country including the need to broaden the usage of different inflationary indicators such as the Producer Price Index (PPI), the Everyday Price Index (EPI) and the Perceived Price Index (PePI)
(iv) Have an open discussion on the impact of imported inflation measured in US$ and also using a trade weighted exchange rate / nominal effective exchange rate as part of a larger exchange rate discussion with interested stakeholders and policy makers
(v) Investigate and openly discuss the extent and impact of illicit financial outflows on BNM’s ability to increase its foreign exchange reserves and how to limit these occurrences.
Dr. Ong Kian Ming
MP for Bangi