In response, finance minister Tengku Zafrul Aziz said the government was disappointed with the rating outcome. He said the revision of Malaysia’s rating was primarily driven by the negative impact of the Covid-19 pandemic on the country’s fiscal position and the ongoing domestic political situation.

He said the rating came amid exceptional circumstances when the pandemic is still unfolding. However, Malaysia has already started to see the green shoots of economic recovery, attributed to the various stimulus packages implemented by the government since March.

“By honing in on Malaysia’s fiscal position and political situation, Fitch’s decision does not give due justice and credit to our crisis response efforts and our strong economic fundamentals,” he said in a statement.

Fitch acknowledged that the authorities responded swiftly to the crisis, with material relief measures for affected individuals and businesses.

“The government has secured passage of core legislation to implement relief measures, including the 2021 budget,” it said in a statement today.

The rating agency said measures to contain the domestic spread of Covid-19, combined with weak investment and low tourism receipts due to the pandemic, have reduced economic activity, as it has in many countries globally.

Fitch expects the gross domestic product (GDP) to contract by 6.1% in 2020 before rebounding by 6.7% in 2021 as a result of base effects, a revival of infrastructure projects and further recovery of exports of manufactured goods and commodities.

“These forecasts remain subject to uncertainty and depend on the near-term evolution of the pandemic, as illustrated by an increase in the number of daily cases since early October,” it said.

It noted that the government expects to vaccinate 30% of the population next year, based on agreements so far with vaccine producers.

“We forecast growth of 4.6% in 2022, on expectation that Malaysia’s diversified economy will deliver strong medium-term growth,” the agency said.

Fitch expects the fiscal deficit to remain higher than pre-pandemic levels, given a continuation of support measures and political pressure for higher spending.

According to Fitch, the 2021 budget targets are achievable 5.4% of GDP, from an estimated 6% in 2020, and an average deficit of 4.5% of GDP from 2021 through 2023.

“We expect government revenue to remain low at 19.1% of GDP in 2020 and dependent on oil production, which the government expects to generate 22% of total revenue this year, including a special dividend from national oil company Petroliam Nasional Bhd.

“The low and concentrated revenue base – exacerbated by the removal of the GST (goods and services tax) in 2018 – has in recent years led the government to draw on dividends of government-linked companies, pending the introduction of new and more sustainable sources of revenue, which Fitch understands are being considered for the medium term,” it said.

Fitch expects general government debt to jump to 76% of GDP in 2020 from 65.2% of GDP in 2019. The debt figures used by Fitch include officially reported “committed government guarantees” on loans, which are serviced by the government budget, and 1MDB net debt, equivalent in September to 12.6% and 1.3% of GDP, respectively.

“On this basis, the debt burden is significantly higher than the medians of 59.2% and 52.7% for the ‘A’ and ‘BBB’ rating categories, respectively. Malaysia’s debt is close to 400% of revenue, around three times the peer median.

“We expect the debt-to-GDP ratio to remain broadly stable after the pandemic recedes, given the likely fiscal deficit reduction, and low debt service costs, illustrated by an average 10-year yield of 2.7% in November,” it said.

Fitch noted that the new government continues to implement some transparency-enhancing measures launched under the previous coalition, and corruption trials of former officials have continued.

However, in its view, the government’s thin two-seat parliamentary majority implies persistent uncertainty about future policies.

“Deterioration in governance and continued political uncertainty could dampen investor sentiment, constraining economic growth,” Fitch said.