Mahathir's surprise return to test ringgit traders' resolve

Newly-elected Malaysian Prime Minister and opposition candidate Mahathir Mohamad speaks during a press conference in Kuala Lumpur on May 10, 2018. (AFP/Roslan Rahman)

The surprise comeback of Malaysian leader Tun Dr Mahathir Mohamad, who once imposed capital controls, is likely to halt a rally in Asia’s best-performing currency amid concerns pro-growth reforms will give way to populist campaign promises.

The ringgit may initially slide to the psychological level of 4 to the US dollar, although the size of its decline will depend on the level of clarity about the new policies, according to Bank of Singapore. ING Groep NV cut its year-end forecast to 4.05 from 3.84 after the vote, citing political uncertainty.

“The first significant resistance is at four,” said Sim Moh Siong, a currency strategist at Bank of Singapore. “We’ll need to see how smooth the power transition is given that this result is historic in nature. Following the transition, we also need to see how the government reconciles key policy differences.”

The ringgit closed at 3.9497 on Tuesday after dropping to an almost four-month low of 3.9507 earlier that day. Trading in one-month non-deliverable forwards on Friday imply the currency will be 1.5 percent weaker when onshore markets reopen on Monday. It is still Asia’s best performer over the past year, rising 10 percent.

The currency’s immediate future looks bleak due to concern the new government will roll back recent financial reforms, namely replacing the consumption tax with a sales levy and reintroducing fuel subsidies. Most investors had expected former prime minister, Najib Razak would retain power, ensuring a continuation of policies that had propelled growth to the fastest in three years.

Mahathir sought to reassure investors Thursday as he pledged to focus on growing the economy and lead a business-friendly administration.

“Our concern over the economy is the main thing,” Mahathir told reporters after he was sworn in as prime minister. “We would like to tell business people to push up the value of the stock market. And on currency, there is no cause to devalue the ringgit. We should ensure this.”

Currency peg

Mahathir is known for his criticism of foreign exchange traders and his imposition of capital controls during the Asian financial crisis. In late 1998, he introduced a currency peg after the ringgit plummeted and reserves dwindled. In a sign he remains wary of financial markets, he said in an interview with Bloomberg on 6 April that he’s willing to implement a peg on the ringgit to ward off “currency manipulators”.

While investors, including those at Fidelity International, don’t expect the return of his past policies, there are concerns that implementation of the campaign pledges would widen the nation’s budget deficit, which has been brought down gradually to 3 percent of GDP. Moody’s Investors Service said Thursday that those promises, if carried through without adjustments, would be credit negative for the nation’s bonds.

“A scenario where the fiscal deficit significantly widens would represent a major headwind for the MYR and government bonds” given where the current account is at, Morgan Stanley analysts Jesper Rooth and Chun Him Cheung wrote in a report.

Crowded positions

The uncertainty may lead some funds to trim holdings given that positioning in both, the currency and the debt have become “relatively crowded,” they wrote.

“An initial negative market reaction to the surprising election results seems probable,” Prakash Sakpal, an Asian economist at ING in Singapore, wrote in a research note. Lingering political and economic risks “…will weigh on investor confidence and performance of local markets, especially the ringgit for some time, probably through the end of this year.”

Technical analysis suggests the ringgit is likely to extend recent declines until it reaches initial support at 4.01, the 23.6 percent Fibonacci retracement of its advance from January 2017 to April 2018. Beyond that, the currency is also likely to be supported between 4.0155 and 4.0278, the lows set on Jan. 3, 4 and 10.

Not everyone is negative.

“Back in the day, Mahathir was a pragmatic person and is less likely to completely close the economy,” Bryan Collins, head of Asian fixed income at Fidelity International, said in a statement Thursday.

“Inflation dynamics in the near term support lower rates for longer, so we would look into buying back our short local rates positions. The ringgit is more volatile to these uncertainties, but a lot of speculative positioning has eroded away." - Bloomberg