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Inflation down, yields up; Malaysia looks set for positive rerating
TEN months since Malaysia formed a new government, its equity market has corrected by almost 9 per cent. The initial variability of government policies had unsettled markets.
For instance, fixed-line telephone and broadband incumbent, Telekom Malaysia, was requested by the government to lower consumer and wholesale prices. This decimated its share price. Infrastructure contractor, Gamuda, had to lower the prices of several government projects it had secured.
Further compounding investors' nervousness was the outright cancellation of government contracts that were already awarded (eg an immigration contract called SKIN); the deferment of mega-projects such as the high-speed rail project between Singapore-Kuala Lumpur and MRT3; the country's widening fiscal deficit and slipping consumer spending after the removal of GST.
It was a struggle for most to be upbeat on Malaysian equities and even bonds. However, we believe a positive re-rating is looming.
First, major government contracts are starting to be revived. After multiple false starts, the highly-publicised RM80 billion (S$26.5 billion) East Coast Rail Link is likely to resume, at a more affordable price tag and scale. This project could be a major catalyst for the country's equity market and economy. A decision is expected as early as April.
Second, the government is making much effort to tighten its finances structurally and provide more transparency. Contracts that were previously directly negotiated will be re-tendered via open tenders. These include the Klang Valley Double-Tracking 2 rail project. The government has also secured cost-savings for its mega-projects. According to the Ministry of Finance, there will be 22 per cent or RM8.8 billion savings for the MRT2 project and 47 per cent or RM15.5 billion savings for LRT3.
Third, consumer spending this year will be propped up by a large RM35 billion refund of GST and income tax. Regardless of the exact quantum spent or saved by households, this should be a net positive for consumption spending.
Fourth, unlike many other emerging markets, Malaysia's external finances remain on a solid footing. Malaysia has been running a current-account surplus for more than 20 years.
Finally, we see room for interest rates to go lower. As our chart suggests, Malaysia's inflation rate hit a watershed when it turned negative in January. This was its first contraction in almost a decade. Meanwhile, the country's real 10-year government bond yield is at 4.7 per cent, the highest in a decade. With inflationary pressure subdued and real yields at elevated levels, we believe there is room for the central bank to loosen monetary policy.
Like any investment proposition, there will always be wild cards. Key for Malaysia will be its fiscal deficit. Malaysia expects a fiscal deficit of 3.4 per cent of GDP in FY19. Behind this is its assumption that Brent crude will trade at US$60-70 per barrel. Petroleum accounts for 20-30 per cent of government revenue. With Brent now at US$65, its fiscal deficit should stay on target. However, any persistent drop in oil prices below the US$60 mark could make Malaysia vulnerable to a sovereign downgrade by rating agencies. For now, we see no such risk.
- The writer is head of Research at PhillipCapital.
Disclaimer: Chartpoint is provided by Phillip Securities Research for information only, and should not be construed as investment advice.
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