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Malaysia already seen losing single-A debt rank in default swaps

[KUALA LUMPUR] As Fitch Ratings considers downgrading Malaysia, the credit-default swap market has already delivered its verdict.

Five-year contracts insuring the nation's debt cost 136 basis points, almost double the average of 75 for the remaining four countries currently rated A- by Fitch. That also exceeds prices for at least five of the seven issuers with BBB+ assessments. Andrew Colquhoun, the company's head of Asia- Pacific sovereign ratings, said Wednesday that Malaysia "sits more naturally in the BBB range." Concern that state investment company 1Malaysia Development Bhd. would default compounded Malaysia's woes after Fitch lowered the sovereign outlook to negative in 2013, citing public finances. The government raised the fiscal-deficit target in January as an oil slump cut earnings for the crude exporter, which provided a credit facility for 1MDB this month. Mr Colquhoun said there's more than a 50 per cent chance of a downgrade, with a second-quarter review due.

"Given the government-linked company debt, Malaysia doesn't look like a single-A country," said Edwin Gutierrez, who helps oversee US$13 billion of emerging-market bonds as a money manager at Aberdeen Asset Management Plc in London. "The underperformance of Malaysian financial assets vis-a-vis the rest of the region partially reflects that." Malaysia isn't worried about Fitch's assessment and the ratings company should consider the positive steps the government has taken, Finance Ministry Secretary General Mohd Irwan Serigar Abdullah told reporters in Kuala Lumpur on Thursday.

Malaysia's current-account surplus shrank to US$1.6 billion in the fourth quarter, the least in more than a year, and exports contracted in January for only the second time since 2013. The ringgit has dropped 13 per cent in six months, Asia's worst performance, and foreign-exchange reserves at US$111 billion are the lowest in more than three years.

Malaysia has grappled with a fiscal deficit since 1998 and will implement a 6 percent goods and services tax on April 1 to boost its finances after bringing down the shortfall for five straight years through 2014. The 2015 target was raised to 3.2 per cent of gross domestic product from 3 per cent. The nation's debt-to-GDP ratio of 55 per cent is higher than BBB+ rated Thailand's, and more than that of the Philippines ranked BBB-.

"If the reserves and the current account continue to deteriorate, risks of a ratings downgrade are very real," Dwyfor Evans, a Hong Kong-based macro strategist at State Street Global Markets, said by e-mail Thursday.

BBB Levels 1MDB has drawn criticism from lawmakers because of its debt totaling 41.9 billion ringgit (US$11.3 billion) as of March 2014. It repaid a 2 billion ringgit overdue loan in February and got a government 950 million ringgit credit facility this month.

The yield on Malaysia's 2.991 per cent dollar Islamic debt due 2016 rose to a 14-month high of 1.47 per cent on March 9 after the anti-corruption commission said it would initiate a probe into 1MDB. It was 1.36 per cent on Friday, compared with Indonesia's similar-maturity non-Islamic yield of 1.39 per cent and the Philippines' 1.13 per cent.

Malaysia's bonds are already trading near BBB levels after Fitch's negative credit watch, said Chua Hak Bin, Singapore- based economist at Bank of America-Merrill Lynch.

A rating in the BBB range might be more suitable for Malaysia due to its level of income and development, and the nation scores weaker in terms of governance than peers, Fitch's Colquhoun said in an interview in Singapore. 1MDB is a demonstration of that, he said.

"When we say that Malaysia is potentially a BBB credit, it doesn't mean it's going to have a crisis, it doesn't mean it's a basket case," Colquhoun said. "It just means the balance of vulnerabilities, the balance of strengths, weaknesses in our view from a credit perspective are slightly against them in the last couple of years." Moody's Investors Service and Standard & Poor's also rank Malaysia at their fourth-lowest investment grades. Both rating companies referred Bloomberg to their most recent reports when contacted for comments by e-mail on Wednesday.

Moody's affirmed its A3 rating and positive outlook in January, and said in a March 5 report its decision is backed by Malaysia's macroeconomic stability and the government's policy of reducing its fiscal deficit. S&P in February maintained its A- rank and stable view, and said the economy can withstand some weakness in the energy sector arising from lower oil prices.

Global funds hold 29 per cent of Malaysian government bonds, compared with 18 percent for Thailand, central bank data show, which could render Malaysia vulnerable to outflows when the Federal Reserve raises interest rates.

The ringgit gained as much as 1.5 per cent amid a rally in regional bonds on Thursday after the Fed said it will go slowly once policy tightening starts.

The yield on Malaysia's 2016 dollar sukuk fell eight basis points Thursday, the most since September 2013, data compiled by Bloomberg show. That augurs well for Malaysia's plan to tap the global bond market for the first time since 2011.

"The whiff of a downgrade is in the air," Nicholas Spiro, a managing director at Spiro Sovereign Strategy, a London-based investment consultancy, said by e-mail Thursday. "Malaysia's upper investment-grade status is looking a lot shakier following the collapse in oil prices. Judging by the CDS market, Malaysia has already been downgraded."