KUALA LUMPUR, Oct 28 (Reuters) - Malaysian bond yields fell to their lowest in four months on Monday, driven by sustained bids from domestic and foreign investors after the government unveiled a fiscally conservative budget late last week.
Five-year bonds fell 10 basis points to 3.34 percent, taking the drop since the end of August to 40 basis points and the yield to levels last seen early in July.
While official data on foreign bond buying is available only for August, analysts said anecdotal evidence of improved demand for longer-dated bonds and the resultant flattening of the yield curve suggested foreigners were back.
Foreigners held nearly 32 percent of outstanding Malaysian bonds at the peak in July this year, before the fear of early policy tightening by the Federal Reserve caused them to sell out of Malaysian and other emerging market bonds.
"The curve's flattened quite a bit," said Winson Phoon, fixed income analyst at Maybank. "Yields have dropped especially at the longer end. The demand is a combination of both local and foreign investors."
The spread between 5-year and one-year bonds is 41 basis points (bps) compared with 51 basis points two weeks ago. The spread between 10-year and one-year bonds has also narrowed, to 65 basis points from 83 basis points two weeks ago.
Nik Mukharriz, a fixed income analyst at CIMB, said the buying was part of a regional trend. But, in Malaysia's case, it was helped by the 2014 annual government budget which seeks to impose fiscal discipline, he said.
"The investors seem happy with the budget. That's added to demand."
Malaysia moved to allay concerns over the country's fast-rising debt on Friday, announcing a new consumption tax at a surprisingly high rate, abolishing subsidies on sugar and raising property taxes to dampen a surge in home prices. The announcement of the 6 percent goods and services tax that kicks off in April 2015 also allayed fears of an inflationary spike in taxes next year.
Malaysian central bank data showed that foreigners held 125.51 billion ringgit ($39.3 billion) of bonds (MGS) at the end of August, compared with 125.54 billion ringgit at end-July and a peak of 144.98 billion ringgit in April.
Analysts, however, warned that renewed foreign interest in Malaysian bonds could wane since the Fed's decision to stand pat on its bond buying programme in September signalled a more gradual tapering.
The likelihood was also low that the ringgit, already up 6.3 percent in two months, could rally any further and add to the yield foreigners get on their Malaysian assets, they said.
The budget announcement of a GST would appease rating agencies worried about Malaysia's massive sovereign debt, thus staving off the risk of a ratings downgrade, BofA Merrill Lynch analyst Claudio Piron said in a note. Malaysia has one of Asia's highest government debt levels, at 52.5 percent of GDP in 2012.
"That said, with MGS having already done well into the budget, we would be nimble once the momentum stalls," Piron added.
(Reporting by Siva Sithraputhran; Editing by Jacqueline Wong)