• On 4 December, Fitch Ratings downgraded Malaysia’s LongTerm Foreign-Currency Default Rating (IDR) from “A-” to “BBB+”, and revised the outlook from “negative” to “stable”
  • This marks Fitch’s first credit rating downgrade for Malaysia since 1998 and follows an earlier outlook revision from “A- stable” to “A- negative” in April.
  • The downgrade was attributable to the weakening of several key credit metrics, which were directly affected by the severity and duration of the COVID-19 pandemic. In particular, Fitch cites Malaysia’s worsening fiscal burden, which was already high compared to its peers prior to the pandemic, and the persistent political instability following the change of government in March, as key factors weighing on Malaysia’s credit rating and outlook. Even with prompt efforts made to address the COVID-19 crisis and relief measures provided to affected parties, Fitch notes that the pandemic’s impact on the Malaysian economy has been very substantial.
  • Interestingly, Fitch has singled out Malaysia from its regional peers,namely other major developing ASEAN economies (ID, TH, PH) despite the fact that their economic predicaments are somewhat similar, especially with regards to putting up with the fiscal challenges. Earlier this year, along with Malaysia, their credit outlooks were revised down to negative to reflect the impact of the pandemic and the deployment of sizeable fiscal policy measures to support their struggling economies.
  • It would be interesting to observe whether the other two major rating agencies, namely Standard and Poor’s and Moody’s, would follow suit. However, it is not uncommon for the rating agencies’ views and decisions to differ. Nevertheless, it should be a wake-up call for the government to take heed and hasten necessary changes and reforms.
• Fitch projects a GDP growth contraction of 6.0% (KIBB: -5.1%; MOF: -4.5%; 2019: 4.3%), while fiscal deficit is projected to widen to 6.0% of GDP this year (KIBB: 6.3%; MOF: 6.0%; 2019: 3.4%)
  • According to Fitch, measures to contain the virus’s spread, coupled with weak investment and low tourism receipts due to travel restrictions, have reduced economic activity. Itsees GDP growth to rebound to 6.7% in 2021 (KIBB: 6.1%; MOF: 6.5-7.5%) due to low base effect, a revival of infrastructure projects and further recovery in exports of manufactured goods and commodities.
  • The continuation of support measures and political pressure for higher spending were the main reasons for the wider deficit. Fitch foresees a narrower fiscal deficit in 2021 (5.4%) up until 2023 (an average of 4.5%)in line with the government’s 2021- 2023 Medium-Term Fiscal Framework (MTFF) (2020-22: 2.8%).
  • Consequently, Fitch expects the government debt level to rise to 76.0% of GDP in 2020 (2019: 65.2%). Note that Fitch’s debt figures include officially reported “committed government guarantees” on loans serviced by the government budget and 1MDB’s net debt. In contrast, we forecast government debt (exclude government guarantees) to exceed the new statutory limit and rise further by year-end to 62.2% of GDP (2019: 52.5%).
• Fitch’s decision to downgrade Malaysia’s sovereign credit rating may dampen investor’s confidence and put pressure on the Malaysian financial markets
  • USDMYR: the rating downgrade may momentarily push ringgit above the 4.10 level due to potential ringgit sell off. However, the weakness is expected to be short-lived as the market had already priced in the impact of COVID-19 on Malaysia’s economy. In addition, we see a muted impact on the local note in the medium to long term on the back of the global risk-on sentiment. We have earlier revised our USDMYR year-end forecast to 4.07 from 4.30.
  • 10-year MGS: a lower sovereign credit rating is associated with a higher risk of default, resulting in higher bond yields as investors expect to be compensated for the risk they undertake. Long-term government bonds such as the 10-year Malaysian Government Securities (MGS) yield may trend upwards due to a sell-off in the Malaysian debt market as investors’ risk perception changes.
• Overall, we believe that the revised credit rating is less alarming. The increase in government debt was justifiable by policy actions to safeguard the country from an unprecedentedglobalhealthcrisisthat brought down the world economy to its lowest since the Great Depression. Nonetheless, Fitch outlines two key factors that would influence the future rating action
  • Public finance: a reduced government debt ratio due to fiscal consolidation after the pandemic recedes will give a positive upgrade. Meanwhile, an increase in government debt ratio over the medium term will lead to a further downgrade. We view that the efforts to resume fiscal consolidation in the medium term would be challenging without new revenue sources and continued leakages. However, we believe that pro-growth policy through sizeable development expenditure in Budget 2021 and global economic recovery may be able to reduce the debt ratio.
  • Structural: greater transparency and control of corruption will help rating upgrade. Meanwhile, a deterioration in governance standards, such as a lower score for the World Bank Governance Indicators, will lead to a rating downgrade. We believe that the government will undertake continuous efforts to promote greater institutional reform. However, a lack of political stability could hinder this effort in the near term.

Source: Kenanga Research - 7 Dec 2020