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Whither the Malaysian Ringgit?

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The ringgit at 2.95 vs the Singapore dollar on March 14, 2016. Today SGD1 buys MYR3.1. pic/shukor yusof

Is the Malaysian Ringgit (MYR) overvalued or undervalued? Will the currency get stronger in 2017, or will it continue to weaken against the US Dollar (USD)? How will the MYR’s plight affect Malaysia’s airlines?

There are many reasons why a currency might lose or gain in value against another but let us look at some of the factors that are pressuring the MYR.

Inflation rate: A country’s inflation rate compared to another (for example, the USD) is just one of several reasons causing it to strengthen or weaken against that currency. Typically in a high inflation environment, te value of the currency will soften.

According to Malaysia’s central bank, Bank Negara Malaysia (BNM), inflation came down to 1.4% in October 2016 (from 1.5% in September). The consumer price index, or CPI, rose 1.8% in November last year, according to the Department of Statistics.

Inflation is likely to go up this year given the rise in daily items such as cooking oil and gasoline as well as utilities. Imported goods will cost more but on the other hand, a weakened currency will benefit the export business as goods become more affordable (and tourism could be a major benefactor).

Interest rates: BNM has kept the overnight policy rate steady at 3%. Rates set by the central bank have an impact on the value of the currency. Typically if rates go up, the value of a currency tend to rise as foreign investors are attracted to invest in that particular country due to the higher returns.

For instance, the USD is strengthening and one of the reasons is an expected further rise in rates in the US in 2017.

Economic health: Money tends to depart a weakened economy, and into those perceived to be stronger. The MYR was pummeled in November 2016 and foreign investors fled the country in large volumes.

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Foreign investors – owners of 40% of Malaysia’s bond market – have left, after bond yields rose worldwide following Donald Trump’s victory in the US presidential elections. There are concerns his stimulus policies will trigger inflation. And in 2015, investors quit Malaysia’s stock markets, dumping over USD3 billion as they exited.

Capital outflow is not a good sign. It indicates that investors are no longer confident in a particular market or country. That said, the money that’s flowed out of Malaysia is not as bad as it was during the Asian Financial Crisis of 1998 and the financial system remains in relatively good health.

Other factors that affect currencies include a country’s financial health. Malaysia has been running a deficit for many years (deficits tend to depress a currency and it has with the MYR) and while this should improve in 2017, it doesn’t quite lend comfort to investors.

Political instability and poor economic performance can also combine to deter investors. While Malaysia is somewhat politically in a mess, it is not unstable. The problem for Malaysia is this: there are others in the neighbourhood perceived, rightly or wrongly, to have better attributes (both politically and economically).

BNM has attempted to stem the MYR’s decline to the tune of over USD25 billion since July 2014, without much success. To compound matters, BNM has less ammo to fight the MYR’s decline given the slide in Malaysia’s foreign reserves to below USD100 billion. And the lower a country’s forex reserves, the weaker its currency will get…

Oil prices are showing signs of rebounding and the agreed OPEC cuts should continue to bolster the sector. Malaysia is a net oil exporter and should benefit from any price hike but alas, this isn’t just about oil anymore.

China is Malaysia’s second largest trading partner and China is facing a slowdown. The strong trade linkage between the two countries ensures that Malaysia will feel the brunt of China’s economic malaise.

The decline of the MYR can be traced to the turmoil affecting Chinese markets 18 months ago, when China executed a 2% devaluation of its currency, the yuan (CNY). But, as the Malaysian prime minister pointed out, most other countries have also lost out against the greenback.

In our view, currency weakness is no longer a big risk to ASEAN economies, unlike during the 1998 financial crisis. However, Malaysia has a huge chunk of USD-denominated debt (see here).

What does this all mean for Malaysia’s airlines?

In our previous posting, we wrote of how precarious discount carrier Firefly’s financial health is and now Malaysia Airlines Berhad has confirmed its plan to acquire 25 wide body planes.

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how many ringgits to pay for one of these? pic/shukor yusof

Our question is: how does MAB plan to pay for these aircraft, even if they were to lease instead of buy them? We don’t know how MAB is doing financially as the airline is no longer listed and therefore not obliged to reveal its operating numbers. However, we have a hunch MAB still isn’t profitable.

The decline in the MYR’s value will have deep and serious ramifications on MAB and other Malaysia-based carriers. Airlines by definition are international businesses and therefore at the mercy of global currency fluctuations.

So what can Malaysia’s airlines do? A few things: (a) they can lock into a fixed exchange rate for a certain period by setting up a forward contract or simply buy the USD in advance; (b) they can use derivatives to hedge against volatility but the use of derivatives is very complicated, and costly; (c) they can set up contracts in the home currency (MYR) so that this gives some protection against any sharp movements; and (d) they can do nothing but just track the markets if they feel there is no immediate risk.

Needless to say, the impact of a stronger USD will differ from airline to airline. For Asian carriers, a costlier greenback will erode and negate all the cost savings from lower oil prices and the situation could become riskier once oil prices creep back up again, as they are expected to this year.

Overall, the weakening MYR is good for Malaysia’s domestic economy as it protects the country from a slump in export earnings. Additionally, export earnings have benefitted. Unfortunately, airlines won’t be among the beneficiaries mainly because aviation-related costs are mostly denominated in USD.

A weakened MYR is likely to mean dampened appetite for flying, too. But critically, forex currency losses can and will hurt carriers. Two years ago AirAsia X suffered huge losses due to an increased cost of foreign borrowings resulting from a weakened MYR.

Airlines that are already financially weak may suffer greatly (if they haven’t already) should the currency touches the USD1:MYR5 level in 2017 – unlikely to happen – but that’s what they said about Trump becoming president…

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