What is driving the ringgit rally?

 

As recently as February this year, the US dollar surpassed RM4.80 against the ringgit, albeit briefly. These levels of ringgit weakness had not been seen since the height of the Asian financial crisis.

When questioned on this matter, Prime Minister Anwar Ibrahim frequently diverted the attention towards Bank Negara Malaysia (BNM), and BNM governor Shaik Abdul Rasheed Ghaffour.

Anwar, who is also the finance minister, instead focused his communication with the media and public on the amount of foreign direct investment his government was able to attract.

Malaysia has successfully attracted potential foreign investments amounting to RM76.1 billion this year, the result of the country’s successful trade and investment missions in Australia, Germany and France,

 said Anwar at an event in March.

Foreign direct investment of such sums should have supported the ringgit, but instead the currency was still performing poorly.

This set of optics put a significant amount of pressure on the central bank as BNM is responsible for the country’s foreign exchange policy with the view of maintaining monetary and financial stability.

Given Malaysia’s positive economic fundamentals and prospects, the ringgit ought to be traded higher,

 the BNM governor said in February.

In reality, the decline of the ringgit was primarily driven by factors external to Malaysia, namely the aggressive rise in US interest rates (and that of other developed nations), China’s economic woes, and geopolitical tensions.

BNM released statements in the following months that it is ready to support the ringgit, which was somewhat successful in stemming the currency’s decline, such that markets expected BNM to use its foreign reserves to support the ringgit by buying the currency in the open market and therefore creating demand.

Some were also pushing for BNM to raise interest rates, typically a tool to curb inflation, to attract foreign capital into the country and boost demand for the Malaysian Ringgit.

This strategy would have however been very short-sighted. Using up foreign reserves in such a manner would leave BNM with less optionality in times of potential need down the road. Raising interest rates and effectively the cost of capital would have hurt the domestic economy.

BNM instead used currency forwards to support the ringgit.

A currency forward is a contract between two parties that sets a fixed foreign currency exchange rate for a transaction, set for a specified future date. Entering into such forward contracts implied demand for the Malaysian Ringgit at certain rates, therefore supporting the Malaysian Ringgit without BNM having to use its foreign reserves.

With the US Federal Reserve (and the central banks of other major developed nations) now going through a phase of cutting interest rates while Malaysia’s interest rates remain unchanged, there seems to be a significant amount of capital inflow into the country in search of yield.

Foreign investors poured RM5.5 billion into Malaysian bonds in July, the largest monthly inflow in a year, according to data from Bank Negara Malaysia.

Over the course of four months, the ringgit has rallied approximately 10% against the US dollar.

With Malaysians suddenly in a position to be positive about something with respect to the nation, it is important to understand BNM’s role, with its patience and clever use of financial tools, in getting us here. - FMT

The views expressed are those of the writer and do not necessarily reflect those of MMKtT.