Sharp depreciating ringgit and foreign investment outflow could lead to another crisis

PETALING JAYA - Tracking the flow of global investment funds is a tricky business. But the ringgit’s recent sharp depreciation against the US dollar has led to suggestions by some economists that as much as RM70bil stands to flow out of the country, largely due to foreign investors liquidating their position in the bond market.

This is based on the outflow of funds in the last two financial crisis in 1998 and 2008.

“In the previous two financial crises, the level of foreign holdings of Malaysian Government Securities (MGS) was halved in a matter of months,” said an economist with a local research firm.

As at end-September, overseas investors held at least RM140bil worth of MGS, according to bond data. The latest foreign interest in the bond market is not out yet.

“But based on the ringgit depreciation and rising yields on the bond market, it seems that quite a bit of money had flown out,” said the economist.

Falling bond prices, as a result of the foreign sell-off, pushed 10-year MGS yields to a 10-month high of 4.232% on Friday. This equals to about a 40-basis-point drop over the past one month, which in the bond market is a significant movement.

“It is an indication of a huge sell-off in the market,” Malaysian Rating Corp Bhd chief economist Nor Zahidi Alias said, noting that other markets too had been hit hard in the latest round of foreign sell-off.

The ringgit had been under pressure since late August, as the price of Brent crude oil dropped below US$100 a barrel. The fall accelerated in December, as crude oil tumbled below US$60 a barrel.

“The impact of weakening oil prices affected the local currency and resulted in the rise of 10-year MGS bond yields,” said Hanifah Hashim, Franklin Templeton Investments’ executive director and head of Malaysia fixed income and sukuk.

Nobody can put a finger on exactly how much has flown out year-to-date. The RM70bil potential outflow is only based on an estimate and is equal to about 7% of the country’s gross domestic product (GDP).

Malaysia could slip into a recession if the outflow nears 20% of GDP, although economists have noted that the risk of an economic contraction happening next year is “very remote”.

The Malaysian bond market, which is the second largest behind South Korea in Asia excluding Japan, has been a magnet for global money managers seeking higher returns.

AllianceDBS Research, in a recent report, said that Malaysia had seen RM139.9bil in portfolio net inflow since the global financial crisis in 2008-09, with the bulk of it parked in MGS.

As at October 2014, foreign investors held 45.9% of MGS, close to the historical high of 49.5% in May 2013. Overseas investors also owned 23.6% of local equities as at end-October, which more than doubled the trough level of 10% in June 2010 but was below the recent peak of 26.4% in July 2013.

“We are seeing a steady outflow of funds from Malaysia amid concerns over the country’s fiscal position, as crude oil prices continue to drop,’’ it said.

Foreign investors pulled out RM11bil in the third quarter, as cumulative net outflow reached RM17.5bil as at end-September. The amount is likely to be bigger in the fourth quarter, judging from the ringgit’s recent sharp decline.

Assuming that recent routs had reduced the percentage of foreign holdings of MGS from 48% to 40%, this would translate to an outflow of RM30bil from the bond market.

On the local stock exchange, where the benchmark FTSE Bursa Malaysia KL Composite Index had dropped more than 10% from its recent peak, the year-to-date net outflow until the end of November had reached RM4bil.

Since the US Federal Reserve started its quantitative easing programme in 2009 to boost the economy there, emerging markets have been the main beneficiary of funds flows.

A study by the Bank for International Settlements in September provided the evidence showing that the presence of asset managers in emerging markets has grown “considerably” over the past two years.

Fund tracker EPFR Global’s data showed that the size of funds targeting bond markets in emerging economies had quadrupled in four years from US$88bil (about RM307bil) at the end of 2009 to US$340bil (RM1.18 trillion) as at the end of last year.

The latest bout had brought the Indonesian rupiah down to its lowest level since 1998, evoking an eerie reminder of the devastating financial crisis that had crippled economies around the region.

Zahidi said the recent sell-down by foreigners was “excessive”, but could lead to another crisis.

“Yes, there is genuine worries about plunging oil prices and its economic implications, but the market also tends to overshoot,’’ he said.

Yet, countries around the region, including Malaysia, are not always in control of their currency movements. When the US Fed eventually raises rates in America, emerging economies will need to adjust.