“Forwards” – Is This BNM’s Favoured Tool?

BNM has been increasingly using currency forwards to support the ringgit, easing pressure on its foreign-exchange reserves. Bank Negara Malaysia’s net forward FX position widened to negative US$27.7 billion (S$37.5 billion) in April – reflecting a record net short position in its the forward books – showing a preference for using that avenue to bolster its currency. At the same time, its foreign exchange reserves are little changed this year (2024).

The central bank has been busy propping up the ringgit in recent months after the currency tumbled to the weakest since the 1997-98 Asian Financial Crisis in February on concern over a worsening export outlook. The ringgit pared losses in March after Bank Negara appealed for state-linked firms to repatriate and convert their foreign investment income.

Source: https://en.wikipedia.org

While Bank Negara’s net forward FX position has been becoming more negative, the nation’s gross foreign reserves were US$113.6 billion at the end of May, almost unchanged from the end of 2023. The ringgit is currently trading at 4.7095 per dollar, having strengthened from a 26-year low of 4.8053 set in February. The currency has gained 0.3% in the first quarter. 

The central bank’s net short position in its forward book may make the ringgit more vulnerable to a selloff if there’s a sudden bearish shift in global sentiment. The central bank’s net foreign reserves excluding gold are estimated to be around US$67 billion, well below its short-term external debt of around US$112 billion. 

What is a currency forward?

Currency forwards are OTC contracts traded in forex markets that lock in an exchange rate for a currency pair. They are generally used for hedging, and can have customized terms, such as a particular notional amount or delivery period. Unlike listed currency futures and options contracts, currency forwards do not require up-front payments when used by large corporations and banks. Determining a currency forward rate depends on interest rate differentials for the currency pair in question.

Malaysia’s central bank isn’t alone in utilising its forward book to support its currency. The Reserve Bank of India had a net short position in forwards of US$16 billion in April as it sought to support the rupee. 

Bank Negara’s net forward FX positions at a historical low “will mean USD/MYR will remain more volatile than some of its ASEAN peers as the capacity to intervene is more limited” according to Bank of America in Singapore. However, it doesn’t mean the Malaysian ringgit is vulnerable to a currency crisis. The ringgit is not overvalued, if anything it is undervalued, and the current account is in surplus soon.

The key in all this still remains our OPR is 2.25-2.50% below the Fed Fund rate, which is not likely to be cut in the immediate future. Meanwhile, inflation is moving up with diesel subsidy reduced and RON95 facing the same prospect.

References:

Forwards become Malaysia’s favoured toll for boosting ringgit, Bloomberg, 20 June 2024

What a currency forward is, how it works, example, use in hedging, Marshall Hargrave, Investopedia, updated 24 May 2022