KUCHING: It was a typical end of the work week for Malaysians on Friday, April 5 when news of Norway’s sovereign wealth fund broke.
The world’s largest fund said it would streamline its US$300 billion fixed income portfolio by cutting emerging market bonds from the benchmark index that it tracks.
This includes Malaysia, the Norwegian finance ministry said in its statement, which makes up US$1.9 billion of the fund according to data.
Market participants expect the Norwegian fund to dispose close to RM8 billion in Malaysian Government Securities (MGS).
Analysts at AmInvestment Bank Bhd (AmInvestment Bank) says this translates to 5.3 per cent of total foreign holdings as at end-March 2019.
“As a result of this noise, our bond yields rose across the curve by two to three basis points,” it said in a report outlook.
“However, the yields eventually settled after 2 days of selling pressure suggesting that the impact from the exit will be gradual and not have significant impact on yields.
This was swiftly followed by British index provider FTSE Russell announced that it might drop Malaysian government debt from the FTSE World Government Bond Index (WGBI) due to concerns on market liquidity.
Currently, Malaysia is assigned a “2” and has been included in the WGBI since 2007. The risk is to be downgraded to “1”.
“Estimations suggest our exposure with the FTSE Russell is around 0.4 per cent which is about US$8 billion or approximately RM32 billion,” AmInvestment Bank noted.
“This translates to 21.2 per cent of foreign share holdings as at end-March 2019.”
A decision on this will be made in September this year.
Finally, international rating agency Moody’s commented that Malaysia risk falling into “negative credit” given that the government plans to bail out Felda with RM6.2 billion that could add on to the debt service ratio and also the fiscal deficit target.
“Our credit rating with Moody’s is currently A3 (Stable). The potential risk is that we could be maintained at A3 but lowered to “Negative” from “Stable” or drop one notch to Baa1.”
Debt outflow at 11-month high
All these insecurities continue to plague the local bond market. The economics team at Kenanga Investment Bank Bhd (Kenanga Research) in its latest observations saw that Malaysia’s foreign debt outflow reached a 11-month high in April.
Foreign investors turned net sellers of Malaysia’s debt securities in April, as total foreign holdings dropped by RM9.8 billion or minus 5.2 per cent on a monthly compatrison to RM180.1 billion — marking its largest outflow in 11 months.
Consequently, the share of total foreign holdings of Malaysia’s debt inched down to 12.5 per cent against 13.3 per cent seen in March.
This was its lowest share in more than nine years.
“Similarly, foreign funds were net sellers in the equity market in April, totalling RM1.4 billion, less than March’s outflow of RM1.6 billion,” Kenanga Research said in its May 10 report.
“Collectively, the capital market experienced its largest net outflow of foreign funds in the last ten months totalling RM11.2 billion.”
The outflow was likely triggered by Norwegian sovereign wealth fund’s omission of Malaysia’s securities from its index and potential exclusion of Malaysia’s debt from the FTSE World Government Bond Index, Kenanga Research said, in addition to elevated concerns over the ongoing US-China trade war.
“The bulk of April’s decline was accounted by a net sell-off of Malaysian Government Securities (MGS) by RM3.5 billion, Malaysian Government Investment Issues (GII) by another RM3.5 billion and Malaysian Treasury Bills (MTB) by RM1.1 billion.
Consequently, the foreign holdings share of total MGS, GII and MTB dropped to 37.1 per cent, 4.8 per cent and 22.4 per cent, respectively.
Private Debt Securities (PDS) also trended down, extending its decline by RM1.5 billion, with the share of foreign holdings softened to 1.7 per cent.
“The reversal of trend into a net outflow was mainly reflecting the knee-jerk reaction following the announcement by FTSE Russell on potential exclusion of Malaysian debt from the FTSE World Government Bond Index, placing Malaysian debt under a watch list for a 6-month period, with another cycle of review slated in September.
“However, damage to sentiments was contained by FTSE Russel’s emphasis that “inclusion on our Watch List is not a guarantee of future action”, whilst suggesting enhanced engagement with the government in addressing investors’ concerns in the interim period.”
Optimism on the front
On the ground, industry observers remain optimistic on Malaysia’s outlook. Local credit ratings agency RAM Rating Services Bhd expects the Malaysian bond market to remain resilient despite the risks of being removed from global index provider FTSE Russell’s World Government Bond Index (WGBI) due to concerns about market liquidity.
Head of data analytics Julie Ng said the expectation is based on strong corporate fundamentals, low foreign participation in the corporate bond market and ample liquidity in the market.
“Corporate fundamentals are still very strong in terms of their financial matrix and their ability to service the debt is still fairly reasonable and resilient.
“That is why, in spite of that the FTSE Rusell index pullout, I don’t think it will affect the corporate debt that much,” she said in a Bernama interview on the sidelines of RAM’s League Award and Conference 2019.
She said foreign participation in the corporate bond market is only at the lower single digit.
“Even if all of them pull out, it will still not affect the corporate bond yield. In that sense, I think the corporate bond space is fine,” she said.
She said Malaysia also has ample liquidity in the market and capable local investors to step in if foreigners decided to exit the corporate bond market.
“Investors like the Employees Provident Fund (EPF) and some of the insurance companies have big funds and enough buffer to step in and buy up the supply,” she said.
Meanwhile, Ng said bond issuance in Malaysia this year is expected to reach RM100 billion, underpinned by the decision to revive the East Coast Rail Link (ECRL) and Bandar Malaysia projects.
“Initially, our house view is actually lower at around RM70 billion-RM80 billion because of the government rationalisation and projects’ extension and delay such as the Light Rail Transit 3. So, we thought bond issuance might? not be able to keep the same amount this year as per last year,” she said.
However, she said the revival of the ECRL and Bandar Malaysia projects could spur some demand for the construction companies.
OPR cut a boon for bonds
With BNM having reduced the policy rate by 25 basis points to 3 per cent, research houses believe this should be positive for Malaysia’s bonds. AmInvestment Bank foresee the 10-year MGS hovering between 3.70 to 3.75 per cent.
“As for the US dollar-ringgit outlook, our base case remains at 4.08 to 4.10 by end-2019,” it said.
But with the ongoing external noises and domestic challenges like trade policy tensions between the US and China that can play out into other areas like the auto industry, it may cause large disruptions to global supply chains.
This is on the back of downside risk to growth in countries like in the Eurozone and China; Brexit noises; a deterioration in global market sentiments that can rapidly tighten financing conditions; and risk of the Federal Reserve making a mistake by downplaying the recent slide in inflation to be due to “transitory” factors.
“All these will cause volatility that could result in the 10-year yields touching the 3.90 to 4.00 levels while the USD/MYR swing is around +/- 2% from the current levels depending on the severity of these noises,” it said.
Kenanga Research expected BNM to retain its accommodative monetary policy, with the OPR to remain at three per cent for the rest of this year, amid subdued inflation.
“On the ringgit outlook, we maintain our US dollar-ringgit year-end forecast at 4.10 as economic fundamentals remain strong, in spite of prospects of softer economic growth and the tendency for foreign funds to flee to safe-haven assets.”
The government’s gross issuance totalled RM10.5bil in April or up 28.8 per cent month-on-month (m-o-m) bringing the year-to-date (YTD) gross issuance to RM47 billion or up 11.9 per cent year on year (y-o-y).
However, net issuance in April was only RM0.5 billion after a five-year GII paper that was issued in July 2013 with a size of RM10 billion came into maturity.
As a result, the combined total outstanding of the MGS and Government Investment Issue (GII) in April rose slightly by 0.1 per cent m-o-m to RM714.5 billion, bringing the YTD net issuance to RM29.8 billion or up 26.7 per cent y-o-y.
Its ratio in percentage between the MGS and GII is 44:56.
During the month, AmInvestment Bank saw the new issuance of the five-year GII 10/24 which reported a bid-to-cover (BTC) ratio of 2.313x. In the case of the reopening of the 15-year MGS 11/33, the BTC was 2.792.
However, the reopening of the 7-year 07/26 MGS saw the BTC at 1.510 times which could be partly be due to the jitters that saw investors take a wait-and-see attitude.
As for the secondary market, the MGS accounted for 58 per cent of trade while the GII made up the balance 42 per cent in April.
The primary focus during the month was on the long-term tenors above 10-years.
This segment of the papers accounted for 28.6 per cent of the total trade in April or RM87.3 billion. Besides, there was a sizeable appetite for the seven year to the 10 year MGS and GII papers, which made up of 18 per cent of the RM87.3 billion of total govvies traded during the month.
Meanwhile, corporate issuance activities moved in tandem with the govvies issuance.
It rose by 4.7 per cent m-o-m to RM10.4 billion in April supported by an increase in government guarantees which made up 65.2 per cent of the overall gross issuances.
Top issuers were DanaInfra Nasional Bhd (RM3.8 billion), Lembaga Pembiayaan Perumahan Sektor Awam (RM3 billion) and Maybank Islamic (RM1 billion).
However, on a YTD basis, corporate issuances fell 10.8 per cent y-o-y to RM35.5 billion following a slower issuance in the PDS market reflecting a softening domestic demand.
For the year 2019, we expect the total gross issuance of the MGS/GII in the primary market to be around RM120 billion and RM125 billion respectively. Meanwhile in 2019, the total amount of the MGS/GII that will come into maturity is RM69.1 billion.
As at end-April, the total amount of the MGS/GII matured is RM17.7 billion, which means the balance that will come into maturity for the remaining months of the year is RM51.4 billion.
Looking at Malaysia’s corporate bonds and sukuks, we project a total issuance of RM80 billion to RM85 billion in 2019. As at end-April, with RM35.5 billion issued, we estimate a balance of RM44.5 billion to RM49.5 billion to be issued in the remaining months of the year.
Impact on the ringgit
Towards Malaysia’s currency, Norway’s fund decision and FTSE Russell’s warning remain a crucial threat to the ringgit in 2019.
MIDF Amanah Investment Bank Bhd (MIDF Research) said the decision of Norway’s sovereign wealth fund to reduce exposure to emerging market including Malaysia is expected to see a substantial outflow from Malaysian bond market over time, putting pressure on the ringgit.
“In addition, the possible downgrade of Malaysian bond market by FTSE Russell will continue to haunt the ringgit until September 2019, given the deadline given,” it said.
“If the downgrade takes place, Malaysia would be excluded from the WGBI for the first time since 2007 hence further outflow from domestic bond market could be seen, heightening chances for more ringgit’s depreciation.”
Concerns on US President Donald Trump’s move lingers on the ringgit, MIDF Research said, as a trade deal between the US and China is expected to provide a relief to rest of the world, fears flare as the delicate trade talks could collapse.
“If the talks fail, it will further dampen global trade and investment activities including Malaysia’s and eventually weigh on growth,” it added.
Meanwhile, weak exports demand is likely to narrow Malaysia’s current account surplus, contributing to the ringgit’s weakness.
Bank Negara Malaysia on Thursday said the ringgit rose 1.4 per cent against the US dollar in the first quarter of 2019 (1Q19), driven mainly by non-resident portfolio inflows at RM13.5 billion.
However, from April to May 15, the ringgit depreciated by 2.2 per cent against the US dollar, in line with most regional currencies.
“The recent depreciation pressure reflected cautious investor sentiment in global financial markets, amid the weakening global growth outlook, as well as uncertainties surrounding geopolitical and global trade developments,” it said in a statement.
Meanwhile, BNM said headline inflation averaged at minus0.3 per cent in 1Q19 from 0.3 per cent in 4Q18.
“Headline inflation turned negative in January and February due to lower domestic fuel prices, but turned positive in March as the increasing trend in global (crude) oil prices led to higher domestic fuel prices,” it added.
Moving forward, the central bank said headline inflation was expected to average between 0.7 and 1.7 per cent this year.
Core inflation – excluding the impact of consumption tax policy changes – was unchanged at 1.6 per cent.
This is expected to be stable, supported by the continued expansion in economic activity and in the absence of strong demand pressures, BNM said.
On the move to cut the OPR, MIDF Research said this would not boost the Malaysian currency as lower interest rates tend to be unattractive for foreign investments, reducing the demand for and relative value of the currency.
“Given that other factors determining the value of Ringgit such as political and policy stability are still in a flux, we believe that OPR cut will result in further depreciation of Ringgit.
“Despite all the downside risks, gradual pick-up in commodity prices particularly Brent crude oil, better fiscal position of Malaysian government, higher investment and domestic consumption activities likely resulting from OPR cut and steady economy growth will be supportive to the ringgit.
“We revised downward our end-2019 ringgit target to RM4.10 against the US dollar.
“We foresee ringgit at RM4.10 by year-end of 2019, a two per cent decrease from RM4 previously forecasted.
“Similarly, we expect the ringgit to average at a higher rate of RM4.12 in 2019 compared to RM4.05 previously estimated.”
Eye on green bonds and sukuk
As awareness grows, sustainability is quickly becoming a key component demanded by investors for financial tools.
Green bonds are a way forward to attract new type of investments or investors, but clear definition must be provided, says Cagamas Berhad President/CEO, Datuk Chung Chee Leong.
He said there was a need to standardised classifications on whether a loan was “green” or otherwise, as Malaysia is beginning to explore green bonds, hence, requiring sufficient green assets to be pooled together for issuances.
The loans are needed to make up a portfolio that allow for issuance of bonds or securities under this category.
“So, the first building block is to define what green housing loan is,” he said at a panel session titled Connecting Capital Markets and Affordable Housing Delivery in early April.
Chung said the definition for green loans would spell out areas such as whether the building should show improvements in either water or energy consumption.
He added that the World Bank could perhaps assist with an internationally accepted definition.
He said there were some pension funds in other parts of the world that allocate part of their funds towards investment in this sustainable green type of instruments, and that supports socially responsible investments (SRI).
The Securities Commission in Malaysia itself has categorised affordable housing as one of the SRI categories in the local market.
Korea Housing Finance Corporation chairman and CEO Junghwan Lee said the Korean government had given preferential treatment to social bonds and SRIs, making it an incentive for more issuance of such bonds in that market.
“Preferential treatment include concessional tax rate for social bonds and a special provision for pension fund reserve,” he said, adding that was expectation of more preferential treatment this year.
On the subject of preferential treatment, the World Bank senior advisor in Finance, Competitiveness and Innovations, Loic Chiquier said that was part of factors that support new players in housing sectors who have yet to access capital markets for funding.
Chung said for example, if a secondary mortgage corporation were to be set up, it could benefit from central bank and government support.
“But I guess the other point really is the prudent risk management standards that Cagamas itself applied so it can be perceived by the market, rating agencies and other investors as a safe model they can invest in,” he said.
He also said Malaysia has a robust fixed income market and Cagamas had facilitated funds from the capital market to the housing sector.
On the topic of government intervention in the affordable housing sector and in setting up structures such as real estate investment trusts, RAM Rating Malaysia Structured Finance Ratings head, Siew Suet Ming said intervention could be helpful at the initial stage, likened to paying “tuition fees” at the start of a college education.
“First it gives (investors) a level of confidence, then (later) be able to build a sustainable pipeline,” she said, adding that intervention would add a certain amount of certainty in the housing market.
To that, CRH France non-executive chairman Olivier Hassler said there were always challenges for investors in the affordable housing sector, as it dealt with lower income markets.
Issues include lower rental yields compared to the cost of funding from the capital market.
But, he said this was where governments could intervene to mobilise more funding from the capital market in general and to fill gaps in terms of returns. Smart subsidies are one way to target end users, Hassler added.