2011 Ringgit Bond Market Outlook

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1 211 Ringgit Bond Market Outlook Wan Murezani Wan Mohamad Head Fixed Income Research 211 Investor Briefing 22 March 211 MALAYSIAN RATING CORPORATION BERHAD Clarity and Integrity

2 Disclaimer The material contained in this presentation may not be reproduced, redistributed or passed on, directly or indirectly, to any other person or published, in whole or in part, for any purpose without the consent of Malaysian Rating Corporation Berhad ( MARC ). The views expressed in this presentation should be construed solely as statements of opinion and not statements of fact. MARC makes no representation or warranty, express or implied, as to the accuracy, completeness or reliability of the material and comments made during the presentation and accepts no liability arising from any use of this presentation or its contents. This presentation is not to be relied upon in substitution of the exercise of independent judgement. 2

3 Presentation Structure Review of the financial market in 21 The Global Economy Stayed on Recovery Path Strong Demand for Risky Assets Globally European Sovereign Debt Crisis Crashed The Party But Asian Market Remained Immune Foreign Funds Dominated the Ringgit Sovereign Bond Improving Corporate Credit Quality Ringgit Sovereign Bonds MGS/GII Supply in 211 Demand-Side Considerations Interest Rate Expectations MGS Outlook in Summary Corporate Bond Issuance in 211 Corporate Operating Environment Credit Spreads Assessments Risk Scenario to The Outlook 3

4 The global economy stayed on the recovery path The global economy continued to ride the recovery path thanks to the various stimulus packages, but the US unemployment rate 6. 2 remained relatively high in UK Real GDP y/y (%) Eurozone Real GDP y/y (%) US Real GDP y/y (%) MSCI Global Equities (Mar 1=1, RHS) Jun-1 Jan-3 Aug-4 Mar-6 Oct-7 May-9 Nov-1 Source: Bloomberg, MARC Fixed Income Research Chng in Nonfarm Payroll (' 6mma, rhs) Unemployment Rate (% of labor market, lhs) Feb-8 Oct-83 Jun-87 Feb-91 Oct-94 Jun-98 Feb-2 Oct-5 Jun

5 Demand for risky asset classes remained strong Lower risk-free rates, improving economic data and stable financial markets sent investors hunting for yields elsewhere in risky asset classes. Risk 6 96 US 5-year BBB spread to TSY (bps, LHS) premiums narrowed and 5 S&P VIX Volatility (%, RHS) global high yield 3 48 issuance rose significantly US High Yield (USD b) All Market High Yield (USD b) 1Q26 4Q26 3Q27 2Q28 1Q29 4Q29 3Q21 Source: Bloomberg, MARC Fixed Income Research 2 1 Jan- Jan-2 Jan-4 Jan-6 Jan-8 Jan

6 European Sovereign Debt Crisis Crashed The Party The sovereign debt crisis in Europe witnessed some countries losing their top-notch credit ratings, posing challenges to global economic recovery and making it costly for 1,2 1,1 1, Portugal (A+) Italy (AA-) Ireland (BBB+) Greece (BB+) Spain (AA+) Jan-6 Sep-6 May-7 Jan-8 Sep-8 May-9 Jan-1 Sep-1 Source: Bloomberg, MARC Fixed Income Research countries with ballooning CDS spreads to raise funds. 6

7 But the Asian Market Remained Immune However, the Asian market in general was unaffected by the adversities facing the European continent. The CDS spreads remained below the crisis level Malaysia (A-) in this region. 1,4 1,2 China (A+) 1, 8 Indonesia (BB+) South Korea (A+) Jan-6 Sep-6 May-7 Jan-8 Sep-8 May-9 Jan-1 Sep-1 Source: Bloomberg, MARC Fixed Income Research 7

8 Ringgit sovereign bonds: Strong demand by foreign funds in 2Q21 and 3Q21 Despite a rebound in the economy which led to a 75 bps hike in the OPR, bond yields remained low in 2Q21 and 3Q21. Foreign funds dominated this market on a strengthening ringgit. The 1-year yield and 4.5 USD/MYR were almost 4.25 perfectly positively correlated in 3Q year benchmark yield (%, lhs) USD/MYR (RHS) Dec-8 May-9 Oct-9 Mar-1 Aug-1 Jan Source: Bloomberg, MARC Fixed Income Research 8

9 Ringgit corporate bonds: Credit quality improved as the economy rebounded Lower corporate default rates and declining corporate downgrade-to-upgrade ratio seen in 21 on an improved operating environment brought by a pickup in economic activity. Real GDP growth (%) Corporate Default Rate (%) Corporate Downgrade-to-Upgrade Ratio (x) Source: Bloomberg, CEIC, MARC Fixed Income Research

10 Government bond supply in 211 Issuance in MYR Billio on The government is expected to raise around MYR86 billion to MYR88 billion in 211 via MGS/GII issuance to finance its budget deficit and maturing 1 Gross MGS/GII Issuance Net MGS/GII Issuance bonds compared to 9 8 MYR58.1 billion 7 6 seen in forecast Source: Bank Negara Malaysia, MARC Fixed Income Research 1

11 Government bond supply in 211 The possibility of a retail bond offering from the government is not discounted given its past success and the government s efforts to boost retail participation in the bond market under the Economic Transformation Programme (ETP). 11

12 Government bond supply in 211 With USD1.75 billion of international bonds maturing in 211, there is motivation for the government to tap this market, but for benchmark continuation rather than financing needs. The current environment looks supportive for new issuance : Narrowing credit spreads. Overwhelming demand in the previous issuance, i.e. oversubscription of almost 5. times. Malaysia 5-year USD Credit Default Swap (CDS) spread in basis point Jan-3 Jan-4 Jan-5 Jan-6 Jan-7 Jan-8 Jan-9 Jan-1 Jan-11 Source: Bloomberg, MARC Fixed Income Research 12

13 MGS/GII: Demand-side considerations Demand is not going to be a major issue as the domestic market is still flushed with liquidity; using banking sector excess deposits as a proxy, the estimated investable amount is MYR258 billion, and this has yet to include funds from insurance and asset management industries. Estimated Banking Sector Deposits and Loans in MYR billion 1,3 Excess Deposits (MYR b) Total Loans (MYR b) Total Deposits (MYR b) 1,2 1,1 1, Dec-96 Jun-98 Nov-99 May-1 Nov-2 May-4 Nov-5 May-7 Nov-8 May-1 Source: Bank Negara Malaysia, CEIC, MARC Fixed Income Research 13

14 MGS/GII: Demand-side considerations Moreover, a rise in global liquidity thanks to the quantitative easing in the US will find its way into emerging currencies, raising bets on further strengthening of the ringgit 3. and resulting in Foreign Holdings of MGS (% of outstanding, lhs) USD/MYR Spot (inverted, rhs) 3.15 foreign funds 3.3 flowing into the 3.45 MGS market Jan-5 Jul-5 Jan-6 Jul-6 Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Jul-1 Jan-11 Source: Bank Negara Malaysia, CEIC, MARC Fixed Income Research 14

15 MGS/GII: Demand-side considerations Foreign funds will continue to favour emerging currencies due to: Stronger economic fundamentals. Healthier fiscal conditions. Relatively stable sovereign credits. Huge positive rate differentials. Sovereign Credits Downgrade to Upgrade Ratio (x) Asia Ex-Japan North America Western Europe Average GDP Growth 1.% Source: Bloomberg, MARC Fixed Income Research CMS = China, Malaysia, South Korea 5.7 Budget balance as % of GDP 8.% 6.% 4.% 2.%.% -2.% -4.% -6.% -1.% -8.% -6.% -4.% -2.%.% 5.5% CMS -.2% -.2% CMS -3.5% JUUE JUUE 2.3% -1.5% -4.4% -8.8% 7.9% % 2.5% % JUUE = Japan, US, UK, Eurozone 15

16 Interest rate expectations The build-up in inflationary expectations brought by a persistent rise in commodity prices is expected to put upward pressure on interest rates. Crude oil prices and the CRB food price index gained more than 5% since the CRB Food Price Index (rhs) 45 peak of the global financial crisis in early West Texas Intermediate Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Jul-1 Jan-11 Source: Bloomberg, MARC Fixed Income Research

17 Interest rate expectations We expect a steepening bias in the yield curve as supply is anticipated to center at the longer end of the curve with rising inflationary expectation is another catalyst. The swap rates are also pointing towards 2 a rising interest rate 1-year swap spread (bps) 15 environment. 1 5-year swap spread (bps) Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Jul-1 Jan-11 Source: Bloomberg, MARC Fixed Income Research -1 17

18 Interest rate expectations Having rebounded in 21, economic growth is expected to remain in positive territory in 211. Hence, bias on the OPR is on the upside and we are looking at a 25-5 bps 5. hike in 2H211 if any 4.5 adjustments are to take place Real GDP (% y/y, LHS) Headline Inflation (% y/y, LHS) Overnight Policy Rate (%, RHS) Apr-5 Feb-6 Dec-6 Oct-7 Aug-8 Jun-9 Apr-1 Feb-11 Source: Bloomberg, MARC Fixed Income Research 18

Supply look Positive Economic Outl Rising Inflation Expectations

19 Interest rate expectations In summary, MGS yields are expected to head north with a steepening bias in the yield curve in 211 due to: but Higher Supply look Positive Economic Outl Rising Inflation Expectations Continuous foreign interest in this asset class will come in to limit the sell-offs. 19

Corporate Bond Issuance We expect corporate bond issuance to hit the MYR5 billion mark in 211 (21: MYR48 billion) on continued economic recovery and the

20 Corporate Bond Issuance We expect corporate bond issuance to hit the MYR5 billion mark in 211 (21: MYR48 billion) on continued economic recovery and the announcement of the Public-Private Partnerships (PPP) programme during the tabling of Budget 211, involving MYR14.5 billion worth of projects to be implemented this year. 2

21 Operating environment to remain healthy Should the economy remain on its growth trajectory, consumer and business confidence are likely to stay put, which would 35. translate to higher 12-mth Trailing Revenue Growth (% 6-month lag, rhs) revenue and profitability Malaysia GDP Growth (%, lhs) Q1 26 Q4 26 Q3 27 Q2 28 Q1 29 Q4 29 Q Business Sentiment Index (Mar 5=1, lhs) Corporate Operating Margin (Mar 5=1,lhs) Real GDP (% y/y, rhs) Mar-5 Mar-6 Mar-7 Mar-8 Mar-9 Mar Source: Bloomberg, MARC Fixed Income Research 21

22 Operating environment to remain healthy And that should help to further improve corporate credit quality and debt repayment capacity in general, resulting in a lower expected default rate Median Interest Coverage (x, LHS) Cash-to-Total Debt (%, RHS) Annual Corporate Default Rate (%) f Source: MARC Fixed Income Research Q1 25 Q1 26 Q1 27 Q1 28 Q1 29 Q

23 Credit spread assessments The rally in risky asset classes, including global equities, sent the global corporate credit spreads narrowing as super-low government bond yields and the economic recovery sent investors Asia USD corporate spread (bps) 15 Asia USD sovereign spread (bps) -7.5 US GDP (% q/q ann., inverted, rhs) elsewhere for 9-5. yield enhancement Oct-5 Jun-6 Feb-7 Oct-7 Jun-8 Feb-9 Oct-9 Jun-1 Feb-11 Source: Bloomberg, MARC Fixed Income Research 23

24 Credit spread assessments The same pattern is also observed in the domestic corporate bond market but only in the AA and AAA rating bands with the 3-year indicative spreads for these credits hovering below their respective longrun means, but the A spread remained wide despite the economic recovery. # std. deviation above/(below) long run mean Source: Bloomberg, MARC Fixed Income Research AAA spread Z-score AA spread Z-score A spread Z-score Jan-8 Jun-8 Nov-8 Apr-9 Sep-9 Feb-1 Jul-1 Dec-1 24

25 Credit spread assessments ) Real GDP Growth (%) Persistent risk aversion in the A rating band is an anomaly in this cycle considering the rebound in the economy, widening operating margins and falling corporate 12. Malaysia GDP Growth (%, lhs) 45 AA Credit Spread (bps inverted, rhs) default rates Mar-5 Jan-6 Nov-6 Sep-7 Jul-8 May-9 Mar year In ndicative Credit spread (bps) Real GDP Growth (%) Malaysia GDP Growth (%, lhs) A Credit Spread (bps inverted, rhs) year Indicative Credit spread (bps) Source: Bloomberg, MARC Fixed Income Research -8. Mar-5 Jan-6 Nov-6 Sep-7 Jul-8 May-9 Mar

26 Credit spread assessments Persistent risk aversion in the A rating band is an anomaly in this cycle considering the rebound in the economy, widening operating margin and falling 13. Median Operating Margin (%, lhs) 12. AA Credit Spread (bps inverted, rhs) corporate default rates. Median Operating Margin (%) Median Operating Margin (%, lhs) A Credit Spread (bps inverted, rhs) year Indicative Credit spread (bps) Median Operating Margin (%) Mar-5 Jan-6 Nov-6 Sep-7 Jul-8 May-9 Mar year In ndicative Credit spread (bps) 3. Mar-5 Jan-6 Nov-6 Sep-7 Jul-8 May-9 Mar Source: Bloomberg, MARC Fixed Income Research 26

27 Credit spread assessments A similar narrowing of high yield credit spreads across the board as experienced in the international market was not seen in domestic 3 US 3-year BBB Industrial Spread to Treasury (bps, lhs) bonds rated below AA. Malaysia 3-year AA Corporate spread to MGS (bps, rhs) ,4 1,2 1, US 3-year BB Industrial Spread to Treasury (bps, lhs) Malaysia 3-year A Corporate spread to MGS (bps, rhs) Jan-3 Apr-4 Jul-5 Oct-6 Jan-8 Apr-9 Jul Jan-3 Apr-4 Jul-5 Oct-6 Jan-8 Apr-9 Jul-1 15 Source: Bloomberg, MARC Fixed Income Research 27

28 Credit spread assessments Interestingly, despite the diverging trend in domestic versus international risk premiums trend, corporate default rates in both the domestic and international credit markets declined in 21. We compared the default rates for BB credits in the international market against the A credits in the ringgit market. Annual Corporate Default Rate (%) 18.% 16.% 14.% 12.% 1.% 8.% 6.% 4.% 2.%.% Source: MARC Fixed Income Research Malaysia Corporate (A & Below) Global Corporate (BB & Below)

29 Risks to this outlook 1. Greater-than-expected fallout from the European debt crisis and an extreme slowdown in the US economy which could cause a significant slowdown in the global economy. 2. Further announcements of fiscal expansion due to a slowdown in the economy will result in the market pricing in huge supply pressure. 3. Greater-than-expected fallout from the Japan earthquake and Middle East North Africa (MENA) geopolitical risk. 29

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The Malaysian Economy

The Malaysian Economy Prospects and critical issues in 2011-20122012 Presentation for ISIS PRAXIS Seminar Nor Zahidi Alias Chief Economist March 3 rd, 2011 In a nutshell US economy is emitting more positive