Institutional Investor Asean report: Malaysia and Labuan

Institutional Investor, September 2011

Malaysia is amid a period of striking ambition. Last year Prime Minister Najib Razak announced a program to develop Malaysia into a fully developed nation by 2020. His goals are wide ranging, including political, social and even psychological development, but a large part of the vision will be realised in capital market development and corporate growth. “I believe that we should set the realistic target of almost doubling our real gross domestic product every 10 years between 1990 and 2020,” Najib said in announcing his policy. “If we do this, our GDP should be about eight times larger by 2020 than it was in 1990.” He calls for an average rate of growth of around 7% annually over the next 30 years – well above the 5% level most economists are projecting for 2010, but broadly in line with the average 6.9% over the last 20 years. If it is achieved, Malaysians will be four times wealthier in real terms in 2020 than 1990.

Can it be done? “There’s very little doubt that the Prime Minister is extremely committed to changing things, but with Malaysia it is a question of delivery and implementation. History suggests we should be cautious in that regard,” says Robert Prior-Wandesforde, head of India and South-east Asia economics at Credit Suisse. A 2012 election will be crucial, with some major social issues at play: Najib has sought to end or alleviate some of the pro-Malay affirmative action policies that have been commonplace in Malaysia for 30 years, in the hope that it will make Malaysia more competitive and society more harmonious, but in the short term the issue is divisive. “It needs to change for Malaysia to be competitive,” says Kelvin Tay at UBS. “But it’s not going to happen overnight.”

Tai Hui, regional head of research for southeast Asia at Standard Chartered, describes Malaysia as a “Very steady as it goes story, where the downside risk is well capped. The question is whether it can deliver upside surprises.” In its favour are commodities, chiefly palm oil and rubber, and a burgeoning Islamic finance industry which is unquestionably now the global leader. The stability and conservative excellence of the central bank, Bank Negara Malaysia, under governor Zeti Akhtar Aziz, also helps.

BOX: Labuan

In an increasingly open and liberal financial market, what becomes of Labuan, Malaysia’s international financial hub on the north coast of Borneo, and in particular its Islamic arm, Labuan IBFC? There is still a role, says David Kinloch, CEO of Labuan IBFC.

“Malaysia’s aim of becoming an international financial centre is the backbone of Labuan IBFC’s growth over the years,” says Kinloch. “We believe the government’s stance of recognizing financial services as a key economic driver only strengthens Labuan IBFC’s position both domestically and internationally.”

The Labuan model has been to act as a catalyst and incubator for products which then tend to be adapted onshore. Labuan was, for example, instrumental in the establishment of the Malaysian International Islamic Finance Centre (MIFC) initiative. It has a one-stop regulator and offers a fast turnaround, relatively low costs, no tax for non-trading companies (3% of net audited profits or a flat rate of RM20,000 for trading companies), 80 double taxation agreements, and “a safe and fiscally effective jurisdiction for wealth management and trading platforms,” Kinloch says. A new round of legislative reform in February 2010 has brought greater regulatory clarity.

In capital markets terms, Labuan hopes to be a conduit between domestic players and international capital. It continues to be involved in landmark sukuk transactions: it was home to Petronas’s dual-tranche US$4.5 billion deal in 2010, and Nomura’s ground-breaking US$100 million sukuk.

Islamic finance appears alive and well in Labuan, with total Islamic banking assets up 63.6% year-on-year to US$1.3 billion in 2010; there are six fully-fledged Islamic banks and nine Islamic windows in the jurisdiction. Gross contributions to takaful and retakaful climbed 27% during the same period, while considerable growth is expected in Islamic funds and private equity vehicles in 2011.

“While some may question the seemingly duplicated roles between Labuan IBFC and MIFC, the truth is that both initiatives complement each other,” Kinloch says.