The State of the Nation: Will the ringgit keep strengthening?

This article first appeared in The Edge Malaysia Weekly, on June 12, 2017 - June 18, 2017.
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SENTIMENT on the ringgit is improving. The currency has risen about 3% in the past six weeks, closing at 4.2653 to the greenback last Friday. It is also up 5.2% from a low of 4.4975 early this year.

Foreigners are net buyers of Malaysian bonds and equities again, and Bank Negara Malaysia’s foreign reserves are at a two-year high.

The big question is whether the ringgit can continue to strengthen, and by how much.

The positive sentiment is reflected in the changes in forecasts for the ringgit’s performance against the US dollar in the fourth quarter of this year (4Q2017) and next year.

The median USDMYR forecast for 4Q2017 was 4.35 at the time of writing, compared with 4.54 in January and February this year. Similarly, the median USDMYR forecast for next year improved to 4.3, from 4.5 in December last year. A similar strengthening trend has been seen among the most bullish and bearish of forecasters compared with the start of the year, Bloomberg data show.

Morgan Stanley Research is one of the foreign outfits that has turned bullish on the ringgit.

“Malaysia has not participated much in the broader emerging market rally and there is a strong valuation case for additional currency appreciation,” it says in a note dated June 4.

“Malaysia is seeing a cyclical recovery in its exports, along with a pickup in the global trade cycle. Interestingly, non-commodity trade has also picked up, likely with help from the undervalued ringgit. Foreign direct investment into Malaysia has turned net positive this year with an increase in direct investment from China. We think that the ringgit has lagged its terms of trade improvement. A pickup in export proceeds, equity inflows and stability in bond flows should help to stabilise Malaysia’s foreign exchange reserves. We think that cheap valuations provide a margin of safety for the bullish ringgit trade.”

Morgan Stanley expects the ringgit to reach 4.20 to the US dollar in 3Q2017 and 4.10 in 4Q2017, an upward revision from its previous forecast of 4.60 and 4.70 respectively.

Nonetheless, it expects the ringgit to give up some of its gains next year, with forecasts of 4.15 in 1Q2018, 4.20 in 2Q2018, 4.25 in 3Q2018 and 4.30 in 4Q2018, which is still an improvement from the 4.70 (1Q2018) to 4.60 (4Q2018) range in its old forecast.

Even so, foreign buying helped Bank Negara reserves gain an impressive US$1.9 billion in May to US$98 billion, its highest level since June 2015 when central bank reserves were last above the psychological US$100 billion mark. The US$1.9 billion monthly gain is also the highest monthly increase since September 2012’s US$2.5 billion gain, bringing total gains over five months to US$3.4 billion — exceeding the US$3.2 billion lost over November and December last year amid the central bank’s clampdown of the non-deliverable forward (NDF) market.

Foreigners, who sold RM62.7 billion of Malaysian debt papers between November last year and March this year, added RM10.1 billion worth of bond holdings in May this year after adding RM6.8 billion in April. Foreigners were also net buyers of equities, adding RM2.6 billion in April and RM2.1 billion in May.

Whether the trend on net foreign flows into Malaysia will continue going forward is “dependent on global risk appetite and how foreigners perceive the risk-reward for Malaysia”, says UOB Malaysia economist Julia Goh.

“We are seeing investors turning more positive, both foreigners and local investors. It helps that the US dollar has softened. Bank Negara has also liberalised the bond market and loosened some of the hedging measures that makes it more conducive to invest in Malaysia and hedge onshore. The export and gross domestic product prints have improved since the start of the year,” she adds.

Two key dampeners in the domestic market are speculation surrounding the timing of the next general election and the sizeable government bonds maturing later this year, particularly between August and September.

Goh, who thinks the positive sentiment on ringgit assets can be sustained, is “less worried about the bond maturities” following the sharp sell-off in the first quarter.

“I believe the current holders of Malaysia’s government bonds comprise longer-term holders that are deemed a more stable base,” she says.

“Recent foreign inflows saw more than 70% [flow] into medium to longer-term papers. At end-March, central banks and governments increased their holdings of government bonds to 34% of the total (versus 30% at end-2016) and pension funds to 19% (versus 17% at end-2016). As such, from … [the] type of holders and tenure of papers currently held, as well as the broad measures Bank Negara has taken to stem offshore ringgit speculation through the NDF market, the risk of another sharp selldown appears lower.

“Moreover, with forex flows between exports and imports more balanced, this improves the underlying support for reserves,” says Goh,  describing the central bank’s foreign reserves as a “barometer of confidence” as it reflects the country’s war chest against external shocks.

According to Goh, investors are “mindful” of a general election being around the corner but “long-term holders expect continuity of current economic policies”.

To be sure, inward-looking policies and macro-missteps from the US could still affect the global economy, including Malaysia.

For now, however, Goh says the Institute of International Finance (IIF) recently estimated that total non-resident inflows into emerging markets will rise to US$970 billion this year from US$718 billion in 2016, amid dissipating fears of a negative external shock from US policy. If true, that sizeable inflow would be a welcome respite for the ringgit. Malaysia will have to do its part in delivering on its growth story.