Malaysia Bonds Lag Indonesia Debt on Fiscal and Political Risks

(Bloomberg) -- Ringgit bonds have lagged rupiah notes as Malaysia’s fiscal outlook deteriorated. Political uncertainties may add to the risks.

Benchmark 10-year Malaysian debt has underperformed Indonesian securities, with the extra yield on the latter shrinking to 305 basis points, near the lowest in over three years. Easing bond supply and a greater sensitivity to lower Treasury yields have aided rupiah notes.

A worsening outlook for ringgit bonds could deter global funds and hamper Malaysia’s efforts to plug its budget shortfall ahead of a possible general election in the coming year. In contrast, President Joko Widodo’s commitment to fiscal consolidation has anchored confidence in rupiah notes and helped counter the damping effect posed by the prospect of less U.S. stimulus. 

Benchmark yields on 10-year ringgit securities have fallen two basis points since end-June to 3.27% while a Bloomberg Barclays index of Malaysian notes delivered a loss of 1.4%. 

In comparison, yields on rupiah notes due in a decade slid almost 30 basis points this quarter to 6.32%. A gauge of Indonesian securities gained 3% during the period to outperform all its emerging Asian peers.

The divergence has been due in part to the fiscal outlook. While Indonesia has stuck to its 2021 budget deficit target of 5.7% of gross domestic product, Malaysia has widened the estimate for its shortfall for this year twice -- most recently to 6.5% to 7% of GDP -- on the back of stimulus spending to mitigate the fallout from the outbreak.

Political turmoil, fueled by former premier Muhyiddin Yassin’s resignation this week, adds another layer of risk. The race to succeed him has started, and investors will parse the list of possible candidates to get an idea of the economic policies that lie ahead. Lawmakers who support Ismail Sabri Yaakob to become the new prime minister are set to have an audience with the nation’s king on Thursday.

“In the near term, there may be further uncertainties about whether there will be a new government in place any time soon,” said Wellian Wiranto, an economist at Oversea-Chinese Banking Corp. in Singapore. “Beyond that, any government is likely to remain expansionary in its fiscal stance given the likelihood of an election some time soon, perhaps in 2022.”

Yield Correlation

Malaysian bonds were under pressure even before the latest bout of political turmoil. Global funds pulled $852 million from the securities in July, the first net withdrawal in 15 months, central bank data show. Indonesia recorded $576 million of outflows the same month, although that’s been reversed by $617 million of inflows so far in August, according to figures from the Finance Ministry.

High-beta Indonesian bonds have also benefited from the recent drop in U.S. Treasury yields, as the 15-day correlation between the respective 10-year benchmarks averaged 0.70 in August. In comparison, the link between similar-maturity Malaysia and U.S. yields stands at 0.29, which suggests that Treasuries have had less of an impact on ringgit yields.

Lastly, foreign positioning in rupiah debt is lighter than in ringgit securities. Twelve-month foreign inflows into Indonesia’s bonds are 0.4 standard deviations below the five-year average while the same gauge for Malaysia is 1.1 standard deviations above the five-year mean.

Overseas investors have trimmed holdings in Indonesian bonds since the start of 2020, rendering the risk of further outflows on the back of a global selloff more manageable, said Jennifer Kusuma, Singapore-based senior strategist for Asia rates at Australia & New Zealand Banking Group Ltd. 

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