Malaysia stands out as a problematic country. Besides struggling with slow global growth and low commodity prices, the country is facing idiosyncratic political risks as well. The 1MDB scandal will remain in the news now that the US is looking into matters. The ringgit has been reflecting heightened risks, but not so much Malaysian bonds and equities. With deteriorating fundamentals and rising political uncertainty, we think Malaysian assets will come under stronger selling pressures ahead.
Political risk remains high due to the ongoing 1MDB scandal. Though local investigations appear to have reached a dead end, US and Swiss authorities are getting more involved. A US federal grand jury is reportedly focusing on properties in the US purchased in recent years by companies linked to Razak’s stepson as well as a close family friend. Swiss authorities have started a criminal investigation of two 1MDP officials for several offenses, including money laundering and corruption of foreign officials. Some bank accounts that are related to the case have been frozen.
The ruling coalition has become divided, with former Prime Minister Mahathir calling for the resignation of current Prime Minister Razak. Razak has been dogged by corruption allegations relating to state-owned investment company 1MDB and a $681 mln payment into Razak’s personal bank account. The ruling Barisan Nasional has remained in power since independence in 1957, and electoral gerrymandering has helped it maintain a strong majority in parliament despite declining popular support.
The opposition remains divided too, but some parties are working to repair the rifts. After the collapse of the old Pakatan Rakyat grouping in June, three of the four main opposition parties are forming a new alliance called Pakatan Harapan. Pakatan Rakyat was formed back in 2008, but had little in common beyond wanting to unseat the ruling Barisan Nasional coalition. Indeed, the PAS will not take part in Pakatan Harapan due to opposition to its plans to implement shariah criminal law in a PAS-controlled state.
The next general elections are due by 2018, and it remains to be seen if the opposition can capitalize on current events that are clearly negative for Barisan Nasional. In the 2013 elections, Barisan Nasional won 133 seats in the 222-seat lower house with 46.5% of the vote. This was its lowest share of the popular vote since independence. In 2013, the opposition won 89 seats with 53.5% of the vote. In our view, an opposition win in 2018 could be seen as positive for Malaysia.
The economy is clearly slowing. GDP rose 4.9% y/y in Q2, the slowest rate since Q3 2013. Monthly data so far in Q3 suggest the slowdown is continuing. Consensus forecasts for GDP growth in 2015 and 2016 currently stand at 4.9% for both, down from 6% in 2014. Part of the slowdown is due to external reasons, while part of it can be traced to the April hike in the goods and services tax (GST).
Despite some fiscal tightening, the budget deficit is likely to remain high at around -3% of GDP in 2015 and 2016. The deficit is one reason we think that rating agencies are focusing on Malaysia. Fitch moved its outlook on Malaysia’s A- rating to negative due to mounting public debt, but then moved it back to stable in June. Our own sovereign rating model has Malaysia at BBB+, and thought that a downgrade by Fitch was warranted. Both S&P and Moody’s ratings match Fitch’s A-.
Malaysia reports August CPI Wednesday, and is expected to rise 3.1% y/y vs. 3.3% in July. Bank Negara does not have an explicit inflation target, but should be happy if further disinflation is seen. With the economy slowing, we think the central bank may have to tilt more dovish in the coming months. It’s been on hold since the last 25 bp hike back in July 2014.
The external accounts remain in good shape. The current account is expected to remain in surplus this year and next, to the tune of about 3% of GDP. Yet capital outflows and likely FX intervention have seen foreign reserves fall sharply to $94.7 bln in August. This is down from $116 bln at the end of 2014 and $135 bln at the end of 2013. Short-term debt is now much larger than reserves, highlighting vulnerability to shifts in investor sentiment.
The ringgit is one of the worst performers in EM YTD, -19% and behind only COP (-23%), TRY (-23%), and BRL (-34%). This underperformance is likely to continue, and charts suggest that USD/MYR is on track to test the all-time high near 4.8850 from January 1998. Oil prices are likely to continue taking a toll on EM exporters such as Malaysia.
Malaysian bonds have held up fairly well. The yield on the local currency 10-year government bond is up only 7 bp YTD to 4.16% currently. This compares to the worst performers made up of Brazil (+385 bp YTD), TRY (+255 bp), and Peru (+208 bp). With inflation likely to ease, nominal yields may continue to hold up. One thing working against this, however, is the exodus of foreign bond investment. According to Bloomberg data, foreign bond outflows from Malaysia totaled -$2.3 bln in Q3, and bond investment is down -$4.5 bln from a year ago.
Malaysian stocks have held up surprisingly well. MSCI Malaysia is -8.2% YTD, and compares to MSCI EM at -16% YTD. This equity outperformance seems unlikely to be sustained if the political risks continue to rise. The growth outlook has also worsened, making it harder to make a strong case for Malaysian equities.