It is already becoming a cliché to hear politicians boasting on how good and resilient our economy is doing. There is always a mention on our large foreign reserves which are able to finance 9 months imports. On top of that there are always repeated assurances that our economy is fundamentally sound. On the surface it seems we are on the right track because normally surplus equals savings. With larger foreign reserves, a country not only able to finance more imports but also acts as a cushion against an economic downturn.
However what we are not told is that there are also disadvantages in having large foreign reserves. Besides generating inflation it also increased our reliance on the US$ which we are already trapped. We are unable to rid our reliance on using the US$ for trade and foreign exchange reserves. This is because for all we know the USD is on the last leg on being the dominant currency of trade and foreign reserve of choice. Recently, De-dollarization or reduced significance of the dollar is gaining momentum as Western countries started with Britain and now followed by Germany, France, Luxembourg and Italy announced that they are joining the China-led Asian Infrastructure Investment Bank (AIIB) as founding members. AIIB rivals the World Bank and the IMF in form and functions and thus with some of the world biggest economies becoming members, the significance of the world institutions are at stake. What this means to the Dollar? It’s role as a currency of choice for Foreign Reserve and pricing for most commodities will be significantly reduced. It’s value is going to plummet and dominance will come to an end. Thus, soon we will see the rise of the Yuan as the next Gold-backed Reserve Currency if not one of the Reserve Currencies. Further evidence on the Dollar over-valuation can be shown by the following chart.
Below is the Dollar index chart.
As can be seen the USD went parabolic since July last year and that coincides with the plunge in the Global Oil Price. It appreciated by more than 25% since last year. Needless to say, anything that goes up parabolic will end in a crash. So, I reckon that the coming plunge in the USD will have drastic repercussions to the Global economy as many nations are now engaging in competitive currency and interest rate devaluations.
Back to our discussion on how the balance of payment works and relates to the foreign exchange reserve.
What is Balance of Payments?
A country can only increase the size of its foreign reserve when it is running a balance of payment surplus. What exactly is the Balance of Payments? To illustrate let me present you below with the table of Malaysia’s Balance of Payment from 2009 to 2012 in summary form.
Balance on Current A/C
Balance on Capital A/C
- Capital Outflow
+ Capital Inflow
Foreign Reserves (Mil)
Sustain Import (Months)
Source : Bank Negara Malaysia
At first look it may be difficult for a layman to understand the concept of a country’s balance of payment. All they read from the media mainly concerns whether a country is running a balance of payment deficit or surplus. Hence, they would not have a clue on how a surplus or deficit relates to a country’s international transaction and payment flows. But fear not, it is not as complex as it seems. Let me present you a quick introduction to the concept of Balance of Payments. Basically, it consist three parts namely the Current Account, Capital Account and the Statistical Discrepancies.
The Current Account deals with the import and export of goods and services. It records transaction arising from trade in goods and services, income accruing and transfers of residents in one country to residents of another.
The Capital Account deals with the import and export of assets. It records the transactions related to international movement of financial assets.
The Statistical Discrepancies or Error and Omissions deal with the problem of data accuracy and timing.
In practice the Current Account and Capital Account should balance. This is because the surplus in the current account should match the deficit in the capital account and vice versa. However, sometimes there might be problems with the data due to delay and timing. To force the current and capital account into balance, the statistical discrepancy is brought into the equation.
Or put it in equation form,
Current A/C + Capital A/C + Statistical Discrepancy = 0
However if you delve deeper into our Balance of Payment above, you will be able to detect not only irregularities in their classifications but also ill conceive government policies on debt management.
Few things to Note
Firstly, our Government did not reduce our debts. From above table, it shows our country is running balance of payment surpluses in three out of the four years. There are two things a country can do when it is running a balance of payment surplus. One, it can add on to its foreign reserves and the other is to retire some of its debts. Malaysia obviously opted for the first option and that is to add to its foreign reserves. In 2010 our foreign reserves dropped to RM 328,649 million due to the absorption of the RM 2,628 million deficits. Then in 2011 it soared to RM 423,331 million due to the budget surplus of RM 94,682 million in 2011. Again in 2012, it went up to RM 427,204 million when we have a budget surplus of RM 3,873 million.
Why are we not using our large reserves to reduce some of our debts or finance our Government expenditure with the surplus? Why our Government implemented austerity measures such reducing subsidies and increasing taxes (GST) which only burden the people?
Secondly, why such a huge Statistical Discrepancies? As you can notice the main objective of the Statistical Discrepancies is to force balance the account due to the delay or accuracy of the respective accounts. Normally these are only minor adjustments and don’t run into tens of billions. If the discrepancy is huge then there should be some serious problems with our data accuracy and hence suspicion. Take for example during 2010 the Statistical Discrepancy stood at RM 70.7 billion which is almost 80% of our Balance of Current Account? Similarly, during 2011 (RM 24.5 billion) and also in 2012 (RM 33.6 billion). One explanation will be due to the large hidden capital flows. Why are there such a large discrepancy?
The only explanation is that there are people secretly diverting funds out of our country or in other words money laundering. The following chart shows the illicit funds flowing out from Malaysia.
Source : Global Financial Integrity
As seen from the data derived from Global Financial Integrity, a U.S based financial watchdog, there has been a constant rise in illicit funds going out of Malaysia. The worst is during 2010 where US$ 64.3 billion flowed out. As its name suggest ‘Discrepancy’, hence it is very difficult to keep track of the financial transaction flows between our residents and foreigners.
Thirdly, there is a massive Capital Outflow from Malaysia to foreign countries. From 2009 till 2012 it totaled RM 168 billion. It is obvious that there is not a single private Malaysian company can afford to invest that much abroad as indicated in the Outward Foreign Direct Investment. Those are illicit capital outflow from our country.
What can be deduced from above is that there is certainly much suspicion on the accuracy of the data presented to us. It raises more questions than answers as to why our statistical discrepancies and capital outflows are way out of normal occurrences. There is no better explanation other than being used to masked illicit funds transfer out of our country. This also helped contribute to our fast plunging Ringgit and falling reserves in the past year as shown by the graphs below. The depletion of our foreign reserves from USD 138 billion to USD 112 billion this year has been mainly due to our Bank Negara intervention in the foreign exchange market.
I reckon it is about time we should open up the bank records to see who are these culprits.