Saturday, 7 January 2017
Return of foreign investors’ appetite for bonds?
BY FINTAN NG
Risk assessment: Analysts believe there are reasons to be cautious on the currency risks, given the ringgit’s movements in recent months.
Risk assessment: Analysts believe there are reasons to be cautious on the currency risks, given the ringgit’s movements in recent months.
Yield gap with US treasuries will drive demand
IT seems a stretch to even think that government bond issuances can impact ordinary citizens but it does. Most people will not even know when governments issue bonds but they are issued to raise money for spending, which can be for development or working capital.
In Malaysia, working capital includes civil service salaries and pensions as well as government procurement of supplies and services, areas that come under the operating expenditure of the budget. Development expenditure refers to spending on civil infrastructure such as roads, utilities and ports, defence, education and training as well as affordable housing. In short, government bonds fund working capital through the operating expenditure, without which citizens will be left without a host of government services.
Malaysia has a total of RM67bil in Malaysian Government Securities (MGS) and Government Investment Issue (GII) maturing this year. The gross issuance of government bonds, as these MGS and GII are also known as, for this year will come to RM107bil, including rollover of the bonds that are maturing. This means that if the entire RM67bil of government bonds are to be rolled over or refinanced, the net bond issuance this year will come to around RM40bil.
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The question is how new issuances and the rollover of the maturing bonds will be received by the capital markets given the challenges the economy is facing, both in the domestic and external fronts. Will foreign investors, who have substantial holdings of government bonds, continue to buy or will they continue to invest in the US markets, where the US Federal Reserve has signalled that there could be three more interest-rate hikes this year?
At its most basic, bonds issued by governments or corporations are rated for their credit risk by the strength of the underlying cash flow, which gives a fair idea of a country’s economic growth or a company’s financial health. Malaysia has a A rating and a stable outlook.
There are other risk assessments too at the country level, including for currency, inflation and politics. Analysts believe there are reasons to be cautious on the currency risks, given the ringgit’s movements in recent months and, political risks, given that a general election may be called this year.
If there is no reason to doubt the finances of a government or company, then international rating agencies such as Standard & Poor’s (S&P), Moody’s and Fitch or local ones such as RAM Holdings Bhd or Malaysian Rating Corp Bhd will rate these entities with a higher credit rating, the higher the rating the less reason to be concerned that the Government or company will default.
The ability of the Government to honour the periodic interests from the bonds and pay the principal really depends on how well and how much tax it can collect. Being fiscally prudent is good too. Also, it helps if the economy is growing at a healthy pace because incomes at the individual and corporate levels will be higher, which means more taxes can be collected. Higher personal incomes mean more spending in the domestic economy, which means more government revenue coming from the goods and services tax.
However, economic growth has been slowing since 2014 and the picture this year is not much better. The International Monetary Fund projects the Malaysian economy to grow 4.5% this year, better than last year but still slower than 2015 and 2014. The Government projects 4% to 4.5%, so growth will be flat this year when compared with last year, which has been projected at 4.2%. While oil prices have risen on production cuts, demand is still uncertain because the global economic outlook remains cloudy.
What this means is that the ability of the Government to spend on all aspects of the economy and society will be constrained, partly because it will collect less tax but also because it wants to lower the fiscal deficit, targeted at 3% of gross domestic product or RM40.3bil for this year, from 3.1% last year. It has recalibrated the federal budget twice, in fiscal 2015 and 2016, to reflect the lower oil prices and to reprioritise spending.
Also, there will be pressure from foreign investors accelerating their selling of MGS/GII should the prospects of the economy remain dim. Yields will climb as bond prices fall, which will mean more funds will have to be allocated from the operating expenditure to service debt, already projected to increase to 9.7% or RM26.6bil last year from 7.5% or RM24.3bil in 2015.
Double-edged sword