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ECONOMICS In this report: Thematic: Malaysia – With challenges comes opportunity from rising MYR KINDLY REFER TO THE LAST PAGE OF THIS PUBLICATION FOR IMPORTANT DISCLOSURES 17 October 2017
ECONOMICS
In this report: Thematic: Malaysia – With challenges comes opportunity from rising MYR
KINDLY REFER TO THE LAST PAGE OF THIS PUBLICATION FOR
IMPORTANT DISCLOSURES
17 October 2017
AmBank Research
Tuesday, 17 October 2017
2
Malaysia
With challenges comes opportunity from rising MYR The Malaysian ringgit (MYR) has been performing well in 2017, appreciating by 6.3% against the USD year to date (YTD). Yet the local currency is trading below the parity line of the real effective exchange rate (REER) since December 2014, suggesting it is in the undervalued region. We also found currencies like the rupiah to be undervalued since October 2011, while the other undervalued currencies are the yen (October 2012 onwards), Aussie dollar (October 2014 onwards) and euro (May 2014 onwards).
Underpinned by undervalued currencies, we believe there is room for the MYR to appreciate further against the USD, supported by macro fundamentals such as the healthy level of reserves, net inflow into equities, improving foreign shareholdings in the MGS, easing of foreign currency deposits, stable growth and prudent monetary policy. We project the USD/MYR to average around 4.33 with our year-end target of 4.15-18 for 2017. At our projected levels, the USD/MYR is expected to trade at a discount from our fair value of 3.9572 based on fundamental analysis and 3.76 using the REER principle. We expect the USD/MYR to strengthen in 2018, averaging around 4.2499 with the year-end target at 3.9500. With a firming USD/MYR outlook, export-led industries that are competitive in the global market should experience challenges. The impact on the industries will depend much on whether the drop in their exports proceeds can be mitigated with cheaper costs of imported inputs due to the stronger MYR. The ability to do so would mean that these industries will benefit from the natural hedge. But it may not be the case for export-dependent industries that are price-takers in the global markets sourcing their inputs locally and pay in local currency. Such industries risk facing strong margin pressures. If the firms source their inputs from abroad and supply the final product locally, they will gain from a strong MYR. While an MYR appreciation could result in some firms facing a decline in profitability, it opens up other opportunities. Those adversely affected would undertake steps to hedge their foreign currency exposure and may need to re-strategize or even venture into other opportunities. Since, exchange rate movements are transitory in nature, those benefiting should not be complacent and should improve their operations to cope with the more challenging times when the situation reverses.
Anthony Dass Chief Economist/Head
[email protected] 03-20322972
Munesh Nair Muralidharan Research Executive
[email protected] 03-20362655
Dalilah Fairoz AmGraduate Executive
[email protected] 03-20362633 ext 3020
AmBank Research
Tuesday, 17 October 2017
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A. MYR and rupiah are undervalued
The Malaysian ringgit (MYR) has been performing well in 2017. It appreciated by 6.3% against the USD year to date
(YTD) (see Figure 1B) after having depreciated by 4.1% in 2016 (see Figure 2B). Comparing MYR’s YTD performance
against the regional currencies, the results turned out to be mixed (see Figure 1D).
As the USD plays a key role in our trade and investment, we examined the impact on the MYR with respect to the USD
on domestic economic activities. It is important to take note that the US is our fourth largest trading partner,
representing around 10.2% of total trade as at 2016.
In examining the impact of the USD/MYR on the domestic economic activities, we applied the real effective exchange
rate (REER). The REER represents the weighted average of the MYR against the currencies of Malaysia’s major trading
partners corrected for the differences in inflation rates. From the REER, we can gauge the overall competitiveness of
the economy since it takes into account of our competitiveness vis-a-vis our major trading partners and not just the
US. It examines the country’s trade capabilities and current import/export situation.
Figure 3 presents the REER of the respective countries. In the ASEAN region, we found Malaysia’s REER has been below
the parity level since December 2014 (see Figure 3I), suggesting the currency is undervalued. Besides, the Indonesian
rupiah is also below the parity line since October 2011 (see Figure 3H). Other undervalued currencies are the yen
(October 2012 onwards), Aussie dollar (October 2014 onwards) and euro (May 2014 onwards) (see Figure 3D, 3G and
3C). Meanwhile, the other currencies are in the overvalued region with the USD being close to parity.
Also supporting the undervalued and overvalued analysis is our trend analysis (see Figure 4).
B. Room for MYR to strengthen remains
Underpinned by undervalued currencies, we believe there is room for the MYR to appreciate further against the USD.
Key factors supporting the local currency are:
1. Strong fundamentals on the back of healthy reserves at US$101.2bil as at September 29 which is equivalent to 7.6
months of retained imports and 1.1x short-term external debt and is poised to improve supported by the healthy
exports (Figure 6), which is above US$100bil mark for the first time since mid-2015.;
2. Despite the recent sell-off in the equities market, the cumulative net portfolio inflows is around RM10bil YTD
following a sharp outflow from 2013-16, suggesting there is appetite on the local bourse (Figure 7);
3. Foreign holdings in Malaysian Government Securities (MGS) have been improving steadily from a low of
RM135.9bil in March to RM156.7bil in September (Figure 8);
4. Foreign currency holdings as a percentage of deposits have eased from its peak of around 8% in January 2017 to
around 7% in August (Figure 9);
5. Stable GDP growth with better-than-expected performance in 1Q2017 of 5.6% and 2Q2017 of 5.8% resulting in
an upwards revision to 5.7% -5.9% for 2017 (Figure 10); and
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Tuesday, 17 October 2017
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6. The OPR poised to stay unchanged at 3.00% in 2017. Upwards adjustment can happen if the GDP continues to
surprise with better-than expected data and core inflation continues to trend upwards.
For 2017, we project the USD/MYR would average around 4.33. Our year-end target for USD/MYR is 4.15-18. At our
projected levels, the USD/MYR is expected to trade at a discount from our fair value of 3.9572 based on fundamental
analysis and 3.76 using the REER principle.
We project the USD/MYR to strengthen in 2018 to average around 4.2499. Our year-end target for 2018 is 3.9500.
Impact on industries
With a strengthening USD/MYR outlook, export-led industries that are competitive in the global market could
experience challenges. The impact on the industries will depend much on whether the drop in their exports proceeds
can be mitigated with cheaper costs of imported inputs due to the stronger MYR. The ability to do so would mean
these industries will benefit from the natural hedge.
However, this may not be the case for export-dependent industries that are price-takers in the global markets,
sourcing their inputs locally and pay in local currency. Such industries risk facing strong margin pressures. If the firms
source their inputs from abroad and supply the final product locally, they will gain from a strong MYR.
Looking at manufacturing, more than 50% of the sector’s activities are export-oriented. From our analysis, we found
this industry to be vulnerable to currency movements, whereby for every 1% change in REER or the USD/MYR, its
impact is 1.66% after a one-lag period. However, as part of the global manufacturing network, a sizeable number of
domestic manufacturers import raw and processed materials which are converted into intermediate goods and
exported for further processing or final consumption. With a strong co-movement between exports and imports, it
makes trade more responsive to global demand than to the MYR performance alone. Owing to the close co-
movement between exports and imports, it allows for natural hedge, which in turn reduces the overall impact of the
MYR’s movements.
As for construction, activities in this industry are poised to gain the most with an MYR appreciation. We found this
industry is more sensitive to USD/MYR than the REER. For every 1% change in the USD/MYR, its impact of this industry
is 0.65% and is felt after one lag. It is not surprising since it is domestic-oriented and its output is priced and consumed
locally, though some of the inputs are imported. A strong USD/MYR will lower the cost of imported inputs while the
impact on its operating figures depends on the contribution from domestic activities apart from its exposure on
imported contents.
We expect the overall impact on services to be broadly balanced from a USD/MYR appreciation. Like construction, this
industry is sensitive to USD/MYR compared to the REER. For every 1% change in the USD/MYR, its impact of this
industry is 0.47% and is felt after one lag. The majority of the industries under services will benefit from a USD/MYR
appreciation due to high import contents and limited reliance on exports. But the positive impact will be partly offset
with the adverse effects on business services industry given that the shared services and outsourcing mostly involve
exports of services, driven mainly by the multinational corporations (MNCs). These MNCs mostly source inputs
domestically in the MYR and export their services in foreign currency.
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Tuesday, 17 October 2017
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With challenges, come opportunities
While an MYR appreciation could result in some firms facing a decline in profitability, it opens up other opportunities.
From cheaper costs of imported inputs and capital, it will facilitate the firms’ transformation from labour- to capital-
intensive production. Such a transformation could enhance their productivity and profits.
The gain in productivity would encourage firms to pay higher wages and promote a vibrant labour market with a
larger pool of skilled workers. Higher wages drive domestic consumption and pave the way for more opportunities,
especially for non-tradable sectors to flourish. This would eventually facilitate the reorientation of the domestic
economy from being trade-dependent towards one that is driven by domestic demand.
In the medium-to-long term, businesses are expected to evaluate whether the current strategies being pursued are
sustainable and robust enough to the changing environment. In the short term, those adversely affected would
undertake steps to hedge their foreign currency exposure and may need to re-strategize or even venture into other
opportunities. Since exchange rate movements are transitory in nature, those benefiting should not be complacent
and improve their operations to cope with the more challenging times when the situation reverses.
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Tuesday, 17 October 2017
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Figure 1: G10 and Asian Currencies YTD Performance against MYR and USD 1A: YTD Performance Against the USD (G10)
1B: YTD Performance Against the USD (Asia)
1C: YTD Performance Against the MYR (G10)
1D: YTD Performance Against the MYR (Asia)
Source: Bloomberg, AmBank Research
Note: Positive changes denote appreciation against the base currency, vice versa.
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Tuesday, 17 October 2017
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Figure 2: G10 and Asian Currencies 2016 Performance against MYR and USD 2A: 2016 Performance Against the USD (G10)
2B: 2016 Performance Against the USD (Asia)
2C: 2016 Performance Against the MYR (G10)
2D: 2016 Performance Against the MYR (Asia)
Source: Bloomberg, AmBank Research
Note: Positive changes denote appreciation against the base currency, vice versa.
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Figure 3: REER by Country 3A: United States
3B: United Kingdom
3C: Euro
3D: Japan
3E: China
3F: India
Source: CEIC, AmBank Research
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Figure 3: REER by Country (continues) 3G: Australia
3H: Indonesia
3I: Malaysia
3J: Philippines
3K: Singapore
3L: Thailand
*Thailand REER base year = 2005
Source: CEIC, AmBank Research Note: REER base year for all countries are 2010 except for Thailand.
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Figure 4: : REER Trend Analysis by Country 4A: United States
4B: United Kingdom
4C: Euro
4D: Japan
4E: China
Source: CEIC, AmBank Research
4F: India
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Tuesday, 17 October 2017
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Figure 4: REER Trend Analysis by Country (continues) 4G: Australia
4H: Indonesia
4I: Malaysia
4J: Philippines
4K: Singapore
4L: Thailand
*Thailand REER base year = 2005
Source: CEIC, AmBank Research
Note: REER base year for all countries are 2010 except for Thailand.
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Figure 5: Fair Value Using REER By Country 5A: United States
5B: UK
5C: EU
5D: Japan
5E: China
5F: India
Source: CEIC, AmBank Research
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Figure 5: Fair Value Using REER By Country (continues) 5G: Australia
5H: Indonesia
5I: Malaysia
5J: Philippines
5K: Singapore
5L: Thailand
*Thailand REER base year = 2005
Source: CEIC, AmBank Research Note: All fair value calculations use REER base year 2010 except Thailand.
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Figure 6: Official Reserve Assets
Source: CEIC, AmBank Research
Figure 7: Cumulative Net Portfolio Flows
Source: AmBank Research
Figure 8: MGS Foreign Holdings
Source: BNM, AmBank Research
Figure 9: Foreign Currency Holdings as Percentage of Deposit
Source: CEIC, AmBank Research
Figure 10: Malaysia GDP Growth Rate %
Source: CEIC, AmBank Research
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