MYR, RMB face weakening trend vs. USD

With both the MYR and RMB seen to be on a weakening trend against the USD, we expect the RMB/MYR to hover around the 0.63–0.66 levels for 2021 with the upside to 0.66 should the MYR weakening trend be far more significant compared to RMB against the USD.

The downside of RMB/MYR is close to 0.63 on the assumption that the RMB weakens more than MYR against the USD.

Short-lived volatility

The MYR started 2021 strongly at 4.02 against the USD. However, by end-May 2021, the MYR had depreciated by 2.6 percent to 4.12, its eight-month low since October 2020. Despite surging global commodity prices, and improving
global economy and trade outlook, the local currency took a hit from rising domestic Covid cases, slow vaccination speed and domestic political uncertainties with the pace of economic recovery weighed down by the
impact of the MCO 2.0 (January–February 2021).

Meanwhile, the RMB which started at 6.53 against the USD, reached its three-year high (since June 2018) of 6.37 against the USD, translating to a 2.5 percent appreciation by the end of May 2021. This was amidst surging global
commodity prices and raised suspicion that the People’s Bank of China (PBoC) had deliberately used the RMB depreciation earlier to curtail rocketing imports.

Due to the tight correlation between both currencies and the USD of around 0.64 percent, the ringgit fell by 4.7 percent against the RMB between January and end-May. The RMB/MYR exchange rate hovered between 0.62 and 0.65
during the period.

MYR and RMB losing strength

However, the trend for both the MYR and RMB had turned negative since end-May 2021. From early June until 3 September, the MYR had dropped by 0.5% to 4.15 against the USD, while the RMB fell by 1.2 percent to 6.46 against the USD.

The drag on both currencies was due to:

1. Change in the USD outlook. The dollar’s strength is partly due to growing expectations that the Fed will announce the tapering of its asset purchases. We expect the Fed would announce tapering in November. It would give Fed enough time to digest the macro data on labour market's recovery and economic growth.

If the incoming data remains good, we expect tapering to start in December this year. But if the data is not strong enough over the next two months, we foresee the Fed moving its tapering timeline to 1Q2022.

On the policy rate, promising incoming data would allow the Fed to start raising its rates as early as 4Q2022. Otherwise, we expect rates to be revised upwards in 2023, factoring in two rate hikes, each by 25bps from its record low policy rate of 0 percent–0.25 percent.

And we believe the financial markets would be able to absorb the Fed’s tapering without much volatility. Any concern will only come about should there be persistent market unrest and spills into the real economy.

Market fears will arise if the Fed’s direction with regards to unwinding of its US$120 billion worth of monthly bond purchases remains unclear – whether by following the post-Great Recession playbook i.e. to first cut back Treasury purchases or mortgage-backed securities to calm a red-hot housing market.

The economic recovery from the pandemic is expected to be more rapid than previously expected. And the Fed could reach its dual mandate of 2 percent inflation and maximum sustainable employment much sooner. We project the GDP to grow by 7.0 percent and 4.5 percent with inflation at 3.0 percent and 2.0 percent for 2021 and 2022 respectively.

2. The RMB’s climb was truncated after the PBoC announced a rare hike of the foreign deposit reserve requirement ratio by 2 percent on 31 May. The hike clearly signalled the PBoC’s intention of limiting the fast appreciation of the RMB exchange rate.

3. Also, the USD, which has a strong correlation with the RMB, has picked up pace since end-May. This resulted in the RMB depreciating quickly against the USD, falling to 6.46 as at 3 September, about a 1.2 percent below its previous low of 6.38.

4. Meanwhile, the MYR fell against the USD due to the rising number of Covid cases which resulted in MCO 3.0 despite the increasing speed of vaccination. It disrupted the gradual economic recovery, pushing the economy back into a negative growth in 3Q2021, dashing hopes of a modest recovery in 4Q2021. We have lowered our 2021 GDP to 3.0 percent–3.5 percent with a downside at 1.5 percent.

Will RMB enjoy appreciation against USD again?

To recap, during the first five months of the Covid-19 pandemic in 2020, the RMB tumbled 2.49 percent against the USD to a deep trough of 7.14 in May 2020, as China bore the brunt of the unprecedented pandemic, on top of
escalating China-US tensions. The MYR plunged by 6.25 percent to a low of 4.35 vs. the USD, while against the RMB, the local currency depreciated by 3.67 percent to 0.61. During this period the dollar index rose 1.97 percent to 98.34.

As for the RMB, it gained strength from May 2020 till May 2021, jumping 10.6 percent to reach 6.37 against the USD supported by macro fundamentals. During this period, the MYR appreciated by 4.5 percent to 4.12 against the USD. But against the RMB, the MYR fell by 6.5 percent to 0.645.

Nevertheless, the macro fundamentals that supported RMB are not sustainable due to:

1. Growth divergence as China's "first-in-first-out" of the pandemic is expected to ease from global recovery;
2. The USD would strengthen in 2021 from the Fed’s potential tapering;
3. Gradual ease of trade balance and current account surplus will weigh on the RMB’s rise as:

Exports, although strong, would lose momentum when global GDP normalizes, though it may take time; Services trade deficit due to almost zero outbound tourism, etc in 2020 will gradually rev up as more countries start to open their borders to support their tourism sector; and

Recent surge of commodity prices compared to domestic pent-up demand increases import values.

Besides macro fundamentals, the China-US relations, global capital flows, China's policy reforms and credit crunch regulations, and the PBoC’s policy intentions on the exchange rate will need to be carefully and evaluated.

We expect a depreciation trend in the RMB vs. the USD as we thread into the remaining months of 2021. The pair will likely hover around 6.45–6.55 levels and with room to reach 6.65–6.80 by end-2021. And MYR is expected to remain soft against USD.

Looking ahead, the MYR’s outlook against the USD is seen to come under slight downward pressure driven by:

1. A downgrade of 2021 GDP growth to 3.0–3.5 percent due to the rise in local Covid cases despite increasing vaccinations. It will sharply lower 2H2021 GDP to 0%–0.5% from 7.1 percent y/y in 1H2021;

2. The government’s plan to widen the budget deficit to 6.5 percent to 7 percent of GDP from the initial estimate of 6.0 percent would mean the statutory debt limit will be raised from 60 percent to 65 percent of GDP; and

3. Domestic political noises pending GE15, which means investors will remain cautious on future debt ratings, added with the risk of being downgraded.

However, the weakening trend of the MYR could be softened under the following circumstances:

1. A reopening of the economy by the end of October where all states transition to Phase 3 of the National Recovery Plan (NRP) and Phase 4 by November after Malaysia inoculated its entire adult population;

2. Favourable external demand environment, supportive economic policies and a gradual improvement of domestic demand would help steer the economy into recovery in 2022;

3. Political stability that boosts consumer, business and investors sentiments, effective implementation of policies and clearer SoP procedures that will improve mobility, pent-up demand and business expansion while reducing stress on the labour market.

Besides macro fundamentals and political stability, global capital flows, domestic policy reforms, policies after the rollback of stimulus measures, credit crunch, bankruptcies/delinquencies, unanticipated provisions and BNM’s policy intentions on the exchange rate will also need to be carefully considered and evaluated.

We expect the MYR to continue its depreciation trend against the USD in the remaining months of 2021. It will likely range from 4.15 to 4.20 levels and with room to reach 4.30 by end-2021.

How will MYR trend against RMB?

To answer this, we took into consideration the behaviour of RMB and MYR against USD, given that both have strong correlations with the USD.

Some RMB appreciation versus the USD might help contain inflation arising from increasing commodity prices and supply-chain bottlenecks. And there is some evidence that suggests heavily indebted Chinese companies took the opportunity to pay down their USD-denominated debts.

But such benefits come with risks. A stronger currency will result in smaller yuan-denominated revenues for exporters and can exacerbate the financial fragility of China where public and private debt exceeds 300 percent of GDP.

And there are worries that too rapid an appreciation could spark a destabilizing of capital inflows or outflows. Managing the fallout from the Fed’s weak dollar policy could also expose China to trade retaliation from the US. These are dangers coming from their credit-fuelled policy mistakes.

Besides China’s macro fundamentals, the China-US relations, global capital flows, China's policy reforms, credit crunch regulations, and the PBoC’s policy intentions on the exchange rate will need to be carefully and evaluated. All points towards a weakening RMB to hover around 6.45 -6.55 with the upside at 6.65 -6.80 by end 2021.

In the case of Malaysia, the underlying logic is quite straightforward. Besides macro fundamentals, domestic political uncertainties, economic blowout due to the pandemic that led to MCO 3.0; the speed of vaccination; uneven recovery; business sustainability, risk of ratings downgrade from ballooning fiscal deficit and public debt, global capital flows from Fed’s tapering, policy reforms, bankruptcies, high provisioning, household debt and retirement crisis, and BNM’s policy intentions on the exchange rate will weigh on the MYR.

We reiterate our MYR outlook to the USD at 4.15 -4.20 with the upside at 4.30 by end 2021.

With both the MYR and RMB seen to be on a weakening trend against the USD, we expect the RMB/MYR to hover around the 0.63–0.66 levels for 2021 with the upside to 0.66 should the MYR weakening trend be far more significant compared to RMB against the USD. The downside of RMB/MYR is close to 0.63 on the assumption that the RMB weakens more than MYR against the USD.