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NEW UPDATES Asean Affairs   24 February  2016  

Foreign capital returns to Malaysia

THIS is no monkey business: capital is finding its way back to emerging Asian markets, including Malaysia, to seek better yields. This happens as doubts about further interest rate hike in the United States arise, while other developed countries have pushed their interest rates deeper into the negative territory.

Figures from international banking giant JP Morgan show that US$5.5 trillion worth of advanced-economy government bonds were traded at negative yields as at the end of last month. But as of last weekend, the amount of sovereign debt trading at negative yields is estimated to have grown to US$8 trillion; hence the inflows of capital to emerging Asian markets that offer positive returns.

“We are cautiously optimistic that longer-term foreign investors are the ones coming back into the emerging markets, as these fresh flows are coming in at a stage where there is still volatility in emerging markets,” CIMB Investment Bank director of regional fixed-income research Nik Ahmad Mukharriz Nik Muhammad told StarBizWeek in an email.

“The fact that emerging markets offer better returns than most developed markets help (drive this round of foreign capital inflow), especially with emerging-market currencies now performing better than last year, while commodities prices have likely seen the worst behind them,” he said, pointing to the trend of low or negative interest rates in developed economies and the dovish tone of the US Federal Reserve of late.

In Thailand and Malaysia, for instance, Nik Ahmad Mukharriz noted 10-year government bonds offer yields of two per cent and 3.90 per cent respectively, compared with levels much lower than two per cent in developed countries.

As one of the beneficiaries of these capital inflows to emerging economies, Malaysia has seen increased foreign holdings in its bond market in recent months, while the ringgit has rebounded from its multi-year lows.

Year-to-date, the ringgit has gained 2.05 per cent against the US dollar. This makes the Malaysian currency one of the top performers in the region so far this year.

Data from Bank Negara show that Malaysia’s bond market registered net foreign inflows of 1.7 billion ringgit last month, compared with 1.2 billion ringgit in December 2015. This brings total foreign holdings of Malaysia’s total debt securities to 216.5 billlion ringgit in January 2016, compared with 214.8 billion ringgit in the preceding month.

Inflows have been particularly strong in the Malaysian Government Securities (MGS) segment, with foreign ownership of MGS rising to 164.4 billion ringgit, or 47.9 per cent of total MGS outstanding, as of end-January 2016, from 162.1 billion ringgit, or 47.7 per cent, in December 2015.

The Malaysian equities market, however, continues to see net foreign selling, albeit at a slower pace now than last year.

“That foreign capital is flowing into bonds, and not equities, is telling that we are not attracting speculative hot money,” said a bond dealer with a local bank.

“We are still in a risk-off environment; there are just too much uncertainties in the global economy, and investors are still looking for an inflection point – whether to take on more or less risk,” he explained.

Developed countries have increasingly relied on unorthodox monetary policies to lift economic growth and employment. Negative interest rates and prior to that quantitative easing were new policies not deployed by global central banks, but now have become more common.

Denmark was the first to take on this unconventional monetary policy in July 2012. Eurozone followed suit when the European Central Bank (ECB) became the first major central bank to go negative in June 2014.

Switzerland cut its interest rates to negative levels in December 2014. Sweden did the same thing in February 2015. Japan joined the club last month.

The ECB will likely go deeper into the negative territory next month, while Sweden had already done so last week.

The world’s largest economy is open to the idea of taking its interest rates into the negative territory, according to its central bank chair Janet Yellen.

However, she has stressed that at this point, the chances of such a move are still low. The US economy will have to get a lot worse before the US Fed considers such a drastic policy.

January Fed minutes show a stark split between the hawks (those that support rate hike) and doves (those that support rate cut), with the overall message, according to observers, being “we are not quite sure what is really going on”.

There are now doubts over whether there will be any rate hike in the United States this year, after the first rate hike in nearly a decade took place in December 2015, when the US Fed raised interest rates by 25 basis points from zero percent to 0.25 per cent.

When central banks cut interest rates, they have one objective in mind - stimulate economic growth by encouraging people and businesses to spend their money.

Cutting interest rates to negative levels is indeed a drastic, with some analysts taking it as a sign that policymakers are running out of ways to support growth.

The theoretical reasons for negative interest rate policy are multifold.

Firstly, it is to fight capital inflow, and to help weaken the country’s currency, through interest-rate differentials. Then, a weak currency will help the country’s central bank meets its inflation targets through higher cost of imported goods.

This is especially crucial in the current market environment as many countries are facing the risk of deflation due mainly to the collapse in oil prices.

Bottomline, the move is to boost the country’s gross domestic product growth.

Unfortunately, negative rates have thus far failed to help the countries that have adopted this policy to curb their currency strength, raise inflation expectations and boost equity markets.

According to Bank of America Merrill Lynch Global Research, the negative interest rate policy has been ineffective as the market currently interprets it as policy exhaustion.

The policy would have been more effective if investor risk appetite was strong, market volatility was low and carry-trades became more popular. Historically, though, quantitative easing (QE or printing money), which involves the central bank buying bonds to inject money into the economic system has been more effective at raising inflation expectations.

The prevailing dovish stance in developed economies has supported capital flows into higher-yielding emerging market economies, including Malaysia. Such inflows have provided some relief to the heavily battered ringgit.

Nevertheless, the current inflows to emerging-market economies have not been as strong as the influx of 2009-2014 when QE was the order of the day.

This is due to low levels of risk appetite that make investors still somewhat wary of higher-yielding emerging-market economies.

So, the still subdued risk appetite of investors amid the current uncertain global environment could cap gains.

According to analysts, foreign inflows to Malaysia’s bond market will likely be sustained through the medium term before the risk of volatility flows sets in again in the second half of this year.

A bond analyst says the current foreign inflows are more of a rebound or correction, than a new sustainable trend, as investors are merely seeking higher yields and taking advance of the heavily battered ringgit for catch-up opportunity.

The market in general remains cautious over the direction of the ringgit, although the dovish stance of developed economies and the recent rebound in crude oil prices have boosted the prospects of the Malaysian currency.

Heightened levels of investor uncertainty will prevent the ringgit from strengthening to less than four against the US dollar. At best, analysts said, the ringgit will range between 4.1 and 4.2 against the US dollar over the medium term.

One of the major risks that could still weigh on the ringgit is the further devaluation of the yuan.

Although concerns over China devaluing its currency have eased in recent weeks, following comments by the People’s Bank of China that there was no basis for the yuan to keep falling and that it was committed to keep its currency stable, the possibility of the second-largest economy going back on its word is still there amid what many investors perceive as an ongoing currency war.

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