Ringgit’s delinking with Oil

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The Ringgit today briefly touched a level not seen for some time when it was briefly quoted at RM 4.200 to the US Dollar. This compared with the momentary rally we saw in  July which saw the Ringgit briefly strengthen past the RM 4.00 handle to the US Dollar.

This drop has surprised many observers as it coincided with a strong rally in Oil Prices, that saw the Benchmark Brent Crude Oil price surge to the highest levels in over a year.

The Government has often blamed Ringgit weakness in the commodity price and have thus been unable to explain this round of weakness, in spite of the bull market in Oil.

The reason we think is several fold.

The most important has to do with the shrinking current account balance. This was talked about at length in our post over here. The current account balance in the second quarter was less than US$500m, a far cry from the heady days of the commodity bull market in 2010  when it was in excess of US$8,900m. Furthermore, the rally in oil prices happened to late for it to affect the 3rd quarter current account balance, which may not see substantial improvement as oil prices tended lower and LNG prices remained under pressure.

The second has to do with the increasing Government debt, both on-balance sheet and off-balance sheet. Total Government debt was over RM 650 billion and the external debt increased by RM 20 billion quarter on quarter to RM 231 billion as of the end of the 2nd Quarter.  This has since retreated to RM 208 billion, indicating a net portfolio outflow over the last quarter.

However, the Government debt figure understates the true Government contingent liability in terms of guarantees to funds such as Danainfra, which recently kicked off an RM 50 billion financing program. When you add to that the cost of the Pan-Borneo highway, where a group of banks were appointed to fund the inititial cost of RM 13 billion, the numbers begin to look staggering. Add to that, the cost of 1MDB, which could easily be another RM 20 – 30 billion in contingent liability, and we are looking at a “true” picture of contingent liabilities well in excess of the last reported figure of RM 178 billion.

The third is a divergence in monetary policy. In July of this year, Bank Negara cut the OPR to 3%.  At the same time, talk is that the Federal Reserve will resume a tightening cycle as early as in December this year. This divergence in interest rates puts further pressure on the Ringgit due to effects in the forward market.

The fourth has to be the fallout from 1MDB and the recent corruption investigations. These scandals has been so widely reported that almost every fund manager interested to invest in Malaysia has to accept that there is a higher country risk due to the perception of corruption. This issue is also made worse by the sometimes erratic flows of money out of Malaysia that appears under the “Statistical Omissions” column in Malaysia’s Balance of Payments. For example in 1Q16,  the Statistical Omissions column amounted to a whopping RM 38 billion outflow that was unaccounted.  In 2Q16, it was a  bit better at an outflow of RM 3 billion.

Personally, with the rally in oil prices lasting slightly longer than fundamentals would dictate, the currency should find some near term support. The risk is that this rally were to fizzle out towards the end of the year, the Federal Reserve were to raise rates at the same time, making it for a very volatile first quarter of 2017.

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