KUALA LUMPUR (Nov 9): Franklin Templeton GSC Asset Management Sdn Bhd said today it is cautiously optimistic Budget 2019 is the short-term reset needed to put the country back on the right footing required to meet the challenges that lie ahead.

"As Budget 2019 refocuses the economy, we may see some negative impact in financial markets," its chief executive officer and head of Malaysia fixed income and sukuk Hanifah Hashim said in a statement today.

"However, we are confident the government is on the right path in systematically reducing fiscal deficit and moving towards sustained economic growth," she added.

According to Hanifah, the higher-than-expected budget deficit target announced at 3.7% of gross domestic product (GDP) for 2018 is expected to create volatility for the markets in the short term.

"The fiscal consolidation plan in 2019 at 3.4%, 2020 at 3%, 2021 at 2.8% and subsequent years at around 2% may cause a re-evaluation of Malaysia’s sovereign credit rating," she said.

"Fiscal measures that satisfy international rating agencies credit metrics are crucial since the country's high debt burden acts as a credit constraint. Any change in rating will drive up the cost of borrowing for Malaysians tapping overseas markets and aggravate further capital outflow from financial markets," she added.

Hanifah expects the local bond market to be impacted for the remainder of the year owing to the higher than anticipated issuance of government bonds, in line with the higher fiscal deficit of 3.7%.

"While we expect yield of government bonds to rise in the short term, the plan for fiscal consolidation in 2019 could see lower government bond issuance next year onwards. This may offer some stability due to potential tightening of yields in the future, especially if the bond market starts to price in the potential reduction of the overnight policy rate by Bank Negara Malaysia to support growth," she said.

The positive news for the bond market, said Hanifah, is the continuation of tax exemption for sukuk issuance in the form of Ijarah and Wakalah structures.

However, the government’s decision to remove the tax exemptions on interest earned on wholesale money market funds may have a negative impact on the overall size of the wholesale market.

"In the extreme case, assuming that all wholesale money market funds, valued at RM42.9 billion are redeemed, it could be detrimental to the overall fund management size," said Hanifah.

On the ringgit, Franklin Templeton believes that the government’s higher budget deficit will make the Malaysian currency susceptible to short-term pressure as concerns on the rating outlook on Malaysia, coupled with uncertainty in global economic backdrop, may lead to continuous net capital outflow and discourage offshore investors from investing in the country.

Hanifah pointed out that with the higher reliance on Petroliam Nasional Bhd's dividends to finance government revenue, Franklin Templeton also believes that the ringgit could experience higher volatility as capital market players once again associate the highly volatile crude oil prices to government oil-related revenue, similar to the 2010-2016 period.