Clean bill of health

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Sep 28

What do rating agencies think of Malaysia’s economic outlook? Representatives from the three global rating agencies and a veteran economist formerly with local agency RAM Ratings shared their views at the recent Economic Update 2015 forum organised by the Economic Transformation Programme (ETP).

The panellists were James McCormack, Fitch Ratings managing director and global head of sovereign and supranational group; Christian de Guzman, Moody’s Investors Services sovereign risk group senior analyst; Phua Yee Farn, Standard & Poor’s Rating Services Associate Director, Sovereign and International Public Finance Ratings; and Dr Yeah Kim Leng, Malaysia University of Science and Technology Dean of School of Business.

Fitch James McCormackMcCormack (pic) started the session with a global overview. The world of sovereign ratings, he said, has changed considerably since the global financial crisis. Back then, emerging markets were doing quite well while developed markets were really suffering and most of the negative rating actions were in the developed markets.

Today, it is the other way around. Emerging markets are seeing rating pressure due to multitude of pressures such as weak commodity prices – as emerging markets on the whole are net exporter of commodities.

“So far, this year, the ratio of negative to positive rating actions that we have taken in emerging markets for commodity exporters is 8 to 1. That gives you an idea on how much rating pressure there is just from the commodity prices affect,” McCormack said.

How does Malaysia fare amidst this?

S&P Phua Yee FarnPhua (pic) noted that Malaysia, like many countries in the ASEAN region, has learnt their lessons from the Asian Financial Crisis 17 years ago and has started being export oriented, having large account surpluses and building up their reserves to prevent another such episode.

“Malaysia right now is in a much stronger and better position fundamentally. Reserves have declined somewhat of late from USD130 billion to about 90-ish billion. But reserves are there for a reason and Malaysia has built itself a very strong external position,” he said, adding that while capital flows have caused the ringgit to decline, Malaysia has a buffer in place.

“I think that the external position, for us at least, is one of the key driving factors for Malaysia and it will remain so,” Phua added.

Dr Yeah Kim LengDr Yeah (pic) recalled that, back in 1998, Malaysia’s private sector credit to GDP ratio was close to 160% of GDP. It deleveraged and hit a low of slightly below 100% of GDP after, and has since re-leveraged up to around 125% as of last year.

“So, from an indebtedness perspective, we find that corporates are now much lower leveraged. Although there’s a couple of so-called pockets of over-leveraging, by and large, the corporate sector has been given a clean bill of health and if you look at the domestic rating agencies, the ratio of downgrades to upgrades has been relatively stable until now,” he said, adding that concentration of risk has also shifted to a more diversified base, and hence less risky than when risk was concentrated in the banking sector and large corporates.

There are also no imbalances in terms of over-leveraging in both Malaysia’s export and domestic sectors, he added.

The panellists shared the criteria and methodologies their respective agencies employ in their ratings.

McCormack stressed that ratings are not intended to move up and down with the economic cycle. “When an economy is performing well, we frequently get asked when’s the upgrade coming. It doesn’t quite work that way. We need to have the rating relatively stable through the economic cycle. Credit fundamentals don’t change very quickly, either improvement or deterioration, they tend to be relatively slow moving,” he explained.

Fitch had changed its outlook on Malaysia from negative to stable mid this year based on the country’s fiscal changes, specifically subsidy reforms and GST implementation, more or less at the same time, said McCormack.

S&P reviewed Malaysia twice this year. In February it undertook a global portfolio of reviews on all major oil and commodity exporting countries and while there were a few negative rating actions, Malaysia’s rating was affirmed at A- rating with a stable outlook.

“The view back then was that economy’s exposure to the oil and gas sector is not as large as what most people think it is. It’s about 10 to 15%, give or take…. And the government has been quite proactive to mitigate some of the fallouts,” said Phua, adding that the second review in July yielded the same outcome.

“Since then, there has been a lot of political noise but our base case is that we do not foresee this interfering with policy making,” Phua said. While S&P does not expect the government to roll back its important subsidies and reforms, it recognises the possibility of the current administration being distracted by the political noise, leading to some slowdown in economic reforms.

Moody's Christian de GuzmanMoody’s have maintained Malaysia at A3 since 2004 till 2013 when it gave the country a positive outlook based on the progress on fiscal reforms. It affirmed the rating and positive outlook in January.

Since then, the environment has changed considerably, such as the impact from China and commodity prices, and the general sentiment on emerging markets which created “a lot of noise in the short term”, says de Guzman (pic).

“In the medium term, that would be a function of how this government responds to challenges, including enacting important policy reforms that will attract higher value-added investments. Can the government continue to keep their eye on the ball with regards to fiscal consolidation? I think we will all know the answer to that on October 23rd [tabling of Budget 2016],” de Guzman said.

Representative from all three agencies voiced their concern on the middle-income trap Malaysia has often been associated with.

“You get competition from the top and the bottom and that’s what the middle-income trap is, you get squeezed in the middle. And I think that’s something that bears watching going forward,” McCormack said.

The agencies were asked what scenarios would prompt them to downgrade Malaysia and how concerned they are about its foreign exchange reserves.

McCormack said external pressures could be a factor but there is no magic number where reserves must not drop below, adding that Fitch is currently not concerned about Malaysia’s reserves number.

Phua concurred. “There’s no magic number that we put before we pull a trigger.”

“Even if its external position weakens to a lower assessment, there could be other factors involved. Rating is very holistic. We don’t look at just one factor, we look at other factors as well, for example, monetary flexibility, effective response, economic strength, growth, fiscal policy etc,” he said.

On the question of whether rating agencies are overrated, Dr Yeah said that although the influence of rating agencies have started to wane because of their inability to predict some of the global financial crisis, their influence on the market remains fairly strong.

“I think one of the reasons is that there are hard-wired regulations, especially amongst institutions that actually require some kind of either implicit or explicit minimum investment guidelines that are actually dependent on ratings. This contributed to the undue power of the rating agencies but I think over time, there is supposed to be regulatory reforms to reduce this influence,” Yeah said.

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