(The following was released by the rating agency)
-- Although Sarawak’s debt burden has increased again, its budgetary performance and liquidity position remain very strong.
-- We are affirming our long-term ‘A-’ issuer credit rating and ‘axAA’ ASEAN regional scale rating on Sarawak.
-- We are also affirming the ‘A-’ issue ratings on the notes of Sarawak International Inc., Equisar International Inc., and SSG Resources Ltd.
-- The stable outlook on Sarawak reflects our expectations that the state will maintain its strong budget performance and high reserves.
On Dec. 17, 2012, Standard & Poor’s Ratings Services affirmed its ‘A-’ long-term issuer credit rating on the Malaysian state of Sarawak. The outlook is stable. We also affirmed the ‘axAA’ long-term ASEAN regional scale rating on Sarawak.
At the same time, Standard & Poor’s affirmed the ‘A-’ issue ratings on Sarawak International Inc.’s US$800 million guaranteed notes (due August 2015), Equisar International Inc.’s US$800 million guaranteed notes (due June 2026), and SSG Resources Ltd.’s US$800 million guaranteed notes (due October 2022).
The rating on Sarawak reflects the state’s very strong budgetary performances, high levels of cash reserves, and its supportive relationship with the federal government of Malaysia (foreign currency A-/Stable/A-2; local currency A/Stable/A-1; axAAA/axA-1+). These factors are weighed against a hefty debt burden, sizable contingent liabilities, and, to a lesser extent, an economy concentrated in commodities.
Sarawak’s operating performance has been extremely good, with high operating surpluses which we project to average 68% of its annual operating revenue from 2010-2014. However, the state’s balances after capital expenditure had been volatile, due to development projects funded by large bond issuances, although volatility subsided after 2007 with the divestment of 1st Silicon, a state-owned wafer fab manufacturer. Sarawak has since recorded five consecutive years of surpluses after capital accounts.
The state’s extremely strong liquidity position supports the credit rating. Its large holdings of free cash and liquid assets provide ample coverage for debt servicing, and comfortably offer Sarawak the capacity to face potential fiscal shocks. The robust liquidity position also buffers against the state’s large unhedged U.S. dollar debt and mitigates short-term exposure risks, in our view. Due to its political and economic importance, the state enjoys a supportive relationship with the federal government.
But this could affect the state should the political composition at the central or state level shifts materially. We view Sarawak as occupying a strategic position within the federation--accounting for half of the country’s crude oil output and being the sole provider of liquefied natural gas (LNG)--which underlines its importance to the federal government. We assess the financial management of the state government as generally sound, but succession issues at the top level linger.
Sarawak’s very high direct and tax-supported debt constrains the rating on the state. A portion of this was accumulated through the state’s past financial support and debt absorption of 1st Silicon. Although debt had declined in the past few years, it rose again in 2012 due to large bond issuances to fund strategic infrastructure investments in the Sarawak Corridor of Renewable Energy (SCORE).
We estimate that Sarawak’s gross tax-supported debt burden reached 191% of revenues in 2012--much higher than for similarly rated peers. Nevertheless, taking into account its large free cash and liquid assets, the state remains in a strong overall net creditor position. Other risks include the emergence of contingent liabilities stemming from the renationalization of Sarawak Energy Bhd. (SEB). We currently view SEB as a self-supporting entity due to its adequate financial performance.
After renationalization, SEB is likely to have a bigger role in Sarawak’s long-term economic strategy. Another credit constraint is the state economy’s concentration in the resource sector. The sector accounts for about half of Sarawak’s GDP, and the concentration could negatively affect the state should there be a protracted downturn in commodities prices.
However, the state’s diversification within its resource sector and recent efforts to diversify the economy through SCORE somewhat alleviates its dependence. We view the state’s economic growth prospects as healthy and we forecast real GDP growth in the medium term at 5%-6% for Sarawak. Liquidity We assess Sarawak’s liquidity as “very positive.”
We estimate that the state’s free cash and liquid assets as of end 2012 can cover 10x its annual operating expenses. The majority of its cash holdings (including the debt sinking fund) are unencumbered. The state’s short-term liquidity risk is minimal, and most of its debt obligations are long term in nature.
Likewise, we project that the state’s free cash and liquid assets are sufficient to cover at least 15x its debt service requirements over the next 12 months. The state’s policy on reserves management is conservative. Most of its cash holdings are held in money-market funds and fixed deposits.
The stable outlook reflects our expectation that the state will continue its strong budgetary performance and maintain its robust liquidity position over the next two to three years. We also believe Sarawak’s debt burden has peaked at about 190% of operating revenue in 2012.
Although it is currently unlikely, downward pressure on the ratings could occur if Sarawak state breaches the 270% tax-supported debt to operating revenue benchmark or if the state substantially depletes its cash reserves. This could be driven by a sharp increase in borrowing or a drastic depreciation in the exchange rate, given the state’s high exposure to foreign-currency debt.
On the other hand, the sovereign credit rating on Malaysia limits the upside potential to the rating on Sarawak.
Related Criteria And Research
-- Public Finance System Overview: Malaysian States, Nov. 18, 2012
-- Methodology For Rating International Local And Regional Governments, Sept. 20, 2010