Fitch downgrades Malaysia’s sovereign rating to BBB+, the first downgrade since Asian Financial Crisis

Fitch downgrades Malaysia’s sovereign rating to BBB+, the first downgrade since Asian Financial Crisis
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KUALA LUMPUR (Dec 4): Fitch Ratings has downgraded Malaysia's long-term foreign-currency issuer default rating (IDR) to 'BBB+' from 'A-', with a stable outlook. The downgrade marks the ratings agency's first for the country since the 1997/98 Asian Financial Crisis.

The depth and duration of the Covid-19 crisis have weakened several of Malaysia's key credit metrics, said Fitch Ratings in a statement today.

The pandemic's impact on the Malaysian economy has been substantial and has added to the country's fiscal burden, which was already high, relative to peers going into the health crisis, Fitch said.

“The government has secured passage of core legislation to implement relief measures including the 2021 budget, but in Fitch's view, lingering political uncertainty following the change in government last March weighs on the policy outlook, as well as prospects for further improvement in governance standards,” Fitch said.

Additionally, Fitch expects Malaysia’s gross domestic product (GDP) to contract by 6.1% in 2020, before rebounding by 6.7% in 2021, due to base effects, a revival of infrastructure projects and an ongoing recovery of exports of manufactured goods and commodities.

Fitch, however, pointed out that these forecasts remain subject to uncertainty and depend on the near-term evolution of the pandemic, as illustrated by the rising number of daily cases recorded since early-October.

“We forecast growth of 4.6% in 2022, on expectation that Malaysia's diversified economy will deliver strong medium-term growth,” it added.

On fiscal deficit, Fitch expects it to remain higher than pre-pandemic levels, given a continuation of support measures and political pressure for higher spending.

Fitch also believes that the Budget 2021 deficit targets of 5.4% of GDP — from an estimated 6% in 2020 — and an average of 4.5% of GDP from 2021 through 2023, are achievable.

While the government expects to generate 22% of total revenue this year including a special dividend from national oil company Petroliam Nasional Bhd (PETRONAS), Fitch expects government revenue to remain low at 19.1% of GDP in 2020 and dependent on oil production.

“The low and concentrated revenue base — exacerbated by the removal of the GST in 2018 — has in recent years led the government to draw on dividends of government-linked companies, pending the introduction of new and more sustainable sources of revenue, which Fitch understands are being considered for the medium term,” it said.

Fitch expects general government debt to jump to 76% of GDP in 2020 from 65.2% of GDP in 2019, owing to the pandemic, noting that the debt burden is significantly higher than the medians of 59.2% and 52.7% for the 'A' and 'BBB' rating categories respectively.

“Malaysia's debt is close to 400% of revenue, around three times the peer median. We expect the debt/GDP ratio to remain broadly stable after the pandemic recedes, given the likely fiscal deficit reduction and low debt service costs, illustrated by an average 10-year yield of 2.7% in November,” Fitch said.

The debt figures used by Fitch include officially reported "committed government guarantees" on loans (12.6% of GDP), which are serviced by the government budget, as well as 1MDB's net debt (1.3% of GDP). Direct government debt stood at RM874.27 billion or 60.7% of GDP as at end-September, according to the Fiscal Outlook 2021 report – slightly above Putrajaya's self-imposed ceiling of 60% of GDP, which was just raised from 55% in August.

Meanwhile, Fitch sees Malaysia’s current account surpluses narrowing to 3.4% of GDP in 2021 from 4.2% in 2020, as the import compression due to the pandemic recedes and government spending on infrastructure development is revived.

It also pointed out that uncertainty about the continued inclusion of Malaysia in a key bond index remains, and exclusion in 2021 could potentially generate capital outflows.

In September, Malaysia was retained on the Watch List for possible downgrade, which risks exclusion from the FTSE World Government Bond Index. The next assessment will take place in March 2021.

The share of the government's foreign currency-denominated debt is also low, at just 2% of total debt, the rating agency noted, adding that foreign holdings of domestic debt are around 24% of the total, down from a high of 34% in 2016.

Fitch also pointed out that Malaysia's external liquidity, as measured by the ratio of the country's liquid external assets to its liquid external liabilities, at 95%, is weaker than the 'BBB' median of 182%.  

Bank Negara expected to trim OPR by another 25bps in 2021

On monetary policy, Fitch views that Bank Negara Malaysia (BNM) has space for further easing and expects monetary policy to remain supportive of economic activity with another 25-basis-point cut to the overnight policy rate or OPR in 2021. This year, BNM has cut the interest rate by a cumulative 125bp to 1.75%.

Fitch noted that the banking sector maintains sufficient loss-absorption capital buffers, given the system's common equity Tier 1 ratio of 14.6% in October, and remains liquid with a liquidity coverage ratio of 153%.

“Moderate earnings pressure is likely to erode some of these buffers, although we expect the major banks to remain profitable in the near term,” Fitch said.

An extension of more targeted relief to individuals and SMEs affected by the pandemic until at least mid-2021, should keep NPL ratios in check but will continue to partially cloud visibility on asset quality, the rating agency said.

Outlook for further governance improvement uncertain

Moreover, Fitch views that prospects for a further improvement in Malaysia's governance are uncertain, adding that deterioration in governance and continued political uncertainty could dampen investor sentiment, constraining economic growth.

The rating agency noted that the government's thin two-seat parliamentary majority implies persistent uncertainty about future policies.

Malaysia's World Bank governance score weakened slightly in 2020 to the 64th percentile, it noted, and is closer to the 'BBB' median of 58th percentile than the 'A' median of 76th percentile.

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Fitch sovereign rating revision due to Covid-19, political developments

Kathy Fong & Tan Choe Choe