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.

Malaysia’s AAA rating is supported by its track record of economic resilience that is underpinned by credible institutions, as well as proactive and practical economic management. It is among the most globally competitive nations in the world, and continues to score relatively well in the government effectiveness and regulatory quality components of the World Bank’s governance indicators. Its macroeconomic fundamentals remain sound, due in part to successful economic diversification efforts. In addition, financial sector reforms in the aftermath of the Asian Financial Crisis (AFC) have helped ensure financial stability, which is critically important to maintain economic resilience. There have been minimal spillovers to the real economy from episodic financial market volatility, thanks to exchange rate flexibility, adequate buffers, a strong banking system, and a deep and diversified financial market.

Another rating support is Malaysia’s sustainable and strong external position, thanks to a history of current account (CA) surpluses. The surpluses also reflect Malaysia’s economic resilience. Over the 2011-2016 period, for example, Malaysia’s CA surpluses had averaged 4.8% of GDP, ahead of Hong Kong and South Korea – its rating peers in MARC’s sovereign rating universe. There are, however, concerns that the CA is heading toward deficit territory as the surpluses have been narrowing. Notwithstanding these concerns, we are not overly worried about Malaysia’s external vulnerability, at least over the short term. Malaysia has a strong policy framework. It is not reliant on external funding, and has a positive net international investment position (December 2016: 6.6% of GDP). According to the International Monetary Fund (IMF), Malaysia’s external position (in 2015) was stronger than warranted, thanks to fundamentals and desirable policies.

Malaysia’s strong and well-supervised banking system is another rating support. Banks are highly capitalised overall, with ratios remaining on a rising trend. The sector is profitable, though profitability has moderated with slower economic growth. The current business outlook has also somewhat affected borrowing sentiment. In addition, the pace of credit growth has moderated as a result of well-targeted macro-prudential policies. Meanwhile, the system’s net impaired loans ratio is stable, and its loan loss coverage ratio remains above the 90% level. We see bank profitability moderating further due to expected slower loan growth and weaker capital market activities going forward. Our analysis suggests that the leverage position of the non-financial corporate sector remains manageable on an aggregate basis. As of 3Q2016, the sector’s average and median aggregate debt-to-equity (DE) ratios stood at 0.4x and 0.2x, respectively.

Malaysia’s fiscal performance remains a rating constraint, especially with oil prices remaining low and gross domestic product (GDP) growth expected to remain below growth trend going forward. In response to the gradual fall in central government revenue as a percentage of GDP, the government introduced the Goods and Services Tax (GST) in April 2015 to expand its revenue base. In addition to broadening the revenue base, expenditure rationalisation efforts have led to enhanced efficiency and effectiveness in public spending. The subsidy rationalisation programme, for example, has helped to reduce wastage. Malaysia did meet its 2016 fiscal deficit target of 3.1% of GDP. However, the fact that the deficit had reached 3.8% in the first three quarters of the year suggests that 2016 had been a challenging year. Going forward, there are concerns about pressure on the operating balance.

Another rating constraint is the government’s high level of debt, though it should be lauded for successfully keeping its domestic debt at about five percentage points below the legally mandated 55% of GDP cap. Total government debt has also been kept below 55% of GDP. Meanwhile, the maturity profile of government debt has improved over the last five years. As of September 2016, total outstanding government debt for maturities of three years and above stood at 70.6%, compared to 62.0% just five years earlier. Government foreign currency-denominated debt remains low at around 3% of total debt. However, with foreigners holding around 34% of outstanding ringgit-denominated Malaysian government securities as of end-2016, the domestic financial market is exposed to sudden large foreign investor portfolio re-allocations. Nevertheless, the impact should be limited considering Malaysia’s deep and liquid domestic capital market coupled with the capacity of domestic institutional investors to absorb the selling by foreign investors.

Malaysia’s high household debt, which is among the highest in Asia, is also a rating constraint. In 2016, it improved slightly to 88.4% of GDP from the previous year’s 89.1%. Loans to the household sector make up a significant 56.8% (December 2016) of total loans in the banking system. In addition, house financing is a key component of household debt, and non-performing loans (NPL) associated with loans for residential property purchases have been creeping upwards. Pre-emptive measures to dampen robust residential property loans growth, as well as improve household debt sustainability, have been implemented. While housing price inflation remains on a moderating trend, house financing will likely continue to be a major growth driver of household debt. MARC will continue to monitor financial sector risks coming from the household loans sector, especially in an environment of slower economic growth.

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 18, 2017