What is the impact of a weak yuan on the ringgit?

What is the impact of a weak yuan on the ringgit?

WITH expectations of further yuan devaluation, the prospects for a weaker ringgit has come under the spotlight.

A question relating to what extent could the ringgit drop on the back of yuan weakening has drawn mixed views.

"A sudden devaluation by as much as 15 per cent may happen for the yuan this year and this may trigger a sudden drop in the ringgit of about the same order," said Pong Teng Siew, head of research, Inter-Pacific Securities.

Advising investors to keep some US dollars, Pong said the ringgit could be starting on another round of weakening that may eventually take it to far lower levels, with 4.50 to the US dollar as the first stage.

"We had a foretaste of this last Monday. Most people underestimate or are unaware of the upheaval that may follow a yuan devaluation; some are not even aware that a devaluation is brewing."

China cut the yuan's value against the greenback last Monday, making it weaker than 6.5 by setting the daily reference at 6.5032 to the US dollar, which was the weakest since May 24, 2011, said AFP, quoting the China foreign exchange trade system.

A surprise devaluation in August saw China lower the normally stable unit nearly 5 per cent against the greenback in a week.

"The trend for the yuan to weaken is continuing into the new year as the People's Bank of China weakens the currency's fixing," Eddie Cheung, a Hong Kong-based currency strategist at Standard Chartered, was quoted by Bloomberg. "The currency will drop further in the first quarter as China makes the exchange rate more market-driven."

Since the inclusion of the yuan in the special drawing rights basket, the People's Bank of China is expected to allow market forces to prevail and that implies there will be more small steps ahead in depreciation in tandem with weaker economic prospects, according to independent economist Lee Heng Guie.

The ringgit would remain on a weakening bias at least in the first half of 2016, weighed down by persistent external headwinds and lingering domestic issues, added Lee.

"Based on the technical outlook, both yuan and ringgit should weaken. Yuan, on fundamentals, should weaken while ringgit, by right, should strengthen but will probably be dragged down by the yuan," said Chris Eng, head of research, Etiqa Insurance & Takaful.

The weakening of the ringgit should be positive for export-driven rubber companies, said Eng, although other companies, there may not be much impact as long as the ringgit does not break 4.50 to the US dollar.

"Uncertainty over the ringgit is likely to subdue chances of a Chinese New Year rally on the KL stock market although the ringgit is fundamentally oversold," said Vincent Khoo, head of research, UOBKayhian.

There are some slightly more bullish views on the ringgit.

"The Chinese Government may continue to let the yuan weaken as it catches up with the rest of the Asian currencies which have weakened quite a bit. The ringgit will probably get dragged down in the short term but there are potential ringgit asset purchases by Chinese parties which may cap any weakness," said Hor Kwok Wai, chief operating officer of global markets, Hong Leong Bank.

Further weakness

"The yuan may be subject to further weakness but it would probably not be a drastic devaluation in the short-term. For the ringgit, further weakness could be an overshoot," said Danny Wong, CEO, Areca Capital.

The previous two years of capital outflows exceeding US$6.5bil has reversed total inflows from 2011-2013. "Similar massive outflows that occurred in 2015 are not likely to be repeated," said Wong, who hoped that the ringgit would find its level in the next three to six months depending on developments in China and oil prices.

"If oil price and thus, the ringgit, find their bottom in these few months, chances are for a rebound to more reasonable levels in the second half of 2016.

"Equity fund managers are likely to move ahead of the rebound. Together with other factors such as liquidation/repatriation of investment proceeds from overseas by government-linked companies and the function of Valuecap, I remain positive on Malaysian big caps in the first half of 2016," said Wong.

But the momentum on big caps may not be that strong until corporate earnings recover in the second-half of 2016.

Downward pressure on the yuan will likely persist especially in the first-half of 2016 as macro adjustments take place and the ringgit will also remain under pressure in the first half of the year. The ringgit is vulnerable to yuan devaluations because of strong trade linkages between China and Malaysia, said Nor Zahidi Alias, chief economist, Malaysian Rating Corp.

Some support

However, a slight recovery in crude oil prices in the second half of the year will lend some support to the ringgit and help it recover from current levels, added Zahidi.

RHB Research Institute expected a 2 per cent-3 per cent depreciation in the yuan for 2016 while it viewed that the ringgit had severely overshot on the downside.

Although the ringgit could weaken along with the yuan, it was unlikely that the ringgit would depreciate significantly, said Peck Boon Soon, head of ASEAN research, RHB Research Institute.

Would the flare-up between Saudi Arabia and Iran have an impact on oil price?

"If history is a guide, a deep military confrontation involving the disruption of oil supply would stir oil shocks, sending oil prices skyrocketing. At this juncture, a direct military confrontation is highly unlikely. As such, the rebound in oil prices should remain short-lived," said Lee.

Zahidi maintains the view that oil prices can possibly revert to about US$40-US$50 per barrel towards the end of the year unless a major disaster hits the global economy.

Downward pressure would persist in the first half due to supply factors but things might change slightly after that, added Zahidi.

Supply factors include the Organisation of the Petroleum Exporting Countries' (Opec) determination to produce without limits; the US' decision to end its 40-year export ban on crude oil; and incoming supply from Iran.

After the second half is the anticipated reduction in supply by non-Opec members by 380,000 barrels per day (bpd), which is more than Opec's initial projection of a decline of 130,000 bpd.

Decline in shale production

Shale production is anticipated to decline further although productivity per rig has increased. At the current prices of US$30-US$40 per barrel, further reduction in spending is expected by shale producers with some expecting spending cuts by US$115bil in 2016 compared with 2015.

Oil consumption by the United States and China, which rose by about 380,000 bpd each in 2015, would likely remain resilient although China's import growth may slow down slightly, said Zahidi.

In October last year, India's oil consumption grew at 17 per cent year-on-year. India is expected to post stronger growth which would help offset the possible slowdown in Chinese demand.

Columnist Yap Leng Kuen recalls when the ringgit was 3.80 to the US dollar, many were already changing the local currency for the greenback. How much more downside would there be for the ringgit this round?

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