Malaysia Likely to Suffer From 1MDB, Oil Developments

In this edition of MarketView, we discuss Malaysia’s political, economic and investment outlook.

POLITICAL OUTLOOK

Malaysia’s anti-corruption agency released a report saying that the money that ended up in Prime Minister Razak’s bank accounts were not from the development bank 1MDB, so technically it may not be illegal.  But this is not the end of the story.  The agency concluded that the roughly $675 mln were “donations,” but no more details were given.  One of the key questions may be whether he received the money as prime minister or as the president of his UMNO political party.  Either way, activists will continue to pressure the government to reveal further information and the political situation remains very tense.

Part of the problem is that even if PM Razak has done nothing illegal, the way he handled the situation has not helped – to say the least.  For example, 20 protestors were arrested last weekend, along with three anti-corruption commission officials.  And on top of this, the PM began to lash out against foreigners, with a tone of rhetoric that reminds us of speeches by Turkey’s President Erdogan.  For example, “I cannot allow white people, the foreigners, to determine our future.  What is their right?”

ECONOMIC OUTLOOK

Malaysia’s outlook has been hurt by plunging oil prices.  Oil and petroleum-related products account for about 20% of exports, so perhaps this is not totally justified.  Recall that the country became a net importer of crude in 2011 and has since been diversifying its economic activities (see chart at the very bottom by the National Trade Promotion Agency of Malaysia).

But some 30% of the government’s revenues come from the oil sector.  So even if this situation was improved by the reduction in subsidies, it complicates the fiscal situation. Either way, the correlation between MYR and oil prices is pretty clear.

The IMF sees 4.8% and 4.9% growth in 2015 and 2016, respectively.  While GDP rose 5.6% y/y in Q1, we think there are growing headwinds on the economy even as Bank Negara has noted Q2 is likely to slow.  Exports in dollar terms have contracted y/y for nine straight months through June.  Inflation is rising, due in part to the 6% GST that went into effect in April.  CPI rose 2.5% y/y in June.  While the central bank does not have an explicit target, Governor Zeti said it is likely to come in near the lower end of a 2-3% range this year.  The central bank has remained on hold since its last 25 bp hike to 3.25% back in July 2014, but we think it could tilt more dovish if the economic slowdown intensifies.

INVESTMENT OUTLOOK

MYR has been one of the worst EM performers this year, -10% YTD and behind only CLP (-11%), TRY (-16%), COP (-19%), and BRL (-23%).  With political risk rising and fundamentals deteriorating, we think ringgit underperformance will likely continue.  We also remain bearish on oil and commodity prices.  USD/MYR continues to make new multi-year highs.  Using a long-term chart, a break of 3.91 and then 4.14 is needed to set up a test of the 1998 high near 4.8850.

On the other hand, Malaysian bonds and equities have outperformed.  10-year local currency government bond yields are -4 bp YTD.  This compares to the worst performers that include Turkey (+159 bp), Peru (+135 bp), Brazil (+92 bp), and Indonesia (+72 bp). Malaysian equities have also held up well, with MSCI Malaysia -3.2% YTD vs. -6.7% YTD for MSCI EM.  We suspect this outperformance in bonds and equities will be difficult to maintain in H2 in light of recent political and economic developments.

Note that bond inflows have been relatively strong so far this year. Using flow data compiled by Bloomberg, accumulated bond inflows this year (ending in June) are higher than those from the last three years.