Bank of China avoids pressure from foreign reserves and uses forward contracts to support the ringgit

Bank Negara Malaysia is increasingly using forward foreign exchange contracts to support the ringgit and reduce pressure on its foreign exchange reserves.

According to Bloomberg, the Bank of China's net forward foreign exchange position expanded to negative $27.7 billion in April — reflecting a record net short position on its forward books — showing that it is more inclined to support the currency through this approach.

Meanwhile, there has been little change in its foreign exchange reserves this year.

Due to concerns about deteriorating export prospects, the ringgit fell to its lowest point since the 1998 Asian financial crisis in February this year, and the Bank of China has been busy supporting the ringgit in recent months.

After the Bank of China called on state-owned enterprises to repatriate and exchange their overseas investment income, the ringgit curtailed its decline in March and became the best-performing currency in Asia this quarter.

Philip McNicholas, an Asian sovereignty strategist at Robeco Group's Singapore branch, said: “Net forward positions have been accumulated for many years. This partly reflects the Bank of China's efforts to support the ringgit and has avoided a more obvious decline in foreign exchange reserves.”

“This reflects concerns about foreign exchange levels, and the Malaysian ringgit is approaching the low point of the psychologically important Asian financial crisis, which can be said to have made the situation worse.”

Although the Bank of China's net forward foreign exchange position became more negative, as of the end of May, Malaysia's total foreign exchange reserves were US$113.6 billion, almost unchanged from the end of 2023.

Should global sentiment suddenly turn pessimistic, a net short position on the Bank of China's forward book may make the ringgit more vulnerable to sell-offs.

According to Bloomberg data, the Bank of China's net foreign exchange reserves after deducting gold is estimated at about $67 billion, far lower than its short-term external debt of about 112 billion US dollars.

More volatile than neighboring countries' currencies

Philip McNicholas said, “This suggests that the ringgit may be extremely sensitive to changes in risk sentiment and may be prone to excessive adjustments.”

The Bank of China is not the only central bank that uses forward books to back its currency. According to a Bank of America research report this month, the Reserve Bank of India held a net forward position of 16 billion US dollars in April to support the rupee.

Claudio Piron, a strategist at Bank of America's Singapore branch, said that the Bank of China's net forward foreign exchange position is at a historically low level, which means that the USD/MYR will be more volatile than the currencies of some ASEAN countries because the ability to intervene is more limited.

“However, this does not mean that the Malaysian ringgit is prone to currency crises. The ringgit is not overvalued; rather, it is undervalued, and the current account has a surplus.”