China’s economic slowdown means lower commodity prices and that affects Malaysia and Indonesia.
The general sentiment toward emerging markets has been negative due to concerns about China’s slowing growth and a potential US Federal Reserve rate hike.
With the next meeting of the US Federal Reserve looming, China continuing to pump out mixed economic data and with Brazil’s credit rating from Standard & Poor’s falling into junk territory, money kept flowing out of emerging markets equity funds during the first full week of September. EPFR Global, which tracks over 65,000 traditional and alternative funds globally, highlights that, since mid-July, investors have pulled over US$40 billion from this fund group, exceeding the pace of redemptions seen during the so-called “taper tantrum” in 2013.
Over the past few weeks, markets have been extremely volatile and concerns about China’s growth and the consequent devaluation of the renminbi (RMB) have been painted as the principal cause of the story.
Amidst all these developments, the currencies of Asia’s two net commodity exporters – Malaysia and Indonesia – had been the worst hit. The Ringgit has depreciated by approximately 25% against the US dollar in the past 12 months and last week marked the 12th week of the Ringgit’s depreciation, the longest stretch in Bloomberg data going back to 1971.
Moody’s Investors Service maintains that the depreciation in the Ringgit is manageable for the sovereign (which it rates A3 positive), banks and rated corporates, although it indicates a weakening environment.
“We see Ringgit depreciation as a symptom of declining export revenues, capital outflows, and worsening investor sentiment toward Malaysia,” says Rahul Ghosh, a Moody’s Vice President and Senior Research Analyst. “These are negatively impacting key credit buffers such as the current account surplus, foreign reserve coverage, and economic growth trajectory.”
Although Moody’s expects its rated corporates — which have natural hedges and better flexibility despite external funding exposure — to weather the weaker Ringgit, it acknowledges that lower Brent crude and palm oil prices will weigh on commodity producers’ cash generation and earnings.
Moody’s recent polling of over 150 attendees at its event offers insights into what some of the country’s largest investors, intermediaries and debt issuers consider key issues for Malaysia going forward.
The majority of market participants surveyed by Moody’s expect the Ringgit and oil prices to stabilise; 44% expect the Ringgit will remain range-bound between RM4.00-4.50 against the US dollar, and 62% expect Brent crude to average US$45-55 per barrel in the coming 12 months.
Mixed views on the Ringgit
Meanwhile, Etiqa Head of Research and Head of Products & Alternative Investments Chris Eng shares that a survey by the house among local and foreign economists found the view pretty much split between the two groups, with “locals putting Ringgit’s fair value at around RM3.60-3.80 and foreigners are all looking at above RM4.”
“My quick back-of-the-envelope calculation is RM3.40 fair value, another RM0.40 for weakness due to oil. Beyond that is local Malaysian-specific factors,” he says.
“So yes, I do believe the Ringgit is currently undervalued and we await the US Fed rate decision to hopefully see the Ringgit strengthening after that as it’s likely a case of ‘Buy USD on rumour and sell on fact’ still,” Eng adds.
Moody’s polling also showed that market participants still view China’s (Aa3 stable) growth slowdown as the largest risk for Malaysian banks, followed by Ringgit weakness. From Moody’s perspective, Malaysian banks’ direct exposure to China is limited, but domestic asset quality may be pressured given Malaysia’s export exposure.
While the full extent of China’s slowdown will take some time to reveal itself, fears that growth may be worse-than-expected are likely to persist. The August manufacturing PMI from China was the lowest in four years.
And although the impact of China’s slowdown may not be that great directly, the larger pressure comes with the other things it brings along with it, notes CIMB chief economist Arup Raha. “The slowdown means lower commodity prices, most likely oil and gas, and that affects Malaysia and Indonesia.”
“Similarly, a weaker RMB may not have much impact in terms of pure trade numbers, as perhaps the overlap in exports is not great. But if a weaker RMB also means, say, a weaker Ringgit, it then means that a slowing Malaysian economy can no longer be helped by cutting policy rates as that could worsen the currency’s slide. In other words, the larger effect of a RMB depreciation on Malaysia could come because of the shackles it clamps on monetary policy,” he adds.
Arup believes that while sentiment is playing a role, the single largest driver of the Ringgit has been oil prices.
“This softness in commodity prices has been the main story behind the Ringgit and Rupiah weakness. When coal prices fell, so did the Rupiah and when oil prices fell, the Ringgit followed. Crude palm oil (CPO) and liquefied natural gas (LNG) are both important exports and both have a strong correlation with the price of oil,” he says.
“Slowing growth in China will likely keep commodity prices soft. Moreover, commodity prices have a high negative correlation with the USD. While we think that the USD probably has limited upside from here, it should still trade on the stronger side.”
“With US monetary policy likely to tighten while the Bank of Japan (BoJ) and European Central Bank (ECB) maintain their respective quantitative easing (QE), it is difficult to see a meaningful reversal in forex trends,” Arup says.