BNM unlikely to raise rates to support ringgit

by **Cals** Mon 10 Feb 2014, 10:18

Business & Markets 2014

Written by Charles Yong of theedgemalaysia.com

Monday, 10 February 2014 10:10

KUALA LUMPUR: Amid a renewed round of foreign investor sell-offs fuelled by fears over the tapering of the US quantitative easing (QE) programme and data confirming a slowdown in China’s economy, some emerging countries have raised interest rates to defend their battered currencies.

This raises the question whether Malaysia will follow suit.

Local economists, however, are not expecting Bank Negara Malaysia (BNM) to raise its overnight policy rate to support the sliding ringgit.

“Malaysia is not in the same boat as the weaker emerging markets and so BNM will not be forced to tighten rates,” says Maslynnawati Ahmad, chief economist at Malaysian Industrial Development Finance Bhd.

“Our foreign exchange reserves are massive, our current account is in surplus, GDP growth is at about 5%, which is not bad, and our exports will benefit from growth in the US,” says Maslynnawati, who expects Malaysia’s economic prospects to improve by year end.

On Jan 28, Turkey more than doubled its benchmark rate from 4.5% to 10% after the lira fell 8% over 11 days of consecutive losses to a record low against the US dollar. India, too, raised its benchmark rate on the same day by 25 basis points (bps) to 8%. A day later, South Africa raised its main rate by 50bps to 5.5% and last week, Ghana raised its rates by 200bps to 18%, citing concerns about contagion risks.

Turkey and South Africa are two of the “Fragile Five” countries, a catchphrase recently coined by Morgan Stanley to identify “economies that have become too dependent on skittish foreign investment to finance their growth ambitions”. The other three are Brazil, India, and Indonesia.

Although Malaysia’s fundamentals are not comparable to the Fragile Five’s, the ringgit has suffered from a contagion effect, declining by as much as 2.66% over the past three weeks. Maslynnawati expects the effect to continue feeding volatility in the currency, peaking in April when voters in several developing countries go to the polls.

RAM Holdings Bhd group chief economist Dr Yeah Kim Leng agrees that Malaysia’s strong fundamentals have helped, and will continue, to buffer the ringgit.

“The current situation in the country does not warrant raising interest rates as it is not as dire as in other countries which have high dependencies on foreign capital and twin deficits (in their current account and government budget).”

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According to the International Monetary Fund, Malaysia’s current account surplus stood at 3.49% of gross domestic product (GDP) in 2013, and will grow to 3.63% this year. All of the Fragile Five, by contrast, have current account deficits, with Turkey’s the highest at 7.38% of GDP and South Africa’s the next at 6.07% of GDP.

Furthermore, Malaysia’s foreign exchange reserves are able to finance 3.7 times the short-term external debt and 9.6 months of retained imports. Turkey, on the other hand, has enough to finance no more than one fifth of its short-term foreign borrowings. BNM would use its rich reserves before increasing interest rates to support the ringgit, says Yeah.

“There is also surplus liquidity in Malaysia to provide a backstop against any reversal of short-term capital,” Yeah adds. Much of this liquidity would come from institutions such as pension funds.

Another bank economist says raising interest rates to defend currencies simply does not work. “It did not help us in 1997 during the Asian Financial crisis, and it isn’t helping Indonesia and Turkey now. Domestic industry would also suffer if interest rates go up. You’ll just end up with a double whammy.”

“BNM would only smoothen the ringgit’s volatility, but it will not support it against depreciation. The bank has said that in determining interest rates, it will look at domestic factors such as inflation and growth instead.”

Maslynnawati adds that Malaysia is able to tolerate a weaker ringgit of up to RM3.60 against the US dollar and expects the local currency to strengthen to between RM3.25 and RM3.30 by year end.

Yeah does not expect the ringgit to be “overly stretched” beyond 3.40. Self-correction kicks in as the weaker ringgit drives exports up, preventing any sharper erosion of sentiments. As a result, he expects the currency to rebound to between RM3.10 and RM3.20 against the greenback by year end.

The ringgit traded at RM3.33 versus the US dollar last Friday.

All three economists expect interest rates in Malaysia to increase in the second half of this year, not to stem foreign outflow of funds but to anchor inflation. Maslynnawati forecasts a 50bps hike, while the other two economists expect 25bps.

“Malaysia’s problems are high household debt and inflation. The priority is to restore market confidence in these areas,” says Maslynnawati.

This article first appeared in The Edge Financial Daily, on February 10, 2014.