Political stability strengthened since the electoral shock of 2018

The political context has changed completely since May 2018 when the long-ruling Barisan Nasional coalition (BN) was unexpectedly defeated in the general elections. It was the first time since Malaysia’s independence in 1957 that the power was transferred to the opposition. The four-party Pakatan Harapan coalition (PH) won with a small majority of the seats (121 out of 222) ahead of BN. Mahathir Mohamad, former PM from 1981 to 2003 and father of the country’s successful economic transformation, became the new PM. Although the now 94-year-old PM pledged to hand over his PM position to ex-opposition leader Anwar Ibrahim – who was released from prison in June 2018 – by May 2019, he might remain in power until the 2023 legislative elections if his health allows it. BN’s sharp defeat had much to do with former PM Najib’s alleged corruption and financial scandals during his long premiership. One of those was his syphoning off of the state investment fund 1Malaysia Development Berhad (1MDB) for which he is currently under trial. Moreover, people blamed his government for the rising cost of living and widening social inequalities. 

Since he returned to power, Mr Mahathir has made progress around three electoral promises. In the anti-corruption fight, he launched former PM Najib’s ‘1MDB trial’. Secondly, he pushed for the removal of the BN’s controversial ‘anti-fake news’ law. The law was introduced last year to crack down on political opponents and is expected to be removed in 2020. Lastly, he successfully renegotiated a large Belt and Road Initiative (BRI) railways contract and suspended China’s high-speed train project linking Kuala Lumpur to Singapore. These decisions have been a popular win for Mahathir.  

On the other hand, he refrained from moving forward in the politically sensitive reduction of ethnic polarisation – which deepened under Mr Najib’s premiership – as racial laws continue to grant the Malay majority a preferential status under many aspects. To maintain this support, PM Mahathir is opting for the status quo, which is a source of rising tensions within the ruling multiracial PH coalition. Still, in the coming years under this government’s rule, one can expect policy continuity because the government will be pursuing a pro-free-trade-and-business stance and focusing on macroeconomic stability. Unlike the previous administration, improving public governance should remain part of the current government’s plans.  

Regarding political violence (risk rated in category 2/7), beside sporadic ethnic tensions between Malays and Chinese/Indian minorities, there is a persisting risk of terrorist attacks from Islamist militants. There is a high risk for ‘IS returnees’ and/or IS-linked local networks attempting to attack public places and western targets in the coming years. All in all, the risk is mitigated by effective counter-terrorism intelligence. 

Economic resilience amid a weakened external trade environment 

Malaysia keeps displaying economic resilience in spite of external shocks. After a sharp drop in oil prices in 2015-2016, the country has been hit by the escalated US-China trade war and its negative impact on global demand and trade since 2018. Yet, the export-led Malaysian economy has somewhat managed to resist external headwinds thanks to diversified exports and robust domestic consumption. GDP growth reached an average 4.6% in 2018-2019, total exports roughly stabilised and the current account surplus strengthened as imports contracted. Like the rest of the region, a continued slight economic deceleration reflecting a weakened manufacturing sector is expected this year whereas global trade uncertainties and the structural Chinese slowdown cloud the medium-term outlook. 

Nonetheless, Malaysia’s prospects remain positive on the back of resilience, good fundamentals and continued support for free trade in Asia. Looking ahead, the potential ratification of the ‘Regional Comprehensive Economic partnership’, a free-trade deal mainly gathering ASEAN countries and China, is likely to boost intraregional trade in the future. In the MLT, Malaysia’s GDP growth is forecasted to be just below 5%, its current account surplus to shrink slowly below 2% of GDP and its balance of payments to be comfortably positive. In the future, Malaysia remains exposed to investor risk aversion and global financial market volatility, especially as the outlook is gloomier on the trade and economic front. The return to political stability, renewed US monetary easing and Malaysia’s economic robustness – reflected by a stabilised ringgit – have nevertheless reduced risks of financial instability and large capital outflows. 

As for public finances, the moderate fiscal deficit increased to 3.6% of GDP in 2018 but has since then been on a declining trend. With a government committed to fiscal consolidation, the fiscal deficit is expected to end up below 3% in the MLT. The main uncertainty and concern is about the public debt. It is moderate, expected at 56% of GDP this year, but could be higher than reported when including PPP-lease payments and undisclosed government guarantees to various entities such as 1MDB. Hence, government debt could reach up to 80% of GDP. It reinforces the government’s willingness to reduce the public debt burden, notably through a privatisation plan for some SOEs but also for part of the civil service. Under the current government, both public revenues and spending are forecasted to shrink which, among other things, will lead to a further increase in the public-debt-to-government-revenues ratio to around 315% next year. Beside public debt, private debt remains high and could weigh on MLT growth. This being said, household debt and non-financial corporate debt, both around 68% of GDP in Q2 2019, are on a slow downward trend and their low share in USD mitigates the potential impact of a weaker ringgit.

External debt at more a sustainable level

Malaysia’s financial risk has seen a notable improvement since Credendo downgraded the country in 2016. External debt ratios and trajectory, including for ST debt, were indeed significantly revised downward. In 2015, external debt was close to 75% of GDP. Since the IMF debt revision, it was expected to end 2019 slightly above 50% of GDP and to slowly come down further in the MLT. Also, Mahathir’s renegotiation of a BRI project (cf. supra) last April will contribute to slightly improving the country’s external debt sustainability as the Chinese loan related to the ‘East Coast Rail Link’ was cut by more than a third (from USD 16 bn to 11 bn) whereas Malaysia finally got a 50% stake in operating the railways. As for ST debt, it has been close to 25% of current account receipts over the past two years, i.e. well below the level that was estimated to be around 40% in 2015. Taking also into account the adequate foreign exchange reserves covering close to 5 months of imports, the liquidity position remains good. 

Considering those developments, particularly the improvements in the political and financial situation while Malaysia has been showing overall economic resilience in a sluggish global trade environment, Credendo decided last December to upgrade Malaysia’s MLT political risk rating from category 3/7 to 2/7.

Analyst: Raphaël Cecchi – r.cecchi@credendo.com