Recovers from six-year low. Malaysia’s foreign exchange reserves increased by US$0.8b in the 1H of October from a six-year low of US$93.3b at the end of September (following four straight months of sharp losses). As at 15 October 2015, the foreign reserves held by Bank Negara totalled US$94.1b (RM418.0b). The current reserves level is sufficient to finance 8.8 months of retained imports and is 1.2 times the short term external debt.

A sign of bottoming out. The pace of decline in reserves slowed noticeably in September when BNM reported a US$1.4b fall in foreign reserve holdings, far lower than the US$1.9b decline in August and US$8.8b decline in July. If not for a quarterly adjustment for foreign exchange revaluation changes, the September decline could have been smaller. The increase in the 1H of October is a convincing sign that the decline in June-September has probably bottomed out. The trend reversal is apparent in the stock market with net inflows of portfolio funds hitting almost RM800m in the 1H of October.

Market forces dictate the value of the ringgit. The last round of large depletion of reserves coincided with heavy capital outflows and BNM intervention in foreign exchange markets to prevent the value of ringgit from sliding too rapidly. However, the central bank has since ceased using foreign reserves to prop up the ringgit and recent comments made to the media by the BNM governor are in support of a floating exchange rate. The movements of the ringgit against other major currencies point to market forces playing the leading role.

Boosting investor confidence. Earlier this month, BNM took action to revoke three permissions granted to strategic investment fund 1Malaysia Development Berhad (1MDB) under the Exchange Control Act for investments abroad totalling US$1.83b and ordered 1MDB to repatriate the full amount. The move is seen as strengthening investor confidence in the independence of Malaysian institutions.

Ringgit will remain weak in near term. We maintain that there remains a risk that BNM foreign reserves could again decline in the coming months as the US Federal Reserve makes its first rate hike since 2006. Despite the rate hike being pushed back repeatedly from mid-year, we view the Federal Open Market Committee (FOMC) as almost certain to raise rates on at least one occasion this year as the credibility of its forward guidance is at stake. Until further clarity on the date of the initial US Fed rate hike and the pace of subsequent increases, the ringgit is to remain undervalued. Our year-end forecast for the USDMYR is 4.48. 

Source: Kenanga Research - 23 Oct 2015