Malaysia: Political and financial instability shake confidence
September 17, 2015
A series of internal and external developments have battered the Malaysian economy, weakening investor confidence and challenging the stability of the government led by the controversial and embattled Prime Minister Najib Razak. Malaysia’s economic woes began last year with the precipitous fall in energy prices and have since snowballed into the economic crisis the country now faces that is characterized by rapidly-dwindling foreign exchange reserves, a plummeting ringgit, soaring debt costs and risks to the political status quo.
Najib first came under fire from journalists in July over reports that had discovered that vast sums of money were deposited into bank accounts that he owned. The funds have been linked to 1 Malaysia Development Berhad (1MDB), a state-owned investment fund that Najib set up in 2009. Since its inception, the fund has grown to become a highly-leveraged and systemically-important institution, which accrued USD 11 billion of outstanding debt. Close to USD 700 million is alleged to have found its way from the struggling investment fund into the bank accounts of Najib. Public scrutiny due to the scandal has since gathered momentum and, in late August, thousands of Malaysians took to the streets in protest, emboldening political rivals and resulting in political risk that has adversely affected investor confidence.
On the financial side, Malaysia faces both domestic and external risk. The substantial debt burden of the systemically-important 1MDB, and investigations into its alleged misappropriation of funds, has raised questions regarding the health of the investment fund, and more importantly, around how exposed Malaysian financial markets are to risks stemming from 1MDB. Capital flight accelerated in July as reports of the 1MDB scandal surfaced, indicating that the scandal had impacted investor confidence. On 8 September, the ringgit weakened to 4.34 MYR to USD, marking a 10.6% monthly depreciation, and a weakening of 36.8% year-on-year. Foreign exchange reserves have rapidly been depleted as the Central Bank attempts to support the currency. In fact, reserves fell to the lowest level since 2009 on 14 August. FocusEconomics Consensus Forecast Panelists expect foreign exchange reserves to end the year at USD 102 billion. Next year, the panel sees reserves to rise to USD 107 billion.
Regarding the precipitous collapse of the currency, Irvin Seah, economist at DBS, Bank noted that indeed it was a question of concerns not only regarding the immediate political and financial instability, but in terms of the economic fundamentals as a whole, stating:
“While a weaker currency should theoretically alleviate the external balances, the crux of the issue is that the depreciation has perpetuated the erosion of confidence in the underlying fundamentals of the economy. Plainly, the currency and indeed, the country as a whole, is struggling with a crisis of confidence. Rating agencies are already flagging the risk of a downgrade on Malaysia’s sovereign credit rating.”
Malaysia is also vulnerable to outside factors, particularly strong capital outflows should the Fed’s rate hike be steeper than expected. Increasingly-expensive debt costs have forced Malaysia to seek cheaper financing though foreign-denominated debt, adding to the country’s already high proportion of external debt (expected to reach 69.4% of GDP in 2015) and exposing it to risk of a currency mismatch, further exacerbating pressures on the ringgit. Such financial development have taken place against a back drop of slowing growth and a weaker yuan in China, and slowing global demand for key Malaysian exports, particularly for crude and refined petroleum products.
On 16 September, Najib announced that the government would inject USD 4.6 billion into the Malaysian stock market via state-owned investment funds in an effort to restore investor confidence and halt the currency deterioration. Najib also pledged more transparency in the financial operations of state-owned investment firms. It remains to be seen what effect, if any, these measures will have on the economy. Given the severity of the challenges facing Malaysia, it is likely that the recent stock market intervention will do more to soften the landing, as opposed to reversing economic momentum.
Author: Robert Hill, Economist