Emerging Markets: Zeti interview

Emerging Markets, World Bank editions, October 2012

Emerging Markets met with Bank Negara Malaysia Governor Dr Zeti Akhtar Aziz in London in September.

EM: For a country heavily exposed to external forces, Malaysia appears to be holding up well. How do you feel about the country’s health and resilience?

Zeti: There has been a tremendous payoff for the strengthening of our economic and financial system in this environment. We have been affected – our export sector has been very affected for some time now – but our domestic demand has held up very well.

It’s not only consumption that’s important. Investment by the private sector has picked up this year. Foreign direct investment has moderated, but there are still inflows, which have strengthened this year in new areas of growth. Our financial sector – both the banking sector and the bond and sukuk markets – have been vibrant. There has been significant new issuance. And it’s not just existing investments that are expanding or being refinanced; there are new investments taking place, and IPOs in the stock market. All these have been very positive in ensuring the financial sector has not been disrupted by all this volatility.

So is Malaysia in the clear now?

Of course we are going to be affected if there is any further slowing down. Already, export market growth has slowed quite significantly, although we do have a diversified export base in terms of products and markets. 25% of our exports are to Asean, and 60% of our trade is with Greater Asia. Since these remain growth centres in the global economy, Malaysia has been able to benefit, because this trade is growing as trade with the US and Europe has slowed. Regional investment activity is also taking place, both inflows and outflows.

EM: But with that greater regional engagement, what is the impact of a slowing China?

Well, we have to monitor that very closely. I believe that of course China is also affected by global developments, but they have implemented many policies and measures to support growth, and we believe they will be able to generate sustainable growth in this environment.

Yes, we are a commodity producer and exporter. We also export manufactured goods and services and have other areas of growth: education, healthcare and tourism, which is growing immensely. Being in the centre of Asia, we grow as incomes rise in the region. We have something like two million tourists a month coming to Malaysia.

EM: There must be an election in the near future, and there has been a lot of noise about it for more than a year now; presumably the uncertainty doesn’t help FDI. What has the impact been?

It hasn’t been a disruptive force. In this kind of environment the focus is on where the opportunities are. As long as Malaysia presents opportunities – not just the areas of economic activity that are open to foreigners to participate, but more importantly the competitiveness, the cost of doing business, and the efficiency of the system in terms of approvals and red tape, which have improved tremendously – then we don’t anticipate the politics will be an important consideration for foreign participation in our economy.

There hasn’t really been a ‘wait and see’. It is more the external developments that cause investors to be on the sidelines, because they don’t know the outcome of policies taken in Europe or the US. I have mentioned many times that global policy spillovers have become more significant: not just global developments emanating from the banking sector, but global policies having implications on capital flows and making them more volatile, making the environment more uncertain for foreign exchange transactions.

To address that, we have liberalized very aggressively, since we moved to a flexible regime in 2005, to allow the private sector to better manage their foreign exchange exposure. We allow unlimited foreign currency accounts, with potential for hedging. Restrictions that increase cost have been removed, allowing investors and exporters to undertake foreign currency business between them. Now, our payment system can handle two international currencies, RMB as well as US dollars. This is another great advance for us.

EM : Do you feel Malaysia is now as open and liberalized as it needs to be?

To a large extent, yes. There are probably two or three other areas that can be [opened]. We always believe in sequencing this, especially for the major fundamental areas, and the most fundamental one is the internationalization of the currency.

We believe we remain vulnerable to speculative attacks; right now there is no restriction on inflows and outflows. Onshore you can trade as much as you want to do, in foreign exchange transactions, either to bring in funds or take them out. So we have a free flow of inflows and outflows of funds, but it is done onshore and in our time zone, which we believe reduces the prospects of speculative attacks on our currency from offshore. The most important thing is that we are able to better intermediate sudden inflows and outflows. So when there is a deleveraging taking place in Europe or the US, as happened in 2009, where huge amounts of outflows followed, we have been able to manage them despite the magnitude of these flows being so much larger than we saw in the Asian financial crisis.

Our financial system is much more developed now than then, not just in terms of the banking sector but the bond market, which is now the largest in southeast Asia. This has helped us intermediate flows because they are dispersed throughout the financial system. Other reforms include the transition to greater market orientation, such as a more market-determined interest rate framework, so the price discovery process is more efficient. So far, the economy and financial system have been able to cope with the volatility, and that is a great step forward.

EM: Malaysia has embraced the RMB. What is the opportunity there?

China has become our largest trading partner. We export commodities and manufactured goods to China, and they account for 13 to 14% of our total exports. It makes sense to settle that trade in a domestic currency, either RMB or ringgit. We engaged with the Chinese authorities to explore this, and I believe we were the first country outside Hong Kong to operationalize the settlement of trade in RMB. This has been growing as exporters and importers come to realize the benefit. The motivation is to reduce the cost of transactions, and to reduce the exposure to the volatility of other, third currencies. Now there is a RMB-ringgit exchange rate against which exporters and importers can make an assessment.

In recent years your hopes for Islamic finance have moved from the domestic industry, which is already mature, to Malaysia as a hub for international Islamic capital. Has that been achieved?

To a great extent. Beginning in 2003, we issued licences to other Islamic financial institutions from other parts of the world. Then we liberalized our bond and sukuk market to allow foreign businesses to raise financing in our market. Then there was an openness for investors to invest surplus funds in our market; there’s quite a high percentage of foreign participation. Our Islamic financial institutions are only now going abroad. This is what we look forward to: to expand activities in the international environment. We’ve already seen a Singapore dollar sukuk, an RMB sukuk issuance, and of course we’ve had dollar issuance, by corporates from the UK, Europe and Japan. Investors have participated, because all issuance is generally oversubscribed, and the investor base is dispersed throughout the world.

What happened to the Islamic megabank idea?

Well that’s still on the table.  It’s also a long process because those who are participating in it and who have been given a conditional licence, within a consortium, are not all banks, so the screening process and the conditions that will be applied to them are a long drawn-out process. When it has firmed up, an announcement will be made.

What is the impact of Asian and Asean financial integration?

That has made a lot of progress. We are not discouraged by developments in Europe. We believe it will unlock the economic potential of the region. Right now, the progress has essentially been in terms of trade and cross-border investment, while financial integration wasn’t so significant. That is what we have worked to achieve more recently. It will not only support economic integration, but will help the financial resources of our region to be channeled and recycled towards economic activity in our region. Asia needs massive investment in infrastructure, and savings can be mobilized for this. We believe the development of the regional bond markets in particular will facilitate this, because many of these investments will be long term, and we have the capacity to absorb the financing of those activities.

Another area of cooperation is to ensure, during these times, that we put in place the framework for crisis management, for surveillance, and for capacity building. This also aims to make us more inclusive: we don’t just want the core countries to press ahead, we want to bring with us Vietnam, Cambodia, Laos, Myanmar.

While we are looking at what is happening in Europe, we can draw many lessons about what we need to do so that should any market crisis occur with systemic implications for the rest of our region, we are already putting in place the mechanisms to deal with it. We can act pre-emptively to address it collaboratively. The region is becoming much more cohesive: when we managed the financial crisis each one of us managed it on our own, but now we have put in place the mechanisms to act together.