Depreciating Ringgit – if unhedged, stay unhedged

THERE is an adage about investing in the stock market – be afraid of the market when everybody is bullish, and be brave when everybody’s fears are at the highest.

The fear of the ringgit depreciating further is at its highest now. It has been a topic of conversation among serious investors for about a year now.

The smart money had started hedging since last year and was going on even until early last month.

But now, hedging the ringgit is a topic of conversation for the ordinary man in the street. It probably is a tad too late to hedge, as the market is volatile and there is no clear trend emerging yet.

One occasional investor called to say that there was a scheme offering various foreign currencies such as the euro, US dollars and the pound sterling at a discount to the market rate for a period of one week only. A week later, the ringgit’s position is to be unwound and the investor is to make some money from the further depreciation of the ringgit.

The idea behind the scheme is to offer the occasional investor a chance to hedge against the ringgit’s falling value against the US dollar. While on the face of it, the scheme may sound like a no-brainer, deeper scrutiny suggests two reasons why one should not go into such investments.

The losses will be great if the ringgit appreciates – meaning the foreign currency when converted to ringgit will end up with a lesser amount.

The second reason is that the period of one week is just too short a time to predict where the ringgit would be heading against the US dollar. It is more so the case in this current period where the world is going through a period of extreme turbulence on speculation of a firm recovery in the US and other developed markets.

This has led to an outflow of funds from emerging markets to the more developed markets such as the US and the UK, and hence, the appreciation of the US dollar and the sterling. According to reports, more than US$4bil has flowed out of the emerging markets in the last one month.

The global markets have not seen such volatility since mid-2013 when the US announced the end of its quantitative easing (QE) programme that caused havoc for asset prices in emerging markets such as Malaysia.

It allowed for ultra-low interest rates and cheap funds flowing out into emerging markets in search of higher yields.

Governments had a field day issuing debt papers that were easily absorbed by foreigners. Between 2007 and 2014, the amount of government bonds issued by the emerging market had doubled from US$6.5 trillion to US$13.5 trillion.

Now, there is a reversal in the outflow of funds and this has caused a drying up of interest in emerging market assets and bonds.

When investors stop buying debt instruments issued by governments, it creates a liquidity problem that leads to volatility.

The bond market is experiencing the highest volatility since 2011, which is causing currency movements far beyond their fundamentals.

Just last week, the euro moved up and down by more than 1.2% against the dollar in a period of a few hours. Two months ago, when the European Central Bank started its QE programme, the expectations were that the euro would depreciate to the point where it could be at parity to the US dollar. That, however, did not happen.

But last month, fears that the recovery in the US was not shaping up as expected surfaced. Hence, the US dollar depreciated for a few weeks before starting to climb again on the back of strong economic data on employment.

Now, expectations of a rate hike in September have been reignited, causing a rise in the dollar.

The current forex market situation is volatile. Even the best of currency strategists are having a difficult time predicting the direction of the currencies.

The ringgit market is driven by fear and confidence.

The fear is the possibility of the 1997/98 currency crisis recurring. At that time, the ringgit had depreciated to more than RM4 against the US dollar, causing a meltdown of the stock market. The ebbing of confidence now is largely due to the Government’s handling of the RM42bil debt tied to 1Malaysia Development Bhd (1MDB).

The fund, which is backed by the federal fovernment and is the brainchild of Prime Minister Datuk Seri Najib Tun Razak, is facing cashflow problems and a crisis of confidence because some RM13bil is invested outside the country and its recoverability is in question. And because of 1MDB, Najib’s leadership has come under fire.

Putting aside the fear and uncertainty, eventually, economic fundamentals will rule the day when it comes to the direction of the ringgit.

The Government has to ensure that its fiscal deficit stays at 3.2% of gross domestic product and the current account remains in a state of surplus. The federal government’s budget growth forecast for this year was based on Brent crude at US$55 per barrel. The price now is above that amount.

The concerns of a repeat of 1998 is largely unfounded because the laws do not allow the borrowing of the ringgit by non-residents other than for the purpose of business and investment.

This means the ringgit cannot leave the country for speculative purposes.

The ringgit will depreciate further if foreign investors unwind their positions in the local bond market in search of high yields and to avoid the currency risk.

But there are not many places that offer high yields. As for the currency risk, the answers lies in several factors, such as the quantum of the rate hike by the US and how well the Malaysian federal government’s balance sheet shapes up.

The additional income from the implementation of the goods and services tax should help, but at the same time, government spending should be trimmed.

And to instil confidence, governance and the handling of public finances, especially the 1MDB fiasco, must improve by leaps and bounds.

Until then, it’s best to stay away from hedging against any ringgit volatility until a clear trend emerges.

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Business , ringgit , hedge , volatile


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