MARC AFFIRMS MALAYSIA’S SOVEREIGN RATING AT AAA

MARC has affirmed Malaysia’s sovereign rating of AAA with a stable outlook based on its national scale. The AAA rating reflects MARC’s opinion on the sovereign’s ability to meet its local currency obligations. It represents the sovereign’s ordinal ranking of creditworthiness within the country and excludes foreign currency transfer and convertibility risks. It is based solely on an analysis of information in the public domain. Malaysia has no local currency debt rated by MARC.

Supporting Malaysia’s AAA rating is its track record of economic resilience that is underpinned by credible economic and monetary policy management. The Malaysian economy continues to grow, albeit at a slower pace. In 2015, real gross domestic product (GDP) expanded by 5.0% year-on-year (y-o-y), slower than during the previous year (2014: 6.0%). The private sector continued to be the key economic growth driver. With the global economic environment continuing to be plagued by uncertainties, we expect real GDP growth in 2016 to slow down further to around 4.4%. The government’s growth target in the recalibrated Budget 2016 has been trimmed downwards to 4.0%-4.5% from 4.0%-5.0% originally. Growth will likely continue to depend on domestic demand, with fiscal space becoming increasingly constrained because of the oil market turmoil. That Malaysia has managed to continue to grow against a backdrop of ongoing global uncertainties is due to the success of its economic diversification efforts. In addition, its economic institutions remain credible, and economic policies proactive and practical. The economy is expected to remain on a positive growth trajectory as the government has also undertaken various efforts to strengthen the external sector to ensure balanced and sustainable GDP growth.  

Another rating support is Malaysia’s strong and well-supervised banking system. The banking system remains sound. It is highly capitalised, with the total capital ratio, tier-1 capital ratio (Tier-1) and common equity tier-1 capital ratio (CET1) standing at 16.1%, 13.8% and 12.8% respectively as of December 2015. Bank asset quality also remains sustained with the net impaired loans ratio standing at 1.2% and the loan loss coverage ratio stable at 96.2%. Going forward, bank asset quality will likely deteriorate slightly on account of slower economic growth. As household leverage is high, macro-financial risks are elevated. However, we do not expect the soundness of the banking system to be materially affected over the near to medium term.

Malaysia has an adequate level of international reserves. As of end-February 2016, foreign exchange reserves stood at USD95.6 billion, equivalent to 1.2 times short-term external debt and sufficient to finance 8.3 months of retained imports. The reserves, together with a flexible exchange rate, continue to act as a cushion against external shocks. While Malaysia continues to run current account (CA) surpluses, its external position has weakened somewhat. CA surpluses as a percentage of gross national income (GNI) post-Global Financial Crisis (GFC) have narrowed considerably. The task of driving economic growth has fallen to domestic demand, and this, when viewed from a savings-investment perspective, is one of the reasons for the lower CA surpluses. In 2015, Malaysia achieved a surplus of 3.0% of GNI, compared to 4.4% in the previous year. Ongoing oil market turmoil has also not helped. Meanwhile, Malaysia’s total external debt (re-defined) has risen to 72.1% of GDP as at end-2015. Notwithstanding this increase, the latest data show Malaysia’s net international investment position (NIIP) improving to +9.3% of GDP (2015).

Malaysia’s public finances remain a rating constraint, especially with low oil prices and lower expected GDP growth likely to make fiscal consolidation efforts going forward more challenging. With the government targeting a balanced budget by 2020, fiscal deficits have been on a downtrend. In 2015, it fell to 3.2% of GDP. As a result of lower oil prices, the contribution of oil-related revenues towards the government’s coffers has fallen. In 2015, tax from petroleum made up 5.7% of total government revenue, compared to 12.9% in 2014. Thanks to the implementation of the Goods and Services Tax (GST) in April 2015, fiscal pressure has been relieved somewhat. Net GST proceeds reached RM27 billion at end-December 2015. With federal government debt and contingent liabilities as a percentage of GDP remaining elevated, we expect the task of reducing public debt burden and improving affordability to become more challenging. 

As a result of low crude oil prices, the government has had to again revise its budget. On January 28, 2016, the government unveiled a recalibrated Budget 2016. We see the recalibration as being vital to government efforts to keep Malaysia on a fiscal consolidation path. In the recalibrated budget plan for 2016, the government is maintaining its fiscal deficit target of 3.1% of nominal GDP. However, according to our base case scenario, the budget deficit in 2016 could reach 3.2% to 3.3% of nominal GDP unless nominal GDP grows faster than our 5.0% projection. 

Notwithstanding a strong and well-supervised banking system, high household debt is a rating concern. The latest data show that as at end-2015, total household debt stood at an estimated 89.1% of GDP (end-2014: 86.8%), among the highest in the region. In addition, loans to the sector made up a significant 56.8% of total loans in the banking system as at end-December 2015. As a result of slower economic growth and rising living costs, risks associated with high household debt have become magnified. There are, however, positive developments. Household lending growth has slowed down, thus cutting down risks to macroeconomic and financial sector stability. In 2015, household loans growth in the banking system slowed to 7.3%, compared to 9.4% in 2014.

Going forward, we expect Malaysia to remain on a positive growth trajectory because it has, among other things, met the basic requirements to ensure competitiveness of the economy. However, the economy could face rising risks if domestic demand growth, the main growth engine, slows down substantially, or if uncertainties in both the global economy and the oil market rise further. A hard economic landing and further financial system stress in China will also notch up risks for Malaysia given the trade linkages. While we expect the government to remain committed to its fiscal consolidation efforts, as well as to containing the growth of direct and indirect public indebtedness, such efforts could become more challenging in the months ahead. 

Contacts: Quah Boon Huat, +603-2082 2231/ boonhuat@marc.com.my; Afiq Akmal Mohamad, +603-2082 2274/ afiq@marc.com.my; Nor Zahidi Alias, +603-2082 2277/ zahidi@marc.com.my.

April 25, 2016