PETALING JAYA: Allowing a larger fiscal deficit and running the risk of a sovereign credit rating downgrade in 2019 could cause balance of payments stress, given Malaysia’s high short-term external debts and low foreign exchange (forex) reserves, said Nomura.
Following the reversal of fiscal reforms like goods and services tax (GST) and the removal of fuel subsidies, the new government now faces the tough choice of either cutting spending at the cost of growth, or allowing a larger fiscal deficit and the risk of a sovereign credit rating downgrade in 2019.
According to a Nomura global research report, Malaysia’s Damocles score in July 2018 was 86.9, below the 100 threshold.
The Damocles index by Nomura summarises macroeconomic and financial variables into a single measure to assess an economy’s vulnerability to a currency crisis.
The oil price slump of 2014 to 2016 was a major shock for Malaysia, one of the few net-oil and gas exporters in Asia.
“While Bank Negara initially expanded forex reserves to defend the ringgit, it eventually allowed a sharp depreciation in 2015 which boosted export competitiveness.
“Malaysia has proved resilient and its current account remained in surplus, benefiting from a diversified economy and fiscal reforms,” said Nomura.
Three countries in the region, namely, Thailand, Indonesia, and the Philippines, have a Damocles score of zero, while Vietnam has a moderate Damocles score of 35.
The Bank of Thailand is signalling policy normalisation to build policy space and reduce financial stability risks following a prolonged period of exceptionally low interest rates. This is as headline consumer price index (CPI) inflation returned to within the 1% to 4% inflation target and economy growing at potential.
Thailand’s current account surplus as a percentage of gross domestic product (GDP) has been sizeable since 2015, driven by weak domestic demand and, more recently, growing tourism revenues as well as an export recovery.
“Over this period, forex reserves rose sharply, and they are now at very favourable adequacy levels relative to both imports and short-term external debts.
“The fiscal deficit is expected to widen slightly in 2018, as the government increases spending to support populist policies targeting low-income earners, in the run-up to the election in early 2019,” said Nomura, adding that real interest rates are falling gradually and remain marginally positive, as inflationary pressures have been stubbornly weak.
Over in Indonesia, a negative terms-of-trade shock in 2014 raised the Damocles score in 2014 to 2016, but it has fallen back to zero due to Bank Indonesia’s build-up of forex reserve buffers and government reforms that improved foreign direct investment (FDI) inflows.
While depreciation pressures have risen again in 2018, BI has acted decisively with 125 basis points in policy rate hikes to date.
“We expect another 25 basis points, with the risk of more.
“Bank Indonesia maintains a flexible forex regime and a dual-intervention framework in forex and bond markets, as well as introduced macro-prudential measures, like requiring residents to hedge external exposure,” said Nomura.
The research house added that Bank Indonesia has also strengthened policy coordination with the Finance Ministry, which is implementing policies to reduce the current account deficit, while prioritising a credible 2019 budget despite upcoming presidential elections.