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Najib faces testing year as Maybank arm sees record sukuk yields

[KUALA LUMPUR] Malaysian Prime Minister Najib Razak faces another testing year as the Islamic asset management arm of the nation's biggest lender predicts record borrowing costs.

Maybank Islamic Asset Management Sdn says benchmark sukuk yields will rise to 5 per cent, adding to an increase that has complicated Najib's efforts to fund a US$444 billion development program and cut the budget deficit. That paints a bleak picture for companies in the world's top Shariah-compliant debt market after contending with a slide in the ringgit last year that made it Asia's worst-performing currency.

The bank's prediction is based on the premise that US interest rates will reach 1.25 per cent this year from a maximum 0.5 per cent now, and if investors price in further tightening in the following 12 months. The ringgit is already down 2.3 per cent in 2016 as a selloff in Chinese stocks sparked risk aversion, driving the yield on 10-year Islamic notes to the widest relative to shorter maturities since 2010.

"Yields for Malaysian sukuk are still going to be volatile," said Syhiful Zamri Abdul Azid, the Kuala Lumpur-based chief investment officer at Maybank Islamic, who helps oversee RM17 billion (US$3.9 billion). We will "cut holdings of Malaysian government sukuk and top-rated corporate debt should US interest rates rise significantly by 1 per cent or more," he said.

The Southeast Asian nation's 10-year Shariah-compliant debt yield climbed 25 basis points to 4.52 per cent in 2015 and touched an unprecedented 4.56 per cent on Dec 14, according to a Bank Negara Malaysia index. The yield's rise will be capped around 4.7 per cent if the US benchmark rate doesn't reach 1.25 per cent, Syhiful said.

The difference in yield between the securities and two-year notes increased to a high of 128 basis points on Wednesday.

Najib aims to cut the deficit to 3.1 per cent of gross domestic product this year, from about 3.2 per cent in 2015, and balance the shortfall by 2020. He's in the midst of a 10-year development plan to achieve advanced economy status.

The outlook for higher borrowing costs hurt Malaysia's Islamic bond sales in 2015, with issuance falling 15 per cent to RM55.1 million, the least in four years, data compiled by Bloomberg show. While CIMB Group Holdings Bhd and AmInvestment Bank Bhd predict a revival in 2016, RHB Investment Bank Bhd sees offerings ending up similar to last year.

"Malaysia's 10-year sukuk yield is expected to remain largely unchanged at 4.60 per cent as lower supply of that maturity and an accommodative monetary policy will offset further increases in the Fed's rate," said Angus Salim Amran, the Kuala Lumpur-based head of financial markets at RHB Investment Bank, the country's second-biggest Islamic bond arranger.

The Fed raised its key rate in December for the first time in almost a decade and Angus predicts it will increase to 1 per cent in 2016, with hikes in the second and fourth quarters.

Bank Negara Local yields have been more affected by what the US will do than on Malaysia's policy direction. The central bank has kept its overnight rate at 3.25 per cent since July 2014 as the ringgit slid 19 per cent last year, the biggest decline since 1997. Current central bank Governor Zeti Akhtar Aziz is also due to retire in April, clouding the policy outlook.

"While most market players agree that the direction of the Fed's rate is on the way up, albeit at a slower pace than anticipated earlier, the direction for the overnight policy rate is far less certain," said Johar Amat, head of Treasury at OCBC Al-Amin Bank Bhd, the Shariah-compliant unit of Singapore's second-biggest lender. "The market is also anxiously waiting for the announcement of who the next governor will be and the opportunity to gauge his or her hawkishness."