KUALA LUMPUR (May 16): Tun Dr Mahathir Mohamad’s return may spell more pressure on Malaysia’s beleaguered bond market — almost a decade of efforts spent narrowing a fiscal deficit is at risk just when capital is flowing out of emerging markets.
Already reeling from the impact of a stronger dollar and higher US Treasury yields, ringgit sovereign securities may face a further blow as newly-elected Prime Minister Dr Mahathir presses ahead with a plan to scrap a consumption tax and reinstate fuel subsidies. Bond investors and rating companies are worried that may hurt efforts to narrow a persistent budget shortfall.
“Deterioration in fiscal conditions can be offset by removing or reducing infrastructure projects, but this eats into growth prospects, so the new administration will need to outline early how it intends to balance these competing outcomes,” said Dwyfor Evans, the Hong Kong-based head of Asia-Pacific macro strategy at State Street Global Markets. “We would expect some nervousness in the government bond market pending clarity on this.”
Even before the surprising outcome of last week’s election, foreign holdings of government securities fell to a five-month low in April. The benchmark 10-year yield has risen more than 20 basis points this year as demand for risk assets took a hit after Treasury yields crossed the key 3% mark. In contrast, stocks have risen since the historic win by an opposition coalition, bolstered by gains in consumer shares.
The Finance Ministry said Wednesday the consumption tax rate will be revised to 0% from 6% effective June 1, according to an e-mailed statement.
Malaysia has run a fiscal deficit since 1998 but managed to narrow the shortfall in each of the last eight years. The gap shrunk to 3% of gross domestic product in 2017, helped by the goods and services tax and higher oil prices for the crude exporter.
“We were positioned broadly neutral heading into the election, and intend to maintain this stance until we hear more clarity on the new government policy,” said Edward Ng, a fixed-income portfolio manager in Singapore at Nikko Asset Management Ltd, which oversaw about US$212 billion at the end of December. “We will be looking closely at details on how the government intends to bring in the extra revenue to fund the proposed GST abolition.”
Fitch Ratings and Moody’s Investors Service have warned the proposed reforms will be viewed as credit negative if implemented without offsetting measures, with the finance ministry previously estimating that the GST contributed to about one-fifth of income.
Others such as Bank of America believe the risks are overstated as higher oil revenues and the reintroduction of a sales tax will cushion the impact.
The Pakatan Harapan coalition has sought to allay investor fears. Tun Daim Zainuddin, a former finance minister and member of a government economic council, said the debt level won’t rise without the GST. In its election manifesto, the coalition had proposed setting up a sovereign wealth fund using profits from state-owned oil company Petroliam Nasional Bhd, a move that may help mitigate any shortfall in revenue.
Malaysia can meet its revenue requirements by increasing the public sector’s efficiency and seeking new sources of income, Tan Sri Dr Zeti Akhtar Aziz, a former central bank governor and a member of the advisory team, told state news agency Bernama. She held briefings with the three main rating companies on Monday to provide clarity on policy direction.
The selldown in global emerging market assets has extended as the 10-year Treasury yield rose to its highest since 2011 on Tuesday, with investors including Goldman Sachs Asset Management expecting it to climb further.
There is the potential for more uncertainty. Dr Mahathir, who imposed capital controls during the Asian financial crisis, said Tuesday he will not allow “ fiddling” in the currency market, and his finance minister will need to be cleared of corruption charges before taking office.
For Western Asset Management Co, the uncertainty is just the latest in a list of reasons why it’s wary of Malaysian securities. Concern about the adequacy of the nation’s foreign-exchange reserves and a scandal centered on state fund 1MDB have curbed the appeal.
“For some time, Malaysia’s fundamentals have been in a slow and steady decline,” said Desmond Soon, Singapore-based head of investment management for Asia ex-Japan at Western Asset. “There are other opportunities in the region which are backed by better fiscal and governance conditions.”
Markets have been volatile after the election, with the ringgit, bonds and stocks rebounding from early losses Monday. Local pension funds have been supportive of the assets, according to Oanda Corp. Other than saying that bond markets saw a “strong recovery,” the central bank didn’t elaborate.
The Financial Markets Committee, which is tasked with developing strategies for Malaysia’s bond and currency markets, said Tuesday the authorities will take measures to address any volatility and onshore markets are expected to remain stable and orderly.
Other investors are more sanguine. For BNP Paribas Asset Management, concerns about the election result may be tempered by the nation’s established economic policies.
“The main thing to watch ahead is how the new government articulates its fiscal policy plans,” said Jean-Charles Sambor, the firm’s London-based deputy head of emerging-market fixed-income. “What remains is will Mahathir alter spending and taxes, what will he propose on infrastructure projects, and how that shapes the country’s growth and debt trajectory.”