When Malaysia forced foreign investors in its markets not to dabble in offshore derivatives in its currency last year, its target was speculative pressure on the ringgit, but it appears to have shot itself in the foot. The ringgit was the weakest currency in emerging Asia last year after China's yuan, prompting Malaysia's central bank to get a written commitment from foreign banks to stop trading ringgit non-deliverable forwards (NDFs), offshore contracts they use to hedge their exposure to the currency.
The upshot has been a flood of money leaving Malaysian bonds as foreigners, who own $47 billion of them, were unable to hedge their risks in onshore markets because of a lack of liquidity. "It's a market that's kind of been destroyed," said Gene Frieda, the London-based global strategist at bond giant fund Pimco, who blamed the inability to hedge for making it difficult to make significant bond trades.
Although Frieda said the currency now looked cheap compared with regional peers, he couldn't see it rallying under the circumstances.
"We don't find the bond market particularly interesting at these levels," he said.
Analysts at Nomura say November-to-January capital outflows from Malaysia hit a record for a three-month period, when 27.9 billion ringgit ($6.3 bln) of foreign cash upped and left. Foreign holding of government bonds fell to 46 percent of the total outstanding value, from 51.6 percent in October.
The Southeast Asian nation's $97.7 billion of currency reserves are looking vulnerable after having fallen by $3 billion in three months, and the ringgit has fallen 5.7 percent since the end of October.
DRYING UP
The central bank, Bank Negara Malaysia (BNM), insists that the NDF market is volatile, opaque and subject to abuse, and it told Reuters it was committed to its policy.
"BNM will continue to enforce the policy of non-facilitation of NDF trading rules on the onshore banks to protect consumers' interests," it said.
It also insisted that the onshore markets were deep and broad enough to facilitate hedging, with spot and forward trade volumes worth more than $152.4 billion over January and until February 22, of which non-residents accounted for 42.5 percent.
But foreign investors say that while the BNM has succeeded in drying up the NDF offshore market, there just aren't enough onshore sources of dollars to take the other side of their trade.
"The NDF market is now extremely illiquid," said Prashant Singh, lead portfolio manager with Neuberger Berman in Singapore.
"The onshore market is also illiquid, and there is no natural seller of dollars other than BNM themselves for now."