The Real Economy Effects of a Weak Currency: Collapsing Ringgit Hurts Small and Medium Scale Enterprises and Increases Credit Risks!

Unlike the Philippines where the weak peso has been propagandized as having mostly beneficial effects, Malaysian media explains its real economic devastating impact.

First let me use a weak currency’s the transmission mechanism on imports, production, profits and economic transactions. Below I used the Peso as example:

Domestic prices of imported goods and services will RISE. So whatever alleged gains from a lower peso on OFW will be largely offset by the price increases on imported goods and services. And rising prices should REDUCE demand for imported goods.

For domestic production, prices of imported production inputs will also increase. Rising input costs should put a squeeze on the profits of producers. And profit margin strains will mean lesser investments, which subsequently should extrapolate to lesser outputs and diminished jobs and wage improvements.

And lesser production output means HIGHER domestic prices. In short, again whatever gains from the lower peso on OFW, exports, BPOs and or tourism will be mostly neutralized by rising domestic prices overtime.

And again, the ascendant domestic prices have been the effects of higher import prices.

Moreover, in the financial dimension, any USD based liabilities will require MORE peso to service. Once again this adds to the cost side of firms exposed on USD borrowings that will amplify debt servicing onus that may reduce access to credit, thereby, put strains on profits and magnify credit risks.

Now here is how I saw the crashing ringgit’s impact on the Malaysian economy

YET it’s not just been about the ringgit’s collapse. There is also the issue of precipitous currency volatility. Combined, these dynamics have already been contributing to the already slowing economy.

But the linkages don’t stop there. There will be an economic-financial feedback mechanism where an economic downturn will lead to financial losses and vice versa. The epiphenomenon will be the shrinkage of systemic liquidity. The process of which will be spotlighted by the following feedback loop: the emergence of cash flow problems to debt servicing problems and to constrictions on access to credit. Finally, liquidity shrinkage will lead to insolvency, and concomitantly, to liquidations.

In short, a currency crash will likely be transmitted to as a banking or debt crisis.

Now real world economic anecdotes from Malaysia’s media The Star Online: (bold mine)

Many small and medium-sized enterprises (SMEs) in Malaysia are feeling the pinch of ringgit weakness, as it has led to an increase in cost pressures on their operations.

According to the SME Association of Malaysia, the decline in the value of ringgit vis-à-vis a rising US dollar has not only adversely affected the bottom lines of many companies, as raw material input costs increase, but the currency volatility has also resulted in cash flow problems for some.

“The ringgit’s depreciation has a negative impact on the production costs, cash flow and profits of most SMEs,” SME Association of Malaysia deputy president Michael Kang (pic)told StarBiz in an email.

He noted that many local SMEs had been grappling with higher production costs, as the bulk of their raw materials were imported. Exacerbating the pressure on their margins was the fact that most SMEs sell predominantly in the domestic market.

According to Kang, some SMEs were also facing difficulties in settling their payments to overseas suppliers due to the ringgit’s weakness.

“A majority of SMEs here do not actually have access to banking facilities such as loans and guarantees to meet their financing needs, so they depend on credit terms from their overseas suppliers,” Kang explained.

“But now, many have been badly hit because the ringgit has depreciated so much against the US dollar; some SMEs can’t even afford to settle their obligations to their suppliers and this may affect the future import of raw materials for their businesses,” he added.

Bullseye!

The crashing ringgit continues to tighten its stranglehold on the Malaysian economy.

The question is: up to what extent can the financial system keep up with this?

Yet all the propaganda peddled by Philippine media on the weak peso will eventually be met with economic reality.