ALMOST 18 months have passed since FTSE Russell added Malaysian government bonds to its watchlist, but there is yet no conclusive decision on whether the country will be removed from the World Government Bond Index (WGBI).
The continued delay on Malaysia’s status leaves concerns on the risk of capital flight as well as its impact on the local bond market and the ringgit unanswered.
In the event of an exclusion, experts say Malaysia faces a risk of a multi-billion ringgit outflow from the local bond market. Maybank Kim Eng head of fixed income research Winson Phoon, for example, estimates the total outflow risk to be around RM25bil.
For now, Malaysia continues to be under the WGBI after FTSE Russell decided on Sept 24 to keep the country on its watchlist.
It is also comforting to note that FTSE Russell has continued to acknowledge Bank Negara’s ongoing initiatives to improve the liquidity and accessibility of the Malaysian government bond market for foreign investors.
Measures that are acknowledged include more re-openings in auction calendar to increase the average outstanding size per issuance and higher availability of Malaysian Government Securities (MGS) via repo for market-making purpose. Also on the list are improvements in the Appointed Overseas Office programmes, allowing Japanese local custodian banks to undertake third party foreign exchange and dynamic hedging.
FTSE Russell’s acceptance of the measures, potentially during the next review in March 2021, will enable the removal of Malaysia from the negative watch and secure its position in the WGBI.
“FTSE Russell will continue to engage with its advisory committees and other stakeholders, over the next six months, to determine the practical improvements that emanate from these initiatives, which should enhance the experience of international participants in the Malaysian fixed income market, ” it said on Sept 24.
FTSE Russell is a British provider of stock market indices and associated data services, wholly owned by the London Stock Exchange.
Speaking with StarBizWeek, RAM Rating Services Bhd senior economist Woon Khai Jhek (pic below) says the positive discussions between FTSE Russell and the Malaysian regulatory authorities, along with improvements to market access for foreign investors, increases the probability of Malaysia being retained on the Index.
“Despite being on the watchlist, Malaysia is still officially a constituent in the WGBI, which is tracked by a large group of passive investors. Hence, we do not expect any significant outflow due to this announcement.
“Furthermore, investors who were wary about entering the Malaysian bond market over the past month amid the exclusion risk in September, may now drive further inflows over the near term.
“That said, we do not discount the possibility of some immediate selloff pressure coming from more risk-averse investors who remain concerned about Malaysia’s prospects in the WGBI, ” he says.
Kenanga Investment Bank head of research Koh Huat Soon says that while the risk of a possible removal remains, FTSE Russell’s decision to retain Malaysia in the watchlist comes as a relief for the capital markets and the economy.
He also points out that there have been positive inflows into the local bond market, which has seen improved liquidity.
This was following Bank Negara’s initiatives and more MGS added to the JPMorgan Government Bond Index-Emerging Markets index despite the phased-in entry of China since February.
“This news is not entirely surprising and has a positive read through for the equity market since it removes the immediate risk of funds outflow (and hence negatively impact overall liquidity) from passive index-positioned funds, ” he says.
Had Malaysia been removed from the WGBI, Koh says there would have been a significant potential outflow of US$8bil (approximately RM33bil), negatively impacting liquidity and raising yields with negative impact on an already fragile economy.
According to Maybank Kim Eng, while FTSE Russell acknowledges the central bank’s initiatives to improve market accessibility for foreign investors, it appears that more time is needed to assess the efficacies of these improvements.
Earlier in June 2020, Maybank Kim Eng said “a major decision could come in September, and our base case is no exclusion”.
However, it is noteworthy that the research firm had also said FTSE Russell could still keep Malaysia on the watchlist if it requires more time to assess.
HSBC Global Research believes that Malaysia will continue to be kept on the negative watch even in March 2021.
“It is important to note that compared with the last index review in April 2020, the index committee made an additional note in this latest review that the regulatory changes “should enhance the experience of international participants in the Malaysian fixed income market”.
“This gives us good reason to expect Malaysia bonds to be retained in the WGBI at the next index review in March 2021, ” it says.
According to HSBC Global Research, while the trading liquidity of Malaysia government bonds may not be as high as that of developed market bonds, it is offset by the country’s relatively small WGBI weight of 0.42% as of August 2020 and the central bank’s efforts to improve the trading environment.
It adds that Bank Negara’s willingness to address the index trackers’ concerns also demonstrates its desire to keep the doors open for foreign portfolio investments.
“While some might have expected significant outflows after Malaysia was placed on the WGBI exclusion watch in April 2019, we had previously expected only a limited impact given the fairly light positioning by WGBI investors.
“Indeed, foreign holdings of Malaysia government bonds bottomed in May 2019 and have since risen to reach RM209bil in Aug 2020, ” it says.
In April last year, FTSE Russell announced that Malaysia was being considered for a potential downgrade from Market Accessibility Level 2 to 1.
The downgrade would render Malaysia ineligible for inclusion in the WGBI.
FTSE Russell’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 includes Malaysia.
The WGBI is a widely used benchmark that currently includes sovereign debt from over 20 countries, denominated in a variety of currencies. Malaysia has been included in the index since 2004.
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