The sharp weakening in Malaysia’s ringgit has reached an unprecedented low based on its Real Effective Exchange Rate (REER) according to data from the Bank of International Settlements (BIS). The REER is a measure of the exchange rate value weighted by trade and adjusted for inflation. On one hand, it explains that exports from Malaysia are now cheaper relative to history and relative to its peers; it also implies that imports are increasingly more expensive, affecting businesses and consumers. As such, while weaker ringgit is said to be an automatic stabiliser since it theoretically raises the value of exports, it exacerbates imported inflation at a time when inflation is a global and local concern, especially since inflation is significantly driven by cost-push pressures and is affecting Malaysia’s rising cost of living.
The automatic stabilisation effect of a floating exchange rate is an elegant theory, which also suggests it has limitations in reality. A weaker exchange rate is only a temporary adjustment to prices to maintain competitiveness. Competitiveness, of course, has several facets, such as policy stability as well as infrastructure and tax rates, and needs to be distinguished from merely having cheap exports. If a country were to rely on a weaker exchange in the long term, it is then pursuing a race to the bottom. This contradicts not just the fundamental concept of raising a country up the value chain, but relegates a country to de-development.
The idea that exchange rate depreciation benefits a country is not holistic — it can only provide a limited boost to the current account balance. Of note, Malaysia’s current account balance-to-GDP ratio deteriorated over time from 15.9% as at end-1999 to 1.0% as at 1Q2023. This proves that cheap does not mean good, especially in the long run. Malaysia’s trade partners and capital market investors have evolved to a higher level of sophistication and will approach their dealings with the mantra of value optimisation, not just cost savings.
A defensive narrative that has been bandied around is that Malaysia is a victim of circumstances, namely the higher interest rates in the US. However, all countries are facing a similar challenge, but it ought to be mentioned that as of the last week of June, the ringgit is the second-worst performer in Asia year-to-date after the Japanese yen.
Perceptions of Malaysia’s economic standing and ringgit performance are related to the degree of international confidence in Malaysia. Besides the issue of weaker external balances, debt sustainability and public financial strength is weakening. At its apex in the 1990s, Malaysia had a fiscal surplus but it is now forecast to record a fiscal deficit of around 5% in 2023. This deficit has an adverse impact on Malaysia’s debt servicing payments-to-revenue ratio, which has trended higher since 2012’s 9.4% and breached the self-imposed threshold of 15% during the height of the pandemic in 2020-2021. This points to structural issues in which revenue was only sufficient to cover operating expenditure, encroaching on the use of debt to fund development expenditure.
This is why the proposed Fiscal Responsibility Act is so important, and it is hoped that the postponement of its planned tabling from June 2023 to the year end is a precursor to a well-thought-through plan rather than an indication of coordination challenges. Maintaining adherence to various debt measures such as debt limits and debt service ratios on a long-term and consistent basis will be a preferred modality by international investors. Building up economic buffers beyond basic adequacy is imperative, since global uncertainties can crystallise multiple risks into a perfect storm — this is when what was once adequate turns insufficient.
