How Malaysia achieved a thriving domestic bond market

Local currency bond markets are increasingly relevant for emerging markets and developing economies (EMDEs), not just to support a country’s development but also to strengthen its resilience to external shocks.

Few EMDEs have succeeded as well as Malaysia in developing its domestic bond market.  With a market size of roughly 98 percent of GDP, the country ranks third in Asia – just behind well-developed markets like Japan and the Republic of Korea. The latest report on Malaysia’s Domestic Bond Market: A Success Story by the World Bank’s Inclusive Growth and Sustainable Finance Hub in Malaysia, validates many of the building blocks needed for development of domestic bond markets.

The roots of Malaysia’s success can be traced back to the late 1980s and 1990s when the country began developing its conventional bond and sukuk markets to support the financing of development objectives, unscored by a goal to increase the private sector's role in economic development. Today, the Malaysian bond market stands as a critical growth catalyst by providing long-term local currency financing to the real sector as well as key sectors such as infrastructure and housing.  

Malaysia’s ability to develop specific segments of the debt capital market have been best reflected in infrastructure and Islamic financing.  Relative to GDP, the value of the Malaysian project-finance bond market stands among the world’s biggest. Malaysia is ranked 21st out of 137 countries for the quality of its infrastructure, aided by the mobilization of long-term local currency financing from the bond market to support private sector participation. Notably, infrastructure bonds accounted for 26% of overall bond issuance between the years 1993-2019, and in the last decade, the bond market has financed up to an average of US$3.4 billion per year in the electricity, gas, and water sectors. 

Further, Malaysia has played a significant role as an Islamic finance center, supporting the growth of the Islamic bonds or sukuk. This has helped pool other non-traditional sources of long-term capital into the capital market - not only serving the needs of Islamic investors but attracting conventional investors such as pension funds. Malaysia launched the first green project-finance sukuk in the world on June 2017 that financed the construction of renewable energy generation facility.

Malaysia’s journey provides important lessons that are applicable to other countries:

• Malaysia’s experience reflects the need for an enabling environment underpinned by sustained macroeconomic stability, a robust banking sector, and a sound legal framework as the foundation for capital market development.
• The country’s robust growth has allowed for a regular increase in income, which combined with economic and political stability, has stimulated and promoted high domestic savings with a long-term focus. 
• The role and commitment of the government is crucial. Malaysian policies have supported the institutions, legal framework, incentives (including tax incentives), and the market infrastructure that created confidence among players to take on new investment opportunities, especially in priority sectors such as infrastructure. Two such institutions have played core roles. The Securities Commission in Malaysia and Central Bank of Malaysia quickly acquired legitimacy in the supervision and development of Malaysian financial markets. Further, the Employees' Provident Fund, a public pension fund, effectively channelled a significant share of Malaysians' private savings in the domestic bond market.
• This enabling environment has been developed progressively by combining a clear vision and merging of real and financial sector objectives to allow cohesiveness of policies and the effective participation of other stakeholders such as potential issuers, institutional investors, and financial intermediaries - to whom the authorities have been leaving space for the private sector to drive innovation.
• The solid cohesion and coordination between the various stakeholders has allowed an adequate sequencing of market developments. The successive capital market development strategies reflected both the government’s agenda and the interests and capacities of other stakeholders, as well as where Malaysia’s position in terms of innovation and liberalization, indicating the level of market and investor maturity.

In light of the impact of COVID-19 pandemic on the economy, the government continues to leverage on its well-developed domestic bond market. One such development was the issuance of a RM500 million Prihatin (Malay translated as Care) Sukuk to help the expand fiscal space needed to finance measures announced in the economic stimulus packages and recovery plan.

Moving forward, Malaysia’s bond market has its share of challenges like attracting new issuers, playing a more significant role as a source of financing to small-to medium enterprises, declining trading and liquidity levels, and a demand side that is still dominated by a handful of big institutional investors. This leaves room for further market development, particularly on diversification. 

Malaysia’s domestic bond market could significantly enhance the financial sector tools to support the post COVID-19 recovery and beyond.  Efforts to further meet the development needs and current challenges of the Malaysian domestic bond market will inevitably set the stage for it to play an even more prominent role in recovery and growth whilst aligning Malaysia’s domestic market more broadly with the increasing emphasis on capital markets role in supporting the sustainable development goals (SDG).