Are the growing reserves in ASEAN nations a concern

Photo: Gunawan Kartapranata/CC BY-SA 3.0
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ASEAN foreign reserves have reached the highest levels seen since 2014. Is this worthy of a celebration or a sign of unhealthy reserves level?

By Oliver Ward, Edited by Joelyn Chan

Many ASEAN nations’ foreign reserve levels are climbing back to the extremely high levels seen in 2013 and 2014. At the end of 2016, ASEAN held over US$627 million in foreign reserves; representing around 6.27% of International Monetary Fund (IMF)’s total foreign reserve holdings of over US$10 billion.  Indonesia is one contributor to the ASEAN foreign reserves’ growth. It rose nearly US$28 billion – from US$95 billion in October 2015 to just under US$123 billion in August 2017.

Source: Capital Economics

Source: Capital Economics, CEIC (Cambodia, Laos)

Should all countries hold foreign reserves?

On paper, holding substantial foreign reserves are a positive thing. Access to extensive foreign exchange reserves offers significant protection from troubles relating to short-term external debt repayment. Nations make payments for imports and international obligations from their foreign reserves. Healthy levels of foreign reserves indicate stability.

Such stability also maintains confidence in the currency and economy. Thereby, it generates more borrowing opportunities. Foreign exchange reserves held by a nation’s central bank also allow it to control the national currency. By purchasing more national currency using foreign reserves, the central bank can prop up the currency in a crisis, vice versa.

However, holding vast reserves of foreign currencies leaves the nation open to external shocks. Although the US dollar has seen its position as the dominant currency for foreign reserves eroded, it still makes up 62% of international foreign reserve holdings. As a result, any fluctuation in the dollar can have significant repercussions on any national economy. The 2008 US financial crisis and the US interest rate increases in 2013 and 2014 have proven capable of causing temporary instability in foreign exchange markets.

Amassing too much foreign reserve can be counterproductive

Past a certain point, the benefits of holding more foreign reserves become nullified. Foreign exchange reserves are not high-yielding assets, and excessive accumulation for short and medium-term future is inadvisable. Further investment in methods to stimulate Gross Domestic Product (GDP) growth will better protect a country’s long-term stability than amassing more foreign reserves.

Do ASEAN nations have a healthy level of foreign reserves?

Source: Capital Economics, CEIC (Indonesia, Cambodia, Laos), World Bank (Myanmar)

Singapore maintains a very high level of foreign reserves to meet its short-term international payments. Its short-term external debt stood at 339% of GDP at the end of 2016. On the other hand, the Philippines and Thailand have short-term external debts of just 4.8% and 13% of their 2016 GDPs. Yet, their foreign exchange reserves are much higher, at over 45% of GDP. They have far more foreign exchange reserves than necessary to meet their impending international payment obligations.

In 2015, Malaysia held foreign reserves amounting to 35% of its GDP, which is also equivalent to four months worth of imports. Its short-term debt ratio of 80% provides enough liquidity to meet short-term international payments.  Concurrently, it defends the currency against any potential attack and frees up more capital for investment in higher yielding areas.

The current increase in reserves across ASEAN will likely prove temporary. If empirical studies stay true, Indonesia, Malaysia and Thailand will reduce their foreign reserves after their 2018 or 2019 general elections. Their respective leaders are accumulating foreign reserves now to prevent from any negative fluctuation in currency. Any pessimism before the run-up to an election may cost them votes.

A shift in US fiscal policy could have a serious impact

While high ratios of foreign reserves to GDP are not going to trigger an ASEAN crisis, any shift in US fiscal policy and European financial policy would lead to a drop-in value for the US dollar and Euro.  Such dependence would severely impact the stability of economies.

But attempts to diversify have still not occurred ASEAN-wide. In 2011, trade in renminbi (RMB) was just 8% of ASEAN’s total trade and still hovers at similar levels globally. At the end of 2016, it accounted for 1.1% of global foreign currency reserves. However, this will increase soon as China entices ASEAN nations with more bilateral currency swap agreements. Existing agreements allowed banks in Singapore, Thailand and Malaysia to handle RMB, but the credit offered was not significant. In April 2017, Japan tried to promote yen with a similar arrangement.

Last year, Singapore and the Philippines started including the RMB in their foreign reserve investments. Singapore has also established an offshore RMB bond market, which will make it simpler to conduct trade in the Chinese currency. If more trade deals begin to use RMB in the region, more countries will begin to hold more RMB and lesser dollar in their reserves.

Vietnam is already trying to wean itself off the dollar. In 2015, the country’s central bank set a 0% interest rate on dollar deposits. However, the adoption of alternative currencies will take years, as seen from how China took six years to fully diversify their low-yield reserves and reduce the percentage of GDP held in foreign exchange reserves.

Is the dollar likely to collapse in the future?

The conditions for a serious collapse of the weakening dollar are present. The dollar declined 54.7% against the Euro between 2002 and 2012 and reached a new two-year low in July 2017. While the dollar remains the dominant foreign reserve currency, it will avoid a collapse. But if the RMB begins to make severe erosions in the US dollar’s dominance, ASEAN will have no choice but to diversify or take huge losses.

ASEAN’s increasing foreign exchange reserves offer security, but at the sacrifice of high yielding investments. While some nations, like Singapore and Malaysia, have kept their reserves in proportion to their short-term debt, nations like the Philippines and Thailand are opening themselves up to unnecessary risk and volatility in the global currency markets. Nations can avoid a crisis while the dollar remains stable, but this is far from guaranteed.