Malaysia Stumbles Toward Fiscal Crisis

A perfect storm of bad economic news appears about to inundate a rudderless government in Malaysia as political squabbling paralyzes leaders, according to sources in Kuala Lumpur. Fiscal revenues are going through the floor, the currency is diving and inflation has risen from 0.1 percent in February to 3.3 percent in July and is expected to rise.

With a huge projected fiscal deficit and steep bond indebtedness, the country may be faced with borrowing on the international markets. But with a sliding currency and allegations of massive corruption threatening the government of Prime Minister Najib Razak, borrowing costs are likely to be through the roof.

Most observers in Malaysia believe that Najib remains insulated from political overthrow by the paid for loyalty of the 192 United Malays National Organization cadres in the Barisan Nasional, or national ruling coalition. But a major financial crisis could change the equation.

Najib skips town

As the economy grows weaker and the scandals percolate, Najib has left the country, first to London for a trade show, then to the United Nations, where he was to address the general assembly. From there, he and his wife, Rosmah Mansor, were due to fly on an official private jet to Milan, Italy, where she is to sponsor an Islamic fashion show.

“Malaysia is quickly entering into the throes of a financial crisis,” according to Focus-Economics, a consensus website of leading global economists. “External factors, such as the slowdown in China, concerns over how sound Malaysia’s financial markets are, as well as uncertainty regarding the extent of the impending Federal Reserve rate hike, have forced the Central Bank to reduce its foreign reserves substantially in order to support the currency. Investor confidence is being further tested by the political situation in the country.”

Malaysia has been almost paralyzed by a lengthy corruption scandal in which unknown Middle Eastern sources were discovered to have poured US$861 million into the prime minister’s private account at AmBank in Kuala Lumpur in 2013, only to have it disappear back out to a Singapore account, and then to disappear altogether shortly after. At the same time, the country is being rocked by the RM42 billion 1Malaysia Development Bhd. financial scandal in which billions allegedly have been siphoned off from the state-backed investment fund and billions more have seemingly been lost to bad investments. There is concern that the magnitude of the projected losses faced by government-linked banks could threaten the country’s financial system.

Stock market heads south

Attempts to prop up the stock exchange using RM20 billion from a revived government investment fund – regarded as too little, too late – bought a two-day bounce on Sept. 16 before the market slide resumed. At 1623.27, it is now 14.57 percent off its April peak, making it the worst-performing bourse in the region.

The ringgit fell in value against the US dollar from 3.5687 in August 2014 to 4.4570 this week before the central bank intervened, a 19.93 percent drop. The central bank has spent at least US$60 billion over the past several months buying ringgit – at least a third of the country’s international currency reserves.

As of Sept. 15, reserves had fallen to US$95.0 billion, enough to finance only 7.3 months of retained imports, raising concerns over how long the country can continue to support the currency, although both Najib and Central Bank Gov. Zeti Akhtar Aziz have repeatedly said there will be no currency controls. The falling currency is raising the cost of imports of goods and services, which made up 69.9 percent of GDP in 2014.

International investors bail out

International investors have lost faith over falling commodity prices and the continuing political crisis, now exacerbated by international investigations into money-laundering in Switzerland, France, the UK and the United States. External debt in Malaysia, as reported by Bank Negara, the central bank, reached an all-time high in the second quarter of this year at RM79.4 billion.

The World Bank’s latest forecast for Gross Domestic Product growth for 2015 is 4.9 percent, down from 6.5 percent in July 2014. It may get worse. According to the International Monetary Fund’s most recent report on emerging markets, “the weak commodity price outlook could subtract almost 1 percentage point annually from commodity exporters’ rate of economic growth over 2015–17 as compared with 2012–14.”

With energy exporters such as Petronas, the national energy company, “the drag is estimated to be larger, about 2¼ percentage points on average over the same period, reflecting a sharp downturn in oil prices over the past year.”

In the current fiscal year, Petronas contributed RMB26 billion to the budget, with another RMB26 billion taken from the Petroleum Development Tax, for a total of RMB52 billion from Petronas reserves. Officials are privately forecasting that because of the collapse of oil prices, the two funds will contribute only RMB10 billion each, leaving a shortfall of RMB30 billion.

Tax collections fall sharply

According to in-house figures, income tax collections are expected to fall by 20 percent to 30 percent from RMB160 billion in fiscal 2014, a drop of another RMB30 billion to RMB50 billion owing to weak consumer sentiment and the slowdown in business activity. Operational expenditure for Fiscal 2015 is approximately RMB230 billion.

“They can’t reduce it unless they begin to cull civil servants,” a well-placed business source told Asia Sentinel. “The deficit is 52 percent, with off-balance-sheet contingent liabilities another RMB18 billion. That's like Italy and Spain and we haven't taken into account 1MDB yet. How are they going to borrow? The ratings will be horrendous next year and cost of borrowing very high given Malaysia’s junk status. I fear they will start selling crown jewels, such as assets in government companies.”

According to Bloomberg and Reuters, 45 percent of bonds are held by foreigners, who are likely to bail out and redeem them as soon as they come to term. The bonds are spread over several years, so the foreign redemptions are not expected to pose an immediate problem. But domestic redemptions may well be. Some RMB33 billion in bonds are expected to come due in the next quarter. There is no reason to believe domestic investors in government bonds are going to be any more enthusiastic about them than foreign investors, although a significant proportion are probably held by government-linked companies that can be jawboned into renewing them.