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This article first appeared in The Edge Financial Daily on April 18, 2018

KUALA LUMPUR: Despite structural improvements, Moody’s Investors Service said it still considers that household leverage represents a significant tail risk for Malaysian banks in case of a sharp deterioration in employment conditions or a fall in property prices.

This view was echoed by the majority of 23 Malaysian and international financial institutions who had attended its “Inside Asean — Spotlight on Malaysia” conference on March 21.

“The majority of poll participants were concerned about the level of household debt, and less so about corporate leverage. We consider that credit risk in the household sector is receding, driven by deleveraging as household debt decreased to 84.3% of gross domestic product (GDP) at the end of 2017, from 88.3% in 2016,” said Moody’s in a report titled “Cross-Sector — Malaysia — Heard from the Market: Trade restrictions, tighter funding conditions are top risks” released yesterday.

“Also, the structure of household debt improved, as the riskiest segment — low-income borrowers — makes up 17.4% of total banking system financing to households, lower than 19.1% in 2016,” it added.

On the other hand, the international rating agency noted that corporate credit risks are well balanced — particularly when looking at the debt-at-risk metric, said Moody’s.

“The share of debt owed by vulnerable firms decreased to 14.1% of corporate debt in 2017, from 15.4% in 2016, driven by higher corporate earnings and more stable commodity prices.

“There are pockets of risk in the corporate sector emanating from a handful of industries such as some parts of commercial property and the oil and gas sector. But the banking system’s exposure to these riskier industries is relatively small, at around 3% and around 4%, respectively,” it said.

Moody’s pointed out that nevertheless, most poll participants expect stable credit conditions for domestic banks in 2018, and around one quarter expect upside in the banks’ credit profiles.

“We maintain stable outlooks on all the rated Malaysian banks, and expect that Malaysian banks will benefit from solid and stable macroeconomic conditions.”

Moody’s said poll respondents also indicated that consolidation among banks was necessary because of intense competition and weaker banks becoming non-viable, and the sheer number of banks in Malaysia.

“In our view, there is room for some smaller banks to consolidate so they can better compete with their larger rivals,” it added.

Moody’s is expecting GDP growth of Malaysia to average 5.2% this year, underpinned by a pipeline of large infrastructure projects that will stimulate both public and private investments.

“However, the recent upturn in trade is unlikely to continue at a similar pace and government spending is unlikely to be as strong as it has been in the lead-up to elections scheduled to be held on May 9,” it said.

Although domestic political risks have increased in recent years, Moody’s believes that they have not adversely affected policy reform as the government has demonstrated commitment to its fiscal deficit reduction goals.

“Going forward, we expect this to remain the case through the election cycles,” it added.

Meanwhile, Moody’s sees Malaysia as vulnerable to measures aimed at curtailing global trade given its high dependence on trade.

The rating agency said trade restrictions that are more aggressive than have been recently proposed by the US and China would impact Malaysia directly and indirectly.

It holds similar views to that of the International Monetary Fund, which had earlier pointed to Malaysia’s highly open economy.

“While the direct impact of recent US tariff increases on Malaysia is limited, the country’s direct exports to the US are 9.5% of total exports, which suggests sizable exposure,” said Moody’s.

“In addition to the direct export impact, higher import duties to the US would inflict secondary effects on Malaysia because of its integrated supply chains, most notably through China, as well as through a shift in demand/supply and price dynamics of key inputs, including commodities,” it added.

It also noted that a significant share in Malaysia’s exports consist of electronic components such as telecommunications equipment and electrical apparatus and parts, which are inputs for final products. These two product categories account for 21% of Malaysia’s total exports.

Nevertheless, the rating agency expects Malaysia to be able to manage a gradual rise in global interest rates.

More than 60% of the poll respondents saw a low to manageable impact from rising global interest rates, which is in line with the rating agency’s views.

“We do not see the US Federal Reserve’s (Fed) rate normalisation, which is expected to be very gradual and well communicated, as a risk for Malaysia. Our baseline expectation is for three to four Fed rate increases in 2018 and a further three increases in 2019,” said Moody’s.

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