The cause and effect of the downfall of Ringgit's exchange rate

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Malaysia’s ringgit completed its biggest two-day drop since January on speculation a stronger US economy will support the case for the Federal Reserve to raise interest rates next year. Rising interest rates and heightened exchange rate volatility would add more to the Federal Government debt burden and raising potentially the possibility of debt monetization, as net claims on Government are substantial in recent years. While Bank Negara raised its benchmark rate in July for the first time since 2011, reports showing a deterioration in exports and factory output may delay any further increase. Fed officials will review monetary policy on Sept 16-17 after reports this month showed US manufacturing and services growth in August exceeded economists’ estimates, while payrolls posted the smallest increase this year. Malaysian exports increased at the slowest pace in 13 months in July, official data released last week showed. The Southeast Asian nation’s central bank raised borrowing costs in July for the first time in more than three years and meets next on Sept 18. Low volatility across financial markets may signal investors are underestimating how quickly the US central bank will raise interest rates, according to a Sept 8 report by researchers at the San Francisco Fed.

The central bank will assess the balance of risks between the outlook for growth and inflation when considering further policy moves, according to the monetary policy statement released on Sept. 18. Policy makers next meet on Nov. 6. The yield on the Southeast Asian nation’s 3.394 percent sovereign bonds due March 2017 fell four basis points this month to 3.48 percent, data compiled by Bloomberg show. It was little changed today. One-month implied volatility, a measure of expected moves in the exchange rate used to price options, rose 216 basis points, or 2.16 percentage points, to 7.77 percent in September. That was the steepest increase since January 2013.

The ringgit’s decline is due to “the hawkish tone to the Fed statement yesterday,” said Michael Every, head of Asia Pacific financial-markets research at Rabobank International in Hong Kong. “The market is still slightly sceptical because on the one hand it is much more hawkish in terms of the overall tone but at the same time the Fed retained the phrase considerable period of time.” 

The ringgit weakened 0.5 percent, the biggest decline in a month, to 3.2880 per dollar as of 9.53am in Kuala Lumpur, according to data compiled by Bloomberg. It earlier reached 3.2910, the lowest level since March 27, and has depreciated 0.2 percent in October. 

One-month implied volatility, a measure of expected moves in the exchange rate used to price options, fell eight basis points, or 0.08 percentage point, to 6.47 percent. The yield on Malaysia’s 4.181 percent sovereign bonds due July 2024 was little changed at 3.82 percent, data compiled by Bloomberg show. The rate fell 10 basis points this month.

Malaysian exports increased 0.6 per cent in July from a year earlier, missing the median estimate of economists for a 5.3 per cent gain, the government reported on Sept 5. The nation’s trade surplus narrowed to RM3.64 billion, the smallest in a year. One-month implied volatility, a measure of expected moves in the exchange rate used to price options, rose 42 basis points, or 0.42 percentage point, today to 6.82 per cent. It earlier reached 6.83 per cent, the highest since April 3. The yield on Malaysia’s 4.181 per cent sovereign bonds due July 2024 climbed two basis points to 4.01 per cent, the highest in two months, data compiled by Bloomberg show.

A major threat posed by the crisis was the serious destabilising effect on the banking and financial system. As local companies and consumers faced difficulties in servicing their loans due to the initial raising of interest rates and the sharp currency depreciation. In general, exchange rate movements may have an effect on inflation through imports. The impact of exchange rate movements on consumer prices can be observed in two stages, namely from the exchange rate impact to import prices, and subsequently from import prices to consumer prices. At the first stage, changes in the exchange rate may be reflected through import prices that are paid by importers. While the exchange rate could be an important consideration, there are other factors that could influence the prices of imports. These include global demand and supply conditions, global competition, prices of global commodities and production costs in the exporting countries.

At the second stage, the changes in import prices would feed into the overall cost of domestic production and eventually determine the final prices paid by consumers. The degree of pass-through from import prices to consumer prices depends essentially on the share of imported inputs and goods in overall production and distribution. In general, the smaller the proportion of imported inputs and goods into overall production and distribution, the smaller the impact on consumer prices. Beyond cost considerations, factors such as the strength of domestic demand and the extent of market competition could also influence the decision by firms to pass-on cost savings from cheaper imported prices.

So, how should Malaysians encounter the bad exchange rate of Ringgit during this hard time with poor economic performance and the coming GST?