THERE are several reasons why currencies appreciate. In Malaysia, the recent appreciation of the ringgit has been attributed to the inflows of foreign funds into the stock market, which has soared to an all-time high as tail-risks receded and growth outlook brightened.
Just to put things into perspective, Bursa Malaysia's benchmark FBM KLCI's recent all-time high was achieved on Jan 4, the second day of trading for the year when it closed at 1,692.65. This was after closing 2012 with a 10.34% gain at 1,688.95.
Last Friday, the ringgit closed at 3.021, a level not seen since last March. Reports noted that the currency's appreciation versus the greenback was underpinned by exports and factory output data, both of which exceeded expectations.
Previous reports noted that foreign funds were net buyers of Malaysian equities and continued to be net buyers as of last Thursday. It's probably safe to say that they have been net buyers for the past several weeks as local institutions and retail investors sold down.
This net buying may continue for some time yet as investors chased yields.
According to Standard Chartered Bank (StanChart) chief investment strategist for the wealth management division Steve Brice in a media briefing last Friday, South-East Asian equities would be seeing more such inflows as “there's a structural trend of Western investors looking to invest in Asia due to its attractive yields.”
However, while the reasoning of more positive economic data is valid on the surface, there are other reasons for the strengthening of the ringgit.
After all, while the macroeconomic outlook is generally brighter, economists are still cautious. Although exports have risen and regional purchasing managers' indices have expanded, concerns over US debt and spending issues, eurozone risks and the pace of China's recovery will continue to be concerns.
If not for the economy, what other reasons can there be for the ringgit's appreciation?
Alliance Investment Bank Bhd chief economist Manokaran Mottain pointed out that, outside of the brighter economic outlook, the US dollar has been on a weakening trend and will continue to weaken.
“Although they may come to an agreement to the debt ceiling and spending issues, the US dollar will still weaken,” he said. His reasoning was that the interest rate differential alone between the greenback and the ringgit would be enough to attract investors.
With an overnight policy rate at 3%, which is likely to be maintained this year, versus the near zero US interest rates, the interest rate differential is around 290 basis points.
Meanwhile, the US Federal Reserve has indicated in mid-December that the interest rate would stay near zero until unemployment falled to at least 6.5% (the latest data showed unemployment held at 7.8%), retreating from an earlier indication of holding rates until at least mid-2015, while for Malaysia, there is a slight chance of a 25-basis point rate hike in the OPR in the second-half of the year.
This is because some economists are expecting price pressures to start picking up stemming from the cutting of subsidies, crucial if the Government is to hit mid and long-term deficit targets.
With the chance of the interest rate differential widening a bit more, the ringgit may then strengthen further, although currency strategists believe that the ringgit will end the year not among the top South-East Asian currencies.
Furthermore, most reports on the strengthening of the ringgit usually ignore the fact that investors have also piled into bonds and sukuk. Although investors may not be investing in bonds as much this year because of the higher yields that can be had from equities, Asian local currency bonds will still be attractive on a combination of growth trends, low debt and interest rate stability.
StanChart senior investment strategist Manpreet Gill is recommending holding Asian local currency bonds at a longer maturity while holding high-yield US dollar denominated bonds with a shorter maturity period of one to three years due to interest rate risks.
“From a bond market perspective, we like Malaysia as yields are pretty attractive while the currency and inflation rate is stable,” Manpreet said, adding that interest in Malaysian bonds and sukuk has been constant and held up even during the financial crisis because investors regarded it as a long-term investment theme.
Underlining his argument of interest in Malaysian bonds and sukuk holding up was the Government's successful sale in June 2011 of two tranches of sukuk wakala totalling US$2bil in what analysts said were historically low yields.
The sukuk was nearly five times oversubscribed, attracting subscriptions of well over US$9bil at a time when the global economic outlook was at a low point.