Should Malaysia become slavish to rating agencies?

By , in Economy Editorial on .

Malaysia has tackled difficulties and challenges with strength and conviction; strength due to the abundance of resources at its disposal, conviction because of the expertise and experience it possesses. It has overcome even the direst, from financial crisis to missing airlines.

In late 2020, Malaysia sought to raise its statutory debt limit from 55% to 60% of GDP to give itself added fiscal flexibility to accommodate additional spending to tackle the Covid-19 pandemic. It’s then direct debt-to-GDP ratio stood at 53.2%, below the existing self-imposed threshold. 

Therefore, the Fitch rating, while having downgraded Malaysia’s Long-Term Foreign-Currency Issuer Default Rating to BBB+ and outlook to stable, is by no means a reflective permanence of the state of current affairs but rather a cautionary indication that things could be better. 

Economists and financial research houses are confident that the Fitch downgrade will not have a critical or sustained impact on Malaysia’s public debt market specifically or the financial sector as a whole

The ruckus made by the opposition, harping on a single sentiment in the report is nothing more than a political ploy to distract from the lack of cohesion of the coalition as well as the major blunder of the opposition leader to oppose the 2021 budget at the policy stage.

According to Dato’ Sri Mustapa Mohamed, Malaysia never had a record of not servicing its debt and our economic situation is strong and diverse, with an average growth rate of 6.1 percent during the period 1971-2019. Nevertheless, he said, the government takes note of the downgrade and strives to improve the country’s financial position, stating that the government is committed to ensuring that Malaysia recovers.

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Finance Minister Tengku Zafrul stated that PH leaders were misinterpreting Fitch’s rating and that the issue has been turned into political rhetoric, adding that Malaysia was not alone in the downgrade, joining 100 other countries such as Britain, Hong Kong, Chile, and Laos.

The downgrade of Malaysia’s issuer default rating reflects the following key rating drivers :

The depth and duration of the COVID-19 pandemic weakened some of Malaysia’s key credit metrics. The authorities responded swiftly to the crisis, with material relief for affected individuals and businesses but the impact on the economy has been substantial and added to Malaysia’s fiscal burden. 

Most recently, the government secured passage of core legislation to implement relief measures, including the 2021 budget but according to the report, lingering political uncertainty following the change in government last March weighs on the policy outlook as well as prospects for further improvement in governance standards. However, it failed to take note of politicians who make spurious claims of having a convincing and formidable majority but are unable to prove the claims.

Domestic measures to contain the spread of coronavirus, weak investment and low tourism receipts due to the pandemic have reduced economic activity, as it has in many countries globally. Fitch expects Malaysian GDP to contract by 6.1% in 2020, before rebounding by 6.7% in 2021 due to base effects, a revival of infrastructure projects, and an ongoing recovery in exports of manufactured goods and commodities and forecasts growth of 4.6% in 2022, on the expectation that Malaysia’s diversified economy will deliver strong medium-term growth.

Fitch acknowledges that these forecasts remain subject to uncertainty and depend on the near-term evolution of the pandemic, as illustrated by an increase in the number of daily cases since early-October.

Fitch expects the fiscal deficit to remain higher than pre-pandemic levels, given a continuation of support measures and pressure for higher spending. It expects government revenue to remain low at 19.1% of GDP in 2020 and dependent on oil production, expected to generate 22% of total government revenue this year.

The low and concentrated revenue base – exacerbated by the removal of the GST in 2018 – has in recent years led the government to draw on dividends of government-linked companies, pending the introduction of new and more sustainable sources of revenue, being considered for the medium term.

Government debt metrics have deteriorated due to the pandemic. Fitch expects general government debt to jump to 76.0% of GDP in 2020 from 65.2% of GDP in 2019. The debt figures used by Fitch include officially reported committed government guarantees on loans, which are serviced by the government budget, and 1MDBs net debt, equivalent in September 2020 to 12.6% and 1.3% of GDP, respectively. 

The PN government continues to implement transparency-enhancing measures launched under the previous coalition, and corruption trials of former officials have continued. However, the government’s thin parliamentary majority implies persistent uncertainty about future policies.

Malaysia’s BBB+ issuer default rating also reflects the following:

Malaysia continues to drive a current account surplus but is expected to narrow to 3.4% of GDP in 2021 from 4.2% in 2020, as the import compression due to the pandemic recedes and government spending on infrastructure development revived. The share of the government’s foreign currency-denominated debt is also low, at just 2% of the total debt. 

The government is still relatively dependent on foreign financing, as foreign holdings of domestic debt are around 24% of the total. This is down from a high of 34% in 2016 and reflects a deep and developed domestic bond market. Uncertainty about the continued inclusion of Malaysia in a key bond index remains, and exclusion in 2021 could potentially generate capital outflows.

Malaysia’s external liquidity, as measured by the ratio of the country’s liquid external assets to its liquid external liabilities, at 95%, is weaker than the BBB median of 182%. Short-term external debt is high relative to foreign-exchange reserves (USD104.6 billion at end-October), although a significant part of this is relatively stable intra-group borrowing between parent and subsidiary banks domestically and abroad, reflecting the open and regional nature of Malaysia’s banking sector.

The policy response of Bank Negara Malaysia has supported the economic environment during the pandemic shock and included cuts in its policy rate this year by a cumulative 125bp to 1.75%. Consumer prices fell by 1.5% in October, given weak economic activity and lower oil prices. Fitch deems that BNM has space for further easing and expects monetary policy to remain supportive of economic activity with another 25bp rate cut in 2021. It expects inflation to become positive again, at 1.5% in 2021, as the pandemic shock recedes.

The banking sector maintains sufficient loss-absorption capital buffers and remains liquid with a liquidity coverage ratio of 153%. Moderate earnings pressure is likely to erode some of these buffers, although major banks are expected to remain profitable in the near term. A blanket six-month moratorium on debt repayment for retail and SME borrowers that began in April 2020 has provided relief to borrowers, but may also mask asset-quality stress. 

An extension of more targeted relief to individuals and SMEs affected by the pandemic until at least mid-2021 should keep NPL ratios in check but will continue to partially cloud visibility on asset quality.

Shan Saeed, an economist thrashed the rating agency for its assessment of Malaysia’s sovereign rating, saying that markets have lost confidence in rating agencies since 2010. He said that their reports and outlooks are behind the curve and that the agencies come up with banal analyses that are not germane to the market.

Mr. Saeed said markets are looking for macroeconomic stability, fiscal and monetary policy levers to maneuver and to spur growth, and, above all, aggregate demand which drives the gross domestic product calculus for all economies.

On concerns regarding the political situation, Shan said the ringgit had appreciated 8.55% since March 23, price inflation is under 1.5% and the budget deficit is still under the threshold in a single-digit despite the change in government. He said the real estate market is still witnessing good momentum and sales of luxury cars are up between 3-5% on a quarter-to-quarter basis, while energy demand, especially liquefied natural gas (LNG), is coming from Asia.

There is a near-consensus these days against unquestionable or uncritical trust in rating agencies as these agencies tend to rigidly adopt a certain outlook that does not take into account the complexities of real-world dynamics.

PH presidential council’s statement is farcical and flippant and attempts to portray Fitch’s report as macabre. The reality is that the report is cautionary at best, for the ratings indicate that expectations of default risk are low and capacity for payment of financial commitments is adequate. The reality is that it’s the markets that need the state and not the other way round.

NMT

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