Use of domestic sukuk credit positive


Malaysia’s increasing use of domestic sukuk to fund its budget deficit is credit positive for the country as it brings stability and diversity to its borrowing profile, Moody’s Investors Service Inc noted.

The rating agency said Malaysian Government Islamic Issues (MGII) grew to 40% of outstanding government debt at the end of the first quarter of 2018 (1Q18), while the country’s efforts to deepen its Islamic financial market should drive this share higher going forward.

Rated A3 stable, Malaysia has a sizeable debt burden at 50.8% of gross domestic product (GDP), which is larger than the 40.1% median of GDP for A-rated sovereigns, according to Moody’s.

It noted that this is partially offset by the country’s low exchange-rate risk due to its relatively low-cost and liquid domestic funding, coupled with 96.4% of its debt denominated in local currency. Islamic financial instruments support this local currency funding component as MGII, or local currency Shariah-compliant debt instruments, accounted for 50% of total federal government financing last year, Moody’s noted.

“We view the shift toward Islamic financial instruments to be credit positive for the sovereign rating because of the more stable nature of these holdings compared to conventional bonds and the diversification that they impart to Malaysia’s debt profile,” it said.

It said MGII is also less volatile than conventional bonds due to its low take-up from foreign investors who hold about 5% of outstanding MGII as of June this year.

This is significant when compared to foreign holdings of Malaysian Government Securities (MGS) which stood at 40.1% over the same period.

Banks, especially Islamic institutions and institutional investors such as the Employees Provident Fund and Retirement Fund Inc, further contribute to demand for MGII, added the rating agency.

“If volatility in MGII holdings continues to be lower for MGS, greater use of the Islamic instruments would lend stability to the government’s financing plans.”

Moody’s said regulatory measures have also supported more active trading in Islamic instruments as the authorities move to increase liquidity in the Islamic finance market and narrow the pricing gap between conventional bonds and MGII.

“In 2017 for example, the central bank announced initiatives, including liberalising short-selling for all residents and making MGII securities with an outstanding nominal amount of at least RM2 billion, eligible for short-selling in addition to conventional government bonds.”

According to Bond Pricing Agency Malaysia Sdn Bhd, the suspension of large-scale infrastructure projects in Malaysia is unlikely to pose a risk to conventional or sukuk bonds as these projects have yet to tap into the local bond market.

Its CEO Meor Amri Meor Ayob said the current Dana-Infra Nasional Bhd Islamic Commercial Paper and Islamic Medium Term Notes programme is to finance the expenditure and expenses in relation to works on the mass rapid transit (MRT) project.

He said it is unlikely the bond was issued for MRT3 as the project has yet to start.

“We do not foresee any credit-related issues for the sukuk of completed projects such as the MRT1 as well as ongoing projects like the MRT2, as these sukuk carry an explicit government guarantee,” he told The Malaysian Reserve in an emailed reply.

“Thus, the government is required to honour the bond which would most likely remain outstanding until they reach their respective maturity dates.”