Malaysia Tax Plan Makes Funds Wary of Inflation: Islamic Finance

Malaysian sukuk investors are designing strategies for 2015 that will profit as a new tax both pushes up inflation and forces central bank rate increases.

Malaysian consumer-price increases will average 4 percent in 2015, the highest in seven years, as a new consumption tax starts in April, according to a Bloomberg survey of 21 economists. One-year interest-rate swaps climbed to a six-year high of 3.87 percent this week, signaling expectations that Bank Negara Malaysia’s policy rate will be raised from 3.25 percent.

BNP Paribas Investment Partners Najmah Malaysia Sdn. and RHB Research Institute Sdn. both recommend buying Islamic bonds in the middle of the so-called yield curve, which are less exposed to losses from inflation and interest-rate moves. The government will implement a 6 percent goods and services tax as part of efforts to cut the fiscal deficit that included scrapping fuel subsidies.

“Domestically, the concern will be inflation next year,” Fakrizzaki Ghazali, Kuala Lumpur-based credit strategist at RHB Research, a unit of RHB Capital Bhd., said in a Dec. 9 phone interview. “The five year would be the ideal duration at the moment to find pick-up and to avoid potential mark-to-market losses from a potential rate hike.”

Commodity Slide

One-year interest-rate swaps have climbed 15 basis points since July, when the central bank increased its benchmark rate for the first time in more than three years.

The yield on Malaysia’s two-year government sukuk, which are more sensitive to changes in borrowing costs, rose 38 basis points this year to 3.63 percent and is set for the biggest annual increase since 2010, according to a central bank index. A yield curve tracks rates of different maturities and longer-term debt are more susceptible to inflation expectations.

The yield on Malaysia’s 10-year sovereign Islamic bonds climbed 19 basis points, or 0.19 percentage point, to 4.29 percent from its 2014 low on Nov. 11 as the ringgit weakened. The increase trimmed its decline this year to 11 basis points.

Prime Minister Najib Razak raised gasoline prices twice in 13 months and scrapped subsidies from December. Inflation averaged 3.2 percent in the first 10 months of this year, up from 2.1 percent in 2013, data compiled by Bloomberg show.

Concern about a drop in revenue resulting from the collapse in crude for oil-exporting Malaysia and an 8 percent decline in palm oil from a Nov. 3 high has pushed the ringgit to a five-year low and threatens to boost import costs.

Rate Doubts

While the implementation of the goods and services tax will push up prices, Bank Negara may keep its policy rate unchanged next year as the slide in commodities slows global economic growth, RHB’s Fakrizzaki said.

“There aren’t any more rate-hike expectations going into next year,” Nik Mukharriz Muhammad, a Kuala Lumpur-based fixed-income analyst at CIMB Investment Bank Bhd., said in an e-mail yesterday. “The deed has been done. The weaker ringgit is hindering people from buying too much on the shorter-end.”

UBS AG lowered its forecast for Malaysia’s 2015 growth to 4.5 percent from 5 percent, citing the negative impact of falling oil, economists including Singapore-based Edward Teather wrote in a Dec. 3 report.

Southeast Asia’s third-largest economy will expand 5.5 percent to 6 percent this year after advancing 4.7 percent in 2013, according to a government forecast on Oct. 10.

Shariah-compliant banking assets in Malaysia increased 9.7 percent to 580.8 billion ringgit ($167 billion) as of July from a year earlier to account for 25 percent of the total market, according to a finance ministry report on Oct. 10.

Undue Risk

The central bank is likely to keep its benchmark rate on hold for the first half of 2015 as it assesses the impact of the consumption tax and removal of fuel subsidies on domestic demand and inflation, according to BNP Paribas Investment.

“The belly of the curve provides decent carry without taking on undue duration risk,” Khoo Poh Sim, a Kuala Lumpur-based senior portfolio manager at BNP Paribas Investment, which has more than $900 million of assets, said in an e-mail yesterday. “We believe the demand for sukuk issuance will remain robust next year, anchored by ample domestic liquidity, and demand for assets by insurance and pension funds.”

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