Edge Weekly The State of the Nation: Bank Negara unlikely to revisit ringgit peg By Cindy Yeap / The Edge Malaysia | February 10, 2015 : 3:00 PM MYT

by **Cals** Tue 10 Feb 2015, 20:12

Edge Weekly
The State of the Nation: Bank Negara unlikely to revisit ringgit peg

By Cindy Yeap / The Edge Malaysia | February 10, 2015 : 3:00 PM MYT

FEARS that the government would reimpose currency controls and revisit its September 1998 peg of 3.80 to the US dollar were reignited last week as the ringgit tumbled past the 3.60 mark against the greenback, a near six-year low.

The ringgit also slipped to a new all-time low of 2.6981 against the Singapore dollar on Jan 14, a level last seen in March 1998, even as Brent crude oil skidded further to as low as US$45.19 a barrel last Tuesday.

Bank Negara Malaysia’s reserves, being at their lowest since March 2011, exacerbated worries that the policymakers might be forced to take “extreme measures” to stem the decline in the ringgit, which has weakened 14% against the greenback over six months on the back of the 55% drop in Brent prices.

Situation is different

Most experts shrug off these concerns, maintaining that Malaysia is better-positioned to weather the current volatility in the foreign exchange market than during the 1997/98 Asian financial crisis.

“This remains largely a fiscal and investment shock, not a financial or currency crisis,” Bank of America Merrill Lynch (BaML) head of emerging Asia economics, Chua Hak Bin, tells The Edge in a recent interview. “The situation does not warrant capital controls, a draconian response with significant repercussions and reputational damage.”

But there will still be headwinds for Malaysia because of rapidly collapsing oil prices, which “could spiral down to US$31 per barrel for Brent and US$32 per barrel for West Texas Intermediate (WTI) by end-March 2015 to spur incremental take-up to reduce the build-up in global inventories”, said BaML’s global commodity research team in a note dated Jan 15. It expects Brent prices to move to US$43 by end-June, US$47 by end-September and US$57 by end-December, to average at US$52 for 2015 and US$58 in 2016.

If it is right, the ringgit could continue tracking the oil price downward.

Already, high public, corporate and household debt levels in Malaysia are seen as limiting Bank Negara’s policy options. Yields for five-year Malaysian Government Securities (MGS) were 3.88% on Jan 15, up 16 basis points (bps) from 3.72% in mid-September. The cost of insuring Malaysia’s sovereign debt climbed further last week after Fitch Ratings kept a “negative outlook” on the country’s sovereign rating and the World Bank trimmed global growth forecasts. Five-year credit default swaps rose 9bps to 154bps on Jan 13, more than double its recent low of 72.5bps in mid-September.

That Malaysia does not allow offshore trading of the ringgit— the ban was imposed in 1998 by former prime minister and finance minister Tun Mahathir Mohamad, who blamed currency speculators such as George Soros for the ringgit’s brutal fall — is a respite for the country “to some extent”, says Lim Chee Sing, executive chairman and chief economist at RHB Research Institute in Kuala Lumpur.

Pressure on ringgit

Even so, the ringgit is expected to continue to come under pressure as foreign investors equate the rapidly collapsing oil price to Malaysia’s economic fundamentals and continue trimming their exposure to local financial assets.

Malaysian residents buying foreign currency forward could also exacerbate the downtrend of the ringgit vis-à-vis the US dollar, which is strengthening on the back of rising dollar yields and the country’s improving economy, Lim adds.

Over RM1 billion flowed out of local equities in the early part of last week from foreign selling, which is happening across emerging Asia, one trader says, although the bellwether FBM KLCI is seeing some support.

“The volatility we see today may well be why our central bank governor [Tan Sri Dr Zeti Akhtar Aziz] did not internationalise the ringgit, although the move was considered at one point to clear the misconception that Malaysia still had capital controls,” says a seasoned investor.

Malaysia lifted the ringgit peg in 2005 in favour of a “managed float” but cross-border trading of the ringgit is still limited to trade-related activities, such as exporters hedging their currency risk on invoiced trades.

That’s not to say there is no cause for concern, however. In fact, some experts reckon more central banks around the world might be considering some form of capital control or “surprising actions” to attain the desired outcome on their respective currency and monetary policies.

The surprise removal of the cap on the Swiss franc’s exchange rate against the euro and the Swiss National Bank (SNB)’s cutting of interest rates last Thursday (Jan 15), which threw European stocks into a tizzy, is but one example of the kind of wildcard that could spring up in different parts of the world even as monetary policies of the US and much of the developed and emerging markets diverge.

HSBC Global Research, for instance, told clients in an a Jan 15 note that the Swiss central bank’s action — done ahead of prospects of more forex intervention by a possible quantitative easing (QE)-type programme from the European Central Bank as early as this week — was “the latest iteration in the global currency war”. It also “highlights that central banks will not always get their wishes when it comes to their currency, or be able to dictate forex fortunes without limit”. “This is a game-changer for the Swiss franc clearly, but its repercussions will be felt across other countries and asset classes,” HSBC says.

There is at least one casualty in US-based FXCM Inc, the biggest retail foreign exchange broker in Asia and the US, which reportedly suffered “significant losses” that left it with a negative equity balance of US$225 million (RM800 million) from unprecedented Swiss franc-euro volatility and needing an equity infusion. Heightened volatility in global markets has also reportedly resulted in lower trading income and quarterly earnings for the likes of Citigroup and BaML, which is likely to have needed to take positions in the market as market makers.

For Malaysia, reserve assets have already fallen, as Bank Negara had tapped them to smoothen the ringgit’s decline. The US$9.7 billion fall in reserves in December last year was its largest monthly decline since September 2008, when 158-year-old investment bank Lehman Brothers collapsed.

Year on year, Bank Negara’s reserves are down 14% or US$18.9 billion (RM36.4 billion) to end 2014 at US$116 billion (RM405.5 billion). Some US$16 billion of reserve assets were used up in the last four months of 2014 alone, during which the ringgit weakened 11% against the US dollar to end the year at 3.4973 while Brent crude dived 44% to US$57.33 a barrel.

“I believe Bank Negara can accept a lower level [of ringgit] if it deems it to be temporary and [it] will likely continue intervening in the foreign exchange market just to smoothen out sharp fluctuations in the currency. A potential tolerance level could be 3.80 [to the greenback] but this question is best answered by Bank Negara,” says RHB’s Lim on when the central bank might begin imposing more drastic measures to defend the ringgit.

Money market dealers say the central bank has been intervening intermittently in the market since the ringgit hit 3.35 against the US dollar, mopping up the local currency.

At the time of writing, Bloomberg data shows that analysts are expecting the ringgit to slide to only 3.60 to the US at its weakest in 1Q2015, 3.65 in 2Q2015 and 3Q2015, and 3.70 in 4Q2015, but the median forecast is below 3.60 for the year.

The degree of intervention needed would likely correspond with the extent of portfolio outflows, the experts say.

Foreign holdings of MGS remained high at RM326.63 billion, or 44.5% of the total, as at end-Nov 2014. Additionally, foreign investors also held some RM71.52 billion in money market papers, 56.5% of the total, says RHB’s Lim.

Nonetheless, he does not expect a sharp sell-down in MGS from the current levels. “High holdings by foreign investors partly reflect structural factors,” Lim says, referring to the diversification of reserve holdings by central banks in the region as well as the seeking of yields by pension funds from developed countries.

Also, Malaysia has a handful of local funds with over RM1 trillion worth of assets, or easily 60% of Bursa Malaysia’s market capitalisation. The largest of these funds is the Employees Provident Fund (EPF) with a fund size of about RM600 billion, followed by Permodalan Nasional Bhd (PNB) with over RM200 billion, and Kumpulan Wang Persaraan (KWAP) at some RM100 billion.

“Support from local funds can be seen from the strength in our local benchmark FBM KLCI despite the more-than RM1 billion net outflows,” one seasoned investor says. He sees a weaker ringgit stemming from foreign selling at some point: “A weaker ringgit would spur profit taking by foreigners but a drop in exchange rates also means less returns for the seller. And unless there is a panic, I don’t think these deep-pocketed investors would want to sell at a significant loss and exit, right?”

If he is right, that is another one-up for Malaysia. The country will need all the silver linings it can get as it recalibrates to face a new normal for oil prices. It is understood that Malaysia is already working based on an oil price assumption of “around US$70 a barrel”, although Budget 2015 tabled last October was based on US$105 for the Tapis.

On Jan 13, Prime Minister Datuk Seri Najib Razak told national news agency Bernama that Budget 2015 would be reviewed in light of falling oil prices, a weakening ringgit and the RM800 million the government needed to spend on flood relief. A statement on this matter will be out this week (Jan 19 to 25), Najib reportedly said.

RHB’s Lim reckons that Malaysia should “be realistic on key assumptions and come out with mitigating measures to address the major concerns of investors”. “A contingency plan may also be warranted as a proactive measure to mitigate the downside risks to economic growth,” he says.

Reforms needed

Whether or not Malaysia can indeed meet its self-imposed 3% budget deficit target for 2015 per se is not as important as a commitment to persevere with reforms. “I think it is more positive than negative even if the government admits it could miss its 3% of GDP fiscal deficit target if it comes up with proactive measures to address concerns of investors,” Lim says.

“In my view, a temporary widening of the fiscal deficit caused by a rapid collapse in oil prices is not a catastrophe as long as the government perseveres with its fiscal reforms. The implementation of GST [Goods and Services Tax] to broaden the revenue base of the government and allowing retail petrol and diesel prices to be market-determined are structurally positive and should be credit positive. And they will prevent the country’s sovereign rating from being downgraded by international rating agencies,” he adds.

Bank Negara’s reserves data for mid-January 2015 will be released on Jan 22, a week ahead of its first monetary policy meeting this year on Jan 28, during which most economists expect key interest rates to be kept at 3.25%.

Barring any panic selling or severe downturn in the world economy, experts do not expect Malaysia to need to consider revisiting its 1998 ringgit peg. The lowered expectations may well work in its favour, should the country successfully surprise on the upside. What it needs to do now is address the vulnerabilities stemming from lower oil revenues going forward and convince investors that it remains steadfast in its commitment to improve its fiscal balance.

[You must be registered and logged in to see this image.]

This article first appeared in The Edge Malaysia Weekly, on January 19 - 25 , 2015.