• Recent depreciation in the ringgit past USDMYR 4.0 does not change our economic assessment
• Expectations are for the ringgit to face continued downward pressure in 2H15 as anticipation builds for the US Federal Reserve to hike rates
• This turns up the heat on capital outflows in emerging markets including Malaysia, suggesting further weakness for the ringgit and regional currencies.
• The Chinese yuan is now in the picture as any further devaluation will have short-term implications for the ringgit and regional currencies
• We are revising our year-end USDMYR target to 3.87 and the 2015 average to 3.83.

Steeper than before. The pace of depreciation of the ringgit against the world’s reserve currency in past weeks has been undoubtedly quicker than in the first half of the year. Against the US dollar, the ringgit has depreciated 13.4% year-to-date, with close to half of it or a depreciation of 6.3% occurring in the past month alone. Thirty-seven days is all it has taken for the ringgit to cross past one psychological barrier to yet another, the first being the 1998 currency peg level of USDMYR 3.8 breached on 6 July and the latest being USDMYR 4.0 surpassed yesterday, Aug 12. For some perspective, USDMYR ended 2014 at 3.4973.

Broadly speaking, the longer-term causes of ringgit weakness can be put down to persistently weak global commodity prices and a widening monetary policy gap between the U.S. and the rest of the word, resulting in what has turned out to be an unrelenting sell-off in emerging market currencies for safe haven alternatives.

CNY in the picture. A more recent event, the decision by the People’s Bank to China to cut the yuan reference rate by 1.9% on 11 Aug, has added to US dollar strength and fed another round of emerging market currency de-ratings. Before this USDCNY was virtually unchanged year-to-date. The event has had major bearing on pushing USDMYR past the 4.0 mark.

Some downtime for regional currencies. Importantly, the ringgit is not alone in its slide against the dollar. Over the past month, currencies that in the past year resisted depreciation such as the Singapore dollar, Thai baht and South Korean won have weakened considerably. But the ringgit is set apart in bleeding the most value among major world currencies, likely due to international investors becoming increasing vary of political uncertainty that a cabinet reshuffle last month failed to resolve.

Exceptional ringgit. It appears that Malaysia seems to be an exception as there are additional reasons investors would want to dump the country’s financial assets. Chief among them is the 1MDB debt fiasco, high household debt as well as sharply lower revenue due to the slump in oil and gas prices which forces the government to raise its deficit target in 2015.

Misplaced worries. Although unexpected, the precipitous fall in the ringgit past USDMYR 4.0 is not reflective Malaysia’s economic fundamentals, which are intact and on track to deliver GDP growth of between 4.5% to 5.5% this year. Instead, the ringgit decline should be thought of as a consequence of a terms-of-trade shock. Flexibility in allowing the ringgit to adjust to a lower rate now against major trading partner currencies prevents a build-up of downwards pressure on the ringgit which would be difficult to rectify at a later date.

Past reflections. The last time the USDMYR breached 4.00 was in early June of 1998 at the height of the Asian Financial Crisis and it went on to peak around 4.27 by mid-July. To stabilise the ringgit and stem capital outflows, the government imposed capital controls and pegged the USDMYR at 3.80 on 2 Sep 1998. It lasted till 21 Jul 2005 as the government relaxed capital control and reverted to a managed float currency regime.

Outlook

Unpredictable and volatile. The current environment makes it very difficult to predict what would be the value of the ringgit for the next three to six months. Since the USDMYR has breached two significant levels (3.80 & 4.00) along with the likelihood that the Fed would raise interest rates before end of this year, we reckon the downward pressure on the ringgit would remain elevated. There will be a tug-of-war between investors' sentiment and the underlying fundamentals that supports the value of the ringgit. Given the two strong opposing forces, it is difficult to predict at what point it will settle by year end. For this reason we've decided to err on the side fundamentals and reckon the ringgit's downward volatility would subside and settle below 4.00. Hence, our new year-end target for the ringgit is 3.87 (previously 3.67). (Average 2015: 3.83).

On the assumption that the global and domestic economy would be relatively more stable next year and the pace of the Fed rate hike would be gradual and likely to remain low (1.00-1.25% by end-2016) we forecast the ringgit to settle in the region of 3.55-3.75 by end of next year.

Several things that make it less scary than the last Asian currency crisis in 1997 or the recent Global financial recession of 2008, is there is far less inflation, larger forex reserves, banks are sound and well capitalized and that financial markets that aren't as rigid as in the past.

Source: Kenanga Research - 13 Aug 2015