Malaysia's efforts to create a local market for Islamic finance instruments and the increasing use of domestic sukuk, in particular to fund the country's budget deficit, are supporting the sovereign's credit quality (A3 stable rating), says Moody's Investors Service.

These factors added stability and diversity to its borrowing profile, and lowered the country's exposure to liquidity risk, the rating agency said in a statement today.

Moody's noted that the government's debt burden was sizeable at 50.8 percent of gross domestic product, larger than the median of 40.1 per cent for A-rated sovereigns.

The rating house said Malaysian Government Islamic Issues comprised 40 percent of outstanding government debt at the end of the quarter to March 31, 2018, up from 13.9 percent at the end of 2008.

The authorities' various initiatives to support the market were likely to drive this share even higher, it said.

“The shift towards Islamic financial instruments is credit positive for the sovereign, because of the more stable nature of these holdings compared with conventional bonds and the diversification that they allow in Malaysia's debt profile,” it added.

According to Moody’s, conventional government bonds and Islamic finance instruments are similar in terms of issue size, coupon rates and range of tenors, and are both direct obligations of the government.

It pointed out that the authorities had taken a variety of steps to further increase liquidity in the Islamic finance market and narrow the pricing gap between conventional bonds and Malaysian government Islamic bonds.

Malaysia stood out in terms of the dominance of local currency-denominated sovereign sukuk issuance, it said.

“While other sovereigns, particularly in the Gulf Cooperation Council, are also important markets for Islamic finance, the legal and regulatory architecture around sukuk issuance in these markets is still relatively nascent compared with Malaysia, which has cultivated the development of Islamic capital markets since the early 1990s.”

Moody's analysis is contained in a new report, "Government of Malaysia: Growing funding via sukuk deepens Islamic capital markets, lowers government liquidity risk, a credit positive."

- Bernama