Moody's affirms Malaysia's A3 rating; outlook positive

KUALA LUMPUR: Moody's Investors Service has affirmed the government bond and issuer ratings of the Government of Malaysia at A3 while the outlook remains positive.

It said on Friday the key drivers of the decision were the government's intention to adhere to its policy of deficit reduction, driven by fiscal reforms that have already bolstered the government's resilience to cyclical commodity price shocks; and

The international ratings agency also cited the resistance of Malaysia's fundamental credit strengths to a more adverse external economic environment, lower oil prices, and global financial market volatility.

Moody’s said the strengths were macroeconomic stability, domestic capital market depth, and a favourable government debt structure.

When Moody's last revised the sovereign's outlook in November 2013, it noted greater prospects for fiscal reform and the stabilisation of the government's debt dynamics, against the backdrop of continued macroeconomic stability in the face of external headwinds.

“While we have seen ongoing fiscal deficit reduction and actual implementation of significant reform, the external challenges faced by the country have risen. Consequently, Moody's has affirmed Malaysia at A3 and maintains a positive outlook on the rating,” it added.

Moody’s pointed out the effectiveness of Malaysia's policy response in the year ahead to challenges already evident and to those challenges that were expected would influence the future trajectory of Malaysia's sovereign rating.

It cited the challenges were lower global crude oil prices and lacklustre global growth while the challenges that were expected would be the normalisation of interest rates by the US Federal Reserve.

In a related rating action, Moody's affirmed the instrument ratings on senior unsecured debt issued by Khazanah Nasional Bhd at A3. These instruments are guaranteed by the Malaysian government.

Below is Moody’s ratings rationale for the A3 rating affirmation:

First driver: Progress on fiscal reform and on-going deficit reduction.

The first driver of the affirmation has been progress on fiscal reform over the past year. In particular, the fiscal accounts are now structurally more resilient to both upside and downside shocks to oil prices.

In December 2014, the government implemented a managed float system for diesel and lower grade gasoline, effectively eliminating subsidies for these fuels that had comprised an increasingly large proportion of expenditure in recent years. The move followed similar revisions to administered prices for electricity, cooking oil, and sugar.

In terms of revenue, the government has continued to reduce its historical reliance on oil-related receipts, which Moody's previously cited as a key risk to fiscal sustainability. 

Gains in tax administration have led to the share of direct taxes (ex-oil receipts) to increase by more than 10 percentage points to 42.5% of revenue in 2013 from 32.2% in 2009. 

Over the same period, oil-related receipts fell to 30.3% of revenue from 39.8%, and we expect this to fall further to under 30% for 2014 and beyond.

In addition, the government has set in place the necessary infrastructure to implement the Goods & Services Tax in April 2015. The new tax will bolster revenue over and above the sales and services taxes it replaces, partly through improved compliance.

Lower oil prices present potential downside risks to continued strong fiscal performance. The government's ability to continue to meet or exceed fiscal targets in a low oil price environment will be a key consideration in lifting the sovereign's rating.

The government has recently responded to the potential revenue impact from lower oil prices by implementing cuts to operating expenditure, demonstrating a commitment to fiscal consolidation and to meeting prevailing fiscal rules.

However, the full impact of the oil market shock -- and the potential for further shocks -- will not be known for some time, because a significant proportion of hydrocarbon revenues are derived from liquefied natural gas, the price of which tends to adjust relatively slowly owing to the long-term nature of supply contracts.

Nevertheless, Moody's expects that the stability of dividend payments from Petroliam Nasional Bhd (Petronas, A1 stable) and expenditure rationalisation will help keep the government's operating balance in surplus and consequently, its stock of debt under 55% of GDP.

Second driver: Fundamental strengths remain intact despite lower commodity prices, global financial market volatility

Despite the current challenges posed by lower commodity prices and financial volatility, Moody's expects Malaysia to continue to exhibit faster growth, lower inflation, and a more robust external payments position than other A-rated countries.

The innate strength of the economy can be attributed in part to its diversification, namely its reliance on services and manufacturing as the key drivers of growth in
recent years.

In addition, favourable demographics and the resurgence of private investment since the inception of the Economic Transformation Programme has supported household consumption and improved competitiveness as evidenced by strong inward flows of foreign direct investment.

Macroeconomic stability is anchored by the credibility of the country's central bank, Bank Negara Malaysia, which has exhibited a solid track record of maintaining low inflation and a stable financial system.

Malaysia's inflation performance is supportive of Moody's assessment of the country's institutional strength.

Malaysia's sovereign rating continues to be supported by the government's favorable debt structure and the depth of onshore capital markets, both of which mitigate the impact of capital account and exchange rate volatility.

As of end-September 2014, foreign-currency denominated liabilities constituted only 2.8% of the government's debt stock, effectively eliminating exchange rate risks from the standpoint of debt repayment. 

While non-residents continue to hold 30.2% of government debt, the capacity for large institutional investors—such as the Employee Provident Fund—to provide a reliable source of domestic financing is supported by low unemployment levels against a backdrop of resilient economic growth.

Credit concerns relevant to the rating action:

Malaysia's fundamental strengths are not likely to be materially affected by several concerns, but that developments over the year ahead will better inform Moody's credit assessments.

The first concern is the high level of household debt when considered in the context of a cooling residential property market after a rapid rise in prices in recent years.

Factors mitigating this concern are low unemployment and the high level of household financial assets. Both factors reduce risks to the financial system, and ultimately contingent liabilities to the government's balance sheet.

Another concern is whether Malaysia will maintain strengths in its external payments position, given sharply lower commodity prices, rising external debt, and possible global credit market volatility once the US Federal Reserve begins normalising interest rates.

In general, Moody's believes that Malaysia is likely to sustain a structural current account surplus, and that foreign currency reserve adequacy will remain in line with similarly-rated peers.

In addition, the opacity with regards to off-budget financing vehicles adds difficulty to a comprehensive and informed analysis of contingent risks to the government, including non-financial corporate debt.

Rationale for the positive outlook:

The positive outlook reflects the likelihood that fiscal consolidation will be sustained notwithstanding a prolonged period of low prices for commodities.

Narrower fiscal deficits have contributed to the stabilisation of Malaysia's debt burden, which remains elevated as compared to A-rated peers.

Continued fiscal consolidation, underpinned by relatively strong economic growth and favorable funding conditions for the government potentially supports a higher rating level.

What could move the rating up/down:

Upward pressure on the sovereign's rating could arise from a continued track record in fiscal deficit reduction and stability in the affordability and refinancing of government debt.

Conversely, a significant worsening in Malaysia's debt dynamics—possibly arising from an inability to manage the impact of lower crude oil and agricultural commodity prices—on the fiscal accounts or the crystallization of large contingent liabilities, could exert downward pressure on the rating.

Country ceilings:

Moody's has maintained Malaysia's long-term foreign currency (FC) bond ceiling at A1 and its long-term FC deposit ceiling at A3. Malaysia's short-term FC bond ceiling and short-term FC deposit ceiling were also maintained at P-1.

These ceilings act as a cap on ratings that can be assigned to the FC obligations of entities other than the government that are domiciled in the country.

The local currency (LC) country risk ceiling was maintained at A1.

GDP per capita (PPP basis, US$): 23,160 (2013 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 4.7% (2013 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 3.2% (2013 Actual)

Gen. Gov. Financial Balance/GDP: -3.9% (2013 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 4% (2013 Actual) (also known as External Balance)

External debt/GDP: 70.4% (2013 Actual)

Level of economic development: High level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On Jan 28, 2015, a rating committee was called to discuss the rating of the Government of Malaysia. 

The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutional strength/framework, have materially increased. 

The issuer's fiscal or financial strength, including its debt profile, has materially increased. The issuer has become increasingly susceptible to event risks.

The principal methodology used in these ratings was Sovereign Bond Ratings published in September 2013. 

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