Sustained fall in APAC sovereign reserves could erode external buffers for some: Fitch

September 08, 2022 (MLN): Official reserves among APAC sovereigns declined by roughly $590 billion in 7MCY22 with the strengthening of the US dollar. Still, many sovereigns in the region have substantial reserve buffers, but for a small number, the fall is an indication of mounting external financing stress, noted Fitch Ratings in its latest report.

The report believes that some of the decline also reflects moves by certain regional central banks to support their currencies, offsetting depreciation pressures that might otherwise have added to imported inflation.

For many APAC sovereigns, reserve buffers have fallen to pre-pandemic levels, after a significant rise over the past two years, partly driven by pandemic-related factors, including demand compression. The largest declines in value terms over 7MC22 were in China (A+/Stable), Singapore (AAA/Stable) and Japan (A/Stable), all from high levels. Singapore’s 31% decline between end-2021 and July 2022, was driven by a transfer of reserves from the Monetary Authority of Singapore to GIC for longer-term investment.

Some central banks with more comfortable reserve positions, including the Reserve Bank of India, have deployed them to support their currencies.

The American credit rating agency generally does not view the use of reserves to smoothen excessive exchange-rate volatility as challenging creditworthiness. However, should the regional decline in reserves be sustained, this would eventually put downward pressure on ratings for some APAC sovereigns.

This risk could be significant where reserves have been a rating strength that offsets other credit weaknesses, such as in the Philippines (BBB/Negative) or where external finances have traditionally been weaker than peers, such as in Indonesia (BBB/Stable). Nonetheless, the fall in reserves so far in 2022 has been moderate in the Philippines and Indonesia, while high commodity prices have temporarily strengthened the latter’s external balance sheet, it said.

For some frontier markets, large reserve drawdowns reflected the scarcity of alternative financing options amid mounting external liquidity strains. This contributed to the revision of the Outlook on Pakistan's 'B-' rating to Negative from Stable in July 2022.

The report also stated that low reserves contributed to Laos’ challenging external debt repayment profile when Fitch downgraded its rating to ‘CCC-’ in August. Lack of foreign exchange also contributed to Sri Lanka’s default on its external debt in May 2022.

“Foreign reserves in Mongolia fell by 38% between end-2021 and end-August. When we affirmed Mongolia’s rating at ‘B’, with a Stable Outlook, in May 2022 we stated that heightened external stress, evident from a marked decline in foreign reserves, could be a driver of negative rating action. We assumed in May that reserves would recover to reach $3.6bn by end-2022. They remain below this level, at $2.7bn at end-August.”

Bangladesh’s reserves fell by 16% between end-2021 and end-August, but its external finances are stronger than those of Laos, Mongolia, or Pakistan, and its external debt servicing profile for the next few years is light. Nonetheless, the rating agency affirmed its rating at ‘BB-’ in November 2021. It highlighted media reports suggesting that some international reserves might be invested in non-liquid assets, and stated that a significant decline in reserves could be a driver of negative rating action.

Meanwhile, Bangladesh is reportedly seeking a multi-billion-dollar loan from the IMF, although official data show it had almost $39bn in reserves at end-August and the country is not facing immediate refinancing stress, according to Fitch Ratings. If secured, an IMF programme would provide additional assurance about the country’s external position.

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