OUM BUSINESS SCHOOL

BMIB5103
INTERNATIONAL BUSINESS MANAGEMENT
SEPTEMBER 2015
i) Introduction
Exchange rate is one of the most important means through which a country’s
relative level of economic health is determined. Exchange rates play a vital role in a
country's level of trade, which is critical to most every free market economy in the
world. For this reason, exchange rates are among the most watched, analysed, and
governmentally manipulated economic measures. The exchange rate is defined as
“the rate at which one country's currency may be converted into another”. Previous
scholar such as Coudert et al. (2015) defined exchange rate as either internally as the
relative price between the two sectors, or externally by the relative price of the
consumption basket between the home country and abroad. It may fluctuate daily
with the changing market forces of supply and demand of currencies from one
country to another.

ii) Synthesis the current situation about the exchange rate between Malaysian
Ringgit and US Dollar. What are the factors that determining the current
exchange rate?
Over the past few months, the Malaysian Ringgit has been the worst
performing currency in Asia against US Dollar. The Malaysian Ringgit started
falling in late 2014. On December 1, 2014, the Ringgit had its largest two-day
depreciation since the 1997-98 Asian financial crisis, falling 2.4% to 3.4300 to the
US Dollar at closing. On January 20, 2015, the Ringgit hit a six-year low to close at
3.60 to the US Dollar which was the lowest it had been since April 2009. Since crude
oil prices began their plunge in the latter half of June, the Ringgit has dropped
around 11.8% in value against the Dollar as at end-February. The decline in
commodity prices resulted in more pressure on the local unit. Further, the Malaysian
Ringgit continue to weakened against the US Dollar by about 22% from end-April
levels of 3.55 to the US Dollar, putting Malaysian importers at a disadvantage. The
Malaysian Insider reported that there was the perception of a “looming crisis”, with
the value of the Ringgit being close to 1997 levels.
Currently, the Malaysian Ringgit continues to depreciate and is now among the
weakest emerging economy currencies. On June 12, 2015, it was reported that the
Ringgit had dropped for four consecutive weeks in the year’s longest losing stretch
so far. The Ringgit has become Asia’s worst performing currency. On July 6, 2015, it

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was reported that the Ringgit had dropped to its lowest level in 16 years, falling to
RM3.81 to the US Dollar. When the Ringgit was pegged to the Dollar in the
aftermath of the Asian Financial Crisis of 1997, it was set at RM3.80. On August 12,
the Ringgit fell to RM4.0025 against the Dollar, the lowest in 17 years. Besides that,
Malaysia has been seeing inflation quickening and trade surplus dwindling over the
recent past. Inflation rate has risen to 3% in October from 2.8% in the previous
month and trade surplus narrowed to RM1.2 billion in October, significantly down
from RM8.23 billion a year earlier.
Despite of the current weakening of the Malaysian Ringgit, few well-known
personalities refuted that. Bank Negara Malaysia (BNM) governor Zeti Akhtar Aziz
said the Ringgit’s weakness does not reflect Malaysia’s current fundamentals which
are still strong. In addition, Minister in the Prime Minister's Department, Abdul
Wahid Omar believed that the weakening of the Malaysian Ringgit did not reflect the
country's economic fundamentals. He said the local banking system was sound and
economic activities still intact to drive growth. He revealed that as at July 31, 2015,
country’s reserves stood at USD96.7 billion, which were sufficient to finance 7.6
months of retained imports and 1.1 times the short-term external debt. Oxford
Business Group Regional Editor, Paulius Kuncinas suggested that people are so
quick to compare the current decline in the Ringgit to that of the 1997/1998 financial
crisis, but they fail to recognise the difference in the country's economic
fundamentals, which is far better now1.
Besides that, Malaysia External Trade Development Corp’s (Matrade) newly-
appointed CEO, Datuk Dzulkifli Mahmud had similar view with Abdul Wahid Omar.
Matrade’s Dzulkifli said that the Malaysian economy remains strong and he believed
the Ringgit will stabilise soon. He also encouraged Malaysian companies to adapt
themselves to the dynamic international trading situation where the various
currencies fluctuate. Under the current scenario of the depreciating Ringgit, he
suggested that the companies should be encouraged more to source for raw materials
locally to save cost instead of relying on imported materials.
A combination of several factors had determined the current exchange rates,
and all are related to the trading relationship between two countries. The following
are some of the principal determinants of the exchange rate between two countries.

1
Source: Bernama, 2015.

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Note that these factors are in no particular order; like many aspects of economics, the
relative importance of these factors is subject to much debate.

[a] Differentials in Inflation Rates

The relationship between the exchange rate and inflation is highly complex and
it involves interactions through a number of transmission channels in the economy,
including trade, domestic demand, expectations of households and businesses,
financial markets, liquidity and monetary conditions, and the costs of production.
Changes in market inflation may cause changes in currency exchange rates. A
country with a lower inflation rate than another does will see an appreciation in the
value of its currency, as its purchasing power increases relative to other currencies.
Contrary, a country with higher inflation typically sees depreciation in its currency
and is usually accompanied by higher interest rates. Clearly, whenever domestic
inflation is in excess of inflation rates elsewhere, the exchange rate must be
depreciated or commercial policy must be changed. This is not only because of the
need to maintain the competitiveness of domestic industry and to maintain an external
equilibrium but also due to the growing strength of protectionist lobbies as the result of
deteriorating competitiveness of domestic industries.

[b] Differentials in Interest Rates

Interest rates, inflation and exchange rates are all highly correlated. Changes in
interest rate may affect Malaysian Ringgit value and US Dollar exchange rate.
Higher interest rates offer lenders in an economy a higher return relative to other
countries. Therefore, higher interest rates attract foreign capital and cause the
exchange rate to rise. The impact of higher interest rates is mitigated, however, if
inflation in the country is much higher than in others, or if additional factors serve to
drive the currency down. The opposite relationship exists for decreasing interest rates
- that is, lower interest rates tend to decrease exchange rates. The falling value of the
Ringgit in June 2015 has also been attributed to the prospect of the US increasing its
interest rates.

[c] Current Account Deficits

The current account is the balance of trade between a country and its trading
partners, reflecting all payments between countries for goods, services, interest and

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dividends. A deficit in the current account shows the country is spending more on
foreign trade than it is earning, and that it is borrowing capital from foreign sources
to make up the deficit. In other words, the country requires more foreign currency
than it receives through sales of exports, and it supplies more of its own currency
than foreigners demand for its products. The excess demand for foreign currency
lowers the country's exchange rate until domestic goods and services are cheap
enough for foreigners, and foreign assets are too expensive to generate sales for
domestic interests. Therefore, balance of payments may fluctuate the exchange rate
of its domestic currency.

[d] Public Debts

Government debt is public debt or national debt owned by the central
government. Countries will engage in large-scale deficit financing to pay for public
sector projects and governmental funding. While such activity stimulates the
domestic economy, nations with large public deficits and debts are less attractive to
foreign investors. Perhaps, a large debt encourages inflation, and if inflation is high,
the debt will be serviced and ultimately paid off with cheaper real dollars in the
future. Foreign investors will sell their bonds in the open market if the market
predicts government debt within a certain country. As a result, a decrease in the
value of its exchange rate will follow.
In the worst case scenario, a government may print money to pay part of a
large debt, but increasing the money supply inevitably causes inflation. Moreover, if
a government is not able to service its deficit through domestic means (selling
domestic bonds, increasing the money supply), then it must increase the supply of
securities for sale to foreigners, thereby lowering their prices. Finally, a large debt
may prove worrisome to foreigners if they believe the country risks defaulting on its
obligations. Foreigners will be less willing to own securities denominated in that
currency if the risk of default is great. For this reason, the country's debt rating (as
determined by Moody's or Standard & Poor's, for example) is a crucial determinant
of its exchange rate.

[e] Terms of Trade

The terms of trade are the ratio of export prices to import prices, and it is
related to current accounts and balance of payments. A country's terms of trade

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favourably improved if its exports prices rise at a greater rate than its imports prices.
This results in higher revenue, which causes a higher demand for the country's
currency and an increase in its currency's value. This results in an appreciation of
exchange rate. If the price of exports rises by a smaller rate than that of its imports,
the currency's value will decrease in relation to its trading partners.

[f] Political Stability

Malaysian political state and economic performance can affect Malaysian
currency strength. Foreign investors inevitably seek out stable countries with strong
economic performance in which to invest their capital. A country with such positive
attributes will draw investment funds away from other countries perceived to have
more political and economic risk. Political turmoil, for example, can cause a loss of
confidence in a currency and a movement of capital to the currencies of more stable
countries. A country with sound financial and trade policy does not give any room
for uncertainty in value of its currency. Increase in foreign capital, in turn, leads to an
appreciation in the value of its domestic currency. However, a country prone to
political confusions may see depreciation in exchange rates.
In Malaysia scenario, the political squabbling at the highest reaches of the
ruling coalition is rattling interested parties, with Prime Minister Najib Razak under
ferocious attack from his opponents, some of whom appear allied to former Prime
Minister Mahathir Mohamad. This is rattling the country’s powerful business class,
whose fortunes are quite often highly correlated with political developments. Besides
that, there is also some anxiety over media reports concerning the financial position
of 1Malaysia Development Berhad (1MDB), a state fund whose board is chaired by
Premier Najib himself. While these concerns also seem exaggerated, the lack of
precise information on the company’s finances and prospects has been used to stoke
anxiety.
These concerns come after a long period during which ethnic and religious
divisions have been aroused by a number of political groups opposed to Prime
Minister Najib Razak. Recently, there has been a series of unseemly public disputes,
with one minister calling for a boycott of Chinese businesses for example and wild
allegations that currency speculation by a well-respected Chinese businessman was
behind the sharp fall in the Ringgit.

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[g] Falling Price of Oil
Falling crude prices also contributed to the decline of the Ringgit’s value, with
the price of Brent crude falling a further 11% in March alone. Besides that, capital
market analysis shows that the Ringgit often falls in tandem with the price of crude
oil. Malaysia was very dependent on commodities including crude oil and the sharp
decline in prices would eventually have an impact on the government's revenue, thus
pushing investors to take a cautious stance. Furthermore, the falling price of crude oil
which affects sentiment on the Ringgit is worse by outflows of portfolio investments
in anticipation of the Federal Reserve’s ongoing cutbacks of quantitative easing.
These refer to slowing down the rate of Treasury bills and bonds.
Oil prices have fallen because supply has been exceeding demand, mostly due
to high production of oil in the US. The price of Brent crude oil has now fallen to a
four-year low. The Organization of the Petroleum Exporting Countries (OPEC) has
so far declined to cut back on its production of oil too. In June 2, 2015, Bloomberg
reported that the world is facing its longest oil glut in three decades as supply
continues to outpace demand.

[h] Other External Factors

The current weakness of the Ringgit also attributed to external factors
including a slowdown in China's economy. On August 11, 2015, China devalued its
currency which caused other Asian currencies to suffer and pushed the Ringgit down
further, as the devaluation of the Yuan strengthened the Dollar.

iii) Is the current exchange rate favorable to Malaysian companies when

dealing with international trade? Evaluate the impact to the international
trade and investment.
According to Alemu and Lee (2014), depreciation or devaluation of a local
currency is good for the export sector, ceteris paribus, it would increase
competitiveness of export goods in foreign markets. On the other hand, it would
cause higher level of import price. The higher import price could bring inflationary
pressure especially those who import a lot of industrial needs, energy resources and
consumer goods. Inflation is likely to occur because imports are more expensive
causing cost push inflation. Hence, the overall economic impact of depreciation will

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not be easy to conclude. Many Asian economies such as Malaysia are heavily
engaged in imported energy resources like oil and gas, natural resources, and many
economies are focusing on export promotion. Therefore, it is worthwhile to look at
the consequences of devaluation.
Exchange rate changes affect Malaysian companies differently. Companies
face a number of risks when engaging in international trade, in particular economic
and commercial risks that are determined by macroeconomic conditions over which
they have little control, such as exchange rates and their volatility.
According to Shu-Ching et al. (2010), the depreciation of currency in country
decrease the relative price of locally produced goods and then stimulates demand for
home export. This is consistent with economic theory. Economic theory assumes that
depreciation is supported by sound macroeconomic fundamentals and can maintain
competitiveness in foreign markets i.e. the economy has capacity to produce more
output for export. In the current situation of weaker Ringgit, companies with
substantial export-oriented operations in Malaysia may be able to enjoy some cost
advantages in its labour and materials, enhancing its competitive position abroad.
Currency depreciation may have a positive effect on sales for Malaysian business
when dealing with international trade, regardless of the currency used. If Malaysian
companies require payment in US Dollars for their exports, customers may buy more
of their products because their currency converts to more US dollars. Malaysian
companies also may benefit if they accept payment in a foreign currency. When the
companies convert the currency into US Dollars, they will have more US Dollars
because of the increased exchange rate.
However, there are differentiating factors for this impact. Malaysian companies
that export with their input costs sourced and denominated locally will stand to gain
the most. The example here is glove-makers such as TopGlove Berhad. On the other
hand, companies that export with imported intermediate materials may or may not
gain from the weakening Ringgit. They will have to depend on their pricing power or
these effects would be netted out. Meanwhile, exporters within the technology and
semiconductor space are well positioned to gain but their sales will also depend on
the economic growth of global economies as well. Ironically, consumer companies
are also net beneficiaries from the weakening Ringgit, despite seeing their input costs
denominated in the US Dollars. The decline in raw materials for some consumer
companies has offset the weakened Ringgit. Despite the negative connotations

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pertaining to the weaker Ringgit being played on the public gallery presently, a
weaker currency actually also presents opportunities for exporters.
In the import sector, a weaker currency could raise the domestic price of
imported goods more expensive. However, currency depreciation’s effect on the
imports depends on the currency that Malaysian companies used to conduct
transactions with their foreign suppliers. If Malaysian companies pay foreign
suppliers in the Ringgit, their business will not be affected because they are not
converting any currency for the transactions. On the other hand, these companies’
costs will increase if their foreign suppliers require them to pay in their currency
because they must spend more US Dollars to convert to the foreign currency.
Pertaining to weakened Ringgit over the US Dollar, companies that derive their
sales domestically with imported intermediate materials would be the worst hit from
the weakened Ringgit. The reason is because they would have to pay for their costs
in US Dollars and sell in the local currency. Even if they are hedged their currency,
once the safety hedge expires it will be back to reality once again. There are some
cases of bottom lines being hit despite still strong operating conditions because of
forex currency losses on foreign debt. Example of this case is AirAsia X Berhad
which had recently reported its first quarter losses widening by a huge margin to
RM125.9 million from RM11.28 million a year ago due to increased cost of foreign
borrowings from the weak Ringgit. The company suffered in its bottom line despite a
strength that was seen it its revenue for the quarter that rose by 3.45% to RM775.37
million from RM749.48 million in the same quarter a year earlier.
Another company that unable to escape from the fluctuations in the Ringgit as
well with its foreign currency borrowings is Tenaga Nasional Berhad (TNB). As of
February 28, 2015, TNB had debts totalling RM25.6 billion, of which 11.3% or
RM2.9 billion were denominated in the US Dollars. TNB’s saving grace is the
imbalance cost pass through agreements that would allow it to pass the additional
costs from the higher raw material prices that is denominated in the US Dollar to its
end users.

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iv) Discuss the effect of having strong and weak exchange rate to Malaysian
economy.
What strong and weak exchange rate mean? In the case of Malaysia, strong
currency mean Malaysian Ringgit is strong in compare to other foreign currency,
while weak currency mean Malaysian Ringgit weaker than other currency. The terms
strong and weak, rising and falling, strengthening and weakening, appreciate and
depreciate are relative terms in the world of foreign exchange. The strong or
weakening of the Ringgit against the US Dollar and the rest of the world’s currencies
has brought mixed fortunes to the local economy. This section discuss on the effect
of having strong and weak exchange rate to Malaysian economy. Some of the effects
on the strong exchange rate are as follow:

[a] Imports Growth

A strong exchange rate means that Malaysian businesses can buy imported raw
goods and services cheaper and that inflation and interest rates will be lower. This
leaves more money in their pockets for local expenditure. Besides that, those
exporters that import raw materials from abroad in order to make their products, they
also will pay less for those materials. It also puts pressure on Malaysian industry to
increase productivity and competitiveness. These benefits can feed on themselves as
foreign capital flows in more readily because of greater confidence in Malaysia
currency.

[b] Investment Opportunities

When having a strong Ringgit, Malaysian company can buy a similar company
or a supplier, in a country that has a weak currency. This enables the buying
company to enjoy the strong currency in order to lower costs. Besides that, the
Malaysian investors can purchase foreign stock or bonds at “lower” prices. When
Bank Negara Malaysia strengthens the Ringgit, they are directly raising the
purchasing power of every single Malaysian. It sounds great. Therefore, the stronger
the Ringgit, higher the purchasing power, the more benefit Malaysian gain.

[c] Sense of Wealth

Consumer sees lower prices on foreign products or services when Ringgit has
risen. Obviously, strong exchange rate benefits the Malaysian consumer. It is

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because foreign products become cheaper even more affordable when the Ringgit is
strengthened. For example, a luxury handbag or a car that once was too expensive to
own, may be purchased for a cheaper price thanks to a higher exchange rate. Next,
lower prices on foreign products or services help keep inflation low. Price imported
is not “expensive” when Ringgit is stronger than other currencies.
Malaysian consumers benefit when dealing with foreign travelling too. A
stronger currency helps Malaysian find it cheaper to take vacations abroad,
improving their quality of life. Vacations and trips to foreign countries become
bargains as travellers are able to see the world at adjusted package prices. Here, not
only has the cost of travel (buying a ticket, booking a hotel room) become cheaper,
voyagers can also stretch their budgets to include more activities that would have
otherwise been foregone. This tends to boost consumer confidence as the shift in
exchange rates make Malaysian citizens feel wealthier.

[d] Hard Foreign Market Competition

Despite a strong Ringgit currency, Malaysian companies will find it harder to
compete in foreign market. When the Malaysian Ringgit strengthens, foreign trade
partners will have to pay more Dollars in order to make up for the appreciated
Ringgit when they import from Malaysia. The increase in Ringgit will eventually
decline the demand as Malaysian made goods become less attractive to buy at the
consumer level in foreign country. This is because the Malaysian has to compete
with lower price foreign goods. This slump in demand will ultimately translate into
thinner profit margins of manufacturers and producers in Malaysia, reducing
expansion potential in the country. The result in the longer term will be slower
growth even as Malaysian consumers up their near term standard of living.

[e] Low Tourists

Foreign tourists find it more expensive to visit Malaysia. Travellers will prefer
the country which has lower exchange rate because it is more affordable. Therefore
strong Ringgit indirectly discouraged foreigners to travel to Malaysia. Moreover,
foreign investors will not expand their investment in the Malaysia.

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 Contradict to strong currency, this section also discuss on the effect of having
weak exchange rate to Malaysian economy. A weak Ringgit would have the contrary
effects. Some of the effects on the weak exchange rate are as follow:

[a] Exports Growth

According to Brei and Charpe (2012), the exchange rate depreciation improves
firms’ competitiveness and foreign sales. A weak Ringgit can act as a stimulus to the
Malaysian businesses as it has now become more affordable for foreign markets to
purchase Malaysian-made goods. The increment of demand for the domestic
products will likely generate more profits for the certain businesses such as the
manufacturing sector. Export-oriented businesses which market its goods to
international markets will find the weak Ringgit beneficial as they enjoy higher sales
volume. As a whole, the increment in exports for some economic sectors will be
observed. However, weak Ringgit, lower currency compare to foreign currency, has
no effect on price of local products which produce in Malaysia.

[b] Tourism Boost

Foreign tourists will benefit from a weaker Ringgit as it grants them a higher
purchasing power to splurge like a shopaholic. For instance, Singaporeans who enjoy
a quick getaway to Malaysia would likely be the prime benefiters as Ringgit falls to
the Singapore dollar. In addition, other foreign tourist can afford to travel and visit
Malaysia. When Ringgit is falling, purchasing power of foreigner is increasing.
Purchasing power is the amount of value of a good or services compared to the
amount that you paid. So when Ringgit is depreciating, exchange rate becomes
smaller.

[c] Increased Foreign Investment

The falling Ringgit makes investment in Malaysia more welcoming. As such,
investors will take advantage of this. A weak Ringgit will encourage foreigners to
invest through foreign direct investment (FDI) and foreign investment portfolio as it
is cheaper to operate and buy stocks and bonds in Malaysia respectively. While the
effects of capital flow generated by foreign investment portfolio is not immediately
felt by the citizens, FDI can generate employment opportunities in the market as
multinational companies build new facilities to conduct businesses in the country.

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[d] Increased Price of Goods and Services
Weaken Ringgit is bad for Malaysian citizen. In the implementation policy of
Goods and Service Tax (GST) that imposed on the daily expenditure items, a weak
Ringgit will worsen Malaysian citizens’ buying expenses. Weaken Ringgit lifted
price import. Consumers face higher prices on foreign products or services. The
increased cost of imported goods will be reflected on the price tags. Among the
industries that affected by the impact of weak Ringgit are automotive, airlines,
power, and telecommunications. The cost of imported components utilised by
domestic producers will also affected by the impact of weak Ringgit. Utimately, cost
of production increased, and we pay for it. This increase local burden on their living
cost.

[e] Inflation
When the Ringgit experiences depreciation, the cost of imported goods will
increase as mentioned earlier. The use of raw materials from foreign markets will
also contribute to inflation caused by imported goods. As a result, domestic
producers are forced to sell their goods on a higher price to sustain the increased cost
of operation. For instance, automobile companies which utilise imported components
in their vehicles would feel the impact of weak Ringgit and market the finished
vehicles on a higher price to the end consumers. Shahzad and Afzal (2013) suggest
that devaluation of currency may raise the domestic interest rate and price level due
to inflation.

[f] Costly Overseas Travel

Since the Ringgit is weakened, Malaysian citizen also cannot enjoy high
purchasing power. The Malaysian consumers find travelling abroad more costly too.
The poor exchange rate for Ringgit equates to a lesser value it carries when they
convert it to foreign currencies. Therefore, they have to spend more money to travel
in foreign country. Thus, weaken dollar does not benefit local consumers, and
investors. Hence, Malaysians should revise their plans to study or travel abroad as
the expenses in their budget is expected to increase on a consequential proportion.

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v) Conclusion
The value of the domestic currency in the foreign exchange market is an
important instrument in a central bank’s toolkit, as well as a key consideration when
it sets monetary policy. Directly or indirectly, therefore, currency levels may affect a
number of key economic variables. They may play a role in the interest rate, the
returns on investment portfolio, the price of groceries in local supermarket, and even
job prospects. Clearly, currency moves can have a wide-ranging impact not just on a
domestic economy, but also on the global one. Investors can use such moves to their
advantage by investing overseas or in Malaysian multinationals when the currency is
strong. Because currency moves can be a powerful risk when one has a large foreign
exchange exposure, it may be best to hedge this risk through the many hedging
instruments available.

vi) References
Alemu, A. M. and Lee, J. S. (2014). Examining the effects of currency depreciation
on trade balance in selected Asian economies. International Journal of Global
Business, 7(1), 59-76.

Brei, M. And Charpe, M. (2012). Currency depreciations, financial transfers, and

firm heterogeneity. Emerging Markets Review, 13, 26-41.
doi:10.1016/j.ememar.20 11.09.003.

Coudert, V. Coubarde, C. And Mignon, V. (2015). On the impact of volatility on the

real exchange rate – terms of trade nexus: Revisiting commodity currencies.
Journal of International Money and Finance, 58, 110-127. doi:
10.1016/j.jimonfin.2015.08.007

Huchet-Bourdon, M. and J. Korinek (2011). To what extent do exchange rates and

their volatility affect trade? OECD Trade Policy Papers, No. 119, OECD
Publishing. doi: 10.1787/5kg3slm7b8hg-en.

Shahzad, I. and Afzal, M. Y. (2013). Impact of currency devaluation on the exports:

A comparative study on Pakistan, Bangladesh and India. Paradigm: A
Research Journal of Commerce, Economics, and Social Sciences, 7(1), 20-31.

Shu-Ching, H, Chao-Min, H. and Ming-Hsein, K. (2010). Currency devaluation and

output growth in Asia. Journal of Economics and Management, 113-131.

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