Central bank strives to control the spillover of NDF deals onto the onshore market
SEEING the ringgit lose about five sen overnight for consecutive days after strong moves by the dollar in the ringgit non-deliverable forward (NDF) market was the last straw.
For years, Bank Negara says it has been making tweaks to tackle the influence of the offshore NDF market on the local ringgit onshore market, but over time, the market reacts by finding different ways to circumvent any administrative tightening.
But with the ringgit volatile and the influence of the ringgit NDF market showing no signs of waning, Bank Negara leapt into action by coming up with a number of new ways to get the focus back on the onshore market to price the ringgit more to what it feels should reflect the fundamentals of the Malaysian economy.
The resetting of the ringgit on Nov 11 was the first step. Telling traders to price the ringgit to the previous day’s close as the reference point was a way of reining in the market influence of the NDF market.
The next step Bank Negara took was to remind market participants to observe compliance with the existing foreign exchange administration rules and that Malaysian licensed banks must avert from facilitating any foreign exchange (forex) transactions that could be related to offshore ringgit NDF market activities.
The signing of attestation forms from clients of licensed banks to ensure transactions are not facilitating the NDF market seems to have worked in some scope.
The other stick against banks in Malaysia getting involved in NDF transactions is the potential punitive action by the central bank.
One trader says a bank in Singapore has told him that it would no longer be dealing with ringgit NDFs, but he suspects the trade is still active in Hong Kong and other financial centres.
These steps, despite arresting the steep decline in the ringgit to the dollar, have not reversed the trend of the local currency against the greenback.
Most feel that it will take time for the currency to regain some buoyancy, but the tide is going against the ringgit and other emerging-market currencies at the moment.
Worries about Malaysia’s past in relation to capital controls is also said to be pressuring the ringgit, even though Bank Negara insists it has no plans to revert to the ringgit peg like it did in 1998.
“We can’t control what happens in the NDF market. But we can control the spillover onto the onshore market. Essentially, the onshore market will be better protected,” says assistant governor Adnan Zaylani Mohamad Zahid.
Bank Negara will love for the ringgit NDF market, which it says its central bank peers feel is a thorn to onshore markets, to become a meaningless market, but there are people who think that will be a difficult task.
“The intention is obvious but it will not be easy,” says a bond trader. “I am not sure they will succeed.”
The onshore market for the ringgit is related to trade and investment purposes where speculation is a no-no for the central bank. Paperwork has to accompany onshore transactions and the central bank does monitor for speculative trades.
One key purpose the ringgit NDF market is used for is hedging purposes. The other reason is that the market has confidence, depth and liquidity.
Bank Negara says it wants to provide those same avenues for companies and investors in the onshore market. Work behind the scenes has started and then some.
“We are looking at ways to make the onshore market the market of choice. Rather than hedge in the offshore market, they can hedge onshore,” says Adnan.
“We have to start somewhere. Our economy is growing and demand from corporates and investors has grown. We have to look at ways for our financial markets to meet these demands. This strategy is a broader one than tackling just the NDF market. It is really about creating a vibrant forex and bond market, as well as money market to meet these needs.”
What is the NDF market?
The NDF market is not some obscure over-the-counter market. Statistics show that the average daily volume is US$3.5bil, based on data by the Depository Trust and Clearing Corp. It is a US regulation requirement for US banks to report NDF trades.
In comparison, the onshore market trades US$8.1bil worth of dollars each day to fulfil the need of businesses and investors. “It is a big market out there,” says Adnan on the NDF market.
The one thing that has bothered Bank Negara for some time is the absence of transparency in the NDF market.
“We don’t know who is trading in those markets,” he says.
“It is a difficult position to be in as a regulator, as you are not able to see the activity in those markets. That is why we have a firm position on the NDF market.”
That, Bank Negara feels, is important because of the influence the NDF market has on the onshore rates.
With the market in Kuala Lumpur open from 8am to 6pm, trading is robust for both the onshore and NDF markets during those times. But it is after the market closes in Kuala Lumpur where it gets worrisome.
Adnan says market liquidity can drop and prices can spiral quickly during trading outside of the KL hours. Bank Negara has now allowed onshore banks to unofficially trade after 6pm.
The other problem is that as the NDF market influences the onshore rate, the trading can be one-sided at certain times.
“Most of the players in the offshore markets are non-residents. This is an environment where demand to take positions can be one-sided. Institutional investors and hedge funds can take a one-sided view.
“The bets are one way that the dollar is going to strengthen. All of them are lining up on one side and the other side of the market can disappear and there is no position of the central bank to intervene to provide the liquidity. People who want to buy can push up prices very rapidly,” says Adnan. The difference is that in the onshore market, Bank Negara can step in and provide liquidity when volatility picks up. “A lot of the time, our market looks at referencing from where the NDF market closed to start trading the dollar-ringgit rate in the onshore market,” he says.
Risk from bonds
The ringgit’s weakness is something that has people scratching their heads. The country’s growth rate of 4.3% in the third quarter was solid enough, with the trade and current accounts showing a surplus.
The other issue is for the ringgit to be at around a year’s low against the currencies of neighbours such as Thailand and Indonesia even though Malaysia’s credit rating by rating agencies is higher than those two countries and the Philippines.
But the credit default swaps for Malaysia is higher than those of Thailand and the Philippines. “But the pricing is two to three notches below our rating,” says a bond trader.
The high cost of Malaysia’s credit default swaps, some feel, is down to perception on the ringgit following the 1Malaysia Development Bhd scandal. “This has nothing to do with country weakness.”
The one constant worry has been the amount of bonds being held by foreign players. With foreign bond holdings being on the high side, foreign holdings in bonds has experienced a sell-off of late, with foreigners selling RM5.5bil worth of Malaysian Government Securities (MGS) in September. Foreign shareholding of MGS was RM181.4bil at the end of September.
Adnan says most of the Government bonds held by foreigners are in the form of long-term holdings, as the weightage of Malaysian bonds in key international benchmarks is high.
“Malaysia has a non-trivial weight and up to 70% of that holdings are stable and for the long-term,” he says.
A sell-off in the bonds do appear to be quite high, as the spike in yields has been the fastest in the past three years.
“The market does not like uncertainty and foreigners might be worried about the prospects of capital controls,” says a trader.
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