WISE OR NOT? FOR BANK NEGARA MALAYSIA, THE ROOT OF ALL EVIL IS OFFSHORE SPECULATION – CAN IT WIPE OUT THE RINGGIT NDF MARKET?
FROM the perspective of Bank Negara, the root of all speculation lies in the offshore non-deliverable forwards (NDF), an investment instrument which is primarily traded in Singapore.
Historically, even during times when the ringgit was appreciating and the fundamentals were sound, the offshore NDF tends to be priced weaker compared with the spot rates. This could mean that excessive speculation might have driven the rates down in the past.
The central bank believes that the NDF market partly contributed to the recent decline in the ringgit against the US dollar. Additionally, the currency is also falling against its peers and remains Asia’s second worst-performing currency.
On Nov 17, it plunged to new 52-week lows against a slew of regional currencies, including the Thai Kbaht, the Singapore dollar and the Indonesian rupiah.
“The anomaly in the offshore markets could be due to illiquid market conditions, resulting in a spillover of negative sentiment on the ringgit. This underscored the point from Bank Negara that recent offshore market activities have brought on significant volatility and undue adverse influence on the currency,” said Maybank FX Research in a Nov 16 report.
Over the past week, Bank Negara has sternly told local banks to stop using NDF rates as reference in pricing the currency in the foreign exchange (forex) markets. Additionally, it has attempted to secure commitments from foreign banks to stop trading NDFs offshore.
On the other hand, it must be said that multinational corporations as well as banks have long used NDFs for conventional purposes. For example, the instrument is essential for firms to hedge their currency holdings against future fluctuations.
To solve this issue, instead of using NDFs, those with hedging requirements have been urged by Bank Negara to trade onshore forwards where the rates are derived from local banks.
As at 5pm last Friday, the one-month NDF rate was at RM4.463, while the onshore forward rate was at RM4.425. The ringgit was last traded at RM4.4183 against the dollar.
Over the past few decades, central banks around Asia have varied approaches in limiting access to currency markets from foreign entities and speculators.
In developing countries such as Indonesia and the Philippines, access to onshore forwards is allowed, but highly restricted and limited.
The prohibitions, which made the currencies less liquid and more difficult to hedge, led to the growth in the NDFs offshore.
Discrediting the highly liquid NDF market is a major challenge for Bank Negara.
For some foreign banks and hedge funds, there are few reasons to quit trading NDFs, as they provide ease of access and are regarded as reliable benchmarks, one currency dealer notes.
“At the end of the day, traders will flock to markets where there is liquidity and where the prices reflect actual supply and demand. Bank Negara has to take persuasive measures to convince investors that the onshore market can meet those expectations,” he says.
Advocates of free markets say that currencies should be priced based on supply and demand with limited influence by regulators.
However, central bank officials, especially those who lived through the 1998 Asian financial crisis, have long argued that a controlled currency is vital in the interest of economic stability and growth, particularly in developing countries.
How NDFs influence markets
According to data compiled by the Bank of International Settlements (BIS), as at 2013 the daily turnover in NDFs globally was worth about US$127bil and accounted for 19% of forward trading globally, making it a vital part of the forex market.
The outsized influence of the NDFs has long been a big headache for Asia’s central bankers. For example, offshore rates for currencies such as the ringgit are fixed by the Association of Banks in Singapore.
While the rates are supposed to reflect supply and demand, it is also a prominent benchmark for sentiment. Offshore NDF rates that are persistently lower than the onshore rates can erode investors’ confidence in the currency, thus driving down the currency further. This also means that commercial bankers operating overseas can easily undermine the official exchange rates set by central banks through their NDF quotes.
According to the BIS, trading in the rupiah-dollar NDF in Singapore saw trading volumes of up to US$1bil daily in 2011, which exceeded the turnover in Indonesia’s onshore market.
In fact, the NDF industry in the country has come under scrutiny in the past.
In the fallout of the London Interbank Offered Rate or Libor scandal in 2012, where traders colluded to manipulate the London benchmark interest rate, the Monetary Authority of Singapore (MAS) conducted a probe over allegations that traders also conspired to sway local benchmark rates used to price trillions of dollars in loans and derivative contracts such as NDFs.
MAS found a total of 133 traders who were engaged in attempts to inappropriately sway the benchmarks. It also censured 20 global banks operating in the country for breaches of professional ethics upon the conclusion of its investigation.