Thursday, August 3, 2017

Reserves and Reserve Cover

This is really tiresome (excerpt):

Malaysia's Bond Recovery Is Under Threat

Malaysia’s bonds are coming back in favor but the respite may be brief. The level of the nation’s foreign reserves is coming under scrutiny as investors brace for outflows from emerging markets.

The lowest reserve adequacy in Asia is sapping demand for the securities just as they are recovering from the longest selloff by foreign investors in eight years. Relatively high foreign ownership and an acceleration in inflation from last year are adding to risks as major central banks sound increasingly hawkish on interest rates….

…Malaysia’s reserves are sufficient to finance 6.5 months of imports, according to data compiled by Commerzbank AG using a 12-month moving average. That compares with 9.9 months for Indonesia, 10.8 for Thailand, 11.2 months for the Philippines, and 21.6 for China.

Bank Negara Malaysia’s reserves amount to just 1.1 times the amount of short-term debt on issue, Commerzbank estimates. The corresponding ratio is 2.8 for Indonesia, 3.7 for the Philippines and 4.3 for India….

My comments:

  1. Reserve adequacy in Malaysia is low only relative to the rest of East Asia. What’s not mentioned here is that international reserves in East Asia are hugely excessive, and costly. Accumulating reserves results in interest differential losses since you have to invest in low-yielding reserve currencies, vis-a-vis higher yielding domestic debt securities that you need to issue to sterilise the FX intervention, not to mention the role they play in global trade and capital imbalances. The international standard is to have reserve cover of just 3 months of retained imports, and Malaysia has more than twice that level. So what if we’re lower than Indonesia and Thailand? They’re paying a price for that privilege. Australia, Canada and France have a foreign share of government debt ownership on par with Malaysia, but with international reserves barely enough to cover 1 month of retained imports. Can you say double standards? I knew you could.
  2. I have no idea why Commerzbank feels the need to apply a 12-month moving average to international reserves. You use smoothing techniques like MMA or HP filters for highly volatile series, to understand underlying trends. International reserves simply don’t have that kind of volatility, and in any case are subject to central bank discretion in terms of levels. This isn’t a market price.
  3. On short term debt reserve cover, Malaysia has a relatively open financial system, and is the global centre for Islamic finance. Countries with more developed banking systems tend to have higher short term “debt” – it’s basically deposits owned by foreigners (regardless of currency denomination). Malaysia is also in the top-20 trading nations in the world. That implies much more in the way of trade finance, which involves a not insignificant amount of liabilities (“debt”) from bills of exchange (i.e. trade finance). So a country like Malaysia, with total trade exceeding 120% of GDP, would always have a structurally larger short term “debt” position than someone like Indonesia (35% of GDP) or Thailand (100% of GDP).
  4. Apropos, why doesn’t anybody ever mention Singapore’s short term debt reserve cover? For those interested, Singapore has SGD1.38 trillion in short term external debt, versus official reserves of SGD362 billion, i.e. roughly 26%. But then, that might be telling and might cause too much cognitive dissonance. People might say, we should exclude deposits and trade finance; but if you apply that standard, it should be applied equally.


  1. When I first read it, I thought not again. You have explained in much detail that made it even more "what the heck - I think they just have a sinister agenda feel to it". Rubbish talk, I think they are in cohorts with PH.

    1. @Zuo De

      I don't think there's anything sinister about it - just too many young analysts, who aren't familiar with how data is constructed and the nuances involved. We now have a whole generation of middle managers and analysts who've never seen a real recession - it's almost exactly 10 years since Lehman Brothers failed.

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