KUALA LUMPUR (Feb 18): While a one-notch rating downgrade for Malaysia will create an initial knee-jerk reaction of a sell-off in both equities and bonds, the negative effect will not be long-lasting, according to CIMB Research.
In a note Feb 17, the research house sees this to be so given that Malaysia will remain an investment-grade debt even after such a downgrade, coupled with stable fundamentals, positive growth and interest rate differentials, and a sustained demand by local funds.
Fitch Ratings associate director Sagarika Chandra had warned in January that Fitch was more likely than not to downgrade Malaysia's sovereign rating based on negative outlook.
However, CIMB Research's Head of Fixed Income Research Nik Ahmad Mukharriz said should the downgrade occur, an immediate impact could be expected on the pricing of bonds and CDS, with the re-pricing of bonds seen immediately pushing up borrowing cost.
Nik Ahmad said the immediate sell-off would be mainly due to the recalibration of portfolio adjustments according to the minimum rating criteria of sovereign bonds held by global managed funds, while local financial institutions and quasi sovereign names re-manage their hedge risk on these papers.
The quasi-sovereign names were likely buyers to smoothen the yield curve from steepening excessively and we could see a longer holding period by local financial institutions, he said.
Nik Ahmad said the extent of impact on pricing was subjective at this juncture given that markets had not fully priced-in the possibility of a downgrade, partly due to the mixed outlook on Malaysia’s sovereign ratings.
Moody's had reaffirmed its "positive" outlook on Malaysia while S&P maintained its "stable" rating. Fitch Ratings maintained a "negative" outlook.
Nik Ahmad said an official had commented that it was quite unusual for a country to have all three outlook - "positive", "stable" and "negative". CIMB Research thinks this attests to the various strengths as well as risks for Malaysia.
“For now, Malaysia is rated three notches above Indonesia and one notch above Thailand, but Malaysia is essentially priced around Baa2 levels.
“Our fixed income team expects an initial knee-jerk reaction to raise Malaysia's CDS prices by another 10-50 basis points (bp) (towards Indonesia's levels) but it will probably decrease later to near Thailand's levels (Baa1/BBB+),” he said.
Nik Ahmad said as for non-ringgit bonds, Malaysia's credit spreads would widen out 20-50bp along the 5-10 year tenures.
He said sovereign and quasi-sovereign Malaysian names will widen to near Thailand's levels as well.
“For now, Malaysia's US$-denominated bonds maturing 2021 are priced 147bp above US Treasuries with similar tenures, whilst comparable Thailand papers are c.190bp. As for ringgit denominated Malaysian bonds, a knee-jerk rise in yields would at least be circa 20-30bp, all else remaining equal,” he said.