The falling ringgit and the non-deliverable forward

With the falling ringgit discussion going on across all age groups in Malaysia. Let us imagine a hypothetical scene of a parent telling his 8 year old child wanting to purchase a toy, “Daddy has to save money now, since the ringgit has fallen in value due to the non-deliverable forward issue.” You can just imagine the look on the child’s face, which I guess would be the exact confused look on my face when reading the news of the ringgit falling. So I went online to investigate what the issue is really all about.

What is the non-deliverable forward?

Basically it is an offshore market where contracts of the target currency, in this case Malaysian Ringgit can be bought and sold in US Dollars. The market helps to “price” the currency outside of the country and although it might not be an official reference to the target currency, somehow banks are referring to the off-shore NDF market. Why might that be? Let’s read further on the guidance from the Malaysian central bank.

Bank Negara Governor statement

“We have also reminded onshore banks to avoid dealing in FX with non-resident banks suspected of engaging in NDF speculative activities except for those that provide confirmation of their non-involvement in the offshore ringgit NDF market.”

If that is the case, how will onshore banks settle the FX transactions when there is a disequilibrium between two currency pairs? And now they have to write to ask for confirmation from the non-resident banks before doing so? Does this make the market more efficient or less? I believe in the first place, NDF market exists to partially transact  legitimate transactions that may not be able to be settled by onshore banks e.g. during out of Malaysian working hours.

The issue of stability

Of course I would like the Malaysian Ringgit to be stable and hence strategies to control the volatility is a good move. However, with market forces playing out in a free market, sometimes statements from the central bank could be detrimental rather than helpful. The market would make a judgement looking at economic variables such as the current account balance, GDP growth, political stability etc rather than a central bank statement. As action speaker louder than words, admittedly the central bank did take steps to introduce a the  KL USD/MYR reference rate which I believe is a good move.

Estimated 60% to 80% of NDF volume is generated by speculative interest

Yes, while the non-deliverable forward is largely due to speculative activity, the question remains of why the currency is speculated to be going down in future value? Has the NDF market itself determined the future rate of exchange or what are the real factors causing speculators to bet against the currency. While it is easy to shift the blame to speculators off-shore and having an unseen foreign enemy, are there issues that need to be fixed in our economy? If the Malaysian economy is rock solid with strong fundamentals, are the speculators fools to bet against an appreciating currency? However, fret not that speculators are only dealing with Malaysian Ringgit currency, other emerging economy currencies are also being transacted such as Chinese Renminbi, Indonesian Rupiah, Indian Rupee etc. But then again the question remains why target the Malaysian Ringgit?

So what does the future hold?

Your guess is as good as mine. The situation might improve with a smart central bank policies, I hope Malaysia will sail through this without the ship being battered too badly. On the other hand, as in the example at the start of the article, should the 8 year old kid actually say, “Daddy, you should buy the toy now since it would be more expensive in future looking at the market forces at play.” You can only imagine the look of the father’s face now.

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