Bank Negara Malaysia Governor Tan Sri Muhammad Ibrahim said the ringgit is now priced more efficiently and increasingly more reflective of Malaysia
KUALA LUMPUR: The ringgit is now priced more efficiently and increasingly more reflective of Malaysia’s strong fundamentals as the influence of external factors have been squashed though it is far from reflecting its fair value due to misperceptions.
Bank Negara Malaysia (BNM) Governor Tan Sri Muhammad Ibrahim attributed this to the measures introduced by the Financial Market Committee (FMC) and BNM which was part of an overall strategy to deepen and broaden the financial market.
He pointed out that during the early part of 2017, which was a period of significant capital outflows, the spike in bond yields was short-lived while the ringgit exchange rate remained well supported.
“This was due to the net export proceeds conversion rule that helped to balance the flows. Short-term positions by non-resident investors exited the market, and the majority of non-resident holdings now comprised of longer term investors, providing stability and depth to the domestic bond market,” he said.
Muhammad said this in his keynote address at the Financial Markets Association, Malaysia annual dinner entitled "Of perception, sentiment and reality" last Friday.
The ringgit was up 0.1% to the US dollar at 3.30pm on Monday. Year-to-date, it was at 4.1557 to the greenback.
The ringgit is the third best performer against the US dollar since January, rising 7.93%., but behind the South Korean Won and the Thai Baht.
He said the measures removed the external destabilising influence of offshore to the onshore market, while at the same time creating a conducive environment for the domestic financial market to develop.
“Nevertheless, questions remain as to why the ringgit is far from reflecting its fair value. Numerous research pieces by analysts based on real effective exchange rates, have in fact, indicated that the ringgit is one of the most undervalued emerging market currencies.
“Despite strong GDP data for the first three quarters and better-than-expected exports performance in 2017, the ringgit exchange rate movements have remained lethargic, with flows and sentiments still driven by external factors and foreign players,” he said.
In his speech, he covered four parts; financial market review, factors that drive the level of the exchange rate, comments on ringgit exchange rate and interventions, and initiatives to build resiliency and liquidity for the market.
Commenting on the factors driving the level of the exchange rate, he said in a global financial market that is driven by short-term developments, the ringgit exchange rate can veer in unexpected directions and reach levels that are far from reflecting economic realities.
“ Unfortunately, most of these movements are not driven by facts, but perceptions. In ringgit’s case, I would call it misperceptions,” he said.
Muhammad cited three instances where perception and actions have been influenced by the biases.
First, take some of the psychological thresholds for example, loan-to-deposit ratio of 90%, ringgit level at RM4.00, and reserves level below US$100bil considered as vulnerable.
“Most of these are not statistically based, but rather convenient rules-of-thumb that ended up shaping our perception and driving sentiments. Unfortunately, in this information age, these perceptions and negative sentiments can be perpetuated rapidly and become self-fulfilling,” he said.
Second, he said there was a tendency to base perception on prior evidence and familiar situations, rather than updating their views with new information.
For many economists and analysts, Malaysia is an oil-dependent economy. When the oil price goes south, the Malaysian economy suffers. While this was true many years ago, these simple relationships are continuously assumed to be fixed and hold to perpetuity.
Despite the many structural changes leading to a more diversified Malaysian economy and reduced reliance on oil, this perception has persisted.
“The percentage of oil revenues to government revenues was 41.3% in 2009 compared to only 14.6% in 2016. This fact seems to elude many analysts.
“Third, and this is the trickiest of the three, is when individuals consciously tap on these cognitive biases to their own advantage. The rise of the asset management industry is one example, where asset managers’ herd behaviour may be looked at as perfectly rational,” he said.
Clearing misperceptions
Muhammad also cited five instances of misperceptions that have been making its rounds in the market.
First, the perception that the ringgit is driven by oil prices. This was derived from fact that Malaysia is one of South East Asia’s net exporters of oil and gas.
Petronas is also one of the world’s largest producers of LNG. Consequently, lower oil price reduces foreign exchange earnings of the country and government’s revenue from the oil industry.
Second, there is this perception, even among forex dealers and traders, that the offshore market knows how to correctly price or is better at valuing the ringgit.
Despite its opaqueness and suspicious pricing, the offshore market is perceived to be better, bigger and deeper than the onshore market, and that its price discovery process is more robust in indicating the direction of the ringgit. As a result, the onshore market is looking offshore for guidance on the direction and pricing of the ringgit.
Third, there is also the perception that the onshore market lacks the necessary liquidity, and with the decline of the offshore market, this negative perception has been driving the ringgit exchange rate weaker.
The lack of liquidity has been attributed to the inability for Malaysia's forward forex volume in the onshore market to replicate the offshore market;
Fourth, the significant non-resident participation in the onshore bond market is the main reason for the market’s liquidity. Consequently, the market perceived that the reversal of NR holdings will have negative bearing on the ringgit and market liquidity;
Fifth, the gross misperception on the adequacy of the reserves. There is this perception that reserves of less than US$100bil is not sufficient to provide comfort to investors. Accordingly, market pessimism reaches new levels when it falls below the threshold.
Muhammad also sought to separate the realities and facts by examining these perceptions, or rather misperceptions.
He said Malaysia was no longer reliant on oil and gas for economic growth. He added the relationship between oil and ringgit had been declining as Malaysia has come a long way in diversifying its economy.
“Our growth is now driven largely by domestic consumption. On the fiscal side, efforts were taken to diversify revenues with the introduction of the goods and services tax and rationalisation of subsidies,” he said.
Similarly, for the offshore ringgit pricing, the reality is that, it is driven by speculation and non transparent price discovery.
The ringgit is not an internationalised currency and therefore any offshore trading and pricing should have no fundamental basis.
"In fact, it is illegal. The sizeable speculative activities and herd-behaviours that take place in the offshore market have considerable influence over offshore ringgit pricing. Consequently, the offshore market significantly misprices the ringgit.
"On the other hand, onshore pricing is based on real demand and supply that reflects real economic activities," he said.
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