Money leaves Malaysia

posted by din merican–January 14, 2010

Asia Sentinel (January 11, 2010)

Money leaves the country on an unprecedented scale

Churches are not the only thing to have been going up in flames in Malaysia. Take a look at the nation’s foreign exchange reserves. They fell by close to 25 percent during 2009 according to investment bank UBS even though the country continued to run a huge surplus on the current account of its balance of payments.

Says UBS: “Question: which Asian country had the biggest FX losses in 2009?” The answer is Malaysia and by a very large margin; we estimate that official reserves fell by well more than one quarter on a valuation-adjusted basis”. It describes the situation as “bizarre” and contrasts Malaysia with other countries with large current account surpluses – Thailand, China, Taiwan, Singapore, and Hong Kong – which have seen their reserves increase – as should be expected.

In short there has been an exodus of money from Malaysia on a scale which surpasses that which occurred during the Asian crisis. Nor is this just a mirage. The decline is also reflected in a sudden decline in base money supply – even while, thanks to Bank Negara, broader M2 has continued to grow modestly.

Who is responsible for this massive outflow? And where has it gone? The questions cannot be answered from the data and probably will not be by a government that knows its own state-controlled enterprises, headed by PETRONAS, may probably be responsible for part of it. The more certain reason, however, is the outflow of local private capital has been taking place on an unprecedented scale in response to political instability, massive official corruption and discrimination against non-Malays.

This capital bloodletting has as yet attracted little attention because Malaysia’s foreign debt levels had declined dramatically since the Asian crisis and its reserves reached very healthy levels. So the outflow has not disturbed the financial markets, and Bank Negara has easily been able to keep interest rates low and the currency strong.

But unlike 1998, when the exodus of hot foreign money was a major contributor to the crisis, foreigners cannot be blamed. There is little speculative interest in the ringgit and the Malaysian bourse has rather fallen off the map as far as foreign institutional money is concerned. The BRICs, (India, China, Russia, Brazil, Russia, India, China), have taken the merging market lead once dominated by Southeast Asia.

Nor is there much evidence that the Middle East money which was supposed to be flowing into Muslim Malaysia, into holiday apartments or Johor’s massive Iskandar development zone, has been much in evidence. Malaysia’s one recent success, the development of its sukuk (Islamic bond) market may have caused more capital outflow than inflow. At any rate any overall net inflow of foreign capital whether into bonds, equities, factories or real estate has been dwarfed by the exodus of Malaysian money.

The latter is reflected in the weakness of private sector investment, which now trails public investment. Indeed it explains why the economy remains weak despite very healthy prices for most of Malaysia’s commodity exports. The nation has been running a current account surplus of more than 10 percent of gross domestic product for the past decade and hit about 17 percent of GDP in the year just ended. Initially this surplus was needed to pay down debt accumulated during the mid-1990s Mahathir boom years and to rebuild foreign exchange reserves to healthy levels.

But subsequently it became simply a consequence of the weakness of private investment. Domestic investors were discouraged by the corrupt and warped system and foreigners moved to China and elsewhere. GDP growth has become ever reliant on government stimulus – again racially biased in its allocation — financed by a persistently large budget deficit.

Meanwhile, publicly controlled capital has been rushing overseas. Petronas has been spending its billions in profits around the world as it attempts to become a major global player – at the expense of Malaysian citizenry in general and the oil and gas producing states in particular. Other government-controlled entities such as Malayan Banking Bhd have been bidding top dollar for foreign assets – such as Bank Internasional Indonesia.

Often with the exodus of money goes an exodus of talent as highly skilled persons disadvantaged by race or, as in the case of some Malays, disgusted by local corruption or primitive religious authorities, take themselves and their capital to Australia, Canada, India, China, etc.

The 2009 reserves loss may have had some specific cause which will not be repeated. But it has merely served to underline a dismal trend which has been in evidence for the best part of a decade. Malaysia has so far been saved from itself by the commodity price gains of the past five years – with even the late 2008 collapse now largely reversed. Oil and palm oil may be off their peaks but both are now double their prices of five years ago.

It is better not to imagine what will happen to Malaysia if prices collapse to 2004 levels and stay there. Better now to address the real reasons behind capital outflow and lack of private investment.

UBS Report (below)

Malaysia–Another Bizarre Story

Confusion is a word we have invented for an order which is not understood. — Henry Miller

What it means

After last year’s series of notes on EM countries with “bizarre” money and credit behavior (Chile, Kazakhstan and Vietnam, see Tales of the Bizarre, EM Daily, 4-6 November 2009), we need to add one more to the list: the very strange case of Malaysia.

Question: Which Asian country had the biggest FX reserve losses in 2009? The answer is Malaysia, and by a very wide margin; we estimate that official reserves fell by well more than one-quarter on a valuation-adjusted basis.  Why is this bizarre? Well, in the first place because Malaysia runs a current account surplus – and not just a mild surplus but rather the largest in Asia, around 17% of GDP. Other structural surplus neighbors like China, Hong Kong, Singapore, Taiwan and Thailand have all seen sizeable increases in FX reserves over the past 12 months … and yet Malaysian reserves nearly collapsed.

How did this happen? In short, Malaysia must have seen massive foreign capital outflows – and sure enough, when we measure implied net flows using the same rough methodology as in our note on Russia earlier in the week (Watching Money in Russia, EM Daily, 5 January 2010), the numbers are simply stunning: peak outflows of nearly 50% of GDP, i.e., more than twice as large as in the “capital flight” case of Russia and many orders of magnitude larger than anything witnessed in the average EM country (Chart 2)*1. In fact, the recent outflows are far, far bigger than those Malaysia experienced in the 1997-98 Asian financial crisis (Chart 3).

It gets stranger. Unlike Russia, Ukraine, the Gulf states or other recent EM capital flight economies, Malaysia didn’t see any net external inflows in the run-up to the current crisis. Indeed, Malaysia has not recorded a year of positive net capital inflows since 1997, i.e., there wasn’t exactly a large pool of “hot” money parked onshore waiting to leave. Nonetheless, as shown in the above charts, capital is apparently still leaving Malaysia in large quantities as of the latest data points – long after most other emerging countries began to see net inflows again.

*1 Implied capital flows in Chart 2 are defined as the difference between valuation-adjusted FX reserve accumulation and the current account balance. Flows in Chart 3 are defined as the difference between the overall balance of payments and the current account balance.

Nor, in contrast to all the above-named economies (and in contrast to Eastern Europe in general), did Malaysia have any noticeable increase in domestic leverage – both broad money M2 and bank credit actually declined as a share of GDP since the beginning of the decade.

So where on earth did the outflows come from? Certainly not local deposits. Unlike Russia, Ukraine or other CIS economies, there was no outflow from the domestic deposit base; M2 growth in Malaysia is still very comfortably positive, in sharp contrast to the Russian figures we published a few days ago (Chart 4).

And this despite a massive, unprecedented decline in high-powered “base” money, as shown in Chart 4. Indeed, over the past 12 months Malaysia recorded one of the biggest base money contractions in the entire EM world, matched only by the Baltic states (Chart 5). This is in part because the Malaysian central bank responded with a sharp drop in reserve requirements to keep banks liquid … but still, we can’t help but note that the domestic financial system seems uniquely unaffected by apparent capital outflows.

In fact, perhaps the most surprising feature of the economy is that interest rates have fallen steadily. In 1997-98, with much lower ex-post outflow pressures, Malaysian short-term interest rates skyrocketed into the high teens; last year the same thing happened in some other countries with strong outflows pressures. Meanwhile, during 2009 Malaysian rates settled in comfortably at around 2% per annum and show no signs of rising substantially any time soon. What is going on? How do we square this circle? To be honest, we’re not really sure – but we strongly suggest the interested reader turn to ASEAN economist Ed Teather for further answers.

For additional information on Malaysia, Ed Teather can be reached at edward.teather@ubs.com.

• Analyst Certification

Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers; and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report.

Required Disclosures

This report has been prepared by UBS Securities Asia Limited, an affiliate of UBS AG. UBS AG, its subsidiaries,branches and affiliates are referred to herein as UBS. For information on the ways in which UBS manages conflicts and maintains independence of its research product; historical performance information; and certain additional disclosures concerning UBS research recommendations, please visit www.ubs.com/disclosures. The figures contained in performance charts refer to the past; past performance is not a reliable indicator of future results. Additional information will be made available upon request.

Advertisement