Malaysia’s central bank, Bank Negara, has made significant reforms to its foreign exchange rules, lifting bans on offshore trading within the goods and services sector.
Three key changes were made: allowing the settlement of international trade between residents and non-residents to be conducted in ringgit; abolishing the caps on inter-company cross-border foreign currency borrowings; and removing limits on anticipatory hedging for current account transactions.
And with rumours that Malaysia will continue on the path to foreign exchange reform, the ringgit has enjoyed a pick-up in performance. On August 19, it reached a 13-year high of 3.1242 against the US dollar -- the strongest level since October 1997 -- and so far this year it has appreciated by 9.3%. At the opening of Asian trading yesterday it was quoted at 3.1340 against the dollar.
The prospects for Malaysia remain bullish as the reforms increase the hedging demand for ringgit among exporters and set a positive tone for further financial reform. Further to this, the reforms may actually encourage healthy speculation on the currency and may increase non-resident demand for the ringgit.
Not everyone is that optimistic, however. According to a report issued by Citi, “in practice, much of Malaysia's exports originate from foreign multinational corporations that may continue to prefer settling in foreign currencies”. Therefore, the bank views the recent ringgit rally as a "knee-jerk reaction" to the reforms rather than the beginning of something great.
“The extent of follow-through remains unclear at this stage,” added Citi.
That said, this is a significant step for the Razak government, which has been working to fully liberalise the domestic markets since taking power in April 2009.
“The main motivation behind these reforms is that they will facilitate trade between China and Malaysia,” said Mirza Baig, market strategist at Deutsche Bank.
Already China has been promoting the use of the ringgit as an offshore trade settlement currency. And on the same day as Malaysia announced the liberalisation of its foreign exchange markets, China’s foreign exchange regulator announced that it will start setting a reference rate for renminbi-ringgit trades and interbank trading.
“Having this kind of a set-up where you can trade ringgit offshore will eventually enable a lot of offshore trade between China and Malaysia to be settled without the intermediary role of the dollar,” added Baig.
Prior to the changes last week, most trades in goods and services had the ringgit quoted against the US dollar. Despite the changes, the dollar-ringgit trade is expected to continue as it has in the past, since non-China trade partners may not have the incentive to settle in ringgit and will opt for the dollar instead.
Taking this into account, Deutsche Bank was of the view that the current reforms will lead the way for the creation of an offshore deliverable market for dollar-ringgit further down the track.
“The pool of ringgit funds in the external accounts will essentially define the size of such a market,” commented Baig.
As yet Bank Negara hasn’t indicated a timeline for further reforms. But given the momentum behind the liberalisation and with no sign that Malaysia's growth is slowing, such speculation continues to play in Malaysia's favour as it attempts to become a more attractive destination for foreign direct investment.
