This article first appeared in The Edge Financial Daily on October 17, 2019

KUALA LUMPUR: The Malaysian government is likely to narrowly miss its deficit targets due to the dampening effect of slower nominal growth on revenue, combined with the difficulty of limiting spending amid weak demand, according to Moody’s Investors Service.

The ratings agency said this in a note yesterday as it took note that the government has maintained a credit-supportive fiscal consolidation path in Budget 2020 — despite weaker external demand and volatile commodity and financial markets — as it targets a deficit of 3.2% of gross domestic product (GDP) next year, wider than its original 3% goal.

For 2019, Malaysia looks likely to meet its deficit target for 2019, through a 13.1% year-on-year increase in revenue that included a RM30 billion special dividend from Petroliam Nasional Bhd despite a 10.1% increase in spending that was also due to a one-off allocation for outstanding tax refunds of RM37 billion.

But projections in Putrajaya’s Medium-Term Fiscal Framework indicate that fiscal consolidation will be challenging amid slowing growth, Moody’s said in the note titled, “Government of Malaysia: Growth-focused budget pursues continued deficit reduction; government may narrowly miss targets amid weak demand”.

“The framework suggests that weaker revenue rather than higher spending will constrain fiscal consolidation. In contrast to the 2020 budget, it outlines a glide path to a deficit of 2.8% of GDP by 2022, based on revenue as a share of GDP moderating to 15% from 15.3% in 2019, driven by a declining share of petroleum-related revenue. It also projects spending to slow to 17.8% of GDP by 2022 from 18.3% of GDP in 2019,” it said.

Under current fiscal consideration, Moody’s said fiscal constraints is a key credit challenge for Malaysia. Government debt is expected to edge close to 55% of GDP in 2019 and 2020, which is higher than the A-rated median forecast of 37.6% for 2019.

Weaker revenue has also weighed on debt affordability. Based on government estimates, interest payments amounted to 12.5% of revenue in 2019, higher than the A-rated median of 4.2%, it added.

While its debt assessment does not include government guarantees, Moody’s said there is also risk from the materialisation of contingent liabilities — particularly from what the government refers to as “committed government guarantees”, which amounted to 10.4% of GDP at the end-June 2019.

At the government’s projected rates, revenue growth would be considerably faster than the average 0.7% posted over the past five years. However, Moody’s said this is a challenging goal, as a difficult global environment hinders corporate profitability.

“It will be especially so if measures to encourage investment, incentivise and support trade-oriented sectors, and spur consumption prove less successful amid weakening sentiment,” it added.

It said achieving revenue goals will also rest on an oil price projection of US$63 (RM263.97) per barrel, which is subject to considerable volatility given both near-term and fundamental factors, such as sanctions on Iran, uncertainty around the Organisation of the Petroleum Exporting Countries output targets, weaker global trade, and growth in US shale production.

The budget also assumes slightly faster expansion in nominal GDP of a 4.8% year-on-year growth in 2020 and an average inflation rate of 2.0%, compared with Moody’s downwardly revised projections of 4.3% and 1.5% respectively.