Malaysia vulnerable to sovereign rating downgrade, says Nomura

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KUALA LUMPUR (July 17): Nomura, which is expecting Malaysia’s economic growth to only recover in 2021, said the country is vulnerable to sovereign ratings downgrade due to its limited fiscal space and higher exposure to exports.

The two risks for Malaysia are its higher exposure to exports and limited fiscal space, said its head of Global Macro Research Rob Subbaraman, in a media conference call ‘The World After Covid-19’ held today.

He, however, lauded Malaysia’s domestic handling of Covid-19, which he said was done relatively well compared with many other Southeast Asian countries.

Noting Malaysia to have a weak fiscal position, Nomura cautioned investors that Malaysia has higher risk premium.

“Malaysia is a very open economy and is quite exposed to weakness that we are seeing in global growth and Malaysia, [when compared with other Asian countries], also has relatively less fiscal room. It has already got a fairly high level of government debt,” said Subbaraman.

Thus, it is unsurprising that Subbaraman said Malaysia is vulnerable to sovereign credit ratings downgrades, as there are limits to how much fiscal expansion Malaysia can do.

Already, rating agencies such as S&P Global Ratings and Fitch Ratings have downgraded Malaysia's long-term foreign currency outlook to negative, with both highlighting concerns over the government's weakening debt position over the next few years as well as political volatility.

Additionally, Nomura said Covid-19 has hit emerging markets (EMs) harder than developed economies because they have weak public health infrastructure, larger informal sectors and less policy space.

“Overall, we see the medium-term growth path ahead as challenging for most EMs,” said Nomura, adding that EM risk-adjusted returns may be faltering.

“After the pandemic, the EM economies are likely to deliver lower growth with their interest rates already near record lows,” Nomura noted.

On the medium-term consequences of the extraordinarily loose macroeconomic policies, Nomura is more sanguine. “We expect inflation to remain low and the excess of private savings over investment to result in an even lower natural real rate of interest than in the pre-Covid-19 days,” said Nomura.

As such, Nomura expects the unconventional monetary policies to be the new normal, and this will reduce the urgency for fiscal austerity to address the sharp rise in public debt.

However, Nomura warned of the danger of moral hazard fuelling excessive risk taking and asset price bubbles. “The Covid-19 crisis has prompted many EM central banks to start QE for the first time, and it is in some of these developing countries where the dangers of fiscal dominance and a loss of monetary policy independence loom largest,” Nomura added.

Nonetheless, Sonal Varma, Nomura’s chief economist for India and Asia ex-Japan, said Malaysia is among some of the Asian countries that will benefit from China’s diversification or trade relocation.

“As the supply chains are diversified away from China, including via reshoring, the world economy will have to contend with shorter supply chains, more concentrated value addition, longer inventory cycles, lower productivity and potentially higher costs over the medium term,” said Nomura.

Notably, the Covid-19 pandemic is likely to accelerate trends towards deglobalisation, protectionism on trade and migration, US-China decoupling and the shift in global value chains away from China, said Nomura.

For Malaysia, Varma is expecting a gross domestic product (GDP) contraction of 5.8% in 2020.

In comparison, Bank Negara Malaysia (BNM)’s forecast is between -2% and 0.5% for 2020.

“We do have 2Q [GDP] as the trough of -10% and we expect a slight pick-up in the second half of 2020 (2H20).

“Malaysia has done well in terms of [handling] Covid-19, but commodity prices are still weak, and the exports dependents still remain a drag. We have a very shallow recovery in Malaysia in 2H20,” said Varma, saying that growth will not recover to 2019 level until early 2021.

She is forecasting GDP for Malaysia in 3Q to be at -8% and -6% in 4Q.

Meanwhile, she is expecting a fiscal deficit of 6% of GDP and given the view of the weak growth and deflation risks which she sees will remain “quite high” this year.

“We do think that there will be further rate easing from BNM. So, we have another 25 bps rate cut pencilled in this year,” she said.

This is in line with the Malaysian government’s expectation that fiscal deficit is to increase to between 5.8% and 6% of GDP this year, following the implementation of the government’s stimulus programmes to cushion the impact from Covid-19 pandemic.