KUALA LUMPUR • It was a one-two punch that has turned the Malaysian ringgit into Asia's worst performer this month.

FTSE Russell said on Monday it may drop Malaysian debt from the FTSE World Government Bond Index because of concerns about market liquidity, roiling the Asian nation's currency and bonds on Tuesday. And less than two weeks ago, Norway said its sovereign wealth fund will cut emerging-market debt, including Malaysian securities, from its index.

Malaysia's withdrawal from the FTSE World Government Bond Index may lead to outflows of almost US$8 billion (S$10.8 billion), based on the nation's weighting of 0.39 per cent, Morgan Stanley estimated. Foreign investors have been reducing their Malaysian government bond positions since late 2016 and held about US$37 billion of the securities as of last month, Hong Kong-based Min Dai, a strategist at Morgan Stanley, wrote in a report.

The latest blow sent the ringgit sliding 0.6 per cent on Tuesday, the worst performance since November 2016, and it crossed its 100-day moving average versus the US dollar. The nation's benchmark 10-year bond yield jumped by the most since October.

"The risk of dropping Malaysian bonds from the flagship index seems more likely than not, in our view, unless fundamental changes are made to improve Malaysia's market accessibility level," said Mr Winson Phoon, head of fixed-income research at Maybank Kim Eng Securities in Singapore.

Malaysia's bonds had just capped a fourth month of gains last month on expectation that the central bank may cut rates as early as in May. Bank Negara Malaysia (BNM) pledged last month to keep monetary policy accommodative as global risks weigh on the trade-reliant economy.

Even Prime Minister Mahathir Mohamad has weighed in, warning that the country may impose measures to protect the ringgit if speculators attack the currency, according to a report in The Star.

Policy support may help protect the currency and bonds from further decline, even if the debt gets dropped from the FTSE World Government Bond Index.

"Foreign bond inflows have been buttressing the ringgit of late as the market has started to price in the possibility of a BNM rate cut at the next policy meeting," said Mr Stephen Innes, head of trading and market strategy at SPI Asset Management. "Even if the exclusion does occur, it should not have any discernible effect on credit ratings so, despite this unexpected shocker, it's likely a bit overdone and I'd expect cooler heads to prevail."

BLOOMBERG