The possibility of a sovereign downgrade might spook some but when it comes to property investment, it might have little or no effect.
Malaysia faces this month the possibility of a credit rating downgrade on its sovereign debt, or government-issued bonds such as Malaysian Government Securities (MGS). As this issue went to print, Fitch Ratings, one of the three international credit ratings agencies with the most influence on the market, claimed there was a more than 50% chance of Malaysia’s respectable Arating dropping to a BBB+ sometime in June. Although only one notch lower, a BBB+ rating sounds to investors’ ears far worse and would see Malaysia sharing the same credit score as Thailand and Mexico.
On the imminent downgrade, much of the discussion has centred on the possible repercussions to an economy already facing slowing growth. We know from previous experience that investor sentiment would be adversely affected, leading to a selldown in capital markets and an increase in borrowing costs for the government, but what of the impact to families and individuals?
Few working Malaysians own government-issued bonds so it is safe to say that a fire-sale following a downgrade will not directly affect the broader population. But many Malaysians dabble in the stock market and depending on the timing could suffer financial losses. Then there is the most important asset class of all: Property. Whether it is the home you live in or an apartment you rent out for side income, it is likely to be your main store of wealth. You might ask: Will the effects of a sovereign downgrade spill over to the property market?
A sovereign downgrade leading to events that could affect property values is a very real possibility. How severe, is another question altogether and difficult to predict. The downgrade itself would not mean much. Credit rating scores merely reflect opinion. What gets damaged is Malaysia’s reputation as an investment destination. The immediate concern would be that investors lose confidence in Malaysia as a place to park their money. In a worst case scenario, the loss of confidence could spread to all sectors of the economy, including property. Properties in overheated markets would be affected the most. That would be places such as the Iskandar development zone in Southern Johore, which counts a high proportion of foreign buyers, the sort that are most likely to pull-back when conditions become unfavourable. If this happens, it would only worsen the oversupply of residential units in the fastdeveloping region and further depress prices.
A more optimistic scenario would see only a temporary stall in investment activity from negative market sentiment. This appears to be a more likely possibility given that only one of the ‘big three’ credit rating agencies, Fitch, is looking to downgrade their rating on Malaysia’s sovereign debt in the near-term. The other two ratings agencies, Moody’s and Standard & Poor’s have communicated that they intend to keep their respective A3 (positive) and A- (stable) ratings. The three rating agencies do not necessarily move in lockstep and split ratings are not uncommon.
Reasons given by Fitch for the negative outlook on Malaysia’s credit rating are varied and include income and governance levels that are more suited to the BBB-range than the current A median, the recent deterioration in public finances from low oil prices and a less-than-convincing policy response to the oil price shock that consists of mainly “one-off budget measures” as well as high level of indebtedness when government guaranteed debt is counted alongside public debt. To sum up, Malaysia scores well on macroeconomic indicators on account of strong economic growth and also does well in assessments of its external finances, mainly because most of public debt is denominated in local currency. Where Malaysia falls short is on its public finances and “structural issues”, usually taken to mean a poor score on governance indicators such as political stability, rule of law and accountability.
Fitch first sounded their intention to consider a downgrade close to two years ago, shifting from a stable to negative outlook on Malaysia’s sovereign rating in August 2013. The market took the news badly, as expected. But even more aggrieved, it appeared, was Treasury secretary-general Tan Sri Mohd Irwan Serigar, who dismissed Fitch analysts as “young guys” too quick to jump to conclusions without first taking all factors into consideration. Another government official which has come out to defend Malaysia’s sovereign rating against a possible downgrade is Dato’ Sri Abdul Wahid Omar, the former Maybank CEO made minister in the prime minister’s department in charge of the Economic Planning Unit. He claims Malaysia’s fundamentals are strong and that the political leadership has been successful in instituting difficult economic reforms such as elimination of subsidies on fuel and the introduction of the Goods and Services Tax.
What is certain is that the A- rating by Fitch cannot remain as is. A negative outlook is a signal that a credit rating is up for review. The options are either to move to a stable outlook on the rating or to go ahead and downgrade. During a recorded conference call held recently, one analyst noted that the negative outlook tagged onto Malaysia’s rating has been in place for close to two years, which he thought a long time for a ratings agency to come to a final decision.
The implication for the property market when that decision is made, Dr Yeah Kim Leng, dean of the School of Business at Malaysia University of Science and Technology and formerly of RAM Ratings said at a REHDA conference, is that credit flows to property developers and purchasers are not expected to be affected by a sovereign rating downgrade. That would mean that any loss of confidence in the property market, if any, would be sentiment-driven. Yeah however cautioned that a “soft landing in property prices due to cooling measures is evident” but will vary by segment and location according to supply-demand dynamics. He said there is currently support for property prices from moderately strong GDP growth with stable employment and income increases amidst a growing and young population.
All in all, while a sovereign rating downgrade will have repercussions on the property market, prospective buyers should not allow themselves be swayed by market sentiment. Instead, it pays to look to the fundamentals. A location-based strategy rarely ever goes wrong. Better to bet on that than to guess the next move of a credit ratings agency.