WHEN Bank Negara raised interest rates for the third time this year earlier this month, expectations were that the ringgit would appreciate.
That, together with the removal of China’s yen peg to the US dollar, led to suggestions that the ringgit could regain some of the buoyancy in its value against the US dollar that had seen the local currency emerge as one of the best-performing currencies this year.
There was also the school of thought that suggested those domestic interest rate hikes had created a buffer between rates in Malaysia and elsewhere that might see the local currency becoming a carry trade currency.
While the ringgit is not yet seen as a carry trade currency, its slow ascendency against the US has been seen after the third rate hike earlier this month.
After interest rates were raised by 25 basis points to 2.75% in the July 8 meeting of the Monetary Policy Committee, the ringgit saw a brief spurt against the dollar but has since see-sawed in a narrow band.
But that has changed a wee bit as the ringgit has strengthened to its highest level this year as RM3.18 to the dollar yesterday.
That pattern of trade has somewhat broken away from the initial pattern seen after the yuan ended its peg against the US dollar last month.
After a surge, the Chinese currency has traded within a narrow band of between 6.77 and 6.78 to the dollar.
Notwithstanding the slow rise towards the year high for the local currency, the interest rates hikes in recent months, which the central bank says is a move towards normalisation, has led to money entering Malaysia.
While higher domestic rates might have been the main factor, another was the fact that selected Asian currencies were the flavour of the month, given the economic malaise in Europe and the sluggishness of the US economy.
In a response from Bank Negara to StarBizWeek, the central bank says portfolio capital flows were influenced by both domestic and external factors. Domestically, the impressive 10.1% GDP growth in the first quarter of the year, talk of a stronger economy and the transformation of Malaysia into a high-income economy have whet the appetite of investors.
The central bank said in the first quarter of 2010, portfolio inflows amounted to US$3.4bil, a healthy gain from the US$1.4bil in the fourth quarter of 2009.
“Nevertheless, the pace of portfolio flows in recent months has been relatively modest, given the volatility arising from the European sovereign debt crisis and the lingering concerns over the global economic recovery,” says Bank Negara.
“Overall, the flows have been manageable and well-intermediated by the financial system.”
Bank Negara points out that because of the strength and depth of the domestic financial system, inflows are more effectively intermediated without causing undue risk to the economy.
It cites the fact that the ringgit bond market is one of the largest in this region, with a size of 94.1% of GDP.
Furthermore, the country’s Islamic bond market is also deeper than other markets, with the highest number of sukuk issuances recorded this year thus far.
“At the same time, Bank Negara has developed a robust surveillance system that enables us to monitor capital flows on a near real-time basis and Bank Negara is equipped with a wide range of monetary instruments to sterilise these inflows,” says the central bank.
“Bank Negara’s policy is solely to maintain orderly market conditions while at the same time ensure that the ringgit is not misaligned from its fundamentals so that it will not contribute to the build-up of internal and external imbalances.”
Bank Negara adds that interest rate differentials is a determinant of capital flows, but it is not the only one.
“Some of the other factors include economic growth prospects, exchange rate expectations, anticipated returns in the equity market and other investments, as well as investor sentiments,” it says.
The central bank adds that the overnight policy rate of 2.75% was broadly in line with other regional interest rates and that there are many other countries that have higher official interest rates.
The official borrowing rates of Indonesia, the Philippines, China, India and Australia are 6.5%, 4%, 5.31%, 5.5% and 4.5% respectively.
A recent report by Morgan Stanley suggests that the interest rate hike might also have been used as a tool to attract foreign capital to bolster the country’s foreign exchange reserves, which have not kept pace with the rise seen in the reserves of Malaysia’s neighbours.
Foreign exchange reserves saw a drop in the middle of last year and has basically plateaued from the last quarter of 2009.
While the hikes would lead to more capital flowing in, which is welcomed, considering the quantum of the fall, the country is comfortable with the level of reserves as data for the middle of June says it is sufficient to finance eight months of retained imports and 4.4 times the short-term external debt.
The interest rates hike, however, is seen to have an influence on the real sector as a means to cap skyrocketing property prices.
“One of the major assets facing some strong pressure has been the property market,” says RAM Holdings group chief economist Dr Yeah Kim Leng.
“We needed a tightening to prevent a further build-up in those asset prices.”
The effectiveness of a 75-basis-point rise in interest rates might not quell speculation on properties but with the household sector debt now at 76.6% of GDP, higher repayments for debt taken to buy cars, houses and for other consumption needs would bite into private consumption.
Yeah says the rate hike was a move towards a balance between consumption and savings.
The rise in household debt to GDP was partly due to the contraction of GDP of 1.7% in 2009 but authorities are confident that the financial asset side of the ledger remained sound as financial assets to debt was 2.44 times.
The ratio and growing affluence of households has allowed for increased access to financing and with gross non-performing loan ratio for household remaining low at 2.7% at the end of April 2010, over extension of debt might not be a problem just yet.
By JAGDEV SINGH SIDHU
jagdev@thestar.com.my
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