The Bersih 5.0 rally has come and gone and the only thing left are the expected arrests of Opposition figures and NGO personnel who helped organise the rally.
This threat was mentioned by Deputy Prime Minister, Dato Seri Ahmad Zahid Hamidi in a speech delivered at his constituency in Bagan Datoh, Perak. When commenting on the rally, the Prime Minister Najib , who is in Peru on an official state visit, said that Malaysians were fed up with the Bersih rally.
Judging by the low turnout, his comments are not without merit. The Rembau Times has consistently said that there are no shortcuts towards fixing the country’s political mess, it will take years and should start with the DAP addressing the deep distrust Malays have towards the party.
However, with memories of the Bersih rally fading fast, the Prime Minister may be beset with a new problem, that of the Ringgit’s exchange rate. Month to date, the Ringgit has declined from RM 4.19 to RM 4.42 to the US Dollar, a decrease of 5.0%.
To Bank Negara, the issue seems to be that of the presence of the Non-Deliverable Forward (NDF) market in Singapore.
Firstly, it is important to understand how the NDF exchange rate differs from the local USD:RM exchange rate. The NDF exchange rate is entirely settled in US Dollars, whereas the spot USD:RM exchange rate is settled in either Ringgit or USD, depending on the transaction. For example, if an investor buys the Ringgit against the USD in the Malaysian onshore market, the transaction will settle by selling Ringgit against the USD. If the Ringgit strengthens, then the investor will gain an net profit in Ringgit. If the Ringgit weakens, then the investor will sustain a net loss in Ringgit. Similarly, if the investor sells the Ringgit against the US Dollar, the investor will either sustain a net gain or less in US Dollar.
In the NDF market, the settlement is always in US Dollar. An example of the contract specification can be found over here. As per the contract specification, the settlement price for the contract is derived from Bank Negara’s Official Malaysian ringgit per U.S. dollar” spot exchange rate spot rate at 3:30 p.m. Kuala Lumpur time 2 days before contract expiry.
The issue is that Bank Negara feels that the rates set in the NDF market is not anchored on the fundamentals of the economy but on speculative behaviour and this will put downward pressure on the exchange rates quoted onshore by local banks.
This concern deserves some explanation. Firstly, we have to understand that the NDF rate cannot be directly compared against the spot rate as the NDF rate refers to the forward exchange rate, and not the spot rate. Due to the perceived real interest rate differentials between the US and Malaysia, the forward rate will always trade at a discount compared to the spot rate i.e. a weaker forward rate for RM.
One important point to note that a forward rate settled in either Ringgit or USD will be linked to the spot rate through a formula derived from interest rate parity arguments. Suppose the NDF rate is lower than the “theoretical” forward rate, then investors/banks will buy the Ringgit offshore at the NDF rate and sell the Ringgit onshore at a higher rate. For example, RHB’s 1 month USD:RM forward is currently quote at a midpoint of 45 points (or effectively at RM 4.3750 (spot rate) +45/10,000 =4.3795. If the NDF rate is quoted at lets say RM 4.500, then an investor can lock in a profit of 1,205 pips by buying Ringgit in the offshore market for RM 4.5000 and selling 1 month forward in the onshore market for RM 4.3795. If each pip was worth, lets say RM 100, then this is a profit of RM 120,500.
We can actually see Bank Negara’s concern over here through an example. On settlement date, suppose Bank Negara’s bid – ask is RM 4.500 / RM 4.625, a wide spread indeed. The average rate will be RM 4.5625. The investor sustains a loss of 625 pips in RM in the offshore market, which will be converted to a loss of 137 pips in USD. In the onshore market, he went short the Ringgit USD at 4.3795 and closed his position by buying Ringgit at RM 4.500. On paper, he emerges with a healthy 1,205 pip profit in RM, but his actual gain is only 278 pips in USD, still a healthy profit of 141 pips (278 pips – 137 pips).
This gain happens because the local banks are giving a better forward rate price than the NDF market. The situation is same in places like China where there are different quotes between offshore rates in Hong Kong and onshore rates in Beijing. The Chinese government however stops this by slapping strict capital controls and drastically changing the Offshore borrowing interest rates to “kill” speculators, where overnight HIBOR rates can reach 30 – 50%. In the case of the NDF, Bank Negara does not have this flexibility as the contract is USD settled, so gains and losses are priced in USD, which are affected in US Dollar interest rates such as the Fed Fund Rates and LIBOR, as opposed to Bank Negara’s Overnight Policy Rate.
Bank Negara has used an interesting option to counter the situation. Bank Negara has insisted foreign banks to cease from engaging in the NDF market as a precondition for approving Ringgit – USD trades, by having the respective Compliance officers sign off on a declaration. This is interesting because should the Compliance officer lie on the sheet, he or she may be open to criminal prosecution if they step into Malaysia. But alternatively, this may enrage investors who see this as a evidence of heightened risk. So far, this latest move has not been seen positively as the Ringgit has traded lower from RM 4.227 last week to RM 4.412 as of last Friday.
Short of capital controls, one traditional tool to fight speculators is to hike up the overnight interest rate, to lets say 10 pct. This will weaken the economy but may actually weaken both the NDF and Onshore rate due to the effect this move will have on Government Bond prices. The bond market will collapse as investors, both foreign and domestic, will sell off Government Bonds, creating more panic driven demand to change Ringgit to USD. This will have the reverse effect of actually causing a further depreciation of the Ringgit, both onshore and offshore. Interestingly, Bank Negara is in a lose-lose situation when it comes to interest rates because if it lowers the interest rate, it may boost domestic bond prices but may also encourage investors to sell it off and lock in profits.
The next policy tool is direct intervention, by buying Ringgit in favour of USD. The Rembau Times views this as a risky move as the country’s current account balance is at historically weak levels and traders may take it as a sign of impending capitulation. Currently, Bank Negara is engaging in this transaction, perhaps with the hope that OPEC will agree to a historic cut in their next meeting planned 30th Nov and drive up oil prices, and with that improve Ringgit sentiment.
The risk with this is that should OPEC fail to come to any meaningful arrangement, or if the outlook of the Oil Market weakens, then this strategy will fail on two accounts. Firstly, Bank Negara would have lost its reserves and secondly the future outlook for the Ringgit would have weakened. The Rembau Times strongly urges Bank Negara to stop this at this current moment and instead wait for the oil market reaction on the 30th Nov. If the reaction is favourable, that will be the best time to “destroy” the speculators. If the reaction is unfavourable, then at least Bank Negara has preserved its reserves and can advise the PM on adopting austerity measures to reduce the exchange flows out of the country. It may also need to bite the bullet and suggest capital controls, as there is a sizable amount of foreign money invested in the domestic bond market.
The best strategy is for Bank Negara to bite the bullet and actually advise the Prime Minister and the Cabinet on the concerns investors have on the Ringgit. The concerns are a mix of economic and governance issues, and both seem to be related. On one hand, we are entering a period of volatility in ASEAN and the region due to the perceived protectionist regime favoured by the incoming US President as well as expectations of rate increases in the US. However, Malaysia is entering this period with a weak balance sheet due to the large amount of Government debt, increased infrastructure spending which will further increase Government debt and cause further outflows due to the high import content, low current account balance and large leakage through the Balance of Payments, called “Net Errors and Omissions”. However, unfortunately it seems that the Cabinet appears disinterested in tackling these issues, and all it seems left to do is for the country to hope for the best that this economic storm will pass away.
(Note: “Net Errors and Omissions” are cross border flows of Ringgit which cannot be accounted. In 2016, there was a leakage of RM 26 billion, although in fairness, there was an inward flow of RM 14.9 billion in 3Q16, compared with unaccountable outward flows of RM 41 billion for 1H16. )