KUALA LUMPUR: The ringgit exchange rate experienced a period of sustained depreciation against the US dollar last year, Bank Negara Malaysia said.
There was a concern after the ringgit hovered close to levels last experienced during the Asian financial crisis, the central bank added.
There were even some calls for the ringgit to be pegged to prevent it from falling further, Bank Negara said in its Financial Stability Review for Second Half 2022,
Since the start of 2023, the US Federal Reserve has continued to increase its policy interest rate by another 50 basis points to a target range of 4.75-5.00 per cent as at end-March.
"Movements in the exchange rate will influence households' and businesses' decisions, and thus in the aggregate, will impact economic activity.
"For a country with a flexible exchange rate like Malaysia, the ringgit can periodically appreciate and depreciate. Over the longer term, the exchange rate should be determined by the country's economic fundamentals relative to key trading partners," Bank Negara said.
Short-term movements in the exchange rate are strongly influenced by cross-border financial flows and investor risk sentiments, which are often affected by global developments and not reflective of the country's economic fundamentals.
This was the case in 2022 when the US Federal Reserve raised its policy interest rate aggressively by 425 basis points to a target range of 4.25-4.50 per cent to address inflation.
The higher returns on US financial assets raised the demand for these assets and led to a period of sustained dollar appreciation. Consequently, other currencies including major currencies and the ringgit depreciated against the dollar during the year.
"This depreciation was a global trend and not indicative of any fundamental weaknesses in the affected economies within the region and globally. With this in mind, the effects of the exchange rate on the Malaysian economy are not only determined by developments in the bilateral exchange rate against the US dollar."
Bank Negara said as a trading nation with key investment relationships with many countries, assessments should consider ringgit movements against the country's major trading partners. This would provide insights into whether Malaysia's relative competitiveness has been affected by movements in the exchange rate.
In 2022, despite the ringgit's sharp depreciation against the dollar, Malaysia's NEER (nominal effective exchange rate) was relatively stable.
As the currencies of key trading partners were similarly affected as the ringgit, Malaysia's relative competitiveness remained unchanged.
A depreciation in the ringgit hurts those who consume imported goods and services, and if sustained, can lead to a rise in the overall cost of living. At the same time, a weak ringgit could increase exporters' earnings.
"When the ringgit appreciates, it benefits those who import goods, services, and travel abroad, but hurts exporters and the domestic tourism industry."
Bank Negara said Malaysia's exchange rate regime and financial system had evolved over the years to serve the growing needs of an increasingly market-oriented domestic economy.
In this regard, the current flexible exchange rate regime has brought benefits to Malaysian businesses and households.
As an external price, the exchange rate conveys an important signal to businesses to guide them toward sustainable investment opportunities and to allocate their resources optimally. Similarly, for households, the exchange rate helps to inform them of their consumption choices such as purchasing more or less imported goods, as well as traveling abroad or locally.
Crucially, the flexible exchange rate regime provides Malaysia with the flexibility to naturally adjust to international economic and financial shocks.
For instance, a ringgit depreciation can help to cushion the domestic economy from external shocks such as a sudden decline in global commodity prices.
In 2022, the flexible exchange rate regime similarly helped the Malaysian economy to adjust to shifting external conditions without disrupting the country's economic recovery.
Bank Negara said despite a major external shock in the form of fast and sizeable adjustments of interest rates in the US which led to the rapid appreciation of the dollar against most currencies, Malaysia's competitiveness was relatively unaffected.
The domestic economy remained on its recovery path, registering a growth rate of 8.7 per cent for the year.
Given Malaysia's flexible exchange rate regime, fluctuations in the ringgit should be expected to occur from time to time.