Malaysia Strategy:The only way forward is (GLC)reform

Event

Macquarie strategist Viktor Shvets, in his 15th Nov report “Rights, Wrongs &Returns”, increased his underweight on Malaysia. With stagflation appearingthe most likely outcome of global state-driven, fiscally-led reflation plans andthe post-Trump world set to have less trade and greater localisation, Malaysiais judged particularly vulnerable given relatively small domestic market, trade /commodities dependency and high external vulnerability (figs 5-6). With scopefor debt-funded stimulus increasingly constrained, the necessity of internallygeneratedgrowth means rising pressure for domestic reform, particularly inrelation to GLCs. This will underpin a more invigorating equity market in 2017.

We have recently added restructuring potential-rich Sime Darby and MRCB toour GLC basket, the latter including Tenaga, Telekom, Maybank and CIMB.

Impact

MGS no longer irresistible. Sharply rising US bond yields and the uncertainoutlook for global trade post-Trump have triggered foreign selling of MGS. Torecap, carry trade-driven buying of MGS has seen foreign ownership rise from21% in 2008, to a record 52.6% or RM181bn at 3Q16. Foreigners own 33% orRM206bn of federal government debt issuances – this represents >50% ofBank Negara’s Oct foreign exchange reserves of RM406bn (USD97.8bn).

Fiscal, monetary policy constrained. Foreign selling of MGS is driving MGSyields higher and the Ringgit lower. The benchmark 10yr MGS yield has risen75bps over the last week, to 4.34% – against federal government debt issuedof RM631bn, a 100bps increase in yield means a c.RM6.3bn increase in debtservicing cost which is almost equal the cost of the recently-announced BR1M6.0 cash transfer programme (RM6.8bn) and implies a 50bps widening in theprojected 3% budget deficit for 2017. Repatriation of sale proceeds offshorehas pushed Ringgit lower, from 4.2 to the USD last week, to RM4.39 currently(we forecast RM4.50 by 1Q17) – cutting interest rates into such weakness istricky, with Bank Negara already grappling to maintain an orderly FX market.

Domestic reforms our last hope? With developed market policy changesand resulting capital reversals laying bare Malaysia’s external vulnerabilities,policymakers have little choice but to pursue debt-neutral domestic reforms tosustain GDP growth momentum. Most impactful to economic efficiency andproductivity would be reforming/restructuring sprawling GLC dominance (fig 7)which crowds out generally more competitive and value-generative privatesector participation (figs 8-10). Encouraging GLIC activism is also essential –uncritical support for GLC investee companies displaces private investors anddistorts capital-market signalling essential to optimising capital allocation andvalue-creation discipline. New, pro-shareholder value-creation managementat PNB, Felda and POS Malaysia is a good start – relaxation of foreign / nonbumiownership restrictions would be a welcome complementary measure.

Outlook

We believe stock-picking leveraging themes like GLC restructuring, yield andringgit volatility will deliver outperformance. Big-cap picks (fig 11) are Tenaga,Telekom, IHH, CIMB, Gamuda, BAT, Sime Darby and AirAsia. Mid-caps withyield backing are Bursa(M), MRCB, Gas(M), TimedotCom, Mah Sing, BAuto,Top Glove and Karex. Top defensive picks are Public Bank and IHH.