KUALA LUMPUR (Nikkei Markets) -- A slew of recent measures announced by Malaysia to boost onshore foreign exchange market will likely be sufficient to stave off a potential expulsion from the FTSE Russell World Government Bond Index next month, analysts and investors said.
In April, FTSE Russell said Malaysia was being considered for a potential downgrade that would disqualify the country's bonds from being included in the index. FTSE Russell has scheduled a review of the index in September.
Malaysia, currently assigned a "2" and included to the index since 2004, may be downgraded to a "1," the index provider had said. FTSE Russell assigns local currency fixed rate government markets a level of 0, 1, or 2, with 2 representing the highest level of accessibility.
If Malaysia successfully retains its slot in the global bond index it will potentially avert foreign outflows up to $10 billion that risk pressuring the ringgit and raise borrowing costs in an economy that has recently been showing signs of fatigue.
However, fund flow data into fixed-income securities of Southeast Asia's third-largest economy suggests that investors remain confident that the measures to improve onshore financial market liquidity will likely appease the index provider.
"Our base case is that Malaysia will stay in the index," said Duncan Tan, a strategist at DBS Group in Singapore. "The measures have been quite comprehensive and I don't think the index provider is going to be too harsh, considering Malaysia's efforts to improve liquidity and deepen the market."
Last week, Bank Negara Malaysia announced further liberalization of its foreign exchange administration, including allowing residents to hedge foreign currency current account obligations up to their underlying tenure, from up to 12 months previously.
In addition, non-residents are now free to hedge on an "anticipatory basis" through the appointed overseas offices for settlement of trade in goods and services. The measures, among others, are part of efforts to further deepen Malaysia's onshore financial market, the central bank said.
Earlier in May, BNM announced initiatives to boost the country's market liquidity and accessibility, including enhancements to repo market liquidity and flexibility as well as increased flexibility for dynamic hedging program participants to manage foreign exchange risks.
Bank Negara Malaysia Governor Nor Shamsiah Yunus said recent discussions with FTSE Russell has been positive and the index provider was "appreciative" of the measures introduced so far.
Malaysian government bonds have in-part, benefited from the rally in Asian bonds as investors chased yields amid decline in U.S. interest rates. In addition, the presence of state-run institutional investors such as Employees Provident Fund have also supported demand for government securities.
Foreign holdings in domestic debt securities have risen back to 182.6 billion ringgit in June from 175.9 billion ringgit in May, according to BNM's data. That helped narrowed total net outflow to 2.2 billion ringgit by June from 8.9 billion ringgit in the first five months of 2019.
The inflow, coupled with purchases of Malaysian equities, helped the ringgit to gain 1.3% against the U.S. dollar in June. The gains helped trimmed the currency's year-to-date loss to 1.2%.
"Taken altogether, we think it suggests a higher chance that Malaysia will be retained in the WGBI," said Maybank Investment Bank Analyst Winson Phoon.
However, if FTSE Russell follows through its move, Barclays estimates foreign investors could unwind as much as $10 billion of their holdings in Malaysian government securities. Maybank forecasts risks of outflow at about $4 billion by passive funds and a further $2 billion-to-$4 billion by active funds.
Barclays' Economist Brian Tan, however, was more cautious. "It remains to be seen if this will be enough to ease FTSE Russell's concerns."
--Jason Ng
