Bank Negara has enough ‘ammunition’ to stop ringgit and sovereign rating decline

Capital volatility: Lee says aggressive currency market intervention may be futile and extremely costly.

PETALING JAYA: Concerns that Malaysia’s external finances may worsen, as a result of continued intervention from the central bank after the ringgit weakened beyond 3.8 to the US dollar, have renewed fears that could lead to a sovereign rating downgrade.

BNP Paribas said the foreign exchange (forex) reserves depletion to prevent the ringgit from breaching the psychologically important RM3.81-a-dollar level was especially concerning, as it heightened the risk of balance of payment strains.

“Should Bank Negara continue down this path, negative pressure on the ringgit and the external balance sheet is set to escalate, raising the potential for a multi-notch sovereign rating downgrade,” it said in a note released yesterday.

As of July 15, Malaysia’s foreign reserves stood at US$100.5bil (RM379.4bil), down from US$105bil as of June 30.

Foreign reserves have fallen by about US$40.9bil from the record high of US$141.4bil as of end-May 2013.

BNP Paribas said that Fitch Ratings’ recent reversion of the country’s sovereign outlook to stable, while welcomed by policymakers, was a temporary relief.

“The revision is understandable if one focuses on Malaysia’s public finances in isolation. Yet, its fiscals have worsened compared with its peers and external finances have deteriorated sharply,” it said.

The ringgit dropped to RM3.806 to the dollar yesterday.

The currency has fallen 8.1% this year and reached a 16-year low of 3.8130 against the greenback this month.

Independent economist Lee Heng Guie, however, said that the central bank had enough ammunition for now.

“Bank Negara’s exchange rate policy has been guided by careful management of exchange rates on a managed float regime with flexibility, coupled with intermittent intervention (if and when necessary) to reduce excess volatility and ward off speculative activities, while maintaining an optimal level of foreign reserves,” he said when contacted.

He added that in principle, the ringgit should bear the entire adjustment burden if capital flows are perceived to be permanent.

“However, there is a case for smoothing the exchange rate adjustment if capital flows are volatile and perceived to be temporary. Maintaining a strong war chest of forex reserves would help to buffer the economy from the volatile capital flows and the steep rise in risk aversion.”

On the other hand, Lee said that Bank Negara was not going to fully deploy its forex reserves arsenal to defend the ringgit, as aggressive currency market intervention may be futile and extremely costly.

“The rapid depletion of forex reserves would undermine investors’ confidence in the ringgit and accentuate more capital outflows. Greater transparency and coordination of macro policies among key government agencies is important to assuage investors that the authorities are well-prepared to deal with capital volatility.”

Meanwhile, Malaysian Rating Corp Bhd chief economist Nor Zahidi Alias noted that Malaysia’s external finances were also affected by the new definition of external debt, which includes foreign holdings of ringgit-denominated government bonds and deposits.

“This has bolstered the amount of ‘external debt’ under the new definition,” he told StarBiz.

He said that Malaysia’s offshore borrowings, such as borrowings denominated in foreign currencies as a percentage of gross domestic product (GDP), was at a relatively comfortable level of 34.3% in 2014 and was “not expected to pose any risks”.

It is extimated that 42.6% of offshore borrowings was made up of short-term debt in 2014, due largely to banking sector activity, and the Federal Government’s share of total offshore non-ringgit denominated borrowings was at a healthy 4.6%.

While the issue of the declining current account (CA) surplus could create negative reaction in the market, Zahidi said there was a positive side in a shrinking CA surplus.

“When viewed from a saving-investment perspective, it reflects the fact that domestic demand has been driving economic growth, as the external economic environment remains weak.

“Shrinking current account surpluses mean investments have recovered significantly, as reflected in the rise of private investment-to-GDP in recent years. Such an improvement will enhance growth capacity in the medium term,” he said.

He said the Malaysian scenario was different from Mexico’s Tequila crisis of the mid-1990s, where the CA balance was under pressure due to an overvalued exchange rate. “Under such circumstances, shrinking CA surpluses give a negative connotation about the economy.”