Absence of a NDF market in Malaysia is the key issue facing the country’s fixed income market, says analyst

by MARK RAO/ pic by MUHD AMIN NAHARUL

MALAYSIA remains on the World Government Bond Index (WGBI), preventing possible billions of dollars in capital inflow but issues over the accessibility of the country’s fixed income market continue to be a contention.

Local government bonds avoided a downgrade following FTSE Russell’s annual review last week of countries monitored by its global equity and fixed income indices, but the global index provider kept Malaysia on its watch list. Malaysia has been on the watch list since last April.

This means that the country, despite having introduced several initiatives and changes to boost market accessibility and liquidity, is still at risk of being excluded from the WGBI if its market accessibility level is downgraded from the current ‘2’ rating.

AxiTrader Asia Pacific market strategist Stephen Innes said the absence of a non-deliverable forward (NDF) market in Malaysia is the key issue facing the country’s fixed income market.

“The biggest problem facing foreign investors is that they cannot hedge the underlying currency for their bond holding when they need to,” he told The Malaysian Reserve (TMR).

Malaysia currently prohibits offshore ringgit trading both on the NDF market and for futures trading — a consequence of the 1997-1999 Asian Financial Crisis as authorities moved to contain speculation and capital outflows in the domestic financial markets.

Earlier last month, Bank Negara Malaysia (BNM) announced further liberalisation of its foreign-exchange (forex) administration policy, alongside other initiatives to boost market access, on the looming risk of Malaysia being dropped from the WGBI.

FTSE Russell said it will continue to engage with market participants to understand the practical impact of BNM’s recent initiatives but that Malaysia will remain on its watch list. In a research note last week, Innes said Malaysia’s weight in the WGBI is 0.39% while assets under management tracking the index is estimated at US$2 trillion (RM8.38 trillion) to US$2.5 trillion.

This would translate into a staggering US$8.6 billion in outflows or 2.3% of Malaysia’s GDP if the country had been dropped from the global index, he said.

Maybank Kim Eng Research said the overall impact of FTSE Russell’s decision is expected to be neutral on the bond market, with any knee-jerk market reaction likely to be short-lived.

“As there will be at least another six months of wait before the interim review is due, investors will likely switch their focus back to the upcoming Budget 2020 which will be tabled on Oct 11 (this year),” it said in a report last Friday.

The research firm said the liberalisation measures taken by BNM thus far are likely working but have not sufficiently crossed the hurdle to completely take Malaysia out of the watch list.

“There could be more follow-up measures taken by BNM on fine-tuning of policies,” it added.

Malaysia, which has been included in the WGBI since 2004, was first placed on the fixed income watch list in April this year and will remain on the list at least until FTSE Russell’s next interim review scheduled for March next year.

Recently, Malaysia’s weightage in JPMorgan Chase & Co’s GBI-EM Global Diversified Index was cut from 6.12% to 5.17% to make room for the inclusion of Chinese bonds.

UOB Global Economics & Markets Research said FTSE Russell is expected to retain Malaysia on the WGBI but will lower its index weightage to pave the way for China’s inclusion.

“We estimate that the potential exposure from these actions of a lower weight by 0.1% in FTSE Russell’s WGBI and 0.95% in the JPMorgan GBI-EMI is around RM10 billion to RM12 billion, or an equivalent of 6% to 9% of foreign holdings of government bonds or 1% of total bonds outstanding,” it said in a report last Friday.

Apart from Malaysia, FTSE Russell had also included China on its watch list but for a potential upgrade to ‘2’ as the country has been making demonstrable progress towards meeting the criteria to be included in the WGBI.