FITCH Ratings’ downgrading of Malaysia’s long-term foreign currency Issuer Default Rating (IDR) from ‘A-’ to ‘BBB+’ is a wake-up call and an attestation that things are not right.

This sovereign debt downgrade has vast implications. Unless a socio-economic policy overhaul is initiated, the future is bleak.

This IDR ‘BBB’ rating indicates that default expectation is still low, but adverse economic conditions are likely to impair capacity for payment of financial commitments.

Although it is still of good credit quality, it is one level above the next, ‘BB’, denoted as speculative, which has serious repercussions on treasury notes and bonds trading in the open market.

A nation’s credit standing has an impact on the corporate sector where bonds are also issued. Once a national’s credit worthiness is denoted as speculative, banks are legally bound against credit provision for corporate bonds.

The lowering of our sovereign debt rating will prompt a sell-off in the sovereign bonds and therefore driving up future cost of borrowing for the government and the private sector.

The interest rate has to increase to attract buyers of new issues. With this sovereign debt downgrade, the corporate bonds issuers are likely to be downgraded as well, regardless of the fundamentals of the corporate issuers.

Higher borrowing cost will drive down corporate capital expenditure and debt issuance, which eventually leads to a vicious cycle of recovery trap.

We are in a situation where the government’s financial and monetary policy has little room to manoeuvre and reliance on corporate spending is the only way out.

Traditionally, credit rating downgrades lead to a decline in bond prices, while interest rates increase and bond yields increase.

Normally, when the rating scale goes down one notch, the price per bond goes down by 1 to 2%. This can be translated into billions of ringgit.

It is not just our government issued securities, the whole economic spectrum – including the corporate sector – will be affected.

Our nation’s borrowing cost will increase by billions of ringgit per year, which inevitably impacts the people and businesses with higher interest rates and borrowing costs.

Malaysia’s well-developed local bond market that ranks third in Asia after Japan and South Korea has a market size about 98% of the gross domestic product (GDP).

It allows market capitalisation and supports a robust economy. This includes the recent RM500 million Sukuk Prihatin, of which Maybank is a main player.

Malaysia’s international bonds, as of November 30, stood at US$38.4 billion (RM156 billion). With the downgrade, the market will sell the bonds in advance leading to a decline in prices.

The reason for Fitch Ratings’ downgrading of our country’s credit rating, amid the hype of poor governance, is quite clear: our debt to GDP ratio has become a cause for concern.

Debt and the likelihood of it becoming a runaway problem is the ultimate reason, not because of the domestic political situation from which politicians have understandably skewed their opinions in this discourse.

Fitch Ratings appears to be concerned with our growing financial deficits, aggravated by the pandemic and the tight revenue source.

Budget 2021 has targeted a deficit of 5.4% of the GDP, while the estimate for 2020 is at 6%.

Statistics show that the ratio of government revenue to GDP has gradually declined from 21.4% in 2012 to a small recovery in 2019 at 17.3%, despite the implementation of GST from 2015 to 2018.

Government debt in 2019 was 65.2% of GDP, and estimated to increase to 76% in 2020 due to the economic stimulus spending. This is way above the average of 52.7% for a ‘BBB’ rating.

The government’s debt is almost 400% of the revenue, which is three times that of the similar rating.

Debt service charges are expected to be at RM34.9 billion or 15.4% of estimated government revenue in 2020.

Financing this comes mainly from domestic debt instruments at 97%, while the remaining 3% is derived from foreign sources. Either way, borrowing costs will be much higher after this.

We are at a dilemma and whether spending more would sufficiently buffer the negative impact of the Covid-19 pandemic.

The World Bank has forecasted our GDP growth for 2020 would shrink to minus 4.9% even with the current stimulus packages. Financial6 policy is unlikely to do much. Nor will monetary policy.

Going forward, Bank Negara is expected to cut interest rate by 0.25 percentage points in Q1FY21 from the current 1.75% with the aim to stimulate private spending.

However, the impact of the lowered sovereign debt rating is likely to provide resistance.

Budget 2021 did not inspire, despite it being the largest budget ever. Emphasis has been on public sector spending and giving money directly for consumer spending, instead of encouraging more capital expenditure in the private sector.

Such emphasis has a lesser economic multiplier effect and higher chance of wastages and leakages, besides a lower propensity to consume in handouts.

Furthermore, there will be a crowding-out effect due to less available funding for the private sector.

On the other hand, putting emphasis on capital expenditure and private sector spending will have a widespread effect on the economy, higher multiplier effect and higher GDP contribution.

The private sector has better efficiency and will see more income for companies, leading to more income for workers, more supply, and more aggregate demand.

Fitch Ratings’ downgrading of our IDR to ‘BBB+’ puts us in a conundrum. A pause is needed to seriously consider a needs-based socio-economic structure.

Politics should feature less in the economic equation. Above all, our economy cannot be sustained by operating in a perpetual debt. – December 10, 2020.

* Captain Dr Wong Ang Peng is a researcher with an interest in economics, politics, and health issues. He has a burning desire to do anything within his means to promote national harmony. Captain Wong is also a member of the National Patriots Association.

* This is the opinion of the writer or publication and does not necessarily represent the views of The Malaysian Insight. Article may be edited for brevity and clarity.