Pru­dent use of bonds in­creases fi­nan­cial re­silience

New Straits Times - - Business -

OVER the last two decades, the Malaysian bond mar­ket had ex­panded at an im­pres­sive com­pounded an­nual growth rate of 12.1 per cent to reach RM1.2 tril­lion, or 95 per cent of gross do­mes­tic prod­uct (GDP) as at the end of last year. The sus­tained growth is a re­flec­tion of the at­trac­tive­ness of the do­mes­tic debt cap­i­tal mar­ket in meet­ing the fi­nanc­ing needs of the gov­ern­ment and pri­vate sec­tor.

Most de­vel­op­ing coun­tries ex­pe­ri­ence rapid in­creases in the is­suance of cor­po­rate bonds, but Malaysia’s mar­ket stands out among the out­stand­ing cases. The depth of Malaysia’s cor­po­rate bond mar­ket, as mea­sured by the out­stand­ing amount to do­mes­tic GDP, stood at 42 per cent, or close to dou­ble the av­er­age of 24 per cent es­ti­mated for emerg­ing mar­kets.

Avoid­ance of dou­ble

mis­matches

The de­vel­op­ment of Malaysia’s cor­po­rate bond mar­ket took on an ur­gent note fol­low­ing the Asian fi­nan­cial cri­sis in 1997/98. Among the causes of the cri­sis was the over-de­pen­dence on the banking sec­tor and ex­ter­nal bor­row­ings, which re­sulted in the dou­ble cur­rency and ma­tu­rity mis­matches that plagued Asian economies. In­ad­e­quate do­mes­tic sav­ings and high costs mo­ti­vated many cor­po­ra­tions to re­sort to for­eign cur­rency bor­row­ings, ex­pos­ing them to ex­change rate risks that ma­te­ri­alised dur­ing the cri­sis, when for­eign cur­ren­cies plunged.

Banks and cor­po­ra­tions were also ex­posed to ma­tu­rity risks. Banks’ short term de­posits and cor­po­rate bor­row­ings were used to fi­nance long term li­a­bil­i­ties and projects.

When liq­uid­ity tight­ened due to for­eign cap­i­tal with­drawals and in­ter­est rates rose, the debt ser­vic­ing bur­den of highly lever­aged firms es­ca­lated, while banks were sad­dled with non-per­form­ing loans.

The deep­en­ing of Malaysia’s bond mar­ket has al­le­vi­ated much of the cur­rency and ma­tu­rity mis­matches for cor­po­ra­tions, es­pe­cially those in­volved in un­der­tak­ing large scale, long-term and cap­i­tal-in­ten­sive in­fras­truc­ture, prop­erty de­vel­op­ment and in­dus­trial projects.

The mar­ket’s depth and re­silience is re­flected by its smooth func­tion­ing de­spite re­cent tur­bu­lence in the world’s bond mar­kets caused by the global fi­nan­cial cri­sis, the euro­zone sov­er­eign debt cri­sis, the 2013 “Ta­per Tantrum” and, more re­cently, United King­dom’s ref­er­en­dum to exit the Euro­pean Union and the elec­tion of Don­ald Trump as United States pres­i­dent

Ef­fects of global liq­uid­ity The al­lure of higher yields, cou­pled with a sound reg­u­la­tory frame­work, sta­ble eco­nomic en­vi­ron­ment and well-func­tion­ing mar­kets, re­sulted in un­prece­dented for­eign cap­i­tal in­flows into the Malaysian and other emerg­ing bond mar­kets. Key fac­tors driv­ing the surge in port­fo­lio flows to emerg­ing economies in­clude the huge global liq­uid­ity cre­ated by cen­tral banks of the US, Europe and Ja­pan through quan­ti­ta­tive eas­ing and neg­a­tive or near-zero in­ter­est rate poli­cies that trig­gered the search for higher yields by global fund man­agers.

The global cap­i­tal flows are char­ac­terised by ebbs and flows driven by global fac­tors as well as coun­try-spe­cific fac­tors. The most re­cent com­mon fac­tors are an ear­lier-than-ex­pected in­ter­est rate hike by the US Fed­eral Re­serve, and the US dol­lar surge in an­tic­i­pa­tion of a strong fis­cal boost that Trump had promised to de­liver dur­ing his elec­tion cam­paign.

Re­silience to non-res­i­dent

out­flows

In com­mon with other emerg­ing mar­kets, the re­ver­sal of cap­i­tal flows to the Malaysian bond mar­ket is ev­i­dent in the de­clin­ing share of non-res­i­dent hold­ings of gov­ern­ment se­cu­ri­ties, which stood at 29.6 per cent as at end Jan­uary.

Ac­cord­ing to the lat­est up­date by Bank Ne­gara Malaysia, non­res­i­dents’ share peaked at 34.7 per cent in Novem­ber.

The sell-down by non-res­i­dents picked up fol­low­ing Trump’s shock elec­tion vic­tory, and Bank Ne­gara’s ac­tions to sta­bilise the ring­git in­cluded mea­sures to curb the off-shore non-de­liv­er­able for­ward mar­ket.

Of the to­tal re­duc­tion in non­res­i­dent hold­ings, amount­ing to RM21.8 bil­lion, Bank Ne­gara re­ported that 70 per cent, or RM15.2 bil­lion, were in short­tenured se­cu­ri­ties of three years and less, sug­gest­ing that the cur­rent out­flow is caused mainly by short-term cap­i­tal, which are typ­i­cally volatile in na­ture.

While a de­cline in for­eign in­vestors’ in­ter­est will re­duce de­mand pres­sures, a lower share of non-res­i­dent hold­ings is ex­pected to re­sult in a less volatile mar­ket, as long-term in­vestors, such as other cen­tral banks and pen­sions, which ac­count for about half of the for­eign in­vestors, tend to ride through mar­ket ups and downs.

Op­por­tu­ni­ties to in­crease

fi­nan­cial re­silience

With the deep­en­ing of the do­mes­tic cor­po­rate bond mar­ket, medium and large-sized cor­po­ra­tions are pre­sented with an ar­ray of fi­nanc­ing op­tions, rang­ing from con­ven­tional to Is­lamic in­stru­ments, to avoid the dreaded dou­ble mis­matches.

The cur­rent low in­ter­est rate en­vi­ron­ment and sta­ble growth ex­pec­ta­tions is con­ducive for com­pa­nies to op­ti­mise their debt-eq­uity mix and re­duce fi­nan­cial risk.

Com­pa­nies with low gear­ing can choose the ap­pro­pri­ate in­stru­ment to suit the fi­nan­cial pro­file of their in­vest­ment projects while those with large for­eign bor­row­ings that are not matched by earn­ings in the same cur­rency can in­crease their fi­nan­cial re­silience through sub­sti­tu­tion with do­mes­tic debts.

On the other hand, over-lever­aged firms need to pare down their debts to re­duce their fi­nan­cial vul­ner­a­bil­ity as well as con­trib­ute to the over­all health and re­silience of the cor­po­rate sec­tor.

The writer is pro­fes­sor of economics at Sun­way Univer­sity Busi­ness School and di­rec­tor of Eco­nomic Stud­ies Pro­gramme at Jeffrey Cheah In­sti­tute on South­east Asia at Sun­way Univer­sity. He is also an ex­ter­nal mem­ber of Bank Ne­gara Malaysia’s Mon­e­tary Pol­icy Com­mit­tee. The views ex­pressed in this ar­ti­cle are his own.

The al­lure of higher yields, cou­pled with a sound reg­u­la­tory frame­work, sta­ble eco­nomic en­vi­ron­ment and well-func­tion­ing mar­kets, re­sulted in un­prece­dented for­eign cap­i­tal in­flows into the Malaysian and other emerg­ing bond mar­kets.

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