This article first appeared in The Edge Malaysia Weekly on December 17, 2018 - December 23, 2018
GOING into the new year, the markets continue to be preoccupied with the US-China trade war, crude oil price volatility and lower global and local gross domestic product growth projections. However, there is an important element that should be kept in mind, according to Maybank Investment Bank Research chief economist Suhaimi Ilias, and that is Malaysia’s sovereign rating.
“Perhaps one thing that is not talked about a lot, or may have kind of died down post Budget 2019, is our credit rating,” he says during a recent interview with The Edge.
He believes the country’s credit rating is a potential wildcard for the local economy next year, given that international rating agencies continue to be concerned about the same issues — the budget deficit and government debt and liabilities.
So far, all three rating agencies have maintained their credit rating and outlook. On Dec 7, Moody’s Investor Services was the first to reaffirm Malaysia’s “A3” sovereign credit rating and “stable” rating outlook in a statement. S&P and Fitch Ratings are expected to announce their assessments next year.
“We hope our commitment to reduce the budget deficit-to-GDP ratio and to contain the government debt-and-liabilities-to-GDP ratio, and efforts to undertake tax reform following the recommendations of the tax reform committee, which will probably be finalised towards end of 1H2019, will make a case for our rating and outlook to be preserved,” says Suhaimi.
That said, he recalls when the country’s sovereign rating outlook was downgraded from “stable” to “negative” by Fitch Ratings not long after the 13th general election in 2013. There were concerns about whether the government would have the political will to implement a Goods and Services Tax (GST). The situation was exacerbated by the downturn in crude oil prices.
In 2015, Fitch Ratings restored its outlook to “stable”, two months after GST was implemented on April 1.
“What I am getting at is that we now have a situation where crude oil prices are low, we have no GST and, if you look at the government’s revenue structure right now, it seems to be back to where we were pre-GST,” says Suhaimi.
The oil-related revenue ratio to total revenue has increased to about 20%, from the low to mid-teens. Were the special dividend of RM30 billion from Petroliam Nasional Bhd to be included, it would spike to 30%.
Moreover, there is now zero contribution from GST. At the same time, the Sales and Services Tax (SST) contribution on a full-year basis has not increased and is essentially the same as in the past — only about 7% to 8% of total revenue.
“We have this issue where our revenue structure does make us vulnerable to oil price volatility and there is a lack of broad-based taxes. There is a risk there. The credit rating is something to watch out for in the first quarter or the first half of the year,” says Suhaimi.
The Malaysian economy in 2019
Malaysia’s GDP growth is projected at below 5% for the next two years given the current environment of slowing global growth.
Maybank IB Research’s forecast is 4.9% next year — up marginally from its 4.7% estimate for 2018 — in line with the central bank’s projection.
“What contributes to the slight upside (in 2019 from 2018) will be derived from the supply side. This year, there has been a contraction in mining and agriculture, which contributes about 15% to 16% to GDP. So, next year we expect whatever disruption to output in the agriculture and mining sector, which is mostly related to oil palm and LNG, to normalise,” Suhaimi says.
However, the economist believes that the outlook next year for the demand side is mixed. Public expenditure is expected to be subdued, while consumer spending should normalise following this year’s fuel subsidy boost, coupled with a three-month tax holiday ahead of the implementation of SST.
Suhaimi estimates that private consumption will normalise to 6.5% next year from 8.1% this year. On the flip side, he expects private investment growth to inch up from 4% in 2018 to about 5% in 2019 on the back of incentives accorded to businesses to invest in technology.
This, he believes, will lead to an increase in investments in machinery and equipment.
“Previously, much of the investment in the economy was driven by structure because of the infrastructure projects and property boom. But this time, we should see a shift in investment towards machinery and equipment,” he says.
On the RM37 billion worth of tax refunds owed to businesses, he estimates that 93% is likely to be returned and could spill over into capital expenditure.
Volatile crude oil, a problem for Malaysia?
At the time of writing, Brent crude was hovering at US$60.96 per barrel. As prices are expected to continue to be volatile going into the new year, one has to wonder if the country’s growth will be hurt should oil prices fail to recover, given the finance ministry’s assumption of crude oil prices at US$72 per barrel.
Suhaimi believes that if such a scenario materialises, the main impact would be on the budget.
“Our estimate is that every US$10 decline in the average annual crude oil price would reduce our oil-related tax revenue by RM3 billion, and it would be RM7 billion if you include the standard Petronas dividend to the government,” he says.
By his calculations, a RM3 billion shortfall would translate into a budget deficit expansion of 0.3% to GDP and the impact would be larger at 0.5% to GDP if it includes the dividend from Petronas.
“What we have seen previously during drops in crude prices is that the previous government had to recalibrate the budget. There is a risk in an environment where crude oil prices are drastically lower than what was assumed for the budget, that we are going to see a need for this government to recalibrate. The impact on the economy will be negative if it means spending has to be cut to reflect a drop in oil-related revenue if there is no option to raise revenue from other means.
“But having said that, one potential mitigation to economic growth would be from a low crude oil price environment. That would translate into lower fuel prices and low inflation, which I think can also be positive in terms of supporting consumer spending growth.”
Same issues to dominate 2019
Looking globally, Suhaimi believes the main issues this year, including the trade wars and geopolitical issues, will continue into next year.
“These issues have contributed to heightened volatility in capital flows, markets, currencies and, of late, have start to spill over to commodity prices,” he says.
Global economic growth will moderate to 3.7% next year, according to a projection by the International Monetary Fund. Maybank IB Research has a more bearish view. It expects global growth to moderate to 2.6%.
“If we look at things from the perspective of what is going to be key next year, the first is definitely the global trade outlook. The question now is whether or not we will see renewed escalation, de-escalation or even an end to the trade war after the 90-day ceasefire between the US and China ends. We don’t know yet because the devil is in the details,” Suhaimi says.
Apart from the trade war, the macroeconomic policies of major economies remain important. China still matters, as it is the second largest economy in the world and a big protagonist in global trade.
“So, I believe these are the issues that we will face going into 2019, and they will likely dominate the outlook for global growth next year,” Suhaimi says.
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