While the 1MDB scandal is back in the news, we do not think it will have much impact on Malaysia’s political outlook. However, we believe Malaysia is facing economic headwinds in an increasingly difficult global environment.
The New York Times reported that the US is preparing to seize $1 bln in assets tied to 1MDB. While Malaysia authorities have dropped their investigations of 1MDB, US, Swiss, and Singaporean officials have not. The $1 bln total is the largest such case brought by the Justice Department, which claims that the assets were bought with embezzled funds that were then laundered in the US.
Prime Minister Najib has not been directly implicated in the 1MDB scandal, but his stepson Riza Aziz is named in the complaint. One of Aziz’s longtime friends is also named, but neither have been charged with any crimes.
Yet the lack of a credible or cohesive coalition has allowed Najib to remain firmly in power. Indeed, the ruling National Front coalition won state elections and federal by-elections in recent months. Najib has also quashed any opposition within his UMNO party. The next general election does not need to be held until 2018, and so Najib may further consolidate his power ahead of that.
The economy remains sluggish. GDP growth is forecast by the World Bank at 4.4% in 2016 and 4.5% in 2017, both the slowest rates since 2009 and down from 5.0% in 2015. GDP rose 4.2% y/y in Q1. This was slightly stronger than expected, but we believe downside risks are growing. Lower oil and commodity prices are headwinds to growth.
Price pressures are still easing, with CPI rising a lower than expected 1.6% y/y in June. This is the lowest rate since March 2015, and suggests that the central bank will continue cutting rates. Even though the bank has no formal inflation target, the low reading should allow it to maintain a dovish stance in H2 after surprising the markets with a 25 bp cut to 3.0% this month. The central bank next meets September 7, and another 25 bp cut should be seen then.
Fiscal policy has remained fairly prudent. However, low oil and commodity prices will likely require some tough choices ahead if the government pushes ahead with plans to boost public spending. The IMF estimates that the budget deficit came in around -3.2% of GDP in 2015. It is expected to remain around -3% this year and next. We see risks of wider than anticipated deficits.
The external accounts are in decent shape. Lower oil and commodity prices have hurt exports, but slow growth has helped reduce imports. The current account surplus was about 3% of GDP in both 2015, and it is expected to narrow slightly to around 2% in both 2016 and 2017. Foreign reserves have risen from the lows and at $97 bln in June, they cover 5 months of import. However, short-term external debt accounts for 165% of reserves, which is an uncomfortably high ratio.
The ringgit has started to outperform within EM. In 2015, MYR lost -18.5% vs. USD. This was just behind the worst performers ARS (-35%), BRL (-33%), ZAR (-25%), COP (-25%), RUB (-20%), and TRY (-20%). So far this year, MYR is +6.5% YTD and is lagging the best performers BRL (+22%), RUB (+16%), CLP (+8.5%), COP (+8%), and ZAR (+8%). Our EM FX model shows the ringgit to have NEUTRAL fundamentals, so this year’s outperformance should ebb a bit.
USD/MYR has retraced about half of the post-Brexit drop. A break above 4.05 and then 4.08 is need to signal a test of the June 27 high near 4.17. Lower oil prices (WTI is breaking lower to new lows for this move) should add to the pressure on the ringgit.
Malaysian equities have underperformed this year after a decent 2015. Last year, MSCI Malaysia was -5.5% while MSCI EM was -17%. So far in 2016, MSCI Malaysia is flat and compares to +8.5% YTD for MSCI EM. This underperformance should ebb a bit, as our EM Equity model has Malaysia at a NEUTRAL position.
Malaysian bonds have performed well this year. The yield on 10-year local currency government bonds is about -62 bp YTD. This compares to Brazil (-468 bp), Indonesia (-169 bp), Peru (-158 bp), Russia (-109 bp) and South Africa (-96 bp). With inflation likely to continue falling and the central bank likely to continue cutting, we think Malaysian bonds can outperform a bit.
Our own sovereign ratings model shows Malaysia to have an implied rating of BBB+/Baa1/BBB+. This suggests some downgrade risk to actual ratings of A-/A3/A-.