Investors trying to make sense of the melodrama transfixing Malaysia might want to look back at the last time things were this bad.
The country’s 17.1% plunge in annualized second-quarter growth was the biggest fall since 1998. Back then, Mahathir Mohamad was prime minister. This year also started with the 95-year-old Mahathir in the hot seat, following a return to power in 2018 – until he was pushed out by current prime minister Muhyiddin Yassin in March.
But tumbling economic growth and the presence – or otherwise – of Mahathir are not the only similarities between now and 1998. The risk of credit rating downgrades is another.
Moody’s Investors Service downgraded Malaysia’s sovereign rating in July 1998, forcing an angry Mahathir to cancel a much-needed sovereign bond sale. Two months later, Moody’s downgraded the five largest Malaysian banks.
Fast forward 22 years. Since April, Moody’s has been highlighting “asset risks for banks” that will “increase in the next 12 to 18 months.” It worries, too, that “banks’ internal capital generation will decline as their profitability weakens.”
S&P Global Ratings recently downgraded the outlook of five of the country’s most important lenders: Maybank, CIMB Bank, Public Bank, RHB Bank and AmBank. S&P worries that loan-loss reserves will be insufficient as Covid-19 savages southeast Asian growth.
The nation’s biggest banks are in damage-control mode, being forced to act creatively to make the best of a near-impossible situation. That includes everything from rapid-fire access to financing to ramping up digital offerings for clients across the board.
“We have realized from the Covid pandemic that we can be very adept at changing ingrained habits,” says Abdul Farid Alias, chief executive of Maybank. “Many companies rightly focus on shareholder returns. But Covid reminds us of the needs of our other stakeholders. Our people, those who work for us, our customers, suppliers, government, regulators, communities and, yes, also our environment. How we behave impacts all.”
Covid reminds us of the needs of our other stakeholders
As well as abiding by the government’s moratorium on loan repayments, CIMB Group is ramping up financing options for a range of clients, from small and medium-sized companies to large businesses.
“Our priority remains to ensure the financial well-being and business-viability of all our customers and also the health of our economy,” says Abdul Rahman Ahmad, CEO of CIMB Group.
Official government views on the health of the Malaysian economy are of the glass half-full variety. Finance minister Tengku Zafrul Tengku Abdul Aziz, for example, spends much of his time debating whether Malaysia’s recovery will be “U-shaped” or “V-shaped.” But not everyone is so optimistic.
Former finance minister Lim Guan Eng has accused the new government of penny-pinching as Covid-19 headwinds intensify. He urged Muhyiddin’s team to add a further RM45 billion ($10.8 billion) to stimulus plans to avoid a deep recession.
“There is no reason for the federal government to be so stingy,” says Lim, prodding it to go big on spending to jolt the economy. “Failure to do so may lead to job losses, business closures in a year’s time and cause untold hardship to the people.”
Lim, who ran the economy in the recent Mahathir 2.0 period, argues that now is the time to tolerate a fiscal deficit of as much as 9% of gross domestic product. In decades past, Lim points out, Malaysia managed a fiscal gap as high as 16.6%, a figure reached in 1982.
Malaysia’s economic tumble in the second quarter far outpaced those experienced in Indonesia, the Philippines, Singapore and other neighbours. Are the ghosts of 1998 coming back to haunt southeast Asia’s fifth-biggest economy?
Sharp drop
Economists are shocked at the sharpness of the drop. In the view of economist Trinh Nguyen of Natixis, Malaysia simply “collapsed” between April and June, as shown by the data: exports plunged 21.7% from a year ago, while consumer spending cratered 18.5%, construction dropped 44.5%, manufacturing fell 18.3% and services slid 16.2%. Nor do data released since then suggest demand is stabilizing.
Izuan Ahmad, economist at Bank Muamalat Malaysia, speaks for many when he warns that the road to recovery will be “bumpy”. Count among them officials at Bank Negara Malaysia, the central bank, which in the middle of August slashed its 2020 growth outlook to a contraction of 5.5%. This scary prediction is based on the assumption that no new Covid-19 lockdowns are needed.
Malaysia is far from the only country struggling. Indonesia is having a rough 2020 with GDP contracting 5.32% year on year in the second quarter. In Thailand, exports and tourism are evaporating. South Korea’s GDP dropped an annualized 3.3% between April and June.
These three economies were at the centre of Asia’s 1997 to 1998 reckoning. Each went to the IMF, cap in hand for huge multi-billion-dollar bailouts. Each was rocked to the core by the turmoil and forever altered by the experience. Financial systems were strengthened, governments became more transparent, currencies traded more freely and governments amassed ample foreign exchange reserves.
Mahathir’s Malaysia, supporters claim, expertly avoided the chaos. As the IMF advocated austerity, Malaysia went the other way. Mahathir’s government pegged the ringgit to the dollar, imposed capital controls and increased support for state-champion companies. But whether you believe they were the right moves or not, it is clear that Malaysia is now in a poor position to combat the latest crisis.
“The global outbreak of Covid-19 and renewed domestic political uncertainty add obstacles for Malaysian banks, which are already grappling with the effects of a slowing economy and dampened investor and consumer sentiments over the past year,” says S&P analyst Nancy Duan.
Officially, S&P expects non-performing loans to rise to between 1.7% and 1.8% this year, up from 1.5% in 2019. But it also worries “transitory asset-quality problems could become permanent if the severity and duration of the disruptions were prolonged.” Chief among them is Covid-19.
One positive: Malaysian banks’ direct exposure to the most vulnerable sectors, such as airlines, hotels and restaurants, is small at only a single-digit percentage of loan books on average. However, S&P notes, “the global health emergency and domestic political upheaval are hitting oil prices, consumer confidence, and the broader economy in Malaysia. We will closely monitor such second-order effects and revise our forecasts as necessary.”
All too many of these second-order effects derive from a political system standing in the way of readying the financial system for the real world. Two decades-plus of provincial squabbling kept Malaysia from raising its game and lifting basic competitiveness. It left Malaysia with serious pre-existing conditions that make it even more vulnerable to the effects of Covid-19.
“The sad reality about Malaysia is that since 1998, while big steps have been taken to restore the nation back on a stronger economic footing, Malaysia remains trapped as a middle-income nation and is still classified as a developing nation,” says Chrisanne Chin, a researcher at Kuala Lumpur-based consultancy Gamelan Emas.
“Although Malaysia has pushed for innovation and transformation from being an input-driven to a knowledge-based economy,” Chin says, “Malaysia’s productivity levels remain weak and the economy is still highly dependent on, and driven by, factor inputs, especially non-ICT capital accumulation.”
The ICT problem – referring to information and communications technologies – is decades in the making. For 20 or so years now, officials from the IMF to the World Economic Forum have urged Malaysia to move upmarket into higher-value niche technology sectors. Even today, too much now flows into old-economy machinery equipment and commercial real estate.
More than just tackling key structural constraints, Malaysia needs political will
“Malaysia’s productivity growth over the past 25 years continues to lag behind several global and regional competitors,” Chin explains. “It is no secret that regional peers like Thailand, China, Indonesia, India and Vietnam have leapfrogged over Malaysia.”
What’s needed, she says, is “more than just tackling key structural constraints. Malaysia needs political will.”
One topic that bankers and executives whisper about, but rarely criticize publicly is a 49-year-old economic model that is exacerbating Malaysia’s troubles in 2020. The “New Economic Policy” was implemented back in 1971 by then-prime minister Abdul Razak Hussein. It’s an affirmative-action scheme that gives the ethnic Malay majority preferential access to civil service jobs, education, business licences, government contracts, housing and real estate.
Numerous regional economists and international organizations including the IMF and the Organization for Economic Cooperation and Development have warned for years that the model stymies innovation and productivity at a time when regional peers are focused on building economic muscle. But it was kept in place by Mahathir, by his successor Abdullah Ahmad Badawi, and by Najib Razak, who became prime minister in 2009.
Najib, who had flirted with ending the affirmative-action policy, instead unveiled a new innovation: state fund 1Malaysia Development Berhad.
The idea behind 1MDB was to propel Malaysia into the ranks of OECD members. Instead, it propelled Malaysia into global headlines for all the wrong reasons. Billions of dollars went missing, some of it allegedly into Najib’s personal bank accounts.
Much of Mahathir’s second crack at leadership was spent cleaning up Najib’s messes, particularly the fall-out from 1MDB. Mahathir’s team also had to reduce the RM1 trillion of public debt, or about $239 billion, equivalent to more than 50% of gross domestic product, that Najib left in his wake. After the scandal, Malaysia was in a poor state to weather global volatility.
Market turbulence
For now, some bankers are positive about the ability of Malaysia’s financial system to help the country navigate the coronavirus crisis. But it remains to be seen if government efforts to contain market turbulence will prove sufficient.
“The Malaysian financial sector has a key role to play in supporting the economy through times of crisis,” says Stuart Milne, CEO of HSBC Malaysia.
“The global market volatility has had its impact, while the decline in overall global trade volume is also taking its toll on this trading nation.
“We have noted that the financial market has been resilient – timely policy measures and effective support by the banking industry has helped cushion the impact of Covid-19 on those who have been affected by the same.”
But political instability is a problem, and there is no guarantee that Muhyiddin – who is nowhere near as well-known as his predecessor – will still be in power next year.
“Renewed political volatility and uncertainty will weigh on investor sentiment that is already affected by the coronavirus outbreak,” says Moody’s analyst Christian Fang.
“At the same time, we do not see a material change in macroeconomic policies regardless of the political leadership, as key policymaking institutions, such as the central bank, have demonstrated their effectiveness in implementing sound policies independent of the government.”
There are rays of hope. On July 28, a Malaysian court sentenced Najib Razak to 12 years in prison for looting 1MDB. Market observers had worried that Muhyiddin might intervene. And in the same month, Goldman Sachs agreed to pay Malaysia as much as $3.9 billion to resolve criminal charges surrounding its alleged role in the massive money laundering scheme.
Could Muhyiddin use the political capital he banks from these wins to reboot Malaysia’s reform process? As Covid-19 adds to the already negative effects of the trade war on the economy, analysts worry that political discord will get in the way of Malaysia finally fixing the cracks in its financial system.
The fear surrounding Malaysia’s economy is such that analysts are warning of what US defence secretary Donald Rumsfeld once called “unknown unknowns”.
Fitch Ratings, says analyst Willie Tanoto, “is wary of as-yet unidentified weaknesses in the manufacturing, trade, transport and hospitality sectors that aggregate to almost 20% of banks’ exposures, and household lending, which accounts for another 58%.”
Banks’ capital buffers are thin, Tanoto adds.
“Fitch is wary of growing strains in the banks’ operating environment,” he says. “Credit stresses will also weigh on banks’ asset quality and earnings profiles.”
There is, in other words, bad news around almost every corner. The only saving grace is that Malaysia has been here before.