Why the worry on the offshore ringgit market?

Under pressure: A currency trader showing the ringgit and US dollar notes at his money changer’s store in Kuala Lumpur. The ringgit has weakened considerably against the US dollar in the NDF market since Thursday. It hit as high as 4.54 against the dollar at 10am yesterday.

REGIONAL currencies coming under pressure after the US presidential election were something that was expected given that the Federal Reserve was looking at raising interest rates before the year ends.

This expectation of US raising interest rates picked up in pace following incoming president Donald Trump’s assertion that he would push for infrastructure projects to drive the economy, something that would raise national debt and spark inflation.

This was reflected on the rising yields on US dollar 10-year bonds, a benchmark for future movements of the interest rate. As bond prices and yields move in opposite direction, they indicate that investors holding the papers sold down their positions in anticipation of a rate hike.

In the next few weeks, as the yields on US bonds move up steadily, it would impact emerging economies such as Malaysia that has been piling up on debts in the past few years. Foreigners hold the bulk of the debts in the form of government bonds.

In Malaysia’s case, foreigners hold almost 50% of the government debt papers.

China on Wednesday added to the weakening of Asian currencies by adjusting downward the band of the yuan against the dollar.

But what happened to the ringgit yesterday was shocking because the abrupt weakening of the currency against the dollar was largely attributed to the movements in the offshore ringgit market better known as the NDF (non-deliverable forward) US dollar-ringgit market.

There has not been any trading of the ringgit outside the Malaysian shores since 1998 when the Government imposed capital controls. However the NDF market is an unofficial market that tracks the movement of the ringgit against the US dollar.

It operates on a 24-hour basis and is used by many corporations and traders as a guide on where the ringgit is heading against the US dollar. It is also seen as a speculative market because it is settled in US dollars.

The ringgit has weakened considerably against the US dollar in the NDF market since Thursday. It hit as high as 4.54 against the dollar at 10am yesterday.

What exacerbated the situation was gentle suasion methods used by Bank Negara to restrict the movement of the ringgit outside the country.

According to dealers, they were told not to enter into any US dollar transactions with banks located outside the country.

The reason for this is because the ringgit-US dollar quotes of the local bank tend to be influenced by the movements in the NDF market rather than the fundamentals of the economy.

To counter this influence of the NDF market, the central bank had initially told banks to quote the US dollar at a rate that is much lower than what was in the NDF market.

For instance, the rate in the NDF market was at 4.33 against the dollar at 8am yesterday. But the local banks quoted at a much lower rate of 4.29.

Then panic kicked in when the local banks were not able to enter into any kind of transactions with the banks located outside the country.

And this caused the ringgit to go haywire at the NDF market. At about 6pm yesterday, the ringgit was trading at 4.55 against the dollar in the NDF market.

This NDF market has always been a problem for Bank Negara. It has tried several times to emphasis that the NDF market is a speculative market and local banks should not quote the ringgit-US dollar trade based on the NDF market movements.

But it has not had much success and this is with a reason.

The currency of the country is determined by the strength of the economy. Bank Negara governor Datuk Muhammad Ibrahim has said many times that the fundamentals of the economy was not reflective of the ringgit.

He is probably right considering that the economy grew 4.3% in the third quarter, which is rather healthy considering the slowdown.

So that being the case, the ringgit continues to be weak because of reasons that are beyond the control of the central bank.

The continued outflow of the ringgit is a reflection of the lack of confidence in the future of the economy.

And this can only be corrected over time or by taking on unorthodox measures to cleanse the system.

In this respect India’s Prime Minister Narendra Modi rattled the people with his bold demonetisation policy.

Overnight, he decided that the 500-rupee and 1,000-rupee denominated notes were no longer valid and to be replaced with new Rp500 and Rp2,000 notes that will come with added security features to eliminate the counterfeits.

Now, let’s get real on what the measure really entails.

Everybody knows that counterfeits currency operations cannot be eliminated completely.

However what is certain in the move by Modi to demonetise the two currencies that make up some 80% of the currency in circulation is that it will rattle the black economy and flush out the black money gained from illegal means.

The reason is that under the policy to switch the old notes to new notes, the persons involved have to produce an income tax registration number to show that they have paid the taxes due for their earnings.

This would be a problem for those who have amassed cash through illegal means or evaded paying taxes due on their earnings.

Without an income tax reference they are likely to be left holding currencies that are no longer valid after Dec 31 this year.

The unorthodox measure by Modi is sexy!

For years India is known to have a huge black economy backed by a system infested with corrupt politicians, civil servants and businessmen who evade tax.

The move by Modi has caused hardship to many small businesses. But the Prime Minister describes it as a grand sacrifice, that is necessary to cleanse the system of the black economy.

Now let us come to our backyard.

What Malaysia needs is to focus on the economy and plug the leakage in the system. Every ringgit spent by the Government must be counted for.

Only a month ago, Malaysians were left shell-shocked by the discovery of some RM30mil in the homes of the top two officials of the Sabah Water Department. The discovery in Sabah is only the tip of the iceberg and the leakage is huge.

To counter the leakage, the country perhaps needs a “Modi-style” demonetisation move.

This will complement the government’s efforts to heal the economy reeling from its over-reliance on oil money.

In the meantime what the central bank needs to do is to forget about the NDF market and let the market forces determine the strength of the ringgit.

Plug the leakage and do what is best for the economy and the ringgit’s volatility will be fixed.