FITCH RATINGS remains tight-lipped over its looming June review on Malaysia but an area of particular interest is likely to be the federal government’s contingent liabilities and off-balance sheet commitments — especially those under the Minister of Finance Inc’s (MoF Inc) 100%-controlled entities, such as 1Malaysia Development Bhd (1MDB). These were among areas mentioned in a Jan 21 note when Fitch maintained a “negative” outlook on Malaysia’s sovereign rating.

Asked about Fitch’s takeaways at a June 2 meeting with Ministry of Finance representatives, Andrew Colquhoun, Fitch’s head of Asia-Pacific sovereign ratings would only say: “We have said we will review Malaysia’s ratings by the end of this month. I have no further comment to make until then.”

He declined to provide any clue on whether the meeting reduced the chances of a sovereign rating downgrade within the coming fortnight. In March, Colquhoun said a downgrade of Malaysia’s A- sovereign rating was “more than 50% likely” and that the country’s rating would “sit more naturally in the lower medium investment grade BBB range [BBB+, BBB, BBB-]”. Anything below BBB- is deemed non-investment grade or speculative.

Economists generally welcome the additional income Malaysia will see from the implementation of the Goods and Services Tax (GST) on April 1 and are heartened that the country’s dependency on oil-related revenue had fallen from 41.3% in 2009 to 29.7% in 2014. That Malaysia’s revised budget deficit target of 3.2% of GDP for 2015 is still below 2014’s 3.4% figure — a continued and gradual reduction from the deficit of 6.4% seen in 2009 towards a balanced budget by 2020 — is another positive.

Yet, the fact that Malaysia had to revise upward its 2015 fiscal deficit target from 3% to 3.2% amid sharply lower crude oil prices “shows that the country’s dependence on petroleum-linked revenues remains a key sovereign credit weakness”, Fitch said in January.

The ongoing controversy surrounding debt-laden 1MDB turns the spotlight on Malaysia’s susceptibility to global uncertainties, even as investors pulled billions of dollars from emerging markets last week on the so-called “Fed taper tantrums”, following June 5’s stronger than expected US jobs data release.

June 17 is the current key date to watch for interest rate normalisation, being the day US Federal Reserve chairman Janet Yellen is due to speak at a press conference after a Federal Open Market Committee meeting.

Apart from the currencies of India and Indonesia, which have a “twin deficit” situation, the ringgit is seen as the major casualty of the Fed taper tantrums — which explains why it is the weakest performer among Bloomberg’s basket of Asian currencies for the past one month as well as six-month period, having weakened 3.85% and 7.06% against the greenback respectively.

Last Friday, the ringgit fell to a new record low of 2.7884 to the Singapore dollar. Closing at 2.7838 to the Singapore dollar, the ringgit had weakened 10.38% against the latter from its 52-week high of 2.5221 on Aug 27 last year.

Similarly, the ringgit weakened to as low as 3.7743 to the greenback on June 8 — past its previous low of 3.7365 seen in March 2009 amid the global financial crisis, putting it at the lowest since hitting 3.7997 in January 2006. Amid speculation of Bank Negara Malaysia intervention after governor Tan Sri Zeti Akhtar Aziz said the ringgit was undervalued relative to fundamentals, the ringgit regained some ground to close at 3.7610 last Friday, down 19.54% versus the strengthening greenback compared with its 52-week high of 3.1463 on Aug 27, 2014.

Yields for 10-year Malaysian Government Securities (MGS) maturing September 2025 slipped to 4.13% last Friday, down 10 basis points from 4.03% the previous Friday (June 5). Similarly, yields for 10-year Islamic Government Investment Issues (GII) maturing October 2025 were last traded at 4.18% last Friday, down 9 basis points from 4.09% over the same one week.

Bank Negara’s reserves have fallen 19.4% over nine months from US$132.04 billion at end-August 2014 to US$106.4 billion at end-May 2015. The central bank is slated to release its mid-June reserves figures on June 22.

“Investor confidence has definitely been hurt by 1MDB, whose RM42 billion debt is 3% to 4% of Malaysia’s GDP,” a Singapore-based currency analyst says.

“The ringgit reaching the 3.80 level (from which Malaysia unpegged its currency from the US dollar in July 2005) looks possible right now … One of your ministers mentioned the ringgit could reach 4 if Putrajaya misses its budget deficit target and Malaysia’s [sovereign rating] is downgraded because of 1MDB,” he says.

Chua Hak Bin, head of Emerging Asia Economics, Bank of America Merrill Lynch expects Fitch to downgrade Malaysia’s sovereign ratings.

“Economic conditions have deteriorated over the last three months with a weakening ringgit, collapsing LNG exports, rising off-balance sheet liabilities, 1MDB concerns, political tail risks, worsening labour market and rising bond yields,” he says, pointing out that as at end-March 2015, the public debt ratio was 53.4% of GDP. Inclusive of government guarantees, the quasi-public debt is some 69% of GDP.

“Prime Minister Datuk Seri Najib Razak took over [from Tun Abdullah Ahmad Badawi in April 2009] and ramped up spending, including infrastructure investment. The usage of government guarantees was more liberal under his leadership,” says Chua.

According to Bank Negara data, government debt stood at RM596.79 billion as at end-March 2015, up 7.38% a year the past three years from RM470.76 billion at end-March 2012.

Over that three-year period, debt guaranteed by the federal government rose an average of 10.16% a year, from RM129.5 billion in end-March 2012 to RM173.17 billion in end-March 2015.

Together, public debt and the guaranteed debt stood at RM769.96 billion or 69.6% of Malaysia’s 2014 GDP and 65.9% of Malaysia’s projected 2015 GDP of RM1.17 trillion.

The revelation in Parliament on June 9 that the government has to assume off-balance sheet obligations of RM4.76 billion to RM11.62 billion a year for nine companies owned by the MoF Inc from this year to 2020 — including Pembinaan PFI Sdn Bhd and Pembinaan BLT Sdn Bhd — also created some confusion.

“As Putrajaya did not provide details on the RM4.76 billion and RM11.62 billion a year in off-balance sheet payments, it is difficult to know the precise nature of the payments. In theory, debt servicing charges for the debt guaranteed by the government should not be paid by the government but by the government-linked corporations (GLCs) concerned, unless that particular GLC could not pay. Under such circumstances, the government could provide a loan to that particular GLC or inject fresh capital into it,” says RHB Research Institute executive chairman and chief economist Lim Chee Sing.

“The rising contingent liabilities of the government, together with the unspecified annual off-balance sheet payments by the government, is definitely an area of concern. It is, however, difficult to comment on the unspecified annual off-balance sheet payments without knowing the details,” Lim adds.

According to him, the RM173 billion debt guaranteed by the government as at end-March 2015 — which is loosely regarded as the size of contingent liabilities — does not include the debt owed by GLCs with sizeable government ownership.

Suhaimi Ilias, chief economist at Maybank Investment Bank, is similarly perplexed by the Parliament revelation: “I am not entirely clear as to what is meant by ‘obligations’ or ‘commitments’ here. But I am inclined to think those figures would include debt-servicing or interest costs for the nine government-owned entities mentioned … the figures could also include operating and development expenses of these entities, especially if they are not revenue-generating.”

Nonetheless, he says the fact that DanaInfra Nasional Bhd — which is building the Klang Valley Mass Rapid Transit Project — may reportedly opt not to use a government guarantee for its RM40 billion sukuk programme implies that the government is actively “managing its contingent liabilities”. DanaInfra, which is also 100%-owned by MoF Inc, had a government guarantee for its first RM21 billion debt papers in 2012.

In addition, should the RM4.76 billion and RM11.62 billion mentioned include debt repayment over the next five to six years, Suhaimi says the government’s contingent liabilities “should be on the downtrend”.

One seasoned economist disagrees. According to him, “strictly speaking”, contingent liabilities should also include the debt of GLCs that are not guaranteed by the government but belonging to an entity with sizeable government ownership because the government will have to shoulder the responsibility of settling the debt in the case of a default.

“The unspecified RM4.76 billion to RM11.62 billion a year in off-balance sheet payments by the government should not occur in the first place if entities under the MoF Inc are well-managed. This is an area of concern, although we cannot comment much without access to details,” he says. These off- balance sheet items are “loopholes that render the 55% debt ceiling meaningless” and cannot replace real fiscal reform, another economist adds.

He also reckons that investors should take note of the rising deficit in the consolidated public sector financial position, which also includes the balance sheets of non-financial public enterprises (NFPEs), which have heavy capital needs, such as for the construction of the Klang Valley MRT. According to the Economic Report 2014/15, including the NFPEs, the overall budget balance have risen from a deficit of 3.9% of GDP in 2013 to a deficit of 6.7% in 2014 and is projected to reach a deficit of 6.4% this year. The higher deficit figures, he says, could indicate future debt burden for the government if the NFPEs are not well-managed.

Whether or not the view is overly conservative, economists agree the rise in contingent liabilities and off-balance sheet in recent years has to stop.

Maybank’s Suhaimi says “greater transparency and disclosure will be positive steps”, given that off-balance sheet items and contingent liabilities are issues of public concerns and can affect the country’s sovereign credit rating.

He declined to speculate on how Fitch will decide in the coming weeks. Observers, however, say there is a chance Fitch could retain its negative outlook until there is greater clarity on 1MDB and the impact of the so-called taper tantrum.

Whatever Fitch’s decision, Malaysia needs to keep to real fiscal reform that goes beyond simple rhetoric that may win over the masses but not the experts, whose opinions have a bigger influence on the direction of money flows.

This article first appeared in The Edge Malaysia Weekly, on June 15 - 21, 2015.

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