Malaysian market risk escalating fast: OCBC

There are more and more warning signs surrounding the country's fiscal health which investors should consider.

While Malaysia is poised to beat GDP forecasts for 1Q12, there is growing risk of runaway fiscal spending, which at 5% of GDP remains the highest in Asia as of last year. Should fiscal worries worsen -- and the threat is becoming very real, according to OCBC -- there might be a reversal of foreign fund flows that could cripple the bond market and the economy.

Here's more from OCBC:

It is important is to note the fact that the (anticipated) upcoming general election has just added another concern to the growing list of risks for the Malaysian market. Several interesting things have surfaced in recent months, including Fitch’s cautionary note on the high level of fiscal spending in Malaysia. Earlier in the year, we had also noted that while Malaysia’s growth has outperformed our expectation for Q4 2011, it is important to know that high fiscal spending (in excess of +20% yoy in H2 2011) has been a major driver of the economy. At about 5.0% of GDP, Malaysia’s fiscal deficit stood at the highest in Asia for 2011, even if it was an improvement from the 5.6% level recorded for 2010. Similarly, at about 55% of GDP, Malaysia’s debt-to-GDP ratio currently stands among the highest in Asia. Should there be growing unease about Malaysia’s fiscal situation, there is a threat of some potential reversal of fund flows, which have been robust since 2009. In fact, while the threat of a sudden reversal of foreign fund flows has been mainly associated with Indonesia since end-2011, it should not be forgotten that foreign ownership of local currency government bonds in Malaysia has increased significantly since early 2009. As of Q1 2012, foreign ownership of government MYR bonds stood at about 28% of total outstanding bonds, comparable to the 30% seen in Indonesia. Unlike Indonesia though, Malaysia has so far not seen any marked reversal of this foreign fund flows in the bond market.

In the most immediate future, the release of Malaysia’s Q1 2012 GDP data later this month is likely to inject some positives in the market, as growth is likely to have outperformed market expectations on the back of the better than expected exports growth in the period. As it is, we have also recently upgraded our 2012 GDP growth forecast from 3.8% to 4.2%, while seeing some signs that domestic demand has continued to be fairly constructive for the medium growth prospects. Nonetheless, current risks for the Malaysian economy go beyond the headline economic numbers alone, especially with regards to the still relatively high fiscal spending growth in the economy.