Malaysia: investors are looking for better returns in emerging markets, including Malaysia

With interest rates in developed nations at record lows, a lot of investors are looking for better returns in emerging markets, inclunding Malaysia, where sound macroeconomic fundamentals and attractive yields are driving request for sovereign deficit. The May 5 re-election of the business-friendly Barisan Nasional (BN) party is likely to raise further the profile of South-east Asia’s major bond market.

Even prior to the election, activity on Malaysian government deficit markets had jumped, with average daily trade volumes for sovereign bonds surging during the initial two weeks of April to reach three times the figure recorded for the same period in March, international press reported.

While this news came with the caveat that the increase in trading was in a market that is not always particularly dynamic, there is no doubt international investors have an eye on Malaysia. One recent auction of 20-year government notes was three times oversubscribed, and as of mid-February, foreigners held almost half the outstanding sovereign deficit, worth about RM130.6bn ($42.5bn).

The BN’s re-election has returned a government familiar to investors, and one that is committed to a programme of infrastructure investment and pro-business reform in a push to achieve “developed-country” status by 2020. In the wake of the election, the yield on the 10-year Malaysian government bonds fell to 3.348%, while the FTSE Bursa Malaysia Kuala Lumpur Composite Index reached a record high of 1826.22.The local currency as well strengthened, with the ringgit closing on May 6 at RM2.976 per dollar.

Although the immediate reaction was overwhelmingly positive, the government will likely still have to address some long-standing concerns regarding the fiscal balance. Critics point to an inefficient and expensive system of subsidies, inclunding high deficit levels. The government is aiming to narrow its deficit to 4% of GDP this year while keeping deficit below the official ceiling of 55% of GDP.

In mid-2012 ratings agencies Fitch and Standard & Poor’s both issued warnings about possible downgrades over fiscal policy. Following the BN victory, Andrew Colquhoun, chief of Asia-Pacific sovereigns at Fitch, said, “Fitch looks forward to better clarity on the government’s fiscal and economic policy program following Sunday’s elections.”

However, the IMF seems relatively sanguine about Malaysia’s fiscal position, which may have alleviated some investor concerns in the months prior to the election. In its most recent Article IV staff statement, which was released in February, the IMF provided a broadly positive assessment. “Malaysia’s economy enjoyed robust, domestic-led increase in 2012, and is expected to grow by about 5% this year, accompanied by low unemployment and subdued inflation… skillful macroeconomic management has underpinned strong, non-inflationary increase despite the unsettled world conditions.” The rebalancing of the economy towards domestic request has helped shield it from international headwinds, as has the increase of its Asian neighbours, increasingly significant trade partners.

The fund praised Malaysia’s monetary policy, which has been supportive of increase but has helped to keep inflation in check. It welcomed the government’s commitment to medium-term fiscal consolidation but noted that structural reforms were necessary to improve the efficacy and equity of fiscal policy. These could include a broadening of the tax base away from the energy sector, replacing universal fuel subsidies with targeted social transfers, and a strengthening of public financial management.

While these are longer-term solutions, in the short run, the government will continue to issue notes to fund its deficit and refinance some maturing deficit. According to a February 2013 statement from the Malaysian Rating Corporation (MRC), the government is expected to issue around RM90bn-95bn ($29.3bn-30.9bn) in bonds this year. The domestic ratings agency as well noted that activity in Malaysia’s corporate bond market is likely to be additional subdued this year, following a record RM124.6bn ($40.5bn) in fixed-gain securities floated in 2012. Gross issuance is expected to reach around RM70bn-90bn ($22.8bn-29.3bn), mainly from projects associated with the Economic Transformation Programme. Because a large portion of this deficit would be government-guaranteed notes, the yields are expected to be in the range of 3.8% to 4.3%, the MRC said.

If post-election enthusiasm remains high, yields on Malaysia’s bonds – both government and corporate – could be even lower, suggesting that presently is a good time for businesses to look to bonds to fund investment someday.