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Dealing with a downgrade

THE Fitch Ratings downgrade of our sovereign bond issuer default rating on Dec 4 from "A-" to "BBB+" has attracted mixed responses ranging from a stance of downright vindication to a couldn't-care-less attitude.

There is, however, a near-consensus opinion these days against unquestionable or uncritical trust in rating agencies that tend to rigidly adopt a certain outlook that does not take into account the complexities of the real-world dynamics.

For example, rating agencies are themselves overly-dependent on a particular macroeconomic policy consensus that has been best exemplified by the World Bank and the International Monetary Fund (IMF).

In turn, the World Bank and IMF have been beholden to mainstream or orthodox school of economic thought that have reigned dominant since the overturn of the Keynesian Revolution brought about by the stagflation phenomenon in the mid-1970s that marked the end of full employment as the ultimate goal of deficit spending first unleashed by US President Franklin Roosevelt's "New Deal" of the 1930s in the aftermath of the Great Depression (1929), although it's now openly recognised that the paradigm is shifting.

It is shifting precisely because the realities have moved on since the days of Reaganomics/ Thatcherism and the New Public Management phenomenon that also influenced the first (Tun) Dr Mahathir Mohamad administration to modernise the civil service from regulator to enabler and embarked on the privatisation of state-owned entities.

Credit default swaps

The pendulum is now swinging in the opposite direction, that is, especially because of the experience of the great financial crisis of 2008-2009 that has seen the soft-touch and low regulatory environment resulting in the proliferation of what is now regarded as financial "weapons of mass destruction", most notably the credit default swaps (CDS) of the collateralised debt obligations (CDOs) comprising principally mortgage-backed securities (MBS), i.e., tranches of debt repayments pooled mainly from subprime housing loans.

The CDOs were, of course, the derivatives based on the MBS. Whereas the CDS was the betting on the betting part, so to speak, of the financial game that was disguised as a form of so-called insurance swap.

Nonetheless, of immediate and practical concern here is how to deal with the Fitch downgrade which would have an impact on the status of our sovereign bonds (i.e., the majority in the form of Malaysian Government Securities or MGS). There's the legitimate concern over selloffs and the concomitant of capital flight in the equity markets.

As mentioned in an Emir Research article, "Alternative avenue to fund deficit", Bank Negara Malaysia should seriously consider doing quantitative easing now, i.e., second-hand purchases of MGS to absorb the offloading and simultaneously ensure that we aren't "captive" to the vagaries of the markets by lowering the bond yields. What rating agencies don't mention is that a sovereign country like Malaysia (i.e., with its own central bank and currency) unlike member states of the eurozone, for example, is always in control of its interest rates and that include bond yields.

To quote Australian economist William F. Mitchell who in turn appealed to the real-world policy experience of the Federal Reserve and Bank of Japan (BoJ): "The central bank always calls the shots on yields and the bond markets only set yields if the government allows them to."

The relevant Federal Reserve and BoJ documents are taken from the minutes of the Federal Open Market Committee (Oct 29-30, 2019) and "Strengthening the Framework for Continuous Powerful Monetary Easing" (July 31, 2018), respectively.

Risk-free haven

Rating agencies also neglect to mention that countries that issue sovereign debt denominated in their own currency not only have an almost zero possibility of default but is a risk-free haven as a form of financial asset. This explains why Malaysia remains a top destination for foreign buyers of MGS.

So, while there's much to take on board from the Fitch downgrade, when it comes to our national or sovereign debt (in terms of the size of issuance, debt ceiling, yield levels), the reality is that, ultimately, it's the markets that need the state and not the other way round.

The writer is head of Social, Law and Human Rights at Emir Research, an independent think tank focused on strategic policy recommendations based on rigorous research

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