Increase of USD1.0b in 1H August. Malaysia’s foreign exchange reserves increased by USD1.0b in 1H of August to USD100.4b. The US dollar reserves plunged below the USD100.0b psychological level during the drastic capital outflows in July 2015. Encouragingly, the US dollar reserves have been rising steadily since the beginning of the year, gaining about USD5.9b year-to-date. The current reserves level is sufficient to finance 7.9 months of retained imports and is 1.1 times the short-term external debt.

Ringgit value of reserves rose concurrently. The local currency equivalent of foreign reserves rose by RM4.0b to RM431.0b in 1H August. Year-to-date, reserves in ringgit term rise RM6.9b as of 1H August despite the depreciation of USD against the ringgit. This is mainly attributable to the rate of increase in USD term reserves (ytd: +6.2%) outpacing the depreciation of the USDMYR pair (ytd: - 4.5%).

Foreign inflows to equities market continues. Meanwhile, the foreign capital inflows to local equities market continued unabated. In 1H August, local equities market saw a cumulative foreign net inflows of RM0.2b, with year-to-date net foreign flows of +RM10.8b, lending support to the central bank’s effort to build up a larger buffer of reserves throughout the year.

Steady recovery ahead. From the current level, we believe the reserves are likely to extend its recovery momentum in the short to medium term. Looking at historical data in the past 17 years, we observe a close relationship between exports revenue and reserves level, with a correlation as high as 0.96. From a historical perspective, the current level of foreign reserves appears to be relatively low in view of the surge in total exports value in recent months (see graph 3). We expect the solid exports performance, if sustained, to lift reserves to a higher level, especially after BNM’s new requirement last year to exporters to convert 75% of all export proceeds.

Positive capital inflows. The big jump in reserves in the first two weeks of August would also suggest that the capital market would also see some positive inflows from both the equity and bond portfolio funds. More importantly we may see a reversal in the flows on foreign funds into the bond market in August following two consecutive months of net outflows. The rise in reserves could also be attributed to the rise in foreign direct investments (FDI) especially from projects related to China’s “One Belt One Road” policy.

Ringgit strength to provide support. On the other hand, BNM’s continued efforts to clampdown on trade of nondeliverable forwards (NDF) by onshore banks have greatly reduced the volatility of ringgit. The ringgit has been relatively stable with the USDMYR trading within a narrow range of 4.26-4.30 since end-May. On the back of improving growth fundamentals, We maintain our year-end target for USDMYR at 4.15. The stability of the ringgit will create more room for BNM to take a light-handed approach in foreign exchange management and facilitate in building larger buffer of foreign reserves. Currently, the reserves level of the country is sufficient to maintain the stability of the financial system. However, we remain wary of the risks of capital outflows and reserves erosion as the Fed embarks on its monetary tightening cycle.

Source: Kenanga Research - 23 Aug 2017