Overview

• The Financial Markets Committee (FMC), in collaboration with Bank Negara Malaysia (BNM), announced several liquidity enhancing measures targeted at expanding Malaysia’s financial markets with emphasis on its onshore foreign exchange (forex) markets. It comes into immediate effect on 5 December 2016 (today)
• These measures include the liberalisation and deregulation of its onshore ringgit hedging markets,
  streamlining treatment for investments in foreign currency assets, and incentives and treatment of
  export proceeds. The announcement comes just weeks after BNM’s attempt to curb offshore ringgit
  market.
• Nonetheless, given the high foreign ownership of Malaysia’s government bond market, weak external
  demand and the high possibility of the U.S. Fed rate hike this month, we expect the ringgit will remain
  vulnerable and continue to be volatile. Overall the ringgit sentiment is biased on the downside with
  USDMYR expected to trade within the 4.40-4.50 range till year end.
   

Supplanting existing hedging avenues. Measures announced by FMC-BNM comes hot on the heels of BNM’s recent moves to clampdown on trade of nondeliverable forwards (NDF), through its reinforcement of rules prohibiting faciliation of NDF trades by onshore banks.The announcement also coincides with a separate announcement by BNM reporting that seven global banks have attested that they have not and will not engage in NDF transactions.

BNM has cited the NDF markets as a negative influence in bringing about undue ringgit volatility, mispricing the ringgit away from Malaysia’s economic fundamentals, and underlying trade and investment activities. However, while NDF may have faciliated speculative activities against the ringgit, the curbs on NDF transaction may undermine legitimate forex hedging activities and reduce forex liquidity for investors and exporters alike.

Bringing back greater control by BNM. The move to oblige exporters to convert 75% of all export proceeds will help BNM retain significant control of the forex market. This, in turn, allows BNM to play a more active market making role in the onshore forex market. We note that this move may somewhat diminish the exporters’ ability to hold foreign currencies as a response to their views of a depreciating Ringgit despite the relatively more attractive 3.25% rates offered by its special deposit facilities.

However, we believe that this is reflective of BNM’s attempt to balance between legitimate hedging considerations and speculative activities; exporters may retain a larger proportion of their export proceeds in consideration of their forex needs upon BNM approval.
 

Additionally, the requirements for exporters to convert export proceeds will also help enhance BNM’s foreign reserves, providing it with sufficient ammunition to play a more active role in market making in the onshore forex markets, responding to excessive ringgit volatility as required.
 

Developing the onshore forex market. With the measures in place and the crackdown on offshore NDF, BNM is effectively promoting the onshore ringgit market as the sole source of ringgit hedging, allowing it to supplant the offshore market as a provider of ringgit hedging. The announcement effectively lays down the rules and establishes the framework for an orderly onshore market with ample liquidity. At the same time, the announcement also brings a greater clarity into forex transactions, particularly with regards to financial market participants seeking to invest in foreign currency assets, subject to necessary prudential limits.

Outlook

Bolstering foreign reserves and control. BNM’s move to require exporters to convert at least 75% of export proceeds would help BNM bolster its foreign reserves. While international reserves remain healthy at RM407.8b (8.4 months of imports and 1.2 times short term external debt) as at15 November 2016 (RM392.5b on 15 Sept), the requirement will further bolster BNM’s reserves, allowing it to adopt a more active stance against ringgit volatility – previously, exporters were required to remit their proceeds within 3 months though they were able to retain those proceeds in foreign currencies. The special 3.25% per annum deposit could be effectively viewed as a compensation for possible depreciation of exporters’ ringgit position.

Setting up the framework.We are positive on BNM’s efforts to setup an alternative framework. While NDF has been linked to increases in ringgit volatility, it has also been a means of hedging. With current measures to develop the onshore ringgit market and creating new avenues for ringgit hedging, we believe that this will restore some measure of confidence in the ringgit while affording BNM with the leeway to manage exchange rate volatility.

Ringgit weak Bias. Nonetheless, given the high foreign ownership of Malaysia’s government bond market, weak external demand and the high possibility of the U.S. Fed rate hike this month, we expect the ringgit will remain vulnerable and continue to be volatile. Overall the ringgit sentiment is biased on the downside with USDMYR expected to trade within the 4.40-4.50 range by year end.

Source: Kenanga Research - 5 Dec 2016