What is Najib’s response to arrest impending ringgit, equity and bond meltdown?

 

The next to be "contagiously infected" would be those that have a combination of these factors: "high fiscal deficits, high subsidies bill, slowing economies and high foreign ownership of government bonds". Malaysia and Thailand fit into these profiles. 

Granted, the Asian currencies which have been weakening since May 2013 have been duly noted. The Malaysian ringgit's recent fall, in that sense, is in tandem with the regional currencies.

Many took comfort in observing that the depreciation is not a reflection of economic weaknesses but more as a result of strengthening of the US dollar, i.e. as a result of US bond purchase or tapering of the quantitative easing (QE).

Some economists went further as treating it as a blessing in disguise as to find our "natural economic equilibrium". While that may be arguably so, it is not entirely true or at best, only half-truth? We couldn’t resist noting that it is too much of an apologia.

Already the Fitch Rating has mooted and alluded to the possibility of credit rating downgrading both the Indian rupee and the Indonesian rupiah if their governments fail to halt the slump in investors’ confidence and maintain financial stability.

The far-reaching implication on the cost of funding and the impact quality of life, i.e. inflation and burden on debt repayment must be fully appreciated. This is especially so if income and wealth divides have been widening, hence affecting the lower income group more severely and creating social tension of sort.

While not forcing a similarity with the earlier crisis, wouldn’t it better for the emerging economies to be more on the alert so as to avoid the recurrence of a catastrophic currency crisis and, subsequently, a full-blown Asian financial melt-down as seen in the late 1990s?

Which countries are at greater risk in these currencies free-fall and why? More importantly is to ask what could and should be done in order to halt the slump in confidence.

For the record, the Indian rupee fell to 64.13 per US dollar (a -13.67% move) and the Indonesian rupiah fell to trade at 10,700 to the greenback (a -10% move), its lowest since April 30, 2012.

After these two countries the next to be "contagiously infected" would be those that have a combination of these factors: "high fiscal deficits, high subsidies bill, slowing economies and high foreign ownership of government bonds". Malaysia and Thailand fit into these profiles.

The Thai economy incidentally shrank in the second quarter of this year and in fact went into a mild recession. Thailand’s baht touched a 13-month low of 31.72 per US dollar(a -3.22% move), its weakest since July 2012.

Let us now consider a closer snapshot of the Malaysian case. The following are our takes that have caused foreign investors to re-evaluate their exposure to Malaysian assets:

1. Economic growth is expected to slow to five years low in 2014,
2. The ringgit currency has already been driven to three-year lows around 3.3 to the dollar, down more than 7% this year. Traders estimate the central bank has spent close to US$1.3 billion (RM4.3 billion) to defend the currency in recent days.
3. Selling spread on Tuesday to the Kuala Lumpur’s stock market – usually seen as a regional safe haven – dragging the main index down 1.85%.
4. While most economists expect the current account to remain in surplus, its sharp fall to RM8.7 billion in the first quarter from RM22.8 billion in the previous period removed much of Malaysia’s perceived protection from heavy fund outflows.
5. Export plunges in recent months could push the current account into a quarterly deficit for the first time in 16 years. People weren’t expecting the deficit to get anywhere close to zero six months ago. Five years of low trade surplus (due to plunging prices of Malaysia' palm oil exports and rising copper imports). Current-account surplus probably decreased to RM900 million (US$274 million) in the second quarter from RM8.7 billion in the previous three months. There are some in the market who think Malaysia could post a current-account deficit in the quarter.
6. The government is silent on the much-needed reforms to fix a large fiscal deficit. The fact that the government remains relatively silent (the new government's first 100 days just slipped by quietly without an economic master plan) may add more to investors’ uncertainty and ringgit weakness.
7.  Despite the proposed set up of a "Fiscal Committee", the government must deal more with the roots of ringgit weakness which is ratings downgrade due to public finance disorders with lack of reforms to control Malaysia’s household debt 83% debt-to-GDP ratio, government debt plus guarantees at 70% of GDP and corporate debt at an alarming 95.8% of GDP. There is high evidence that debt growth has been growing faster than GDP growth over the last 10 years which can be the tipping point to send our economy to vicious market instability spiral.
8. We note that the month-long selling has pushed 10-year Malaysian government bond yields to their highest in 2-1/2 years (Ten-year bond yields have crossed 4% for the first time since early 2011) which can pressure borrowing cost and affect local investors.
9. Given that overseas investors held 33% of Malaysian government debt and 25% of Malaysian equities (among the highest proportion among Southeast Asia’s biggest economies according to central bank data), we expect more capital outflows over next few weeks which could cause the ringgit to underperform and people to lose more of their quality of life. Foreigners have been selling Malaysian bonds, reducing their holdings to RM138 billion in June from RM145 billion in May, according to the latest data.
10. Ironically, we observe the local GLIC fund, pension fund and even local banks are purchasing less of Malaysian equities and bonds with most now focusing on overseas assets and this can be a serious worry.

Hardly surprising that the Fitch ratings agency cut its outlook on Malaysia’s sovereign debt last month, citing worsening prospects for fiscal reforms, such as proposed cuts in the country’s steep subsidy bill and a new consumption tax to reduce its reliance on oil revenues.

We also notice there wasn't a strong counter ringgit policy response from the government which is very important to spur investors’ morale while breathing a positive perception into the fledgling new administration.

We believe the absence could be Prime Minister Datuk Seri Najib Razak's strategy in response to the shrinking number of parliamentary seats won by BN and, of course, dwindling business electorate support (especially Chinese & urban middle class), which has dealt a certain blow to the PM.

Similarly, Najib faces a possible leadership challenge from within his ruling party in October, raising uncertainty over his pledge to cut one of emerging Asia’s highest budget deficits of 4.5% of GDP.

Hence, we strongly advocate that the government to immediately release counter ringgit response and communicate with the business communities (investors, analyst and rating agencies) and come up with major manoeuvres within 48 hours to fix the country's economic problems so as to arrest the impending ringgit, equity and bond market meltdown.

* Dr Dzulkefly Ahmad is executive director PAS Research Centre (Corporate Finance Resource Group).