On the fall in Malaysia's Forex Reserves -Why is Zeti not worried?

Zeti , governor Bank Negara has told THE STAR:

“The decline in reserves is mainly due to a reversal of short-term capital flows. That was the result of the deleveraging process by investors following the financial distress experienced in the United States and in Europe,”
“In October, we had the international meltdown. Are we concerned (about the fall in reserves)? No, because this is part of the deleveraging process and immense demand for US dollars by the international investment banks and other entities that are deleveraging,”
(http://biz.thestar.com.my/news/story.asp?file=/2008/11/13/business/2532269&sec=business)


No need for concern? Perhaps, but here are some numbers which are so large, it is hard to see how anyone would not be concerned.

First, between 15 May 2008 and 31 October 2008, Bank Negara’s total assets in Malaysian Ringgit terms fell 26% from RM 506,986,188,441 to RM 374,372,661,598.

Reserves of foreign exchange and gold alone fell 13.6% , from RM 399 919 106 509 to RM 345 549 644 622. This equated in US dollar terms to a fall of 20%, from USD 125.1 billion to USD 100.2 billion.

I have previously written about the danger of having the “reserves” financed substantially by deposits from financial institutions (see reference below).
Given that the “reserves” are financed significantly by statutory deposits placed at Bank Negara pursuant to the SDR (statutory deposit ratio), a withdrawal of foreign funds requires a draw down on the forex reserves , as well as the statutory deposits as financial institutions cover their funding needs (Recall that banks borrow short term , and lend long-term).
The withdrawal of foreign funds which Zeti says is the cause of the fall in assets caused,as one would expect, a fall in the value of the Ringgit. Bank Negara often acts to stabilise the Ringgit, but the withdrawal of funds creates a shortfall in the financing of the reserves that needs to be financed from some other source.

Bank Negara appears to have financed this fall by simply printing more Ringgit.
Over the same period from 15 May 2008 to 31 October 2008 currency in circulation has increased 9.3%, from RM 42 614 989 793 to RM 46 595 122 319.
However this might not be the whole story.
Federal Govt deposits have increased 130%, from RM 9,434,186,821 to RM 21,622,286,904

This increase raises the question of where the deposits came from. It is possible that these may well be “new” Federal Government funds, recently minted and issued by Bank Negara.
All this would mean a further decline in the value of the Ringgit,and higher inflation as more money circulates in the economy. Only Zet would not be worried.

END


References:
Malaysia's reserves of Gold ,Foreign Exchange and Other Reserves including SDR as at 29 June 2007 stood at MYR 339,774,970,225.
67.4% of this amount was financed by deposits from financial institutions which totalled RM
229,099,593,853.
It was a similar asset-liability position that left Malaysia and the Ringgit vulnerable to speculative attacks in 1997.
As then finance minister, " Dr" Anwar Ibrahim was responsible for financing Malaysia's foreign reserves almost entirely out of statutory deposits -- placed at no interest by financial institutions -- at the Central Bank. (for full story by Sahathevan see http://findarticles.com/p/articles/mi_m0BJT/is_24_6/ai_55143627)

Almost a year later, as of 15 May 2008:
Malaysia's reserves of Gold ,Foreign Exchange and Other Reserves including SDR equals RM 399,919,106,509
The proportion of this amount financed by deposits from financial institutions now totals RM 284,175,898,063 , or 71.06%, compared to 67.4% as at 29 June 2007

http://sahathevan.blogspot.com/2008/06/quality-of-bank-negaras-reserves.html

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