This article first appeared in Forum, The Edge Malaysia Weekly on April 26, 2021 - May 2, 2021

Not many knew of the existence of the National Trust Fund (KWAN) until the government — using its emergency powers — decided to tap into it to procure Covid-19 vaccines and meet any other related expenses incurred.

The fund was set up in 1988 to help build up the country’s wealth and prepare it when resources from oil and other commodities are depleted. It is also known as the National Heritage Fund.

Towards meeting this objective, when crude oil was north of US$90 per barrel (and even breached the US$100 barrier) for a few years before prices collapsed in June 2014, Petronas contributed to the fund aggressively. Other commodity sectors — such as timber, oil palm and rubber — are supposed to contribute too but, so far, only Petronas has done so.

KWAN, managed by Bank Negara Malaysia, is an integral part of the Malaysian government debt market ecosystem. Tapping the fund to expedite the vaccination programme may have consequences on the future take-up rate of Malaysian government debt papers.

Every year after the budget is tabled, the government decides on the auction timetable of government debt papers to raise money to cover the shortfall in its finances. Towards this end, the government issues longer-tenure debt papers such as Malaysian Government Securities (MGS), Malaysian Government Investment Issues (MGII), Malaysian Islamic Treasury Bills (MITB) and shorter-tenure papers that are known as the Malaysian Treasury Bills (MTB).

Generally, about 30% of the debt papers are placed out to the principal subscribers and the rest are auctioned in the open market.

KWAN is among the three principal subscribers who take up the debt papers that are placed out by the government. The other two are the Employees Provident Fund (EPF) and Kumpulan Wang Amanah Pencen (KWAP).

The “open market” auction market consists of about 15 primary dealers that mainly represent domestic and foreign investors of the bond market.

The EPF, KWAP as well as KWAN form the backbone of the government debt market ecosystem. When the government decides to place out debt papers, these are the agencies that are seated on the ringside and provide the stability to absorb these debt papers.

Apart from taking up placement of government bonds, these agencies also participate in the open market auctions.

The supply of government debt papers coming into the market this year is more than what it has been previously due to the federal government’s weakening financial position.

The federal government fiscal deficit as a percentage of the gross domestic product (GDP) for 2021 is estimated at 5.4%. According to Bank Negara statistics, the shortfall between federal government revenue and expenditure came up to 6.2% of the economy last year.

Prior to the Covid-19 pandemic, the federal government deficit was usually at 3% or just above it.

To give the government more leeway to borrow, the self-imposed ceiling on the federal government debt-to-GDP ratio was increased from 55% to 60% until October 2022.

Critics, including former prime minister Datuk Seri Najib Razak, have contended that the federal government debt-to-GDP ratio has exceeded 60%, prompting a response from Finance Minister Tengku Datuk Seri Zafrul Abdul Aziz. He clarified that federal government statutory debt, which refers to only the MGS, MGII and MITB debt papers, stands at RM820.7 billion and is expected to reach 58.5% of GDP at the end of this year. However, if other federal government debt, including its Treasury bills and offshore borrowings, is taken into account, the total amounts to RM879.6 billion and will be 62.2% of GDP.

To be fair, the government is not doing anything different from other governments during this pandemic. Covid-19 has forced all governments to break the rules of public finance. Even developed countries are borrowing more to resuscitate their economy.

There is no consensus on what is the ideal debt level. Rating agencies such as Fitch and Standard & Poor’s — which, by the way, are the last to react to any situation — continue to watch from the sidelines without doing any downgrades.

As long as the capital markets are able to absorb government debt papers, everything is fine.

In relation to this, the supply of more debt papers coming into the market at higher yields has attracted more foreigners into the Malaysian bond market.

According to Bank Negara, foreigners have ploughed RM33.5 billion more into Malaysian debt papers between July last year and end-February this year. They make up 24.7% of the government bond market, which is not far from the five-year foreign shareholding average of 26%.

Foreigners are taking up the Malaysian debt papers because they offer better returns compared with US treasuries. It is not necessarily related to the confidence foreign investors have in the country.

But when the market reverses and returns are compromised, they are the first to take the money out. The consequences are dire, especially on the ringgit.

It has happened several times before. The last was in 2013 when the US signalled a rise in its interest rates, causing a flow of funds back to that country. It was called the taper tantrum.

Previously, when foreigners exited the debt market, local institutions such as the EPF, KWAP and KWAN were well-placed to absorb their selling. But now, the capacity of institutions to support new debt issuances is in question. 

The EPF is facing more withdrawals than contributions due to the i-Sinar and i-Lestari programmes. As of April 16, the amount withdrawn by contributors from both programmes was close to RM77 billion. This does not leave the EPF with much leeway to put its money in other classes of assets such as debt papers when the need arises.

Now, the federal government is tapping the resources of KWAN. The amount allocated for the vaccination programme has increased from RM3 billion — announced during Budget 2021 last November — to RM5 billion. The government should have been able to raise the additional RM2 billion from issuing more debt papers, instead of tapping into the fund.

Why it has decided to do so and how much of its resources are going to be utilised need to be explained.

M Shanmugam is contributing editor at The Edge

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