This article first appeared in The Edge Malaysia Weekly on March 29, 2021 - April 4, 2021

MALAYSIA is likely to be kept on the FTSE Russell watch list for potential exclusion from the World Government Bond Index (WGBI) at the index provider’s interim review this week, market watchers say.

Nevertheless, the actual risk of exclusion is low, they add.

“It is unlikely that Malaysia will be removed from FTSE Russell’s WGBI given the positive discussions between FTSE Russell and the regulatory authorities, along with the ongoing effort by Bank Negara Malaysia to provide better market access for foreign investors,” senior economist Wong Khai Jhek of RAM Rating Services Bhd tells The Edge.

“That said, should FTSE Russell decide that more time is needed to assess the efficacies of some of the more recent liberalisation initiatives, there is still a possibility that it might decide to keep Malaysia on its watch list, albeit the probability is certainly lower than before,” he adds.

Malaysia has, since 2007,  been a constituent of the WGBI, a widely-used benchmark that currently includes sovereign debt from over 20 countries. News reports indicate that an estimated US$2.5 trillion of both active and passive funds track the WGBI.

On April 15, 2019, FTSE Russell placed Malaysia on its watch list and said that the country was being considered for a potential downgrade from ‘2’ — which represents the highest level of market accessibility — to ‘1’, which would render Malaysia ineligible for inclusion in the WGBI.

FTSE Russell, which undertakes a fixed-income review twice a year, is due to have its first for the year on March 29 (or March 30, Malaysian time). The outcome will be closely monitored, with Malaysia hoping for a positive outcome at this review as it has been on the watch list for almost two years now.

Cognisant of the risks, Bank Negara Malaysia attempted to address some of the concerns raised by investors, implementing a series of measures to open up and enhance liquidity in the bond and foreign exchange markets.

Its latest initiative, effective March 15, was to liberalise the interest rate swap (IRS) market. It now allows non-resident banks to trade ringgit-denominated IRS with any onshore bank (or their appointed overseas offices) without any underlying commitment. This follows a pilot programme in November 2020, which initially accorded selected onshore banks the flexibility.

Liberalising the ringgit-denominated IRS market is expected to add depth of diversity and liquidity, says Winson Phoon, head of fixed income research at Maybank Kim Eng.

He says the initiative, while not a game changer in itself, adds to the momentum of recent measures that help build Malaysia’s case for being taken off the watch list and having the threat of being excluded from the WGBI removed.

Malaysia faces the risk of a multi-billion ringgit outflow from the local bond market if it were to be excluded from the WGBI.

“The outflows can be quite huge … we think it could be about RM25 billion. But this is not the base case that we are looking at. We are optimistic that Malaysia will stay in the WGBI, perhaps still on the watch list in March’s interim review, but by September — at the next review — FTSE Russell is expected to remove Malaysia from the watch list, thereby removing the threat of exclusion from WGBI,” Phoon tells The Edge.

Malaysia’s current weighting in the WGBI is at about 0.4%.

UOB Malaysia’s senior economist Julia Goh notes that there is no mention by FTSE Russell of a definite time frame to be on the watch list, but UOB presumes it to be no longer than two years.

“As such, there are high expectations for FTSE Russell to make a decision in the coming review. We reiterate our view that a complete exclusion of Malaysia from the WGBI is low given that the country’s sovereign rating at A-/BBB+ is still investment grade. The strong foreign demand for Malaysia’s domestic bonds in the first two months of the year suggests that in an environment of ongoing quantitative easing (QE) and improving recovery across Asia, Malaysia’s bonds remain attractive to certain classes of investors,” she tells The Edge.

“Furthermore FTSE Russell acknowledges the additional initiatives by Bank Negara to improve the accessibility of the Malaysian government bond market for foreign investors,” she adds.

Nevertheless, Goh believes Malaysia’s weighting in the WGBI may be lowered in the upcoming review to pave the way for China’s inclusion from October 2021. Details on China’s inclusion are expected to be confirmed this week.

Bank Islam chief economist Dr Mohd Afzanizam Abdul Rashid also does not think it is likely that Malaysia will be taken off the WGBI. “Generally, I think it will be maintained [on the watch list] for now as Bank Negara remains committed to keeping the bond market healthy and accessible as well as equipped with the right infrastructure, especially in areas relating to hedging,” he says.

At FTSE Russell’s last review in September 2020, it acknowledged the additional initiatives by Bank Negara to improve the accessibility of the Malaysian government bond market for foreign investors. However, it kept Malaysia on its watch list as it was still evaluating the practical improvements from the initiatives, alongside feedback from investors and stakeholders.

Bank Negara’s additional initiatives included improving secondary market bond liquidity through further progress on the establishment of a debt management office, an improved auction calendar that offers more re-opening of prior issues, a greater number of Malaysian Government Securities (MGS) available via repo, consolidation of bond issuances to increase the outstanding size per issuance and reducing the number of issuances, and introducing MGS futures with physical delivery.

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.