KUALA LUMPUR -- U.K.-based Oxford Economics said in a report on Monday that Malaysia is at risk of a credit rating downgrade, weighed down by debts at a state fund. Foreign investors' interest in its stock market is weakening despite liquidity inflow into regional markets.
Malaysian public debt swelled to 54.5% of its gross domestic product in 2015, up from 40% in 2008 and near a state-imposed ceiling of 55%. The rate, noted the report, is the highest since 1992, and far above Indonesia's 29% and Thailand's 31%.
"The government has in excess of 15% of GDP of debt not currently on the balance sheet in the form of contingent liabilities due to commitments to state-owned companies, including 1MDB," wrote Sian Fenner, the research firm's Asia economist in Singapore.
1Malaysia Development Berhad (1MDB), the country's strategic investment fund, is saddled with debts. In recent months, it has defaulted on interest payments as a result of an ongoing dispute with its bond guarantor, Abu Dhabi's state fund International Petroleum Investment Co. Banks that acted on behalf of 1MDB are the subject of fraud and money laundering investigations by foreign countries, including Singapore and Switzerland.
The government is in the midst of transferring all 1MDB holding assets to the treasury, reducing the fund to a mere shell company to cut further losses.
Oxford Economics estimates that the government's guarantee on part of 1MDB's debts could add $7.5 billion, or 2.5% of GDP, to its balance sheet.
"Higher public debt and the prospect of fiscal slippage could be just the catalyst for one or more credit agencies to respond by downgrading Malaysia's credit rating," said Fenner.
At present, Malaysia has an "A-" rating by Fitch Ratings and S&P Global Ratings, and an "A3" by Moody's Investor Services.
A downgrade could trigger a sell-off in the country's equity and bond market, and add pressure on the ringgit, Oxford Economics' report says. Even so, it adds that such knee-jerk reactions will be short-term, given the ample liquidity from domestic institutional funds.
But even without a downgrade, the ringgit and stock market have been under pressure from funds outflow. Foreign selling from Bursa Malaysia continued for the sixth consecutive week through June 3, noted MIDF Research. Foreign net inflows have been reduced by half to 1.28 billion ringgit ($312 million) so far this year.
Last week, foreigners offloaded $289 million, the highest weekly sell-off since October 2015, amid a $2.21 billion inflow of liquidity into six other markets, including Indonesia, Philippines and Thailand, that were tracked by MIDF Research.
The FTSE Bursa Malaysia index has contracted nearly 3.3% year to date, the worst showing compared to its peers in the region.
While assessing the outlook of sovereign ratings to be "stable," Moody's pointed out "current account deterioration, capital flow volatility is most apparent in Malaysia," in a recent report on ASEAN issued in May.