Ahead of Malaysia's Budget on Nov 2, Bank of America Merrill Lynch (BAML) analysts are expecting the country to surprise the market with a potential fiscal deficit of 3.5 per cent in 2019, up from 2.8 per cent in 2018.
Arguing that Malaysia's balance of payments picture is peaking, with fiscal risks having been "considerably underpriced", they added: "Unlike other Asian curves, Malaysian NDIRS (non-deliverable interest rate swap) curve has steepened even against the face of flatter USD IRS curve implying that Malaysia is increasingly being driven by idiosyncratic factors."
BAML said it has been bearish on Malaysia for the last two months for structural reasons, noting that while the current account outlook has marginally improved with higher oil prices, their concerns over the fiscal situation have risen.
If the fiscal deterioration is large enough to surprise the market, ratings agencies could react: "Specifically, we believe that Malaysia could be put on a negative watch, a risk that we mentioned before." This could put a strain on Malaysian ringgit bonds, they added.
An earlier Citi Asia Economics flash noted that chances of ratings action after the Budget "cannot be ruled out, though there are mitigating factors". Ratings agencies will probably be watching to see if a credible medium-term fiscal consolidation plan is announced, said Citi, which estimates a deficit of 3.6 per cent of GDP in 2018, narrowing to 3.3 per cent of GDP in 2019.