KUALA LUMPUR (Nov 20): Malaysia's public finances are a weakness relative to rating peers and offer limited scope for counter-cyclical fiscal stimulus at the current rating level of 'A-'/Stable, according to Fitch Ratings.

In a statement on its website Monday (Nov 19), Fitch said that while this had not hindered the public sector's capacity to contribute to GDP, which grew 5.2% year-on-year (y-o-y) in the third quarter according to Bank Negara Malaysia Friday, the growing provision of guarantees to government-linked borrowers was concerning.

Fitch said that domestic demand continued to support economic growth in the face of a weak external demand.

It said while private consumption and investment are increasing, public-sector linked activity remained a key support.

“Public consumption moderated in Q312, posting a 2.3% y-o-y increase (down from 10.9% in Q212), while public sector gross fixed capital formation increased 22.4% y-o-y, following a 28.9% increase in Q2.

“With a general election due in the first half of 2013, government and government-linked activity is expected to remain a significant contributor to growth,” said Fitch.

The rating agency said that the greater drawdown of existing federal government guarantees of debt issued by public sector enterprises suggested increasing use of quasi-fiscal policy to support economic activity and may apply further pressure on the sovereign credit profile.

It said the value of outstanding debt guaranteed by the Malaysian federal government has increased by RM23.4 billion (US$7.6 billion), or 20%, between December 2011 and September 2012.

“Such debt is now equivalent to 15% of GDP compared with 9% at end-2008, and suggests a growing contingent liability on the sovereign,” said Fitch.

The rating agency said that given Malaysia's lack of fiscal headroom, the increasing reliance on off-balance sheet funding could potentially call into question the meaningfulness of the 55% of GDP federal debt ceiling (debt/GDP had risen to 52.4% at end-Q312).

“These concerns, coupled with the need for structural reform of the public finances and a credible plan for fiscal consolidation, suggest that Malaysia's public finances will remain a weakness versus ratings peers, as has been the case for some time.

“As Fitch warned when we reviewed the ratings in August 2012, fiscal trends may eventually lead to some form of negative rating action,” it said.

Fitch said other areas of the credit profile including the external finances and level of foreign reserves (US$138 billion) remain strengths.

“However, foreign holdings of government debt have continued to increase and now represent nearly 50% of Malaysia's foreign exchange reserves, up from 36% at end-2011,” it said.