Ringgit has stabilised, no need to raise OPR

Last week, the financial markets committee (FMC) at Bank Negara Malaysia (BNM) made it very clear that the current weakness in the ringgit against the dollar does not reflect economic fundamentals. They are right.

A lot of the negative sentiment in the markets reflects the underperformance of the ringgit relative to other currencies for most of the year. However, BNM correctly stands by its position that this weakness is driven by external factors outside the control of Malaysian policymakers as well as news and sentiments in the financial markets.

The ringgit has performed slightly worse than other countries for many reasons, including lower interest rates. Even recent hikes did not affect the ringgit much, so other factors outside Malaysia are more important than the policy stance here.

They noted very clearly that there is a mismatch between financial market sentiment and underlying economic fundamentals. The ringgit and stock market performance should not be taken as barometers of the economy, and the underlying value of the ringgit should be stronger if we look at the strength of economic fundamentals.

The economy grew 8.7% in 2022 and 5.7% in the first quarter of 2023. It is forecast to grow by 4 to 5% by the end of the year. Inflation has slowed to around 2.8% and will fall toward and below 2.5% in the next few months. Interest rates have risen much less than in other countries and are now in the normal range of around 3.0%. Monetary policy still accommodates underlying growth.

This success is due in large part to BNM sticking to its mandate and using the overnight policy rate (OPR) to maintain price stability, financial stability and sustainable growth, rather than chasing market sentiments on the ringgit. They have been very independent and conservative, with only four rate hikes since March 2022 compared to 15 rate hikes in Hong Kong over the same period.

By contrast, policymakers in Singapore and Hong Kong have been using active exchange rate intervention to protect their currencies, even if it means a loss of economic growth. This is because they have different economic structures, whereby the exchange rate has a much bigger influence through trade and financial flows.

Raising interest rates in Hong Kong and Singapore to defend their currencies has proved very costly in both cases. Hong Kong raised its rates by 500bps since March 2022 and fell into recession, contracting in every quarter last year. Its GDP fell by 3.5% overall in 2022.

Singapore's GDP contracted in the first three months of the year, and now risks a technical recession due to a 320bps hike in rates since March 2022 to defend the Singapore dollar.

If BNM had done the same and matched every rate hike by the US federal reserve, the OPR would be 6.75% instead of 3%. This would crush borrowers, risk recession and collapse the ringgit.

So market speculators and those calling for a hike in the OPR to defend the ringgit must learn these lessons. BNM has done a good job setting the OPR according to domestic conditions that are strong enough to balance the volatility in the exchange rate without the need to raise interest rates too much.

So the FMC statement has done its job ahead of the monetary policy committee's meeting on July 6 and stopped the decline of the ringgit, which has been stable at around RM4.66 to RM4.68 to the dollar.

They emphasised that BNM would intervene only in line with its mandate if movements in the exchange rate were excessive. This means that intervention is only justified if it affects the mandate of price stability, financial sector stability and sustainable growth.

Although they acknowledged that the current movements in the ringgit are excessive when compared to economic fundamentals, it does not appear that this would necessarily affect the mandate as inflation is falling, the financial sector is stable and the economy is
expected to grow between 4 and 5%.

They also noted the consensus among financial analysts for the ringgit to strengthen to around RM4.50 by the end of the year. Separately, some put their estimates around RM4.20 to RM 4.30, more closely reflecting long-term norms.

Interestingly, BNM also noted that many exporters and corporations are holding lots of foreign reserves which are profitable at current rates. Encouraging firms to buy ringgit with their foreign currency reserves will help strengthen the ringgit in the short term as a market-driven response. They could lose that opportunity if they wait.

This clearly signals that the market itself can help correct the mismatch between the current spot rate and the underlying economic fundamentals. So things are not that bad; the ringgit strengthened slightly after the statement and has remained stable for a full week.

Apart from this, BNM can do very little, if anything, to systematically influence the ringgit in the short term. As we have seen from recent hikes, the OPR only has a short-term impact, and keeping the OPR high could damage the ringgit in the long term. Foreign currency reserves are too low to intervene for long and would quickly run out.

It is also important to note that intervention by BNM does not necessarily mean hiking the OPR if the depreciation in the ringgit has stopped. Based on fundamentals and the stable ringgit, there is less need to raise the OPR now, especially since it is already in the normal
range.

So we can safely pause any increase in the OPR in the next meeting.

Geoffrey Williams is an economist at the Malaysia University of Science and Technology.

The views expressed in this article are those of the author(s) and do not necessarily reflect the position of MalaysiaNow.