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Malaysia among countries that are susceptible to capital outflows [26-08-2013]  
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MALAYSIANS who need to exchange their ringgit for currencies of certain major developed economies – be it for holiday, education or business purposes – must have felt the pinch of late, as the ringgit has depreciated quite substantially against several major currencies in recent weeks.

Against the US dollar, for instance, the ringgit had depreciated by about 7.6% year-to-date to 3.31 per unit as of noon yesterday.

Against the British pound, on the other hand, the ringgit’s value had declined 3.7% to 5.16 while against the euro, the ringgit had depreciated by about 8.6% to 4.41 as of noon yesterday.

Such phenomenon, though, is not unique to Malaysia, as currencies of other emerging Asian economies have also shown similar trend of weakness against major-economy currencies in recent weeks.

This trend is mainly attributable to the widespread capital withdrawal from emerging Asian economies back to developed nations – in particular, the United States.


Contagion risk unfounded

Clearly, Asia’s resilience to capital flight has now been put to the test once again, as widespread capital withdrawal from the region sends its financial markets into disarray.

The broad-based sell-off in assets of Asian emerging markets (from equities to bonds) has led to significant decline in the values of the region’s currencies. Particularly hit hard have been India and Indonesia, which have seen their respective currencies, rupee and rupiah, crash over the week.

The highly disruptive capital reversals from the region may have also tempted some punters to draw comparison between the current turbulence and the 1997/98 Asian financial crisis, but economists stress that such comparison is superfluous, as the current phenomenon is nothing like the previous predicament.

“Asia’s economic fundamentals (now) are much stronger than in prior crisis periods (1997/98 and 2008/09) and they are backed by a more stable and better regulated financial sector,” CIMB Equity Research explains in its regional strategy note.

Economists believe that some countries in the region will be able to withstand the effects of the current turbulence because of their strong fundamentals.

Such is the case for Malaysia. The third-largest economy in South-East Asia has not been immune to the recent capital outflows, as evident in the movement of the ringgit, yet policymakers and economists alike believe that the country could be able to hold its ground.

Bank Negara governor Tan Sri Dr Zeti Akhtar Aziz, for one, has over the week assuaged concerns over the effects of destabilising capital flows on Malaysia by saying that the country has the strength and capability to manage the current volatility.

Among others, Zeti says, Malaysia has strong and sound financial intermediaries operating in a well-developed market. She adds that the country’s robust foreign exchange reserves level, which stood at US$137.9bil (RM456.5bil) as at Aug 15, and low levels of foreign-currency debt at around 1% to 2% of the country’s gross domestic product (GDP) should also serve to protect Malaysia from the impact of disruptive capital flows.

“We had demonstrated our ability to handle such weakness at the height of the global financial crisis in 2008/09 ... we would be able to do the same in the current environment,” Zeti says.

Indeed, after being wrecked by the 1997/98 Asian financial crisis, Malaysia, along with some other regional economies, have emerged stronger with a better and sound financial system.

CIMB Investment Bank chief economist Lee Heng Guie tells StarBizWeek: “At the moment, we do not see a high risk for Malaysia amid the current capital outflows. This is because the country has a flexible currency exchange rate and a strong balance sheet.”

Lee also stresses that Malaysia’s strong foreign reserves, high national savings and low external debt would enable the country to absorb external shocks and reduce risks of external financing sustainability.


The current reversal of capital flows back to developed nations is spurred by talks of US Federal Reserve planning to taper its monetary stimulus.

In June, US Federal Reserve chairman Ben Bernanke reaffirmed a plan to taper their US$85bil-per-month bond-buying programme, or quantitative easing (QE), by the end of this year through the end of next year, if the US economy could find a firm footing. Little has changed in the US Fed’s message since then.

The release of the Federal Open Market Committee’s minutes over the week showed that there was broad support among US Fed policymakers for Bernanke’s plan to start moderating the pace of QE later this year, if indeed the country’s economy improved.

The rising expectation of the United States tapering off its QE soon has contributed to a spike in US bond yields and lured capital back to the world’s largest economy. This development is expected to continue prompting investors to shun emerging market economies, including those in Asia, that had over the past few years appeared so attractive to them.

“With US bond yields rising, the relative attraction of emerging Asian markets is now being undermined,” Bank of America Merrill Lynch (BoAML) Asean economist Chua Hak Bin says.


Volatility ahead

Asian economies have in recent years served as magnets for global capital flows. This is not surprising as the region boasts brighter growth prospects amid the global economic slowdown.

Asia has benefited when major developed nations such as the United States and Japan launched monetary easing policies to revive their flagging economies. Such easy-money policies have subsequently resulted in a surge of global liquidity, the bulk of which found its way to emerging Asian markets to seek relatively better returns.

And the huge capital inflows to Asia, in turn, have led to higher asset prices – from the property to the bond and equity markets – in the region over the past few years.

But US Federal Reserve’s recent talk of a plan to taper its massive easy-money policies has put an end to the party for Asia. While the tapering has yet to take place, it does mark the beginning of the end of easy money, and the massive capital that had come to Asia earlier in search of higher returns are now beginning to reverse back to Western developed nations.

According to CIMB, Asia is expected to suffer from more widespread capital withdrawal, which will take regional currencies and equity markets lower, in the coming months. There will be further rise in financial-market volatility, the regional investment bank warns.

“The unwinding of ‘easy money’ will inevitably cause asset prices in Asia to correct,” CIMB’s Lee points out.

“We knew all along that capital reversal would come. The question is whether it would be in an orderly manner or not,” he says.



Vulnerable economies

India and Indonesia’s financial markets were the first two to be routed, as exit of foreign funds gathered momentum in recent weeks. There are reasons that these two markets were the first – and worst – hit. Both have huge and widening current account deficits, which reflect their dependence on external financing, and they also running on fiscal deficits.

India’s current account deficit, for instance, stands at around 4.8% of its GDP, while its fiscal deficit is around 4.9% of GDP. Indonesia, on the other hand, has a current account deficit of around 3.2% of its GDP and a fiscal deficit of around 2% of GDP.

This month alone, India’s rupee has depreciated about 6.5% against the US dollar, while Indonesia’s rupiah has fallen by around 6.2% against the greenback.

According to analysts, countries with what economists call “twin deficits”, involving the current account balance and fiscal (or government’s budget) position, will be particularly susceptible to capital reversals.

Countries that are not running on twin deficits, but have deteriorating current account balance and/or fiscal position, will also be vulnerable. Malaysia and Thailand, hence, fall into this category.

Credit Suisse analyst Santitarn Sathirathai in his note argues that there are stress points in Malaysia and Thailand that put the ringgit and baht under selling pressure. While the external funding situation in Malaysia and Thailand is nowhere near as bad as either India or Indonesia, both remain susceptible to capital reversals due to their deteriorating current account balance.

As it is, the ringgit has already depreciated about 2% against the US dollar, while Thai baht has fallen by around 2.1% against the greenback in this month alone.

Thailand, which fell into a technical recession in the second quarter of this year, saw its current account swung from a surplus of US$1.3bil in the first quarter of this year to a deficit of US$5.1bil in the following quarter.

Credit Suisse notes that Thailand’s weak growth momentum is an unhelpful factor, compounding foreign equity outflows.

Malaysia, while registering faster economic growth in the second quarter of this year, saw its current account surplus narrowed substantially to RM2.6bil – the lowest since the 1997/98 Asian financial crisis – from RM8.7bil in the preceding quarter.



According to BoAML’s Chua, investors are somewhat nervous about the narrowing current account surplus of Malaysia. The country, which has already been maintaining a fiscal deficit since the late 1990s, also has worryingly high public and household debt levels that could add to the concern of investors, Chua says.

In Malaysia, the key risk to capital flows, argues Credit Suisse, emanates from the large foreigners’ holding of bonds (47%) and bills (84%), which are much higher than that for Thailand (18% for bonds and 6% for bills).

“The fiscal concerns and the risk of Fitch (Rating) downgrading Malaysia’s rating could trigger net outflows from the bond market, hitting the ringgit further,” Sathirathai points out in his report.

Fitch had earlier this month downgraded its outlook on Malaysia from “stable” to “negative”. The international credit rating agency’s move was prompted by what it saw as deteriorating prospects for budgetary reform and fiscal consolidation to address weaknesses in public finances in view of the Government’s poor performance in the 13th general election in May.

“It would be superfluous to dismiss the recent weakness in the ringgit as part of a broad-based sell-off in emerging market assets. Malaysia now faces a formidable problem – how can the economy grow when fiscal flexibility has been exhausted and commodity prices are softening,” Sanjay Mathur, Royal Bank of Scotland’s economics research head for Asia-Pacific ex-Japan, argues.

“The traditional cushion of a strong current account surplus has eroded and the ability and desire of foreign investors to hold on to local currency assets is no longer certain,” Mathur shares his views on Malaysia. Hence, Mathur says, he remains bearish on the prospects for the ringgit.


All is not lost, though

According to Aberdeen Asset Management Sdn Bhd managing director Gerald Ambrose, Malaysia needs to implement structural reforms to improve its prospects.

“US Fed’s talk about tapering has changed the whole business of US dollar carry trade. The impact on Malaysia has been exacerbated by Fitch’s downgrading its outlook on the country, the country’s GDP growing slower than expected, and the existence of burgeoning public and household debt in the system.

“The current environment is pretty negative for Malaysia if the Government does not put investors’ mind at rest through determined structural reforms,” Ambrose argues.

Lee concurs, saying, “Malaysia needs to safeguard its fundamentals and start preparing to strengthen its surplus position.”

“Investors are driven by herd instinct. When they see deteriorating current account balance, for instance, they will exit without giving it much thought,” he explains.

On a positive note, while Malaysia is subject to short-term capital reversal that could undermine its financial markets, economists say the country is expected to be able to withstand the volatility without any long-term negative impact. The important part, they argue, is to work hard in preserving the country’s fundamentals.

Meanwhile, Zeti says the central bank is closely monitoring the current challenge to ensure orderly movement of the ringgit.

She is confident that the financial markets and currency would eventually move to reflect the country’s macroeconomic fundamentals.

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