Malaysia: Moody's correct in highlighting risk – BBH

Analysts at BBH note that Moody’s warned last week that Malaysia’s foreign reserves are amongst the weakest in Asia and they agree, as BBH’s rating model has Malaysia at BBB+/Baa1/BBB+ vs. actual ratings of A-/A3/A-.  

Key Quotes

“Political Outlook

The next national elections don’t have to called until August 2018.  However, speculation is picking up that Prime Minister Najib Razak may call early elections.  He has fended off a corruption scandal at home, with little apparent impact on his popularity.

Malaysia scores very high in the World Bank’s Ease of Doing Business rankings (23 out of 190).  The best components are protecting minority investors and getting electricity, while the worst are starting a business and paying taxes.  Malaysia does less well in Transparency International’s Corruption Perceptions Index (55 out of 176 and tied with Croatia).”  

“Economic Outlook

• The economy is picking up.  GDP growth is forecast by the IMF to accelerate modestly to 4.5% in 2017 from 4.2% in 2016, before picking up further to 4.7% in 2018.  GDP rose 5.8% y/y in Q2, the strongest rate since Q3 2015.  With monthly data so far in Q3 suggesting further improvement, we see some upside risks to the growth forecasts.  
• Price pressures bear watching, with CPI accelerating to 3.7% y/y in August from 3.2% in July.  Part of the story reflects this year’s rollback in cooking oil subsidies.  Another part reflects rising oil and energy costs.  Note that core inflation eased to 2.4% y/y in August.  Bank Negara does not have an explicit inflation target, which allowed it to keep rates steady even when CPI spiked to 5.1% y/y back in March.
• Despite the uptick in inflation we see steady rates well into 2018.  Bank Negara kept rates steady at 3% on September 7, noting that global growth is “becoming more entrenched.”  It added that Malaysia’s growth will be stronger than earlier expected, but that inflation should continue its moderating trend.  Next meeting is November 9, and no change is expected then.
• Foreign reserves have moved back above $100 bln for the first time since June 2015.  At $100.5 bln in August, they cover nearly 6 months of imports.  However, reserves barely cover 75% of the stock of short-term external debt.  Moody’s is correct in flagging this vulnerability.  Looking at the rest of Asia, the ratios of short-term debt to reserves are almost all below 35%.  The only two exceptions are Malaysia (the highest at 129%) and India (the second highest at 65%).”

“Investment Outlook

• The ringgit has done much better after a poor 2016.  In 2016, MYR fell -4% vs. USD and was ahead of only the worst performers ARS (-18%), TRY (-17%), MXN (-16%), CNY (-6.5%), and PHP (-5%).  So far in 2017, MYR is up 7% YTD and is behind only MXN (16%), THB (8%), SGD (+7%), TWD (7%), and KRW (+7%).  Our EM FX model shows the ringgit to have NEUTRAL fundamentals, so this year’s outperformance is likely to ebb a bit.
• Before this month’s drop, USD/MYR had traded largely in the 4.25-4.30 range since mid-May.  The pair broke below 4.25 early this month to trade as low as 4.1825, the lowest level since November 2016.  The pair is turning higher, as a bottom near 4.18 appears to be in place.  Retracement objectives from the August-September drop come in near 4.2270 (38%), 4.24 (50%), and 4.2545 (62%).  
• Our own sovereign ratings model showed Malaysia’s implied rating steady at BBB+/Baa1/BBB+.  As such, downgrade risks to actual ratings of A-/A3/A- remain on the table.”