Malaysia faces Fitch judgment day as oil fails to allay concern

[KUALA LUMPUR] Fitch Ratings said an oil rally that helped make Malaysian bonds Asia's best performers over the past three months hasn't allayed concerns over the nation's deteriorating finances ahead of a second-quarter review.

Malaysia's fundamental picture remains clouded by a shrinking current-account surplus and the build up of "contingent liabilities" for the government related to state investment company 1Malaysia Development Bhd, Andrew Colquhoun, Fitch's head of Asia Pacific sovereign ratings, said in a phone interview from Hong Kong on May 7. He warned in March that there was more than a 50 per cent chance of a credit downgrade.

"I don't think the rating view will be driven by relatively small changes in the oil prices," said Mr Colquhoun. "We've had a negative outlook of the credit since the middle of 2013. The view since then has been that the changes in Malaysia's macroeconomic fundamentals have left the credit more exposed to a potential shift in investor risk appetite."

The government raised its 2015 fiscal deficit target and cut the growth estimate as crude prices slumped to almost half what they were at their peak in June, cutting revenue for the net oil exporter. While Brent has recovered some of its losses in the past few months, easing pressure on the nation's finances and trade accounts, the jury is still out as to whether prices will continue rising amid the more volatile global sentiment, according to Spiro Sovereign Strategy.

Ringgit sovereign bonds have gained 1.2 per cent in the past three months, compared with declines of 5.7 per cent and 2 per cent, respectively for Indonesian and Philippine notes, according to Bloomberg indexes. While the currency has strengthened 3.7 per cent since reaching a six-year low in March as oil picked up, it's still down 2.9 per cent in 2015, the region's second-worst performance after the rupiah.

The government implemented a new 6 per cent goods and services tax in April, after scrapping fuel subsidies to narrow the fiscal shortfall that's plagued the country since 1998. While the 2015 target was raised to 3.2 per cent of gross domestic product from 3 per cent, that's less than 2014's 3.5 per cent.

"There's been some effort to consolidate the budget deficit," said Mr Colquhoun. "We acknowledge all of that. One area where we might have a slight difference in emphasis is that there's been a buildup of contingent liability and debt."

As Fitch prepares to review Malaysia's A- rating, its fourth-lowest investment grade, the cost to insure the nation's bonds from default has declined to a more than two-month low. Moody's Investors Service and Standard & Poor's both affirmed assessments on their similar rankings in March and have outlooks of positive and stable respectively.

Five-year credit-default swaps on Malaysian debt have dropped 16 basis points, or 0.16 percentage point, in the past three months to 117, CMA prices show. That compares with 161 in Indonesia and 88 for the Philippines.

Data this week may renew financial concerns. The current- account surplus was 6.1 billion ringgit (US$1.7 billion) last quarter, the same as the previous three months and the lowest since 2013, according to a Bloomberg survey before figures on May 15. Growth in the quarter slowed to 5.4 per cent from a year earlier, the least since the end of 2013, a separate report may show.

To head off political flak for 1MDB's rising debt, which led to calls for Prime Minister Najib Razak to step down, the company is winding down operations and selling off some assets. It flirted with default after missing a loan repayment in November before settling it in February, and the government provided a 950 million ringgit credit facility in March.

"Malaysia is by no means out of the woods," said Nicholas Spiro, London-based managing director of Spiro Sovereign Strategy and a former consultant at Medley Global Advisors LLC. "Malaysia's underlying economic, political and governance weaknesses remain the same, and there's no room for complacency, not least with the Federal Reserve planning to hike interest rates later this year."

The relatively high foreign ownership of Malaysian bonds compared with regional counterparts may make the nation vulnerable to US tightening. Global funds own about 30 per cent of the government notes, compared with 18 per cent for Thailand, according to central bank data.

Overseas investors increased debt holdings in March by 5.8 billion ringgit to 157.3 billion ringgit, the biggest net purchases since May 2014, the latest central bank figures show. That's up from a seven-month low in November.

"Basically, all the bad news got priced in," said Edwin Gutierrez, who helps oversee US$13 billion in emerging-market bonds at Aberdeen Asset Management Plc in London. "The rebound in oil prices has also helped to stabilise the ringgit."

BLOOMBERG