S&P sees Malaysia sticking to fiscal, economic reforms

Malaysia should be better positioned to benefit from a recovery in the global economy, particularly trade.

KUALA LUMPUR: S&P Global Ratings sees the Malaysian government continuing with its fiscal and economic reforms and  it projects net general government debt will peak at 51% of GDP in 2017 and to modestly decline thereafter.

The international ratings agency said on Monday although challenges to the political environment from the 1Malaysia Development Bhd (1MDB)  fallout have yet to dissipate, “we believe it will not impede effective policymaking”. 

“We project net general government debt will peak at 51% of GDP in 2017, and expect it to modestly decline thereafter.”

S&P affirmed its “A-/A-2” foreign currency and “A/A-1” local currency sovereign credit ratings on Malaysia. It also affirming its “axAAA/axA-1+” Asean regional scale rating on Malaysia.

“The stable outlook balances Malaysia's strong external asset position and high monetary flexibility with its relatively weaker but stable public finances,” it said.

Below is the statement issued on Monday:

S&P Global Ratings affirmed its 'A-' long-term and 'A-2' short-term foreign currency sovereign credit rating on Malaysia. 

At the same time, we affirmed our 'A' long-term and 'A-1' short-term local currency sovereign credit rating on Malaysia. 

The outlook on the long-term rating remains stable. We also affirmed our 'axAAA/axA-1+' ASEAN regional scale rating on Malaysia.

The sovereign credit ratings on Malaysia reflect a strong external position and considerable monetary policy flexibility. 

We weigh these strengths against Malaysia's moderate fiscal deficits and government debt burden. 

In our view, ongoing political challenges in relation to the corruption allegations of 1Malaysia Development Bhd. (1MDB) will not impede current policy flexibility and responsiveness.

Malaysia's strong external position, a result of many years of substantial current account surpluses, underpins the ratings. 

We believe this position can withstand a further slowdown in the oil and gas sector over the next two years. 

Likewise, external indicators are likely to remain unchanged, given our assumption of continued healthy trade surpluses. 

The weakened ringgit should continue to support the competitiveness of Malaysia's manufactured goods, partially offsetting the impact of depressed energy prices. 

Malaysia has a high degree of monetary policy flexibility. The central bank, Bank Negara Malaysia (BNM), has an established track record in controlling inflation, indicating strong monetary flexibility that helps absorb major  economic shocks. 

Malaysia also has a deep domestic bond market, compared with its peers', which reduces its reliance on external financing. 

Long-serving BNM Governor, Tan Sri Dr. Zeti Akhtar Aziz, retired in April 2016. The introduction of a new governor has gone smoothly. 

We expect her successor, Datuk Muhammad bin Ibrahim, to uphold and maintain the central bank's independence.

Malaysia's fiscal performance has improved after deteriorating in the wake of  the global financial crisis. 

The annual increase in general government debt averaged 6% of GDP over 2009-2012 in the aftermath of the global financial crisis. 

Deficits have since been curtailed, and we project the average annual increase in debt at 2.9% of GDP over 2016-2019. 

Despite the weaknesses from oil-related fiscal revenues, the administration has not changed its target to balance the budget by 2020. 

This goal appears to be somewhat of a stretch, particularly given that spending would likely rise in line with a sustained recovery in oil prices. 

Nevertheless, Malaysia's efforts in fiscal consolidation are encouraging. The government has shown considerable commitment toward fiscal consolidation even amid deterioration in the country's terms of trade, and ongoing political challenges. 

High subsidy spending and a heavy dependence on energy-related revenues 
weighed on Malaysia's fiscal position in the past. 

The removal of oil subsidies in December 2014 and the introduction of a 6% goods and services tax (GST) in April 2015 substantially alleviated those pressures. 

In response to lower-than-expected crude oil prices, the government also revised the budget in 2015 and 2016 to maintain deficit targets. 

In our view, these measures indicate that policymaking in Malaysia is generally effective. 

The government's measures to cut petroleum subsidies and introduce GST will 
ease its debt burden over time. 

We project net general government debt will peak at 51% of GDP in 2017, and expect it to modestly decline thereafter. 

Malaysia's general government fiscal position also carries contingent risks from its public enterprises and financial sector. These contingent risks include guarantees on debts and letters of support (including the US$3 billion 
letter of support for 1MDB, which we regard as a direct financial obligation of the government). 

We do not expect such contingent liabilities to materialize significantly within our forecast horizon. 

Malaysia's public enterprises have diverse financial profiles--some with strong free cash flows and sizable liquid assets that, in the past, have been used to support other parts of the public sector. 

Although high household debt levels pose some risks, we believe this is somewhat contained by a banking sector that is well capitalized and has a good regulatory record. 

Household financial assets are also ample. Our Bank Industry Country Risk Assessment for Malaysia is '4', with '1' being the strongest assessment and '10' the weakest.

However, there are some other areas of credit risk. Malaysia's relatively high share of non-resident holders of ringgit-denominated government bonds leaves the country's capital market exposed to the potential for a sudden funds outflow. As of end 2015, this metric stood at about 26%. 

We believe this risk is attenuated by our expectations of continued sound policymaking, and a floating exchange rate, to which the central bank has adhered despite financial market volatility. 

Although Malaysia's foreign exchange reserves bore the brunt of this volatility over the past two years, falling to an estimated 5.4 months of current account payments (CAPs) in 2016 from 6.4 in the prior year, we believe  the reserves remain sufficient. 

Malaysia's deep local capital markets provide another pillar of support. 

We project Malaysia's GDP per capita to be about US$9,400 as of the end of 2016, lower than that of most peers in the same rating category. 

Nevertheless, the economy is diversified with a large manufacturing and services base. However, the declining trend in non-energy exports as a percentage of GDP suggests that poor external demand conditions have undermined the government's  efforts to improve competitiveness and strive toward higher-margin exports. 

Although we see improvements in these areas, the external environment has not been conducive. That said, Malaysia should be better positioned to benefit from a recovery in the global economy, particularly trade.

We do not expect the weak energy sector to materially impede economic growth over the next 24 months, given that production of crude oil and liquefied natural gas account for only about 10% of GDP. 

We project Malaysia's average annual growth in real per capita GDP to be approximately 3.0% over 2016-2019. 

Exports of manufactured goods and growth in private consumption and investment are likely to drive this expansion. 

The stable outlook reflects our expectation that Malaysia's strong external position and monetary flexibility will balance its relatively weaker, but stable, public finances over the next 24 months. 

We believe Malaysia's credit fundamentals can withstand further stress in the oil and gas sector during that period.

We may raise the ratings if stronger economic growth and the government's fiscal efforts improve budgetary outcomes, and that in turn allows the government to substantially lower its debt burden.

We may lower the ratings if we assess Malaysia's public finances or institutional settings to have weakened. 

Such a change could happen, for example, if the government reverses its recent fiscal measures or there is a material deterioration in political stability related to ongoing allegations against senior government officials. 

We may also lower the ratings if contingent liabilities increase such that we revise upward our assessment of the government's debt burden.

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