As expected, Budget 2017 is a lean budget. This is hardly surprising, given the expected 3% drop in revenue in 2016, following the steep decline in the global prices of crude oil, the commodity which continues to be a major source of revenue for Malaysia.
With petroleum income tax revenue expected to come in below RM11 billion in 2016 and 2017, it is imperative for the government to be extra prudent, or the country’s fiscal position will continue to be in deficit territory. At the same time, however, the budget was not so contractive as to hurt the economy (government projections show expenditure will still climb by 3.4% in 2017).
The budget did not draw much attention from the financial markets, with both the equity and bond markets exhibiting benign reactions in the week following the presentation in Parliament. Financial market players have yet to fully ruminate on all the measures proposed and assess their impact in the coming months. This was, again, not a surprising outcome as there were no surprises during the two-hour budget speech. As a result, Malaysian bond yields and stock market indices hardly moved. The ringgit continued to be in the limelight, however, thanks to the outflows from the bond market.
More critical to investors at this time is, perhaps, the relative assessment of the current economic situation vis-à-vis what Malaysia experienced during the commodity crisis in the mid-1980s. Budget deficits at that time hovered at around 10% of gross domestic product (GDP), while the federal government operating balance (revenue less operating expenditure) was in negative territory for two consecutive years (1986 and 1987). The debt level was about 100% of GDP, according to statistics from the Department of Statistics (DoS), while the depth of the Malaysian capital market at that time was nothing to shout about. Of course, those numbers are not exactly comparable to today’s due to their different underlying definitions.
Although the vastly differing statistics seem to present the present in a more favourable light, savvy investors are also aware of the alternative opportunities currently available regionally. Indeed, many countries’ capital accounts are now more open than they were 30 years ago, prior to the Washington Consensus. Huge sums can be transferred instantaneously from one country to another at the click of a button. This is of significant importance because in the current liquidity-flush financial market, investors who anticipate unfavourable market conditions in one country can quickly shift their funds to other parts of the world. This is why relative assessments are so critical for making investment decisions in today’s world.
When it comes to the financial market, the current hot topic in Malaysia is the level of foreign shareholding of Malaysian Government Bonds, which is closely watched by observers. For Malaysian Government Securities (MGS) alone, foreign shareholding represents a hefty 51% of total MGS outstanding in September this year (valued at roughly RM181 billion). The ratio has picked up since hitting its trough of 43% in July 2013, in response to then US Federal Reserve chairman Ben Bernanke’s infamous “Taper Tantrum” that caused jitters in the bond market.
At the same time, the proportion of overall Malaysian debt securities held by foreigners was circa 20% of total outstanding in September this year. While the level does not appear very high, it would still cause considerable volatility in the financial market if sudden and massive outflows take place.
The major question, then, is just how much of this amount would flow out should investors decide to redirect their portfolio investments to other countries in the region. No one can accurately predict this quantum, but the good news is that not all of the foreign holdings (RM239 billion as at September 2016) are under threat. And although foreigners liquidated about half of their holdings during challenging times in the recent past (at the end of 2005 and during the 2008/09 global financial crisis), the proportion could be smaller this time around.
Why? There are now more long-term investors holding Malaysian debt securities — central banks, pension funds and insurance companies hold a combined 45% of the total foreign portion, based on the statistics at the end of January this year. And being long-term investors, they are not prone to taking short-term views when it comes to investing. This is the comfort that we can take at this juncture.
But what are the arguments on the other side of the fence? Let us assume the following simple scenario. For whatever reason, if foreign asset managers who hold that 45% Malaysian debt securities decide to trim about a quarter of their holdings, they will flee with about RM27 billion (based on the amount of foreign holdings in September 2016). This is almost equivalent to the outflows experienced during the Taper Tantrum in mid-2013 (from peak to trough).
During that time, the ringgit weakened by roughly 6% against the greenback. Assuming the same dynamics take place this time in the financial market — for example, same degree of intervention by the central bank (if there was any in the past) and so on — a back-of-the-envelope calculation suggests that the ringgit could weaken to circa RM4.45 against the US dollar (a 6% depreciation from the current level of RM4.18/USD).
Of course, no two periods are comparable when it comes to seeing how financial market players react. Sentiment can change (for better or for worse) and therefore such a prediction could deviate significantly from reality. For instance, during the 2008/09 period, foreign shareholdings shrank by about RM84 billion from peak to trough. At the same time, the ringgit weakened by 13%. This depreciation would have been more severe if we were to base our estimation on how the ringgit reacted to the outflows during the Taper Tantrum.
But what are the factors that can contribute to these outflows in the near future? The US Fed funds rate hike is one of them. If the pace of increases is less gradual than expected, then US Treasuries will react negatively and so would Malaysian bond yields, as the latter tend to track the former rather closely.
A second factor could be the jitters arising from a possible twin deficit in Malaysia, as trade performance remains lacklustre on the back of waning global demand. Indeed, the closer the current account numbers get to negative territory, the more eyes will be glued to the Malaysian bond and equity markets.
As for now, the global financial market will brace for one thing, and one thing only — higher volatility. We can only hope for the best outcome.
Nor Zahidi Alias is chief economist at Malaysian Rating Corp Bhd. The views expressed here are his own.
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