Edge Weekly The State of the Nation: Ringgit's 'Fitch-surprise' relief rally short-lived

by **Cals** Tue 28 Jul 2015, 23:00

Edge Weekly
The State of the Nation: Ringgit's 'Fitch-surprise' relief rally short-lived

THE ringgit rallied to its strongest level in nearly three weeks at the opening bell on July 1 following Fitch Ratings’ surprise decision the previous day to lift the country’s outlook to “stable” from “negative” while affirming Malaysia’s A- sovereign rating — barely three months after a key official said a downgrade was “more than 50% likely”.
“The move was a surprise, given that in March, Fitch was signalling a downgrade. However, although we did not expect a move back to a ‘stable’ outlook, this was more in line with our sense that the meetings between Fitch and the [Malaysian] government earlier in June were constructive and our views that the economy remains resilient and fiscal reforms are ongoing,” Nomura’s economists tell their clients in a July 1 note.
Alas, the exuberance appears short-lived, with the ringgit closing the week little changed from June 30, at 3.7795 to the US dollar and 2.8026 to the Singapore dollar.
On June 30, it fell to an all-time low of 2.8108 to the Singapore dollar. It also hit a decade low of 3.7887 to the greenback on June 29, just a shade away from the 3.80 peg imposed in the wake of the 1997/98 Asian financial crisis through July 2005.
Year to date, the ringgit has depreciated 8% against the US dollar, making it the worst-performing currency in Asia-Pacific, Bloomberg data shows. It has depreciated 15.5% over the past 12 months, comparable to the yen’s 16.9% slide.
At its strongest last week, the ringgit fetched 3.7287 to the US dollar and 2.7673 to the Singapore dollar.
Closing at 5.9065 to the British pound and 4.1973 to the euro last Friday, the ringgit is still slightly firmer compared with a multi-year low of 5.9563 against the pound on June 29 and 4.2435 against the euro on June 30.
Will the ringgit again slide to the pre-Fitch relief rally levels against these currencies? Or will time prove Bank Negara Malaysia right — the ringgit’s weakness is not reflective of its fundamentals?
“In an environment of elevated uncertainty in global capital flows and ahead of the US Federal Reserve [interest rate] lift-off, investors are likely to find the ringgit relatively more vulnerable within Asia to global developments,”Citi Research’s economists Kit Wei Zheng and Siddharth Mathur say in a July 1 note.
“Investors will continue to look for faster improvement in the current account, a resumption of [Bank Negara foreign] reserve growth and more reliable inflows into the local bond market before turning bullish for the medium term,” they add, telling clients that “a likely pick-up in sentiment after the Fitch decision may be short-lived”.
RHB Research’s economist Peck Boon Soon, in a July 1 note, says the ringgit “will likely remain weak and hover at 3.65 to 3.75, as foreign investors will continue to adjust their portfolios ahead of the US interest rate increase”. While Greece could potentially vote itself out of the eurozone and cause some volatility in the financial markets, Peck believes its impact “will likely be manageable and it is unlikely to derail the eurozone’s economic recovery”.
Forward rates for the ringgit point to the market wagering on further weakness. Rates for the next four quarters range from 3.81 to 3.88, all of which are beyond the landmark 3.80 peg to the US dollar, which was removed a decade ago (see table).
In a June 28 report, AmResearch says Malaysia remains vulnerable to further capital outflows, which will dampen any upside potential for the ringgit. “The country is faced with a deteriorating currency reserves coverage, weak international liquidity position and high leverage in both household and corporate sectors that render the ringgit vulnerable to the twin prospects of a stronger US dollar and higher US interest rates later this year.”
In revising Malaysia’s outlook to “stable”, Fitch said the move reflected its view that the “upside and downside risks to the rating are currently broadly balanced”.
It added that the main factors that could lead to a negative rating action on Malaysia were fiscal slippage relative to the government’s targets and lack of progress on structural budgetary reform, problems for the banking sector potentially derived from a shock to interest rates or employment sufficient to impair the sovereign’s debt service capacity, and deterioration in the balance of payments or investor sentiment that impairs the sovereign’s external balance sheet.
Factors that could lead to a positive rating action on Malaysia were greater confidence on the resilience and pace of deficit reduction and the government’s commitment to contain public indebtedness, sustained growth without the build-up of macro imbalances, and narrowing of structural weaknesses relative to peers, including development indicators and governance, Fitch’s June 30 statement reads.
In any case, Fitch’s decision does remove one overhang from the market.
“The near-term recovery that you see is a relief rally, now that the Fitch uncertainty is off the table.
We believe that the second quarter was exceptional for its volatility in regard to the ringgit, and there will be new positive catalysts going forward,” says AmBank chief currency strategist Wong Chee Seng.
He adds that externally, there is still negative sentiment towards emerging market economies. The market is still factoring in the near-term possibility of an interest rate hike by the Fed, which is expected to put further pressure on the ringgit. Given the large proportion of foreign holdings in the stock market and Malaysian sovereign bonds, he says the risk premium attached to Malaysia remains high.
“Just look at the five-year credit default swaps (CDS) for Malaysia’s sovereign notes. The spread stood at 130 points despite our notes carrying an A-rating. In comparison, Thailand’s CDS rate is only 100 points for a BBB+-rated note. It will take time for the sentiment to normalise, but the current global volatility across all asset classes is not helping,” he says.
The excessiveness in the credit risk premium puts pressure on the government and Bank Negara to institute more pro-growth initiatives. The central bank is expected to keep its policy rate, pending the Fed’s interest rate decision that could come in September.
In the near term, Nomura’s economists say a rating decision by Standard & Poor’s (S&P) “will be the key to watch next”.
“We understand that [S&P] visited Kuala Lumpur recently and we expect similar positive findings to be announced in the coming weeks. S&P already has a ‘stable’ outlook but a reaffirmation of that will reinforce Fitch’s more positive assessment and establish a more uniform view on the sovereign across the rating agencies,” says Nomura’s July 1 note.
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This article first appeared in The Edge Malaysia Weekly, on July 6 - 12, 2015.