The Yuan & The Ringgit, Missing Cousins

Before the weekend, the ringgit was at 3.25 to the USD, this morning it went to 3.19. The Chinese renminbi has been effectively pegged to the U.S. dollar since late 2008, as one of the supportive policies put in place during the global recession. This peg, and the fact that it impeded other countries adjustments, has contributed to international pressure, especially from the U.S., to allow more flexibility of the exchange rate as Chinese exports rebounded.

Ahead of the G-20 meeting, on June 19, 2010, the People's Bank of China announced the intention to move towards a more flexible exchange rate regime by allowing the currency to move within a band against a basket of currencies of its major trading partners. The statement, coming less than a week before G-20 leaders meet in Toronto on June 26-27, represents a departure from a two-year period during which the RMB was effectively pegged to the dollar.

An increase in inflationary pressures and stronger export growth led market actors to expect some appreciation against the USD by mid 2010. However, the RMB's significant rise against the EUR, and thus on a trade weighted basis, could deter significant appreciation against the USD and should the EUR fall further against the USD, so too might the RMB.

Despite market expectations of a major move, any shift might be modest. Standard Chartered's Stephen Green said in the FT: "The danger is that on Monday morning everyone gets very excited and then end up being disappointed with what happens. There is very little appetite for appreciation, so in the short-term the central bank is likely to be very conservative."

The initial response to the statement has been positive, with the U.S. and European leaders lauding the decision. Dominique Strauss-Kahn, Managing Director of the IMF suggested that the move was in line with the "G-20 Mutual Assessment Process, to be presented in Toronto..., and will help increase Chinese household income and provide the incentives necessary to reorient investment toward industries that serve the Chinese consumer." The move also suggests that the G-20 will be more focused on the development in the eurozone.

Morgan Stanley's Qing Wang argues that an exit of renminbi from the US$ peg will come most likely in the Summer of 2010 (early Q3) involving a one-off revaluation of 2-3%, followed by gradual appreciation for a total strengthening of 4-5% in 2010. China is likely to exit the peg given its role in reducing imported inflation, because a free and open trade system is in China's interest, helps rebalance the domestic economy towards the non-tradable sector, and to move to a more flexible exchange rate needed for independent monetary policy. A move in July gives the U.S. administration the ability to claim successful diplomacy and Chinese to show their global responsibility before the November G20 meeting.

On April 8, 2010, the People's Bank of China sold RMB15 billion in three-year sterilization bills, the first batch since June 2008. The three-year bills are considered a more aggressive tool for managing liquidity, and may signal that the central bank is preparing to sterilize "hot money" inflows betting on RMB appreciation.

Greater CNY flexibility may lead to some initial nominal appreciation against G3. Other Asian currencies – especially those that are regarded as proxies for Chinese growth and commodity demand (AUD) - or non-FX assets in China (e.g., Shanghai A-share Index) may end up attracting greater inflows and seeing a bigger price action.

The expectation that a stronger CNY will support China’s demand for imports (including from the rest of Asia) can be beneficial for Malaysian Ringgit, Korean Won and Taiwan Dollar. Central banks across Asia may also feel a bit less pressure to stem FX appreciation in order to maintain competitiveness. The entire playbook would favour going long on the following currencies for the rest of 2010: long CNY, KRW, MYR and INR. Short the EUR and JPY. That being the case, the natural long will see a boost in financial assets in those respective countries.

Ringgit Riding On Yuan's Coattails

To those who pooh-pooh ringgit unofficial ties with the Chinese yuan, the last two weeks have showed that they were dead wrong. Palm oil futures have risen by about 23 percent over the past six months to yesterday as drier-than-usual weather in Malaysia, the second-largest producer after Indonesia, curbed yields. The U.S. dollar got smashed down against the South Korean won, Indonesian rupiah and Taiwan dollar, not to mention the yuan and the ringgit. The Malaysian ringgit, considered a good proxy for the yuan, has risen 4 percent against the dollar in the past two weeks. The Indian rupee has gained 3 percent.



A firmer ringgit yields more benefits to Malaysia than the things we lose out on competitiveness.

The ringgit strengthened 1.8 percent this week to 3.1900 per dollar in Kuala Lumpur, according to data compiled by Bloomberg. It reached 3.1860 yesterday, the strongest level since May 2008. India’s rupee climbed 1.4 percent to 44.2938 and South Korea’s won appreciated 0.7 percent to 1,118.15.

Equity funds focused on developing economies attracted $3.27 billion in the week to April 7, taking net inflows for the year to $10.8 billion, according to Cambridge, Massachusetts- based research firm EPFR Global, which tracks funds with $13 trillion of assets globally. The Asia Dollar index, which monitors the performance of the region’s 10-most active currencies, climbed 0.6 percent this week.

April 7 (Bloomberg) -- China is considering allowing the yuan to trade against the Russian ruble, South Korean won and Malaysian ringgit to promote its use in cross-border trade, an official at the China Foreign Exchange Trade System said.

The People's Bank of China is investigating the possibility of offering new currency pairs, said an official at the Shanghai-based interbank exchange, a subsidiary of the central bank. He asked not to be identified as authorities have yet to make a final decision. Traders now can buy or sell the yuan against the dollar, the euro, the yen, the Hong Kong dollar and the British pound.

China is seeking greater use of its currency to reduce reliance on the U.S. dollar after Premier Wen Jiabao said last month he is “worried” about holdings of assets denominated in the greenback. From July, the government started allowing companies in Shanghai and four cities in the southern province of Guangdong to use yuan in cross-border trade with Hong Kong, Macau and members of the Association of Southeast Asian Nations.

President Barack Obama will keep pressing China to end the yuan’s 21-month-old peg to the dollar and may bring up the topic when he meets Chinese President Hu Jintao next week, spokesman Robert Gibbs said yesterday. Executives at Chinese banks have backed a stronger currency to allow it to play an increased role in global trade and spur growth in financial markets.

China’s currency has been held at around 6.83 to the dollar since July 2008, after appreciating 21 percent in the previous three years. Twelve-month non-deliverable forwards traded at 6.6355 per dollar, reflecting bets the currency will climb 2.9 percent from the spot rate of 6.8254 in the coming year.

U.S. Treasury Secretary Tim Geithner last weekend announced the postponement of the April 15 deadline for an annual foreign-exchange policy review, which may have resulted in China being labeled a currency manipulator. He said meetings over the next three months will be “critical” to bringing policy changes that lead to a more balanced global economy.

“They’re becoming more open to the world, and with that, you’re going to see the currency take on a broader role internationally,” Geithner said in an interview with Bloomberg Television to be aired today. “That’s a healthy, necessary adjustment.”

Expectations that China’s currency will appreciate drove yuan trade settlements to 7 billion yuan ($1 billion) in the first two months of this year, almost twice the 3.6 billion yuan in the second half of 2009, Zhang Yanling, vice chairman of Beijing-based Bank of China Ltd., the nation’s biggest foreign- currency lender, said in a March 19 interview.

“If the yuan is expected to be a strong currency, neighboring countries will prefer to hold the yuan instead of the dollar,” she said.

Since December 2008, China has set up 650 billion yuan worth of swap agreements with Indonesia, Malaysia, South Korea, Hong Kong, Belarus and Argentina, broadening access to the yuan. The central bank has also proposed expanding the use of International Monetary Fund depository receipts in reserves instead of dollars.

“They’re trying to encourage yuan trade settlement, so it would make sense to commit to more trading pairs,” said China chief economist at Royal Bank of Scotland Group Plc. “It would be a natural part of the growing convertibility of the yuan and a step towards widening the use of the yuan. Convertibility of the yuan is a long-term change, but China is taking all the right steps.”

China’s dollar purchases to maintain the currency link have driven currency reserves to $2.4 trillion. Chinese investors held $889 billion of Treasuries in January, the biggest overseas holdings of such debt.

Dejavu 1993, Capital Inflow, Asian Currencies Uptrend

It looks increasingly likely that we have seen the start of an inflow of capital into Asia. The weakening USD will help prop up US shares, but may see more international investors migrating excess funds into Asia to obtain a better return over the next 6 months. This looked much like the 1993 bull run in Asia. No, before you get ahead of my views, this is not going to be the repeat of the extended 1993-1996 bull run. The last 2 months have seen what we shall refer to as the US$ carry trade - borrowing in USD to invest elsewhere in anticipation of a weaker USD down the road. This is a replication of the yen carry trade which fueled much of the liquidity sloshing around all markets in 2007.

An example is the recent upgrade by Macquarie on Malaysian markets, mainly in anticipation of a higher ringgit value over the next 24 months. They forecast the RM/US$ will hit 3.20 (+6%) by end 2010 and 3.00 (+14%) by end 2011. Gawd, I hope they are right as I can travel overseas with a fatter wallet then. In fact Macquarie said that currencies usually overshoot, so we could easily hit 20%. The two key cross-rates to watch are RM/US$ and RM/Rmb:
- Immediate 10% upside suggested by RM/Rmb cross-rate: Macquarie believe over the next two quarters, the ringgit will appreciate to its previous fixed level against the Rmb.
- Additional 5–10% upside suggested by RM/US$ cross-rate by end 2010: They expect the renminbi and Asian currencies to resume its upward appreciation against the US$ in late 2010.

Taking this tack, importers will gain the most, eg Astro and auto companies, who import from Europe and the US. Thats the view of Macquarie, my view is that auto, auto parts and protected industries should be largely ignored over the next few years. Exporters such as plantations would suffer from an effective price cut. Companies with a high proportion of offshore earnings such as Parkson (> 90% of EBITDA), MISC (> 90%), YTL Power (75%), and KNM (60%) would have lower translated earnings.

Back to the foreign capital inflow - YTD net foreign portfolio investment in equities as of November 4, 2009: Best-performers: South Korea: US$21.18 billion, India: US$14.21 billion, Taiwan: 10.87 billion; Others: Thailand: US$1.51 billion, Indonesia: US$0.77 billion, the Philippines: US$0.40 billion, Pakistan: US$0.19 billion, Vietnam: US$0.01 billion, Japan: -US$17.12 billion. Can't seem to get the Malaysian figure but it should be negative judging from the previous posting on net foreign investors holdings of Malaysian stocks. All major Asian currencies are an appreciation path thanks to improving export performance and liquidity condition. Unlike 1997-98 crisis, Asia has enough reserves to defend its currencies and dollar liquidity has improved considerably when compared to Fall 2008, although it remains tight in some countries.

Notable economist Joseph Stiglitz said, "The inflows of easy money" is posing a risk of asset bubble in Asia as "such funds are usually not long-term investments and won't be a foundation for robust growth for Asia." Yes, we are seeing these short term funds finding Asia as a nice playground, but unlike the 93-96 rally, these funds will not be here very long, so we need to watch the US$ carry trade when they start unwinding in a big way. Presently, the outlook for most Asian currencies are still good for the next 6 months, and as Macquarie pointed out, the ringgit is a great selling point, so we are "safe" for the time being.


p/s photo: Han Ga In

On Bank Negara, PPP & The Ringgit

hishamh said...

A couple of problems here. Purchasing Power Parity (PPP) is no more than an academic curiosity these days, for the simple reason that it doesn't remotely describe currency movements even between advanced economies, much less for emerging markets. So there is no firm foundation for using it as a basis for evaluating currency misalignments.

It therefore follows that analysing currency policy based on PPP values is also a red herring.

In fact, based on current theories, it's possible to argue that the causality runs the other way from your analysis - an export-oriented strategy results in low relative incomes and a depressed exchange rate, rather than a weak currency being used to support export competitiveness. Which means that the MYR exchange rate is in fact market-determined, and there is no deliberate central bank policy to weaken the currency.

3:14 PM

hisham,

You make a few good points... herein lies the 64,000 dollar question... is Bank Negara deliberately suppressing the ringgit?

Considering that the ringgit is tightly controlled, and is not totally freely exchangeable overseas, BN exerts a lot of control over the ringgit. What I mean is that no hedge fund or trade would seriously dare to bet against BN's persuasions, they would rather bet alongside with BN's persuasions. When the currency is "limited" in its free trade and its circulation, that is tantamount to controlling the currency - not that that is a bad thing. For a small open economy like ours, we cannot seriously have a totally free floating currency, how do you think our exporters and services sector going to adjust if in January the ringgit is 3.6 to the USD and in May its 4.1 but by October its 3.1.

I am more concerned in the usage of the ringgit to shape the industries we have over the longer term. Yes, short term, fighting inflation is priority number one followed by maintaining a sustainable economy. But just look at where the ringgit has been over the past 20 years. I remember it was 2.7. What that tells me is that we are deliberately attracting FDI via such a mechanism.

The ringgit should be managed, but manged to appreciate so that we can flush out those industries that should not be here. We need to move up the value curve. Ifwe have an internal target of 3.2 average for 2010, 3.0 average by 2011 and 2.8 average by 2012, believe you me, we will see some industries being taken out naturally or indrectly. The kind of FDI we attract will be different for sure. We have the resources, don't short change ourselves, don't keep adding low cost foreign workers, it makes the substantial bottom rung of the industries stay manual and low value add.Yes, its easier said than done as industries will be displaced, jobs will be lost... in other words this is exactly the structural unemployment that we need to go through. Its tough, business wise and politically, but being in positions of leadership, we must make tough decisions or else we will lock ourselves into the same sandstorm. It is very sad to see the same sunset industries still operating in Malaysia 5 or 10 years from now.

... Oh, you want to do large scale manual soldering... go to Malaysia, there got plenty of cheap labour... Even if we keep bringing these labour intensive FDI, the best jobs that Malaysians can hope for is factory manager of a labour intensive factory looking after foreign workers. Get the ringgit to where our resources should be, and not cater and pander to the lowest common denominator.


p/s photo: Miwa Cocoa

Outlook For Ringgit For The Rest Of 2009

• Malaysia Ringgit (MYR) has appreciated 6% after hitting a low in early March taking the ytd losses to 1% as of May-end 2009
• March 3, 2009: MYR fell to the lowest level (3.725-3.735/USD) in 3 years due to weakening exports and foreign investment
• February 2009: To promote bilateral trade and investment for economic development, Malaysia's central bank and Chinese central bank established RMB40billion currency swap arrangement for 3 years
  
  Risks for ringgit in 2009:
• External balances: electronic and commodity exports are contracting at a sharp pace and the trend is likely to continue through 2010 with a sluggish recovery in 2010. Presently greater contraction in imports relative to exports is sustaining the trade and current account surpluses and forex reserves
• Easing capital flows: keeping interest rate on hold in April and May 2009 has helped reverse some of the past capital outflows. Rising bond issues at higher yields and sharia bond issues are a plus. But ratings downgrade due to increasing fiscal deficit can weigh on debt inflows. Impact on lower corporate earnings ad revival of risk aversion can weigh on stock market. A recession in 2009 and rising bond issues in U.S. (safer-haven) can be a negative. FDI is expected to fall over 50% y/y in 2009 due to decline in export manufacturing related capex
  
• Central Bank policy: In 2008, central bank was intervening in the FX market selling USD reserves to contain currency depreciation but in 2009 the central bank has been defending the exchange rate to support exports especially as reserves have also been declining. foreign exchange reserve stood at US$88bn as on 15 May, 2009 which is sufficient to finance 8.3 months and 3.8 times the short-term debt. Large forex reserves and external surpluses are a plus to deal with export contraction and any revival of capital outflows. Trend in USD and SGD will also be improtant determinants of movement in ringgit
  
• Since the central bank decided to keep key rate at 2%, USD/MYR is expected to be higher by the end of Q2 2009. But USD/MYR will be lower in H2 2009 as the economic situation is improving. But further stabilization in domestic and global economy is still necessary to guide USD/MYR around 3.45 by the end of 2009
• MYR continues to track the SGD and is expected to weaken against USD in mid-2009 due to anticipated resurgence in USD strength
  
• Declining forex reserves and depreciating SGD would put further pressure on ringgit
  
• Confidence of ringgit would be dampened due to increasing deficit on overall balance of payments, declining exports, outflow foreign capital, and expectation of further rate cut by central bank
• In 2009, ringgit would be weak against USD as the process of de-leveraging by international investors will continue to boost demand for USD
  

p/s photos: Hanako Takigawa