Fitch Affirms Malaysia at 'A-'; Outlook Stable

Fitch Ratings has affirmed Malaysia's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'A-' with a Stable Outlook.

A full list of rating actions is at the end of this rating action commentary.

KEY RATING DRIVERS

Malaysia's 'A-' rating is supported by strong GDP growth compared with the median of 'A' category peers, sustained current account surpluses and the country's net external creditor position. However, the rating remains constrained by some structural metrics, including per capita GDP and governance indicators, that are weaker than the 'A' median, and government debt that is somewhat higher than peers and could be affected by sizeable contingent liabilities.

Fitch estimates average five-year real GDP growth of 5%, well above the 'A' category median of 2.9%. Economic performance has been resilient over the past two years even as the economy has adjusted to a number of challenges including lower oil prices and volatile capital flows. Growth momentum has gained pace in 2017, and Fitch has raised its full-year GDP growth forecast to 5.1%, from 4.5% previously. Private consumption spending received a boost in 2017 from a 15% increase in cash transfers under BR1M (a cash transfer program of the government targeted at lower income households) and exports have strengthened.

Bank Negara Malaysia's (BNM's) monetary policies have been effective in keeping inflation contained. Although inflation rose to an average of around 4.1% in 1H2017, this was caused by base effects from very low commodity prices a year earlier. We forecast inflation of 3.5% in 2017 as the base effect eases.

The government has managed to contain the impact of falling oil prices on the budget deficit and we expect the government's target for a federal government deficit of 3% of GDP in 2017 to be achieved, with a slight further narrowing in the next two years. As a result, federal government debt will stabilise at around 52% of GDP in 2017 and 2018, below the authorities' self-imposed debt ceiling of 55% but moderately above the 'A' median of around 49%. The agency continues to view contingent liabilities as a risk to public finances. Explicit federal government guarantees amounted to 15.2% of GDP at end-2016. In addition, there are lingering risks that the sovereign balance sheet could be affected by the liabilities of state-owned fund 1Malaysia Development Berhad (1MDB) and external financing of certain infrastructure projects.

BNM's willingness to allow the exchange rate to fluctuate in response to a challenging external environment over the past few years has cushioned Malaysia's external finances. Nevertheless, the central bank seeks to manage ringgit volatility. Towards the end of 2016, the central bank reinforced certain existing exchange rules to contain external pressures on the currency. During the seven-month period through July 2017, the central bank was able to accumulate close to USD5 billion in reserves. International reserves relative to Malaysia's short-term external debt remain relatively low at just over 100%, although reserve coverage of current external payments, at around 5.1 months, is in line with peers. Malaysia's external account remains in a net external creditor position, supported by large private external assets. We expect the current account to remain in surplus at almost 2% of GDP over the forecast period as resilient export performance is forecast to counter strong import growth associated with capital goods related to infrastructure projects.

Malaysia scores below the 'A' category median on per capita GDP, standards of human development and governance. Per capita GDP at end-2017 is projected at USD9,815 against USD19,955 for the peer median. Weaker governance is highlighted by issues related to 1MDB. The fund remains the subject of international investigation over embezzlement charges. A general election is scheduled to be held before August 2018 but is unlikely, in Fitch's view, to lead to a significant change in the direction of economic policy.

Malaysian banks' asset quality and capitalisation levels remain reasonably healthy. Household debt levels are high, at 86.7% of GDP in 1Q2017 but reasonably strong employment and income growth counter some of the risk for the banking sector from high household debt.

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)

Fitch's proprietary SRM assigns Malaysia a score equivalent to a rating of 'A-' on the Long-Term Foreign-Currency IDR scale. Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final Long-Term Foreign-Currency IDR.

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign-Currency IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

RATING SENSITIVITIES

The main factors that could, individually or collectively, lead to a negative rating action include:

• Deterioration in fiscal discipline and broader public finances that leads to higher government debt or deficit ratios.
   
• Deterioration in political stability or governance that leads to a weakening of credibility of policy-making institutions.
   
• External financing pressures that strain economic stability.

The main factors that could, individually or collectively, lead to a positive rating action are:

• Narrowing of structural weaknesses relative to peers, including per capita GDP and governance standards.
   
• Material reduction in government debt ratios or contingent liabilities

KEY ASSUMPTIONS

The global economy performs broadly in line with Fitch's Global Economic Outlook.

The full list of rating actions is as follows:

Long-Term Foreign-Currency IDR affirmed at 'A-'; Outlook Stable

Long-Term Local-Currency IDR affirmed at 'A-'; Outlook Stable

Short-Term Foreign-Currency IDR affirmed at 'F1'

Short-Term Local-Currency IDR affirmed at 'F1'

Country Ceiling affirmed at 'A'

Issue ratings on long-term senior-unsecured local-currency bonds affirmed at 'A-'

Issue ratings on short-term senior-unsecured local-currency bonds affirmed at 'F1'

Issue ratings on Malaysia's global Sukuk trust certificates issued by Malaysia Sukuk Global Berhad (MSGB) affirmed at 'A-'