A Prudent Malaysia 2017 Budget: Overweight Rates Market

24 October 2016

Rates & FX View

A Prudent Malaysia 2017 Budget: Overweight Rates Market

Malaysia’s 2017 Budget again signals fiscal consolidation even as the country faces slowing growth. It is commendable that Prime Minister Najib resisted the temptation to pursue a hugely expansionary budget to drive economic growth, especially as the next general election draws near (on or before 24 August 2018). The challenge to spur growth lies in the private sector given the limited fiscal manoeuvrability, thus it is important for Malaysia to have a clear medium-term plan in order to promote a business and investment-friendly climate.

For the financial markets, investors should be comforted by Malaysia’s continued commitment towards sustainable fiscal health. Debt service costs are expected to remain manageable at 13.4% of total operating expenditure in 2017, although debt sustainability took a hit (2015: 11.2% of total operating expenditure). Lower OPR is expected in 2017 and the continued deepening of the capital markets should lower the cost of borrowing and improve debt sustainability.

Summary of Key Analytical Views

¨                  MoF’s fiscal deficit estimate of 3.0% of GDP in 2017 (2016: 3.1% of GDP), broadly in line with market expectations. As such, we do not foresee a significant impact on MGS and MYR beyond the initial reaction. Nonetheless, maintaining fiscal consolidation amid a tough external environment will likely be appreciated as favourable by the market over time.

¨                  2017 MGS/GII gross supply to range between MYR107-109bn (2016E: MYR89bn) in part due to higher redemptions of government securities. We opine this increased gross issuance should not be a concern given the current search for yields, provided financial conditions remain stable.

¨                  2017 GST forecast of MYR40bn appears achievable relative to 2017 GDP and private consumption growth forecasts of 4-5% and 6.3% respectively. We think economic growth risks are towards the downside, given deteriorating external growth drivers and an unlikely acceleration in domestic growth dynamics.

¨                  Global rating agencies are likely to remain cautious towards any upgrades to Malaysia’s credit rating over the near term, given the relatively slow improvement in fiscal fundamentals.

¨                  Currency outlook: The MYR remains a beneficiary of: i) carry inflows; ii) stable commodity price outlook; and iii) softer USD backdrop for 2017 as compared to 2016. While we are comfortable being mild overweight MYR on the compelling valuations versus historical trends, global risk sentiment and the regional currencies are likely to remain highly influential on the MYR. Furthermore, investors had adjusted to the new normal of lower oil prices and a USDMYR above 4 by now.

¨                  Rates outlook: With BNM likely to take policy rates lower amid subdued price pressures and a softer growth backdrop, front-end yields are likely to fall further, which could have spillover effects throughout the curve as investors continue to find value in duration premiums. Tightening global liquidity conditions are a potential risk, exacerbated by high foreign ownership of MGS as well as the increased volatility of MYR. Nonetheless, easy global and domestic monetary policy will likely remain supportive of carry inflows and anchor yields at the lower end of the range.