The ringgit is exposed in this scenario due to its high beta to the Chinese yuan, bearing a 60% correlation to yuan weakness

By MARK RAO / Pic By MUHD AMIN NAHARUL

THE growing rift between Washington and Beijing is threatening to spill over into currency devaluations, putting the ringgit at risk, while raising the case for a second rate cut by Bank Negara Malaysia (BNM) this year and fiscal spending by the government.

US President Donald Trump’s plans to impose 10% tariffs on an additional US$300 billion (RM1.25 trillion) worth of Chinese imports starting next month saw Beijing vowing to fight back and reportedly asked state-owned agricultural firms to suspend imports of US agricultural products in response.

Prospects of a full-blown trade war sent equity markets across the globe and emerging and risk-based currencies lower yesterday.

FXTM chief market strategist Hussein Sayed said the yuan breached its key psychological level of seven against the US dollar yesterday after the People’s Bank of China (PBoC) fixed the yuan’s midpoint at 6.9225.

This is the first time since May 2008 that the Chinese yuan traded above this key psychological level, he said.

“The PBoC has spent hundreds of billions of dollars over the past couple of years to prevent the currency from breaching this key level, but now that doesn’t seem to be the case,” he said in a research note yesterday.

“In fact, the currency tool may be very effective as it significantly offsets the impact of US tariffs.”

If the Chinese currency falls by another 8% from the current level, the 10% tariffs paid by US importers will be offset by the yuan’s weakness, he said.

This is leading to fears that the US-China trade war could tip into a currency war, whereby countries deliberately depreciate the value of their local currencies to stimulate the domestic economy.

In this situation, the yuan fix will be adjusted higher and higher to offset trade losses, potentially prompting other nations to adopt similar exercises of their own.

The ringgit is exposed in this scenario due to its high beta to the Chinese yuan, bearing a 60% correlation to yuan weakness.

VM Markets Pte Ltd managing partner Stephen Innes expects the Malaysian currency will weaken further and test the RM4.20 mark against the greenback if there is another keg higher in the US dollar-yuan exchange.

“Frankly, I don’t see any reason to fight this move as we may get an even more aggressive response from Trump,” he told The Malaysian Reserve (TMR).

“If a full-out currency war occurs, the ringgit would theoretically strengthen, forcing BNM to counter the cycle by lowering rates.” He noted that a currency war is a “very messy affair” that no party will be eager to engage in.

Bank Islam Malaysia Bhd chief economist Dr Mohd Afzanizam Abdul Rashid said there could be growing concerns over a currency war or competitive devaluations, especially in the current context.

“We have seen the PBoC devalue its currency in 2015. Therefore, investors could draw some parallels from that incident in view of the ongoing trade conflict,” he told TMR.

He added that the US dollar-yuan exchange has gone past the seven mark yesterday and, therefore, the case for currency devaluations seems to be compelling.

He said global growth prospects have become increasingly uncertain following the re-escalation in US-China trade tensions, indicating that monetary policy may need to be loosened in order to support growth.

“Typically, a lower interest-rate level would mean the home currency could be weakened as investment returns are relatively lower compared to other countries. So, the angle for lower rates is to support growth.”

Even if a currency war does not materialise, BNM is still expected to lower its Overnight Policy Rate (OPR) to manage the domestic economy.

Hong Leong Investment Bank Bhd (HLIB) forecast the Malaysian central bank to lower the OPR for the second time this year as full-blown trade war conditions threaten to dent Malaysia’s economic growth.

“As the trade war between the US and China continues to prolong, with the possibility of worsening relations, we now anticipate BNM to reduce the OPR by 25 basis points…as early as the November Monetary Policy Committee meeting,” the research firm said in a report yesterday.

This will bring Malaysia’s benchmark lending rate to 2.75%, the lowest since March 2011, after BNM lowered the OPR to 3% in May this year.

HLIB said effectively, all of Chinese imports to the US (totalling US$550 billion) will be taxed if the next wave of US tariffs comes into play.

“As a small open economy, Malaysia will not be insulated by the escalating trade tensions. Based on BNM’s estimation, a 25% tariff on remaining trade with China (note that the proposed rate is at 10%) and a blanket auto tariff would lead to a reduction of Malaysia’s GDP growth by 0.9 to 1.1 points.”

The impact of the US-China trade war will account for half of that decline, the research firm added.

Malaysia’s benchmark FTSE Bursa Malaysia KLCI declined 16.35 points to 1,610.41 yesterday, while the ringgit extended its losses to close at RM4.177 against the greenback.

As the trade tensions highlight the scope for protectionism to weigh on growth, Malaysian Rating Corp Bhd (MARC) said the government needs to up spending as private investment growth has slowed significantly in the first half of the year.

It does not help that public investment by both the federal government and public corporations has fallen due to fiscal consolidation efforts.

“It is important that the government steps in to provide the necessary investment support to prevent growth falling below the 4% level if global risks continue to rise. We believe the government will provide the necessary support. The question is to what degree, and it remains a sensitive one due to Malaysia’s fiscal health,” the rating agency stated in a release yesterday.

MARC said monetary policy has a supporting role and BNM’s monetary policy stance is to “maintain price stability, while remaining supportive of growth”.