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Saturday February 4, 2012
COMMENT By SURINDER KATHPALIA
DESPITE the current turmoil in Europe and shaky prospects for the global economy, Standard & Poor's Ratings Services maintains a strong outlook for Malaysia's bond market. Our view reflects: positive bond market developments, ongoing growth in Islamic finance, and steady macroeconomic fundamentals in Malaysia.
Bond issuance in the G3 currencies (US dollar, euro, and yen) in Asia generally stalled in 2011. However, South-East Asian (Asean) local currency bond markets including Malaysia's continued to bustle in 2011 with local currency bond issues, providing alternative funding and investment options for Asian issuers and investors. It wasn't just Asean companies that tapped the markets, those in Hong Kong, India, and Korea also issued bonds in the region.
Data from the Asian Development Bank indicate that local currency bond issuance by Asean companies during the first nine months of 2011 rose 25% over the similar period in 2010. In Malaysia, the growth was just above 26%. Further, local currency bond issuances from Asean amounted to four times the issuance in US dollar, euro, and yen from the region, compared with three times in 2010.
We believe the positive trend for local currency bonds in Asia will continue. Standard & Poor's expects most Asean nations will continue to grow this year. Our 2012 forecast for Malaysia is 3.8%-4.3% real GDP growth. This is a stark contrast to our expectation that the United States will grow moderately and the European Economic and Monetary Union (EMU or eurozone) will experience a mild recession in the first half of 2012. Given this scenario, Asean companies are likely to continue to seek alternative funding sources as those in G3 markets (United States, Japan, and the eurozone) become harder and more expensive to tap. Policymakers in Asean have made significant regulatory changes and related reforms to address long-standing concerns about liquidity and diversity. Establishing legal frameworks and creditor rights, promoting higher standards of disclosure, and streamlining issuance processes (as in the July 2011 guidelines for corporate bonds in Malaysia) have stimulated the development of bond markets.
Foreign issuers and investors broaden and deepen the region's bond markets. They are attracted to the liquidity and pricing in Asean's local currency bond markets such as Malaysia and Singapore. In turn, foreign issuers help build the yield curve and establish pricing benchmarks. As more global and regional investors participate in the local currency bond markets, funding costs for issuers will reduce. At the same time, the availability and diversity of financing options will increase. Like global issuers, investors will also demand greater transparency and will be keen to see the region's credit culture strengthen further.
Within Asean, Malaysia stands out. Policymakers in emerging markets view Malaysia as a poster child for bond market development, given that it's now the fourth-largest bond market in Asia, after Japan, China, and South Korea. Malaysia's bond market has a strong infrastructure and a record of solid growth due to a transparent and predictable regulatory environment, the availability of independent credit research, the existence of “risk-free” bonds of various tenors, and a bond pricing service.
Domestic debt issuance in Malaysia is 10 times the volume of cross-border issuance by local companies. This is also due to the country's withholding taxes on cross-border issues by Malaysian companies, which make offshore bond issuance less attractive. Issuer concentration is relatively low, with the top 20 Malaysian issuers accounting for less than 50% of outstanding debt. Dominant issuers largely come from the infrastructure sector, which will continue to be a major contributor to the growth of the bond market in the next few years.Malaysia and Singapore lead Asean in providing issuers particularly in infrastructure with access to long-term finance over 10 years. In other Asean countries, debt securities with short tenors dominate. Besides making it difficult for infrastructure sector issuers to get funding, pension and life insurance funds also find it tough matching long-term investments to obligations.
Malaysia has rapidly become the Islamic finance centre for Asia with smart regulation and a growing ecosystem around Islamic finance. Approximately 70% of Malaysia's domestic debt issuance is in the form of sukuks (financial certificates, similar to bonds, that are compliant with Islamic law), making it the world's largest Islamic bond market with over 60% of global sukuk issuance originating from Malaysia. The recent RM30bil sukuk by Projek Lebuhraya Usahasama Bhd is the largest sukuk issue globally and has set the market abuzz.
Issuers are likely to seek alternatives to conventional financing, given the uncertain outlook for global credit markets. Islamic finance is one such alternative. In Standard & Poor's view, infrastructure projects are a logical fit for Islamic finance for two reasons: (1) the Islamic finance market is growing and deepening; and (2) Sharia (Islamic law) governs Islamic finance and is based on the concepts of asset-backing and shared business risk.
Malaysia pioneered the use of Sharia-compliant sukuk bonds to fund infrastructure projects and is the leader in Islamic financing. The key issue for this market, in our view, is that a lack of standardisation constrains sukuk issuance. It also deprives the market of an organised structure to facilitate secondary trading and liquidity.
Malaysia has other challenges, too. Corporate governance standards are moderate and the enforcement of governance practices could improve. Shareholder activism is limited and corporate scandals far too frequent. While the law provides for creditor protection, the process for enforcing claims can be protracted. These should be easy to fix, provided they are approached with vigour and zeal.
We are confident in Malaysia's ability to continue to develop a robust credit culture where risk can be measured and priced using objective standards. Standard & Poor's is assisting in this area via independent and objective credit research. In 2009, we launched our regional Asean rating scale, which provides more granularity of credit risks than is possible with the Standard & Poor's global scale.
In our view, the Malaysian capital market is on the right path to creating debt platforms that will deliver the depth and sophistication needed to fund the next stage of economic development. But local policymakers cannot take their foot off the pedal. A sustainable supply of credit and associated reforms will be critical. Without them, growth could be constrained.
Surinder Kathpalia is the managing director of Standard & Poor's in Singapore.
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