Mahathir's Surprise Return Set to Test Ringgit Traders' Resolve

(Bloomberg) -- The surprise comeback of Mahathir Mohamad, Malaysia’s former prime minister 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 per dollar, although the size of its decline will depend on the level of clarity about the new government’s policies, according to Bank of Singapore. ING Groep NV cut its year-end forecast to 4.05 from 3.84 after the vote, citing lingering political uncertainty.

Mahathir's Surprise Return Set to Test Ringgit Traders' Resolve

“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 the key policy differences.”

Mahathir's Surprise Return Set to Test Ringgit Traders' Resolve

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 Thursday imply the currency will be 3 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 abolishing the consumption tax and reintroducing fuel subsidies. Most investors had expected Prime Minister Najib Razak would retain power, ensuring a continuation of policies that had propelled growth to the fastest in three years.

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 April 6 that he’s willing to implement a peg on the ringgit to ward off “currency manipulators”.

In remarks to reporters after his inauguration late Thursday, Mahathir said that his government will focus on addressing concerns over the economy, with state finances and economic management as priorities, and that there should be no cause to devalue the ringgit.

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.

“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.

“We think the Malaysian ringgit is still undervalued from a real-effective-exchange-rate and nominal-effective-exchange-rate perspective,” Sue Trinh, head of Asia foreign-exchange strategy at Royal Bank of Canada in Hong Kong, wrote in a research note. “The ringgit has scope to outperform the region once the dust has settled with steady domestic growth path amid lower inflation.”

The currency is likely to end the year at 3.93 per dollar, she said.

©2018 Bloomberg L.P.