HIGHER INTEREST RATE IN ASIA

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Bank Negara, the central bank, is likely to take similar, though less drastic, action by raising interest rates on July 10 for the first time in more than three years, to curb strong domestic demand that has ratcheted up debt levels and inflation. The global economy continues to expand at a moderate pace. In the advanced economies, while growth performance has been uneven, a number of key economies have continued to show broader signs of improvement. In Asia, growth is supported by the continued expansion in domestic demand and the improved external environment. In this environment, the international financial markets have remained relatively stable.

Malaysia, Singapore and Thailand all have debt-to-GDP ratios above 70%. Malaysia's ratio stands at 86.8%, up from 60.4% in 2008, and the second highest in Asia after South Korea's 91.1%. Malaysia’s $303 billion (RM964 billion) economy grew at an average 6% in recent years due in large part to a growing government and household credit bubble and its public debt-to-Gross Domestic Product (GDP) ratio has been hovering at all-time highs of over 50% since 2010, thanks to large fiscal deficits incurred when an aggressive stimulus package was launched to bolster the country’s economy during the Global Financial Crisis. After Sri Lanka, Malaysia now has the second highest public debt-to-GDP ratio among 13 emerging Asian countries according to a Bloomberg study. Rising interest rates typically incur an inflow of foreign funds and currency strengthening. Short-term fund flows in Malaysia though, according to AllianceDBS Research chief economist Manokaran Mottain, are negative.

A number of banks raise their base lending rates (BLR) and base financing rates (BFR) in tandem with Bank Negara’s announcement to raise the overnight policy rate (OPR) by 25 basis points (bps) from 3% to 3.25% effective from 16 July 2014 to 18 July 2014. JP Morgan Research noted that it was cautious on banks, as the combination of rate hikes and subsidy rationalisation would test the credit risk management of Malaysia’s consumer-led loan growth in the past five years. For now, the ringgit will remain volatile, or rally to higher levels. The trading range could be moving [to between] 3.18 and 3.22 [against the US dollar]. If there will be an easing, it may stabilize around 3.20 to 3.25. Strengthening US dollar could weaken the ringgit, due to the rapid improvements in the US’ macro picture. The rate hike may be delayed as the authorities may wish to assess the impact of several measures and developments in the economy [such as stricter lending standards, higher inflation and pre-GST consumer reaction] on consumer spending.

What’s interesting is US rate hike cycles don’t normally lead to equity market weakness in equity markets, but it really takes US interest rates to go above a neutral rate, meaning more focused on inflation than growth [before it shows weakness]. From that perspective, the US stock market should continue to do well. We still believe in a global bull market, although we may see a hiccup within a three-to-sic-month window. For Malaysia market, consumer stocks is underweighted due to the impending GST. The first quarter of 2015 should be fantastic for the consumer sector next year, while the second quarter is expected to be weak. Overall though, Malaysian market is affirmative for the next 12 months. A barbell approach is being taken to the market. Interest rates are still low globally and also in Malaysia, although it is starting to go up a little higher. Utilities and telcos wouldn’t be badly hit by any reduction in consumer spending. Sectors that are leveraged to the capital investment side, like the Economic Transformation Programme (ETP) and infrastructure [-related stocks] is preferred.  For banks, people should sit on the sidelines first to see how that works out because of the uncertainty due to the [CIMB-RHB-MBSB] merger talks. As for bonds, Standard Chartered Bank is overweight on emerging market, high-yield government bonds due to their attractive absolute yields of just under 7% and attractive values relative to developing market, high-yield bonds.