Policy makers in Indonesia and Malaysia have been so successful in quashing currency volatility that this is breeding a new danger: complacency.
Traders are being deprived of the experience to cope when fluctuations inevitably return, according to PT Bank OCBC NISP in Jakarta. At the same time, companies may cut back on hedging, exposing themselves to potential losses, says PT Sinarmas Sekuritas.
Three-month historical volatility for Indonesia’s rupiah has slumped for four straight quarters, falling to a four-year low of 2.53 percent in May from as high as 16 percent in 2013. Ringgit volatility has shrunk by two thirds this year to 2.95 percent. The two currencies were previously the most volatile in Asia — now they are the least after China’s yuan.
“The problem with stability is that it generates instability because you become complacent,” said Michael Every, head of financial markets research at Rabobank Group in Hong Kong. “You think things will always be the same and you don’t bother hedging and looking at risks at how things could change. You build the entire house on the beach and then the tide comes in and it gets swept away.”
The central banks of Indonesia and Malaysia both took steps last year to limit currency swings after volatility surged following the election victory of U.S. President Donald Trump. Bank Indonesia said it stepped in to stabilize the rupiah on Nov. 11 and traders have reported officials have been in the market regularly since then.
Bank Negara Malaysia cracked down on speculators around the same time as the ringgit slumped toward the weakest since the 1998 Asian financial crisis. Policy makers enforced pre-existing curbs on trading in offshore non-deliverable forwards, which some investors said made it more difficult to hedge currency exposure.
Malaysia’s central bank has continued its clampdown, saying last week offshore ringgit derivatives traded on the exchanges of neighboring Singapore contravened its laws. At the same time, it has tried to address investor concerns by allowing funds to fully hedge their currency exposure.
The ringgit has stayed between 4.25 and 4.30 per dollar since the end of May, compared with 3.85 to 4.49 last year. The rupiah traded in a range of just 1.3 percent in the second quarter, versus a quarterly average of almost 9 percent since 1991.
One outcome of these measures is to weaken the trading community, says Johannes Husin, managing director for treasury at OCBC NISP in Jakarta.
“It’s in the best interests of the economy to have deeper currency and interest-rate markets with sizable liquidity to execute, in order to support our aspirations for growth in the Indonesian economy,” he said. “It’s important for all Indonesian market stakeholders to stay alert and agile, in skill and in talent development, to cope with continuous changes in the global financial markets.”
Companies are also at risk from low volatility as they will be tempted to save costs by forgoing currency hedging, says Jeffrosenberg Tan, head of strategy at Sinarmas Sekuritas in Jakarta.
“Looking at the stability of the currency, I’m sure they will have less hedging,” he said. “Right now the global liquidity is still abundant and there are lot of funds flowing into emerging-market bonds. As long as that continues it’s fine, but in one or two years from now, if they have to pay the debt at a higher USD rate, they will have a problem.”
Indonesian companies excluding banks and insurance companies, have $40 billion of outstanding dollar-denominated bonds, according to data compiled by Bloomberg.
Not everyone is being turned off by the dwindling volatility. The new-found stability is boosting the appeal of carry trades, which involve borrowing in lower-yielding currencies and investing in higher-yielding ones.
“Declining foreign-exchange volatility for the rupiah and the ringgit increases the attractiveness of carry from a foreign investors’ perspective,” said Divya Devesh, Asia foreign-exchange strategist at Standard Chartered Plc in Singapore. “Valuations are very attractive for the ringgit, while high volatility-adjusted carry should keep the rupiah supported.”
The rupiah’s stability and rising demand for emerging-market assets lured $8.3 billion of inflows into Indonesia’s bonds in the first seven months of the year. That’s the most for a comparable period since Bloomberg started compiling the data in 2010. Foreign holdings of Malaysia’s bonds have climbed from a two-year low in March.
The lack of volatility still reduces the appeal of the two markets, according to Samsara Wang, an emerging-market strategist at Credit Agricole CIB in Hong Kong.
“Given the rupiah is expected to be rangebound this year, not much value can be dug from it,” she said. “There isn’t much profit that can be earned in the short term as the levels are trapped in a tight range. The thin profit will be consumed by the bid-ask spread anyway.”