Bold decisions and strong political will needed

Rating matter: A fiscal expansion due to Covid-19 is necessary to ensure stronger economic revival in 2021.

ON Dec 1, Moody’s Investors Service’s regular update note to issuer maintained Malaysia’s sovereign debt rating of A3 with stable outlook.

However, on Dec 5, Fitch Ratings downgraded our rating to BBB+ from A-, citing lingering political uncertainty that weighs on the policy outlook as well as prospects for further improvement in governance standards.

This marks Fitch’s first downgrade in 16 years since 2004 when it raised our rating to A- from BBB- in April 2004.

Rewind to June 26, S&P Global Ratings revised its outlook on Malaysia to negative while keeping A-, to reflect the additional downside risk to the government’s fiscal metrics given the weak global economic climate and heightened policy uncertainty.

Plain and simple. Political uncertainty, policy uncertainty and fiscal pressures were flagged as weak rating metrics that could, individually or collectively, lead to negative rating action/downgrade.

A country rating is important. Borrowing costs in the overseas markets, both for the country, and the sovereign rating may have a constraining impact on the ratings assigned to domestic banks or companies if the sovereign rating is tweaked. Some institutional investors have lower bounds for the risk they can assume in their investments and will choose their bond portfolio composition taking into account the credit risk perceived via the rating notations.

A fiscal expansion due to Covid-19 is necessary to ensure stronger economic revival in 2021.

Malaysia is not a country with ample fiscal space. The unprecedented Covid-19 will affect economic growth, fiscal balance, debt burdens, the health of the financial sector, and the access to external liquidity.

The negative dynamics would lead to global rating agencies to evaluate our ability to withstand economic and financial fluctuations, including the room to manoeuvre and the policy flexibility it possesses to defend the economy and financial sector against such fluctuations.

The question is whether any sovereign rating action would be influenced automatically by the Covid-19 induced temporary economic downturn and the fiscal situation arising due to the pandemic?

Should Malaysia be given the elbow-space by the rating agencies given this extraordinary pandemic crisis?

While the global economic recovery should start picking up pace in 2021, underpinned by the availability of vaccines, Malaysia’s economic growth is expected to rebound by between 5.0% and 7.5% (market consensus) in 2021 from estimated contraction of between -5.5% and -6.0% in 2020.

A sustained turnaround in economic expansion in the medium-term would lessen pressure on the fiscal balance and debt burden, anchoring on a resumption of fiscal consolidation after the pandemic recedes.

Renewed economic growth may reduce some of the deficit but will not be enough to stabilise debt. Restoring sustainable finances will require the government to implement credible medium-term fiscal consolidation strategies and plans.

These include broadening tax base, the rationalisation of expenditure, consolidation of social safety net, minimise tax fraud and optimise revenue by plugging the shadow economy.

Fiscal consolidation plan needs to be complete and detailed to improve fiscal sustainability and restore market confidence, but challenges remain as fiscal consolidations often do have considerable political and economic costs.

It is believed that the implementation of decisive, well-designed fiscal reforms can even turn these costs into short-term benefits.

If implemented as planned, the government has to decide on whether to announce and implement pre-emptive fiscal consolidation or substantial adjustment or front-loaded fiscal adjustments under market pressure.

Merely announcing an ambitious deficit target over the medium term with no accompanying consolidation plan on how to achieve the deficit target may undermine the government’s steadfast commitment towards fiscal consolidation.

Global rating agencies also take political institutions, governance standards as well as the policy uncertainties into account in making their sovereign risk assessment.

A government’s ability to implement the reforms also sends a credible signal regarding its general willingness to reform and to reverse an unsustainable fiscal trajectory.

If a government can easily reverse its decisions due to political pressures or being a populist, the policy initiatives will only be cheap talk that lack political will. Rating agencies and market investors will not regard them as a credible signal.

In strengthening governance standards and addressing corruption, particularly with respect to public finances, the government has to implement institutional reforms such as the migration towards accrual accounting, introduction of a Fiscal Responsibility Act, a Government Procurement Act, and the continued practice of open tender and zero tolerance for corruption and non-compliance of budgeting procedure. The measures are viewed as credit-positive by the rating agencies.

Lee Heng Guie is executive director of the Socio-Economic Research Centre. The views expressed here are the writer’s own.