More bond selldown?
SO there was that alarming Malaysian Government bond selldown last month.
A record RM26.2bil of local bonds were dumped by foreigners in March, bringing total foreign ownership to 38.5% currently from about 47% in November 2016.
The main culprit? The drying up of liquidity in the ringgit non-deliverable forward (NDF) market.
However, it isn’t as bad as most people think.
For one, despite all that panic selling, Bank Negara’s foreign reserves rose US$0.4bil to US$95.4bil as at end-March, equivalent to 8.3 months of retained imports and 1.1 times of short-term external debt.
At the same time, foreigners switched their attention to equities and bought some RM4.3bil worth of local equities, marking the third month of net buying and the highest monthly purchase since March 2016.
So, what’s with all that bond panic-selling in March?
Recall that last November, Bank Negara finally responded to the volatility and slump in the mangled ringgit by clamping down on the trading of the offshore NDF market.
This move was certainly effective in neutralising currency speculation. However, it also dampened interest from overseas investors, as they found it harder to hedge their positions in the country’s assets.
Global funds pulled more than RM35bil from Malaysian sovereign bonds in the four months through February, the longest stretch of outflows since 2014.
Reports have indicated that offshore trading in the ringgit (NDFs) has dropped by about 70% since policymakers took steps in November to deter foreign banks from trading the contracts. This was because the curbs on the NDF market made it harder for some offshore investors in Malaysian debt to hedge their risk.
In December, Bank Negara further imposed a requirement for exporters to convert at least 75% of their export proceeds to ringgit, which was a key move to defend the local currency’s value. The move was in response to the growing unwillingness of exporters to convert their foreign exchange (forex) receipts into ringgit.
So far, this has worked. Year-to-date, some US$2bil has been converted into ringgit.
The problem, though, is that foreign investors are selling their bonds as a result of the restrictions on the NDF market. This can ultimately affect the ringgit.
At a briefing on Thursday, the central bank’s financial markets committee (FMC) introduced further initiatives such as allowing companies to hedge up to RM6mil of their forex exposure and non-bank entities to hedge 100% of their forward positions.
It said the flexibility would allow exporters and importers to unwind 100% of their hedged positions.
The central bank said the focus would be on improving liquidity and trading activity in both the forex and bond markets. Apart from further liberalisation measures in the two asset classes, it also intends to strengthen the underlying financial market’s infrastructure.
Among the new measures, investors will now have more flexibility in actively managing their forex exposure with onshore banks.
The distinction now will be companies being eligible to undertake the management of their forex exposure, aside from institutional investors, a timely move given that some exporters can be more vulnerable to large forex fluctuations in their foreign currency earnings, as well as in their dollar-denominated borrowings.
According to Bank Negara, registered non-bank entities will now be allowed to have a net forward hedge position of up to 100% of their underlying assets and manage an additional 25% of their forex exposure.
Additionally, entities will have the freedom to hedge up to RM6mil per client per bank on a net open position basis.
To further enhance the bond market, the FMC has expanded regulated short selling activities in Malaysian Government Securities to include all resident entities. Prior to this, only licensed banks and investment banks were allowed to undertake this activity.
Economists and currency experts contacted feel that Bank Negara is attempting to soothe the situation and entice players back to the market, following the fierce selling of local bonds.
“Yes, I can see that Bank Negara is trying to promote that hedging channel. So with these measures, by right, investors can hedge both their forex and bonds onshore. Is that enough for the investor? It remains to be seen. But I feel that the current foreign investors’ tone is to exit,” says Nizam Idris, head of forex and fixed-income strategy at Macquarie Bank Ltd in Singapore.
“Investors dislike any kind of controls. When their investment strategy has been affected by regulations and controls, they react by going elsewhere. After all, Malaysia is not the only market to trade in,” says Nizam. On a more positive note, Nizam says that global funds are generally still under-invested in emerging markets. As interest in this part of the world is increasing, Malaysia could also see some inflows.
“You cannot have your cake and eat it too,” remarks one economist.
“If you want to have capital controls, you can’t expect that much portfolio flows. Investors will bypass your market. With capital controls, yes you have avoidance of outflows, but you will also have inflows that are less enticing,” he says.
He adds that investors in general do not like flip-flop policies.
“The more restrictions you have, well, it just deters investors. It also becomes more risky for them. So, they would rather go elsewhere,” he says.
On the other hand, Shan Saeed, chief economist at IQI Global, feels that fund outflows are normal.
“Money flowing out of the country constitutes a part of the financial market. Sophisticated investors are simply repositioning their asset portfolios according to the market condition. We are living in uncertain times now, as volatility is the new norm of the market structure.
“Investors are feeling the pressure of the global market uncertainty. For example, US President Donald Trump has indicated that he wants a weaker dollar to spur growth in the US. However, Federal Reserve chairman Janet Yellen wants a stronger dollar. So, there is a clear policy mismatch in the decision makers. All this policy ambiguity will cause volatility in the market further and keep investors on the edge,” he says.
Shan is personally very bullish on Malaysia and the Malaysian economy due to five reasons.
There’s strong economic confidence, which is akin to an appreciating asset for the country at the macro level. Then, there is solid aggregate demand, modern infrastructure, an educated labour force and the Straits of Malacca.
Shan said that 80% of China’s trade moves from west to east through Malacca. Some 40% of the global oil supplies move through the Straits of Hormuz and Malacca.
He adds that over the last six months, the Malaysian Prime Minister has demonstrated remarkable diplomatic and economic brinkmanship by securing investments tantamount to RM175bil – RM144bil from China and RM31bil from the Arab world. Now, more money is coming from India.
He further adds that Malaysia’s Government balance sheet is strengthening, sending positive signals to global smart investors.
“At the end of the day, investors are looking at the economic confidence at the macro level,” he says.
The ringgit has yet to strengthen despite a weakening US dollar
Now, perhaps we know why the ringgit has not been appreciating despite the fact that the US dollar has been weakening.
Regionally, it is the worst performer of the 11 Asian currencies over the last six months.
Year to date, the ringgit has strengthened only against the yuan, the rupiah, the Philippine peso and the Hong Kong dollar.
What is even more puzzling is that foreign money is coming in for Malaysian equities.
As of April 7, it had been nine straight weeks of foreign buying on Bursa Malaysia, during which RM6.1bil made its way to Malaysian shores.
Year to date, the cumulative amount is slightly higher at RM6.39bil. The inflow this year has already offset the estimated net outflow of RM3.01bil in 2016.
So, with all that buying frenzy over a few weeks, why then hasn’t the ringgit gained strength?
As of now, the ringgit stands at RM4.43 to the dollar. Most analysts and economists are unanimous that the ringgit is undervalued at least by 10%.
March figures for the foreign ownership of Malaysia’s Government bonds are very telling.
We already know that there is a risk of Malaysian bonds being sold down, as some 34% are held by foreigners. But to fall to this drastic level?
Foreign ownership of Malaysia’s Government bonds in March fell for the fifth straight month at a record RM26.2bil. It was RM6.6bil in February. The redemption was mainly driven by Malaysian Government Securities (MGS), which plunged by RM23bil, followed by Bank Negara Bills (-RM3.4bil) and Government Investment Issues (-RM0.6bil).
“This marks its fifth straight month of decline, outpacing the previous record slump of RM18.9bil in November last year, following the result of the US presidential election.
“MGS fell the hardest,” says Maybank Investment Bank Research (Maybank IB).
As a result, foreign holdings of MGS dipped to 38.5%, the lowest in almost six years or since April 2012.
The cumulative outflow from government bonds since November last year has reached a staggering RM61.5bil.
To put this in perspective, outflows during the taper tantrum episode in June to August 2013 totalled only RM28bil, while the highest annual inflow into Government bonds was just RM52.6bil in 2010.
In Maybank’s Fixed Income Foreign Flows report dated April 10, it said that outflows are not simply maturity-driven.
“The RM23bil outflow from the MGS in March had far exceeded the RM10.5bil maturity even if we assume a very high foreign share. This suggests that a significant amount of positions was unwound by foreigners in addition to the exit of funds from bond maturity,” it said.
The next big maturity to take place will happen in August, where there is a RM9.5bil redemption, and a RM13.5bil redemption in September.
Maybank IB’s report further added that the reduction in Malaysia’s weightage in the Global Bond Index – Emerging Market (GBI-EM GD) index would naturally mean outflows from passive funds. However, it opined that the bulk of the outflows in March came from foreign banks and active total return funds.
“Foreign banks’ positions had likely dropped to a very low level, if not already zeroed out. Active total return funds also had the flexibility to position more heavily in the front end and potentially are the major sellers in March, as opposed to passive funds which track the index constituents – recent changes in GBI-EM GD were the removal of MGS 7/20 in March and MGS 4/26 in February,” it said.
Risk of additional outflows?
While this is a valid concern, as consecutive months of outflows since November last year had widened further in March and Malaysia’s weightage in the GBI-EM GD index is declining, a lower foreign holdings equally means that this has now become less of a threat to the country’s external vulnerability.
Maybank IB is of the opinion that the second half of 2017 will fare better than the first quarter of 2017 (RM37.4bil total outflows), with a view that foreign positioning risks have reduced.
It also believes that even if Malaysia’s weightage in the GBI-EM GD index continues to decline, it will be at a gradual pace, as index weightage is reduced through the removal of off-the-runs while not adding new bonds to the constituents. Therefore, there will be no abrupt flight of capital.
Maybank IB group chief economist Suhaimi Ilias expects the current selldown of portfolio capital in the bond category to continue, given the prospect of two more rate hikes by the US Federal Reserve on top of the remaining bond maturities amounting to RM67bil.
“However, we expect the worst is over and the selloff will subside, largely supported by the buying strength of local institutional funds led by the Employees Provident Fund (EPF), as it raises its holdings of Government securities.
“Last year, it invested 23.8% of its total asset size of RM703bil or RM167bil in Federal Government securities. As it had already increased its purchase of Federal Government securities by 2.5% to RM4.1bil in January, presumably to absorb the foreign selloff, we will not be surprised that it would surpass last year’s total investments in govies.
“Perhaps, a reversal in the equity market will also pull some of the money back to the safety of Government bonds,” he says.
RHB Research agrees, saying that the impact of selloffs is cushioned by the strength of local institutional funds, with the EPF raising its holdings of Government securities.
Secondly, since Bank Negara implemented the requirements for exporters to convert at least 75% of their export proceeds into ringgit, it has increased the supply of dollars, which helps buffer foreign reserves.
Last week Second Finance Minister Datuk Seri Johari Abdul Ghani reassured investors that Malaysia sees no need to impose further steps to stabilise the ringgit, and domestic growth should provide ammunition for the currency to strengthen.
While the ringgit continues to see some upside against the US dollar, Suhaimi remains cautious on the relative weakness of the ringgit.
“With at least two more indicative rate hikes by the US Fed, it could weigh down on the ringgit’s strength and heighten the vulnerability of foreign holdings of domestic financial assets,” he cautions.
But there are signs that the US Fed is gradually toning down its hawkish slant.
“This may help to taper down risk of large capital outflows from the emerging economies. Nevertheless, we maintain our view that the ringgit will be range-bound in the short to medium term between 4.40 and 4.50, while our year-end forecast is 4.35,” he says.