This article first appeared in Forum, The Edge Malaysia Weekly on April 6, 2020 - April 12, 2020

Anxiety is intensifying over the black swan event — the Covid-19 pandemic — and for good reason.

The novel coronavirus outbreak looks set to diminish the global economic recovery that the International Monetary Fund had expected at the start of the year. Many are anticipating that the global economy will weaken to 2008/09 global financial crisis levels or worse, prompting concerns about the extent of the downturn that Malaysia will experience this year.

While investors are fixated on the possible impact of this perfect storm, their focus could move towards other factors once the pandemic subsides. Indeed, investors will likely scrutinise the country’s policy continuity in view of the recent changes in its political landscape.

On this note, the long history of commendable macroeconomic management is reassuring. The country has benefited tremendously from policies that promote growth, reduce income gaps and ensure a business and investor-friendly environment. Bank Negara Malaysia has also played a crucial role in monetary policy management, keeping inflation and the financial markets stable over the decades. All these continued after the 2018 general election (GE14).

In addition, economic policy has tended to focus on addressing macroeconomic imbalances as and when they arose. A case in point: Before the recent change of administration and prior to the surge in Covid-19 cases globally, the government fulfilled its promise to unveil an economic stimulus package on Feb 27.  The RM20 billion package aimed to assist tourism and tourism-related businesses affected by the outbreak as well as individuals employed in those businesses.

The new administration upheld the package and subsequently announced additional measures that include monthly Employees Provident Fund withdrawals of up to RM500 per month for one year for members below 55 years old and the lengthening of the PTPTN study loan repayment extension from three months to six. Hardly a month later, another RM250 billion stimulus package, Prihatan, was unveiled, of which RM25 billion comes from a direct fiscal injection. Although the main feature of the package is direct income transfers to the rakyat, there are also measures to assist businesses that have suffered more than 50% income loss since the start of this year through wage subsidies.

It is notable that just a week before the new administration took over, the financial market reacted anxiously. Malaysia’s five-year credit default swap (CDS) rose by roughly 43% at the end of February from a month earlier. Of course, that was prior to the global acceleration of the Covid-19 pandemic, which led to the collapse of crude oil prices that further pushed the five-year CDS upwards. In a similar vein, the ringgit depreciated by 3% against the greenback while the FBM KLCI fell 4.5% during the period. The deterioration in investor sentiment was partly attributed to various factors, including the slump in global stock markets, which was due to rising concerns over the pandemic’s impact on world economic health.

We saw similar financial market reactions after GE14 in 2018, although the global economy was not seriously under threat then. The day after the election, the five-year CDS surged 32% from a month earlier. This spike was primarily due to investor concerns over policy continuity and how the country’s future economic backdrop would be affected. The FBM KLCI also dropped 5% from the prior month, two weeks post-GE14.

We can also assess foreign investor anxiety levels through other financial market developments, such as capital flow trends. It is critical to monitor these because a sudden surge in capital outflows will weaken the ringgit. A sustained depreciation of the ringgit would, in turn, erode business and investor confidence. In this regard, it is worth noting that last year as a whole, the trend in capital flows looked more favourable than in 2018.

Malaysia experienced a net foreign inflow of capital into its bond market to the tune of RM20 billion, a sharp reversal from the RM22 billion in net 

foreign outflows in 2018. The turnaround was particularly evident in the final quarter of last year, when net foreign flows turned positive (RM15.6 billion), contrary to the net foreign outflows of RM2.2 billion in the first half of the year. Future capital flow trends will depend on the severity of the financial markets’ reaction to the Covid-19 pandemic, among others.

From a sovereign rating perspective, the focus will be on the country’s fiscal consolidation path from here on. Specifically, should the government commit to gradually reducing the fiscal deficit, this will be perceived favourably. However, with many countries now announcing huge fiscal packages (including advanced economies like Germany and the US) and planning to raise their budget deficits beyond their normal levels, Malaysia will not likely be penalised if its deficit increases this year.

Bear in mind that during the last financial crisis, when the budget deficit surged to 6.7% of GDP from 4.7% earlier in the year, no global rating agencies downgraded Malaysia’s sovereign rating. However, once the current pandemic is over, the government will have to clearly show its efforts to consolidate the country’s fiscal position in order to give comfort to the rating agencies.

From a longer-term perspective, measures that the new administration can put forward to enhance revenue-generating capacity will be credit positive. This is because the revenue-to-GDP ratio remains in the teens, lagging behind that of its rating peers. With rising expenditure needed to support long-term development activities, government coffers will have to be expanded. Similarly, efforts to ensure greater debt sustainability will be viewed favourably. This is in the light of Malaysia’s debt metrics being weaker than those of its rating peers.

Investors are concerned about how current economic headwinds could significantly affect the country’s growth trajectory. Thus, policy flexibility in addressing these headwinds will enhance investor confidence. While there are fiscal constraints, there is still room for further fiscal-monetary policy ammunition to cushion against potential sharp drops in economic growth. The debt level, subject to the self-imposed threshold of 55% of GDP, remained below 50% as at end-2019. Thus, there is some leeway for fiscal spending if required.

Supporting economic growth is necessary for Malaysia as global rating agencies view its commendable historical growth and low volatility as important support for its sovereign rating.

Nor Zahidi Alias is chief economist at Malaysian Rating Corp Bhd. The views expressed here are his own.

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