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Rating Action:

Moody's affirms Malaysia's A3 ratings; maintains stable outlook

07 Dec 2018

Singapore, December 07, 2018 -- Moody's Investors Service ("Moody's") has today affirmed the Government of Malaysia's local and foreign currency issuer and senior unsecured debt ratings at A3. The outlook remains stable.

The affirmation of Malaysia's A3 rating recognizes that Malaysia's fiscal strength has weakened. Government debt will stay high for longer and the government's fiscal policy choices will narrow the revenue base and reduce fiscal flexibility further. At the same time, robust growth potential, notwithstanding a slowdown in the next few years, and deep domestic capital markets continue to support the rating at A3. A solid institutional framework, including strong monetary policy effectiveness, also supports the credit profile, although in Moody's view, the government will face hurdles to significantly reining in pervasive corruption.

The stable outlook balances credit constraints from low debt affordability and a high debt burden against inherent credit strengths, including resilient economic growth and a stable and broad funding base for the country's debt. Relative stability in financing conditions in a weaker global environment also underpins the stable outlook at A3.

Moody's has also affirmed the backed senior unsecured US dollar trust certificates issued by Malaysia Sovereign Sukuk Berhad and the backed senior unsecured debt issued by Malaysia Sukuk Global Berhad, special purpose vehicles established by the Government of Malaysia at A3. The payment obligations associated with these certificates are direct obligations of the government. In Moody's opinion, the payment obligations represented by the securities issued by these two special purpose vehicles are ranked pari passu with other senior, unsecured debt issuances of the government. As such, ratings for the sukuk issuances mirror the Government of Malaysia's issuer rating.

Moody's has also affirmed the local currency ratings on the backed senior unsecured debt issued by Khazanah Nasional Berhad at A3. The Malaysian government guarantees these instruments.

Malaysia's long-term foreign currency (FC) bond ceiling is unchanged at A1 and its long-term FC deposit ceiling is A3. Malaysia's short-term FC bond and deposit ceilings are also unchanged at Prime-1 and Prime-2 respectively. These ceilings act as a cap on ratings that can be assigned to the FC obligations of entities other than the government that are domiciled in the country.

The long-term local currency (LC) bond and deposit country ceilings are unchanged at A1.

RATINGS RATIONALE

FURTHER FISCAL DEFICIT REDUCTION WILL BE INCREASINGLY DIFFICULT AND THE DEBT BURDEN WILL STAY HIGH FOR LONGER

Following a change in government in May 2018, the new government has signaled a significant shift in policy priorities, towards supporting lower incomes and enhancing the transparency of public finances. The government's fiscal choices, most notably the abolition of the Goods and Service Tax (GST), will have long-lasting negative effects on revenue collection.

Moreover, the measures implemented and announced will lead to a concentration of the revenue base on oil-related revenues and a dependence on non-tax revenues, such as dividends from state-owned enterprises, that will limit fiscal flexibility in future years. As a result, Moody's assesses that Malaysia's fiscal strength has weakened.

Malaysia's fiscal deficits narrowed to 3.0% of GDP in 2017 from a peak at 6.5% in 2009. With the loss in GST revenue that is not fully compensated by revenue from the narrower Sales and Services Tax (SST), the deficit is projected to widen to 3.7% of GDP in 2018. Supported by higher dividends from state-owned enterprises (SOEs), a portion of which are one-off, the deficit will only narrow slightly to 3.4% in 2019. While the government expects fiscal consolidation to resume from 2019, the absence of political support for a substantial increase in revenue and the narrow space to cut expenditures further imply that the path towards narrower deficits is likely to be slower and more difficult, particularly in a weakening global environment.

Policy space and debt affordability are already constrained by a much narrower revenue base than available to other Moody's A-rated sovereigns. According to the government's budget estimates, revenue will remain at a record low as a share of GDP, at 16.3% in 2018. As a result, debt affordability is weak, with interest payments accounting for 13.1% of revenues in 2018, much higher than the A-rated median of 4.7%. The measures announced by the government so far will not significantly widen that revenue base.

While expenditure restraint should keep the debt burden relatively stable, it is unlikely to edge lower. At 50.7% of GDP in 2017, Malaysia's debt burden is higher than the median of 39.7% for A-rated sovereigns.

Following the Malaysian government's assertion in 2018 that liabilities from state-owned entity 1 Malaysia Development Berhad (1MDB, unrated) will be resolved and involve budget transfers, Moody's will include 1MDB's outstanding debt in its estimates of Malaysia's government debt. As a result, Moody's expects Malaysia's debt burden to rise to 52.8% of GDP in 2018 and remain relatively stable thereafter.

More generally, Moody's estimates government debt burden based on direct debt obligations. While Moody's considers contingent liability risks posed by SOEs, including through potential calls on debt guarantees, the rating agency continues to assess that the financial health of most SOEs is robust pointing to limited risks for the government's balance sheet. Moreover, ongoing support for operations and debt servicing to some of the weaker SOEs is accounted for in government expenditure and therefore part of the deficit and government debt projections.

ROBUST GROWTH DYNAMICS AND DEEP DOMESTIC CAPITAL MARKETS SUPPORT THE CREDIT PROFILE

A diverse, growing economy, coupled with deep domestic capital markets supports Malaysia's sovereign rating.

Malaysia has been among the fastest growing A-rated sovereigns after China (A1 stable), Ireland (A2 stable)and Malta (A3 positive) in the last five years (5.2% in 2013-17). Moody's expects GDP growth to slow to slightly under 5% from 2018, owing to slower trade flows and lower investment growth.

Notwithstanding this slowdown, Malaysia's growth will remain stronger than the median average for A-rated sovereigns. In the longer term, Malaysia's economic prospects are supported by well-developed infrastructure, substantial natural resources, globally competitive manufacturing and services sectors. Robust growth will contribute to rising incomes from already strong levels, at just under $30,000 in GDP per capita terms and at purchasing power parity.

Malaysia's deep capital markets provide a stable funding base at moderate costs. Government debt is nearly entirely (97.6%) financed in local currency, sheltering the balance sheet from a sudden rise in the debt burden as a result of a depreciation of the ringgit. Moreover, two-thirds of overall government debt is held by domestic investors that are large and long-term investors, such as the Employees Provident Fund and Kumpulan Wang Persaraan (KWAP), the civil servant pension fund.

INSTITUTIONAL FRAMEWORK REMAINS ROBUST BUT ACHIEVING GREATER TRANSPARENCY AND LOWER CORRUPTION MAY FACE CONSTRAINTS

Malaysia's institutional framework has demonstrated sound monetary policy management and relatively strong governance, supported by a skilled bureaucracy. The legal and regulatory framework have supported robust growth and macroeconomic stability. Stable inflation at low levels denotes effective monetary policy.

However, pervasive corruption has acted as a credit constraint, undermining government effectiveness.

In response, the new government has emphasized strengthening accountability and increasing transparency. To this end, fiscal measures have included adopting zero-based budgeting, carrying out immediate payment of tax refunds, reclassifying certain spending items, and trimming both recurrent and non-priority infrastructure expenditure. Further planned measures, notably implementation of a Fiscal Responsibility Act, introducing accrual accounting by 2021, creating a Debt Management Office, and tightening procurement policies, will also support transparency and accountability.

The government's mid-term review of the 11th Malaysia Plan also points to a greater focus on governance -- suggesting that this will dominate policy goals across the board. Plan documents indicate that the government intends to strengthen anti-corruption legislation, introduce laws governing political financing, limit the terms of office for key political positions; and enhance the authority of the parliament. The offices of the Minister of Finance and the Prime Minister that were conventionally held by the same person, have already been separated.

Some of these measures -- planned and implemented -- are aimed at ensuring a more rigorous system of checks and balances to prevent a repeat of past practices of corruption and non-transparent, off-budget spending. Moody's expects these measures to materialize only slowly. Over time, they may face some resistance especially if the stated intentions of improved transparency and lower corruption are not accompanied by material improvements in living standards.

RATIONALE FOR THE STABLE OUTLOOK

The stable outlook balances credit constraints from a high debt burden and vulnerability to external risks against inherent credit strengths, including resilient economic growth and the presence of sizeable domestic institutions providing stable financing conditions for the government's debt.

Relative stability in financing conditions in a febrile global environment also underpins a stable outlook at A3. An active nonresident investor presence in Malaysia's financial markets leaves it vulnerable to sudden swings in capital flows. External vulnerability is also apparent in Moody's indicator measuring the ratio of external debt payments due over the next year to foreign exchange reserves, at around 160% in 2019. However, the large domestic institutional investor base, as described above, provides supportive demand for local currency debt, should foreign investors' appetite for Malaysian assets diminish. Resident banks and corporates hold three-quarters of Malaysia's external assets, which can be drawn upon to meet their external debt obligations without creating a claim on official reserves.. While Moody's does not expect a return to the very large current account surplus position of the past, continued current account surpluses will preserve the net foreign asset position.

FACTORS THAT COULD LEAD TO AN UPGRADE

The stable outlook indicates that a change in the rating is unlikely in the near term.

Over the medium term, the probability of an upgrade would rise materially should the scope for fiscal consolidation increase significantly, in particular through measures that broaden the currently narrow revenue base, and its pace accelerate substantially, pointing to decline in the government debt burden and improvements in debt affordability.

A reduction in external vulnerability risks, such as through a reversal of the rise in short-term external debt liabilities that would diminish Malaysia's sensitivity to confidence-based capital flows would also support a rating upgrade.

FACTORS THAT COULD LEAD TO A DOWNGRADE

Moody's would likely downgrade Malaysia's rating should it revise its prospects for fiscal consolidation and anticipate a marked increase in government debt over the next few years. This could result from more limited scope to cut expenditure than currently assumed and/or a pronounced and lasting negative economic shock that undermined government revenue. More significant financial support to state-owned enterprises over a number of years would also weaken fiscal strength.

Rising political tensions and divergences of views within the government could undermine policy effectiveness. If this was likely to impair the government's capacity to adhere to its fiscal consolidation objectives and/or threatened the stability of capital flows in Malaysia, this could also lead to a rating downgrade.

In the context of broad-based and likely lasting tensions between the US and China, significantly slower global trade and heightened uncertainty about the trade environment impeding investment could undermine Malaysia's economic strength. If sustained, this would put downward pressure on the rating.

GDP per capita (PPP basis, US$): 29,144 (2017 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 5.9% (2017 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 3.5% (2017 Actual)

Gen. Gov. Financial Balance/GDP: -3% (2017 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 3% (2017 Actual) (also known as External Balance)

External debt/GDP: 65% (2017 Actual)

Level of economic development: Very High level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 04 December 2018, a rating committee was called to discuss the rating of the Malaysia, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutional strength/ framework, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has materially decreased.

The principal methodology used in these ratings was Sovereign Bond Ratings published in November 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Anushka Shah
Vice President - Senior Analyst
Sovereign Risk Group
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

Marie Diron
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

Releasing Office:
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

No Related Data.
© 2018 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

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