Friday, October 22, 2010

Currency Wars Part III: How Much Is BNM Intervening In The Ringgit?

It finally occurred to me that there absolutely has to be some forex intervention going on in Malaysia, if only because the level of reserves is not dropping as fast as the Ringgit is rising. But the degree to which BNM is intervening is so small, that I’m not sure whether its worth talking about.

To understand the relationship between Malaysia’s international reserves and the Ringgit, you have to understand the mechanics of intervention, as well as BNM’s policy on revaluation of reserves. The level of international reserves can only change from one or the other, or both. If there is no intervention – and this is important to understand – there will be no change in the level of reserves except on revaluation (added 22/10/2010 for clarity).

The mechanics of intervention are fairly simple. When BNM is acting to prevent an appreciation in the Ringgit exchange rate (typically via the MYRUSD rate), then they buy dollars from the interbank system with Ringgit. Since the supply of Ringgit in the interbank system has increased, ceteris paribus the exchange rate depreciates. International reserves also rises in tandem, but the banking system’s holdings of foreign exchange falls. BNM can either use its existing cash (no change in the size of BNM’s balance sheet), or create new Ringgit deposits for the transaction (increase in the size of the balance sheet).

The opposite occurs when BNM is trying to prevent a depreciating Ringgit, where cash account increases, international reserves decreases, and the banking system’s holdings of foreign exchange increases.

But forex intervention also implies changes in the domestic money supply. When there is intervention to weaken the currency, the banking system receives cash that can then be used for domestic lending purposes – the amount of high powered reserves in the banking system has increased, which can then be used for lending to borrowers.

Since BNM is using an interest rate targeting regime to manage domestic monetary conditions, that further implies that any intervention must necessarily be fully sterilised to maintain the interbank overnight rate at the Official Policy Rate target that’s set by the Monetary Policy Committee at BNM. Sterilisation is just the term used for open market operations that offset any discretionary action that the central bank makes (see this post for the mechanics of open market operations).

The end result is that there is almost always an increase in the BNM’s balance sheet, whether it uses existing cash or not, when selling Ringgit; and a decrease in the balance sheet when buying the Ringgit.

Revaluation is easier to understand, as BNM revalues reserves at the end of each calendar quarter – March, June, September and December – based on prevailing market exchange rates. If the Ringgit is generally rising there will be a loss on revaluation of the reserves, and if the Ringgit is falling there will be a gain. The problem here is that to figure out the actual effective change in reserves, you also have to know its composition. I don’t actually know off hand of any central bank that actually releases that kind of information publicly, and BNM is certainly not one of them.

So I’m going to make some heroic assumptions, and see where that leads me.

First, a visual representation of the change in reserves (RM millions, sample:2005:1-2010:9):


There have been obvious cases of intervention throughout the decade, but intervention has become more symmetrical (both up and down) and greater in magnitude since the Ringgit was floated in July 2005. I’d also point out that even during the fixed rate period, intervention was not one way i.e. keeping the level of the Ringgit down relative to the USD. For most of 2000-2001, BNM had to support the Ringgit level to maintain the peg, which entailed a loss of reserves. This was due to the sharp appreciation of the USD, which reached a three-decade trade-weighted peak in 2002:


Going back to the post-float era, intervention has been:

  1. periodic rather than continuous,
  2. greater in magnitude, and
  3. almost as likely to strengthen as to weaken.

The numbers from July 2005 up to Sept 2010 work out to about RM210.8 billion spent to weaken the Ringgit, and about RM184.2 billion to strengthen, for a net increase of about RM26.6 billion over five years (i.e. a slight bias towards weakening).

But if you look specifically at the period from 2009 onwards, the numbers show BNM generally acting to strengthen the Ringgit, not to weaken it – RM32.0 billion to strengthen, RM25.2 billion to weaken, for a net of negative RM6.7 billion.

This generally supports BNM’s contention that it is no longer targeting the level of the Ringgit, but rather limiting its volatility. This chart reinforces that notion:


Even though intervention has increased in magnitude in the float era, it has also fallen as a ratio to the forex market volume (combined spot and swap), which means that the impact on the exchange rate level has become progressively less. (Update 22/10/2010: Note that since capital controls were first instituted in Sept 1998, trading in the Ringgit can only be done in the domestic market).

But what happens if we adjust the reserves position for revaluation gains/losses? Most external trade in Malaysia is invoiced in USD, but some holdings of other major currencies would be a sensible precaution for BNM to take. On that basis I assume BNM is holding 15% in EUR, 15% in JPY, and the rest in USD. There’s probably some gold and SGD in there as well, but to simplify things I’m assuming there isn’t. What I’m trying to achieve is essentially a mark-to-market series (using average monthly exchange rates), which would give a better idea of the scale of intervention.

So here’s the adjusted series (click the pic for a bigger version):


And a close up of the floating rate period:


One thing that stands out is that BNM intervened far more often than I originally thought, but that intervention has also been a bit more symmetrical. The general trends I pointed out earlier are still there – general bias towards weakening since the float, but with a bias towards strengthening since the beginning of 2009.

The biggie for the latter was in February 2010, with a total adjusted loss of RM10.3 billion (unadjusted RM20.1 billion) – and I have no idea why that happened, as the Ringgit was strengthening anyway. About the only I thing I can figure is that BNM was concerned over the long term decline of the USD, and wanted to diversify the international reserves portfolio.

But since then, there’s been not much movement in international reserves, even accounting for changes in valuation. There’s a few analysts who claim that BNM has been intervening lately (Morgan Stanley for one), but I just don’t see it, unless I’ve completely screwed up the adjustment calculations. There’s been an accumulation of about RM6.4 billion (adjusted) in August and September, but that just about covers the reduction in reserves of RM5.6 billion (adjusted) in July. And the scale of intervention is nowhere close to what it was pre-crisis.

So is BNM intervening in the Ringgit exchange rate? Yes, but not much lately and the bias is upwards, not downwards. This contrasts sharply against the general trend in the region (with the exception of Singapore).

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