Pimco Becomes Cautious on Malaysia as Tax Reform to Hurt Revenue

(Bloomberg) -- Pacific Investment Management Co. is cautious on Malaysian bonds, predicting the new government’s economic reforms will hurt state finances, while a review of infrastructure spending curtails investment.

The administration’s decision to replace the GST with a sales levy threatens to erode public revenue at a time when growth is expected to moderate as the pre-election boost to domestic demand wears off, said Roland Mieth, emerging markets portfolio manager in Singapore at Pimco, which oversees $1.77 trillion.

Here are the key comments from Mieth:

Risks to growth:

  • “We hold a cautious view on Malaysia due to fiscal and political uncertainty, potential negative ratings action and uninspiring valuations. We note a slower growth potential due to a lack of structural reforms in recent years, narrow balance of payments and weak FX reserve buffer versus high foreign ownership of Malaysian government securities”
  • Pimco has been constructive on Malaysia this year due to the positive impact from exports as well as higher oil and LNG prices, but the pace of expansion could moderate as the pre-election boost to domestic demand wanes and the private sector may hold off on capex decisions until there’s more clarity in government policies

Eroding revenue:

  • “The replacement of GST with service and sales taxes adds uncertainty to Malaysia’s fiscal trajectory. Based on our initial analysis, impact to government revenues could be negative up to 0.5 to 0.7 percent of GDP this year"

Less close to China:

  • “Malaysia’s pivot to China will be much softer than it was under Najib, given Mahathir’s criticism on the campaign trail of Najib’s China-hugging, and ties with Singapore won’t be quite as warm either”
  • The fate of several planned Chinese-backed investment projects is in doubt, and these include an expansion of Malaysia’s port facilities, a number of real-estate developments and the new East Coast Rail Link
  • “In upcoming years we could see a sharp slowdown in investment growth. Specifically, China’s share of FDI inflows had risen materially since 2015, reaching a peak of 1 percent of GDP in 1H2017. Any delay in related projects could impact fixed investment and thus growth”

Positive side:

  • “On the positive side -- but also more long term -- the election victory opens up the possibility that Malaysia will look to tackle some of the institutional problems that are holding back the country’s long-run prospects”
  • “Focus would be on tackling corruption, wastage, abuse of power leading to a smaller government budget, renewed public trust in the government and the rule of law. Let’s not forget that under Najib’s tenure Malaysia’s reputation was tarnished by the 1MDB scandal”

©2018 Bloomberg L.P.