Pause in decline of foreign reserves. Malaysia’s foreign exchange reserves unexpectedly increased by US$0.2b in the 2H of August compared to a fall of US$2.2b in the 1H of August and US$8.8b in the month of July. As at August 28, the international reserves held by Bank Negara Malaysia totalled US$94.7b (RM357.7b). The data suggests that large depletion of reserves might have taken a breather, although the latest reversal to the general trend could turn out to be temporary. The current reserves level is sufficient to finance 7.4 months of retained imports and is 1.0 time the short term external debt.

Pause in forex market intervention. We understand the small increase in reserves in the 2H of August, opposite to market expectations, as a further sign that BNM has eased off from intervening in foreign exchange markets and that the central bank is now more comfortable with letting market forces decide the value of the ringgit. Recent comments by the BNM governor are in support of a floating exchange rate as it functions to absorb the terms of trade shock from the commodities rout. Tan Sri Zeti Akhtar Aziz has also assured the market that forex reserves will eventually be rebuilt. This in contrast to July, when BNM was believed to have been aggressively defending the ringgit from rapid depreciation and USDMYR stubbornly held at around 3.80 in spite of large outflows of capital. We view the shift to a policy of minimal intervention as appropriate given the difficulty in swimming against the tide of massive portfolio outflows. The sophistication of today’s financial markets and Malaysia’s open economy present a high barrier for BNM to return to capital controls or a ringgit peg. Hence, we maintain expectations for BNM to mostly allow market forces to determine cross rates outside of periods of high volatility.

Ringgit will remain weak in near term. Nevertheless, the depletion of reserves is expected to resume in 1H of Sept ahead of the FOMC meeting on Sep 16 and 17 as speculation of a rate hike would likely spur further outflow of capital. This would exert more pressure on the ringgit and possibly would again test the 4.30 level to the US dollar which it just missed by a whisker on Aug 26. The currency was last traded at around 4.26 on Sep 4. The ringgit is the worst performing currency in the region, down 17.9% year-to-date and 25.3% over the past 12-months relative to the US dollar. Though the Fed rate hike increasingly looks likely to be delayed to later this year, expect downward pressure on the ringgit to hold at least until the US Federal Reserve makes its first rate hike. The unprecedented speed of ringgit depreciation in recent months means that USDMYR looks almost certain to settle above 4.00 by year-end according to our preliminary analysis. 

Source: Kenanga Reseach - 7 Sep 2015