● FTSE Russellhas decided to retain Malaysia in its World Government Bond Index (WGBI). However, Malaysia would continue to be on the watch list for potential downgrade from its current Market Accessibility Level of 2. While it also decided to retain China for potential upgrade to Market Accessibility Level 2 for possible upgrade, FTSE Russel has assigned Israel a Market Accessibility Level of 2 and its local currency government bonds will be added to the index from 1 April 2020.

● BNM initiatives helped to avert removal from index. BNM’s recent measures to improve hedging flexibility and give greater Ringgit accessibility in an attempt to deepen its market liquidity has been fruitful and somewhat managed to buy Malaysia some time. In a statement, the global index provider added that it “will continue to engage with market participants to understand the practical impact of recent initiatives announced by Bank Negara Malaysia (BNM) to improve market liquidity and accessibility.”

● Given that there is a high probability that it would upgrade China at its next review cycle (every6 months), there is a possibility that Malaysia would be removed from the WGBI or at best its weight in the index reduced significantly. Alhough Malaysia had loosened currency hedging rules in August to help boost liquidity following the FTSE Russel warning in April to avert the possibility of being ousted from the WGBI it might have to continue to move down that path of allowing greater access to its onshore Ringgit market possibly via an eventual return to the Non-Deliverable Forward market for a start. This is one of the viable options given that the Ringgit is not allowed to be traded off shore.

● The asset under management (AUM) tracking the WGBI is estimated at USD2.0-2.5 trillion although the exact figure is unknown. Given Malaysia's current weight in the index is 0.39%,the estimated amount of funds at risk is about USD8.0-9.0b, equivalent to 22.0%-24.0% of total foreign holdings of MalaysiaGovernmentSecurities(MGS) if Malaysia is excluded from the index. Though the risk of capital flight is temporarily averted, we still believe that a decision to remove Malaysia from the WGBI would result in an estimated foreign funds outflow of between USD3.0-5.0b. Some market observers foresee outflows of up to USD5.0-8.0b.

● Negative market reaction averted…for now. The ringgit continued its slide against the US dollar yesterday as investors remained cautious ahead of FTSE Russell’s decision. At 6pm, the Ringgit settled around at 4.1935 against the US dollar from 4.1885 at Tuesday’s close. Following the FTSE Russell’s decision, we expect the ringgit to remain volatile and maintain our year-end USDMYR target of 4.20.

Source: Kenanga Research - 27 Sept 2019