This article first appeared in The Edge Financial Daily on February 21, 2018

KUALA LUMPUR: Moody’s anticipates the country’s robust economic growth to continue this year. However, the rating agency warns of limited growth potential in Malaysia in the long run should the government fail to improve productivity significantly.

Also, Moody’s cautioned that the implementation of further fiscal consolidation remains a major credit challenge in Malaysia, although the trend of fiscal deficit reduction has been maintained.

“Malaysia faces the challenge of meaningfully lifting productivity growth to avoid falling into a middle-income trap.

“Although by some definitions, Malaysia is already classified as a high-income economy, absent improvements in productivity growth, growth potential will continue to slow,” said Moody’s in its annual credit analysis report.

Moody’s noted that labour productivity levels are stronger than its peers in Asia, such as China, Indonesia, the Philippines and Thailand, but are weaker than those in more developed economies. That said, the rating agency concluded that the country’s ongoing efforts to raise productivity, coupled with the relatively well-diversified nature of the economy and its ability to withstand shocks in the past, reinforces its expectations that Malaysia’s growth performance will remain robust relative to similarly rated peers.

In 2016, labour productivity grew 3.5%, driven by ongoing government efforts to increase digitalisation and improve accountability at the industry level, said Moody’s in the analysis.

Moody’s expects Malaysia’s gross domestic product (GDP) growth to moderate slightly to 5.2% in 2018 driven by infrastructure development activities. It said that a pipeline of large infrastructure projects — such as the Pan Borneo Highway, the Pengerang refinery and petrochemical plant, mass rapid transport projects in Kuala Lumpur, and the East Coast Rail Link and Kuala Lumpur-Singapore high speed rail — should stimulate both public and private investments. “By contrast, the 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 [the] elections, that are scheduled to be held before August 2018,” said the report.

Commenting on the country’s budget deficit, Moody’s said further fiscal consolidation is likely to be very slow with the absence of any meaningful revenue-raising measures (the past two budgets have contained none). “The government had acknowledged that its goal of achieving a balanced budget by 2020 will not be met, instead pushing it forward by another two to three years. Achieving this goal will likely rest primarily on economic growth, rather than any structural budgetary measures,” said the report.

Moody's has affirmed Malaysia’s A3 rating with a “stable” outlook. However, it is noted in the credit analysis that the downside risks of the current rating are — a significant worsening in Malaysia's debt dynamics — possibly arising from a renewed fall in commodity prices or the crystallisation of contingent liabilities; a deterioration in the balance of payments position or material capital flight which puts further pressure on reserves; and a long-lasting negative shock to the economy, possibly amplified by high household debt levels.

Meanwhile, the rating agency noted that Malaysia continues to be exposed to potential volatility in capital inflows given an active non-resident investor presence. Moreover, foreign reserve adequacy remains low when compared with A-rated peers.