KUALA LUMPUR (March 20): Malaysia's fiscal strength has weakened to "moderate" from "high" on the continued deterioration in revenue, which in turn has negative effects on the country's other fiscal metrics, according to the latest analysis by Moody's Investors Service.

"The government's large debt stock and poor debt affordability relative to A-rated peers are balanced against the high proportion of local currency-denominated debt and manageable — but rising — contingent risks to the government's balance sheet," Moody's said in a report released today.

The report, authored by Moody's senior credit officer Christian de Guzman, noted that fiscal strength is one of the four factors that determine a sovereign's government bond rating. The other three factors are economic strength, institutional strength, and susceptibility to event risk.

According to rating agency, Malaysia's debt affordability — as measured by interest payments as a share of government revenue — also continues to worsen in contrast to the improving trend among A3 and A2-rated peers.

"In light of the relative openness of its capital account, the large participation of non-resident investors in the domestic government bond market, and the further tightening of monetary policy in the United States, we expect benchmark interest rates for Malaysia's government securities to remain elevated. As such, an improvement in debt affordability will depend on prospective enhancements of revenue," it added.

Despite its large debt burden, Moody's noted that only 3.3% of Malaysia's direct government debt was denominated in foreign currency at end-2016.

"This result is one of the lowest among A-rated countries that issue their own currency. Much of this exposure is comprised of syariah-compliant US dollar issues that help to form a benchmark for similar private sector instruments. Consequently, the depreciation of the ringgit against the US dollar in recent years has only had a minimal impact on the government's debt burden or debt servicing obligations," said the agency.

Moody's added that Malaysia's government debt as a share of the gross domestic product (GDP) has peaked, and it foresees "limited improvement starting in 2017".

"The fall in the debt ratio in 2016 was due to a transfer of debt related to the civil servant housing loan scheme to a recently established statutory agency, the Public Sector Home Financing Board. Although this move lowers the federal government's direct debt burden, keeping it under the self-imposed ceiling of 55% of GDP, it does not have a material credit impact, because the fall in direct debt is offset by an increase in contingent liabilities," it added.

According to the Ministry of Finance's Economic Report 2016/2017, the federal government's debt stood at RM655.74 billion in 2016, a 4% increase from RM630.54 billion in 2015. However, in terms of debt-to-GDP measures, it has dropped to 53.2% from 54.5%.

"[Malaysian] government debt as a share of GDP remains higher than for many similarly-rated peers," Moody's said, adding that "At the same time, as revenue performance continues to decline, we expect debt as a share of government revenue to deteriorate from an already comparably worse position versus the same peers."

The ministry estimates that Malaysian government revenue declined 2.63% to RM219.73 billion in 2017 from a revised estimate of RM225.66 billion in 2016.

Meanwhile, as for the country's economic strength, Moody's said Malaysia scored "very high" as the county balances its large scale and robust medium-term growth prospects relative to similarly rated peers against signs of eroding competitiveness.

"We expect robust GDP growth [averaging at] 4.3% in 2017 to 2018 and continued current account surpluses. The stability in foreign currency reserves belies currency and capital flow volatility," Moody's said.

In mid-February, Bank Negara Malaysia said Malaysia's economic growth, as measured by the GDP, came in at 4.2% in 2016 from 5% that the country chalked in 2015.

"Real GDP expanded 4.4% year-on-year in the second half of 2016 versus 4.1% in the first half, as stable private consumption and investment offset the weakness in government spending," said Moody's.

As for institutional strength, Moody's said Malaysia scored "high" on "track record of sound monetary management and banking stability, as well as demonstrated commitment in recent years to fiscal consolidation".

"The final score is set below the indicative score of 'Very High (-)' to capture our assessment that corruption and imperfect implementation of the rule of law constrain government effectiveness to a greater degree than the Worldwide Governance Indicators indicate," the rating firm added.

On susceptibility to event risk, Moody's rated Malaysia as "Moderate (-)", driven by External Vulnerability Risk.

"High household indebtedness contributed to the low score for banking sector risk, while political risk at 'Low (-)' reflects our expectations of broad policy continuity through the electoral cycle. The government's liquidity risk — at 'Very Low (-)' — reflects the domestic funding strengths that mitigate the impact of capital flow volatility in local currency government bond markets," Moody's added.