KUALA LUMPUR (May 16): Moody's Investors Service anticipates that, despite the government's projected 3.2% fiscal deficit by 2025, Malaysia's consolidation of its fiscal deficit will take longer than three years due to a rigid operating expenditure and difficulties in increasing Putrajaya's revenue base.

“On the expenditure front, I think there is also some risk [to] certain items; specifically on operating expenditures, [they] are rigid in terms of the government’s capacity to be flexible with spending commitments, and these would include things like government salary, pensions, subsidies, and debt services charges,” said Moody’s sovereign risk group analyst Nishad Majmudar.

“Overall, I do think that the fiscal deficit will consolidate over time, we do have a forecast that is somewhat more conservative than MOF [Ministry of Finance] has forecasted over the next three years.

“So, we will see a more gradual consolidation of about 3.6% deficit by 2025 [and a] 5% deficit this year in line with the government’s budget estimate. These are more conservative expectations around what the government is able to achieve,” he told reporters in a virtual briefing on Tuesday (May 16).

Nonetheless, Nishad said there is a potential upside to the government’s fiscal deficit should it manage to follow through on measures that they have proposed, like the Fiscal Responsibility Act and fuel subsidies. 

Nishad said these deeper fiscal reforms, which are key to narrowing the country’s fiscal position, were slowed by various political disruptions over the past few years.

“It is important to note that we currently assess that the political noise of the last several years have not affected the ability of the key institutions like BNM [Bank Negara Malaysia] and MOF to execute their mandates. [However], we assess that the noise has inhibited the passage of some of the deeper reforms, fiscal initiatives that the current and he current and previous governments have proposed to support the credit profile and an upward direction.

“Institutional credibility is something that will be tested in the next three-to-five years, in terms of Malaysia's capability in managing these fiscal risks in this economic transition post-pandemic, given the political environment,” he added.

Last month, Moody’s affirmed the Malaysian government’s local and foreign currency long-term issuer and local currency senior unsecured debt ratings at A3.

Nishard, who expects Malaysia’s GDP to expand by 4.5% this year, also highlighted that fiscal reforms are crucial as the country’s debt service charges are expected to remain high in the next two years, given the fixed spending in the government's budget.

He noted that Malaysia has the weakest debt affordability amongst Moody’s A-rated countries, with interest payment amounting to 14% of general government revenue last year and likely to remain at 14-15% over the next two years.

“Notwithstanding the improvement in the economy over the last 20 months or so, the revenue base remains constrained and has structurally narrowed over time. An important mitigating factor though, is that the domestic investors base remains very deep, liquid and ample, [with the presence of] EPF, KWAP, PNB, and the others.

“From a debt affordability perspective, we don’t see it deteriorating substantially, unless we see the domestic investor base lose its appetite for government bonds, we assess that there remains a significant appetite to investors in Malaysia government securities and sukuk from the domestic funds,” he said.

Nishad also foresees that the ringgit is likely to “appreciate or at least remain stable at current levels”, given the country’s account surplus.

“Services exports will rebound strongly this year, continuing to rebound with the tourism sector reopening and China reopening inflows coming in for that. Commodity prices, oil and gas prices have come off but are still relatively elevated,” he said.

“[In terms of] exposure to foreign capital in the sense that foreign investors, their holdings of Malaysian government bonds has declined in a structural sense to around 20% to 23% of overall government debt. 

“So, there's been a bit more of a home bias in the government's financing, which will reduce outbound payments of interest and principal and so on,” he explained, referring to government financing with a higher portion of domestic investors.