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LGT Beacon: Malaysia shaken by political turbulences

July 29, 2015

Malaysia has lately caused negative headlines worldwide because of unprofitable and opaque investment practices of its state investment vehicle 1Malaysia Development Berhad (1MDB). Allegations range from misallocations to wastage and enrichment. While not only political, but also cyclical headwinds are cause for concern, solid fundamentals allow for a positive long-term outlook.

The case of 1MDB now stretches into ever higher political circles as Prime Minister Najib itself is accused of enrichment. Although he has denied taking money for personal gain, he has so far not ruled out using these funds – almost USD 700 mn – to finance election campaigns in May 2013. Under the guise of ensuring public safety and stability, the government has currently been taking rigorous measures against various media involved in revealing the misappropriation of funds. Furthermore, several ministers were fired at the beginning of this week. The situation of the loss-making state fund and the associated entanglement of Prime Minister Najib remain highly opaque. Political tail risks have risen accordingly.

Political developments have also taken their toll on financial markets. The Kuala Lumpur Composite Index lost around 10% within one year, and the Malaysian ringgit has recently crossed the psychologically important threshold of MYR 3.80 against the US dollar. In the aftermath of the Asian crisis, the Malaysian currency was fixed at this rate during 1998 until 2005. Hence, the exchange rate has fallen to a 17-year low despite central bank interventions.

Malaysia is struggling with the commodity bear market

But not only the turbulent political scenery, but also the deteriorating economic momentum of the Southeast Asian economy has caused financial markets to tumble. The resource-abundant country has been facing cyclical headwinds from low energy prices. Palm oil as well as crude oil and gas are among major export goods. In the wake of the oil price collapse, the state-owned oil giant Petronas had recently been forced to cut capital expenditures sharply. In addition, Malaysia’s important trading partner China is plagued by cyclical woes. Accordingly, the current account surplus has fallen considerably in recent years, amounting to only 3.5% of gross domestic product (GDP), compared to a record-high 17% in 2008.

However, not only lower export revenues aggravate Malaysia’s economic situation. Although holding up surprisingly well, consumption may suffer similarly due to the introduction of a goods and services tax of 6% in April this year. High household debt further weighs on consumption. And also public expenditures have to be cut. With targeted -3.2% of GDP the budget deficit remains large this year, especially in light of potential contingent liabilities by 1MDB. Nevertheless, the G&S tax is a step into the right direction. Moreover, the government in Kuala Lumpur has taken advantage of lower commodity prices in order to cut energy price subsidies. In the long run, these consolidation measures are very positive, albeit economic costs may occur in the short term.

Diversified economy sustains growth momentum

The economy is still expected to grow at 4.8% this year and at even 5.1% in 2016. Malaysia benefits from an overall relatively well-diversified economy that does not rely exclusively on commodity exports. Domestic consumption contributes to overall growth just as the industrial sector. The latter profits from gains in competitiveness thanks to a weaker exchange rate. Last but not least, US demand is relatively robust. Monetary policy further plays its part. While fears of a weaker ringgit make rate cuts rather unlikely, the central bank may also shy away from hiking rates as long as cyclical headwinds persist. Thus, policy rates are expected to remain on hold for the time being.

Read about the resulting investment positioning changes in our portfolios in the LGT Beacon below. To subscribe to a weekly newsletter, click on "Abo".
Note: The next LGT Beacon will be published on 5 August 2015.

LGT Beacon 07/29/2015 (pdf)

From: LGT Beacon Abo