The recent drop in the Malaysian ringgit hasn’t had the same impact as declines in other key EM currencies headed by Brazil’s real.

But the ringgit is down 2.6 per cent this month against the US dollar: that makes it the fifth-worst performing emerging market currency in March – behind the real, the Indian rupee, the South African rand and the Turkish lira but ahead of the widely-watched Hungarian forint.

It’s not necessarily a sign of economic weakness in Malaysia: more a reflection of the ringgit’s inherent volatility as a liberalised and widely-traded currency. In risk-on times, investors buy the ringgit; risk-off, and they sell.

So in this year’s risk-on surge that petered out in late February, the ringgit performed well, particularly against other Asian currencies. Even after the march sell-off, it stands 3 per cent up on the year against the dollar, the second-best performing Asian currency after the Indian rupee, which is 3.6 per cent higher.

That’s well short of the year’s top emerging market currencies – which are headed by the forint with a 10.3 per cent gain. But the forint and its closest rivals (the Colombian peso and Polish zloty) were far weaker last year than Asian emerging market currencies, so had greater recovery potential.

Sanjay Mathur, an economist at RBS, doesn’t see the current phase of ringgit weakness lasting. He forecasts the Malaysian currency strengthening modestly to M$3.03 against the US dollar this year from its current level of M$3.07. That compares with this year’s strongest level of M$2.99 and last year weakest point of M$3.19.

As Mathur points out, Malaysia has a relatively small equity market so has not seen its currency boosted by the recent inflows into EM equities as much as other countries, for example Russia.

But, with foreign investors holding some 35 per cent of Malaysian local bonds, the ringgit is more exposed than many other EM countries to swings in sentiment among fixed income investors, who have been less bullish this year than their equities counterparts.

Meanwhile, Malaysian officials are responding to the growing evidence of a global economic slow down, with the central bank this week cutting its 2012 GDP growth forecast from 5-6 per cent to 4-5 per cent and predicting inflation of 2.5-3 per cent.

Bank Negara made clear in its 2011 annual report that its main concern was about the global economy. It said in a statement:

[The] risks include an escalation in the eurozone sovereign debt crisis and much slower growth in our major trade partners. …A key challenge for the Government in 2012 is to continue providing support to domestic demand amid the weakening external sector, while ensuring that the fiscal position remains sustainable.

As well as the US and the European Union, China is now a big market for Malaysian exports, accounting for 13 per cent of the total. While this diversification is positive for economic development, it means that if China runs into trouble managing its expected slow down, Malaysia will feel the impact.

With elections due this year, the government has raised spending, boosting civil servants’ pay and social support for poorer Malaysians, and running a chunky fiscal deficit in the year to September 2012 of 4.7 per cent. With a public debt/GDP ratio of 53 per cent, compared to a national ceiling of 55 per cent, there’s not a lot of headroom.

There are no immediate dangers in all this, but there are some uncertainties that investors will have to take into account. Mathur at RBS doesn’t see the central bank intervening much in the currency markets. “If you have a deep bond market with foreign investors, there’s not much you can do.”

In other words, the ringgit will go with the flow – risk-on and risk-off.

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