Malaysian Domestic Bond Market Experience: Lessons for Emerging Economies

Research Question: Are there effects of crowding-out from persistent fiscal deficits and what are the role of the banking sector on development of the government and corporate bond markets in Malaysia? Motivation: This paper revisits the aftermath of the 1997-98 Asian financial crisis that led to challenging years for Malaysia when its running balanced budgets switched to fiscal deficits. A policy option is to develop the domestic bond market to raise funds, but this is not without challenges. Idea: Raising long-term government bonds through the domestic bond market to cover the fiscal shortfall may crowd-out the corporate bond market. An already established banking sector is also likely to compete with the domestic bond market to provide financing to the economy. Data: To focus on the Asian financial crisis for policy lessons, this paper uses quarterly data on the Malaysian government and corporate bond markets based on the old categorization of Bank for International Settlements from Q4 1993 up to Q4 2011. The sample includes observations up to the period before the categorization was changed beginning from 2012. Method/Tools: Regression analyses are conducted to examine the effects of government debt and the growth of banking sector on the development of the domestic bond market. The ARDL approach is used to screen for possible long-run relationships between the variables. Findings: We find that a dominant banking sector complements development of the government bond market. It, however, impacts the corporate bond market negatively. Over-concentration of power in large banks does not augur well for both bond markets, but this impact disappears as the bond markets develop. Persistent fiscal deficits, resulting in the growth of the government bond market, do not result in crowding-out of the corporate bond market. Contributions: Our findings suggest that efforts to boost domestic bond market development must take cognizance of the possible complementary and competing roles between the two bond markets and the banking sector