THE unprecedented move by Bank Negara last Friday to restrict the activities of local banks entering into transactions tied to the US dollar-ringgit exchange rate is a bold one.
The over-riding objective of the central bank is an attempt to reduce the influence of the offshore US dollar-ringgit movements on the onshore exchange rate between the two currencies.
Since mid-2013, the offshore rates, also known as the ringgit non-deliverable forward (NDF) market rates, tend to overshoot the onshore rates.
Local financial institutions were told last Friday not to enter into any US dollar-ringgit transactions tied to derivatives or spot trades with banks based outside Malaysia.
The move was to prevent any party from taking a speculative position arising from the huge difference in the spread between offshore and onshore US dollar-ringgit exchange rates.
The central bank had again warned financial institutions yesterday not to enter into any foreign exchange transactions that could be related to offshore ringgit NDF market activities.
Towards this end, the central bank intervening by scrutinising certain US dollar-ringgit transactions between local and offshore banks can be expected.
Whether this would reduce the US dollar-ringgit spread between the onshore and offshore market is something that would be closely-watched.
The offshore market is settled in US dollars and dominated by large funds taking a position based on what they perceive as the future movement of the ringgit.
Some corporations use it for hedging purposes but there are some speculative trades that take place in the offshore market.
Since September 1998, the ringgit has not traded at the international market.
The ringgit is not alone like many other currencies including the yuan.
Being de-internationalised means it is not officially available in the international market.
Like the ringgit, even the yuan comes under pressure in the offshore market.
Generally for currencies that are de-internationalised, foreign investors can buy or sell them if they have undertaken transactions for trade or long-term investment purposes. In a normal environment, approvals are given within days to facilitate a smooth and orderly movement of currencies.
The problem arises for large funds that move their money in and out in a short period of time. It is called hot money and it tends to cause volatility of the currency.
The equities market in Malaysia has seen an outflow of funds for more than a year.
The biggest fear now is the amount of investments held by foreigners in Malaysian government bonds.
They used to hold some 30% of government debt papers. Now it is closer to 50%.
The view is that the foreigners would tend to reduce their holdings in Malaysian bonds to move their money back to the US markets.
Until the situation in the bond market stabilises, Bank Negara probably has no choice but to keep a close tab on the operations of local financial institutions going into foreign exchange transactions with non-Malaysian based banks.
It is a tedious process and there would continue to be apprehension on the ringgit against major currencies until the foreign holdings of debt papers reduce.
Until that happens, the ringgit will continue to come under pressure.
And Bank Negara will have its hands full in trying to minimise disruptions on the supply of US dollars to local banks.