Malaysia's currency faces two key risks after beating Asia peers

[SINGAPORE] The Malaysian ringgit has defied the odds to outperform most of its Asian peers. Now investors will be watching to see if it survives the trials of September.

A three-month rally in the currency could come to a halt when FTSE Russell announces a decision on whether it'll retain ringgit bonds in its World Government Bond Index. A lesser risk is also brewing in the form of an expected rate cut from Bank Negara Malaysia.

The ringgit's surprising strength in the face of months of political turmoil has been a vote of confidence for Prime Minister Muhyiddin Yassin who is looking to revive spending to pull the economy out of its biggest slump since 1998. If Malaysian bonds are removed from FTSE's index, debt inflows could dry up, depriving the currency of a key source of support.

Like most of its Asian peers, the ringgit has benefited from a weak dollar and robust demand for higher-yielding debt. It has gained more than 3 per cent since the start of July to outperform all but one of its Asian peers.

The ringgit bullishly breached resistance at its March high against the greenback, and may head toward 4.05 before year-end. The currency traded at 4.1475 on Friday.

But what happens from here would depend much on FTSE's decision which is due Sept 24. Goldman Sachs Group said last year outflows could reach US$6 billion should the nation be dropped.

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"We continue to see a higher probability of status quo ie no change in classification and weights," MUFG Bank analysts led by Derek Halpenny wrote in a report last week, referring to the FTSE decision. "This means that foreign investors may continue to buy Malaysian sovereign bonds, particularly as real yields remain the highest in the region albeit at a declining trend."

Investors will also be watching Bank Negara Malaysia's policy meeting on Thursday, with four of 14 economists in a Bloomberg survey expecting a 25-basis point cut. The remaining 10 see no change.

At its last review on July 7, the central bank said it would "continue to utilize its policy levers as appropriate" to support growth, fuelling speculation of more easing.

BLOOMBERG