Navigating Currency Risks in a Strong Ringgit Environment: Opportunities and Challenges for Malaysian Companies

In recent months, the Malaysian Ringgit has seen a remarkable rise in value, emerging as one of the best-performing currencies globally against the US Dollar. This significant appreciation has filled many Malaysians with pride, as a stronger currency is often viewed as a sign of economic strength and stability. However, while this newfound strength offers various advantages, it also presents challenges, especially for Malaysian companies involved in cross-border business dealings.  

For businesses exporting goods, a stronger Ringgit automatically means that purchasers need to pay a higher price, potentially making Malaysian products less competitive in the global market. Conversely, for companies looking to import goods or materials, the current exchange rates may make purchasing from abroad appear enticingly cheap. However, this perceived affordability comes with risks that need to be carefully managed.

The Double-Edged Sword of Currency Strength Under a Long-Term Agreement

While it may seem that today’s favourable exchange rates create an opportunity for cost savings, businesses must remember that what is cheap today may not be so tomorrow. Should the value of the Ringgit fall in the future, companies that have relied on imports will suddenly find themselves facing significantly higher costs.

This is less problematic when a Malaysian company still has the choice to enter into a contract. If the goods sold by the foreign company become too expensive, the Malaysian company may simply choose to not purchase from said company any longer. However, in contracts with a longer duration, as would be the case where a Malaysian producer in the E&E industry purchases aluminum from China under a long-term purchase agreement, the situation changes. The Malaysian producer of E&E products will ordinarily not be able to get out of its long-term purchase agreement so easily, and – assuming the Ringgit falls – suddenly have to pay much more for the same amount of aluminum. What once seemed cheap may have gotten very expensive.  

To mitigate these risks, companies must take proactive steps to protect themselves from potential currency fluctuations. Larger corporations often have access to various financial tools, such as hedging, diversification, and strategic pricing, which allow them to manage their currency exposure. However, for small and medium-sized enterprises (SMEs), the situation is more complicated. Due to their size and the scale of their contracts, SMEs typically have fewer options available. If a negative currency movement occurs, they can be hit just as hard as larger companies, yet they may lack the resources to absorb such shocks.  

While some SMEs may consider insurance to hedge against currency risks, the costs can be prohibitively expensive. Therefore, one of the most effective strategies for these companies is to incorporate currency clauses into their contracts.

Understanding Currency Clauses

Currency clauses are provisions within contracts that allow for adjustments based on fluctuations in exchange rates. These clauses can help parties share the burden of currency risk and provide a mechanism for price adjustments if the exchange rate moves beyond an agreed threshold. The following provides three examples of typical currency clauses.  

1. Fixed Exchange Rate Clause: This clause specifies a fixed exchange rate for the duration of the contract. For example, a Malaysian exporter may agree to sell goods at a price based on an exchange rate of 4.0 MYR to 1 USD. If the Ringgit appreciates, the exporter benefits; if it depreciates, the importer bears the risk.
2. Escalation Clause: An escalation clause allows for price adjustments if the exchange rate fluctuates beyond a certain range. For instance, a contract might stipulate that if the exchange rate varies by more than 5%, the price of the goods will be adjusted accordingly.

By way of example, the Ringgit currently stands at around 1.66 to the Chinese Yuan Renminbi. A 5% variation would mean that if the Ringgit appreciates to around 1.75 or depreciates to around 1.55, this would exceed the 5% threshold and an according adjustment would have to be taken.

1. Adjustment Formula: Contracts can include a formula that recalculates the price based on prevailing exchange rates at specified intervals. For example, a contract could stipulate that prices will be reviewed and adjusted every six months based on the average exchange rate during that period.

The three above examples show how useful currency clauses can be. However, while their effectiveness as tools for managing risk is clear, they are only as beneficial as their validity and enforceability.  

Challenges with Currency Clauses

One significant challenge that Malaysian companies often overlook in their contractual dealings is that their contracts may be governed by the laws of another country, often that of their foreign business partner. While the differences from the Malaysian legal system to that of another country are typically smaller when the other country is a common law legal system just like Malaysia, this cannot be said when the legal system of the other country is that of a civil law country. Most of Malaysia’s most important trading partners – China, Indonesia, Japan, almost the entirety of the European Union and Korea, to name but a few – are from civil law countries. Their civil law systems, may impose different requirements and interpretations of contract law than those familiar to Malaysian businesses.

For example, in civil law jurisdictions, certain contract terms may not be enforceable or may require specific formalities that are not customary in Malaysia. This can lead to situations where a currency clause, which seemed beneficial at first glance, could be rendered ineffective or difficult to enforce in a dispute.

The Importance of a Thorough Legal Review

To navigate these complexities, it is crucial for Malaysian companies to have their contracts reviewed by legal professionals who understand the nuances of other countries’ legal systems and are familiar with the legal systems of civil law countries, in particular.

While engaging a lawyer represents an additional cost, it is typically significantly cheaper than the costs associated with insurance or financial instruments. Moreover, it is a fraction of the potential price increase that could occur if a company suddenly finds itself paying 5% more for imported goods due to unfavourable currency movements.

Therefore, having one’s contract reviewed thoroughly is typically a worth the costs and efforts.  

Conclusion: A Cautious Approach to Opportunities

The strong Ringgit undoubtedly presents both opportunities and challenges for Malaysian companies engaged in cross-border trade. It is vital not to overlook the potential pitfalls that come with currency fluctuations, particularly in a landscape that is constantly changing. Just a few months ago, the government faced heavy criticism for a weaker Ringgit, highlighting how swiftly economic sentiments can shift.

As businesses navigate this dynamic environment, they must approach the situation with a balanced perspective. While it is tempting to focus solely on the benefits of a strong currency, a prudent assessment of the associated risks is essential for sustainable growth. By taking proactive measures – such as incorporating currency clauses and seeking legal guidance – Malaysian companies can better position themselves to thrive in an increasingly interconnected global marketplace.  

In the end, a robust strategy will not only safeguard against currency risks but also capitalize on the opportunities presented by the evolving economic landscape.

This article is written by Prof. Harald Sippel, the firm’s Senior Foreign Advisor. Harald regularly advises companies with respect to their cross-border contracts, including on currency clauses. He has been involved in several disputes which arose because the parties had failed to include a currency clause into their contract. For assistance with drafting legally sound contracts, contact Harald at harald@aqranvijandran.com.

This article only contains general information. It does not constitute legal advice nor an expression of legal opinion and should not be relied upon as such.