Prudent use of bonds increases financial resilience
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
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
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
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.