Malaysia Stimulus Plans Hampered as Islamic Yield Curve Steepens

  • Ten-year borrowing costs rising as ringgit sours sentiment
  • Challenging funding environment as GDP growth slows: Manulife

Prime Minister Najib Razak’s plan to revive Malaysia’s faltering economy is getting no help from the country’s Islamic bond market.

Yields on government 10-year sukuk, used by companies to gauge the cost of Shariah-compliant financing, are at their highest level in 18 months relative to two-year securities, according to data compiled by Bloomberg. And with the slide in Brent crude prices sapping Malaysia’s oil-export revenue against a backdrop of looming U.S. interest-rate increases, investors say longer-term borrowing won’t be getting cheaper anytime soon.

“With the U.S. expected to raise interest rates soon, Malaysia’s yield curve will remain steep next year,” said Elsie Tham, a senior fund manager at Kuala Lumpur-based Manulife Asset Management Services Bhd. who oversees more than $1 billion. “Companies will find it challenging to raise funds because of slower economic growth.”

That’s bad news for Najib’s government as it looks to simultaneously reduce the budget deficit and finance a $444 billion public and private-sector spending program at a time when the economy is growing at its slowest pace in two years. Islamic bond sales in Malaysia, the world’s biggest sukuk market, dropped 56 percent in the third quarter from the previous three months, according to data compiled by Bloomberg.

Investors are shunning 10-year sovereign sukuk as a sliding ringgit hurts sentiment and fuels capital outflows. The concern was reflected in a conventional sale of 2025 bonds last week that drew the fewest bids since December.

Ten-year Islamic bond yields climbed 14 basis points in 2015 to 4.41 percent, 12 basis points shy of a record 4.53 percent reached in September, while those on notes due in 2017 have declined 23 basis points to 3.40 percent, central bank indexes show. The 101 point difference is the highest since March last year.

Malaysia Sovereign Sukuk Yield Curve 5M Change
Malaysia Sovereign Sukuk Yield Curve 5M Change

The economy expanded 4.7 percent in the third quarter and growth is officially forecast at 4 percent to 5 percent in 2016 from as much as 5.5 percent this year, according to the Finance Ministry.

“Slower growth, capital outflows and a weaker ringgit are contributing factors that will make it difficult for companies to raise funds next year,” said Edward Iskandar Toh, chief investment officer for fixed income at Areca Capital Sdn., which oversees 500 million ringgit in Kuala Lumpur. “Investors will want higher yields to compensate for the perceived deterioration in the credit profile.”

The odds of a Federal Reserve rate increase in December have climbed to 66 percent and global funds have already pulled 33.7 billion ringgit ($7.7 billion) from Malaysian stocks and bonds this year. Slowing growth in China, the nation’s second-biggest export market, is further dimming the outlook. Brent crude prices have more than halved since last year’s peak, making it more difficult for Najib to meet his deficit-reduction target of 3.1 percent in 2016 from an estimated 3.2 percent this year.

The ringgit has also come under pressure amid a political scandal involving Najib, who’s received flak over a personal donation from the Middle East as well as rising debt at state investment company 1Malaysia Development Bhd. The currency has dropped 20 percent this year in Asia’s worst performance.

The cost for top-rated companies to borrow in the conventional bond market for 10 years has increased to 4.81 percent from a 2015 low of 4.59 percent in June, a Bank Negara Malaysia index shows. Average yields reached a four-year high of 4.87 percent in September. 

“It will be challenging for market debutants, greenfield financiers and unfamiliar names as investors may be asking for higher returns to compensate for both liquidity and credit risk,” said Fakrizzaki Ghazali, a Kuala Lumpur-based strategist at RHB Research Institute Sdn., a unit of the country’s top sukuk arranger RHB Capital Bhd. “Nonetheless, demand for high-quality names will remain favorable.”

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