What Moody's Is Watching as Malaysian Credit-Default Swaps Soar

  • Malaysian bond risk is rising twice as fast as Indonesia's
  • AllianceBernstein sees risk of Malaysia rating downgrade

If Malaysian Prime Minister Najib Razak wants to avoid a credit-rating downgrade, the embattled leader could start by prioritizing fiscal discipline over winning political favor in next week’s annual budget.

Moody’s Investors Service says it will be watching for any signs of slippage in the government’s efforts to trim the budget deficit, especially given the drag from falling commodity prices. The ratings company has an A3 rating on Malaysia, the fourth-lowest investment grade and in line with the assessments of Standard & Poor’s and Fitch Ratings.

“Thus far, we have not seen increased political risk translate into higher policy risks,” Christian de Guzman, a senior sovereign analyst at Moody’s in Singapore, said in an e-mail interview on Oct. 12. “However, political considerations may affect the fiscal outlook.”

The cost to insure Malaysian sovereign bonds reached the highest level since 2009 in September after Najib faced calls to step down over a probe of fund transfers into his personal bank accounts. The combination of political turmoil, falling oil prices and a broader selloff in emerging-market assets has pushed up the nation’s credit-default swaps twice as much as those for lower-rated Indonesia in the past 12 months, even as the government makes progress in reining in the fiscal deficit.

Najib has come under fire over debt accumulated by state investment company 1Malaysia Development Bhd., whose advisory board he chairs, and about $700 million of political donations. The central bank said last week it had proposed criminal proceedings against 1MDB after its probe found inaccurate disclosures, a recommendation the Attorney General rejected when he concluded there had been no wrongdoing.

Fitch kept Malaysia at A- in June after signaling a possible cut earlier in the year, saying finances are improving and economic growth remains steady. It revised the outlook to stable from negative. S&P said in a July report affirming its credit assessment for the Southeast Asian nation that it expects the government “to stay the course on its fiscal and economic reforms.” The company referred Bloomberg to that article when contacted for fresh comments on Oct. 2.

1MDB isn’t “news” for the rating but it is “probably contributing to the deterioration in investor sentiment,” Andrew Colquhoun, Fitch’s head of Asia Pacific sovereign ratings in Hong Kong, said in an e-mailed update to an interview on Oct. 13. There are two main moving parts in Malaysia’s credit profile, which are the government’s efforts to strengthen the budget and the broader pressure on the economy from weaker commodity prices, he said, adding that the rating view needs to strike the right balance between them.

Cyclical Factors

The prime minister has denied accusations of wrongdoing in relation to political donations. The recent volatility and widening spreads of Malaysia’s credit-default swaps don’t reflect the country’s underlying economic strength, Mohd Irwan Serigar Abdullah, secretary general of the Treasury, said in an e-mailed statement on Sept. 26. “Malaysia will continue to maintain well-being of the people and continue its prudent fiscal management as have been outlined previously,” the spokesman for the prime minister’s office said by text message on Monday.

Five-year credit-default swaps on Malaysian bonds have increased 116 basis points in the past 12 months to 205 and reached a six-year high of 247 in September, CMA prices show. Those for Indonesia have climbed 46 to 219.

“In addition to cyclical unfavorable factors, such as the commodity price downfall and general emerging-market risk aversion, negative sentiment on Malaysia has been exacerbated by political uncertainty,” said Vincent Tsui, a Hong Kong-based economist at AllianceBernstein LP, which oversees $485 billion. “Based on the weak fiscal position and deterioration in the external position, we see the justifications for sovereign rating downgrade arguments to Baa1/BBB+.”

1MDB will reduce its debt by 16 billion ringgit after Abu Dhabi-based International Petroleum Investment Co. agreed to assume obligation for $3.5 billion of dollar bonds through an exchange of the state investment company’s assets, according to an Oct. 9 statement from the Malaysian firm.

Deficit Cuts

The government has said it wants to reduce the fiscal shortfall to 3.2 percent of gross domestic product this year from 3.5 percent in 2014 after running deficits since 1998. It also implemented a new 6 percent goods and services tax in April and removed fuel subsidies. Brent crude has more than halved from last year’s peak, cutting revenue for Asia’s only major oil exporter. The current-account surplus narrowed to 7.6 billion ringgit ($1.8 billion) in the second quarter from 10 billion ringgit in the previous three months.

The 2016 budget will prioritize projects to help Malaysians cope with an expected slowing in global and domestic economic growth, Second Finance Minister Ahmad Husni Hanadzlah said in an e-mailed statement on Sept. 30. Malaysia will look at the shortfall in revenue and budget constraints in 2016, he said from Cebu in the Philippines on Sept. 11.

Global funds have pulled 23.9 billion ringgit from Malaysian debt this year and 17.6 billion ringgit from stocks amid the biggest slide in the ringgit among Asian currencies. The yield on its 10-year dollar notes has increased 49 basis points since they were sold in April to 3.50 percent. The price of 1MDB’s U.S. currency debt dropped to a record 72 cents on Oct. 5 and was 76 late on Tuesday, data compiled by Bloomberg show.

While there’s “a growing risk” that Malaysia could be downgraded due to weaker growth and rising private debt, “the country’s fundamentals remain pretty strong elsewhere and the rating agencies have so far been willing to close their eyes to the 1MDB scandal and rising political risk,” said Anders Faergemann, the London-based senior sovereign manager at PineBridge Investments, which oversees $77.7 billion globally. “The latter could determine where Malaysia should be rated going forward.”

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