This article first appeared in The Edge Malaysia Weekly on March 23, 2020 - March 29, 2020
GOING by the downbeat forecasts, “lower for longer” applies not just to interest rates but also oil prices, even as more countries enter into various degrees of lockdown to contain the spread of Covid-19.
Already in uncharted waters, thanks to a decade of unconventional monetary policy, the global economy now faces the challenge of another recession, one whose road to recovery is still uncertain and may not see as big a lift from China’s economic growth as it did a decade ago, post the 2008/09 subprime bubble-induced global financial crisis (GFC).
Malaysia — which projected gross domestic product growth to range between 3.2% and 4.2% for 2020, before oil prices halved precipitously to US$30 a barrel on March 9 — last saw a recession in 2009. That year, the economy contracted 1.5% for the full year, shrinking as much as 5.8% in the first quarter. Further GDP downgrades are expected worldwide should Covid-19 infections continue to rise. Last Thursday, Standard Chartered Bank Research slashed its 2020 GDP forecast for Malaysia to 2.5% from 4.2% “to reflect a greater hit to local and external demand from a more protracted outbreak”, but raised 2021 GDP forecast to 4.8% from 4.4% “on a favourable base effect” (see cover story on Pages 43 to 46).
It is understood that Bank Negara Malaysia is delaying the release of its much-anticipated guidance on the economy that traditionally accompanies its annual report, owing to the ongoing movement control order (MCO) that runs until March 31, unless it is extended. The central bank’s 2019 annual report was initially slated for release this Wednesday (March 25). Bank Negara governor Datuk Nor Shamsiah Mohd Yunus is a member of the supreme committee of the Economic Action Council (EAC), announced by the Perikatan Nasional government on March 16 to address the issues confounding the economy, including the impact of low oil and gas prices on a net oil and gas exporter.
Last Thursday, the ringgit — which, at the start of this year, was projected to average 4.0 to 4.1 against the US dollar for 2020 — almost breached the weakest level of 4.457 seen in December 2016, when the Organization of the Petroleum Exporting Countries reached the Opec+ production-cut deal, which unravelled on March 6 and meant a supply flood.
Lockdowns to curb the spread of Covid-19 have already reduced demand for travel and oil. Both Goldman Sachs and Morgan Stanley last week slashed their forecasts for Brent for the second time in two weeks. Goldman now expects Brent at US$20 and Morgan Stanley at US$30 a barrel in the second quarter versus US$30 and US$35 the week before.
The ringgit weakened to 4.4207 against the greenback intra-day on March 19, even as Brent crude oil skidded to US$24.52 a barrel before retracing some losses. This was also due, in part, to a stronger US dollar, which gained against several key currencies as well.
For now, no one expects the ringgit to revisit its all-time low of January 1998, when the ringgit closed at 4.71 after skidding as low as 4.8850 intra-day.
Those that reckon the ringgit has been oversold include UOB Bank Malaysia, which told clients in a March 18 note that it expects the ringgit to revert to 4.35 in 2Q2020. The ringgit should gradually strengthen to 4.30 in 3Q2020, 4.27 in 4Q2020 and 4.20 in 1Q2021, assuming a modest growth recovery in the second half as the outbreak shows signs of getting under control, the research house says. The fear here is if the lockdowns continue well into the second half of the year — a scenario that governments globally are working hard to avert.
Foreign exchange analysts at Maybank Kim Eng Research see support for the ringgit at the 4.40 and 4.343 levels and resistance at the 4.44 levels, according to a March 20 note.
Liquidity boosts
Economists expect further weakness in the ringgit in the near term, as investors prefer safe-haven assets such as gold and US dollar-denominated assets amid the ongoing uncertainties. They reckon that the central bank “can tolerate” further near-term weakness of the ringgit to prop up growth.
Economists expect at least another 25-basis-point reduction or a cut of up to 50bps in the Overnight Policy Rate (OPR) to 2% (last seen from February 2009 to March 2010) by the next scheduled monetary policy committee meeting on May 5. Bank Negara’s MPC can also choose to make changes outside its scheduled meetings, the way the US Federal Reserve cut interest rates by 50bps on March 3 and, within a fortnight (on March 15 — a Sunday), further dropped its benchmark by a full percentage point to zero.
Economists also expect another percentage point cut in the Statutory Reserve Rate (SRR) to 1%, the level it was at in March 2009 amid the 2008/09 GFC, a move that would release at least another RM15 billion into the banking system.
Last Thursday, Bank Negara slashed the SRR by one percentage point to 2%, releasing RM14.8 billion into the banking system, just four months after a 50bps cut. Another RM15 billion was injected by allowing principal dealers to recognise up to RM1 billion worth of government papers as part of the SRR compliance requirement until March 2021, lifting the total liquidity boost to RM30 billion.
Over in the bond market, a flight to safe-haven assets saw 10-year Malaysian Government Securities (MGS) yields spike to as high as 3.69% on March 19, before settling at 3.54%, according to central bank data. Yields on the same 10-year MGS had closed at 2.8% just a fortnight ago on March 6. Last Friday, 10-year MGS fetched as much as 3.58% before settling at 3.51%.
RAM Ratings deems the spike in MGS yields a “knee-jerk reaction” that is expected to normalise on account of further monetary policy easing.
Other economists took note of the RM8.14 billion monthly decline in foreign holdings in ringgit-denominated debt securities last month — the first monthly decline since October and the largest monthly decline since April 2019, according to central bank data. They are watching out for March data, given that selling had continued this month.
Bank Negara reserves, which fell US$800 million to US$103.4 billion month on month in February — the first monthly decline since September, slipped another US$400 million, to US$103 billion as at March 13, but remains ample at 1.1 times short-term external debt and 7.3 months’ retained imports.
Rating wildcard
“There is likely to be greater scrutiny on Malaysia’s rating outlook [not so much rating changes, at the current juncture],” says a seasoned economist, adding that credit rating agencies “are looking for evidence of an alternative long-term revenue stream that can support the government coffers in order to service its debt”.
Another factor to watch out for is a statement by the FTSE Russell, which is scheduled to release an interim review of its Market Accessibility Level on April 2. Last November, it had decided not to remove Malaysian bonds from its World Government Bond Index. However, Malaysia remains on its watch list.
FTSE Russell is expected to maintain status quo on Malaysia for now, says Winson Phoon, head of fixed income research at Maybank Kim Eng in Singapore.
“The final decision should come at the annual review in September, as FTSE Russell may need more time to assess the efficacy of the measures rolled out by Bank Negara to improve bond and forex liquidity,” Phoon says, citing initiatives such as the Appointed Overseas Office pilot programme, which allows principal dealers to quote benchmark as well as “off-the-run” bonds outside Malaysian trading hours (London and New York hours). “Bank Negara has been proactively engaging with foreign investors to provide updates and gather feedback; we think this will certainly help.”
Engagement with rating agencies is also important, going by the pushback from foreign investors when Fitch downgraded Malaysia’s sovereign credit rating outlook to “negative” from “stable” in July 2013, before raising the outlook back to “stable” in early July 2015 without an actual rating cut.
Of the “Big Three” sovereign rating agencies, Phoon expects two — Moody’s and Standard & Poor’s — to keep Malaysia’s rating unchanged, barring “major growth and fiscal shocks”.
He reckons, however, that Fitch’s rating outlook “could be more at risk, as their sovereign rating model has already assigned a BBB+ (one notch lower) output for Malaysia since March 2018. Fitch’s rating committee has been exercising model override to keep Malaysia’s rating at A- because they think the deteriorations in metrics could be temporary — this assumption may be tested in the current environment”.
In a March 15 note, Phoon writes that Fitch and S&P last affirmed Malaysia’s rating last July, while Moody’s had affirmed its rating in November. That implies that Fitch and S&P’s decision could come within the next three months. “Ratings decisions reflect the balance of strengths and weaknesses. The key questions are whether the prevailing challenges will tilt the balance more to the downside and whether these effects are transitory in nature. To be fair, downside risks will [be reduced] substantially if the global growth outlook improves, but this argument does not hold water amid the Covid-19 pandemic. Strict virus containment measures, unfortunately, hurt economic activities.”
Among S&P’s considerations are government interest payments staying below the prudential threshold of 15% of revenue.
Federal government revenue needs to be at least RM233 billion, going by the forecast debt service charges of RM34.95 billion estimated for this year and the prudential ceiling of 15%, back-of-the-envelope calculations show. That provides about RM11 billion wriggle room of sorts for federal government revenue to come in lower than the projected RM244.53 billion estimated in Budget 2020, which was tabled last October and assumed oil prices at US$62 a barrel.
If every US$1 drop in Brent takes away RM300 million from government coffers — as per the old official guidance given when the ringgit did not average 4.2 to 4.4 to the US dollar — there will be a RM9 billion shortfall if Brent averages US$30 all year. There is also a need to prepare for a possible lower tax collection.
In a March 19 statement on the Covid-19 crisis affecting global growth, Fitch says its forecast for Brent crude oil has been lowered to US$41 per barrel for 2020 (annual average), from US$62.50. It now expects oil prices to average US$48 per barrel in 2021, down from US$60 per barrel, following the collapse of Opec+ cooperation.
Clever messaging by the government needs to happen swiftly to help rating agencies decide in Malaysia’s favour for the ringgit not to see any more shocks than what the global economy is already bringing.
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