Malaysia risk tops Mexico's to approach Indonesia

[SINGAPORE] Malaysia's default risk is surging the most in 19 months after Prime Minister Najib Razak said sliding oil prices mean the government will miss deficit and growth targets.

The cost of protecting sovereign debt against non-payment has leapt 29 basis points this month to 135.5, the most since June 2013 and the steepest increase in Asia in the past month, according to data provider CMA. That's higher than for similar or lower-rated nations including Thailand at 111 basis points, Philippines at 96.5 and Mexico at 122. It's approaching the 156 for Indonesia, ranked three steps lower.

After the fuel slid below US$50 a barrel, Mr Najib this week widened the government's fiscal deficit target for 2015 to 3.2 per cent of gross domestic product from 3 per cent and cut its growth forecast to as low as 4.5 per cent from an earlier lower bound of 5 per cent. Fitch Ratings said it's "more likely than not" to downgrade its A- grade for Malaysia due to its reliance on oil.

"The sharp drop in the price of oil is clearly negative and we probably have yet to see the worst of the current-account deterioration," said Anthony Chan, a Hong Kong-based sovereign strategist at AllianceBernstein LP. The firm managed US$474 billion on Dec 31.

"The risk of a further widening in sovereign and CDS spreads may persist for some time."

The government derived 29 per cent of its RM225 billion (US$62.4 billion) revenue in 2014 from crude, including a RM29 billion dividend from state energy company Petroliam Nasional Bhd or Petronas, according to the finance ministry.

Mr Najib took over the top post in 2009, inheriting an economy that's been saddled with a funding deficit since the Asian financial crisis in 1997. The shortfall likely narrowed to 3.5 per cent of gross domestic product in 2014 from 4 per cent the previous year, according to treasury estimates.

Authorities moved to scale back subsidies for fuel in December, and the savings will add RM3.7 billion to state coffers, Mr Najib said on Jan 20.

Tumbling crude prices are turning Malaysia's currency into the biggest loser in Asia's foreign-exchange market this year. The ringgit has fallen 2.9 per cent this year, exceeding the 0.8 per cent decline in Indonesia's rupiah and the 0.6 per cent drop in the Singapore dollar.

There is a silver lining in the ringgit's decline, according to Victor Rodriguez, Singapore-based head of Asia- Pacific fixed income at Aberdeen Asset Management Plc, which oversaw US$525.9 billion as of September.

"With a lower currency, some of the exports like electronics and so forth can create some rebound," he said in a Jan 22 interview. "But we are quite pessimistic on the ringgit."

Investors are also watching Malaysia's current account as another gauge of its financial health. The measure may fall to a surplus of about 2 per cent to 3 per cent of gross national income this year from an estimated 5.1 per cent in 2014, Mr Najib said this week.

The risks to Malaysia's current-account surplus are to the downside, Fitch said on Jan 21. Should it fall into a deficit, the country will likely face greater volatility from capital flows and disruption to the economy, it said.

As investors seek safe havens, the yield on Malaysia's benchmark 10-year government bond has fallen to 3.967 per cent from 4.145 per cent on Dec 31.

Malaysia's government was slow to revise its economic outlook in light of the oil crisis, considering Norway reviewed its forecasts in early December, according to Wong Chen, an opposition lawmaker overseeing financial and economic matters with the People's Justice Party.

"They were late to reassess the oil situation," he said by phone on Jan 22. "We are not trying to talk the market down, but the new forecasts still show the government remains too comfortable and complacent."

The impact of oil cannot be underestimated, according to Aaron Low, the Singapore-based principal at emerging-market fund Lumen Advisors LLC. Without mitigating measures such as budget consolidation, weaker crude prices would have caused a bigger dent to Malaysia, he said.

"The market is already pricing in a downgrade which is very likely the base case" as long as oil remains below US$50 per barrel, Mr Low said by e-mail on Jan 21.

"It'll keep CDS prices at these elevated levels unless we see signs of any improvement or traction in structural policy initiatives."

BLOOMBERG