Reserves dropped by US$1.9bn in two weeks ending 30th November

Malaysia’s international reserves fell by US$1.9bn to US$96.4bn in the two weeks ending 30th November 2016, compared to an increase of US$0.5bn to US$98.3bn in the first-half of the month ending 15th November. Similarly, in ringgit terms, reserves declined to RM399.6bn as at end-November (RM405.5bn as at end-October), falling below RM400bn for the first time since the revaluation in end-September 2016. Nevertheless, despite the decline, the current reserves level is still sufficient to finance 8.3 months of retained imports and 1.2 times of short-term external debt.

We believe the drop in reserves by US$1.9bn in the two weeks ending 30th November can be partly attributable to Bank Negara Malaysia (BNM)’s intervention in foreign exchange market, following Trump’s victory in the US Presidential Election, which led to a surge in volatility in foreign exchange markets across the region, including Malaysian Ringgit. The Ringgit sharp depreciation against US$ were partly caused by the non-deliverable forward (NDF) activities in the offshore market. As Ringgit is a non-internationalised currency, BNM had intervened earlier to prohibit facilitation of NDF market activities of Ringgit in the offshore markets. In recent days, the difference in the trade/spread between the onshore and offshore ringgit non-deliverable forward (NDF) rates have narrowed sharply, indicating that the volatility in the domestic currency market has become more manageable for now. This may be attributed also to several measures by BNM to further develop the country’s onshore foreign exchange (forex) market, involving the liberalisation and deregulation of the onshore ringgit hedging market, streamlining treatment for investment in foreign currency assets as well as Incentives and treatment of export proceeds.

In another words, BNM is taking pre-emptive measures to enhance the depth and liquidity of onshore financial market, including easing requirements for hedging as well as promoting settlements of trade and investment in ringgit. As stated in BNM’s Foreign Exchange Administration (FEA) policies, regarding the rule on repatriation of export proceeds, exporters must repatriate to Malaysia in full as per the sales contract and not exceeding six months from the date of export. In the latest announcement, effective 5 December 2016, BNM maintained this policy, where exporters will still have six months to repatriate their new export proceeds, but once the new proceeds are repatriated back, the measure will require exporters to convert 75% of their new export proceeds to Malaysian Ringgit, and retaining 25% of proceeds in foreign currency. However, the existing foreign currency balances are not affected. BNM has also proposed that exporters placing their Ringgit proceeds from exports in local commercial banks can earn a special deposit rate of 3.25% per annum. As such, we believe that exporters may be incentivised to comply.

Based on our rough calculation, given that we are projecting net goods account balance to be around RM98.6bn for 2017 (RM97.3bn estimated for 2016), a 75% conversion will likely translate into RM74bn. We believe the BNM measure on export proceeds is expected to support the country’s reserves and ringgit, but uncertainties in the foreign exchange market remains, especially in 1H2017, where volatility in short-term capital flows due to the shift in investor sentiment still persist.

We believe the country’s foreign reserve will come under some pressure in December 2016 and 1Q17, with some potential risk of portfolio capital outflows. Market observers are concerned on capital outflows as the levels of foreign holdings in Malaysian Government Securities (MGS) remains high at 48.4% as at end-November 2016 (51.5% as at end-October 2016). The foreign holdings of MGS fell by RM11.5bn to RM173bn as at endNovember, whereas the total bond foreign holdings (including MGS) declined by RM19.9bn to RM221bn as at end November.

We believe that if the strength of US$ continues, this will likely lead to increase foreign investors’ appetite for US Dollar-denominated assets. There is still some possibility of selling pressure on foreign holdings of Malaysian bills and bonds as well as Malaysian Government Securities (MGS), but will remain manageable. However, we believe that the sustainability of trade surplus, and hence current account surplus, will continue to support reserve level in the country, where we project reserves to be about US$94.5bn by end-2016 (US$95.3bn by end 2015).

Source: Affin Hwang Research - 8 Dec 2016