Malaysian bonds at crossroads as Najib prepares election budget

[KUALA LUMPUR] A nascent recovery in Malaysian bond inflows is set to depend on whether Prime Minister Najib Razak will be able to shrink the fiscal deficit while appealing to voters in an expected election budget.

Mr Najib will be able to count on higher revenue from a consumption tax and a recovery in crude prices, giving him room to commit to a balanced budget that would spur Malaysia's bonds to outperform, according to Investec Asset Management Ltd. Aberdeen Standard Investments said it remains cautious.

The first net foreign inflows into local bonds in four months comes amid speculation Mr Najib will call an election as soon as this year to take advantage of an improving economy, although polls aren't due until August 2018. The turnaround in inflows comes as money managers are starting to become more cautious about emerging markets due to signs of policy tightening in the US and Europe.

"The case for ringgit assets is fairly constructive," said Wilfred Wee, a fund manager in Singapore at Investec Asset Management, which oversaw US$132 billion at the end of September.

"The hope or expectation is that the commitment to a balanced budget plan remains intact. If we see this translated into action, as in a significantly narrower 2018 deficit target than this year's, there is room for Malaysian government bonds to outperform."

Mr Najib presents the 2018 federal budget on Friday with state coffers being boosted by crude oil prices, which climbed to a two-year high of US$59.49 per barrel last month.

National oil company Petroliam Nasional Bhd, the single largest contributor to state income, increased its dividend payout by more than a fifth in August to RM16 billion (S$5.15 billion).

Collections from the goods and services tax increased 17 per cent in the first half to RM19.3 billion, helped by rising private consumption, HSBC Holdings Plc economists Joseph Incalcaterra and Noelan Arbis wrote in a report last week.

With the tax accounting for about 22 per cent of revenue, higher earnings will enable Mr Najib to announce a budget deficit of 2.8 per cent of gross domestic product for 2018, versus an expected 3 per cent for this year, they said.

Optimism over an improving economic outlook saw global funds plow almost RM8 billion into Malaysian bonds in September. Even with those purchases, holdings have still fallen RM14.8 billion this year.

Aberdeen, which oversees the equivalent of US$770 billion worldwide, is cautious on Malaysian debt and the ringgit, citing the impact of rising US interest rates and the Federal Reserve's decision to unwind its balance sheet. There's limited room for the government to unveil an expansionary budget as it seeks to further narrow the deficit, said Lee Jin Yang, a macro research analyst at the money manager in Singapore.

"Prime Minister Najib will try his best to balance out these conflicting needs in an attempt to cement his position," he said. "Hence it is likely to be more redistributive rather than aggressively expansionary - an attempt largely centered around allaying cost-of-living concerns."

Aberdeen will be "more comfortable adding risk" should valuations get more attractive before the election, he said.

Aviva Investors favours Malaysian assets, saying the ringgit "screams as being the cheapest" among 26 currencies it tracks.

The central bank's measures constraining the amount of foreign currency proceeds exporters can hold have also boosted sentiment toward the ringgit, the money manager said.

"The incumbent government will win the election," said Stuart Ritson, Singapore-based head of Asian rates and foreign exchange at Aviva Investors, which oversees more than US$437 billion. "Foreigners are beginning to come back to the market."

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