Malaysia to grapple with mounting fiscal pressure

Its debt/GDP ratio will continue to rise until 2016, predicts Fitch.

While Malaysia should successfully fend off most of the impact of the global slowdown through fiscal stimulus, there is concern that moving forward, reforms might be implemented too little too late, and could damage the country's credit profile.

Here's more from Fitch:

The strong contribution of public-sector spending and investment to economic growth may sustain pressure on Malaysia's public finances, Fitch Ratings says. Malaysia's high level of trade openness exposes it to possible external growth shocks, such as that seen in 2009. The fiscal space for further counter-cyclical stimulus at the current 'A-' rating level appears limited in light of the continued deterioration in public debt ratios as well as the current strength of public sector economic activity.

Bank Negara Malaysia said last week that the Malaysian economy grew by 5.4% in the second quarter. Q1 growth was revised up to 4.9%, from 4.7%. Data clearly shows that, alongside robust private sector activity, public sector-linked activity has been a key driver of GDP growth for the last four quarters. Public sector investment increased by 28.9% year-on-year in Q2, following a 10.3% year-on-year rise in Q1. The third and fourth quarters of 2011 both saw year-on-year public sector consumption increases of over 20%.

Malaysia's public finances already compare poorly with both 'A' and 'BBB' range medians. The ratio of federal government debt to GDP reached 51.8% at end-2011 despite the strong GDP growth, following the fiscal stimulus of 2009-2010. Resilient domestic demand, aided by supportive monetary policy settings, can cushion the Malaysian economy from the current global economic weakness. Barring a further deterioration in the global economy, the Malaysian government should be able to meet its 2012 deficit target of 4.7% of GDP (5.1%, using Fitch's calculations that exclude proceeds from the securitisation of government mortgage loans and one-off windfalls), continuing the deficit reduction that began in 2009.

Looking beyond this year, however, the Malaysian authorities have yet to outline a credible near-term plan to reduce the fiscal deficit to 3% of GDP, and the debt/GDP ratio to 50%, by 2015, in line with their official targets. This will be challenging without significant fiscal reform to address the cost of fuel subsidies, broaden the fiscal revenue base, or reduce dependence on energy-linked revenues. A general election must be called by 27 June 2013, making substantial progress on subsidy reform and fiscal consolidation unlikely until then.

Without such reforms, our base case is that the debt/GDP ratio will continue to rise until 2016. The federal debt ceiling of 55% of GDP, which was increased from 45% in July 2009 to accommodate fiscal stimulus, suggests that the room for fiscal slippage may be limited without further alteration to the debt ceiling. If this were to happen, it would apply additional negative pressure on Malaysia's credit profile.

These concerns are countered by ratings strengths - including Malaysia's track record of macroeconomic stability, a strong net external credit position, and funding flexibility. We affirmed Malaysia's rating, with a Stable Outlook, on 1 August, but noted that the strains on the credit profile were increasing.