TTF: DBS Research downgraded Malaysian government bonds (see news item below) and attributed it to rising valuation and mounting risk.
To understand what this means, first, you’ll have to understand what a government bond is.
Generally, governments issue bonds to raise money to finance projects or day-to-day operations.
When you buy a government bond, you lend the government an agreed amount of money for an agreed period of time.
In return, the government will pay you back a set level of interest at regular periods, known as the coupon, which makes bonds a fixed-income asset.
In Malaysia, bonds are typically issued by a department under the Ministry of Finance (MoF) known as the Federal Treasury.
The Federal Treasury in Malaysia presents a very low risk to bond purchasers because the Government of Malaysia (GoM), as most governments worldwide, underwrites its bonds and is deemed stable and well managed economically.
Nonetheless, there is always some level of risk, which is where the credit rating agencies come in.
These agencies look into key indicators to evaluate the overall health of an economy and decide if there is a chance a government will default in interest and principal payments.
In simpler terms, when a credit rating agency downgrades a bond rating, it simply means that the government issuing the bond is at higher risk of defaulting its obligations to people who lent it money.
PETALING JAYA: DBS Research has downgraded Malaysian government bonds to “neutral”, even as the local debt papers rank as the third-best performer among Asian emerging markets year-to-date.
In a research note issued yesterday, DBS Research attributed the rating downgrade to Malaysian government bonds’ rising valuation and mounting risk.
Moving forward, the research firm expects “limited scope” for the Malaysian Government Securities (MGS) to record further capital gains, pointing out that “the reward-risk proposition of the MGS is much less attractive when compared to the start of 2019”.
“The 10-year MGS performance has been the third best within emerging market Asia, just behind the Philippines and Indonesia government bonds. However, recent events have led us to re-evaluate our view.
“We now think that valuations are no longer as cheap and the risks around performance have risen considerably.
“At the centre of our shift are concerns that technicals could be less supportive ahead,” the research house said.
Among the key risks and uncertainties shrouding the MGS outlook are the FTSE Russell’s September review and the decision by Norway’s US$1 trillion sovereign wealth fund to cut Malaysian bonds, together with nine other emerging-market peers, from its benchmark index.
On April 15, FTSE Russell announced that Malaysia had been placed on its fixed-income watch list for six months until September 2019, following the completion of its first fixed-income country classification review.
Malaysia, currently assigned a ‘2’ and included in the World Government Bond Index (WGBI) since 2004, is being considered for a potential downgrade to ‘1’.
In the event of such a downgrade, it would render Malaysia ineligible for inclusion in the WGBI and pundits expect significant capital flight out of the local bond market.
Despite market concerns over Malaysia’s potential disqualification from the WGBI, DBS Research believes that the country will likely be retained on the index once a review is done in September this year.
On the pullout by Norway’s sovereign wealth fund from the Malaysian bonds, which is expected to be done after June, DBS Research said it is likely to be gradual in order to “limit market impact and get the best possible price”.
As of end-2018, the fund held US$2bil Malaysian government bonds.
“The elevated uncertainties and risks around future developments and outcomes would likely see MGS and the ringgit trading in a more volatile manner ahead.
“It would be prudent not to discount the possibility of an extended selloff should MGS holders decide that event risks are too much to bear,” stated the research house.