Ringgit Tipping Point

Debt market remains firm, backed by Malaysia’s strong long term fundamentals.

In the last one year, as the ringgit went into a tailspin to depreciate by about 34%, the financial logic in the capital markets has been in tatters.

Malaysia’s foreign exchange reserves and current account have started to improve. The Government is sticking to its economic growth forecast of between 4.5% and 5.5% for this year and remains committed to keeping the federal government budget deficit lower at 3.2% next year.

But the ringgit is the worst performer in the region and one of the worst in the world.

Stripping out the noise such as the local political upheavals and issues in relation to 1Malaysia Development Bhd (1MDB) that have affected confidence in the currency, bankers point out to the fact of the growing amount of foreign currency deposits held by Malaysians.

In January 2007, the foreign currency deposits held by Malaysians were equivalent to only RM820mil. Based on Bank Negara’s latest statistics, the amount held by individuals is a staggering RM14.43bil.

The amount of foreign currency deposits held by business enterprises is even larger – at RM71.47bil as of July this year. It was only RM17.88bil in January 2007.

The amount held by individuals and business enterprises as foreign currency deposits is at its highest level since 2007. It is an indication of how much locals and companies are holding back from converting their foreign currency deposits into ringgit.

“A 10% swing in the foreign deposits can make a big difference to the exchange rate,” says a trader.

Exporters are bringing back the proceeds but are not converting it yet to the ringgit account, with the view of riding on the bullish US dollar.

But there is nothing wrong with that. The regulations require exporters to bring back their proceeds within three months, but there is nothing to state that they have to convert the proceeds into ringgit.

A top banking executive says that exporters are probably looking at the windfall gain from the appreciating US dollar.

He says the numbers in the foreign currency deposits say a lot on the ringgit’s movement.

He says when the reverse happens; it will be like a herd instinct.

“When some of the exporters start converting back to the ringgit, the stampede will happen,” he says.

“I feel the tipping point is coming closer. A 10% swing in conversion can make a lot of difference to the ringgit’s strength,” he says.

The depreciation of the ringgit so far has defied common logic.

The greatest casualty from the weak ringgit has been the equities market that has shed more than 300 points from its peak of almost 1,890 points.

Foreign investors have taken out some RM24bil from the equities market.

But the Government bond market is still seeing healthy participation, albeit at a small decline. Global funds reduced holdings of Malaysian Government bonds by about 6% to RM166.1bil in August from June. During this period, the ringgit dropped about 13% against the US dollar.

The percentage of foreign investors holding Malaysian Government Securities (MGS) has not gone down significantly despite the weakening ringgit. It was at 46% in August from 47.8% in July.

What has reduced is foreign holdings in the Bank Negara’s monetary notes (BNMN) of about RM40bil. The maximum maturity of BNMN is three years.

No major sell-off

There were reports of a major sell-off taking place on Wednesday, as RM11bil worth of Government papers came up for renewal. But it did not happen.

A tranche of RM2bil worth of 15-year MGS was successfully sold on Tuesday, with an over-subscription rate of 2.17 times. The coupon rate for the paper was 4.498%, which is an attractive return.

According to a dealer, he feels that the coupon rate was fair, given that short-term papers carried a rate of 3.2%.

‘It’s not very much exorbitant,” he tells BizWealth.

The Malaysian MGS bills were well-absorbed due to a few reasons.

A sizeable amount of the papers is held by institutional investors and central banks as part of their plan to diversify their risk and reduce their exposure of low-yielding US Treasuries.

“This is unlike previously when the MGS papers were largely held by hedge funds. So, they are not short-term investors,” says a bond trader.

The Retirement Fund Inc chief executive officer Wan Kamaruzaman Wan Ahmad says that a big proportion of outstanding Government debt is held by foreign central banks and other institutional investors that seek long-term investments and have confidence in the country’s long-term economic fundamentals.

Secondly, the 15-year MGS coupon rate of 4.498% is attractive, considering that similar tenure papers in the United States are going for less than half of the returns.

“When foreigners invest in Malaysia, they are looking to gain from the interest rate differential between the US Treasuries and MGS, which is about 2.3% for 10-year tenure MGS,” explains Wan Kamaruzaman.

He dismisses the notion of short-term money in the bond market.

“Short-term international investors will not be attracted to a 2% interest rate differential, considering that they would need to take foreign exchange risks.

“Thirdly, the foreigners still holding the Malaysian MGS papers would have already hedged their ringgit currency exposure.

“When the ringgit started to decline a year ago, investors who had not hedged would have cut their losses and exited.

“Lastly, the Malaysian Government bond market is also attractive to foreign investors due to its liquidity. Malaysia is among the top-three countries that has the most liquid Government bond market after Japan and South Korea.

Until mid-2014, Malaysia’s rates, liquidity and local currency were relatively high compared to peers, drawing in billions of ringgit of foreign investment into the country’s bonds, equity and local currency.

“The liquidity has lessened due to volatility in the market that has caused investors to adopt a wait-and-see approach,” says a market observer.

Battered ringgit

A bank executive says foreign appetite for Malaysian fixed-income instruments remains strong, despite the ringgit being battered, because they also look at the country’s economic fundamentals.

The fundamentals are measured by the strength of Malaysia’s international reserves, as well as a healthy current account surplus.

As at mid-September, Malaysia’s international reserves stood at US$95.3bil, gaining US$600mil from US$94.7bil on Aug 28. The reserve position is sufficient to finance 7.3 months of retained imports and is 1.1 times the short-term external debt.

Although the price of crude oil has halved since last year, cutting Malaysia’s export earnings, the trade account remains within the surplus level. The trade account, which is a measure of exports minus imports, has remained in surplus since 1999.

Meanwhile, as the world’s second-largest palm oil exporter, Malaysia’s export earnings would be supported by the current rally in the crude palm oil (CPO) prices.

According to leading industry analyst James Fry, CPO prices are likely to surge 40% to US$700 per tonne by mid-2016 due to the El Nino weather event to curb and dent output and Indonesia’s palm-based bio-diesel programme.

However, a dampener is the uncertainty surrounding a US rate hike that could cause an outflow of funds from the domestic bond market.

This is because the increase in US interest rates would reduce the interest rate differential between the US Treasuries and MGS, which would make the MGS less attractive for yield hunters.

But Kamaruzaman expects a modest rate hike in the US. “Should the Federal Reserve decide to increase the US interest rate, the percentage would be very low and on a gradual basis, depending on its economic performance,” he says.

A bank executive reckons that the selling of the ringgit might be overdone. “If based on fundamentals, the ringgit should not be at this level.”

The sentiment on the ringgit being oversold and that it does not reflect the fundamentals is generally shared by many, including Bank Negara governor Tan Sri Dr Zeti Akhtar Aziz.

But so far, the market does not seem to think so. The exporters still holding on to the foreign currency deposits are looking at further upside.

But the tipping point is probably not far away. When the foreign deposits in the system start to convert back to ringgit, the stampede will start and the ringgit will regain strength. (The Star)