The governor of Bank Negara Malaysia says curbs imposed on ringgit non-deliverable forwards (NDF) last year have worked far better than expected, while acknowledging the need for a deeper onshore hedging market.
To curb speculation it viewed as a threat to currency stability, Malaysia’s central bank moved to rein in the US dollar/ringgit NDF market in November by asking banks with an onshore presence in the country not to deal in NDFs.
“We have achieved much more than we had hoped for. We thought we would see [these kinds of results] sometime in July or August, but we have in fact seen this earlier than expected, so basically the curbs have worked,” Muhammad bin Ibrahim, governor of Bank Negara, tells Risk.net.
Following the central bank’s restriction last year, daily NDF volumes collapsed by more than 75%, from $4 billion to less than $1 billion on “normal days”, according to the governor. He also notes the price of five-year credit-default swaps on Malaysian government bonds – one indication of the country’s sovereign risk – has fallen from a high of 172 basis points in November to just above 100bp. Onshore market volatility is also down, having slipped from 12% to 5% since the curbs were introduced.
“It didn’t make sense that the volume of the NDF market was 300% of GDP [gross domestic product] – it didn’t make sense at all,” says Ibrahim. “We welcome genuine investors to our market, but research shows 80% of the activity in the NDF market was pure speculation, rather than providing instruments for non-residents to hedge.”
The other dimension to this reform process, says the governor, is to find ways to deepen and develop the onshore hedging market.
“We will come up with new rules and new regulations, and we might even relax more rules for non-residents, simply because, as we promised, we want to take a lot of business from the offshore market and bring it to the domestic market. We know that we will only be able to do this if the rules are clear, relaxed and easy for people to follow,” he says.
Bank Negara’s Financial Markets Committee is looking at ways to relax rules and regulations that inhibit the development of a deeper market, and it has already taken some steps in this direction.
In December, the central bank eased several restrictions for market participants who want to hedge their risk onshore, including removing the need for residents to provide underlying documents (up to certain limits) and giving non-resident fund managers greater freedom to manage their forex positions.
In April, Bank Negara removed the limit on the amount of forex exposure that institutional investors can actively manage, and it also moved to allow all resident investors – not just investment banks – to conduct regulated short-selling of government securities. The governor says this will provide additional risk management tools and encourage two-way liquidity in the onshore financial market.
Market participants have broadly welcomed these initiatives, which they say go most of the way towards meeting hedging needs onshore.
“There is now no more excuse for investors to go to the NDF market,” says Chu Kok Wei, group head of treasury and markets at CIMB. “What Bank Negara has done is definitely positive, especially with regard to the April announcement, which means that physical investors now have full flexibility to conduct their onshore hedging.”
Shift in stance
He says that even more important than the substance of the liberalisation is the tone that the central bank has set for future regulatory development.
“Last year, investors perceived the actions from Bank Negara as a tighter enforcement of rules, but with the April announcement they can sense a shift in the central bank stance from tightening mode to focusing on what markets need in order to develop the onshore activities, presumably with the NDF squeeze largely accomplished,” says Wei.
His sentiments are borne out by performance in the markets. Between November last year – when the central bank imposed curbs on NDFs – and the middle of April this year, the ringgit weakened from 4.19 against the US dollar to more than 4.35. Following the easing of hedging restrictions, the currency strengthened to 4.25 against the dollar (although it has softened slightly).
We are determined to realise the idea of having a market… able to contribute to the overall wellbeing of the economy and [withstand] market volatilitiesMuhammad bin Ibrahim, Bank Negara
“Prior to the April liberalisation, most strategists thought the ringgit was undervalued and there was a lot of concern that this undervaluation would persist or worsen. That was when you saw some of the biggest outflows of foreigners’ holdings of government bonds. But since the April announcement and the improved frequent communication from Bank Negara, the market has had a lot more comfort that the central bank is on top of these things and there is a well thought out plan to attract flows onshore,” says Wei.
While the decline of the offshore ringgit NDF market has been dramatic, the Bank Negara governor believes that for its influence to disappear altogether, the onshore financial market must become much more competitive.
“We are determined to realise the idea of having a market that possesses the breadth and depth to cater to the increasingly complex and diverse needs of the economy, and a market that is able to contribute to the overall wellbeing of the economy and [withstand] market volatilities,” says Ibrahim.
To guard against future market volatility, the governor also wants to increase the size of the central bank’s international reserves. Latest figures show these reserves stood at 436.1 billion ringgit ($98.7 billion) at the end of May, which is sufficient to finance 8.2 months of retained imports. Ibrahim says he would like to build the reserves up to cover 12 months of imports.
“We will not impose any rules that will basically limit inflows into our markets, but we are certainly ready in case there is a large outflow. One thing I have learnt [in my 30 years with Bank Negara] is that the international reserves must be high and strong enough to cater for any eventual outflows,” says Ibrahim.
A particular question he has grappled with is how the central bank can continue to support healthy growth and stability in Malaysia as the US Federal Reserve proceeds to raise interest rates and begins to reduce its bloated balance sheet – a move anticipated to take place in 2018.
The challenge for Bank Negara is to make sure returns are not outstripped by the costs of maintaining such a large reserve. Developed bond market returns can be very low or negative, and usually have a negative spread compared with ringgit-denominated liabilities. The negative spread can also be aggravated if the domestic currency appreciates.
“Some central banks have faced the problem that the costs of pick-up in the domestic currency are much higher than the returns on the reserve. That hits the balance sheet and can require the Ministry of Finance to inject some capital,” says Ibrahim. “This very much depends on what asset classes you invest in and we are keen to diversify. If we invested only in Treasury bills, right now our balance sheet would be showing a loss. But if we diversify into other asset-classes like rates, equity [or] emerging Asian markets, then we can cover our pick-up costs and make a bit of money on the side.”
Ibrahim says that despite the headwinds Malaysia is facing, the reforms undertaken in recent years have put the country in a good position. Between November and April this year, about 60 billion ringgit ($14 billion) flew out of the country.
“That is huge by any measure, but because we have a strong financial market that is able to intermediate those outflows, the bond market hardly moved,” he says. “That is testament to all the reforms we have done since the Asia financial crisis almost 20 years ago. There is no substitute for strong macroeconomic fundamentals and a strong underlying structure.”
The week on Risk.net, July 14–20, 2017Receive this by email