TEXT-Fitch:Malaysia has limited room for fiscal stimulus

(The following statement was released by the rating agency)

Feb 16 - The substantial contribution of government spending to Malaysian economic growth in late 2011 suggests that fiscal expansion is already being deployed as a buffer against the effects of global economic weakness. This is potentially a cause for concern given the country's limited headroom for fiscal stimulus, Fitch Ratings says.

Malaysian GDP grew 5.1% in 2011, the central bank said Wednesday, in line with our full-year forecast. The third and fourth quarters saw significant year-on-year increases in government consumption, of 21.7% and 23.6% respectively. These increases reflected higher staff costs and spending on supplies and services. GDP growth excluding government spending was 4.1% in 2011, down from 8.3% in 2010.

A further global slowdown means the growth rate of Malaysia's trade-dependent economy will slow further this year. We forecast full-year GDP growth of 4.0% in 2012. Private consumption remains strong and we think domestic economic activity will support growth, while Bank Negara Malaysia is in a position to ease monetary policy if necessary.

However, public finances in Malaysia, which we rate 'A-' with a Stable Outlook, have both short-term and long-term weaknesses that limit the government's scope for fiscal stimulus. The authorities increased spending and failed to curb the deficit in 2004-2007, prior to the financial crisis. Fiscal stimulus in 2009-2010 left general government debt ratios higher than the 'A' range medians. Revenue as a percentage of GDP has been lower than the 'A' range median. Sovereign revenues are still highly reliant on petroleum-derived receipts. A broader tax base would boost the resilience of public finances and support the ratings. Fuel subsidies remain a burden on public finances.

Revenues rose 16.0% in 2011, leaving the general government deficit likely to come in around Fitch's forecast of 4.7% of GDP. However, the government's decision to spend a positive revenue surprise in 2011 indicated fiscal consolidation aims are balanced against the need for growth supportive policies. Indeed, elections must be called by early 2013, raising the risk that the political backdrop becomes less, not more, conducive to fiscal consolidation this year.

Malaysia's public finances are a key ratings weakness and we will continue to monitor them closely. If aggressive stimulus measures were implemented and this led to a sustained increase in public debt ratios, it would be negative for the ratings.

Conversely, if the government is able to prioritise fiscal consolidation, strengthen and broaden its fiscal revenue base, and lessen energy dependence, it would be positive for the ratings.