The storm clouds gathering on Malaysia's false dawn

Viewpoint

When I look at Malaysia as a fixed income investment proposition and observe the 10-year government bond yielding 4%, my first thought is “that is too low.”

Like most Asian government bond markets, Malaysia’s have rallied this year, pulling in almost 25bp at 10 years.

Only the Philippines and South Korea have missed out on the party – the former on the back of a weak peso, the latter on a bribery scandal which unseated the incumbent president.

Malaysia, of course, has a scandal of its own in the form of state-owned investment company 1MDB. But this scandal has failed to unseat the incumbent prime minister, despite his being placed firmly at its centre, according to the narrative of foreign law enforcement including the US, Singapore and Switzerland.

For Malaysian bonds to have rallied against such an inauspicious backdrop might seem perverse, but it has been based on a variety of bullish inputs, and in my opinion the dawn which seems at first blush to be appearing in the Malaysian bond markets will prove to be false.

The recovery in the crude oil prices from last year’s collapse to US$30 a barrel, and then back up to an average of around US$50, has had rather a lot to do with it, with Malaysia’s flagship producer Petronas reclaiming its spot as a nerve-soothing cash cow.

My suspicion is oil is set for a retrace down, as OPEC’s efforts to propel the oil price up to US$60 a barrel are likely to prove ineffective in the face of uncooperative producers and the US shale oil production dynamic, which provides a marginal cost for crude at US$40 a barrel. An overshoot to the downside cannot be ruled out, particularly given the current perky state of the US shale industry.

That would strip a large garment from the emperor’s clothing in Malaysia, should it occur.

Then I look at Malaysia’s potential to add a current account deficit to go along with the fiscal deficit it has run for most of the past 20 years – government spending consistently outstrips revenue in the country.

That seems a strong possibility as Malaysia looks to join China’s Belt Road initiative via the construction of vast transportation infrastructure projects and the consequent surge in capital goods spending.

In the face of his 1MDB-linked political woes, Malaysian Prime Minister Najib Razak has been openly courting Chinese investment over the past few years. A current account deficit might be the consequence.

To sense the danger on the horizon in Malaysia, one only has to recall the pummelling the Indian rupee and Indonesian Rupiah received on the back of government deficits in those two countries around five years ago.

Another risk is the less-than-pristine tally of foreign exchange reserves at Bank Negara Malaysia. These have collapsed over the past few years, from US$141.4 billion in 2013 down to US$99.4 billion at the last count this month, in part due to the central bank’s efforts to stem downside pressure on the ringgit.

According to Commerzbank, these reserves are sufficient for 6.5 months of imports – one of the worst cover ratios in Asia. Bank Negara suggests the coverage amounts to 7.9 months. Ah, Malaysian statistics – don’t you just love them?

One moving part of all this is 1MDB’s July 31 default on a payment due to be made to Abu Dhabi’s IPIC, which is all part of the 1MDB imbroglio.

A five-day grace period granted by IPIC to make good on the US$603 million – part of a US$1.2 billion settlement agreed by 1MDB – has expired. Default on those monies due would just help darken the storm clouds I see gathering on Malaysia’s horizon.

Date

15 Aug 2017

Channel

Capital Markets

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