Why is Malaysia's currency so low
Risk factors and outlook
Malaysia has long been one of the countries in Asia with the lowest political risk (category 2 out of 7). The ongoing political stability and the high degree of economic openness in the very dynamic environment of Southeast Asia have ensured solid macroeconomic indicators for many years: external debt is low, the current account shows surpluses, inflation is under control, and average growth rates are high.
The Malaysian economy is strongly export-oriented, but has reduced its dependency on exports somewhat - the share of domestic demand and private consumption in gross domestic product has been increasing for some time. A significant middle class is increasingly contributing to growth with their consumption. However, the downside of this trend is an alarming rise in household debt. Malaysia is also moderately susceptible to external shocks: the economic downturn in China (the effects of which are also being felt in other Malaysian export markets), weaker demand from the USA and the EU, and the withdrawal of the US Federal Reserve (Fed) from politics The monetary easing will not remain without consequences for the Malaysian economy. The last-mentioned factor in particular could set in motion a cycle of capital outflows and currency devaluations - but only temporarily, as investors assess the situation in Malaysia positively and can rely on a comfortable cushion of currency reserves.
The state of public finances deteriorated after 2008. This increased the political risk. As a result, the government tried to consolidate the state budget. The fiscal measures combined with a more restrictive monetary policy resulted in economic stabilization at the expense of growth. At the moment, the economic outlook is generally favorable and the business environment is good. Malaysia is rated with the best categories for short-term political risk (1/7) and for business risk (A). To ensure that Malaysia does not get stuck in the middle-income trap, the country must implement structural reforms and promote economic diversification.
The one-party government ensures political continuity and is the key factor in Malaysia's low political risk. It is also beneficial for economic development, which should also apply in the future. However, the risks of domestic political destabilization have increased since the controversial election results last year. The opposition responded to the election results with violent protests. Young people in Malaysia in particular are calling for more democracy, better governance and liberalization. At the same time, ethnically motivated tensions are growing in importance as the Malay majority continue to receive preferential treatment over other ethnic groups.
Facts & key figures
- Political and economic stability
- Robust consumer demand in the face of an affluent population
- Healthy banking sector
- Malaysia is a net foreign creditor
- High export dependency in a very competitive regional environment
- Economy is prone to external shocks
- High household debt
- The state budget situation allows only limited countercyclical measures
Main export goods
- Electrical and electronic products (27% of current account revenues), crude oil and liquefied petroleum gas (10.4%), tourism (7.5%), chemical products (5.9%) and palm oil (5.4%)
- High middle income
Electoral system (elections every five years)
- King (election by the sovereigns): November 2016
- Parliamentary elections: May 2018
Head of government
- Prime Minister Najib Razak
Head of state
- King Abdul Halim Mu’adzam Shah
Political continuity in an environment of increasing polarization
Political development in Malaysia has been smooth since the declaration of independence in 1957. The country's largest party, the “United Malays National Organization” (UMNO), has been in power since then with the help of the Barisan (BN) party alliance it heads. The political supremacy of the UMNO, which has lasted for 56 years, has so far been made possible by its domestic political backing and ongoing economic successes. But since 2006, these stable political conditions have been shaken for the first time by the protests against corruption and the discrimination against ethnic minorities. The governing coalition BN had to accept a loss of popularity in the parliamentary elections in 2008 and 2013.
Prime Minister Najib Razak (UMNO) was re-elected for a further five-year term in the parliamentary elections in May 2013. But the ruling coalition BN had the narrowest victory in history against the opposition coalition Pakatan Rakyat (PR) and missed a two-thirds majority in parliament for the second time in a row. After all, the BN achieved a simple majority. Political continuity is likely to continue, especially since tensions within the opposition coalition are weakening them. But for Prime Minister Najib Razak the stumbling blocks are mounting. He is increasingly feeling the resistance of some hardliners and other potential leaders in his own UMNO party, especially when it comes to his policy of national reconciliation. Although Najib won the UMNO intra-party elections last October, his position within the party has weakened. This also explains his recent actions in favor of the Malay ethnic group.
Najib has also lost popular support. On the one hand, this is due to the poorer economic conditions for consumers. On the other hand, the government came under heavy criticism in view of its poor crisis management in connection with the alleged (and as yet unexplained) plane crash of Malaysia Airlines (MH370) in March 2014. Not only the inefficient crisis management of the government in this important case, also the increasing dissatisfaction with the rampant corruption, the suspicion of electoral fraud, the ethnic preferential treatment and the orientation of the economic policy have caused the government to lose popularity.
Najib is likely to remain in the office of prime minister for the near future, however, as he plays an important role in integration within his party. The divided opposition also gives him strength. The opposition coalition PR was shaken by the judgment of the court of appeal. This sentenced the opposition leader Anwar Ibrahim to five years in prison on charges of homosexuality. The ruling would put an end to his political career if the federal court upheld it. In this case, it is expected that internal power struggles will weaken the opposition in parliament, so that their chances of winning an election in 2018 are slim, unless a new credible leader emerges. The first peaceful and democratic change in power in Malaysia is likely to be a long way off.
Ethnic tensions, widespread corruption in the political system and poor governance could endanger stability
The political landscape in Malaysia is changing. Malaysian society is becoming increasingly urban and striving for modernity and change in an open but conservative state. The party alliance BN is traditionally supported by the rural population as well as by poorer and older population groups. Opposition PR has a growing electorate that can be found primarily in the urban middle class and among young people. These voters are tired of the corrupt system based on nepotism, the privileging of certain groups and an ethnic preference policy.
Ethnicity is a sensitive issue in Malaysia. Ethnic tensions can sporadically be observed, especially between the Malay majority and the large Chinese ethnic group. The cause of these tensions lies in the inequality between the different ethnic groups. The social preference given to ethnic Malay during the long reign of the BN can be traced back to the original improved position of the Chinese and Indian minorities in all areas of society (because they had access to better jobs, schools and housing). The rise of PR has prompted Najib to ensure more inclusion of different ethnic groups in the political and socio-economic system. But the radical members of his party and the judiciary are resisting this orientation (as the condemnation of Anwar showed). Given its declining popularity, there is little incentive for Najib to advance reforms and dismantle the privileges of the Malays until the next elections in 2018.
Even if internal stability is unlikely to be jeopardized in the foreseeable future, the risks of unrest and ethnic conflicts have increased. The growing dissatisfaction of opposition supporters with government policy could trigger further demonstrations, especially in the run-up to the 2018 parliamentary elections. There are also certain risks associated with radicalization of Muslim fighters returning from their missions in war zones in Syria and Iraq. Nevertheless, Malaysia has always advocated a moderate form of Islam. The state structures as well as the secret and intelligence services should be able to ward off the dangers of Islamist attacks in the country.
Despite vulnerability to external shocks, the economic outlook is positive
Malaysia is no longer the economic tiger state before the Asian financial crisis of 1997/98. But the country still shows robust economic development and benefits from the services it has provided over many years. A long phase of sustainable growth ensures a healthy economic basis. Its main characteristics are macroeconomic stability, low external debt, high investment rates, falling poverty (although ethnic inequalities have increased), low unemployment and a persistent current account surplus. Malaysia is a net believer country. Foreign debt in relation to gross domestic product (GDP) is around 38%, around the pre-crisis level before 2008. The economy is still strongly export-oriented, but the share of exports in value added (China is the most important trading partner) has steadily declined since 2006. Although export dependency is clearly decreasing, exports still account for 70% of GDP and have a major impact on economic development.
The marked opening of the market makes the country vulnerable to external shocks. This was observed in the course of the Asian financial crisis and the global financial crisis of 2009. In the course of both crises, Malaysia slipped into recession, but quickly recovered. Average GDP growth leveled off at 5% (compared to a level of over 8.5% before the Asian crisis). Last year, growth reached 4.7%, the lowest level in the past four years. The reasons for this were the lower raw material prices (raw materials, mostly oil and gas, make up one fifth of exports) and falling foreign demand (especially from the USA and the EU), which was not adequately supported by demand from China, where the growth dynamic also flagged , was compensated. The emerging upswing this year (+ 6.2% in the first half of the year) confirms the good growth estimate of 6% for 2014 as a whole, even if this is still questioned in view of the uncertain global environment. The growth is broad. It relies on robust exports of electronic goods and raw materials, particularly petroleum, liquefied gas and palm oil, as well as services and industrial production.
Consumer demand is also robust. It is fueled by a now significant and affluent urban middle class. Private consumer spending could be curbed by deteriorating conditions such as price increases (see below) and the persistently high level of household debt, half of which is attributable to variable-rate mortgage loans. Mortgage loans represent 85% of GDP and pose a risk to economic stability, even if household financial wealth is higher and could act as a cushion in the event of a negative shock.
The US Fed's exit from its monetary easing policy could hit Malaysia. As a side effect, the capital withdrawal from the emerging markets had already caused the ringgit to devalue 10% against the US dollar in just a few months in mid-2013.
Overall, however, Malaysia is likely to manage these risks; volatility in the financial market is likely to be limited to short-term capital outflows. This is supported by some strengths such as robust domestic demand, the better balance between export and domestic market orientation and the strengthened financial sector. The central bank also has a comfortable currency cushion. The currency reserves cover six monthly imports or twice the short-term foreign liabilities. Investor confidence in the country should be maintained, which was already reflected in the gradual appreciation of the ringgit during the course of this year.
Monetary and fiscal tightening aims to reduce imbalances
In the near future, the restrictive economic policy will be continued and possibly slow down economic growth somewhat in the medium term. For one thing, the central bank recently raised key interest rates for the first time since 2011 in an attempt to contain high growth and accelerating inflation. The rising inflation rate (between 3.5% and 4%) is due to the dismantling of subsidies. It is likely to be further increased in 2015 by the introduction of a Goods & Services Tax (GST).
On the other hand, Kuala Lumpur is faced with the task of consolidating the heavily deficit budget. Since 2008, high budget deficits have been driving up national debt. After the global financial crisis, the government stimulated domestic demand with an aggressive monetary policy. As a result, Malaysia's national budget now has the highest deficits in a regional comparison. The inevitable consolidation of the national budget is expected to be achieved through the dismantling of subsidies for fuel, electricity and food (which are partly offset by direct transfer payments to poor population groups). As a result, the budget deficit should be gradually reduced from 6.8% of GDP in 2013 to less than 5% in 2016. Public debt - at 57% of GDP, one of the highest values in a regional comparison - is likely to decline only slowly over the next few years. Investors will thus closely monitor whether budget consolidation continues. Currency risks or the risk of an external financing shock should, however, be kept within limits. The Malaysian capital market has reached some depth and the bulk of the national debt is financed by domestic investors.
High growth potential - but will Malaysia succeed in climbing into the circle of high-income countries?
The re-election of Najib Razak promises political continuity. This is also reflected in his ambitious ten-year plan for economic development (Economic Transformation Plan - ETP). The aim of the ETP is to improve the country's competitiveness. Investments have already been increased. In connection with the weakened raw material exports, this has led to a noticeable reduction in the current account surplus since 2011. This fell from 11.6% to 4% of GDP, a level that is estimated to be maintained in the medium term.
The main objective of the ETP is for Malaysia to move up into the circle of high-income countries by 2020 or to abandon its current status as a high-middle-income country. Malaysia's per capita GDP currently amounts to over USD 10,000, which is significantly less than in comparable neighboring countries (e.g. Taiwan). Economic diversification has not yet been sufficiently implemented in Malaysia. The manufacturing industry, especially the electronics industry, has to contend with tough regional competition.
The raw materials sector is still the key factor for economic growth. In order for Malaysia's economic prospects to improve and the country not (like Thailand) to get stuck in the middle-income trap, key issues such as productivity development and the promotion of research and development must be addressed. A larger supply of highly qualified workers, further development of the service sector and institutional reforms are necessary in order to improve the general political and economic framework.
Nevertheless, the medium-term growth prospects are still promising in view of the planned infrastructure projects, the attractive conditions for (foreign) investors and the favorable demographic development. Malaysia's economy will continue to benefit from the young workforce - albeit the fertility rate is falling. The country is doing well compared to its neighbors in this regard. In addition, the business environment is one of the best in Asia. For this reason, the business risk in Malaysia is rated A. Indeed, in a stable political environment, companies have a better chance of doing business. In Malaysia, legal security is high, the labor market flexible, the economy open and competitive, and the infrastructure is well developed. Corruption and bureaucracy are the two main weaknesses that companies criticize.
Country Risk Analyst: The Risk Management Team, [email protected]
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