Foreign reserves reached a record US$130bil at the end of April but economists do not think that amount, lifted by continued inflows of short term capital into the economy, would pose a risk to the economy.
“If the economy is doing well, capital will naturally flow in,” said Thomas Lam, chief economist at OSK-DMG.
CIMB Research in a note yesterday said reserves were boosted by substantial inflows of short term money and that positive economic vibes had contributed to the fundamental reasons for such inflows.
“Large reserves act as a strong buffer against large capital reversals. Sound financial policies, developed domestic financial markets and macro-prudential surveillance also act as cushions against large shifts in funds,” it said.
CIMB Research said foreign investors were a net buyer of US$193.4mil worth of equities in April.
“Foreign holdings of Malaysian debt securities also ballooned to RM146.8bil in April from RM137.9bil in March, constituting 22% of the total of Malaysia's outstanding bonds,” it said in a note.
CIMB pointed out that the bulk of the money had been invested in Malaysian Government Securities (55.1% of total foreign holdings), followed by Bank Negara bills (31.2%), and private debt securities and others (10.5%).
“The massive capital inflows also lifted the ringgit to a 13-year high of RM2.96/US$1 on April 29 before coming off to RM3.00/US$1 on May 6, marking an appreciation of 1.9% year to date,” it said.
Lam said the exchange rate appreciation of the ringgit, which was more pronounced against the dollar than the basket of currencies of the country's largest trading partners, would be beneficial in keeping prices in check.
“The more the exchange rate appreciates, the less likelihood of an asset price misalignment,” said Lam.
CIMB Research said emerging market economies, after the subprime crisis, had been seeing large capital inflows that were driving up their exchange rates and inflating asset prices.
“Malaysia is no exception, having attracted RM67.9bil net inflows of portfolio investment in the third quarter of 2009 to the fourth quarter of 2010 and is now facing the challenge of managing the magnitude and volatility of capital flows, as well as their repercussions on the domestic economy,” said CIMB Research. It worries that a swing factor to volatile capital flows, a change in investor sentiment or unexpected shocks could trigger a reversal in capital flows.
CIMB Research said that was seen in 2008 when the massive de-leveraging during the height of the global financial crisis led to a large reversal of portfolio flows, and in Malaysia RM110.7bil left between the second half of 2008 and the first half of 2009, resulting in a substantial decline in the international reserves to US$95.1bil as at end-June 2009 from a peak of US$125.8bil in June 2008.
The large amount of liquidity in the capital markets have led to Bank Negara raising the Statutory Reserve Requirement (SRR) to 3% to mop up excess funds in the market.
“We expect another 100 basis-point rise in the SRR to 4% in July. SRR may go above 4% if private capital inflows remain substantial.
“The last time the SRR hit at double-digit level was in Jan 1998, when it reached 13.5%,” said CIMB Research.