Why Malaysia is riskier than its credit ratings suggest

COPYING AND DISTRIBUTING ARE PROHIBITED WITHOUT PERMISSION OF THE PUBLISHER: SContreras@Euromoney.com

By:
Jeremy Weltman
Published on:

Economic growth is slowing and the fiscal metrics are off-kilter, implying its sovereign borrower A-grade ratings are too high.

Petronas-Twin-Towers-jumpers-R-780
Too high: But much like the base jumpers in Kuala Lumpur, agencies appear unconcerned by their A-grade credit ratings

The Pakatan Harapan alliance, which claimed a stunning victory in the elections seven months ago, has produced a budget bill for 2019 in which finance minister Lim Guan Eng is committing to the development expenditure and debt-servicing incurred under the previous administration.

The government inherited a substantially worse financial situation than its predecessor had been admitting, exacerbated by ballooning government guarantees for state-funding projects.

A corruption scandal engulfing the 1MDB state development fund, pinning the blame squarely on former prime minister Najib Razak, finally put an end to the dominance of the Barisan Nasional coalition and its main party, the United Malays National Organization (UMNO).

Yet it left a debt burden that has ballooned to roughly one trillion ringgits, a sum equivalent to 65% of GDP, not the 50% of GDP the previous government claimed, causing considerable financial volatility after it was revealed earlier in the year.

Since Malaysia now greatly exceeds the median debt criterion for A-rated sovereign borrowers, it calls into question why credit-rating agencies would not contemplate a downgrade.


ECR_Malaysia_five-year-780


Risk score highlights concern

Few experts believe the rating agencies will act, at least not now, given confidence in the government’s ability to manage the public finances better over the long term.

Improving transparency and governance are factors supporting the credit-risk profile, according to one of Euromoney’s survey experts under the condition of anonymity, while another pointed to Japan’s 10-year guarantee for yen-denominated Samurai bond issuance at low interest rates as a factor easing debt-servicing concerns.

However, Malaysia’s risk score continues to slide in Euromoney’s survey, with more than two points shaved-off the total this year, causing a six-place slump in the global risk rankings, to 42nd out of 186 countries surveyed.

Analysts have lowered their scores for currency stability, unemployment and government finances in comparison with year-earlier levels, with capital access tightened, plus many are acknowledging both explicitly and in private there are notable vulnerabilities, not least the recent drop in oil export prices.

The budget states the fiscal deficit will widen to 3.7% of GDP in 2018, compared with a forecast made by the previous government it would decline from 3% in 2017 to 2.8%.

It will then ease to 3.4% of GDP in 2019, but the margins remain rather fine.

Lim, a former bank official with a reputation for investing and tackling debt in his former guise as chief minister of Penang, aims to raise revenue by levying a special dividend on Petronas, the state-owned oil and gas concern.

He also proposes cutting subsidies on fuel for smaller vehicles, and lowering cash handouts alongside new taxes on sugary drinks and online services, with a rise in tax rates on property gains and the gaming industry.

Uncertain global environment

However, achieving the targets also depends on fulfilling the economic growth assumptions, in an uncertain global environment of tightening financial conditions, rising trade protectionism and other geopolitical risks – as economists begin to discuss the dreaded R-word in the wake of the considerable market volatility and flattening US yield curve.

GDP growth averaged 4.9% year on year in real terms in the first half of 2018, slowing from 5.7% in the same period of 2017. In the third quarter, it decelerated to 4.4%, but if these global fears transpire, it may be much worse.

This would quickly put the budget estimate of 4.9% growth for 2019 out of line.

Fortunately, Malaysia continues to enjoy a balance-of-payments surplus, supported by capital inflows with foreign-exchange reserves adequately covering more than seven months’ worth of imports.

Yet portfolio inflows can easily reverse, and the current-account surplus is shrinking, so the situation could easily become less fortuitous well before the government has time to improve fiscal metrics.

Even if worst-case scenarios fail to materialize, Malaysia’s risk profile is presently similar to – in fact, slightly worse than – those of Italy, Cyprus and Portugal, sequentially higher on Euromoney’s rankings, all of which are triple-B rated:


ECR_Malaysia_Dec_18_risk_rankings-780


There is no doubt that Malaysia is investment grade, but can it be seriously considered an A-rated issuer?

And besides that, the likelihood of a global downturn has materially increased, making Malaysia’s bond yields a virtual one-way bet. In that respect, 2019 could prove to be very interesting indeed.