MALAYSIA saw foreign fund outflows of RM11.2 billion in April — the highest in 10 months — in contrast to the trend of foreign fund inflow into emerging markets (EMs). Foreigners sold RM9.8 billion of Malaysian debt securities — the biggest outflows since May 2018 — and offloaded RM1.4 billion of equities as well.

Bankers, economists and industry observers believe the foreign outflow is partly due to FTSE Russell’s surprise announcement last month that it might remove Malaysia from its World Government Bond Index (WGBI).

Julia Goh, senior economist at UOB Research, points out that one of the reasons Malaysia was put on the watch list of FTSE Russell’s WGBI was due to concerns over foreign exchange and bond liquidity.

“This can be rectified. Regulators can do something about that by looking into the liquidity concerns,” she says.

Given that Malaysia’s removal from the WGBI will have an impact on the ringgit and, to a certain extent, the bond market’s development in the country, is Bank Negara Malaysia taking any steps to prevent this from happening?

Bank Negara will be announcing the first quarter gross domestic product (GDP) growth numbers this week. It will be interesting to see if it will address this issue, which has raised some concern among market players.

Goh thinks the impact is manageable should Malaysia be taken off the list in September.

“We estimate Malaysian exposure in FTSE to be about RM16 billion. That works out to around 4% of total Malaysian Government Securities (MGS) outstanding as Malaysia was carrying a 0.39% weightage in the WGBI as of March 2019. With the potential size of this exposure, we think it can be absorbed by the local institutions should there be a sell-off,” she says, adding that WGBI excludes Government Investment Issues (GII).

When asked if the local bond market can grow without foreign participation, Goh says foreign participation will be beneficial for breadth and depth.

“It is good to have some foreign participation given the size of our market. At the end of the day, you need to be part of global indices … and there are other indices like Barclays and JP Morgan. We need to do something to ensure the liquidity of our market is enhanced. Regulators need to continuously look at ways to enhance liquidity.

“I believe things are manageable fundamentally but at the end of the day, it is the sentiment that we have to manage with regards to this matter,” she adds.

She says something to watch out for is the impact when the major indices include China bonds. “This could trigger outflows from other EMs to make way for China bonds.’

A local money market dealer, on the other hand, points out that if there are fewer buyers for MGS, the yields would increase and lead to the borrowing cost for local bond issuers going up in tandem.

Financial Markets Association president Datuk Lee Kok Kwan believes the ringgit bond market is in good shape. “Rates have rallied strongly, as much as the recent reduction in OPR where demand has been considerable with new issuances oversubscribed. Credit spreads have tightened considerably this year and there is reasonable liquidity,” he tells The Edge.

He does not expect the local bond market to be impacted much should Malaysia be taken off the FTSE Russell bond index. “The FX side will have more turbulence, so the ringgit might be more volatile should that happen. But the ringgit bond market itself — I don’t see any issue there as markets are hungry for assets, which are well bidded, and the bond market has gone through cycles like this before,” he says.

Regarding the liquidity of the ringgit, even if the foreign fund managers might not be familiar with Malaysian banks, there are manylocal foreign banks onshore with which they can transact their FX with, he notes.

Asked if he sees an exclusion triggering a credit rating downgrade, Lee says no.

“The fundamentals are in good shape as we have a current account surplus, the GDP is reasonably strong, FX reserves are at US$103 billion to US$104 billion, we have no reliance on foreign currency borrowings and with the Goods and Services Tax refunds going out in excess of RM30 billion — mostly in the second half of the year — that will be a fairly decent stimulus to the economy. So, any FX volatility will be backed up by decent fundamentals,” he says. He projects the ringgit this year to be at RM4.08 to US$1.

Phee Lip Ooi, senior portfolio manager at Affin Hwang Asset Management Bhd, also believes the implications of the local bond market being taken out of the FTSE index will be manageable as there should be sufficient domestic liquidity to absorb the risk of a sell-off.

“The ringgit, however, is likely to be more vulnerable should all the foreigners exit at the same time,” he says.

FXTM market analyst Han Tan reckons the outlook for Malaysia’s economic growth will be “respectable”, with “manageable inflation and robust domestic consumption” — all of which should provide a “strong base for the ringgit throughout 2019”. The markets have already largely priced in the recent rate cut by Bank Negara, he adds.

Recent data reveal MGS and GII suffered the largest foreign sell-off at RM3.5 billion each last month, bringing foreign holdings of government bonds down significantly to RM162.3 billion, or 21.9% of the total outstanding — the lowest level since January 2011, says UOB’s Goh.

Data also shows that foreign funds remained net sellers of Malaysian equities for the third straight month , disposing of RM1.4 billion last month, bringing foreign equity outflows to RM2.8 billion year to date.

Notwithstanding the foreign portfolio outflows, Goh points out that Bank Negara’s foreign reserves increased further by US$400 million month on month to US$103.4 billion at end-April.

“The reserves position is sufficient to finance 7.4 months of retained imports and one time total short-term external debt. Foreign reserves remain supported by sustained merchandise trade surplus and foreign direct investment flows. Another positive is that Bank Negara’s short position in FX swaps narrowed further to US$14.2 billion in March from US$18.4 billion in February. This is equivalent to 13.8% of total foreign reserves in March — the lowest level since May 2018,” she says.