This article first appeared in The Edge Malaysia Weekly on July 17, 2023 - July 23, 2023

A confluence of events in the country’s financial system over the past few weeks has intrigued market watchers. In the two weeks leading up to Bank Negara Malaysia’s monetary policy meeting on July 6, the Kuala Lumpur Interbank Offer Rate (Klibor) started ticking higher, especially for the one- and three-month tenures.

This was because the central bank has been mopping up liquidity in the interbank money market by issuing larger-than-usual short-term bills, which caught many players by surprise.

“Everyone — the principal dealers — was caught by surprised; nobody was prepared for the amount and bid up to 3.2% for the bills. In market lingo, they tendered for very high yield thinking it wouldn’t be accepted. Bank Negara accepted up to 3.2%. Those who didn’t want the bills had to accept, had to borrow from the interbank market,” says a Treasury officer at a local bank.

Principal dealers, comprising licensed banks operating in Malaysia, are obligated to bid for all government and Bank Negara paper in the primary market and provide two-way price quotations for benchmark securities under all market conditions to ensure liquidity in the secondary market.

Bank Negara has also lowered allocation rates in reverse repurchase agreement (reverse repo) auctions in the past two weeks.

“By reducing reverse repo, the central bank effectively reduces the liquidity available in the banking system, which can help manage excess funds and control inflationary pressures,” says a fixed-income trader.

She believes Bank Negara is taking a two-pronged approach to drain short-term liquidity via a larger issuance of Bank Negara Interbank Bills (BNIB) and reverse repo to ensure that the man on the street would not be affected by further interest rate hikes while ensuring economic growth remains intact.

Analysts at Maybank Research call this quasi-tightening, as opposed to tightening directly via a higher overnight policy rate (OPR), which was kept unchanged at 3% on July 6.

“An unusually large RM5 billion BNIB tranche was issued on June 23 and, since then, issuances have totalled over RM20 billion compared to infrequent issuance averaging less than RM1 billion per week previously,” according to a July 7 report by Maybank Research’s Winson Phoon and Se Tho Mun Yi.

“The allocation ratio of Bank Negara reverse repos dropped to 63% on average in the past two weeks from close to 100% prior to this. We think this represents a quasi-tightening,” they say, adding that the central bank’s intention is unclear. (See “Central bank explains its liquidity operations” for answers to The Edge on its recent move.)

Nevertheless, they note that the action affects corporate funding “as opposed to an OPR hike, which would have broader implications”.

By tightening liquidity in the interbank money market and pushing Klibor rates higher for the shorter-term paper, the central bank is making it more expensive for corporates to borrow. Some say this will limit “capital flight” as the interest differential between the ringgit and other currencies such as the greenback narrows.

“Raising the OPR may be unpopular with retail loans based on the BLR (base lending rate), which is based on the OPR. By leaving the OPR unchanged, the retail borrowers won’t be affected. But when corporates borrow, the reference is the Klibor; so, their cost of funds will go up,” says another money market specialist, adding that this will indirectly support the ringgit.

Asked whether the move could help shore up the ringgit, which had shown strength last Thursday, another fixed-income trader says it is possible but it is not the main factor.

“When the Klibor rate increases, generally, it will increase the bond yield and narrow the interest rate differentials. However, it’s important to consider the broader economic and other reasons behind these increases,” the trader says.

Maybank Group’s regional head of FX Research and strategy Saktiandi Supaat says tightening of liquidity in the banking system has an impact on strengthening the ringgit.

“The tightening in banks’ liquidity can in part enhance the ringgit strength via issuance of Bank Negara bills or papers as part of money market operations, as it reduces ringgit supply,” he tells The Edge.  

The ringgit hit a low of 4.6783 against the US dollar on June 23, on the back of an aggressive rate hike campaign by the US Federal Reserve since March 2022 to tackle inflation, raising rates to between 5% and 5.25% from close to zero.

Scepticism abounds, however, on the effectiveness of “quasi-tightening”.

“It depends on how much Klibor goes up, and this will affect sentiment for the corporates. The central bank has to balance this carefully,” says the money market specialist.

An economist says: “This is interbank liquidity, so the money stays within the domestic system. I doubt it would have much impact. Even if it could, it’s not a large amount.”

Central banks manage the liquidity in the interbank money market on a daily basis to ensure the stability of the financial system. They have three ways to manage liquidity or money supply: (i) by using the interest rates; (ii) through banks’ reserve requirements; and (iii) through the money market — by conducting quantitative easing or tightening.

A senior banker sees Bank Negara’s move as simply soaking up excess liquidity in the market in a bid to curb inflation, using one of the tools all central banks have at their disposal. “They do it from time to time,” he explains.

A former banker says: “It tells me that Bank Negara will rely more on open-market operations, as it believes the OPR is closer to optimal level. The CPI (Consumer Price Index) is now 2.8%; at 3%, the OPR is offering a positive real interest rate. This tells me the OPR is closer to optimal. Conversely the Fed is close to its optimal rate as the federal funds rate is 5.25% and the CPI there is [close to] 5%.”

In the US, inflation cooled to 3% in June, slowing from 4% in May and below market expectations of 3.1%. It was also the slowest rate of inflation since March 2021.

Malaysia’s latest inflation reading in May eased to 2.8% from 3.3% in April. Bank Negara’s Monetary Policy Committee statement also struck a more moderate tone on inflation compared with the previous statement, saying “both headline and core inflation are projected to trend lower, broadly within expectations”.

Meanwhile, a former chief investment officer says Bank Negara’s move may be intended to ensure that deposit and lending rates are in sync.

“The financial institutions now are also very aggressive to increase their deposit rates. Some banks are offering higher than 4% returns for fixed deposits. As such, Bank Negara is looking for ways to raise the lending rates to minimise credit risk,” he says.

The Treasury officer disagrees with the stealthy rate hike narrative. “The fact is Bank Negara is managing liquidity in the banking system. What the central bank did was smoothen the amount of liquidity across the curve,” he says. “There’s no need to read into whether it’s a stealthy rate hike. If the central bank is doing a stealthy rate hike, it’s creating an imbalance between policy and action. If it’s to support the ringgit, do a proper market measure. Otherwise, it confuses whole market, doing something from a position of weakness.”

The move coincides with a rare statement by the Financial Market Committee on June 27 on the ringgit foreign exchange market, noting that “the extent of the recent depreciation of the ringgit is not reflective of Malaysia’s economic fundamentals”.

The committee, comprising representatives from Bank Negara, financial institutions, corporations and financial service providers, also encouraged exporters to take advantage of the attractive level of exchange rate in managing their foreign currency balances and foreign exchange (forex) risks. Key in its messaging is Bank Negara’s mandate to intervene in the forex market to stem currency movements that are deemed excessive.

Meanwhile, Bank Negara’s foreign currency reserves as at June 30, 2023, fell below US$100 billion (RM458.9 billion) for the first time since November 2022, reflecting its intervention in the forex market and loss from the quarterly forex revaluation, owing to a 0.4% rise in the US dollar index, says Kenanga Research. The reserves dropped by US$1.1 billion, or 1.1% month on month, to US$99.2 billion.

It is worth noting that July 1 also marked the start of Datuk Shaik Abdul Rasheed Abdul Ghaffour’s term as Bank Negara governor for a five-year term until June 30, 2028, leading some to ask whether the aggressive move to drain liquidity in the interbank market may simply be “a new way” for the central bank to manage liquidity. 

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's App Store and Android's Google Play.