This article first appeared in The Edge Malaysia Weekly on June 24, 2024 - June 30, 2024
WITH Bank Negara Malaysia’s use of currency forwards to manage short-term pressures on the ringgit making headlines last week, its scheduled disclosures on the reserves this week should garner more attention than usual.
Of interest is the fact that the central bank’s forward liabilities had reached a record high of US$27.85 billion in April, or 24.7% of international reserves — having jumped substantially month-on-month in March. The increases coincided with the ringgit’s renewed strength after Bank Negara appealed to government-linked investment firms to repatriate and convert foreign income into the ringgit.
“The movements in Bank Negara’s forward position reflect the activities undertaken to ensure the orderly functioning of domestic financial markets during periods of heightened capital flow volatility and to ensure sufficient onshore liquidity for effective financial intermediation. To be clear, Bank Negara has focused its foreign exchange (forex) interventions in the spot market. The forward transactions are tools deployed to manage ringgit liquidity and certainly not for influencing the exchange rate or the reserve level,” the central bank replied to questions sent by The Edge, noting that its forward transactions essentially either provide or absorb ringgit liquidity through the banking system during heightened capital outflows or inflows.
“The recent build-up in forward position reflects demand from onshore banks with excess foreign currencies to source ringgit funding during an environment of high volatility,” Bank Negara explained (see the central bank’s full reply in the accompanying article below).
Winson Phoon, head of fixed income research at Maybank Investment Banking Group in Singapore, reckons that the net shorts in Bank Negara’s forex forward book “may remain elevated in the near term, but should ease gradually in the next six to 12 months” when the easing of interest rates by the US Federal Reserve reduces the pressures arising from rate differentials.
He says the Fed’s easing should see “a more consistent repatriation and conversion of forex proceeds to ringgit [and] should contribute to a healthier equilibrium in the USD/RM spot”.
Phoon, for one, dismisses the notion of the ringgit being artificially lifted using these forward shorts: “We don’t think forex forwards were used to lift the ringgit. Instead, we think the ringgit is undervalued. Market imbalances necessitated increased Bank Negara intervention.”
The higher forex forward net shorts, he says, “also partly reflect the management of ringgit liquidity in the money market”.
“Ideally, the amount of net short is trimmed back to a less elevated level over time when market conditions permit, and Bank Negara managed to achieve this twice in the past,” Phoon adds.
For the record, Bank Negara’s short positions had been trending lower for four months from US$25.06 billion (23.1% of official reserves) in October 2023 to US$22.79 billion (19.9% of official reserves) in February this year before jumping 18.1%, or about US$4.1 billion, month-on-month to US$26.92 billion (23.7% of official reserves) in March. From there, it gained another US$928 million, or 3.4% month-on-month, to the new high of US$27.85 billion in April.
Meanwhile, Bank Negara’s international reserves gained US$7.3 billion, from US$108.5 billion as at end-October 2023, to US$114.8 billion as at end-January 2024, but gave up US$2 billion of those gains over three months to US$112.8 billion as at end-April.
By end-May, however, its international reserves were up US$800 million month-on-month to US$113.6 billion, being 1 times total short-term external debt and is enough to finance 5.4 months of imports of goods and services (6.7 months under the old measure).
If one took into account the forward liabilities, Bank Negara’s net foreign reserves would be at US$84.95 billion in April, which would be about 0.75 times short-term external debt, back-of-the-envelope calculations show. Using this same method, Bank Negara’s net reserves were lowest at US$80.85 billion in October 2022, The Edge’s compilation of Bank Negara’s data shows (see chart).
Bloomberg took an even more conservative calculation, in an article headlined “Forwards became Malaysia’s favoured tool for boosting the ringgit” dated June 20, where it noted that excluding gold, Bank Negara’s net foreign reserves “are estimated [at] US$67 billion, well below its short-term external debt of around US$112 billion”.
Asked about this, Phoon says: “To the extent where gold positions are excluded from the [calculation of] net reserves, it is a very conservative way of stress-testing the official reserve balance, in our view. Gold is a very liquid asset.”
At the Sasana Symposium 2024 (SS2024) two weeks ago, Bank Negara deputy governor Adnan Zaylani Mohamad Zahid spoke on the central bank’s efforts in encouraging more corporates and institutions to convert their repatriated earnings into ringgit, eliciting laughter from the audience when he corrected himself for saying Bank Negara “would be happy” to approve conversion into foreign currency where necessary: “Not happy, but approval [will be granted].”
At a separate session at SS2024 on buffering against external vulnerabilities, Bank Negara deputy governor Datuk Marzunisham Omar had said that in a flexible exchange regime, where the ringgit can play the role of a “shock absorber”, the local currency “is subject to over- and undershooting”.
“When the ringgit is significantly and persistently undervalued, it can have repercussions on the economy. It could [affect business’ decisions in a way that could] lead to higher imported inflation and lower capital investment, which has a long-term impact on Malaysia’s productive capacity. The role of the [central] bank is to ensure orderly adjustments of the ringgit to avoid excessive volatility [and] prevent a permanent misalignment of the ringgit exchange rate,” Marzunisham said.
Bank Negara is slated to release its fortnightly update of its international reserves position as at June 14 on Monday (June 24) and detailed disclosures for May 2024 on Friday (June 28).
Build-up reflects demand from onshore banks, says central bank
1. Bank Negara Malaysia’s forwards were at a record high in April 2024, both in absolute terms as well as percentage. Are forwards still going up in May and if so, how should we read this data?
2. Critics say Bank Negara’s net reserve levels are below 0.8 times short-term external debt. Why shouldn’t we be worried?
3. What does Bank Negara have to say on comments that the central bank is artificially boosting the ringgit using forwards and that this action, and consequently the ringgit’s recent appreciation, are unsustainable as net reserves are falling?
Malaysia adopts a flexible exchange rate regime. The exchange rate flexibility is key as it allows the exchange rate to play the role of shock absorber in the economy. Exchange rate flexibility remains our first line of defence to facilitate necessary macroeconomic adjustments when confronted with large external shocks. For example, as a net exporter, the ringgit depreciation has allowed exporters to benefit from translation gains, hence higher nominal earnings. Nevertheless, the exchange rate can also be subject to extreme volatility and over-adjustments due to sharp swings in financial market sentiments. These can potentially lead to movements in the ringgit not reflecting Malaysia’s economic fundamentals and growth prospects.
Bank Negara’s presence in the foreign exchange (FX) market, therefore, aims to smooth excessive volatility in the ringgit and thus, ensure orderly FX market conditions. To do this, Bank Negara undertakes two-way FX interventions by using Bank Negara’s international reserves. Bank Negara has always been and will continue to be judicious in the use of international reserves to manage the ringgit volatility.
Bank Negara’s international reserves stood at US$113.6 billion as at May 31, 2024. Central banks hold international reserves for two key reasons. First, international reserves are drawn down to provide foreign currency liquidity in the FX market to prevent market dislocation. Second, international reserves also act as a precautionary buffer to absorb or self-insure against balance of payment shocks such as sudden stops in capital flows.
Bank Negara has always been transparent on the level of international reserves available at our disposal. Our international reserves are fully usable and sufficient as measured by a broad range of indicators. As at May 31, 2024, the reserves position is sufficient to finance 5.4 months of imports of goods and services, and is 1.0 times of the total short-term external debt. The reserves also remain adequate at 115% of the International Monetary Fund’s Assessing Reserve Adequacy (ARA) metric.
While most of the indicators are well above the minimum adequacy thresholds, the reserves cover of short-term external debt at one time is often highlighted as a potential risk for Malaysia. However, it is important to also assess whether the short-term external debt would pose a claim to reserves. Looking at the composition of short-term external debt, almost half (47%) is in the form of intra-group borrowings (by banks and corporates) on stable and concessionary terms, while another 16.8% is in the form of trade credit backed by export earnings. As such, the risks of claims to reserves from this short-term debt are contained, given the favourable debt profile.
In addition, it is important to recognise that for Malaysia, foreign currency reserves held to meet external obligations are decentralised, that is, they are not only held by the central bank. Having experienced 25 continuous years of current account surplus, Malaysia’s corporations and financial institutions have accumulated a significant amount of foreign currency assets. These assets, particularly the liquid portions, which amounted to RM927.2 billion, can be drawn upon to meet their short-term external debt obligations of RM531.2 billion at the end of 1Q2024. Banks also maintain foreign currency liquid asset buffers that are sufficient to cover more than twice the level of their external debt-at-risk. Thus, banks and corporates are able to manage their foreign currency obligations without creating a claim on Bank Negara’s international reserves. In addition, given this and owing to the Malaysian financial system’s deep and ample access to foreign currency funding, Bank Negara is also able to tap the financial markets to manage its foreign currency assets and liability efficiently. This underscores the perspective that the entirety of the gross international reserves are effectively usable to achieve Bank Negara’s mandates.
The movements in Bank Negara’s forward position reflect the activities undertaken by Bank Negara to ensure the orderly functioning of domestic financial markets during periods of heightened capital flow volatility and to ensure sufficient onshore liquidity for effective financial intermediation. To be clear, Bank Negara has focused its FX interventions on the spot market. The forward transactions are tools deployed to manage ringgit liquidity and certainly not for influencing the exchange rate or the reserve level. Bank Negara’s forward transactions are essentially two-way transactions that are conducted either to provide (during capital outflows) or absorb (during capital inflows) ringgit liquidity through the banking system. The recent build-up in the forward position reflects demand from onshore banks with excess foreign currencies to source ringgit funding during an environment of high volatility.
While Bank Negara’s forward position is still expected to be mainly driven by demand from domestic banks, Bank Negara expects it to decline as onshore liquidity conditions improve amidst improving global financial market conditions and more capital inflows in the later part of the year.
In addition to FX intervention to manage short-term pressures on the ringgit, the government and Bank Negara have taken coordinated actions to ensure timely and consistent inflows into the FX market. These include encouraging government-linked companies (GLCs) and government-linked investment companies (GLICs) as well as exporters and corporates to repatriate and convert their overseas investment income into ringgit. These efforts have helped cushion the pressure on the ringgit and will continue to provide sustainable support to the ringgit, given that the focus is on realised investment income and export revenue which are recurring in nature. As of June 20, 2024, the ringgit has appreciated by 1.4% against the US dollar, despite the renewed strength in the US dollar following the Federal Reserve’s signal to delay rate cuts amid continued inflationary pressure in the US.
Over the longer term, implementation of structural reforms remains critical to provide more enduring support to the ringgit. Continued structural reforms will lay the foundations for a resilient Malaysia and strengthen our economic prospects. The government’s commitment to the medium-term fiscal consolidation plan will ensure fiscal sustainability and improve the re-allocation of resources to more productive economic sectors. This will, in turn, boost investor confidence and attract further inflows.
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