Letter from... Malaysia

Rumours of an impending ringgit revaluation spurred Malaysian capital markets in 2004. Scenting the prospect of lucrative currency gains, investors poured some RM2.5bn (US$657m) into ringgit-based assets - including portfolio investments - in the first half of December 2004, on top of around RM57bn (US$15bn) in shares and corporate securities during the first nine months of 2004.

Their incentive is the Malaysian ringgit, which has been fixed at RM3.80 to the US dollar since 1998 in the aftermath of the Asian currency crisis, and is widely perceived as undervalued today. But is the ringgit really undervalued? Consensus views among many analysts and economists hold that fair value for the ringgit is between RM3.50 to RM3.69 to the dollar, meaning that the ringgit may be undervalued by only about 3% to 8%. Furthermore, recent statements from central bankers and high-level Ministry of Finance officials also indicate that the Government believes the ringgit is close to fair value at its current level.

Although such assessments should pour cold water on speculative inflows or the dreaded 'hot money', which wreaked havoc on Asian currencies and assets in the currency crisis of the mid-1990s, ringgit speculation will keep fuelling Malaysian markets in the near future. 'The currency factor will probably be the number one catalyst for Malaysian stocks in 2005,' says Tammi Lim, chief investment officer of Phillip Mutual Berhad.

Pundits believe that US dollar weakness is the key that may unlock the peg sometime in 2005, probably in the second half of the year, and that the peg may be replaced with a more flexible 'managed float system' that allows for government intervention to keep the currency at desired levels. 'The probability of a regime change is rising, as structural US dollar weakness has pushed yen and euro closer to key 100 and 1.40 benchmarks, levels which the Second Finance Minister, Tan Sri Nor Mohamed Yakcop, warned would provoke a serious review,' commented DBS Bank recently, in a review of the Malaysian macro-economic outlook for 2005. However, Nor Mohamed also said that a review would only be triggered if the ringgit moves 20% or more against regional currencies, using 1998 as the base year. In addition, the ringgit would have to hover around these levels for some time before the Government moves.

But the decision to break the ringgit peg may ultimately hinge on China's own revaluation of her currency. Phillip's Lim says that Malaysia would want to learn from the Chinese experience. Lately, speculation has been rife that China will liberalise its trading band for the yuan under pressure from the US and Japan, which claim that an undervalued yuan gives Chinese exporters an unfair advantage. The yuan has traded within a band of 8.276-8.280 against the US dollar since late 1997, and has weakened in tandem with the sliding US dollar. China has said it is committed to freeing the yuan but at its own pace. Changing her exchange rate regime now would cause 'great disruption to China's economy and, therefore, her rapidly transforming society,' notes independent investment adviser Capital Dynamics.

Taking the cue from the Chinese, Malaysia too may implement currency reform only when it is good and ready. 2005 may not be the right time because the weaker ringgit sustains exports and, thus, Malaysian economic growth in a slowing global economy. However, strengthening the ringgit has its advantages. A stronger ringgit would reduce import bills, improve the Government's fiscal position by slashing the debt burden, which is about 70% US dollar denominated, and keep a lid on inflation.

When it does come, revaluation will be a 'lightning strike', notes Dato Dr PHS Lim, President of the Malaysian Investors' Association, because the Government will not want to play into the hands of speculators. An announcement is most likely when speculation has petered out and the opportunists, bored with waiting, have exited Malaysia for the latest greener pasture.

Nazatul Izma Abdullah is a freelance writer on business and finance issues, based in Malaysia.