VOLATILITY HERE TO STAY: Foreign selling in M'sian shares may continue but demand for RM bonds still STEADY

KUALA LUMPUR - The outflow of foreign funds from the capital market is not expected to impact the Malaysia's economy significantly due to the country's strong fundamentals, according to The Royal Bank of Scotland Plc (RBS).

"When there's news on quantitative easing (QE) taper, foreign holdings of Malaysian bonds have not collapsed. It has come down a bit but it has not changed much," RBS head of economics research for Asia Pacific ex-Japan Sanjay Mathur told reporters after presenting Asia's and Malaysia's economic outlook here yesterday. He added that foreign funds have a "comfortable" view of Malaysia.

Sanjay foresees Malaysia's foreign inflows for sovereign notes to be stable due to its good fundamentals based on the ratio of its international reserves over its current account and debt servicing needed in 2014.

Bank Negara's international reserves stood at RM436 billion as at Jan 30, 2014.

Regional bourses have experienced a bout of aggressive selling from investors anticipating the tapering by the US Federal Reserve, and Sanjay said January was a big surprise for emerging markets.

"As we move from the end of January, people (investors) are more discriminating and are looking at countries with better fundamentals.

"Bond yields have moved up higher over the course of last year and we don't see it moving significantly higher from here on. Global recovery is paramount and if G3 (the US, Japan and Europe) growth accelerates faster than we think, it is positive for Malaysia and vice versa."

He said there will be periods of sell-offs and periods of strong inflows.

"You may get another sell-off but it doesn't mean from January to December you will see a sell-off. There may be periods of volatility and it is not just about QE taper but also other global events. Volatility is here to stay but the momentum is positive and inflows are good."

High foreign ownership of local currency bonds

Malaysia is particularly affected by outflows of foreign funds due to high foreign ownership of local currency bonds, which is at some 30%. However, Sanjay said when investors participate in a particular bond market, they based it on the fundamentals.

"In Malaysia, there's a number of long term players with a lot of holding power, it may be a foreign central bank or a sovereign wealth fund ... that share is increasing. To that extent, we're much insulated," Sanjay said.

The ringgit is likely to trade in a weak range in the first half of 2014 and can expect some strengthening thereafter, pegging the ringgit against the US dollar at 3.36 by end of June 2014 and to end the year at 3.32, he added.

Meanwhile, Malaysia's economy is expected to grow at a modest 4.6% this year on the back of exports, from an estimated 4.5% growth in 2013.

Sanjay said subsidies will be rationalised and will be lower, with another fuel hike expected in the early second half of the year.

"We think toll rates will be raised. It may not be this year but these rates haven't change for a long time and they should change at some stage or other."

Subsidy rationalisation should result in higher inflation but with negligible second-round effects. Policy rates should therefore remain unchanged.

Malaysia is going through a challenging but valuable process of fiscal consolidation. The process will have a short term impact on growth, he opined. - The Sundaily