Why Should Malaysians Pay Attention To The Country’s Credit Ratings?

Why Should Malaysians Pay Attention To The Country’s Credit Ratings?

Every once in a while you will come across headlines such as “S&P reaffirms Malaysia’s currency rating, outlook stable” or “Moody’s Cuts Malaysia Credit-Rating Outlook on Weaker Finances”.

Credit ratings, as these metrics as known, are usually seen in the wider context of the country’s economic health, so it is unsurprising that after breaking such news, economists and politicians will weigh in on the implications of what it means to either be graded an “A+” or a “BBB” or even “junk”.

But what are these letters and what significant impact do they make in determining the everyday life of the common folk… people like us? In essence: are they important? We take a look.

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What are credit ratings?

Similar to how our personal credit rating works, credit ratings are a service to investors, letting them know how likely a borrower is to repay their debts.

The companies that issue these ratings are known as rating agencies. There are about 70 rating agencies worldwide and it is the most concentrated industry.

Most investors, however, base their decisions on ratings published by Moody’s, S&P and Fitch. They control about 95% of the rating business.

Ratings assigned to an entity are comparable across international borders. The three sectors and types of ratings that may be assigned are:

Sovereigns and Local Government

  • Long- and short-term local currency ratings
  • Long- and short-term foreign currency ratings

Banks and other Financial Institutions

  • Long- and short-term local currency ratings
  • Long- and short-term foreign currency ratings
  • Financial strength ratings (an opinion of stand-alone financial health)
  • Support ratings (an assessment of the likelihood that a bank would receive external support in case of financial difficulties)

Corporates

  • Long- and short-term local currency ratings
  • Long- and short-term foreign currency ratings

Source: Capital Intelligence Ratings

In their methodologies, rating agencies have developed criteria for assessing the performance of key macroeconomic and socioeconomic indicators.

The results are usually placed on a sliding scale of letter-based grades to rank borrowers from AAA to single C, with slightly different configurations.

The point is that by assessing the indicators, these agencies will be able to determine the borrower’s ability and willingness to honour debt obligations.

For this article, we discuss sovereign ratings, which involves countries and governments.

What do agencies look for when reviewing a country?

Rating agencies usually focus on four components and indicators: economic structure and performance, government finances, external payments and debt, susceptibility to events.

So, when reviewing sovereign ratings, these agencies hold discussions with various stakeholders in government, labour, civil society and the private sector. The reason for the latter’s inclusion is simply to get an independent view on government policies and strategies.

4 Main Indicators
Economic structure and performance

• Real GDP
• Per capita income
• Headline inflation rate
• Gross investment as a percentage of GDP
• Gross domestic savings as a percentage of GDP
Government finances

• Government revenue to GDP
• Government expenditure to GDP
• Government debt to GDP
• Debt interest payment to revenue
• Budget balance as a percentage of GDP
External payments and debt

• Current account balance as a percentage of GDP
• The ratio of external debt to GDP
• Level of official reserves
Susceptibility to event

• Political risk
• Socioeconomic risk
• External vulnerability risk
• Institutional independence
Source: The Conversation

 

In Malaysia’s context, a credit rating is used by sovereign wealth funds, pension funds and other investors to gauge the credit worthiness of Malaysia, thus playing a huge role in the country’s borrowing costs.

What do agencies do with their results?

After concluding their reviews, the agencies announce credit rating opinions which reflect the borrower’s creditworthiness or the likelihood that the borrower will pay back a loan within the confines of a loan agreement, without defaulting.

Similar to how financial institutions review our personal credit report from CCRIS to determine our credit application and also the interest rates for the credit facility, the sovereign credit ratings also tell the creditworthiness of a country.

A high credit rating indicates a high possibility of paying back the loan in its entirety without any problems.

A poor rating on the other hand suggests that the borrower has had trouble paying back loans in the past and might follow that same pattern in the future.

Various stakeholders use these opinions for different reasons, but the common ones are:

  • To guide investment decisions. Credit ratings provide an independent assessment of the creditworthiness of a country or corporation. This helps investors decide the riskiness of investing money in a said country or corporation.
  • To obtain funds at a lower cost. A favourable rating allows corporations or governments to raise money in the capital at lower interest rates.
  • To gauge performance. Credit ratings are also used as measure by governments to gauge their performance relative to peers to effect improvements.

Junk in the trunk?

In ratings parlance, junk is associated with high risk, meaning higher borrowing costs. This is the main reason countries have to avoid being downgraded into a junk or sub-investment grade.

What does this mean?

For fund managers, they have to sell the assets they hold as it is mandated to only invest in investment-grade assets.

For ordinary folk, they will pay more interest on amenities, leaving little money for savings and expenditure on rent, school fees and food.

For governments, they will have to allocate more to debt-servicing costs (interest payments). This means less will available for social grants and investment priorities. Even job creation will be affected.

More interest payment also crowds out other critical spending such as social services, for example.

And governments can’t ignore their ratings

One thing credit ratings ensure is easy access to international capital markets, and favourable ratings imply low borrowing costs.

For Malaysia – where foreign ownership of government bonds is estimated around 50% – positive ratings from top agencies ensure it can easily and cheaply access foreign capital needed to accomplish the country’s economic agenda.

What developments have been cited that can affect Malaysia’s ratings? The scandal involving state investment vehicle 1Malaysia Development Berhad (primarily due to investor sentiment), economic reforms such as the government’s efforts to strengthen the budget, the deteriorating ringgit, and the broader pressure of the economic on commodity prices, among others.

Malaysia on the ratings scale
Agency
Credit quality
S&P’s
A-, stable outlook
Moody’s
A3, stable outlook
Fitch
A-, stable outlook
Source: Trading Economics
*For a complete table on credit ratings, visit the Reuters Guide to Credit Ratings.

How many agencies operate in Malaysia?

At the moment, there are two: Malaysia Rating Corporation Berhad and RAM Holdings Berhad, and they act as counterweights to international rating agencies.

Note: Rating agencies can operate unsolicited but the major players such as Moody’s, S&P and Fitch are solicited by countries to provide credit ratings.

Moody’s operates in 36 countries, Fitch in more than 30 countries and S&P in 28.

So… why bother?

Well, since foreign investors hold about 50% of government debt, what the famous three agencies – Fitch, Moody’s, S&P – say about Malaysia will have an impact on the economy.

One of the positives of having a stable outlook is better value for the ringgit, which means a boon for travellers, parents supporting kids studying overseas and businessmen with foreign dealings. These people get better exchange rates for their money, whether spending or investing.

Also, with good ratings come a stable economy. With increased revenue from foreign investors, the government can speed up infrastructure projects, which in turns helps raise employment rates and investments in private sectors.

A downgrade however risks pushing away investors, which means a gloomy economy where Malaysians will pay for basic amenities, deal with a weak currency, and even be up for a job cut.

Image from Financial Tribune.

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