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The State of the Nation: Can we have our cake and eat it too?

The Edge logo The Edge 20/5/2019 Anna Taing
© Provided by The Edge Communications Sdn Mhd

LAST month, FTSE Russell said it might remove Malaysia from its the World Government Bond Index (WGBI) in September, citing liquidity concerns. Whether the axe will fall is the question many market players have begun to ask as the date looms nearer.

If the axe does fall, what will be the short- and long-term impact on the ringgit and domestic bond market, currently among the three largest in the region?

First, some history. What led to the possible exclusion of Malaysia from the WGBI dates back to November 2016, when Bank Negara Malaysia tightened existing rules to prohibit the trading of the ringgit offshore.

Prior to the tightening, Malaysia had an active two-tier foreign exchange market — one onshore and the other offshore. The latter was via the non-deliverable forward (NDF) US dollar-ringgit trade. (The offshore NDF market operates 24/7, and exerts considerable influence on onshore ringgit value.)

The tighter measures were aimed at stabilising the local currency, and at the same time, prevent speculation that could distort the fair value of the ringgit. That was the case in late 2016, when a strengthening US dollar sparked a wave of activity in the NDF market, causing the ringgit to fall below RM4.40 levels, which was seen as undervalued and not reflecting Malaysia’s economic fundamentals.

Since 2016 to date, foreign shareholdings of Malaysian government securities (MGS) have fallen significantly, from a high of around 50% of the outstanding total to about 21% currently. The outflow, market players say, was in part due to tighter measures put in place by the central bank. In fact, back then, money market dealers were concerned that Malaysia’s bond market and ringgit could be impacted if foreign investors started exiting.

It will be interesting to see if Bank Negara will, or needs to, do anything in the next three months leading up September to avert the possible exclusion of the country from the WGBI.

The prevailing view in the market (see main story on this page) seems to be that Malaysia’s removal may not have that big an impact on our bond market. This is premised on still solid economic fundamentals and strong domestic demand for investment grade bonds in the local bond market.

Apart from some knee-jerk impact on both the forex and bond markets, some market participants, especially local players, aren’t too worried about the exclusion.

Be that as it may, the question really is this: If Malaysia’s capital markets want to stay relevant in the global and regional space, can it afford to be marginalised by foreign investors?

While exclusion from the WGBI may not have a significant short-term impact on these markets, there may well be some long-term implications if the Malaysian market becomes too inward looking.

Already, in the equity space, the domestic market, once one of the largest in Asean, is a laggard and some would say, sidelined to the peripheral. Is there a danger of the same happening to the bond market if Malaysia is no longer on the WGBI?

As it stands today, the domestic bond market is one of the largest in Asia, behind Japan and South Korea. Of course, it is never viable when foreign investors dominate any markets, simply because when they decide to withdraw, the backlash on the currency can be debilitating. Malaysia is an open economy and foreign investor presence is essential if it is to stay regionally integrated and relevant.

Certainly, the central bank’s priority has always been to ensure a stable ringgit and minimise market disruptions. Prohibiting ringgit facilitation of offshore NDFs may work to ward off speculation in the currency, but in the larger scheme of things, such measures are best for the short term.

Perhaps, the better option is to build an economy strong enough to withstand any headwinds that blow this way. This means, among other things, strong sustainable growth, a conducive investing environment, vibrant capital markets and strong governance.

Speculators see opportunities only when there is a fault line in our economic foundation, as history has shown.

In the Second Financial Masterplan (2011-2020), one of the initiatives is the development of deep and dynamic financial markets for money, forex and government securities to meet the diverse needs of a more developed and internationally integrated economy. The question is whether such prohibitive measures to prevent speculation are in sync with the goals of the blueprint. Can we have the cake and eat it too?

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