BNM needs to respond to concerns over fiscal deficit

KUALA LUMPUR: Malaysian bonds are starting to show some concern about the nation’s rising fiscal deficit. It may be time for the central bank to respond.

The nation’s 10-year yield briefly climbed above 3% this week, from as low as 2.79% in May, after the authorities pledged to pump in another RM35 billion ringgit to counter the impact of Covid-19. That’s on the top of the RM260 billion announced earlier. The government is now forecasting the fiscal deficit to widen to 5.8% to 6% of gross domestic product, the most in a decade.

Demand for bonds by domestic investors was lacklustre even before the latest round of stimulus was announced on June 5. Total bids at an auction of three-year Islamic debt on June 3 only just scraped in above the amount on offer, compared with a bid-to-cover ratio of more than three times at a similar sale of 10-year Islamic securities in April.

The spread between benchmark 10-year yields and the central bank’s overnight policy rate has more than doubled over the past six weeks. It climbed above 100 basis points earlier this week, matching the peak seen at the height of the coronavirus sell-off in March.

The prospect of further interest-rate cuts may revive demand for local bonds, but the market is not pricing in a full 25 basis-point move at any point in the next three months, according to swaps data compiled by Bloomberg.

Igniting interest

There’s something else the central bank could do though to revive local interest.

While policy makers have already lowered the reserve requirement ratio for local banks by 100 basis points to 2% and included bonds as reserve-compliant assets, there is room to go further.

The ratio was cut as low as 1% in 2009 during the global financial crisis. Both Indonesia and the Philippines have lowered their respective ratios by 200 basis points, albeit from a much higher base, and this has helped ensure onshore banking book demand remains robust despite widening budget deficits.

Other regional central banks have also directly intervened to support their domestic bond markets. Bank Indonesia is buying up to 25% of the government’s debt offerings in primary auctions as well as in the secondary market. The Philippines central bank snapped 300 billion pesos of government debt in March under a repurchase agreement, with scope to buy more.

Of course, Malaysian policy makers can point to a number of other factors that will help support the bond market even without their intervention. The recent doubling of Brent crude to around US$40 per barrel will be positive for the nation’s budgetary position, while muted inflationary pressures will continue to underpin real yields.

In the near term though, it’s likely Malaysian bonds will remain under pressure unless the central bank takes further steps to shore up demand.

What to watch

Bank Indonesia meets next Thursday after unexpectedly keeping its benchmark unchanged at its previous gathering on May 19. Developments since then are favourable for it to resume easing, with the rupiah becoming Asia’s best-performing currency this quarter.

Indonesia’s next conventional bond auction on Tuesday will be closely watched after demand climbed to the highest in more than four years at the prior sale on June 2.

Thailand will auction five- and 15-year bonds on Wednesday. The bond curve has been steepening amid concern supply will rise in the second half as the government ramps up borrowing to finance its stimulus programme.

Marcus Wong is an emerging markets (EM) macro strategist writing for Bloomberg. - FMT