Malaysia Rate Rise Flagged by Yields on New Tax: Islamic Finance

By Liau Y-Sing and Elffie Chew

Photographer: Charles Pertwee/Bloomberg

Malaysia Prime Minister Najib Razak may reveal the items that will be subject to the 6... Read More

Islamic bond yields and the swap market are signaling Malaysia will raise interest rates for a second time this year amid concern government consumption-tax plans will aggravate inflation.
The two-year sukuk yield rose 24 basis points this year to 3.49 percent, 24 basis points higher than the benchmark policy rate, a Bank Negara Malaysia index shows. That’s narrowed the spread with 10-year debt to 65 from a record 122 in December. The swap market is pricing in at least one more rate hike ahead of 2014’s final meeting on Nov. 6.
Prime Minister Najib Razak may reveal the
items that will be subject to the 6 percent goods and services tax scheduled for April in his annual budget tomorrow. While the central bank has said its implementation will fuel inflation, Barclays Plc sees the move as positive for bonds as it will help repair the government’s finances and reduce the supply burden.
“Yields for shorter-dated sukuk will continue to be anchored by interest-rate expectations,” Elsie Tham, a senior fund manager at Kuala Lumpur-based Manulife Asset Management Services Bhd., who oversees more than $1 billion, said in an Oct. 7 phone interview. “Investors are buying longer-dated debt because they are less sensitive to interest rates.”

Insurers’ Support

Ten of 21 economists surveyed by Bloomberg predict Bank Negara will boost the 3.25 percent overnight policy rate by a further 25 basis points next month. The rest see no change. One-year interest-rate swaps have climbed six basis points to 3.75 percent since July 10, when the central bank tightened for the first time since 2011, data compiled by Bloomberg show.
Consumer-price increases averaged 3.3 percent this year through August, compared with 2.1 percent in 2013. Inflation will average 3.2 percent in 2014, Rahul Bajoria, a Singapore-based economist at Barclays, wrote in an Oct. 2 research report.
Yields on 10-year Shariah-compliant notes dropped 26 basis points, or 0.26 percentage point, in 2014 to 4.14 percent, according to the central bank’s index.
Demand was supported by pension funds and insurers who need longer-maturity debt to match assets with their liabilities, said Angus Salim Amran, the Kuala Lumpur-based head of financial markets at RHB Investment Bank Bhd., a unit of RHB Capital Bhd.

Yield Elevated

Sales of Islamic bonds in Malaysia have climbed 92 percent in 2014 to 48 billion ringgit ($14.8 billion) from a year earlier, just shy of the 49 billion ringgit for the whole of 2013, data compiled by Bloomberg show.
“The rate-change bias is still on the upside rather than the downside so that should help keep the front-end yield elevated,” Winson Phoon, a Kuala Lumpur-based fixed-income analyst at Maybank Investment Bank Bhd., said in a phone interview yesterday. “The room for the spread to narrow further might be limited for now.”
Malaysia is implementing the new consumption tax to replace the existing sales and services levy as the government bolsters efforts to lower the fiscal deficit to 3.5 percent of gross domestic product in 2014 from 3.9 percent last year. The administration is seeking to balance the budget by 2020.
Prime Minister Najib increased fuel subsidies by 10 percent last week as part of that effort. Tomorrow’s budget speech may also include further measures to cut government debt, Malayan Banking Bhd. economists including Kuala Lumpur-based Suhaimi Ilias wrote in a Sept. 29 report.

‘Market Positive’

At 54.6 percent, Malaysia’s debt as a ratio to GDP matches that of Pakistan, the highest levels among 13 emerging Asian economies tracked by Bloomberg after Sri Lanka. The government has a self-imposed limit of 55 percent, according to the Maybank report.
Malaysia’s latest increase in fuel prices will result in savings of up to 1.5 billion ringgit this year and as much as 7 billion ringgit in 2015, Bajoria at Barclays wrote in his report. Bank Negara is likely to deliver another 25 basis point interest-rate increase in the first quarter, he said.
“The impact of cutting subsidies and the implementation of GST will reduce the government’s debt burden and improve its fiscal position,” Angus at RHB Investment Bank said in an e-mail interview yesterday. “This is market positive.”