In this multi-part series, we dissect drivers of currency phenomena, including: i) interest rate perceptions, ii) current account intricacies and the real economy, iii) capital flow dynamics in the financial account, and iv) money supply theories in relation to debt levels and the fiscal position. In this second part, we discuss the influence of the current account balance on the currency.

Competitiveness in global trade influences the long-term value of the exchange rate. A country with a consistent current account (CA) surplus, a sign of external strength, earns more foreign currency than it spends, thereby supporting the relative value of its exchange rate.

While Malaysia has regularly posted a CA surplus, it has trended downwards over time from 15.9% of gross domestic product (GDP) in 1999 to 1.2% in 2023 (2022: 3.1%), falling short of the 3.3% official projection. As the trade balance declined by 16.5% in 2023 amid a tepid recovery in global demand, the goods surplus of the CA balance declined to 7.3% of GDP (2022: 10.4% of GDP), lower than the 2018-2022 average of 9.5% of GDP. The decline in CA surpluses over the decades is driven by a shift from exports-oriented growth to domestic-led strategies. Relatedly, Malaysia’s exports as a share of GDP halved from 119.8% in 2000 to 68.4% in 2023.

Furthermore, Malaysia’s deceleration in industrialisation after the late 1990s occurred when the national income per capita was less than half of the high-income threshold, coinciding with a significant decline in gross capital formation as a share of GDP (2023: 22.5%, 1995’s peak: 43.5%). These conditions contributed to the slow progress in Malaysia’s structural economic transition as most industries remain at the lower end of the value chain. The limited investments to scale opportunities for industrial developments and skilled labour led to Malaysia’s gradual loss of competitiveness.

Moreover, despite Malaysia holding nearly one-tenth of the global semiconductor market share and supplying over one-fifth of US semiconductor chips imports, the local players are primarily engaged in assembly and testing. These back-end activities are exposed to substitution risk, as companies seek cheaper options and diversify their supply chain amid uncertainties in the geopolitical landscape. Furthermore, low-cost exporters within the ASEAN region are capitalising on cheap labour and gaining market share of global semiconductor exports.

Malaysia’s medium- and high-tech exports as a share of total manufacturing exports (ME) declined from 76.4% in 2000 to 62.0% in 2021, due to regional competition. Additionally, there has been a decline in the attractiveness of Malaysia’s exports, alongside receding interest in the country as a base for outsourcing. In response to these challenges, the latest New Industrial Master Plan 2030 (NIMP) outlines medium-term strategies to progress towards producing high-value and competitive goods, building upon past industrial master plans that have developed a mature yet recently plateaued electronic industry. While the goal includes increased employment, higher wages, and greater value add in the manufacturing sector, successful execution remains a key challenge.

With the NIMP expected to attract more foreign investments, attaining net benefits from external collaborations towards higher value-added exports should be prioritised. Facilitating technological diffusion requires absorptive capacity supported by well-designed investment policies, high quality infrastructure, and continuous human capital investment. This is required to facilitate the timely implementation of approximately RM188 billion worth of approved foreign investments in 2023, a 15.3% increase over those recorded in 2022. Malaysia has typically demonstrated its ability to turn approvals into actual investments, with as much as 78.7% of the total approved investment for the period from 2018 to June 2023 already realised. The materialisation of foreign investments over time will raise Malaysia’s net foreign direct investment (FDI) inflows-to-GDP ratio, which, at 3.6% as of 2022, is ahead of most of its peers in the region.

Apart from the goods component, there is potential for improvement in the services component of the CA balance, particularly in the travel subcategory. After three years of deficit, Malaysia registered a surplus in the travel subcategory in 2023, although it remained at half of the pre-pandemic level. While tourist arrivals are projected to normalise in 2024, ongoing initiatives such as tax incentives and visa waivers to promote tourism should persist with a focus on emerging sectors such as the medical and cultural sectors as well as ecotourism. With higher competition from ASEAN peers, gaining a comparative advantage requires an improved hospitality ecosystem, coordination across state administrations, and consistency in the quality of services.

Over the long term, sustaining the CA surplus and attracting foreign investments hinge on Malaysia’s ability to upgrade the value add of its goods and services outputs, providing fundamental resilience against cyclical headwinds to its exchange rate.

This press announcement is the second in a multi-part series enumerating our opinions over the ringgit’s pathway and accompanying adjustments that can potentially be made to better align the value of the ringgit, such that it reflects Malaysia’s solid fundamentals.