PETALING JAYA: Selling pressure on the ringgit would intensify should Malaysian government bonds be removed from an important global bond index, with a potential capital exodus of almost RM20bil to RM30bil out of the domestic capital market.
Following the news flow on Malaysia’s potential disqualification from the World Government Bond Index (WGBI), the ringgit has already come under pressure as the local note weakened against major currencies yesterday.
However, the selling pressure eased after mid-day as the ringgit saw some recovery, after the market seemed to have digested the news flow on the WGBI exclusion.
The weaker ringgit triggered a sea of red in the country’s stock exchange, which was shaken by concerns about potential capital flight worth billions of ringgit.
By 6pm, the ringgit declined 0.05% to RM4.1345 per US dollar, extending the depreciation trend that has continued for almost a month since March 21.
Based on Bloomberg data, the ringgit is the fifth worst performer among major Asian currencies year-to-date. The worst performing Asian currency since January 2019 is the South Korean won.
The ringgit also lost 0.08% against the pound sterling at 5.3949 and 0.35% against the euro to 4.6804. In comparison to its Asian peers, the ringgit fell 0.26% against the Singapore dollar to 3.0583 and 0.04% against the yen to 3.6910.
Stock market index provider FTSE Russell said on April 15 that Malaysia was placed on its fixed-income watch list for six months and a final decision on the withdrawal from the WGBI might be done in September 2019.
The country’s government bond market, which is currently assigned a “2” and included in the WGBI since 2004, is being considered for a potential downgrade to “1”. In the event of a downgrade, Malaysia will be removed from the WGBI, stated FTSE Russell.
The index provider’s move to review Malaysian government bonds’ participation in the WGBI came a week after Norway’s US$1 trillion sovereign wealth fund was told to cut emerging-market government and corporate bonds, which include Malaysia.
Investors were alarmed that Malaysia’s potential exclusion from the WGBI would mean reversal of funds out of the domestic bond market. This would have a major impact on the ringgit and local debt instruments.
According to Maybank Kim Eng Research, the risk of dropping Malaysian bonds from the WGBI seemed “more likely than not”, unless fundamental changes are made to improve Malaysia’s market accessibility level.
It estimated that Malaysia faced a total capital outflow risk of US$6bil to US$8bil (RM24bil to RM33bil), if the country is removed from the WGBI.
“If FTSE Russell decides to remove Malaysia from the WGBI, foreign selling will likely concentrate on the Malaysian Government Securities (MGS), as currently the WGBI index excludes the Government Investment Issues (GII), although the GII curve will inevitably be affected if foreign selloffs weigh on the MGS curve.
“Malaysia’s exit from the WGBI is not conclusive but active funds may offload some positions in advance. Actual removal from the index would result in additional outflows, especially from passive funds, and likely further cheapening of the MGS curve,” said the research house in a note.
The weakening of ringgit and the news flow related to the potential WGBI exclusion took a toll on the Malaysian equity market, pushing the FBM KLCI to its lowest level since 2016.
The benchmark index closed at 1,620.90 points, lower by 0.53%, or 8.56 points, yesterday. Year-to-date, the index is down 4.12%, making it the worst performer among the key Asian markets.
Market breadth was overwhelmingly negative, with 661 decliners and 208 advancers. A total of 365 counters remain unchanged.
VCAP Asset Managers Sdn Bhd chief executive officer Taufiq Iskandar Jamingan said the the reasons behind FTSE Russell’s move to put Malaysia on the watch list is unknown.
“However, one may point to the liquidity of the market as one of the causes. In addition, despite several shenanigans and incidents of failed governance uncovered recently, the ratings are yet to be affected, raising questions on the state of our fiscal position.
“The market has yet to be presented with concrete plans to diversify and expand the country’s revenue base.
“The effects could be extended to the currency market and the ringgit may experience downward pressure in the short term. As for equity market, investors may seek refuge in yield and value plays as the outflow of foreign funds continues,” he told StarBiz.
On the bond market, AmBank Group chief economist Anthony Dass said that room for further consolidation remained until a final decision is made by FTSE Russell in six months.
He also said that MGS yields rose by three to 14 basis points (bps) across the board yesterday, as a result of the FTSE Russell announcement.
The 3-, 5-, 7- and 10-year MGS yields increased by 3.5 bps, 9.5 bps, 13.5 bps and 5 bps to 3.46%, 3.715%, 3.835% and 3.875%, respectively, he said
“Should there be a full withdrawal, the impact on our yields will be around 28 to 32 basis points. Our assessment showed that for every RM1bil outflow in MGS, the impact on the yield is around 1 basis point,” said Dass.
In an e-mail reply to StarBiz, RAM Ratings said the FTSE Russell announcement sparked a knee-jerk reaction as the benchmark 10-year MGS yield jumped four basis points to 3.81% on the April 16, from 3.77% the previous day.
“Given how investors are sensitive to these announcements, it is perhaps not a surprising development that investors have started to reposition their funds on account of this.
“If Malaysia is excluded after the review period come September, the impact could be cushioned by the fact that portfolio rebalancing will be staggered across time rather than a one-off sell-down,” said RAM Ratings.