Fitch Ratings: Reserve dynamics among APAC sovereigns appear to be diverging, with potential implications for their credit profiles, says Fitch Ratings. Some central banks have been able to accumulate reserves on current account improvements or investment inflows, while others still see their currencies under pressure from US Fed tightening prospects.

Official reserves among Fitch-rated sovereigns in APAC increased by almost USD170 billion in 1H23, mostly driven by growth among those with already large reserve buffers, including China (A+/Stable), Singapore (AAA/Stable), India (BBB-/Stable), Japan (A/Stable) and Taiwan (AA/Stable). Strong external liquidity positions support these sovereigns’ credit profiles, but further reserve increases are unlikely to have much near-term influence on ratings.

Several sovereigns in ASEAN, including Indonesia (BBB/Stable), Malaysia (BBB+/Stable), the Philippines (BBB/Stable) and Thailand (BBB+/Stable), saw reserves decline over 2Q23, which may in some cases reflect intervention to support currencies. The changes have been marginal so far, not influencing credit profiles significantly, but currency pressure may continue until the Fed finishes raising rates.

Reserve dynamics may have a greater impact for frontier market sovereigns, especially where reserve coverage ratios are low and external liquidity positions fragile. In our most recent rating assessments, we stated that external finance factors, potentially including marked or sustained declines in foreign-exchange reserves, could be a driver of negative rating action in sovereigns such as Bangladesh (BB-/Stable), the Maldives (B-/Negative), Mongolia (B/Stable) and Vietnam (BB/Positive).

Official reserves fell by around 29% in the Maldives over January-July 2023, reversing the improvement in reserves in late 2022 following the conclusion of a USD200 million bilateral currency swap with India. Bangladesh improved reserve transparency with the adoption of IMF definitions in June. IMF data show its reserves declined 31% over January-July, but we estimate the decline could be around 16% if the new definitions applied throughout the period.

By contrast, reserves in Mongolia and Vietnam climbed over 1H23. Official reserves rose by 3% in Vietnam over January-May 2023 (most recent available data), after falling 21% in 2022. The modest increase partly reflects a widening of the goods trade surplus in 1H23, as weaker domestic demand has curbed imports, offsetting the effects of a continued contraction in exports.

At USD3.9 billion in August, Mongolia’s reserves remain below the historic peak of USD4.9 billion seen in 2Q21, but have risen significantly from their recent low of USD2.7 billion in August 2022. This partly reflects strong growth in exports over 2H22 and 1H23, as well as Mongolia’s USD450 million bond issue and a USD200 million exchange and tender offer in January 2023. Larger reserve buffers should reduce Mongolia’s external financing vulnerabilities. Nevertheless, these will still be significant in light of the country’s high net external debt burden and our projections for further current-account deficits in 2023-2025.

Pakistan’s reserves rose by around USD3.8 billion in July after the country agreed to a nine-month Stand-by Arrangement with the IMF. We upgraded Pakistan’s rating to ‘CCC’, from ‘CCC-’ in July, on the assumption that the IMF deal would catalyse other funding and anchor policy around the parliamentary elections. A rebuilding of reserves and easing of external financing risks could increase upward pressure on Pakistan’s rating. However, the political climate remains volatile and we view risks to IMF programme implementation and external funding as high amid Pakistan’s large external financing requirement.

Fitch rates Sri Lanka’s Long-Term Foreign-Currency Issuer Default Rating at ‘Restricted Default’, or RD. The country’s reserves levels will influence the rating only once we have moved it out of ‘RD’. Despite an increase in reserves over the last nine months to around USD3.8 billion in July 2023, they remain well below the USD7.3 billion average over 2014-2019.