KEY POINTS:

• The Federal Government net borrowing forecast to be RM45.1 billion for the full year of 2011 and RM43.6 billion in 2012.
• Private debt securities (PDS) issuance was RM38.5 billion in the first nine months this year as compared to the target of RM50.0 billion by end of 2011.
• Foreign holdings of Malaysian bonds remain strong at RM186.0 billion, or 22.0% of total outstanding debts as at end of August 2011.
• Debt-to-GDP ratio remains high and forecast to be 53.8% in 2011 and 54.8% in 2012.
• Debt-to-GDP ratio and budget deficit as a percentage of GDP are at the higher end compared to peer countries.
• Target GDP growth at 5.0% – 5.5% in 2011 and 5.0% – 6.0% in 2012 may be too optimistic in light of sluggish global economic growth.
• The budget lacks a long-term strategy in terms of cutting government debts to a sustainable level.
• Investors are advised to invest in Malaysian bond funds that have high allocation in Private Debt Securities (PDS).

2012 Federal Government Net Borrowing Forecast

First, let’s look at the Federal Government net borrowings since 2000.

CHART 1: Federal Government Net Borrowing

The net domestic borrowing requirement for 2011 is expected to be RM45.1 billion, raised through 21 auctions and 8 private placements. As of 14 October 2011, RM78.2 billion has been raised by the government, of which RM46.6 billion has been used for repayments, resulting in a balance of RM13.5 billion which will be raised through the 4 auctions left in this year.

For 2012, the forecast net borrowing is RM43.6 billion with a RM48.3 billion of repayments, resulting in gross borrowing of around RM91.9 billion.
These borrowings are mainly used to finance the budget shortfall in 2012 for the development expenditure under the Tenth Malaysia Plan (10MP) which costs RM51.2 billion.

Private Debt Securities Market Remains Buoyant

The private debt securities (PDS) market continues to be strong this year driven by the Economic Transformation Programme (ETP) that was introduced by the government under the 10MP. The new issuance of corporate bonds totalled RM38.5 billion for the first nine months of this year which was much higher as compared to RM31.3 billion in the same period in 2010.

Chart 2: Private Debt Securities (PDS) Issuance For First 9 Months Each Year

We expect the target of RM50.0 billion of PDS issuance this year to be achieved. Moreover, due to the encouraging response to the USD2.0 billion of Wakala Global Sukuk issued earlier this year, the government has proposed in Budget 2012 that tax deductions on expenses incurred will be given to corporations that issue sukuk wakala (Islamic fixed income securities) for a 3-year period commencing from 2012. On the other hand, income tax exemption given to non-ringgit sukuk issuance and transactions are extended for another 3 years until 2014.

Therefore, we expect to see more issuance of sukuk moving forward and the PDS market should remain buoyant in 2012 when the Second Rolling Plan (RP2) (e.g. Gemas-Johor Bahru double tracking rail project; Pantai Timur Jabor-Kuala Terengganu Highway; Redevelopment of the Sungai Besi Kuala Lumpur Air Base, etc) is in place in 2012 and 2013.

Solid Foreign Holdings in Malaysian Bonds

The foreign holdings in Malaysian bonds have been increasing momentum these few years as a result of increasing confidence in Malaysia’s economy, political stability and its highly developed sukuk market – Malaysia boasts the world’s largest sukuk market according to Bursa Malaysia. Even though there was a significant sell-off during the 2008 financial crisis, foreign holdings have picked up tremendously since then and amounted to RM186.0 billion, or 22.0% of total outstanding debts, as at end of August 2011.

Chart 3: Foreign Holdings of Malaysian Bonds

Debt-to-GDP Ratio Remains Unhealthy

The high debt-to-GDP ratio is still a concern to Malaysia but the government did not pursue much fiscal consolidation in this budget. The government has surprisingly excluded the implementation of goods and services tax (GST) and also dropped the plan of rationalising subsidy (subsidy level remains high at RM33.2 billion in 2012).

Chart 4: Debt-to-GDP Ratio

Due to this, the total federal government outstanding debt is forecast to remain at RM503.2 billion for 2012 (RM 455.7 billion for 2011) which translates to 54.8% of debt-to-GDP ratio for 2012 (53.8% for 2011) as shown in Chart 4.

Moreover, we believe that the 55.0% debt-to-GDP cap imposed by the government is not prudent enough and a more discipline measure should be taken by the government. Also, the Budget 2012 should include a long-term strategy to reduce government borrowings.

Debt-to-GDP Ratio And Budget Deficit At The Higher End Among Peers

Based on Table 2 above, Malaysia’s debt-to-GDP ratio is at the higher end compared to its Asian peers in 2010 and 2011 forecasts. However, Malaysia’s credit rating (A-) is higher than some of its peers which have a lower debt-to-GDP ratio, for example Indonesia, Thailand and India.

In addition, Malaysia’s budget deficit as a percent of GDP was -5.6% in 2010 and forecast to be -5.4% in 2011, the highest among its peers.

Malaysia is in an uncomfortable debt position and may face the pressure of a rating review in the short- to medium-term if the debt-to-GDP ratio and the budget deficit remain at current levels. Any rating cut may lead to higher borrowing costs for Malaysia.

On a positive note, the government aims to cut the budget deficit to -4.7% of GDP in 2012 and further to -3.0% in 2015.

Worse Scenario May Be Yet To Come

In the article Malaysia: An Optimistic Election Themed Budget?,we believe that the government is too optimistic in the Budget 2012 and that the current sluggish global economic growth is not factored in the budget. The government is projecting that the full year GDP growth will be between 5.0% – 5.5% this year while in the first half of this year, we have only achieved a GDP growth of only 4.4% year-on-year. This means that GDP growth in the weaker latter half of this year must be at least 5.0% - 6.0% year-on-year.

The government has also forecasted the GDP growth in 2012 to reach 5.0% – 6.0% year-on-year. In achieving these targets, the government is expecting a significant growth in private consumption and private investment as shown in Table 3.

In a very bad economic situation such as the 2008 financial crisis, the private consumption and private investment dropped drastically. We remain sceptical that these targets can be achieved given the current situation and expect GDP growth for next year to be around 4.0% - 4.5%. Having said so, the target of -4.7% budget deficit and 54.8% of debt-to-GDP ratio may not be achieved if the government missed the GDP growth target in 2012.

Furthermore, the debt-to-GDP ratio which is currently at the border line may trigger the 55.0% cap and affect the government issuance of debt to finance the budget deficit.

Conclusion

The Budget 2012 provides goodies (e.g. maintain subsidies level high at RM33.2 billion; assistance of RM500 to households with a monthly income of RM3,000 and below; schooling assistance of RM100 to all primary and secondary students from Year 1 to Form 5, etc) to the people to ease their pressure under current rising cost environment.

However, the budget lacks a long-term strategy for cutting government debts which is currently at an uncomfortable level. We believe that cutting debt to a sustainable level should be the main priority for the government instead of a lofty economic growth.

Implication to Investors

As there are still much challenges faced by the Malaysia government to achieve the targets set in the Budget 2012, we expect the private debt securities to remain buoyant going forward driven by the Second Rolling Plan (RP2) in 2012. Moreover, we also expect the sukuk market to grow strong moving forward under the incentives provided by the government to corporate in sukuk issuance. Therefore, at this juncture, we continue to advise investors to allocate a portion of their investments to Malaysian bond funds that mainly invest in higher-yielding PDS so as to stabilise their portfolios’ return. Having said that, investors should bear in mind that there is credit risk involved investing in this type of fund and in the event of any corporate bond default, the bond fund’s performance will be affected.

Recommended Malaysia Bond Funds:

AmDynamic Bond Fund
AmBond Fund
RHB Islamic Bond Fund

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