Summary

● In recent years, the CNY and MYR exhibit an increasingly tight co-movement, reflecting the inclusion of the CNY into the IMF’s Special Drawing Rights basket in 2016 and strong economic ties between China and Malaysia.

● The co-movement was engendered through the channels of international trade and currency management. Deciphering these factors is integral in predicting future movement of the MYR in different economic episodes.

● CNY’s strong influence over MYR is underscored by China’s rising importance as a source of final demand, Malaysia’s relatively high degree of participation in the global value chain and China’s gradual push towards an exchange rate reform and currency internationalisation.

● On average, since the launching of China’s belt and road initiative in October 2013, a 1.0% decrease in CNY against USD results in 1.76% decrease in MYR against USD. Based on this correlation, we forecast the CNY to depreciate by 0.57% to 7.03 per dollar (avg. Mar-20), thus prompting MYR to depreciate by 1.0% to 4.26 per dollar (avg. Mar-20).

Identification of Co-movement between the CNY and MYR

● Since the New Silk Road initiative was launched by President Xi Jinping in 2013, China has significantly expanded its economic and political domination. These initiatives deepen the economic ties between China and Malaysia consequently intensifying the interdependence of financial markets between the two countries, especially in the currency market.

● The affiliation of the CNY in the International Monetary Fund’s Special Drawing Rights (SDR) basket in October 2016 consolidated China’s effort to internationalise the CNY. After joining SDR, there is a significant positive correlation between the CNY and MYR on account of increasing trade relationship between China and Malaysia.

● Ringgit is dragged by weaker yuan during the US-China trade war and the recent COVID-19 due to elevated risks and uncertainty. Inversely, the ringgit has also strengthened in tandem with the value of yuan after the announcement of the phase-1 US-China trade deal middle of 2019.

● The co-movement between currencies could provide indications for both China and Malaysia, in terms of central bank interventions and risk management. This could aid policymakers in making a pragmatic policy decision in the future.

When China catches a cold, Malaysia shivers

● In the wake of the US-China trade war, China demonstrates its strength by allowing the yuan to weaken pass its psychological threshold of 7.0 prompting the policymakers to allow the MYR to depreciate against dollar.

● Yuan continues to serve as a barometer for ringgit’s movements during the emergence of the COVID-19. The rapidly spreading coronavirus, which is now officially a pandemic, offset the positive outlook on the US-China trade deal, affecting global economic growth.

Among the ASEAN currencies, MYR and SGD are more sensitive to CNY swings, given their trade, tourism and financial links.

● These moves though are complicated by unceasing spread of COVID-19, political environment, capital flight from the US, geopolitical tensions in the Middle East and volatility in oil prices.

Interpreting Co-movements in Currencies

● Understanding the factors that engendered the comovement between the CNY and MYR is integral in predicting future movement of the currency. As such, we try to decipher the co-movement by zooming into two segments, specifically international trade linkages and proactive currency management.

● Existence of extensive trade linkages to enhance comovement of currencies.

- Direct linkages: China’s importance as a source of final demand has risen over the past decade, with its economic mass, as depicted by demand for global value added (VA), edged up from 4.3% of global GDP in 2005 to 13.6% in 2015, bucking the downtrend of other major economies. Specifically for Malaysia, China registers itself as the largest export market (14.2% of Malaysia’s exports) and trade partner (17.2% of Malaysia’s trade).

- Indirect linkages: relative to other regional economies, Malaysia has a high degree of participation in the global value chain, with the foreign VA used in its exports (backward linkage) and its total VA in exports of other economies (forward linkage) sums up to USD114.1b or equivalent to 55.6% of its exports. Notably, after dissecting into its VA in exports of other economies, we observe that majority of its VA (USD9.2b or 24%) ends up in China’s exports, largely explaining the influence of CNY over MYR.

● Policies pushing for exchange rate reform and currency internationalisation to lift up the CNY’s position as a leader amongst the regional currencies.

- Major milestones of the CNY exchange rate reform:

▪ 1994: unification of dual exchange rates into a single exchange rate regime, with adoption of a fixed dollar peg for the next 10 years (Jun 1995 – Jun 2005).

▪ 2005: removal of a fixed dollar peg, kicking off an era of managed-floating exchange rate regime based on market supply and demand with reference to a basket of currencies, allowing the yuan to trade within a band of +/-0.3% (currently widened to +/-2.0%) around a mid-price set every morning by the People’s Bank of China (PBoC).

▪ 2008: re-pegged to the USD (Jul 2008 – Jun 2010), amidst the Global Financial Crisis.

▪ 2010: de-pegged from the USD, CNY exchange rate reform resumed.

▪ 2015: the PBoC modified the central parity fixing mechanism by referring to the previous day close and a currency basket, instead of setting it on its own discretion.

- Main measures of the CNY Internationalisation:

▪ Jul 2009: establishment of CNY Cross-Border Trade Settlement Pilot Scheme, allowing companies to import and export using CNY with neighbouring countries.

▪ Aug 2011: foreign investors allowed to settle foreign direct investments in China using CNY, instead of the USD.

▪ Dec 2011: launch of Renminbi Qualified Foreign Institutional Investor Scheme (RQFII), permitting foreign investors with the RQFII quota to invest directly in China’s bond and equity markets. It loosens restrictions on currency settlement, adds permissible asset classes, and expands investor eligibility.

▪ Dec 2012: sanctioning of additional CNY offshore trading centres (e.g. TW - 2012, SG - 2013, MY - 2015).

▪ Oct 2015: launch of the China International Payment System (CIPS) to facilitate settlement and clearing of cross-border CNY transactions.

▪ Oct 2016: CNY included into the IMF’s SDR, giving it the status of a reserve currency similar to the USD, EUR, JPY, GBP.

Outlook

● With the expectation that the above-mentioned factors would accelerate in the near term, we foresee the CNY and the MYR to exhibit strengthened co-movement, unless the country gradually enhance its financial liberalisation by changing its de-facto currency regime towards a free-float. We view that a free-float regime could unleash the MYR’s underlying strength, attracting more foreign funds into the capital market.

● Status quo, since the China’s massive belt and road initiative was launched in October 2013, a 1.0% decrease in CNY against USD results in an average decrease of 1.76% in MYR against USD. Based on this estimation, we forecast yuan to depreciate against the greenback by 0.57% to 7.03 (avg. Mar-20), thus prompting ringgit to depreciate by 1.0% to 4.26 per dollar (avg. Mar-20).

Source: Kenanga Research - 16 Mar 2020