SOME 11 years after Malaysia announced its ambitious plan to reach a “near-balanced” budget by 2020. The country has not only missed its target but is also facing a fiscal dilemma amid a widening budget deficit and the call for more stimulus injection.
The budget deficit level had been steadily declining since 2010, but this came to an end in 2018 after the then Pakatan Harapan government recognised off-the-books projects as development expenditure to deal with the burgeoning debts left by its previous administration.
Nevertheless, it was the Covid-19 pandemic and the pressing need for government stimulus that worsened the deficit level. In 2020, the national budget deficit leapt to 6%, the highest since 2009.
Since early 2020, a total of RM380bil in stimulus packages have been announced, of which RM77.6bil came from the government’s coffers. These are in addition to the RM322.5bil Budget 2021, dubbed as the “mother of all budgets.”
For a country that has yet to come out of the lockdown, it is unsurprising that there are growing calls for more assistance from the government.
Just last week, the Federation of Malaysian Manufacturers called for a RM200bil stimulus package to support the economy.
Bank Islam Malaysia Bhd chief economist Dr Mohd Afzanizam Abdul Rashid believes that Malaysia could not afford a rating downgrade, considering the potential impact on fund flows and the ringgit
While the government has said that there are more stimulus measures to be announced, there are concerns on whether the country could handle more spending without having its fiscal discipline derailed.
The government could take on more borrowings to fund additional stimulus packages, but the country would have to incur much higher interest payments in the years to come.
A key question is how the additional government spending would affect the country’s sovereign ratings and in turn, hurt investor sentiment.
On June 22, S&P Global Ratings cautioned that its ratings on Malaysia could face downward pressure over the next 12 to 24 months if there is a weaker commitment to fiscal consolidation or if the economic growth suffers a deeper or more prolonged downturn than expected.
“The situation could result in the faster accumulation of net general government debt. Change in net general government debt surpassing 4% on a sustained basis, net indebtedness surpassing 80% of gross domestic product, or interest paid by the general government exceeding 15% of revenue would indicate such deterioration.
“Downward ratings pressure could also build if political stability in Malaysia deteriorates such that policymaking becomes materially less predictable, or if the country’s external position weakens such that the economy’s annual gross external financing needs surpass current account receipts plus usable reserves, ” according to the ratings agency.Nevertheless, S&P has reaffirmed its A- long-term and A-2 short-term sovereign credit ratings on Malaysia. The outlook on the long-term ratings remains negative.
CIMB Group Holdings Bhd head of treasury and markets Chu Kok Wei and Maybank Kim Eng head of fixed income research Winson Phoon agree that rating risks have increased for many countries, including Malaysia, in the past one year.
This is considering the effects of the pandemic on the economy as well as the higher public indebtedness amid declining fiscal revenues.
Increased rating risks may lead to downgrades and while experts say a downgrade is understandable in times of crisis, it is often not easy for countries to return to the initial rating levels.
In a reply to StarBizWeek, Chu says sovereign rating is used as one of the many inputs in the decision makings or evaluation processes of foreign direct investments.
A rating downgrade, according to Chu, may impact investment decisions of the foreign multinationals companies, such as where to set up the next manufacturing plant, regional headquarters or shared service centres.However, the most direct impact would be on the credit spread payable for borrowings on government bonds.
“Next is the consequential impact to corporate credit spreads for Malaysian corporates, risk premiums for Malaysian equities and others.
“Country sovereign ratings are also a common parameter used to decide the amount of investment allocations by portfolio investors.
“Any sovereign downgrade could trigger an adjustment to both price and volume of financial investments, ” he adds.
Meanwhile, Phoon thinks that the impact of a rating downgrade would be limited on the domestic financial market.
“Investors consider a range of factors and do not rely solely on rating change by one rating agency. Institutional funds are sophisticated investors who often have their own assessment of creditworthiness.
“The tapering of quantitative easing and the rate tightening risk by the US Federal Reserve pose a much bigger risk to bond flows, in my view, ” he says.
Phoon points out that Fitch Ratings had downgraded Malaysia from A- to BBB+ in December 2020.
One of the reasons for the downgrade was Malaysia’s increased fiscal burden, which was high relative to its peers going into the health crisis.
While the rating downgrade by Fitch affected market sentiment on a knee-jerk basis, it has not caused any long-lasting impact on the domestic foreign exchange and bond markets.“I think Malaysia can afford a rating downgrade, as the current A3/A- rating is considered a relatively high investment-grade for an emerging economy, giving some buffer.
“Rating agencies such as Moody’s, S&P and Fitch can sometimes have different views on a country’s rating, ” Phoon adds.
He also says that while Malaysia scores strongly in rating metrics such as economic, institutional and monetary, the fiscal pillar has been a weak spot for Malaysia, even well before the pandemic.
On the other hand, Bank Islam Malaysia Bhd chief economist Dr Mohd Afzanizam Abdul Rashid believes that Malaysia could not afford a rating downgrade, considering the potential impact on fund flows and the ringgit.Nonetheless, he points out that the foreign ownership in Malaysian Government Securities (MGS) and Government Investment Issues (GII) have not abated, despite the one notch downgrades by Fitch Rating in December last year.
The share of ownership by the foreign funds in MGS and GII stood at 41.1% and 7.9% in May, higher from 40.1% and 6.3% respectively in November 2020.
“So perhaps, fixed income investors may have differing views with the credit rating agencies (CRAs). After all, CRAs are in the business of giving credit opinion which can always be debated and challenged.
“So I would say, the government should not be too fixated with the CRAs and instead focus on formulating and implementing the right policies to benefit the rakyat holistically, ” he says.
According to Mohd Afzanizam, government finances make up a large part of the sovereign credit rating matrices.
“Nonetheless, there are other considerations too that would have a bearing on the ratings such as the gross domestic product (GDP) volatility, governance and balance of payments.
“Therefore, it is important to note that every government spending would yield the highest impact on GDP so that the volatility can be reduced and institutional reforms such as in areas relating to corruption could mean that every spending would result in a larger multiplier effect to the economy, ” he says.Chu, who believes that the government needs to spend adequately to support the economy, also highlights the importance of the “commitment for medium term fiscal consolidation.”
“Sovereign ratings remind us that we need to do the right thing in the medium term, which is a good discipline reminder.
“I don’t believe at this stage it is mutually exclusive between sovereign ratings and livelihood, ” he says.