Ringgit a victim of EM contagion


Emerging market (EM) contagion fears have been dominating the front pages of news- papers in the recent month.

EM currencies as represented by the MSCI EM Currency Index has tumbled by more than 7% in US dollar terms over the last six months with the Argentine peso and Turkish lira plummeting more than 59% and 44% respectively.

The negative sentiment has weighed on other Asian currencies such as the Indian rupee, Indonesian rupiah and Philippine peso.

The ringgit has also depreciated by more than 7% since April 2018.

EM stress is not new with the last episode in the 2013 Taper Tantrum. One of the obvious similarities between 2013’s Taper Tantrum and today is that these fragile markets face a “twin deficit” problem, both fiscal and current account deficits.

Countries that suffered significant fall in their currency values include Argentina, Turkey, Indonesia and the Philippines; all face the twin deficit problem.

In Argentina and Turkey, the respective central banks bear a significant share of accountability due to their ineffective monetary policy in containing high inflation (31.2% in Argentina, 17.9% in Turkey).

The shrinking global liquidity and stronger US dollar is leading to substantial foreign fund outflows from EMs with weak fundamentals.

Despite the fiscal deficit the Malaysian government is facing right now, we believe the healthy current account, as well as strong foreign reserves, are likely to provide a comfortable cushion against external uncertainties.

Although EM capital flows in terms of portfolio or other investment flows might face a squeeze due to the higher volatility and tightening global liquidity, we believe the countries with strong foreign direct investment, such as Malaysia and Thailand, can endure increased volatility in

the global financial market as such investors are unlikely to pull out their investments due to short-term uncertainties.

As such, the EM contagion may have made currencies like the ringgit undervalued. The US Federal Reserve’s (Fed) rate hike decision would be another factor that might drag the ringgit lower.

We are not expecting Bank Negara Malaysia to increase interest rates as aggressively as the Fed which might pose downside risk to the ringgit.

One should note Malaysia is way ahead of others in normalising the interest rate right after the 2007/08 financial crisis.

We believe foreign fund outflows are likely to be minimal from Malaysia as the current real yields offered on fixed income instruments are attractive and current foreign holdings of Malaysian debt securities are standing below the two-year average.

Given most of the global equity funds have an ‘Underweight’ position on Malaysia since the elections, we do not expect any massive foreign outflows from the local equity market.

The healthy fundamentals, coupled with an attractive real bond yield, makes us believe the downside risk for ringgit is limited.

With that, investors might want to consider limiting their unhedged foreign currency exposure.